The Mutual Fund Show: Investing For A Year Or Three To Five Years? Here Are The Options

KIRTAN SHAH: For somebody who's looking at building a portfolio for a year, I would definitely not advise going to either Gold or equity. So, the focus is going to be 75% on floating rate funds, that's the debt category and 25% arbitrage funds, so that is something that you can look at for a one-year perspective. While you look at a three-to-five-year perspective, I think 40% in flexi-cap, 25% in large and mid, 25% in mid-cap and a 10% global exposure. That is how I would kind of build a portfolio for the next three to five years.

KIRTAN SHAH: Absolutely yes.

BHUSHAN MAHAJAN: For a one-year portfolio it is very difficult to think about equity, however, in case of debt also, debt has become equally challenging. So, I think in a one-year portfolio we’ll look at a fund with a roll-down strategy, which is maturing in March or probably in June maybe because there is a huge sort of sword hanging on our heads about interest rates going down. If the economy does well interest rates will go up and in that case with a debt investment—and with total innocence, one might lose if the interest rate changes. That is one area and second of course I fully agree with Kirtan that arbitrage funds will make a good choice but in the case of arbitrage, I think the minimum holding should be at least six months or more because arbitrage doesn't deliver in a linear fashion. Sometimes the opportunities are better, sometimes they're not. So, for one-year clearly on debt that too, maybe a roll-down maturity portfolio of one year and arbitrage maybe in the mix of 60-40. That would be my choice. It also depends on the tax bracket of the investors. If the investor is on the highest tax bracket, then probably arbitrage will take up the most difference. Then it will be 40-60.

BHUSHAN MAHAJAN: With a three-to-four-year bucket, then we can be more relaxed. In fact, we always think that the large-caps are the building blocks of any portfolio but nowadays, flexi-caps are predominantly large-caps. So, either a large-cap or a flexi-cap fund will form the chunk of the investment, about 40%. However, you have to understand here that, because of this SEBI classification, large-caps, and index funds—beating index funds has become very tough. That's one thing which we have to think of. I would also give some thematic funds as a tactical allocation because if we have three to five years as our horizon, we have been given thematic funds for short durations, maybe one year or years like tech funds, digital funds or pharma funds or maybe even a banking fund. So, some part of the portfolio for that. Even in international funds now, as a matter of composition, they have been coming though, we would have preferred international exposure about five years ago, when the Indian economy was struggling and the U.S. economy is doing so well but nonetheless, as geographical diversification, I’ll look at international funds also and large and small-cap will make the balance. So, probably not more than 15-20% in mid and small-cap funds. About 15% in mid-cap, 5-10% in small-cap. But these funds—you must also remember that they follow a cyclical pattern. So, it has to be there for a longer duration to get anything worthwhile out of it.

KIRTAN SHAH: So, I think Gold and equity will absolutely not make sense in one year because for a greater extent, both of these asset classes over the last two years have ran up because of liquidity. Today we're at an inflection point where most of us are wondering where the DXY is or where are the yields going to go which is going to have a large bearing on both of these asset classes. So, while I talk for one year like I said, extremely specific, I think 75% to floating rate funds and 25% to arbitrage. Now I will give you a little logic as to why this breakup and why both of these categories. Now, in my opinion, arbitrage funds will really work well for somebody who's in the 30% tax bracket, that is because the taxation is equity. So, if you hold for one year and below you can charge 15% and above that is 10%, but I'll tell you a problem that I see with arbitrage funds. So theoretically, it may look really good in terms of lesser tax in terms of versus liquid or an ultra, but in the current market scenario where the debt or especially the lower end of the curve is so cheaply priced at three, three-and-a-half, that while arbitrage funds are trying to keep something on the debt category to take leverage to short on the futures side so that arbitrage can take place, that part of the portion is really making peakers. At the same time you've seen because of whatever is happening in the market, the futures is to a one larger extent, a lot of time trading at a discount to the cash market, which is why also arbitrage is not happening.

Which is why in my opinion, arbitrage funds generating more than four, four-and-a-half looks slightly difficult in my opinion and which is why I would have a very small component to arbitrage which is limited to 25%, even to somebody who's in the 30% tax bracket and in the same context, I think a larger weight can be given to floating rate funds. Of course keeping all the technicalities aside of how it would work, but in the given scenario, you will generally see that floating rate bonds which are limited in nature, typically have a higher spread versus a similar kind of a bond in the market with a similar maturity profile. That's going to be one additional advantage and because I'm expecting personally two quarters later, interest rates to kind of align and start moving up with the economy, these bonds will make more sense in my opinion. So, I think on the floating side, I will go with HDFC and Nippon because these are two funds which have average maturities very close to one-and-a-half to two-year time period and with arbitrage I’ll go with Tata. So that's my composition and reasoning of why.

