The Mutual Fund Show: How To Make High-Risk Funds Part Of Your Portfolio
While the adage “higher the risk, higher the returns” holds true for mutual fund investing, it’s often advised to evaluate risk tolerance to avoid mishaps.
But there might be a way out if investors take a calculated risk in their satellite portfolio—additional positions added to the portfolio in the form of actively managed investments—and not in the core basket.
Radhika Gupta, chief executive officer at Edelweiss Asset Management, shared a similar opinion as she talked about converting the fund house’s close-ended maiden opportunities fund to the open-ended “Recently Listed IPO Fund”, which would invest in recently listed 100 companies or upcoming initial public offers.
The fund was launched in February 2018 and is approaching maturity on June 28, 2021. It has returned 14.3% versus 11.2% by Nifty 500.
The IPO fund, according to Gupta, allows anchor investing options and focus on new-age businesses, helping investors get concentrated exposure to good issues. “[But] this isn’t a core portfolio. It’s my fund but I will never say it’s a core portfolio holding fund. It’s a satellite or thematic idea,” she said on BloombergQuint’s weekly special series The Mutual Fund Show.
Shalini Dhawan, director and co-founder of Plan Ahead Wealth Advisors, too, would recommend this fund as part of a satellite portfolio, but suggested investors weigh its risks as well.
One of the concerns, according to Dhawan, is that not all IPO stocks are worth investing. “It’s about how that IPO performs and there could be a case where a mid-cap stock becomes a small-cap stock, or a small cap becomes a micro, and as an investor, you do not have much say except for exiting that scheme, if you had to.”
Another risk, she said, is what would happen when IPOs dry up or in a bearish scenario when there aren’t too much choice in analysing which IPOs to go for.
Note Of Caution
Dhawan advised investors to not get lured by “too good to be true” return promises.
Citing the instance of SBI Special Situations Fund, which according to a text message circulating claims to promise 13-14% returns, Dhawan said while the fund has given decent returns so far, it’s suitable for sophisticated or ultra high-net worth individuals with high risk appetite, and isn’t a replacement of fixed deposits part of the portfolio.
Investors, she said, should understand this as a very risky investment as it seeks to invest in unlisted high yield debt.
Watch the full interview here:
Here are the edited excerpts from the interview:
Radhika, it’s an interesting time to be talking about a primarily or predominantly or a totally IPO-driven product when everybody’s talking about taking a bit of a risk off the table. What is this product about?
RADHIKA GUPTA: I didn’t predict that the old fund would close and open at this time but I think it is an interesting time to talk about the IPO market. Now, as I’m having this conversation probably five IPOs are happening or are in the middle so there is a sort of IPO mania going on, and that’s not the reason this fund is being launched, it’s an old idea. I think IPO investing is significant but it’s not significant because of the narrative you see in the market which is a cool IPO is coming, let’s get listing day gains, buy on leverage and then exit it. I think IPO investing is not that. IPOs are any other company and an IPO is an event in the life of the company, but what the IPO investing opportunity represents is something that your traditional equity funds, and I run a traditional equity business, does not represent because these are new generation sectors and companies that are coming to the market. So, whereas we have traditional financial services which is your banks and NBFCs your new listings that are coming to the market or your depositories, your RTAs, your asset management companies, whereas you have traditional IT services you have a lot of fintech companies, you have a lot of aggregators, e-commerce companies coming to the market and you have gaming. So, for every old age sector that is represented in the mainstream funds and indices, there is a new age sector that is coming to the market via listing. If I was sitting in the U.S., this would probably be a less exciting opportunity. But in India where even your largest exchange it yet to list today, new listings are fundamentally a very exciting opportunity. The reason to package it into a fund is because if you look at a traditional multi-cap fund, it probably has only 5-7% exposure to IPOs. I think the average number is 8-9%. So, in your traditional portfolios, you don’t have exposure to these new generation companies, which is why as a diversification instrument, this makes a lot of sense and it’s taking the three core problems of IPO investing which we can talk about in detail. Access selection and holding on and trying to solve them in a fund format.
Why is it that a special fund is needed for something like this wherein a company after listing is good, it can be taken into virtually, any fund?
