The Mutual Fund Show: Redeem, Pause Or Add On? What Should You Do With Your SIPs Amid Market Rout

SWARUP: It was so refreshing to see that data. You preach something and then you see that being practised, that is you buy at a good value and those numbers come out so refreshingly strong and more importantly, across categories. It is not skewed to any one category. People have bought large-cap, multi-cap, mid-cap, and small-cap. Thematic also—though there could be some NFOs there. But whatever is that, it’s a broad-based buying and those values at which they would have bought would be much better valued than the previous month itself. So, all that is well for long-term wealth creation. I was quite happy to see that data.

SWARUP: So far, our numbers have been intact. I think we’re very happy that I got my SIPs on Monday and that NAV is a very to lock in at. So, our flows have been as per the last month.

SWARUP: We have not yet seen that, that’s the beauty of the market now. I mean we have to give credit to the advisory side of the business for holding good. The long-termness of this asset class of equities is really playing out well. So, a lot of maturity in the market, so all good so far.

MAHENDRA: I guess the debt flows are positive. There are categories in which the outflows are happening. So, if you look at the last month data also, the three categories which got a decent inflow are the “low-duration”, “banking PSU,” and, “short term”.

So, that is in line with the current interest rate environment and clearly the credit side is going to suffer more. I mean, we’re just less than a week away from one of the most shocking credit events that have happened. So, I think the flows are robust and are into the schemes which have a high-quality portfolio and I think there is a universal acceptance now that they will be cutting the interest rates going forward so that should be positive for fixed income.

MAHENDRA: Well, as I said, my view is that we are not over the worst as far as the rate is concerned. This is the same question that I have been asked over the last six-eight months and every time I say that if you’re less than one week away from the last great event, whether it is Yes Bank this time or in the previous situations, other cases, how do you say that your troubles are over? This is because there is a change in the governance model and it is very clear that even going forward, only high-quality will perform.

I mean, there is a certain overhang of how we have been operating and there is a very little recognition of how the governance structure has changed for the economy. I’m not referring to any specifics but I’m just talking about how the banks are now either not taking a decision or are unable to make a decision, etc. So, it is becoming increasingly difficult for people to roll over financing and therefore there are challenges. Is that going to go away? If that is not going to go away, then I think one needs to be careful. I was saying that the government bonds have given perhaps the best return of all the categories and that is a reflection of how things are changing in India. People who continue to vouch for the high risk or aggressive funds, I think perhaps have yet not recognised that change in the underlying mechanism.

SWARUP: We are already seeing that happening. I think numbers which are already there over the last two months are a poor reflection of the same numbers last year. See, I always believe that when you leave it to somebody to take a call, that person will invariably not take a call.

But when you look at the flows, I think what is very heartening to see is that these are the best times to probably put your fund manager to task. You are paying the fund manager and hiring a fund manager, and these are volatile times and in volatility, always lies the opportunity. These are good times for giving fund managers the money and making use of the fees that you pay or hire them for and let them worry about the markets. You do the needful (giving them the money) as per your allocation. I think the fund managers would like to receive money at this moment of time in my opinion. It’s a great time to look at the fund manager’s expertise and it’s a great time for a fund manager to do that and come out trumps over a period of time.

SWARUP: We are big proponents of a fully invested portfolio. We believe static allocation is superior to any dynamic elements. That is our view, we might be right or wrong, but we’ve played it over and this is not just in India, we have fully invested funds globally. But a pure simple asset allocation model works over a period of time. What has happened over this- what I’ve been debating with people over a large period of time is that as we get into this SIP, STP regime, we somehow lose the risk appetite (and correct me if I’m wrong) of doing a lump-sum purchase.

The markets have corrected so dramatically and if you’re not able to do lump-sum purchase right now you have to go back and do the risk-profiling again. At these levels and you just keep the corona aside a little. I mean, everybody will agree with me when I say this you are you aspire to buy a good business at a good price. Just two months ago, we were staying away from them good businesses because of the prices we’re out of our range. But look at the prices now and at these prices, if we don’t buy a bit, then you can hurt your overall wealth creation procedure. But here we are completely static and blatant investors rather than the dynamic side of the story. That’s what we bring to the table.

MAHENDRA: So, let me just put it this way that when there’s an AT1 bond, there’s an issuer which is the bank and there’s an investor who is typically a fixed income investor. Now, the fixed income investor, throwing it as part of his fixed debt portfolio, banks are showing it as a part of its equity. That’s where the whole problem is. I think there needs to be better recognition of the risk that is being carried in the portfolios without corresponding reward. When you invest and you take the risk, you expect to be rewarded. When this kind of a situation prevails in the market, de-facto people are buying equity at the rate of fixed income. That’s where the return and the reward mismatches exist vis-à-vis the risk that is there. Now, what I think what will happen is that people will understand that these are the kind of risks that are there. So, the sensitivity to high-quality portfolios will improve hopefully in the future.

