Infrastructure And Balanced Funds Are Pockets Of Value Right Now: S Naren

You invest in what I call early cycle, mid cycle and end cycle. I think the early cycle of it is over, and today you are in the mid cycle, where it’s relatively easy to get people to invest but the market is not cheap any longer. You have markets that are either fair value or above fair value at this point of time. So the safer part of the returns are over. But we are not in the end cycle, so that’s an advantage. From the mid cycle to the end cycle there are possibilities of decent returns and that’s how we are looking at it.

Certainly not because mutual funds are not just equities. If you were to sell only equity mutual funds, then the market is definitely very risky. But any mutual fund, say ICICI Mutual Fund, we have products which are safe debt products, we have products which are slightly more aggressive debt products, and you have products which are both in debt and equity like dynamic asset allocation and you have equity. So I think it is very important to see the mutual fund industry as just not equity mutual funds but see it as a combination of debt, equity, mixed like dynamic asset allocation.

One big difference is the amount of money coming in. I would say products which can invest in both equity and debt, like balance, balance advantage, equity income, have been a refreshing change. So once you get money in these kind of products, you are not just investing in equity, you are investing in equity and debt. And obviously the level of risk of a product which is partially invested in debt and partially invested in equity is definitely much better than a product which is only invested in equity. I think it’s only in pre-2007 phase that mutual funds were seen as an equity vehicle. I think a lot of effort has been made by the industry to try to see the mutual fund industry as both debt and equity and a combination of both like dynamic asset allocation.

Yes, we have been advising people to look at the gamut of products which invest in both debt and equity, like equity income, balance advantage, balanced and not choose only pure equity products. That has been a clear message for over a month or so.

Obviously, you can’t invest in a very aggressive equity fund if you are 80 years old. Having said that, I think market levels are also an important factor. We are no longer in that early cycle. In an early cycle, if you invested in any equity product and just sat on it, you would have made money. Now we are in mid-cycle. In the mid-cycle, it’s very easy to collect money but it’s not a time when valuations are cheap. I would say, compared to more than three to four years ago, you should have a more conservative investment pattern today. Now you are investing after a 3-4 year bull market, so you are in mid-cycle. As the cycle becomes more and more advanced, you should invest in more defensive products.

We have had a continuous bull market and some of the ETF products are products where you do not have any cash in the portfolio. Our own view is that over the next 10-20 years ETFs will become pretty popular, but in the near term, till maybe our industry doubles in size or something there is still scope for active management. So, I would say that ETF is a 10-year story, and it’ll keep improving and keep increasing as a percentage of the market over the next 10 years. But at this point, we are arguing that we are much better off being in products like equity income or balanced advantage, or balanced kind of products, rather than being in ETFs because they are well-suited in the early cycle when you would have got mega-returns. You have to be patient. Now you are clearly in the mid-cycle. So, in the mid-cycle, we are believers in dynamic assets. Having said that, in 10 years ETFs are going to take off.

Age does play a role. How dependent a person is on the return from the investment plays a role. For example, we have always argued that if you had a fixed deposit and you are moving to mutual funds, it should be in products which are on the conservative side of the equity spectrum, like equity income and balanced advantage funds. A person who comes from a fixed deposit mindset, if he/she invests in a higher-risk product, it is a problem. You cannot have a single-sized, single-model approach. You have to look at age, you have to look at asset allocation. People come and ask me should I take out money from equity? I tell people if you’re massively underweight in equity, you should add to equity. If you’re massively overweight in equity, it’s time to cut equity exposure. So a person’s asset allocation has a role to play in decision-making. Along with age, dependence on income from a particular asset class is another factor people must consider while investing.

We have been saying over the last six months, that if people have to look at a theme, they should look at infrastructure. If I tell sometime to invest in an infrastructure equity fund, the will person say, I had a bad experience in the last cycle, why should I invest? In 2013, mid-cap funds and small-cap funds had no money, but today an investor or wealth manager says he’s willing to invest for the next 20 years in small caps. Why is it that in 2012-13 they weren’t willing but in 2017 they are. It is primarily the last four years’ returns. So we believe that if we have to pick a theme, we have to pick one which has done badly, where performance from here will be good. A lot of people pick themes that have done well. Small cap has done very well, but it doesn’t make sense now to invest aggressively there. But if you look at Infrastructure, returns are next to nothing. So, we like to invest in themes which have actually not worked in the past, because we believe past returns are not equal to future returns. And that’s how we picked infrastructure as a theme, large cap relative to small cap is the theme, dynamic assets allocation fund is a theme, because these all are kind of themes we like in this part of the cycle at this stage.

I have been telling people who want to take more risk to invest in Infrastructure whereas people who want moderate risk can invest in equity, income and balanced advantage funds. So it depends on each person’s risk level, return expectations etc. and that is how we look at investing.