RADHIKA GUPTA: So, I think the simple answer to that is, it can be taken into any fund, but it is not taken into any fund and the data suggests that. The average exposure to this basket of recently 100 listed IPOs is 8-9% in a traditional fund. It’s not because a traditional fund doesn’t want to take exposure, the reality of life is a large-cap fund or a mid-cap fund is going to mirror very closely, or at least indicatively be following the existing benchmarks, and these companies don’t find their way into those benchmarks, these are largely mid and small-cap companies, with the exception of select issues. So, to invest in them, you do need a dedicated vehicle they are not and they will not be represented in a meaningful quantum in traditional funds. There is also I would say, a different level of diligence that is involved when doing investing in IPOs versus traditional companies because these are companies just coming into market, they don’t have the earnings track record and history. So, the way we manage this is a little different from the management of traditional funds.
How would this be different?
RADHIKA GUPTA: This is one, a limited capacity idea. This is a 500-crore fund. Because this was an old fund it was made an opportunities fund, that is converting into Edelweiss recently listed IPO fund. It is not an infinite capacity fund, because as you said it’s universe is the recently listed IPO market. We intend to close this fund at somewhere between 1,000 and 1,200 crore. I’m probably one of the few asset managers saying this even before the fund is open. So, it is a limited capacity idea, one. Secondly, it will invest in a basket of 30-40 IPOs its benchmark to the new NSE India IPO index, which means 80% of it has to be the last 100 IPOs. That is a pretty wide universe actually that gives you a couple of years of IPO history, you have this little flexibility of 20% just so that if something goes from 100 to 102, you don’t have to exit it and you don’t have a large amount of churn and the idea is that you bucket companies into either sort of secular compounding stories or cyclical stories. You take larger weights and secular compounders, smaller weights in cyclical companies and hold about 4% per company in these 30 to 40 stock portfolios, after doing all your due diligence in the company. So, that’s broadly how this idea is constructed.
Is there a target in mind about what’s the anticipated return that a product like this could give out?
RADHIKA GUPTA: This is a thematic idea. We’ve done it for three years. It’s not a new product so I can quote data from the past three years of experience. This has the kind of risk issues associated with a mid- and small-cap fund. It was passed and it was formally benchmarked to the multi-cap index, I think maybe mid and small cap, so the average portfolio composition usually is about 60% mid and small cap, the balance large cap because you do have some IPOs. Its volatility therefore is similar to those kinds of funds. It’s very difficult to predict return profile of anything, but I think you should see multi-cap plus kind of returns. I think the last three years, its track record as a closed-end fund has been exemplary of course and that was an average IPO season, I think 2018-2021 was average for IPOs. So, I think we are optimistic about the road ahead, but please remember this is not a core portfolio, it’s my fund but I will never say it’s a core portfolio holding fund. It is a satellite or thematic idea, but if you’re looking to get access to IPOs, I think the one thing that a fund vehicle can do which an individual can’t do is, we can participate as anchors, we can participate as qualified institutional buyers, and we can also participate after listing. This is something that is unique to a fund format because these days, everyone’s asking what a fund can do that an individual can’t do? In the case of IPO investing, it is definitely something that the fund brings to the table.
Would this fund be constrained from investing into, let’s say a company which recharts its growth path suddenly, either made a discovery or a management change or a corporate action, and you can see in front of your eyes that this company will do really well, but it’s not a recent listing?
RADHIKA GUPTA: I’ll give you the technical answer and the practical answer. The technical answer is that 80% of the universe is recently listed IPOs so there is a 20% flexibility. The practical answer which I think you already know is that at Edelweiss, we have believed in running funds true to level. So, if it is a fund where people are coming in for recently listed IPO exposure, that’s what we will do. It could be top 100, could you go to the 105th or the 110th IPO, yes you could. But would you hold Page Industries which IPO-ed in 2007 or 2008, or HDFC Bank that was an IPO company once upon a time, I don’t think that would be right to the investors. So, at the risk of skipping opportunities, we also have to be true to the mandate of the fund is.
What are you guys at Edelweiss telling investors currently at these levels? Staying invested is probably an all-weather answer but is there tactical merit in trying to be a bit cautious at these levels
RADHIKA GUPTA: I will tell you this, I think, markets are healthy but precarious and it is a time to be calm and quality focused. I always joke that when markets are at all-time high, caution unfortunately goes to all-time low and this is the time when most mistakes are made. So, keep a tight eye on quality. If things are expensive at least focus on things that are more quality-oriented in nature, never forget your asset allocation and stretch the limits of asset allocation and finally do what makes sense for you. Just because everybody else is talking about some asset class or something else, don’t push yourself on that. So, be cautious in how you think.