As far as the treatment of AT1 is concerned, I think this is the first time that we are actually seeing an AT1 bond being written down to zero following a restructuring scheme. So, therefore obviously the entire legal field is open. There is a certain term of issue of those bonds which clearly mentions that prior to any such restructuring of the bank, that bond has to be written down to zero which is the copybook action that perhaps the Reserve Bank has taken. Perhaps right, perhaps a little hard-hitting those who were knowing it that it can happen, but it actually never happened. So, I think the legal process will take its course. I believe some of the bondholders who have been hit are going to the courts. I don’t really know exactly what will happen but if you just go by the terms of the issue of the bond, I think it’s par for the course. Those bonds will have been written off prior to any restructuring of this nature.

MAHENDRA: I think after this event, for the past two days, already there is a significant erosion in the value of the bonds which are being held in some of the portfolios. So, just to give an example, some of the AT1 points of the truly blue-chip banks which were trading at about 7.5 percent prior to this event, have then be repriced to 9 percent. So, already there’s a hit in the NAV on account of that. There is already one case where IndusInd Bank has postponed its meeting to consider raising of the AT1 bonds. So, I think there are serious implications of what has happened. We cannot take it lightly. I think it will reset the whole markets’ thought process on these issues.

Even as you felt that I did not answer your questions, but I started, therefore, saying that people did not understand what is the risk, where is the fit and that’s where I think the biggest impact will come. The pricing of the bond will change for 30 different regions. There’s another very big risk which these bonds carry always from the credit risk. That’s something which never appealed to us, which is why we did not buy any perpetual bond. So, luckily, we have stayed away from most of the problem areas because of our core philosophy that our system follows.

But coming back to the point, these bonds are asymmetrical in terms of their pay off because every bond has an embedded call option in favour of the issuer. Now, what happens if the interest rates go up or if the credit rating is downgraded, the issuer will obviously sit on the bonds peacefully and not call it (like what Yes Bank did by not calling the bonds in the first week of March). But if the interest rates come down or if the rating gets upgraded or so and so on, so in effect if the situation moves in favour of the issuer then he’ll call the bonds and then reissue it on terms which are favourable to them. So, therefore the bonds have an asymmetrical payoff. I have all the downsides I have no upsides. Therefore, that was an economic risk, not the credit risk which these bonds had in the top of the credit risk. So, I think for this region these are the bonds which are suitable for a more exotic or more aggressive portfolio. I think our highest authority said also once in the last few months that look mutual funds are investors, they’re not bankers, they are not lenders. So, I think that’s the biggest impact I hope that it will cost to the system.

SWARUP: When you look at the typical investor, he behaves very differently when it comes to equity and debt. The same investor when he’s approaching equity knows his risk and is spread across the risk spectrum. On the debt side, he’s been very cyclical in his purchases. First, there is credit. When credit goes, there is duration. Then there is bank PSU.

There is one fund that continues. It is not that we didn’t say that and if we reflect on the growth of our AUMs, because we said that they didn’t grow very fast. But now that the event has happened, that is the sad part. People learn after such things and whenever they learn, there is a loss behind that loss. If you track us in the last two-three months, certainly you start getting money. It’s not that we didn’t say that. Mr. Jajoo has been very vocal about this part on the credit risk especially, but there was a time when for a long period of time, there were no takers for around credit risk fund. Then it’s okay to buy credit risk. It’s like you are buying only a small-cap, you only buy that much. Your core of the portfolio; if you look at the equity side, the core is practically formed by your large-cap and multi-cap. Similarly, the core in the debt side is capital preservation and after that comes returns. If you want real risks, then you have to really assess the risk aside and put your portfolio allocation in place. The only request is if that were to happen, it is not that it hasn’t happened to us. It happened to us in 2008, we went out and talked to people, but people didn’t hear us, but we’ve learned it the hard way. So, from 2008 till today, our liquid funds have not seen a single day of negative returns; not a single day. It’s been 11-10 years post that and in this entire procedure and this period, thanks to Mr. Jajoo and his team have been isolated from this part. So, you learn the hard way. It is a fiduciary business and you cannot uphold the fiduciary business, then we have to be answerable. Mr. Jajoo will come in and say there is a way of creating returns within a said risk paradigm, that’s there. But you have to know what the risk is involved.

