The Mutual Fund Show: Right Time To Invest In A Focused Fund?
Focused funds is a category of schemes that invest in a limited number of stocks, either large, mid, small, or multi-cap categories. The market regulator allows such funds to invest in up to a maximum of 30 stocks, with at least 60% of the total assets comprising equities. When do such funds make sense for investors?
There is a place for a focused equity scheme in an investor's portfolio over the long term and timing does not matter, Vetri Subramaniam, head of equities at UTI Asset Management Co., said on The Mutual Fund Show.
The things to consider are valuations, possibility of a dip and quantum of allocation, he said. And the answer to all those concerns is a systematic investment plan, according to Subramaniam. Allocation, however, will vary with person, needs and goals, he said.
UTI AMC is launching a focused new fund offer for long-term investors.
Amol Joshi, founder PlanRupee, however does not suggest investing in an NFO unless it brings something new to the table. Existing schemes have a demonstrated track record of how a fund manager has navigated through different cycles.
Joshi though considers focused equity fund is a good category to have in a portfolio. He suggests Motilal Oswal Focused 25 Fund, which is benchmark agnostic and has a seven-year track record with high-conviction bets. His other pick is the ICICI Pru Focused Equity Fund, which he said has a mix of quality and value investments.
Watch the full video here:
Here are the edited excerpts from the interview:
Let's start with the broader climate. The index investors have nothing to complain about we're trading at new highs. Does this make you reasonably confident about the prospects or do you believe is there a valuation scare out there, which might hamper the near-term prospects?
VETRI SUBRAMANIAM: I think just to put things in perspective, and we’ve perhaps discussed this in the past as well. From my mind, really from an investor point of view when you think about it it's all about getting your asset allocation discipline in place and really that asset allocation discipline calls for rebalancing portfolios in favour of equities when valuations are weak, and maybe away from equities when valuations are slightly more expensive. A second derivative of that argument is to look at what the alternative asset class is in terms of its attractiveness to consider whether that shift if at all- rebalancing of the portfolio makes sense. So, when you look at it from that perspective, let's be very explicit, the bargain and placement opportunity in terms of valuations as we now know in hindsight, unfortunately because of the worst point of the news flow was when you got the cheap valuations. That was a great time to be taking up your allocations. To look at the rear-view mirror and the last one year's return and now take up your asset allocations would actually not only be futile ,but it would be dangerous.
My only recommendation to people would be to stick to asset allocation discipline. The fact that equities have done well in the last one year which now therefore makes equities look like a fantastic asset class over the last three or five years should not be the reason for you to raise your equity allocations. If your goals require you to raise it, then you have a reason but not performance.
What to your mind is the right asset allocation for a long-term investor wanting to park money into mutual funds? At the current juncture, what's the asset allocation mix that you propose?
VETRI SUBRAMANIAM: That's a very fair question for you to ask me, but let me also say it's the most inappropriate question because I think the harsh reality of this is that we can't dispense this wisdom, without knowing anything about the needs of that investor, the financial goals, the income, the spending plans, the saving capability and it's only after all of that is known can you give a framework. Now, there are many thumb rules, invest more in equities when you're young, invest less when you're old. Honestly, the more and more I see there are more people living into their 70s and 80s, which we actually think that whole framework needs to change. Then there's a rule of 100 or 110, I find that also inappropriate. So, I'm actually going to say let's not make it so simple for people. I think there is a need for people, there are planners like Amol on the show, I think you need to sit with them. You don't ask a doctor to give a prescription, right? You go through a whole series of medical tests and then he gives you a prescription, and that prescription is appropriate for you, it's not appropriate for somebody else. As we've discovered during Covid, using medication because somebody else used it actually does harm to your body. So, I don't want to give a one size fits all answer on this. I think it's something people need to work through with an advisor.
What are the kinds of risks for somebody who's looking at investing in mid-cap and small-cap funds? That's because those seem to be have taken the fancy, and in light of the fact that in the last couple of quarters at least, mid caps and small caps have really outperformed.
