The Mutual Fund Show: How To Build A Low-Risk Portfolio

Kaustubh: So I think given the backdrop what’s happened; it’s important for every investor to sit with his adviser, kind of just review the portfolio and I think that’s a very important thing to do, especially in times like this. It doesn’t have to be a sweeping change to the portfolio at all but it’s a good time to kind of just revisit some of the pieces you had in terms of your risk return appetite, or the time horizon that you have in mind and then just in that perspective think about—you have in mind an emergency fund that everyone’s obviously realised the importance of that. If that is in place and things like insurance and all in place but for your portfolio, obviously, thinking about your risk-return objectives, thinking about your time horizon and then kind of seeing if your current portfolio still fits into the context of these things; would be a useful exercise for every investor to sit and do with his adviser. I think that’s very prudent, I’m not saying that everything needs to be swept or changed overnight, that’s definitely not the thing. A lot of these portfolios have been constructed with these things in mind, but you know there’s no harm in just revisiting some of those pieces that you had in terms of you know how much risk would you potentially have when you have new bills to pay.

Amol: Yes, the most asked question at this juncture is, is there a further downside and should we exit at this stage? My response has been that, and we have discussed it many times, and everybody knows that asset allocation is prime determinant of your portfolio returns and not security selection. So what I would like to say is, if you still have four years three years of horizon ahead of you, market has seen recently a substantial downside and I’m not ruling out the further downside but suffice to say that in fact this is the time to rebalance your asset allocation. I’m sure since the market is off by about 25 percent or so your equity asset allocation would have been currently, it would be in favour of debt, you should ideally switch it or rather rebalance it in favour of equities. So my advice to the question is, the further downside is not ruled out, but this is not the time to throw in the towel if you have a horizon of two or three years ahead of you, you should stay back in the equities.

Amol: In my opinion, investors who want to look at pharma fund at this stage can look at Nippon India Pharma Fund. It is one of the oldest pharma funds. It is also the largest pharma fund with assets under management. I’m not saying that is ‘the’ criteria, but these are just some of the data points that you should consider. So this is a pharma fund which does not invest purely in pharma companies alone. As we know there are various sub themes under pharma, you have something like health care services, you have something like companies that are domestic oriented and export oriented, you also have companies that are into new molecule research. So this fund invests into various sub themes like this one as well. And this has been a consistently performing pharma fund in the space. So my recommendation would be somebody wanting to invest in a sector fund, pharma fund specifically, can look at Nippon India Pharma.

Amol: The fund manager Sailesh Bhan has been able to manage this fund very well. The fund has managed volatility well as well as when the pharma cycle becomes bullish, I think this fund has done traditionally well compared to the peers.

Kaustubh: So let me start by first addressing that to be honest, we’re not very big fans of techno funds and the reasons, like I said, because, I mean there is a certain element or a fair bit of element of timing risk. We know that active managers who diversified equity funds would anyways take their underweight-overweight, also. Traditionally, we’ve always favoured to do allocations through that and even if an investor does want to express a view I would recommend not more than 5 percent in a particular sector of his portfolio. That said, I would actually agree with Amol in terms of his take on Sailesh’s fund and probably add on to the answer that he very well-articulated. Sailesh has been obviously running some other diversified equity funds too, and if you see his expression of his overweight calls on the pharma sector, who has large-cap with multi-cap fund manages, it’s been something that he’s been building over a period of time and it’s not something that he suddenly turned bullish on pharma overnight. So he’s been kind of very closely tracking the sector towards diversified equity fund also and having a much more meaningful exposure than say the rest of the peer group. So clearly that gives me conviction that he’s got his eye on the ball and he’s been kind of running this, especially the pharma take for a while. So I mean that’s certainly one fund that I would recommend. If I were to think of another name, I think it would probably be from the ICICI stable. That’s purely because they’ve also been contrarian investors in that sense and you could see their portfolios for very similar reasons have had more outsize positions to pharma over periods of time as compared to some of the other peers. So obviously, they’ve been another set of a fund house with a positive sense of pharma view, not now, but they have been doing that for a while now. Obviously, ICICI Prudential, its pharma with their diagnostics is one of the funds that we would like in the space, if we were to recommend those.