What is your true and fair opinion about a product like this, an IPO opportunities fund?
SHALINI DHAWAN: I think per se when one looks at it from an investor’s perspective, it is an interesting theme or an idea to think of and then, one does understand that, the fund house has had about a three-year horizon that they have been handling this fund in a maiden opportunities closed-end format, and they’re now going to make it an open-end scheme. I think from an investor’s perspective, one has to say that if the investor is looking at IPO investing as something that he or she is looking at or comfortable with, then this would be a scheme or a fund to look at. Of course, there are a lot of risks that the investor should be very careful about. Usually IPO investors are doing their own reading or research and so on and probably are investing maybe in IPOs without maybe a lot of either adviser or professional help. So this kind of a scheme actually gives them some kind of professional fund manager research and guidance in that scheme so all that they need to do is really come in, put some money into the IPO fund and essentially get the flavour or the kind of participation in returns of the scheme. So, they don’t have to do a lot of that guessing or groundwork or checking around with friends and family etc. or their own research. So, that’s one benefit that the scheme gets to them. The concern on this kind of scheme is in cases where, because the universe is an IPO universe, there will always be restrictions about either the scheme, or the stock selection being a mid-cap stock or a small-cap stock or even a micro-cap stock for that matter. Not all IPO stocks are really worth investing in that sense, and therefore, when a particular fund house is doing their due diligence and research and still getting into that stock, it’s about how that IPO performs and there could be a case where a mid-cap stock becomes a small-cap stock or a small-cap becomes a micro, and as an investor, you do not have much say except for exiting that scheme if you had to. That’s one of the risks and the other risk, which of course, right now we aren’t fathoming or thinking about is, what happens when the IPOs dry up or what happens in a bearish scenario when you have not too much choice in analysing which IPOs to go for. So, then what does happen in an open-end scheme like this? I think. On one side they do have a good performance by a closed-end scheme which is now becoming an open-end, but on the other side there are some risks. So, I think investors need to kind of weigh both these items.
Have you recommended this, or would you look to recommend this fund to any of your clients?
SHALINI DHAWAN: I think I would but to someone who is fairly savvy, and probably someone who understands either a thematic product, or is having the appetite for a small, micro-cap kind of fund, and also a long horizon because a lot of IPO investors have a listing game mindset. When listing happens, I will come out but what we have seen is that it’s not so that all IPOs will actually give listing games. So, we also need to understand that this money is going to a business, as an IPO and then business would need like a three-to-five-year horizon to actually show that kind of performance. So, I think someone who is having a bit long-term horizon a little bit of risk appetite, and not someone who is only used to investing in maybe in very diversified large-cap kind of a scheme so that’s the matching that one would have to do.
Shalini, there was a message floating around about a scheme from SBI Mutual Fund which guarantees 13-14% returns, regular dividend payouts etc. It’s a ghost of the past that has kind of returned to haunt because so many people tend to “fall” for guaranteed returns which are very high. What are the most obvious things or signs that people should keep in mind when they see something like this?
SHALINI DHAWAN: I think like the old adage goes, that when something is too good to be true it normally is. So that’s one thing I think that, again, like all investors would understand there’s nothing is called guaranteed in today’s market except for a few government guaranteed schemes. A little bit of deep dive into these messages that have come, or the fund in particular that we are talking about, the SBI Special Situation Fund, so essentially, just to understand high yields and also secured and also credit, I think the most important item that an investor is focusing on is high yield, but I think they have to focus on the credit risk part. I think what’s happening here is that this fund is actually going to identify seven or eight companies or projects, and the entire 750-crore that they envisage to collect is going to be given to these seven or eight companies. These projects or companies are unlisted. So, there is one level of risk there. These companies may be going through some cash flow problems which is how the fund has come into the picture in trying to lend to these companies. So, there is a level of risk and definitely like the messages are saying that fixed deposit kind of investors can look at this. I think FD kind of investors cannot look at this at all because essentially, the credit risk in this particular investment is very high, because you’re basically talking about your money going to seven or eight projects and there is a discussion about the IRR of the project being in the range of 20%. It can so be that that project doesn’t fructify at all. So, the risk is not just that okay not 20 then will it give 18 and not that kind of thing but just that IRR may not fructify at all because it is going into a company and then the company may have its own shares of hurdles that they will have to face before they can make that IRR and return it to the fund and then the fund has to return it to the investor. So, I think here is where some of the risks lie. One is very high concentration, second is that, of course they are saying that the credit they are giving to the company is secured but the security is in terms of land, in real estate and also promoter pledge. So, there are many shades of risk here in terms of how and when the monies will continuously flow to the investor. Again the ticket size again being one crore. So, what you are doing is you’re investing into a fund which is very high risk, it has very high credit risk, you’re putting about a crore of rupees, of course there are stages in which you put the money. So you would need to be maybe a ultra-HNI to kind of take this kind of risk appetite or this kind of leap of minimum ticket size of one crore and also the lock-in of the product is about seven years or so. So, you have to be a savvy investor or a sophisticated investor with a very high risk of appetite and you also have to stomach the kind of illiquidity. So, there is a long illiquidity in the time frame. Now, I do understand that currently the scheme is giving a gross IRR of about, of I believe 12-13 to 14% because it’s been in existence for about 17 to 19 months. So, I won’t take away that from the scheme that it has been given but at the same time because we are in a very fluid pandemic situation, things can go wrong without much notice. I think it’s a credit risk instrument so that’s the big concern.
