The Mutual Fund Show: How Investors Can Counter Volatility In Samvat 2077
Indian equity markets fell to their lowest in three years in March after the Covid-19 lockdown. Since then, they not only recouped losses but also surpassed previous peaks.
Amid such volatility, investors must adopt a long-term strategy and diversify their asset allocation strategy in the Hindu New Year of Samvat 2077, according to Nilesh Shah, managing director of Kotak Mahindra Asset Management. “By being a regular investor, a long-term investor and a good asset allocator, you will be able to achieve optimum returns on your portfolio,” he said on BloombergQuint’s weekly series The Mutual Fund Show.
Kalpen Parekh, president of DSP Mutual Fund, suggested investors build a portfolio by focusing on downside protection with a mix of equity and debt.
“My only advice is to build portfolios which can live through the worst phases. Start by that thought in mind that if the worst were to happen, what will my plan be?” he said. “Will I be able to live through that temporary phase of sharp corrections in the market? Design the portfolio accordingly, don’t design the portfolio for highest returns, design the portfolio for survival.”
Watch the full show here:
Here are the edited excerpts from the interview:
Nilesh, what’s your feeling as the new Samvat is kick-starting? There is a confluence of factors that are happening, the economy seems to be bouncing back, we have a new president in the U.S. and we might actually have a vaccine.
Shah: I think the biggest news in this new Samvat is a successful vaccine. While there will be challenges of logistics and other things but having a medical solution to Covid-19 is of utmost importance.
That not withstanding, do you think that the other factors are also contributing with optimism. We’ve seen the quarter two numbers turning out well. Are you in general more bullish than maybe you were three to six months ago? It’s probably a no-brainer of a question, still asking.
Shah: Six months ago, I was undoubtedly super bullish. We gave overweight calls on equity because valuations were cheap. Now, valuations are no longer cheap, they are fair value, but we remain bullish on the recovery side. The month-on-month economic activities are picking up. September was better than August, October was better than September, November looks like to be better than October. More importantly listed corporate companies have done an amazing job on cost-cutting and margin expansion. In a quarter where everyone was expecting margins to go down because of volume drop, they have cut costs, they have tightened working capital and expanded margin. In case of 37 companies which have declared results so far in Nifty, there is almost 25% profit growth.
This kind of margin expansion—when volume comes back, one can imagine what will happen to the profits.
So, clearly valuations are factoring in part of this optimism but undoubtedly fundamentals have improved tremendously month-on-month in terms of economic activity and margin expansion.
Kalpen, as we look at the next 6 to 12 months or the new Samvat ahead of us, are you a lot more optimistic than what you would have been maybe a couple of months back?
Parekh: Clearly six months back, we were actually questioning our own survival as human beings. Of course that risk still remains. Markets are secondary to our own survival. But clearly, the entire economic activity has taken everyone by surprise that things are moving much faster than what we would have expected and we’re still not out of the woods from the Covid perspective. So while there is the announcement of some progress on the vaccine front, that does not really reach everyone. We can’t really bet on that completely.
Having said that, markets are always discounting machines for the future. Looking at the last three-month numbers—in our own case we were very worried three months or six months back that how would the year really end. Yesterday when we were doing our annual number review, we realised that our numbers could marginally be better than last year. Primarily coming out on a belt-tightening, cost-cutting, becoming more frugal becoming more efficient and productive and leveraging technology. So, I’m more optimistic in terms of the operating trends and businesses.
At the same time a lot of it is in the price. So, the balance between what is in the price and what will really play out in the future is what we should be mindful of.
Kalpen, what are the key learnings from Samvat 2076?
Parekh: I think the key learning is markets keep giving the same learnings. What we do is we forget them because of the recency effect. So, if you remember last year when we were speaking, we were coming on a high because of tax cuts and a fairly optimistic mood that a lot of manufacturing will shift to India and prices that will run up. I remember last year, sometime in November, one-year return of Nifty was 15% and other asset classes like gold or fixed income were subdued. As we speak today, one-year return of Nifty is 5%, gold is 33%, fixed income is 12% and international asset classes are 15% or 18% up.
So, the learning which markets give us every time is do not try to predict me, I will always be ahead of you, I will keep proving you wrong and hence, I think the learning that I take every year or every passing day is, constantly keep asking where is the risk in an asset class and where is the risk lesser in an asset class and try to put that together.