Kaustubh: We’ve been huge fans of sort of asset allocation and we definitely think that gold as an asset class has merits in an investor’s portfolio. Purely from a risk aversion sort of portfolio hedge, we’ve seen how they can be sort of moving in opposite directions when the market is under stress. This is something that we’ve been articulating that having a 5-10 percent exposure to gold definitely makes sense from a long-term perspective, obviously gold prices have recently spiked and I think it’s important to set the context to the expectation from the investors because we see super normal returns of 40-45 percent on sort of gold ETFs. I think it’s important to temper the expectations because obviously we’ve seen the gold prices rise, the rupee depreciate which has kind of helped us kind of return coming. There have been periods of it; in fact gold went through a huge lull period since 2012 when it fell off its highs of close to 1,900 per ounce and then was trading in 1,150-1,300 band for a very long time. Only late last year that gold prices are moving up, like I said the rupee also depreciated which has helped gold ETFs do well. So if you’ve come from a long-term portfolio allocation, asset allocation perspective, it’s great. Don’t come with expectations of getting like extremely high returns what you’ve seen in the past, you need to think about it as a portfolio hedge and that’s really the role of gold in your portfolio.

Amol: Gold of course is an important asset class to have in your portfolio. I mentioned about asset allocation, I spoke about allocation in the answer to our first question so that’s obviously out there. Along with the debt, equity, gold certainly would be a part of your overall asset allocation, number one. Number two, let me give you the product hierarchy of how I go about  it. If you have five to eight years of an investment horizon, I think sovereign gold bond is a no-brainer. It’s a choice that everybody should make, and there is a solid reason behind it. First, a sovereign gold bond as well as ETFs both of them will track gold prices, so there is no alpha to be generated by any fund manager or otherwise. Having said that, ETFs do have some element of expense ratio; where your returns are slightly going to be lesser than the gold prices; the gold price movement. Sovereign gold bond is actually contrary to that. It actually pays you an interest of 4.5 percent per annum and obviously your prices are still bench marked with international gold prices. So my hierarchy goes like this- sovereign gold bond, if you have into eight years of investment experience, if you do not have that long in investment horizon, then ETFs. My last choice would be gold funds. Obvious reason for gold funds is expense ratio it’s slightly higher than ETFs, but if you want to have SIP sort of arrangement, then doing SIP in ETF not many brokers, not all brokers allow for it, then gold savings fund, as they’re popularly known in the mutual fund industry, these would be your choice. If you want to take exposure via SIPs.

Amol: Currently the sentiment is risk, especially because what has happened in credit funds over last one month or so. So, and it’s not just limited to Franklin Templeton, it also goes about widening of the spread, which, in other mutual funds have given up some gains in the mark to market component, as well as you read a lot about credit funds losing their assets under management because again, we go back to the risk of sentiment. So I would say building a safe debt portfolio could not be any easier, all that you have to do is look at the portfolio. So what are the two components? There are many components that bring the volatility into your portfolio but what are the two main components? First and foremost is credit risk and second one will be division risk. There are other risks in theory, but these two are the biggest ones that you should ideally control. So to control the first risk which is credit risk, you should ideally look at the portfolio which is clearly made up of the AAA companies, only. Second, risk is duration—if you have a five year, seven year or 10 year duration and even if you do not have a credit risk, if interest rate movement is adverse, in other words if interest rates go up, you will make mark to market losses in your portfolio. To sheer from that, you should invest in a portfolio, which will have one to two year of maturity only, or one to two years to be to be more precise duration only. So that’s one way of going about building a safe portfolio—AAA rated and one to two year duration. If you have a slightly longer horizon of three to four years, what you should do is you should identify a fund, or a scheme. If you’re not sure you can obviously get in touch with an adviser. Identify a fund which runs a roll-down strategy in debt. In simple terms, what a rolled-down strategy does is, it buys a three-year or a four-year debt paper depending on whether it’s a three-year hold-on fund or a four-year hold-on fund and just holds those assets till maturity. So, at maturity which is three years or four years away, you do not have any duration risk in the portfolio at all. So, that’s in short look for a AAA rated portfolio. Look for one to two year duration, or opt for the three to four-year roll-down strategy. That’s the way to go about building a safe debt portfolio at this stage.

