The Mutual Fund Show: One Way To Build A Portfolio As The Economy Recovers
The Louvre-Pyramid is seen in the courtyard of the Louvre Museum, in Paris, France. (Photographer: Alastair Miller/Bloomberg News)

The Mutual Fund Show: One Way To Build A Portfolio As The Economy Recovers

While the second wave of Covid-19 rages in India, investors should build portfolios keeping in mind that the current phase will eventually end in a vaccinated, fully open economy.

That’s according to A Balasubramanian, managing director and chief executive officer; and Mahesh Patil, chief investment officer at Aditya Birla Sun Life Asset Management Co. And with the economic growth likely to pick up, bottom-up stock-picking in selected themes can offer good returns to investors, they told Niraj Shah on BloombergQuint’s weekly special series The Mutual Fund Show.

Over the course of the year, Patil said, the economy-facing themes such as banks and niche areas like specialty chemicals, production-linked incentive scheme beneficiaries and digital disruptors will generate higher returns for investors, but only on specific bottom-up ideas.

That prompted the asset manager to launch a multi-cap fund, open-ended equity scheme investing across large, mid and small caps. While a flexi-cap plan has a mid-cap flavour, large-cap stocks still occupy 65% of the flexi-cap fund as per Aditya Birla Sun Life AMC’s design, Balasubramanian said. With the multi-cap offering, the fund house will have a scheme that is equally distributed between the three categories — large, mid and small caps, he said.

Still, Vishal Dhawan, founder and CEO of Plan Ahead Wealth Advisors, advised investors to watch the performance of the fund before they take a decision. Instead of NFOs, investors should invest in funds that have some track record so as to be able to make an informed decision, he said on the same show. Dhawan recommended the Parah Parikh Flexicap fund in that category, citing its combination of value-orientation in India component and growth-orientation in the international part of the portfolio, offering diversification.

Watch the full interview here:

Here are the edited excerpts from the interview:

Everybody is caught between this uncertainty of rising Covid cases in India and the vaccination drive going to be started full steam from May 1. How do these two push and pull lead from an investing perspective?

A BALASUBRAMANIAN: I think it is an interesting trend that we are seeing, the repeat of the second wave of Covid definitely has put many citizens of the country a bit on tenterhooks and has increased the worry among people. Therefore, this is something we’ll have to pay attention to seriously. But at the same time, the effort is being put in by the government in terms of going for a partial lockdown, and lockdowns have varied from state to state, and at the same time had to keep the economy going and continue to provide necessary support that needs to be provided. If we go by that model, definitely what we have seen in the beginning of April 2020 when the pandemic hit the world for the first time there were a lot of unknowns. There were many things that we did not know—how to address or how to handle it. Partly this time around, while there has been a rise in cases, they’ve also been able to take some bit of action that I think are bringing a solution to some of these issues. At the same time from the economic growth perspective, whatever the steps that they took especially in the last one year in terms of making the interest rates low, in terms of increasing the liquidity and the same time giving more support to the borrowers to the banking systems, by the way of getting moratoriums and so on so forth. All these things I think have already started playing in terms of having a positive impact in the economic growth. The current pandemic situations may probably take a bit of backseat by one or two months. As you rightly put it, I think the vaccination drive is also going in a full swing. Probably the number of people that are getting vaccinated in the last three weeks has gone up quite tremendously. With the number of cases coming down, the vaccination rates going up and the continued low interest rate regime to drive the economic growth and put the income in front of the government on various spending—all of this I think after a few months will really make an impact on the economic growth. So that’s how I see it. I think its some of a temporary reversing, but growth should come back as we have seen in the past, with a V-shaped recovery. I think probably, we are on that path too.

Mahesh, you want to come in and juxtapose this both not just for an Indian investor but also an investor has the choice between investing into India versus investing into global funds?

