The Mutual Fund Show: The Learnings From 2019

Balasubramanian: The year was tough, both credit market and liquidity was tight. I must say that the mutual fund industry has managed the whole thing quite well. Managing the business in such a tough time with a lot of confidence and ensuring that we actually manage the money in a manner that does not actually give too much of systemic risk as well as to the investors perception get changed. I think both of them managed it well. I think 2019 was in some sense the worst year from the point of view of credit and debt markets and even from the equity point of view it was a little tough. The earnings were not coming in, but I must say that the industry has managed it quite well.

Mahesh: So, I think 2018 partly and 2019 were very difficult years for money managers because we have seen the broader rally in the market. Nifty is showing one picture, right? Year till date, Nifty is up around 3 percent or so, small cap is down 13 percent, mid cap is also negative. Within Nifty also if you look at the top 10 companies, they have given more than 20 percent return. The next 30 companies have given negative returns. So, in that kind of environment for a money manager to really outperform the Nifty was a big challenge because normally, one would built diversified portfolios and that would be the source for alpha. For fund managers, it worked out beautifully for the last 15 years, since I’ve been managing. The last one year was difficult here in that sense because the breadth for the market has been narrow and also, there was a little divergence between what the headline indices are showing, and what the underground reality has been. So clearly, there has been a dramatic slowdown across. We have witnessed it in the last 2-3 quarters. But the market, because driven by global liquidity I would say this time around are not so much domestic liquidity, has been going in other direction. So, these dichotomies which are there in the market have been a bit of a challenge and we are probably reaching a phase where we are seeing the end of that phase. Since January 2018 we have seen this phenomenon. We are nearing the end, that was a tough time—beating the benchmark itself was a big challenge.

Balasubramanian: Whenever the markets turn volatile and the volatility stays for a prolonged period of say one year, two years or three years, then naturally, the investors will then start looking at how I am performing in every investment that I have taken exposure... One thing that has gone quite well in the MF industry is, look at investing in mutual funds for a longer term, ride through the volatility, then only I think you will get what you desired to get from the mutual fund industry. That messaging is very clear, the understanding of that is also very clear from an investor’s point of view. That reflects on the SIP flows. One month’s numbers shouldn’t make us believe that it is a complete reversal of trend. The way the momentum got built up, in accepting mutual funds as a vehicle through which one can make the investment for a longer term, that still stays good. I think it is temporary. One should not pay attention to the one-month numbers being low for the industry.

Balasubramanian: I think it will change. The people who would have redeemed and probably would have found some other alternatives have maybe temporarily not understood how the investment has to be held for a longer term to get the real benefit. But, all of them will realise it. I have seen this in the 2008 crisis, the 2009 crisis, most people started writing off equity as an asset class in 2009 as if the world has come to an end and therefore, one shouldn’t make an investment in equity. And we saw, the entire thing got reversed in 2012 and 2013. The moment people start seeing that experience and they start staying in for a longer period, they will come back. That is something which I have seen in the last so many cycles. We are in the phase where people realise that I put the money for a longer term but why should I get bothered about short-term volatility? That is the messaging that is continuing to go and that’s when people will start accepting that yes, I have to stay invested for a long term if I have to reap the benefit of being in the mutual fund industry.

Mahesh: In the mutual fund side, what outflows we see, we always maintain liquidity in the portfolio. So, it’s not a question in terms of managing the funds but clearly, some large outflows I would highlight over here. There are mainly some large redemptions which we have seen. The SIP flow has been steady, right? So, long-term investors continue to invest. The market rallied a bit in the short term so there could be some profit-booking. Those kind of inflows and outflows are likely to happen.