So, to me, I think the question always is that each asset class has had its journey and is at a different phase in its cycle.
Where is the risk fully captured? Where is the risk understated? Accordingly put it together and be prepared for surprises at all points in time. Take nothing for granted.
Also that buying something very expensive usually leads to poor returns, Kalpen?
Parekh: That generally has been the norm historically and in textbooks, but in recent times we’ve all seen that with the cost of capital almost close to zero world over and interest rates being very low generally all asset classes are at the higher band of their own multiples. So, just to give an example when we look at our portfolios—companies that we like, all our portfolios are not the market, they are not the Nifty but they are companies of our choice. These are all good companies growing well, growing at a steady rate, but they’re not growing at their peak rates as they were growing 10 years back or seven-eight years back. Yet they are getting valued at a higher premium than their own past history and that is the only dimension that I would be a bit worried about coming from old anchors of lower valuation, but what are we also realising is that world over and in India, in every industry very few companies which are becoming better and better at the cost of a lot of other companies. So, we are all ultimately finding the comfort in few good companies which are survivors and because they are few but the quantum of money is very large—and the quantum of money is at a very low price, these companies are trading at higher multiples.
Now, past data says that from high multiples generally future returns tend to be moderate or modest and we should keep that in mind. If we still get more returns that’s bonus, but I think just should moderate our return expectation and then accordingly build the portfolio.
Nilesh, what did 2076 Samvat taught you the most? Biggest learning?
Shah: So, if you’re a disciplined investor, the market will reward you. As Kalpen mentioned, we all try to forecast the market and the market keeps on surprising us every year. We are all students of the market and we have to be disciplined. In times of extreme despair, we should not lose hope. In times of extreme optimism, we should not become greedy.
Having an equilibrium between fear and greed, having that discipline to maintain your calmness is extremely critical to make money in the market weather this Samvat year gone by or with the next Samvat coming by.
Let me come in on the expensive valuation side. So, let me quote an incident which I heard about Mr. Radhakishan Damani talking about HDFC Bank Ltd. He was one of the largest individual owner of HDFC Bank at the time of listing or around after listing. And someone asked him, why are you buying such an expensive stock? He replied in just one sentence—“Dekh bhai, Dharavi Dharavi hota hai, Peddar Road Peddar Road hota hai”. So don’t measure expensiveness in absolute terms, measure it in terms of the relative terms of governance, growth and profitability.
Can I ask your follow up then? Everybody seems to be suggesting that the decade gone by, it’s been a decade of growth stocks and values which have underperformed. This is not strictly mutual funds; I’m still asking you. Do you reckon that this whole call of the next decade being the decade for value and not high price growth stocks, do you reckon that is a policy?
So for growth in value, in reality, there is some convergence. Growth without value loses meaning and value without growth also loses meaning. MTNL Ltd. has been a value stock for decades and yet it hasn’t provide any return to shareholders. On the other end, Hindustan Unilever Ltd. or HDFC Bank has been growth stock for decades and year after year, they have provided returns.
So just categorising stocks in growth in value and sitting idly, hoping that someday value will outperform growth or vice versa is not appropriate. Every value stock requires a catalyst.
For example, by and large all public sector undertakings have become value stocks. They’re trading at their lifetime low valuations or near around it. Now, when they start outperforming next decade on its own—answer is unlikely but if there is a catalyst—for example strategic divestment, for example, buy back by these corporates, for example better capital and allocation by PSUs, will then result into them re-rating and outperforming the market? Undoubtedly, yes. So, value will outperform growth provided there is a catalyst.
Kalpen, the jury’s divided simply because there is enough number of people who are saying that maybe the beaten down names, the non-Nifty names might make a comeback and therefore, maybe look at mid-cap funds, maybe look at small-cap funds. What’s your sense at DSP? How are you bifurcating, what is it that you believe could do well in the next Samvat?
I will just carry forward from what Nilesh said that labels are very harmful in investment decision making. So, whether it is the label of growth versus value, or even large cap, mid cap and small cap, they actually trap us sometimes to give wrong label to the wrong outcomes.