VETRI SUBRAMANIAM: There are two ways of looking at this. One is where are we in terms of valuations when we look at large-cap mid-cap, small-cap. Is any one of these segments of the market showing a valuation comfort compared to the others? Unfortunately, the simple answer is that all three are looking equally expensive at this point of time, so I'm really not able to see that differential anymore. The second thing to keep in mind and this is also important is when I look at the rolling return differentials between, let's just take large-caps and mid-caps, the historical rolling return gap between these two is more like 200 to 250 basis points over a very long-term timeframe, five-year seven-year or a 10-year rolling period. Now, when you go through a period of a year, year-and-a-half and the outperformance starts to become 30% and 40%, people start to think that is the norm every year. That is not going to happen. The same feeling that people had all the way back in 2017-18, and then you paid a price for that over the next two years. I would say don't go by the outperformance of the last three quarters or four quarters, go by the historical return differential that's maybe 200 basis point at an index level.
Finally, when it comes to small-caps and we made this point strongly last December, actually the asset class return is irrelevant. That is one category in which risk-adjusted returns are actually adverse. It's the ability of the fund manager to pick the stocks that creates value for you in a small-cap strategy. So, I think with a really top-down perspective, I don't see a valuation gap between any of these, the historical return gap is only 200 basis points over a longer time frame. I don't refer to one-year, two-year periods, and in small caps, it's the stock picking which is important.
Investors who want to do individual stock picking—I welcome investors coming into the stock market, whether they come in directly, or through the mutual fund route. I think eventually it's a great thing. Everybody needs to plan for their financial future. Equally importantly let Indians participate in the wealth creation that's happening in the country, otherwise for the longest time we had only foreigners participating in wealth creation and providing capital so I think it's a good thing.
What many people will discover over time that even if they can develop the IQ for investing, the hardest part in investing is the EQ (emotional quotient) component. The ability to absorb drawdowns, setbacks, to hold your conviction during difficult times, that is what eventually will create returns. If you don't have that or you believe you don't have the process and the time to devote to that then it's better you give it to a professional manager.
Do you advocate thematic funds at all for investors, first time or otherwise, or are they specific for high-risk investors?
VETRI SUBRAMANIAM: So, I won't use the term high risk. To be very honest, we do offer our own share of sector and thematic funds but I do believe there is a big difference between these and the traditional diversified funds. They could be segmented across market caps in different ways based on regulations, but that's a separate point.
In these diversified funds, what you can hope for over a period of time, is the ability to capture the returns of the asset class and some alpha on top of that as well. With the sector funds and thematic funds, it's not so simple. The cycles are far more pronounced. It's not only important when you get in, it's equally important when you get out.
And when you get into this loop of when will you in and will you get out, I find that there are too many people who managed to even sometimes get the entry point right, but they don't know when to get out. So, really you need the armoury board to determine entry and exit you can improve the aggregate returns of your portfolio if you have the skill set to capture that entry and exit points but if you don't have the armoury or the skill set, then be careful because you might realise that you're the one who actually is completely unprepared to deal with that level of volatility. So, you can use it as a return enhancer but do you have the skill set is what you need to ask yourself.
The common advice or the common conversation right now is that, park yourself in debt funds in a way which enable you to either lower the risk, or maximise returns because interest rates are going to move up. My question to you is, is it as predictable and should investors position themselves that way or wait for events to happen before they take a call like that because at least my experience shows it's virtually impossible to predict which way the turn of events would be in a given year?
VETRI SUBRAMANIAM: I think that again comes back to understanding what's the purpose of those fixed income funds in your portfolio. Is it to give stability to your portfolio? Is it to ensure that that part of your capital does not experience a drawdown? If that's the thought process, which are coming in, then clearly you don't want to take a very big risk particularly on credit and then at a second level in terms of the interest rate risk. I'm a little bit more sympathetic to the argument that I think a lot of what we are seeing the inflation data globally as well as an India is slightly transient. The harsh reality of the fact is that the economy is running at a level of income generation, which is unchanged from two years ago. The economy is under-utilised and in economic terms, there's a positive output gap, which means we are operating below capacity. So, to my mind some of these inflation fears are transient, unless we get an unbelievable recovery and growth which I think the jury's still out on that. My sense is, you will see a lot more stability in rates and perhaps the markets are nervous about it. I think India's case compared to—the same fear of inflation has been there in the U.S. and the 10-year bond in the U.S. has actually seen a dramatic rally. Yields have gone down, the bond prices are up, it's not happened in India, partly because our bond borrowing programme is a lot more aggressive, there are some concerns about the size of the overall deficit and we are not the world's reserve currency, the way the dollar is—that’s the simplest reality but I'm not as concerned about that interest rate movement perhaps like some others are. I think on the credit side why take that risk if the purpose of fixed income in your portfolio is to conserve and keep capital available.