MAHESH PATIL: As Bala mentioned, clearly, the second wave has kind of slowed down the recovery what we were looking at because the economy was recovering very quickly here and also globally. But I think if you look at it and the protocol is very well laid out in terms of how to handle this. So, there is an end to it like in the year back we didn’t know how it will pan out. So it’s a matter of one or two months where you will see an impact because of the lockdowns which could be there. I think there is an end to it and the market interestingly is willing to look beyond the one quarter and look at the slightly medium-term outlook. At the same time, I would say that the global environment is still fairly good and conducive. Globally, we have already seen the peak of the virus curve and there’s a sharp rebound in the economic growth in fact this year. The global GDP growth has been increased now to around 6%, which is the highest in many years and overall, the financial conditions convey that they’re fairly benign. So, while foreign investors would be slightly worried about the second wave but if anybody is coming with a one-year view or a medium-term view, I think for them it doesn’t really change much because we don’t expect any material change to our FY23 earnings outlook because of the second wave. It will impact a bit in the FY22 numbers slightly. We are yet to establish that impact but for investors, I don’t see any major pullout. For foreign investors or long-only investors, I think, in fact, any correction in the market would be looked at as opportunity to really buy because that will make the market more attractive. I think the recovery will also come from the second wave as in terms of the economy, it should be also equally swift, I would say, and the government would also do its bit to support the economy. It means that probably the interest rates in India also will remain low for an extended period of time and that should help to support the growth comeback.

Mahesh, the common parlance at least in the months of January and February was that, try and look beyond the index, the larger activity would happen in the broader end of the spectrum, that is where the real money could be made because the recovery would be more pronounced there, the beta would be higher. Would you second that or would you believe that high-quality, large caps might still outperform compared to the mid caps and the small caps?

MAHESH PATIL: I think we have been on the view for now almost three to four months that the breadth of the market is likely to improve and the reason for that are a couple of things. One is, we seeing multiple sectors now looking up. The sectors which were down and weren’t not doing well even in pre-Covid are seeing a cyclical upturn—be it domestic as well as the global cyclicals. We are positive on that despite the short-term disruption which could be caused by the second wave. Our belief is that India’s economic growth coming out of this crisis even beyond the FY22 should be fairly strong and we should probably hit around 7% GDP growth which might be a pretty strong growth compared to the growth what we have seen even in the pre-Covid level, we were tracking a much lower growth rate and in this period, again it is driven by multiple things—not only the easy financial conditions, government focus on stimulating growth, loose fiscal policy but also sectors like real estate which has been in the doldrums is kind of taking off. Even the investments or the whole investment cycle is starting to pick up because of the government focus on manufacturing. The production-led incentive schemes across various sectors which has been rolled out will stimulate growth too. There are multiple levers to sustain that growth and during periods of strong economic growth, we’ve seen that the earnings growth in the mid-cap and small-cap is much stronger and that segment of the market tends to do better. We saw that in the period from 2004 to 2007-08 and again, from 2013 to 2018. I think we are in a similar cycle and considering the underperformance of the mid and small-cap sector in the last two years from 2018 onwards I think there is some room to catch up over there. So, I would say a broad-based recovery is what one would expect going forward compared to the narrow rally we saw in calendar year 2018 and 2019. That means good news for money managers or more diversified equity funds to outperform the benchmark which has been a tough task in the last two years.

Bala, would that be the reason why you guys are launching this NFO, the Aditya Birla Sun Life Multi-Cap Fund? Please tell us a bit about the fund and the rationale behind the timing of this. Is it because of Mahesh is saying that the outperformance might come in the broader end of the spectrum?