I always tell people it’s impossible to predict markets, it is much easier to predict valuations because you know what the current valuations are and where you are in the cycle. But I don’t think you can ever predict markets. The day after Brexit, the entire world thought that equity markets will fall, and the market just went up. So, I think prima facie, it’s much better to look at things from an asset allocation lens. And from an asset allocation lens I would argue that if a person is over-invested in equity to cut it to overweight and if a person is underweight in equity to add to positions in equity albeit defensively.

I have slightly different view. We are, in what we call a reflexive boom. As the market keeps going up, there will be more and more interest. On the other hand, if there is a massive correction, investors are unlikely to be interested subsequently. That may not be the right behaviour. But George Soros has taught us that this is how investors are likely to behave. What that means is you have to respect asset allocation. If a person respects asset allocation, over time they’ll make money. I am a big believer that right now we are in a boom market in equity and when you invest in boom market equity funds, returns in the long term will be average.

Right now, smallcaps are high risk, we think midcaps are definitely higher risks than largecaps so that part is very clear. In terms of long term returns, when you invest in this boom market, technology and pharma should do well because those sectors have become cheaper by the day.

We like both, but we believe that you have to be guarded in your investment because at the end of the day this boom seems to be much less a boom for IT and pharma. If you look at the sector for the last one year or so, these two sectors have done very badly and that’s why we think that if you have to invest slowly in two years, these are the kind of themes to invest in because you are buying cheap. Our belief is that if you want to make big money, you need to have fear and cheap valuations. IT and pharma are the only two sectors where you have fear. What will happen with the U.S. FDA? What will happen to rupee-dollar? Over the next two years that’s the kind of sector to invest in. But in this boom will that be the sector delivering the biggest return? I doubt it.

They are not. You look at the size of infrastructure funds in 2007, those funds were three times what they are today in terms of size whereas you look at some of the mid and small cap funds they are 15 times what they were in 2007. One of my gurus says you go and invest in the themes where there is no assets under management because those are the themes where you find it difficult to buy shares. Infrastructure is an area where you have small sized funds and small and mid cap are areas where you have record-sized funds.

You have to buy a big theme, you have to buy road construction, you can buy telecom, we do buy some corporate banks. We believe that capital goods sector will improve in the next two years, power is going to improve. If you look at metals it’s only in the last 18 months that they have delivered returns. Prior to that there was a 10-year period where they have given negative returns.

It’s not a theme from an equity point of view because first of all the addressable universe is much smaller and most of us know that it’s very difficult to make money in that sector in equities but I think a few years from now physical real estate, residential real estate should become cheap. We have 5-6 years of no returns in real estate and then that could become a cheaper asset class. That’s an interesting thought as well.

We have a fund called ICICI Prudential Infrastructure Fund that’s been there for more than 10 years actually.

If you are a 10-year SIP investor, then I think you should choose small and mid caps as a strategy because over the next 10 years it will be so volatile that you will get good returns over a 10-year period. But if you want to invest in SIPs for the next 3-5 years this is the kind of strategy I would recommend.

There is a lot of money on the sidelines because markets are at an all-time high. So, what we have been trying to do is launch closed-end equity funds like ‘Value Series 14’ and things like that. So that investors are invested for the next 3-3.5 years. We can always take a decision keeping the next 3.5 years in mind because there is no risk of redemption.

Clearly. We are believers in the entire dynamic asset allocation space. So equity income, balanced advantage, balanced dynamic- we think the entire basket is a product depending on what the customer’s risk level is. Right now we are in a boom and we are not in that early phase where you can say invest in small caps, buy and forget. We are not in that phase.

Our view is that on a price-to-earnings basis the market is expensive. On a cyclical basis we think that the earnings will go up in the next two years and decently. For example, you take a sector like metal, earnings have shot up in the last two years. We think the earnings for the entire market is likely to improve.

Yes, what we think is over the next two years from a cyclical perspective there will be good benefits. We are in a strange situation. Even before the earnings came, the markets have gone up. Which is a reason why we recommend investing defensively in equity because we still expect earnings to come. But, this is a strange situation where the market has not waited for earnings to come, the market returns have come upfront.

We are not bearish because the entire outlook is to actually support financial savings. We believe as interest rate goes down equity markets will benefit. After a long time this week we have seen a rally in fixed income. We think interest rates should also go down because, the entire financial savings which keep booming can bring down both interest rates, why should only equity markets go up? That’s why we are constructive on financial savings but we want investors to focus on their asset allocation. We believe in this part of the cycle a lot of investors will forget the idea of asset allocation and that is a big worry from our point of view. If, you are massively overweight on equities I think this is the time to book some profits particularly in small and mid-caps.

Yes, because you are exposed to equities and what worries me is that in the last 5 years there has not been any sustained drop in the market. So, what happens is people forget that equity markets can give you good corrections and that’s the reason why we are recommending investing defensively.