I’ll give you an example. We had kept our small cap fund shut for a long period of time. In April we restarted the fund to take inflows. And when we restarted the fund, we were at the peak of the Covid fear and crisis. The lockdowns had just been announced. We were wondering whether is it the right thing because while these companies are solid companies, they are very good they’ve already fallen 35-40% since last two-three years, but they can get worse because small-caps will struggle a lot more in a more difficult environment. You’ll be surprised to know and we are surprised to law that the small cap fund is probably beaten NASDAQ and in the small-cap category the index has done better than most other categories. Now, imagine in March or April to visualise that small caps will outperform large stable, and steady businesses which have been around for decades. So, this again, proves to us that label-based investing can actually go wrong.
As an investor, what we do is, we keep focusing on what are the businesses that will survive and if that business comes from small-caps, so be it.
Then we’ll put the weight accordingly because we know that it’s not very liquid and it has impact costs. The whole thesis is always to put together a portfolio of good businesses independent of their market cap bias. Now, if I still have to make a comment and try to predict which I know, I’ve never been a good astrologer but I would still keep my bias, more for large-caps or multi caps over small-caps or mid-caps. One, because there is a lot of run up which has already happened and then there are other dimensions also like, how much is the liquidity going to be there in the system. If there is ample liquidity, then these companies tend to do much better than otherwise.
If liquidity starts coming down, then small-caps and mid-caps can struggle.
Now, as we see data trends month-on-month, the segment is you know losing AUM every year. If you notice small-caps and mid-caps, they’ve actually started seeing outflows. The overall equity category has started seeing outflows, so that’s another dimension which is unpredictable. So, I would urge our viewers to largely keep emphasis on having multi-cap portfolios at all points in time and only in extreme despair, once in four or five years when there is a lot of despair, when there is a lot of fear and small caps as a category are reflecting that in their price, go overweight there. Anyways through multi-cap funds, you’re getting exposure to, small-caps of to the extent of 10 to 15%, you’re getting exposure to mid-caps to the extent of 25%. So, 35% of your portfolio anyways is going into small and mid-cap when we invest in multi cap funds.
Kalpen, tongue in cheek, I ask you multi-cap funds of flexi-cap funds?
My bias is multi-cap funds. Though we may move our multi-cap fund to flexi-cap, but when it comes to my personal money, I will go to multi-cap funds.
Nilesh, what is your thought? I can understand that we shouldn’t label things into large, mid, small, but when we look at what the larger universe of companies on which business growth might be turning out and then you place your hypothesis on multiples as well as growth assumptions, do you reckon that the broader end of the market may start performing better and therefore maybe the chance of outperformance of mid cap or small cap funds might be higher than large caps? Is it possible to predict that? Are you trying to do that?
There has been extreme polarisation world over. Top five stocks in any index has delivered disproportionately higher return than bottom 45, or top 15 stocks have delivered better return than bottom 35—assuming a 50-stock universe. Now, this polarization has happened for a variety of reasons. One could be the fact that big is becoming bigger and smaller is getting marginalised. The second could be re-rating of certain set of companies. But right now, we are seeing broad-based economic activity picking up. Very few sectors where Covid-19 has hit them directly like retailing, aviation, hotel, travel and tourism, rest of the sectors, either because of pent-up demand or otherwise are seeing record growth. In this scenario, it is likely that recovery will become more broad-based and companies in small and the mid-cap universe by virtue of better availability of liquidity and lower borrowing costs, will be able to do better business. This may reflect in their share prices as well. As of today, our view on broad market is fair valuation. So, equal-weight call to investors. Within that we are saying, be marginally overweight small and mid-cap and be marginally underweight large-cap. The large, mid and small cap valuation is still an equilibrium which we see from the top, large cap is almost at all time high level whereas small cap is still 30% lower than January 2018 levels. So, keeping that in mind in the broad-based recovery, quality portfolio of small and mid-cap stocks has slightly higher chances of outperforming the broad market.
Nilesh, this whole debate about active versus passive funds. Now irrespective of what you at Kotak may be doing but just trying to understand, there is a whole barrage of people were saying that the movement towards passive funds is alive and kicking and maybe a hybrid of active and passive or pure passive might do better in in the in the large cap category if not in the mid in the small cap. Where are you on this debate for the next Samvat, arguably for the next few Samvats?