A BALASUBRAMANIAN: As Mahesh mentioned that definitely post-pandemic, the way I think the support that is being given to drive the economic growth is making it visibly a more broad-based output that could come across different sectors and across the market caps. Also what we have seen in the last two to three years that a single directional growth was coming in the Nifty companies, that is the time where money managers would have gone through some tough time but I think it looks like probably we are in a broad-based participation rather coming more than the rally. So, with a broad-based participation coming in, I felt that there is a need to fill that gap by offering a product which currently is not in existence in the multi-cap category. As you know SEBI had introduced multi-cap as a category after doing a review of various type of mutual fund products that exist in the mutual fund space. Five large-cap and flexi-cap, the mid-cap and small-cap. That is the time when the multi-cap got announced which gives the flexibility for money managers to choose whichever sectors within the predefined criteria between the large-cap, mid-cap and multi-cap and the small- cap that it can take exposures. So that’s really where the merit of this comes in. Secondly, historically if you see, we’ve taken a 10-year period and in your own chart that you just put out just before, clearly the longer time horizon if we give, the tendency for stocks in the mid and small-cap to outperform the market is very high. Given the fact that earnings growth for the companies as you go down, the smaller the size the earnings growth generally gets better and because of the higher earnings growth and the increased level of pickup that we’ve seen in the economic growth, I think the combination makes it much better in terms of stock price performance in the long run. Keeping that in mind and being in the industry for 25 years, we looked at the gap that exists in every product offering that we have. Therefore it was felt that maybe in the beginning of the financial year, we must begin with the launch of the multi-cap fund. We see a greater opportunity not just one time but it’s going to be an opportunity which is sustainable for the longer-term investment purpose. Therefore our advice to all investors as part of this launch is to consider this fund as part of the normal allocation that they have between large and flexi-cap and multi-cap and the mid-cap kind of portfolio allocations. Now, this also fits into the overall allocation that investors might want to consider. So that’s the purpose that we have planned. Of course, the fund again is being managed by Mahesh Patil and is being supported by another manager named Dhaval Shah and he has certain plans in terms of leverages the benefit of the analyst’s group, bring the best of the ideas in each of the categories and being a part of the portfolio that’s part of the game portfolio strategy which probably Mahesh would explain in a while.

Bala, for somebody who has got exposures to say a flexi-cap plan within your stable, what’s the differentiation that this brings to the table vis-à-vis if the person already has a plan or is planning to choose between?

A BALASUBRAMANIAN: The way I see it is, if you take the large-cap fund they have roughly 80-85% in the large-cap and roughly about 10-15% in the mid-cap. If I take the flexi-cap, generally we have the discipline of having roughly 65-66% in the large-cap and roughly about 38% goes into the mid-cap. Whereas the multi-cap fund will probably have 35+35+35 kind of a model which is between the large, mid and the small-cap. Having said that money managers can choose the segment in which they want to go overweight depending upon the outcome that they have for each of the segment of the market, at each point of time. So, that’s the flexibility that has been given in this category. So that’s the fundamental difference that brings in, in order to bring in the necessary outperformance expectation that one builds in on this fund.

Mahesh, do you want to come in on the stock selection methods, what will lead you to choose between the caps and even otherwise. I’m presuming, when I read the literature; it will be a lot more bottom up and then being top down. Can you talk a bit about that?