BHUSHAN MAHAJAN: I’ll add to what Kirtan said. In arbitrage, what we have found that if you really want to get four to four-a-half-percent returns, the MTM exit has to be on the last Thursday of the month, because that is the time when the arbitrage ends and the investor gets the best returns because it doesn't work like the liquid funds. In liquid funds, at least some NAV portion goes up every day, or maybe in a week but in case of arbitrage it happens so that if you enter and exit on the last Thursday of the month. So that is one thing which we have to keep in mind, that is why you have to have an at least six months of duration for that. Number two, I found that in many funds them they're really not comparable, but many funds in a month they will really have outstanding results but in the next month, they will not be in line with what we expect out of a liquid fund. So generally, on the long- term basis, Edelweiss has also have been a little aggressive, it is one good fund and even the Tata Arbitrage Fund. These are the two funds.

In case of debt, though I agree with the theme of floating debt, I would rather go with a maturity profile of that short-term fund probably, if I remember rightly, Axis is one which has a PSU and a short-term debt fund which has a maturity around May or June next year. So, what we have to remember is that we have to really convince our client that your returns in the short term are not going to be great, but you have to be ready for that interest rate cycle. Even DSP has one fund in that bracket, I believe that DSP Corporate Bond fund has similar funds right now in cash. Even Mahindra Manulife has been gathering in their new fund, though it needs to be seen how it performs and they are in mostly in cash and would rather call when the interest rates will change and move. So, after looking at Mahindra’s performance for some time because it's a new fund, otherwise there are these two establishments where I'll put my money.

BHUSHAN MAHAJAN: So, the best way is to avoid equity as people are ready with the worst possible scenario in mind. Having said that, in three to five years as I said, I have an inclination to give some tactical allocation maybe up to 10% in the portfolio.

We have done that in the past and we have found it to be extremely useful to create the alpha in the portfolio. Like, till banking and finance came under trouble, we used to give banking as one of the thematic plays. After the pandemic, we have given that to pharma, IT funds and digital funds and they’ve worked well. Now as the results have been coming out, it seems that it's a structured story. It's a structured story for the next few years, so I wouldn't mind taking that particular risk after explaining the client that this is the risk you're taking, but they have to be viewed at the FMCG stocks at a little lesser valuation, something like that and even with the pharma story. The pharma industry has been reeling for a very long period of underperformance. So, this one year of 100% returns, doesn't mean that you have to really dump it. Maybe it will give you index beating returns for a period of the next one or two years, you have to be alert to get the client out of the thematic funds because earlier we have had many experiences when infrastructure funds did well in the last bull run 2003 to 2007, and people continued to hold them for years together for a total misery of returns. So, the responsibility lies with the distributor of pointing out that, that period is over and now, maybe we'll switch it to normal standard diversified equity.

Diversified equity has become almost synonymous with a flexi-cap fund nowadays because the fund manager has freedom to move large-cap to mid-cap to small-cap. So, that freedom does wonders for the book. As I said earlier, it has become very tough to beat the benchmarks though there are funds which have beaten SEBI’s official benchmark. But the choice being very restricted again to these top 100 stocks, so I think, large-cap outperformance is tough but still, I would prefer to make it my building block maybe about 40% because these are the most researched funds and negative surprises generally will not come.

Whatever negative surprises come, will be absorbed by the market as long as it's in the good and particularly in this age when foreigners call the shots, sticking to large-cap becomes a very safe strategy. So, 40% is large-cap. International exposure as I said, I would have loved to have higher international exposure of at least 20 to 25% in the last decade because I repeat, the last decade belonged to the U.S. They had a real rate of return of at least six to seven percent whereas our real returns were hardly 2-3% and with our inflation, probably by 5-6% is also low. That was the time probably to look at foreign funds in total. I mean 20-25% would have done well now, for geographical expansion. One country is dicing us. You will find that the entire world has gone up, if you look at the foreign goods indicator, in China, they are resting at hardly 6-7%. It is because of many reasons, China has a lot of regulations too. So, that becomes a very attractive bet. So, I don’t mind giving some exposure to China and some exposure to the rest of the world. Here we have a few funds which are long tested. One of the oldest funds in this category was ICICI U.S. equity, Motilal Oswal has also come up with S&P 500 but about that, we’ll see after some more time. PGIM has a global equity fund as well. So, among these three funds we’ll select one. It is beyond doubt that stocks like Apple and Amazon are bound to do well. So, it will be predominantly U.S. based. Just to add a last line, we feel that the U.S. economy stocks will also do well. So, we may not be totally focused on science, there's a lot of money there but these are the few reasonings.