So, undoubtedly like global markets, passive funds will come to India. In the market which has become efficient and where AUMs are going, there is always likelihood that our ability to add value to clients will come down and then passive will emerge, but it is still some time away. Now, many people have been saying all kinds of rumours about active versus passive funds in analysing data and pointing out that fund managers are not creating alpha. Let me set the record straight. In Nifty and Sensex, two stocks—HDFC Bank and Reliance Industries are more than 10%. Under current SEBI regulations mutual funds are not allowed to put more than 10% in any stock. Second, index does not carry cash component for meeting day-to-day liquidity. Funds do carry cash for meeting day-to-day liquidity. Unlike global markets where index exclusion or inclusion happens with impact costs in India index inclusion and exclusion happens without impact costs, but funds do carry impact costs when a stock goes out of portfolio or comes into portfolio. Indexes does not carry any taxation burden, but fund managers carry about 0.5% of GST and STT in their performance. Globally when TRI are compared with fund performance, it is gross of expenses. In India, we compare it with the net of expenses. Put all these restrictions into play and you will recognise that funds are still generating alpha. However, over a period of time as the size increases, markets become efficient, ability to create alpha will come down and there will be emergence of passive index funds. However, fund houses will also respond by launching high risk high return funds. They will generate alpha either by concentration or by leverage or by long and short going together or by local and global markets. So there will be responses from the fund-house side and there will be a market push. And eventually we will see existence of passive as well as active funds. In the U.S. very active funds have given way to passive funds on the mutual fund side, they still exist—hedge funds which charge 4% fees and 40% profit share because they have leveraged or they’re invested across the world—wherever money can be made. Both will co-exist.
Kalpen, where are you on this argument? A few sceptics would also say that the debate around the fact that mutual funds have to operate within particular guidelines, but the index does not is true, but can the benchmarks be changed? Various kind of arguments are thrown in, right? Now I’m not an expert on these you guys are, and therefore I’m asking you. With all the constraints that are there, where are you on the active versus passive debate for the next few Samvats?
So as an investor, if I wear the hat of an investor, I should be happy that I’m getting choices and I should not get again caught in the either-or debate, I should use the word ‘and’ so that my long-term financial plan and long term portfolio design benefit from a blend of active and passive and at different points in time active could do well or passive to do well—let me build a portfolio taking advantage of both. I will give a cricket analogy since Nilesh bhai is waiting, but if you are building a cricket team as a coach or a selection committee member, and you have a choice of Rohit Sharma and his stable defence and you have a choice of Virat Kohli and flamboyance and an ability to do better or not. So, if you have a choice of stable players, as well as flamboyant players, if you have a choice of a spinner and a fast bowler, a choice of a defender –because you don’t know what is going to be the environment every day when you go to play your match. The pitch could be different, the field could be different, the weather could be different. Likewise, the investing climate keeps changing every few quarters. As an investor, the mutual fund industry is giving you such a diverse choice, where each fund has diversity of active and passive and one can then smartly pick and choose. Sometimes the choice also can confuse you. Now what do I do? My approach is very simple. We have active also and we have passive also. Like Nilesh bhai keeps on saying all the time that good fund managers will generate alpha, average fund managers will give below average returns.
Now, the industry is competitive enough and investors have choices. So, please exercise those choices and there are years when active funds underperform and passive does very well. Reversion to mean keeps happening. So let’s say you’re allocating your money in the next round, then choose what has underperformed today. Now let’s say, in a year like today, if passive has done better and active has underperformed, but the fund manager is fundamentally good and over 10 years has generated value, today I would allocate more money to the underperforming portfolio because when reversion to mean happens, he will do better than passive. Now let’s say in the next year, my portfolio has done 5% more than Nifty. I would say that okay chances of normalisation are there, let me now tweak it a bit and give more to Nifty. So, as investors I think we have great choices and we should take advantage of the choices. I realised many times in this debate we harm ourselves more than anyone else by taking very strong ideological polarised points. It’s better to say that I have both and let me take advantage of both. In my own portfolio today, I have let’s say around 12% or 13% in passive as well as rule-based funds. This concept of rule-based funds is a blend between active and passive together which respects that passive does has its own strength of less human bias, less turnover in transaction costs. On the other side, active has great advantage of judgment of experience, of saying that what should the portfolios look like. Also remember one thing that today the Nifty for example is highly concentrated with just the 3-4 stocks. If I as an investor believe that fundamental principles of good investing means not being concentrated so much, what if one stock doesn’t do well? What if the top three stocks don’t do well in the next few years? My long term plan can get affected. So hence let me balance the two and I think that’s the approach that I would continue to pursue and advice at all points in time.