MAHESH PATIL: Just to take it further from what Bala said, I think here compared to a flexi-cap there’ll be equal emphasis on large-cap, mid-cap and small-cap and try to get the best ideas in each of these categories. So, it can be looked as a focused large-cap or a focused mid-cap or a focused small-cap. A combination of these three is what one can get in this fund. So, that’s what one will be looking at and in terms of stocks selection, our bias would be to get companies with a growth-oriented portfolio, companies which have got a very strong competitive advantage, which can drive growth superior to the industry and category growth. We’ll also ensure that companies which are much more secular in terms of their business outlook and have a good filtering criterion for management quality because we understand that this is a slightly more aggressive portfolio because it is small-cap and mid-cap and we don’t want really oar on the management quality because that’s been a big pain point for some of these small-cap names. So clearly there’s a clear filter in terms of the management quality and what we would be looking at before we enter into a particular stock. These are some of the filters which we’ll be looking at. Having said that, it is going to be primarily a bottom-up approach and each of the sectors like for example, a couple of themes which we are looking at and on which we are positive for the next three to five-years timeframe, is on the banking sector as clearly we like large banks. We think that they will continue to gain market share and our primary holdings in the banking sector will be in the large-cap space. Then we’re looking at the shift from unorganised to the organised sector which is being further emphasised by the Covid crisis. This is a segment where we are seeing a lot of consumer discretionary names—retail, apparel, footwear, consumer durable companies were the penetration levels are low and we see a long road map for growth over that driven by higher per capita income, increased penetration and the shift from unorganised to organised. That’s another broad theme which we will be looking at and here primarily the stocks will be in the mid cap and the small cap space. Then we’re looking at certain themes like specialty chemicals, which has been doing well for the last two-three years and we see a long road map over there because of India’s share in specialty chemicals. The global market is still 3-4%, China is around 30%, there is enough room for Indian companies to gain market share looking at the trend of China Plus One foreign policy. So that’s another theme which we like, and we look at stocks building upon that portfolio. Finally, as I said the production-led incentive schemes with the government has announced, has seen initially a good start and is being rolled out across sectors, consumer goods, electronics, auto ancillaries, pharmaceutical API and that could provide additional growth avenues for companies which can take advantage of that. So that’s another area and a growth driver which we see. So, these are some of the secular themes which we see and we will be trying to pick up stocks from these categories to build a portfolio on a more bottom-up basis with a slightly growth-oriented approach.

One final follow up to you. Do you reckon that this would have the ability to outperform the benchmarks by a wider margin simply because say 66% of the weightage would be in mid-caps and small-caps which typically tend to have in a good cycle, much higher outperformance?

MAHESH PATIL: It depends on what benchmark you’re looking at but I would say a normally a flexi-cap fund or a multi-cap fund across a market cycle if you look at it should be able to outperform the front-line benchmark if you say a Nifty or a BSE 200 because of the ability for one to invest across the spectrum and even though it’s still growth conducive, a lot of new companies which are coming up either through the IPO route which provides an opportunity to do participate in the fund before they actually become a part of the benchmark and there are other sunrise sectors which are coming up which are still nascent. For example, digital—that’s another sector which we are looking at, the digital transformation which is happening, the digital disruption which is happening across sectors and there are more companies you will see coming to the market in that space which definitely we will look at in this fund and there’ll be across mid-cap and small-caps mainly in that space which can enable us to make a difference over a market cycle and potentially deliver better returns than the different front-line indices like the Nifty or the BSE 200.

Bala, what would the risk be at such a juncture for anybody wanting to invest in a multi-cap fund of any kind, let alone your fund?

A BALASUBRAMANIAN: I think the risk which normally exists in equity investment are like in the last one year, the market has run up quite a lot on open optimisms. But open optimism continues to drive the market as a defender. Somewhere the market has to start looking at the earnings and the real growth that’s coming in and then followed by those earnings. Therefore, as the earnings come, generally the market goes through a consolidation phase and probably the markets may not give a return but as that period gets over, then you will see that the market will start driving again. So, we’ll go through that kind of volatility, a big rise with hope and optimism, then a consolidation phase, then the optimism returning. So, it’s a cycle which you go through and then especially in these kinds of scenarios while the volatility in the market as if you stepped in has sometimes also tended to be a little higher in the small and the mid-cap space. For as long as one keeps in mind that the time one is coming in for, this risk can actually be ignored by way of understanding that yes, I’m making an investment for the long term. So that’s something I think one has to keep in mind which normally exists in any market cycle. But this market cycle... has done exceedingly well in the last one and a half years, is mainly thanks to the power of regulators. It was something that is so powerful to drive the sentiment back to normal and increase expectation that growth will come back fast and that’s something which will also lead to a consolidation risk that the market will go through. That’s something I think one has to keep in mind which in my own experience in the last number of years, every investment whether it is multi-cap or large-cap, or any equity investment will go through this cycle of hope and growth phase and the optimism phase. Therefore, as long as one makes the understanding right and stays invested in the long term, then this can be mitigated.