Tell us about the new fund offering from your stable. The rationale for launching that offering and the timing of the same?
VETRI SUBRAMANIAM: So first off, let me get to the timing aspect because that's the question I get asked most often. There's no rocket science to the timing. Let me be explicit, I'm not suggesting that there's something unique that I have divined about the markets today which make the focused fund, the most appropriate strategy to launch in today's market and a milestone for every investor in this portfolio. That's not where I'm coming from. Look, I represent UTI mutual fund, we have schemes which have been in existence for 30 years and 35 years. Investors who have bought those schemes 35 years ago, who have bought it 10 years ago or 20 years ago they've done well for themselves. I hope and I'm of the firm belief that there is a place for UTI focused equity fund in an investor's portfolio over the next 20 or 30 years as well. It doesn't matter when we launch it and I'm explicitly telling investors that you don't have to give us money only in the NFO, if you have some money to give us in the NFO, give us a little bit there but do a SIP-STP for the money and give us the money over the next one to two years. This is not an IPO of a company where you will get it at this price in the IPO, and you may never again get it at that price post listing. Of course, that's happening only recently I can tell you many IPOs which traded below the IPO price in the past but this is a mutual fund NFO. You can buy at any time, the discipline is in buying it all time. So, there was absolutely nothing to do with timing as regards this product. We just think we've demonstrated the strength of the investment process and the research framework at UTI across a range of strategies. Many investors wanted this kind of portfolio offering from us. We've got the right fund manager for it today and we just felt comfortable going out there and putting the product in the market. So, it's nothing to do with timing the market, and I repeat, even if you're looking at investing in this fund, I'll be happy to accept your check in the NFO, but I'll be happier if you split your investment between the NFO and the next one year or two years, rather than give me all the money in the NFO. This is certainly not an IPO where you will expect it to open immediately.
I am assuming Sudhanshu Asthana would be managing the fund?
VETRI SUBRAMANIAM: Sudhanshu was somebody we specifically thought of. We went to look for outside talent, we wanted somebody who was already comfortable with the idea of a concentrated, conviction-led portfolio. We're very glad to have him on board, he's got top notch experience with some of the top mutual funds, he's also run a similar strategy on the PMS side. So, we found him very well suited to do this with our team. We spent four months getting him to understand the research framework, creating the model portfolio, understanding how he would run it and only then we brought it to the market.
Will this scheme be different than the others or do the guidelines make it difficult to have a different scheme, than the rest of the peer pack?
VETRI SUBRAMANIAM: Look internally what we do is, we always look at portfolio overlaps between our individual schemes and this scheme has about a 30% overlap, with most of our other sort of main schemes so it's not going to be significantly similar in terms of portfolio to the others. Partly it's also just got to do with the concentrated 30-stock portfolio.
I meant, different from the others in the market who are also offering a focused equity fund?
VETRI SUBRAMANIAM: There's one simple difference, it has the name UTI on it. It has core alpha investment process backing it and it has I think it has a first notch investment team of fund managers and analysts sitting behind it. That's all that is different about it I'm not going to claim that it is a rose which smells different compared to any of the others.
Amol, have you been studying UTI AMC NFO, which is the focused equity fund and do you recommend that or would you believe that investors can give that a skip and look at some other focused equity funds if indeed focused equity funds are good to invest into?
AMOL JOSHI: Vetri has really made my job easier. He has very candidly mentioned that there is nothing unique, of course they have the core alpha unique kind of investment process, backing up and a very capable team of different managers who are going to manage the scheme. But having said that in NFOs it doesn't ever harm to repeat the traditional wisdom, and that wisdom is do not invest into an NFO unless it brings something new to the table. So, what is new? Unless it brings new geography to the table, in the sense if there was one point in time there was a Japan equity fund that was launched, if you wanted to participate in Japanese equities probably that NFO was probably a good bet but a focused fund as you rightly said there are several other schemes already existing in the market. The second point of course is the existing schemes have demonstrated a track record over a period of time, how the fund manager was able to handle during the sectoral rotation times, how the fund manager was able to handle during the various valuation phases of the market. If a scheme or a couple of schemes that have proven themselves in the market, I think those are probably a better bet. If you are a big fan of risk management then you can of course, apply at UTI but having said that since it's the NFO, you are better off investing or looking at schemes with a proven track record.
