The Mutual Fund Show: Should You Invest In Infrastructure Funds?

Amol Joshi: Whenever there is fear in the market, rates or yield-to-maturity of mutual funds have gone up. Whenever there are higher yield-to-maturity, you are likely to make more returns in the long run. This is not to say that there is no credit risk. In a credit fund, you obviously run the credit risk.

With the RBI’s rate cut and higher yield-to-maturity, the debt fund investment remains as strong an investment proposition as it always was.

Vishal Doshi: The risk reward as we perceive in the financial market is that the ratio is now probably tilting toward reward. The difference between the repo rate and yield-to-maturity of many of the accrual schemes have now started looking attractive. In the past whenever these kinds of differences occurred, the investors have made double-digit returns. So, I think probably it is time investors should start looking at accrual funds or credit risk funds.

Vishal Doshi: Sure. But equity has a different kind of risk profile compared to a debt scheme. So, when you invest in equity scheme you are investing probably to 2 times growth or some larger returns at least of 15-20 percent returns. Debt naturally is not that kind of product. Debt investors have a set view that they have to have their principal protected and are looking for certain kind of return profile. The schemes are probably not comparable.

Amol Joshi: This school of thought is also right when somebody says that if I have to take the risk, then I might go to equities and have a much better reward at the end of the day after my investment horizon is done. However, in that we are ignoring one point that based on your risk profile, if you don’t want to take the credit risk, then there are other products in debt as well. You have liquid funds, which in my opinion, have very less chances for going wrong.

In credit funds, we have to look at some calculations. Earlier some of the credit funds had a 5-7 percent exposure to one single security. If that security goes by, you are probably looking at a much bigger dent. These days, I know some funds that have around 70-80 securities. So, the average holding is not more than 1-1.5 percent. Even if you lose 25 percent of that 1 percent security, then your overall hit in that portfolio or in that scheme is restricted at a quarter percent. And most debt investors who come to long-duration or medium-duration schemes, they will stay for three years because at the end of three years, they will get huge benefit called indexation via taxation. Over three years, this 25 paisa cuts are hardly anything.

Based on that, the risk-reward matrix is probably looking attractive at this stage. Certainly, we have seen some of the names that have faced troubles and those names were able to pay all their maturity. That’s something that cannot be ignored. Whenever times were bad, we looked at it with caution. Whenever the repayments have happened on time, the credit goes to the fund manager for selecting right credit.

Amol Joshi: A particular scheme that comes to my mind is Franklin India Short Term Fund. This fund has done consistently well. It had one of the papers, but that was around three years back or probably more. After that the fund’s concentration in each security has drastically reduced. Fund size is large enough to take care of the liquidity redemption. Funds also follow something called auto-liquidation of papers, which is where you have papers that mature at regular intervals, so that it automatically generates liquidity. Franklin Templeton has also shown one of the better credit evaluation expertise in all their funds. So that would be my pick.

Vishal Doshi: ICICI has a very good accrual fund which investors should look at. Returns have done fairly well in the last six months and the yield-to-maturity of the scheme is very good. So, I think investors can look at that scheme for double-digit returns.

Vishal Doshi: People should invest in the infrastructure funds, but with a longer horizon. Earlier when the National Democratic Alliance-1 government came, I think in 2014 itself the infrastructure funds gave probably 50-60 percent returns in one year. So, investors are getting excited even now that the NDA has come back and maybe we can see that kind of returns. But you have to remember that in 2011 and in 2013, infrastructure funds gave negative returns. So, the base for 2014 was very low for these funds to start with. But now, in the last five years during the first NDA government, these funds have given returns anywhere between 10 percent and 18 percent compounded annual growth. The base is not so low. So, funds will do well but not like the 2014 kind of scenario, where we saw 50 percent return in one-year time. But definitely, investors should look at the infrastructure funds because the government has got clear focus on this sector. So, these funds are bound to do well.

Amol Joshi: I have this long held view that sectoral funds, being at the extreme end of risk and return matrix, probably run the highest risk simply because everybody knows sectors can be affected by one single government policy. Sectors can be affected by technological disruption, which nobody sees coming. They can be affected based on how the political outcomes of the other end of the world are—something that IT companies have seen two to three years back. Having said that, since the equities are always unpredictable, you do not want to add one more risk to that entire mix.

Another point was made that currently, these have given 15-18 percent CAGR. So, you are probably looking at this entire space as highly valued. My view is that infrastructure or any sectoral funds, you should go only when you know what you are doing and when you are comfortable with the valuations. Else, normal investors are always best served with diversified funds. Fund managers are much better equipped to take sectoral calls than an individual investor.

Amol Joshi: Of course. For a stock market, over medium to long term, if stocks have to do well, banking has to be the part of that entire growth story. Banking as such is about one-third of the weight in the index composition. When all those things are there, that makes banking slightly different.

There were certain infrastructure funds, which held banking stocks as well because banks lend to those particular infrastructure projects. You will have banking almost at every sector you look at since it forms 35 percent of the market currently in terms of the index composition. In diversified funds, you still have funds which have maintained banking anywhere from 25-40 percent, which is as large an allocation as you hope for and so diversified funds makes sense. May be not on banking funds directly.

Amol Joshi: ICICI Prudential Banking and Financial services fund has done really well, if you have a view on banking and are comfortable with valuation and if you are allocating it only as proportion. If you are building a portfolio and if you want to go towards banking and if it is restricted towards 5-15 percent of your portfolio, then the sector won’t do you much harm in case your call goes wrong. If that is the perspective, then you can look at this fund.