Shalini, a point that somebody or other most people are now making is that while small-caps are expensive, large-caps are expensive, mid-caps or the mid-cap index is trading at a discount to the small and the large-caps, and therefore mid-cap funds might be great to buy into. Now, with a hypothesis that mid-cap funds are good to buy into, which are those one or two good mid-cap equity funds that one should get into and why?
SHALINI DHAWAN: Like you rightly said, the investors are looking at—having exhausted the usual large-cap, which used to be the favourite — are looking at mid and small as well. As advisers, we also do suggest some allocation to mid as well as small of course keeping valuations in mind. I think, with that thought in mind, one would think, the DSP Midcap to be one of the strong suggestions that we do have in our current research universe and I think one of the reasons as we look at schemes more and more, we do enough weightage to both qualitative as well as quantitative parameters. Usually, of course from investors who do their own research, there is a lot of more weightage given on the returns, etc. I think there are also some advantages that this scheme does bring because of a very long fund manager history. I think he’s been with the fund since 2012 if I’m not mistaken. So that bit of strategy that he brings to the table also has some merit. Another, of course, as we have been reading about this scheme because of our research process we understand that there is a very good process of stock selection, that they have arrived at. I think in the mid-cap space, they have figured that how they can identify companies with a good amount of competitive advantage which leads to maybe them gaining a certain kind of market share and therefore pricing power and so on and that kind of obviously shows in the stock price and therefore obviously in the NAV of the scheme. The third is that this stock selection is not necessarily just buying at any price, as well, because when we looked at the P/E of DSP Midcap, if we compare it to like a peer group, or if we compare it to the Nifty P/E and so on, what we find is that, it’s fairly reasonable. So, when an investor is looking at a mid-cap scheme with a reasonable P/E, one is actually saying that okay I’m buying this but I’m not buying it expensive in that sense, so I have a fair amount of predictability or probability of some kind of good returns from where I’m buying that. I think the valuation of the scheme, some bit of thought or reading around that also does help in the selection. So, that’s been one of our choices.
If you’d like me to add, I think we have Axis Midcap also being a very close contender to DSP. I think Axis has been a scheme which has been almost like about 10 years now in existence. So again, they have a fair amount of assets very close to what DSP manages in terms of—if we talk about investor confidence given to the scheme, in terms of asset size. When we look at returns and we don’t look at just trailing returns or just past so many years but we look at returns on more rolling basis, we understand that this has been a fairly good consistent performer, so much so that there have been very high double digit kind of returns in the three and the five year horizon also. So, that I think brings a lot of confidence when one suggests as that as a scheme to an investor. That and of course, they have a certain bit of being in the mid-cap space, they do have like a certain bit of orientation on how they can cap the drawdowns because mid-cap schemes do tend to be more volatile but they have been able to with the selection or the way the scheme composition is, they have been able to cap the drawdown when a market is bearish or a market has seen something like in March 2020, when the market saw a lot of fall. These instances do allow us to understand that the drawdowns have been fairly capped in that sense, a limited drawdown. So, that also allows us to understand that it could be a mid-cap scheme which will show less volatility. So, that also is something that allows us to suggest that to the investors.