So, if somebody is inclined to invest in a focused equity category so to say, which are the funds that are good to invest in?
AMOL JOSHI: There are a couple of focused equity funds that you can consider. One of them is Motilal Oswal Focused 25 Fund, second is ICICI Prudential Focused Equity Fund. Now both of these funds, obviously the category name itself says that these funds typically have around 20 to 25 stocks. The first one, Motilal Oswal, that fund has taken a big sectoral bet on banking and financial services. The top 10 stocks in the fund contribute to about 72% of the weight. So really, if there ever was a deflection of conviction bets, which I think this is what they have demonstrated and, when the financial space was not really doing well until a few weeks back or for the last couple of months we have seen a big uptick in the last few days, keeping that aside, I think they have been able to accumulate about 40-45% of financial services over there and as the sector picks up again, which we saw since the last few sessions, I think that scheme should do well. Since I also mentioned the track record, let me also mention that this scheme has about seven to eight years of track record and has done really well over the one-year, three-year and five-year parameters. The second scheme ICICI Prudential Focused Equity Fund I think whenever somebody talks of focused funds, even in my talk I mentioned about the conviction bets, you would actually probably want to look at a manager with basically, a quality or a growth bias. The ICICI Prudential Focused Fund also has a value orientation to it, typically in the style, the way, ICICI Prudential manages it and since its value oriented, currently they are bullish on few macro themes. Those are credit upticks in the banking sector, that's one, real estate, two, and domestic recovery that's three. So, these are some of the sectoral calls, macro calls on the value side that ICICI Prudential Focused Equity Fund takes that’s why its my second pick in the space.
Are you comfortable with the results of say a Motilal Oswal Focused 25 or the ICICI Focused scheme?
AMOL JOSHI: When you talk about returns, I mentioned macro calls, sectoral calls in both of the spaces. If you are talking about the Motilal Oswald Scheme I think this scheme has done comfortably well with about a five-year return of 12% CAGR or 50% CAGR return over a three-year period. I don't think there is anything to complain and another point which I touched upon in the previous bit is that this scheme is heavily invested, having about 40% plus in the financial space and that space has not been going well for last several weeks maybe couple of months. Now it has really picked up, and as the sectoral themes of the fund manager play out, I think if there is any bit of complaint on return spreads I think that should get addressed as the banking and financial sector picks up from here.
Amol, what is a good debt scheme at the current juncture and why would you recommend that?
AMOL JOSHI: So this question I get asked a lot from investors as well I think this is going to benefit a lot of viewers and listeners. See, not too long ago maybe in the last quarter, suddenly all of us got kind of a shock if I can use that word when the rates were reduced on the government saving products. That notification of course was pulled back and there was no rate reduction so to speak, but people are really looking at some kind of increased yield or a slightly higher yield compared to what bank fixed deposits are able to offer you. The largest banks in India are offering you for one-year, a fixed deposit rate of something like a 4.9% or thereabouts, give or take. Ideally, considering long-term orientation and higher yield, I am looking at something called is Nippon India Dynamic Bond Fund. The scheme is dynamic in the dynamic space, but currently they are running on a roll-down strategy. A roll-down strategy—we have discussed it several times in the past on this very show. A roll-down strategy is simply run by a fund manager by a particular maturity paper, let's say, over here, the fund manager has bought a 10-year paper about one to two years back, and that's when the scheme has a resilient maturity of about eight to nine years. If you have five-years upwards or seven to eight years kind of an investment horizon, then this scheme has a very high-quality portfolio, 100% into state government securities also known as STLs and the yield-to-maturity are very decent. I would say 6.70, in the last declared fact sheet because of the reasons of a roll-down structure. You also mentioned when speaking to Vetri about the interest rates and how they will move. When you invest into a rolled-down structure and since this is typically a eight to nine-year product, there will be some volatility, but if you stay put for the duration, then the paper is continuously using maturity in the sense, one year later, an eight year paper will become a seven-year paper and so on and so forth. So, all the volatility that you will see in the portfolio over the next few years, if you stay put for a five, six-year to a seven-year period, I think that volatility will not affect you. So, you'll benefit from the highest quality debt portfolio, number one, high YTM too, and shielding you from the interest rate volatility, especially if interest rates make a u-turn upwards.