Can I please start with the your view if you have one, on this NFO that is coming in from the Aditya Birla Stable?

VISHAL DHAWAN: In general, our view has always been that NFOs need to be brought into portfolios only once they’ve built up a very solid track record. There are such a large range of options available for investors today to buy into funds with track records. There has to be something very distinctly different in an NFO to be able to add in there and therefore I would say that considering that the multi-cap and flexi-cap categories in general have a very large number of funds, I would actually suggest that investors wait for the track record to get built up over a period of time before they allocate capital to this kind of an NFO. Of course Aditya Birla has a good track record on many other schemes of theirs and if someone’s looking for specifically buying a Birla fund for some reason, then I think the flexi-cap fund with a track record already in place could be an alternative that could be it.

In which case most NFOs would get discounted because if a house is coming out with an NFO there will always be 10 other houses which already would have a product like that under most categories. So then one could probably not be able to subscribe to an NFO at all. So, what would be the qualifying statistics or characteristics for an NFO to pass the muster of somebody like you? And, the fact that I hear from a lot of people that mid caps and small caps could be the flavour for the next 12 months. Since a flexi-cap fund would not have as much mid cap and small cap exposure as a multi-cap fund in Birla’s case, or somebody wants a slightly higher exposure, could that be considered?

VISHAL DHAWAN: I think the first question is very relevant because what tends to happen with new fund offers is that very rarely do they come in with something which is dramatically different from what already exists. If you do find certain characteristics that are coming in, in an NFO which don’t exist among players in the existing space and those characteristics you believe are likely to add value to you as an investor, I think in those cases you might want to bring that in. Let’s say for example, if you want to bring in some international exposure into a portfolio as well and there is an NFO which combines say Indian equities with international equities and you believe that you’re not comfortable enough as an investor to buy a completely international mutual fund in your portfolio yet. Then I think you might want to consider that provided the fund house or the fund manager or both have good track records managing money, both domestically and internationally. So, I think that might be a kind of case which you could build up to invest in in NFO, otherwise we simply say that you wait for a short period of time. In most cases in about three years or so you’ll be able to see how the fund has actually performed and at that point you then go ahead and invest in that fund which is no more an NFO but now an existing fund with a track record.

To the second question around the mid-cap and small-cap mix, I think what does tend to happen is the advantage of a multi-cap fund, in general, is that the fund manager has got some very fixed rules within which there is a need to operate. I think sometimes that’s very helpful because what could end up happening is in any investment process if let’s say one goes with the hypothesis that mid-caps and small-caps do very well at the time of an economic recovery, then there is a tendency to want to go overweight on mid-caps and small-caps, and vice versa when you’re going through a situation like we were about a year ago, there could be a tendency to want to have only large-caps in a portfolio, which is a mandate that a flexi-cap fund could adhere to because it could swing to extremes on either sides. Whereas a multi-cap fund will always have at least 25% in each of these allocations and it’s only the leftover after the 75% which is 25 large-cap, 25 mid-cap, 25 small-cap, that they have flexibility. So, because the rules are much tighter in terms of the allocation mix that can be taken, I think for investors who prefer a rule-based investing style and don’t want the fund manager to have complete flexibility in terms of doing whatever he or she believes is correct, I think to that extent multi-cap funds have a role to play in this environment as well.

Is there a preferred flexi-cap/multi-cap fund that you have, which you would recommend investors to invest in? Why and why would you choose that over the others?