MAHENDRA: I think, first of all, he mostly covered almost all the things, maybe there is very little to add from my side but basically, in the fixed income, you get returns in one of the two sources: duration or credit risk. We always say that market risk is temporary, credit risk is permanent. So, if you get trapped in a duration situation, interest rates are cyclical in nature, they move in a band. So, most of the times you get good returns if you get hold it long enough. The only risk in fixed income is when you lend money and it doesn’t come back. I think as Swaroop rightly said, credit risk has a space in the portfolio but it’s like small-cap. So, how much you invest depends on the risk appetite. The problem with the fixed income space in India is that people invest in credit risk funds not with an expectation of higher return but with the hope of just being able to outperform a bank fixed deposit by about 50 basis points. That I think is the real issue that you are investing like a bank in search of that 50 basis points above the FD, and then at some point, you end up like a bank that generates a lot of NPAs. So, I think the source of alpha in fixed income- by the way, there is a lot of analysis now saying that fixed-income funds have done very well in terms of returns even compared to the bank; some of the more aggressive asset classes like equity. So, if you look at the 30-year bond in the U.S. now, it is priced at 200 rupees, which means your capital value has doubled.

So, if you look at the problem in India, it is the pricing of the credit. If you look at the Crisil indices, AAA versus government bonds versus A, the difference in the return historically, it is not meaningful. So, the point is, should one invest in credit risk funds, should one invest in government bond funds? That carries different types of risks. One has a credit risk; one has a volatile risk. So, it’s up to one’s risk appetite- his adviser will tell him what he should do. But I think that outperformance of the bond funds or the government bond funds or duration funds when the markets are in their favour is humongous. For example, some funds have given 17-18 percent returns in the last one year, 12 percent returns, etc. But the credit risk funds even when the situation is in their favour, they give you a 50 basis points high. So, the point is when you put the whole thing on a risk-return profile, would you take such a risk? Because the highest risk into fixed income is great, would you take the highest risk for 50 basis points extra or would you take a much-diluted risk profile for a significant outperform when the market is in your favour? So, that’s where I think a lot of thinking has to be done by the people who make those decisions. We as fund managers can only do our job and say, look this is the right thing you have to do. There is nothing right or wrong, it’s just how you look at it.

SWARUP: I think they’ve started broad-basing just before the budget. I think a lot changed post the budget. Prior to the budget, the mid caps had started unfolding and it was good to see that. But if you look at the present situation and if you do a broad analysis between now and say 2015-16, which gave rise to this great mid-cap sort of search, at that point in time if I’m not wrong really 60 to 70 percent of stocks are outperforming the index. At this moment, it is just 30 percent stocks outperforming the index. So, the market has narrowed dramatically hence giving rise to different styles of portfolios.

You can take two ways; I mean, from our perspective we remain diversified. So, when you are diversified in a very skewed market you tend to underperform a bit, which is okay. But if you want to outperform then you have to grow with the market and narrow it down to some seven-eight stocks. Now, there are different styles in the market and each one has to pick up different styles as per one’s portfolio and that’s where one has to go a little beyond just past performance to come to a conclusion as to what fund I should buy.It’s very interesting to see the market over the last one and half months. Having said that, the future from a perspective of portfolio allocation has become the equity part. We always and I’ll come back to the same simple sentence that we buy a good business at a good price. Two months ago, the price was not looking good at this moment the price is looking fairly good to us. The only unknown part and I’ll repeat is the coronavirus part, which is really an unknown, you do not know where it ends. That’s something which will have to wait.

SWARUP: As a fund house, we have never been advocates of caps. We’ve always said it’s a bottom-up stock-picking process. If you look at the 10-year horizon returns, there are enough large-cap funds meeting mid-cap funds. In fact, there are enough large-cap funds outperforming small-cap funds also. So, that basic submission does not hold good anymore. A good scheme with good stocks will outperform, irrespective of whether their large-cap, mid-cap or small-cap. The risks are very different. Please understand that in the mid-cap space, especially after the categorisation, it’s a very different category of 150 stocks.

So, one has to look at the mid-cap post—Oct. 22 in a very different light to the previous. It is wrong to look at the previous mid-cap regime and generalise on that. It is not the same. Generating returns in this regime will be very different from the skill set and from a fund manager perspective and from the previous day. Markets have also changed so we are not advocates of this capitalisation and see, we’ve been open to and are product manufacturers as much as you rightly said. But a good fund with good stocks and that availability—so the big will become bigger. So, we’ve been briefed proponents of the large-cap fund when people were writing us off and because we got skewed into just the mid-cap side of the market, we probably missed great opportunities on that side. Similarly, on the debt side, we got so skewed into our focus on credit that we most missed a wonderful great run on the duration side. So, look at the broad market and build portfolios accordingly. There are opportunities everywhere now and, in this volatility, the fund managers trust me when I say this, they have a lot of potential to build a good portfolio.

SWARUP: I would look at a large-cap at this moment. Rs 500 is a lot of money, please go out and buy them or important thing is to buy it right. The prices have become so good, I would rebound on the large-cap to be more definite than mid-cap at this moment. That is our view.