Psychology plays a huge role in mutual fund investing as people are geared to look at past returns, said Nimesh Shah, chief executive officer of ICICI Prudential Mutual Fund.
That means mutual fund investors often end up entering the market at the wrong time, he said on BloombergQuint’s weekly series, The Mutual Fund Show. So the key is to “create products which are contra-cyclical because customer’s behaviour is not going to change”, he added. ICICI Prudential’s contra calls include healthcare, telecommunications and utilities.
Here’s a checklist every investor should keep in mind before investing in mutual funds, according to Shah.
- Take the help of a financial advisor
- Do not ignore debt mutual funds
- Core portfolio should have a large cap and balanced advantage fund
- Asset allocation is of paramount importance for wealth creation
- Invest lumpsum in dynamically managed products in current market condition
- Invest systematically in large cap funds throughout the market cycle
Watch the interview here
Here are edited excerpts from the interview.
Somebody put it very aptly – that it is now time for new participants in equity markets to learn some very old lessons. Is that how you would put the characteristics of the market for 2018 and for the near term?
While we would always like that to happen, it never does. Whether it is in the Indian market or western markets, people make the same mistakes every time. Because it has more to do with psychology than finance. Human psychology plays a huge role in the way people invest. That’s been proven worldwide.
So, I don’t think that is going to change. People will still see past returns and come into the market. So, if it is an expensive market, people will come in and when the market is cheap, people will start thinking what to do next and whether it is the right time to sell.
Past returns give a lot of confidence to people. So, they always tend to enter at the wrong times. Even if you see the Indian mutual fund industry, whenever the markets are valued very high that is the time maximum investors come in. So, the customer will be pro-cyclical, but money is always made when you are contra-cyclical.
So, what we try to do a mutual fund houses is, can you create products which are contra-cyclical because customer’s behaviour is not going to change. So, in bullish markets can you give a product which are relatively bearish in nature. That’s what the game is. So, can we get him into asset allocation product?
In a bullish market, can you give the customer a bearish product...You wouldn’t hear asset managers speak such a language..
We have been consistent in that in the last 3-4 years. Even 1.5 years back, I would have said the same thing. We believe that when the markets are very high, people tend to come into the markets, take the money but do not invest the full money in equity at that point of time.
Try and do your asset allocation within the product in a way that allocation towards debt is high and allocation towards equity is low and that’s how you create that kind of product for your customer. It has worked well. We have got 7-8 years of experience of doing it and those models of asset allocation should be beyond emotions. So, it should be quant-based asset allocation between equity and debt. The quants and the algorithms which we have created over the years, that should work and indicate that should be the allocation towards equity and debt. Otherwise, emotions take over. In the bullish market, you tend to become more bullish about the markets and you tend to invest more in equity than in debt, while it should be the other way around.
Are you a lot more bearish than what the Street is?
I will not say bearish but realistic. Along with our factsheet, every month we print a valuation index. So the valuation index is something which suggests that what are the levels of valuations today. Primarily, there are 3-4 factors. One of the main factors is price-to-book ratio of the market. So, the price-to-book ratio at the market level fairly indicates where the markets would be and where your allocation between the equity and debt should be.
We have seen that valuations are not cheap today. We are in a very interesting phase of equity investing where the market is not as cheap as we would like it to be, to make serious returns. When you buy cheap, you make good money. But the market is expensive. So, this is the challenge posed by the Indian market right now. If you see, large caps are more than fairly valued. The average PE is between 24 and 27.
We are worried about mid and small caps. We have a portfolio of small-cap companies which are called as PIPE companies. In January 2018, we returned serious amounts of money back to investors and they had a fantastic experience. We took that money in 2013-14 and we returned it in early 2018. Not that we believe that we can always time the market well, but the call in January 2018 of redeeming small caps has done very well for customers. A lot of them have switched from small to large caps. Customers who are holding small and mid caps should switch over to large caps. It is a no-brainer.
You are getting the best companies of India at relatively lower valuations. You are getting companies which have promised growth but are smaller in size at higher valuations. So, the risk in that element is high, to move from a high-risk area to low-risk area. So, that is a no-brainer that I would advocate investors to do.
One risk that everyone seems to be hearing about these days is oil. The risk that oil has on markets and on mutual fund investing as well...
We always believed that Indian macros were very good and the micros had to be corrected. The corporates had to do better. Oil is a fundamental thing which one has to be conscious about because that affects India in a very serious way. Every dollar increase of oil crude will increase our current account deficit by almost a billion dollar plus. So, oil is a very relevant number. I have not met anybody who has predicted oil [correctly]. The way the oil is priced today, India macros would be that much of a challenge.
There is an issue of current account deficit which leads to an impact on the rupee which in turn impacts interest rates in the country. So, macros do not look as good as one year ago when oil was at $50 to the barrel. Now it’s at $75. Obviously, the macros don’t look that good. So, there is no debate.
But the good thing the micros (companies) are playing out well. In the next two years, we believe that a lot of corporates in India will do much better in terms of earnings. The market has already discounted it. When we see the PE ratios, that means market has, to a certain extent, discounted it.
There are pockets where money can be made. If you are able to take the contra-call in this market, one of the very straightforward call is that the banking system, especially the corporate banks have taken a huge amount of pain in the last two years. The way the numbers have come out and the way RBI has gone about cleaning up the whole thing, the pain is coming to an end. Serious amounts of write-offs have been taken. I believe 2019-20 onward, we will be in a much better state then what we are in today in corporate banks. The market will start to recognise it in a year in advance.
Both private and PSU banks?
We have got a view on private sector banks and not so much on the public sector [banks]. We are more positive on the private sector banks. We see value in private sector corporate banks. Even in an expensive market. Another call that we have since a long time – and maybe that has not gone right – is our call on pharma. We believe healthcare is a great place for Indian corporates. Because the West doesn’t want to manufacture chemicals in their backyard. That’s going to be manufactured in this country.
So, the bulk drugs business is there in this country. Our companies have been facing some challenges on FDI. But when you look at the portfolio of companies, when you look at the whole basket, individual companies can have issues. I can’t predict today which company will have issues and which company will not have FDI issues in the next three years. But if I got a portfolio of pharma companies, overall, I believe that our people are competent.
They have challenges and they will manage those challenges. Even from a healthcare point of view, go beyond pharma to bulk drugs, formulations. When you go to the overall healthcare industry, whether it is diagnostics or hospitals, I believe unfortunately a lot of diseases are growing in India. So, one sector which will benefit is the hospital sector. So, the overall healthcare sector is another opportunity.
Another contra-call we like and believe in is telecom. The amount of data being used in Bombay local trains – out of 10 people, all 10 are looking at their phones. That’s the amount of data and amount of voice that we consume. There is a new player which has come in and created ripples in the market. At some point, there could be three players and all of them would want to make money. So, I think that telecom should be another play that one should be invested in. Ultimately, look at any country in the world. There is a serious market cap on the telecom sector.
Then the power sector is another contra call. Also, utilities. We could be buying air conditioners every day. We can buy more washing machines every day but at the same time we say lesser power will be consumed, that can’t be. There are issues. But by next 2-3 years they will get sorted out. So, there are spaces. The market is expensive, but within that market, there are pockets of value.
Do you have some thematic funds in some of these?
We have an infrastructure fund. This is the most apt time to come with a pharma fund. So, in June we are coming out with a healthcare fund too. We explained to SEBI that this is the space that we want to be. In June, we should be launching that fund too.