VISHAL DHAWAN: One of the funds that we’ve been talking to investors for a long while and I’ve mentioned this on multiple shows earlier as well, has been the Parag Parikh Flexi-Cap Fund which was earlier called the Parag Parikh Long Term Equity Fund. I think there are two three different reasons why we like what it does. So, one is it does combine domestic investing with international investing, which we feel is quite valuable for investors who are especially starting off or kind of dipping their feet into international markets. I think the merits of being globally diversified are well demonstrated. Covid-19 as we’re going through in India right now is a great example. So, we’re seeing many other parts of the world, especially in the developed world where the economies are starting to open up fully and go back to being much more growth oriented while in India, we are actually seeing a bit of a slowdown on the back of what’s happening today. I think that’s exactly how international investing works which is, it gives you some protection when things that are unexpected happen as far as your primary or base case is concerned. Now, the other reason why we like the fund is because on the India side, it follows a value-oriented style and essentially, we think the value-oriented style is very good for investors because what it means is that the price that you’re paying for individual stocks that you’re buying, are being measured and monitored very carefully rather than just buying a growth business at whatever price it’s available. At the same time for the international part of the portfolio, the fund does have a tilt towards a lot of growth businesses especially high technology businesses which unfortunately, we don’t really have exposure to in India because India is a very IT services kind of a market while a lot of the innovation and changes that are happening globally are happening in other parts of the world. So I think that’s the second reason and the third is the fact that they’ve been very consistent in terms of the approach that they’ve taken over the years of trying to ensure that they’re able to keep portfolio sizes under control, get investors into invest only if they have a five-year investment horizon at least and even set up an exit load on the fund which is typically longer than other funds so that is to disincentivise short-term investors to really come into equities, which actually should never be happening.

What are the funds you believe investors should give a miss right now? A lot of people might be at times just investing on the basis of the stars or the rating given to the fund, at times just given on the basis of returns of the funds without quite understanding what the category is or the risk that it brings or at times the performance of the fund is given, but maybe the reasons why the fund may not be able to perform in the future.

VISHAL DHAWAN: I think while it’s most common to want to stay away from the best performing funds or the best performing fund category, we think sometimes it’s also important to even be careful about categories where the performances may not have been the best. One shouldn’t automatically believe that a mean reversion will take place as a result of which the fund or the fund category will start to do better going forward. I think one of the categories that we’ve been giving a miss to is the thematic category of PSU funds and while it’s not a very big category because there are much fewer number of schemes in there, I think the way we’ve always looked at it is that the amount of intervention that happens from the government in terms of decisions that are taken can sometimes cause these entities to have to take differing actions depending on what the largest shareholder wants and sometimes the views of the largest shareholder may not necessarily align with the views that the public shareholder could have or the benefits that could be transferred to a public shareholder. Let me give you an example of what I mean by this. Let’s say if you look at public sector banks. So one of the things that public sector banks in a country like India do, is in spite of the increased presence of private sector banks they have a much larger reach as compared to what the private sector banks have and they also have reach into a much wider segment of the population as compared to what the private sector banks have. Therefore, if there is the need for, say for example financial inclusion to take place or there’s a need to increase credit because you want to spur the economy back or you want to provide money into the SME space because capital is not available enough there. Then as a primary shareholder, the government could suggest to a lot of these public sector banks to actually go out and make those credit decisions, which may not necessarily be what a public shareholder might require because he might be saying that the risk in those elements could possibly be even higher. Therefore, we need to be able to run this business independent of what the needs of the economy might be. Similarly, if there’s a need for a lot of money for the government to spend then they may increase dividend payouts in a public sector entity, which may actually be at crossroads because the industry that exists, might actually require more capital to be infused and retained within the company itself for growth. I think it’s very important that the promoters and the public shareholder interests are completely aligned. I think that’s one of the reasons why we would say that rather than just looking at past returns and looking at things like privatisation and a lot of other potential benefits that could flow throughout in the future, I think one needs to look at some of these things very fundamentally and make choices on whether you want to expose yourself to that kind of a risk or not. It doesn’t mean it’s bad to do it but I think you need to be aware of what you’re getting into and the risks that come with some of these choices.

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