Vishal Doshi: Yes. I think banking as a sector is probably the backbone of our economy and if the economy grows, then the sector is bound to grow. When there is blood on the street, that’s the time when you have to invest. This is a sector which has seen all kinds of troubles in the last one to two years. From the non-performing asset mess which was created to the NBFC crises that we have seen but as things move on, I think the sector has only grown in proportion. Now investors have a choice as either they invest in diversified mutual funds where 20-30 percent of portion is already in banking stocks, largely in private sector banks, or they can go for specialised banking funds.

Investors can go for these banking funds because the government is trying to cure the NBFCs liquidity crises. The government is trying to do merger of PSU banks, and probably capital infusion is happening. Also, the economy is slowing down so, the government is looking to reverb the economy. All this is going to help the banking sector. So, there are two to three good funds in the banking space, which investors can look at.

Vishal Doshi: Yes. A small proportion of portfolio can be invested in these funds.

Vishal Doshi: HDFC Top 100 is the fund which has done well and is probably likely to continue to do well, given how the portfolio is. In the other funds from the mid- and small-cap space, ICICI has got a small-cap fund which is doing reasonably okay now. In the mid-cap space, there are a couple of funds which are continuing to do well. So, I think investors are probably okay to hold on to these funds. As market probably grows, then these funds are bound to do well.

Vishal Doshi: It is the index fund for the Next 50 index. I am not so comfortable with that index composition, because I think around 40 percent of the composition is in sectors which are not doing so well as of now, are probably lagging, and are showing trends of de-growth. I am not so comfortable in holding that kind of fund.

Amol Joshi: Within the well-performing funds, I will take the name of HDFC Top 100. Whenever a fund performs, you always should know about the story or the reason behind the fund performance. The manager of this fund has always been very active in communicating that we work ahead of the cycle.

Before the maturity for particular sector or large company, we take the profits much before that maturity and we get into the sectors that are looking up now. One of such calls are taken for the corporate banks. Based on that, this fund is probably doing well. If you believe that such a fund or such a strategy sits right with how you will want your fund to manage your money, I think then you can stay with that fund.

In the mid and small caps that have not done well, three months is not the right time window to look at. But having said that, if you have taken a three- to five-year view or you have more than a five-year view, then mid and small cap certainly can be taken exposure into ,especially via systematic investment plans or systematic transfer plans. One important point is compared to January 2018, just before the scheme categorisation and budget for last year took place, you had maximum divergent between mid- and large-cap valuation. Now that large-cap valuation has gone up and mid-cap valuations have come down, mid cap looks slightly better placed than large cap, if you have a five-year-plus sort of horizon. So, you can continue, especially if you take exposure via a systematic way like SIPs or STPs.

Vishal Doshi: I think those funds can be held on to, because the valuation gap between the large and mid caps have increased substantially. We all understand the market is probably moving by 10 stocks, which is pushing the index up. So, I think there is nothing wrong in the portfolio for those stocks. It is just that the market is now in such a zone that even 10-15 stocks are pushing the index up. So, there’s nothing wrong in holding those funds. Investors can continue to hold those funds.

Amol Joshi: If a fund is doing well, you should know what the story is. Similarly, this is the new fund, so you should know what the story is before you go out and put your money into it. This is a quant fund and it works on a certain rule, certain methods of calculation—algorithms let’s say. First, this fund wants to not invest in the companies that are not doing very well in terms of return equity, corporate governance, and various parameters that the fund has selected. Second, this fund intends to have a very low churn to keep the expenses down. Finally, the fund has categorically tried to communicate that we want investors with preferably five years or more horizon.

One more point, the fund has communicated that in a one-way sort of market which is driven by liquidity rally, and by something which is not really valuations, then this fund will not do well. That’s the reason why you should have an extended time horizon. If your view is two to three years or anything less than five years, you should not look at it. However, if you believe that quant funds or the funds that work on certain rules or certain algorithms or computer model, and you think this is the way to go you can allocate certain portion.

In quant funds, the re-balancing is once in six months. I would say that to my comfort this is probably much longer. I would want something which has an evolving view on the market. Six months is probably something too long. So if you were sitting in April last year, you just had a budget in which you had a long-term capital gain tax and before completion of three months you had scheme re-categorisation, in which a lot of mid-cap and small-cap were sold, you will miss this entire event.

Amol Joshi: As of now in the new fund offer, the fund says it will re-balance only once in six months. I don’t think the fund or the team would want to change it so quickly because that will not be a great point on conviction.

Vishal Doshi: I think one of the interesting points of this fund is that it removes stocks which are not doing well, and which are basically called alpha destroyers. They have BSE 200 as a benchmark. So, when they run their model, I think, 99 stocks were eliminated such as stocks which are either highly leveraged or stocks which exhibit high volatility or high beta and stocks which have management issues etc. So, we now have got only 100 stocks left out of BSE 200. Now again they have set of rules to choose 50 stocks out of that and those rules are pretty interesting, where they are looking at stocks which have consistently shown higher return on equity, higher earnings growth etc. and probably good dividend yields and free cash flow yields. So, that is precisely what an investor would want in his portfolio.

But the point is that the investor has to be ready to sit in this fund across market cycle which is probably the key point here and the market cycle may probably last seven years in India. So, if the investor has that kind of horizon only then it makes sense for him to enter in this fund. In the end, these funds don’t really have a stay in India. Probably there is only one quant fund in India which is Reliance Quant fund and that again has a different set of rules. So, that will perform differently than this quant fund. Investor should have that kind of horizon, if they want to invest in this fund.