Kaustubh: So, I would actually mirror and echo Amol’s thought around this. Clearly, given the risk of sentiment, this time funds that are largely AAA or the mandate is to invest in AAA bonds, and have been running it in that mandate for a long time. That would be the first thing to tackle the credit risk bit. Like Amol very nicely articulated that the duration risk by buying into bond funds or your other categories which would tend to have lower durations would be the thing to do. I know there’s been some sort of maybe I will pre-empt the question in terms of where investors are coming from because we’ve seen the flows coming to gilt funds, right? That’s something that we want to touch upon a little more. Gilt funds obviously don’t have any credit risk do bring in a fair bit of interest rate risk in them. And more recently when we saw the yields go up, gilt funds did more than deliver to mark to market in negative returns and because the duration of the funds as we know are anywhere between five to seven years for most of the gilt funds. I think that’s something and that’s very important for investors to keep in mind that you need to look at both components of a portfolio before investing. The other thing which Amol very nicely put is that if you have a slightly longer horizon if you can get a roll down maturity sort of strategy, which means that the interest rate risk while might actually exist in the time horizon of while you’re investing but long as it matches your investment horizon, the maturity and it rolls down the interest rate is actually zero or minimised in that sense. I think that’s largely the way even I would consider building a investment portfolio right now for a large set of investors who are managing both duration and credit risk.

Amol: So, Kaustubh has already covered the duration aspect, and duration brings with it volatility or capital loss at least on a temporary basis. So since Kaustubh has covered it, let me go to a different bit. So now investors have to really come to terms that we cannot take extreme positions at every market extreme. What I mean by that, when the going is good, investors ideally should not flop towards credit risk funds clearly looking at YTMS of 11 or 12 and what not. When the sentiment is bad, you should not purely find and go and hide into gilts. Now we should remember that gilts although, and since again I repeat that they are safer because there is no credit risk so to speak of, the duration we have already spoken of. Let me now talk about returns against being the safest asset class around it obviously gives you the lowest kind of return that you will get. If you want to be as safe as gilt, you should be looking at something like banking and PSU debt fund as well. As far as our experience goes, banking and PSUs have provided a pretty good safety margin even in debt. So, you will not be completely compromising by going to the gilt and getting extremely low rate of return post expenses of the funds. So I would say, this duration of credit we have spoken of, go to banking and PSU debt fund to get as close to safety as a gilt fund is likely to offer you with slightly higher returns.

Kaustubh: So, a clear cut answer to that is no, because like we’ve said there’s volatility in the math given the interest rate that exists. So clearly for monthly income generation is not something you would recommend. What you want for a monthly income sort of generation is something which gives you a steady sort of you know NAV movement, and that’s where you would want to get into a fund which completely minimises both credit risk as well as interest rate risk. So, your funds that would typically be starting from your liquids to your sort of low duration, ultra-short bond funds, again looking at the credit risk inherent of them also, the ones that are buying your AAA bonds have very limited interest risk. Since they buy anywhere between three-six or six to 12 months, would the better or more plausible alternatives in that sense, because you’re getting a better or streamline movement of the NAV rather than trying to get into a gilt fund which can have very lumpy returns. So, we have seen in the past as it has had the yields go up and down.

Amol: So, we have discussed about sector fund something like pharma. In the past, we discussed about other sector funds as well as IT. Now banking is very unique. What I mean by that is banking already has more than one third of exposure in index itself. If you have bought into any diversified large-cap fund, banking already has anywhere between a 30 to 40 percent exposure you already have to banking. If you have a specific call that banking will do well henceforth, I’m sure you can look at any of the banking funds but having said that, my idea for such a large sector is always to take exposure via a diversified large-cap fund. Kaustubh mentioned in one of the earlier answers that fund managers anyway due to overweight and underweight call. I think I couldn’t agree more. You know, there’s nothing more to add. If you are completely bullish then you can simply opt for any one of those, but if you’re a normal lay investor, just wanting to find an opportunity since banking stocks are beaten down or banking indices have been beaten down compared to Nifty, I think you have already that exposure in your diversified large-cap funds.

Kaustubh: No, I think we’re on very much the same page with Amol there that like you rightly said it anyway is a very large component of the indices. We’ve seen managers take that active call. So, diversified is probably the best way to go, but you have quite a few banking PSU and banking equity funds that are available. So, if you do want to express that specific view I think that there are quite a few that you could do with. But largely for the majority of the investors, just stick to diversified equity fund.