Kalpen, what is the most important advice for Samvat 2077 for a mutual fund investor? It could be debt fund category, it could be general investing category, it could be an equity fund category what have you.
My approach Neeraj is to know yourself as an investor first. Understand what am I here to achieve? Why am I investing? I’m investing so that my current capital can compound and grow over long periods of time. One big learning I’ve had over time, with dealing with sensible investors is—one year, two-year return, three-year return—these are all percentage returns. That’s not well so if you make 10% in one year and 30% in the next year, fine. You feel good about it but wealth is when a reasonable return on 12% or 13% blends or multiplies with a 20-year horizon is where wealth really becomes meaningful. And I would only advise investors that look for data points, look for changing trends and turning points but in the mind, think of tenor, think of time.
Time is your biggest friend. Events will come and go. They will be good times there will be bad times exactly one year back we were more optimistic because of the environment. Today the environment is looking still challenging. So seasons will keep changing our mindset should have that tenor in mind, number one. Second point, for staying long for being durable for us to be a durable investor so we always say that I want my funds to be durable, I want my companies where I’m investing to be long term to build wealth over time. The question I always posed to myself is am I durable in my own mind with respect to my portfolio and my time horizon? The challenge that human beings face and it’s a very natural challenge is that we are not able to stay long because one, data points keep changing and volatility keeps hurting us. So, in the month of March, it was not easy. So how do we, navigate volatility?
I think to investors, my only advice is to build portfolios which can live through the worst phases. Start by that thought in mind that if the worst were to happen, what will be my plan be? Will I be able to live through that temporary phase of sharp corrections in the market?
If the portfolio survives those short-term phases of six months or one year or two years of poor performance or poor return, you would have won a lot and you will last and add a lot of value to your portfolio.
Survivability will come not with chase for returns but with stability and that’s where fixed income becomes important. So I would always tell investors to respect both asset classes. Long-term investing and wealth creation is not only about returns, it’s also about not letting capital fall and we are still not out of the woods, we may have one good year but we could again have the second year which is not very good because the world overall is fragile. Interest rates are at 20-25 years low, if they turn up things can turn volatile so blend your equity with some amount of debt. That percentage could vary depending on your risk appetite but please have both of them and then be a long term investor.
Nilesh, final question to you on the show. The most important advice, may be some cricket analogy too?
So let’s look at Mumbai Indians. They have now won five IPL finals. What is their strategy? If we look at their strategy from an investment point of view, they invested in players like Rohit Sharma, Jasprit Bumrah, Surya Kumar Yadav and that became their core. There were certain players they dropped as they reached their peak and when they were in need of certain talents, they didn’t mind acquiring it from the outside. And one key fast bowler in this season made a difference, who was actually from Delhi Capitals earlier. This is how you have to build a portfolio. There will be core stocks or equity mutual funds like Rohit Sharma, Jasprit Bumrah and Surya Kumar Yadav. There will be certain instruments which will have to retire and I don’t want to name them otherwise, it might create controversy but people do reach their peak and then you have to retire them.
At the same time, you also have to add new players in your portfolio so that it continues to deliver on and it continues to perform. By doing this combination of disciplined investing, your portfolio will emerge as winner. To any lay investor, my recommendation has remained consistent over the last 30 years. We are regular investors. There is a proverb which says ‘boondh-boondh se hauj banata hai’ which means that little drops of water make the ocean. This is also true in stock market. The second one is to be a long-term investor. There is a proverb, which says that “Utawale Aamba Na Pake”—you have to wait for 12 years to get mangoes. Third, be a diversified investor, be a good asset allocator. There is a proverb which says like, “Don’t put all your eggs in one basket”. By being a regular investor, a long term investor and a good asset allocator, you will be able to achieve optimum returns on your portfolio.