BHUSHAN MAHAJAN: I'm very comfortable again with PGIM flexi-cap, number one, even Axis’ flexi-cap fund—both have done fairly well. The portfolio construct is good and both have a different style of management. One sticks totally to growth not totally but predominantly to growth, other one is more keen on finding out newer opportunities in either space. So, we like both the funds and we've been following them for the last three years, more than that but since the fund managers change, we’re focusing on the last three years more.

KIRTAN SHAH: My allocation and I’ll leave from where Mr. Mahajan stopped. My allocation is mixed across international and domestic of course 80% of the component is domestically fixed but I would like to start my conversation with the international exposure. Now, if you look at the last 10 years and the 10 calendar year performances specifically, the top three countries which have worked across all countries in terms of absolute returns is U.S. China and Taiwan. Now, of course 80% of component has to be focused on India but there's no reason that I see why we should not have any specific, concentrated allocation to U.S., Taiwan, China, and of course to India. Now of course the argument will lay as to how China is going to work out with the regulatory challenges around manufacturing and all, so you have to be very specific in terms of what fund are you choosing so that exposure in China or so that the exposure in the U.S. works out well.

So, we've identified funds which we think will work the theme really well. Though I've taken an India specific domestic fund which is the PPFAS & Canara Flexi-Cap Fund but it has 30-35% exposure to specifically U.S. international equity so that's where technology play of the U.S. comes into picture. I've also taken a Edelweiss’ Greater China Offshore Fund, where it has exposure to Chinese, Hong Kong and Taiwanese businesses. Now if you very predominantly look at it the focus is healthcare, technology and pharma—so it is not to do with manufacturing which we are seeing going through trouble because of the economic challenges and all. So that's my exposure to international and that is how I think, a global diversification will happen. Talking to you of India, I think we are very clear that in our opinion for the next five years, is actually not going to be the new economy but the old economy stocks that we want there. Why do we make that comment?

I think there are four specific reasons. First is global growth. Now we've seen this time around 10 trillion worth of liquidity has been pumped in by the central government. You've already seen U.S. have $1.9 trillion of infra spending that they've done and another 2 trillion is under consideration. Europe is also looking at a 750 billion of infra spend. So even if the global growth moves up by 1%, there is definitely going to be a 0.3-0.4% pump up in Indian GDP. That's how specifically the old economy stocks will really do. Again, specifically to lower interest rates, which is my second point, of course, all of us are expecting rates to go up but very specifically versus pre pandemic, today we are at 225 basis points lower on repo and 180 on G-sec. Even if it has to go up by 25-30 basis points, it is still much lower in terms of interest rate than we were at the pre-pandemic levels. Another reason why old economy will do really well in our opinion. Now if you look at capex and I specifically talk about housing, right, today the housing price to income ratio is at 4.5 times, which has been the best in the last two decades. Interest rate today you go and pick a home loan, it's at sub 7% which three years back was nine-and-a-half percent. Again, we don't see a reason why housing and the ancillary sectors will not do well and of course, all of us know how the PLI scheme has been really helping the China plus one theme. We've seen mobile handset imports have already become almost zero, because of the PLI scheme and which is why I think the old economy stocks will really do well. So, keeping the old economy stocks in mind, our domestic focus is the Canara Flexi- Cap, Kotak Equity Opportunities Fund and Axis Mid-Cap. So that's how we've split Indian domestic and international exposure to put together and that's our why.

KIRTAN SHAH: In my opinion the flexi-cap funds still because of the flexibility to be able to invest across large mid and small, will have these challenges, much lower than what we seen in a large-cap fund. Also, close to a 10,000 level I don't think the fund is anywhere close to facing a challenge specifically from that perspective. Of course, had this been a large-cap fund where the focus was 80% in top 100 companies, this would definitely have been a red flag but if you've seen that the larger part of the investment return that a fund really has been able to generate has been through international equities in the last two years, but the reason why the domestic part also appeals to me is because it is more value oriented right now. In my approach at these high market valuations, I think a value fund should be able to do much better than a momentum or a growth fund. That is my reasoning of why the domestic value, domestic exposure also makes sense in the current flexi-cap.

BHUSHAN MAHAJAN: I’ll just add one thing. PPFAS we also like, and this time is totally different. They're not scared of being in cash and there's a least overlap with other funds. So that is one of the greatest features of PPFAS which I think investors should keep in mind. It is an excellent fund.