Balasubramanian: One of the key things that we keep advocating is that it is more about asset allocation. No one asset class will give you a continuous experience without going through the volatility. Whether it is an equity, whether it’s a fixed income, whether it is a liquid fund. What is most critical from an investor’s point of view is, look at mutual fund as an asset class right from liquid fund which basically takes care of the saving needs of every investor. Go up to the income funds which takes care of the income needs of the people and then the wealth creation from equity and then it comes to taxation. If you look at the entire cycle and if you have an exposure to each of them because for every instrument there is a place for it in the customer’s portfolio. That is something which we need to look at as the next level of growth where the MF industry can cater to every need of the savers. The moment that messaging goes very clearly with the acceptance that has come from the investors, the SIP way of investing in mutual fund is a great way of investing.

Mahesh: It has been a bit challenging in terms of trying to beat the benchmark because you would normally look at companies on a valuation growth framework which has not exactly played out in the last couple of years because of the money flow into a few stocks. We have seen that stocks have become excessive in terms of valuations as compared to their historical averages. That at times, becomes challenging for somebody like us who buy stock, we like good stock, good companies with growth and are willing to pay a price for that but a reasonable price. So, that has been a challenge. Having said that, a lot of changes are happening. With economy shift, you need to do changes to the portfolio. Some of the cyclicals which one thought would pick up haven’t really done well because of this slowdown in the economy. So, some tactical shift into the portfolio allocation, in the sectors needs to be warranted looking at the underlying economy. At the same time, high conviction ideas which are there in the portfolio, which in the near term, because of some of the stocks being out of favour or money not getting into these names, they have underperformed or the valuation multiples have gone down without the earnings actually changing. So, one needs to really stay put over there, get the confidence in the names and we have seen times change. This has been a slightly elongated period of the divergence but I am getting a feeling that we are probably coming to end of that. In fact, in the last three months we were able to beat the benchmark. That gives us confidence that we are at a time where some of the broader markets or bets which are there, which we have taken from a longer-term perspective, are now starting to playout. I think it will slowly start to improve. It will probably take more momentum only when we see the domestic economy starting to move up because the broader market is more to do with the underlying domestic economy. It is a more reflection of that. Nifty is a reflection of domestic economy as well as what’s happening globally. Global recovery has actually happened slightly earlier because of the global liquidity money flow that has been moving in. So, as the economy bottoms out here, probably say in this quarter, you should see it bottom out and as it improves, you will see the breadth of the market improving. A lot of other sectors will start to participate. Investor experience has been not good, right? People have seen Nifty at a level, but the mutual fund returns might not be to that extent. That will also start to change. I would bet on that going forward. At least into 2020, you should see that playing out.

Mahesh: You are right. The markets can be against or irrational for a long period of time and only way out of that, even as a money manager or as an investor is that, you do the right allocation. You like the mid and small caps from a long-term perspective, they probably would give you a slightly better return than large caps over a 5-10-year time frame. But there are periods where there could be serious underperformance. If you have allocated in the right amount and the right proportion which you can manage in that volatility, then you are fine. It averages out over the long term. Similarly, in a portfolio also, I think as long as your allocation concentration is to the extent, which is manageable and as per the mandate, I think these periods are challenging periods. You have to really take some corrective action but once things normalise, it should again come back. So, it’s more about concentration allocation because many investors in the bull run after 2013, 2015, 2016, 2017, we saw taking a larger exposure to mid- and small-cap funds. We saw good inflows over there. So, some of the investors where their portfolio allocation had gone higher, they are probably seeing the pain at this point in time but if you had a balanced approach, it’s not that bad.

Balasubramanian: As Mahesh said, there is a complete divide between the large, mid- and small-cap stocks in terms of performance. There is a huge deviation. But having seen this, and it has remained that way for the last one-and-a-half years— since 2018 and till date—the divide continues. Essentially, it means the greater outperformance from the large cap has already come. How much more time it can come would be a question mark then. Having said that, it has also created a valuation gap. So, keeping this in mind one message that we are giving as a fund house is there is a great merit for one to have an exposure to multi-cap funds, which have the flexibility to move between large caps, small caps and mid caps and that is one thing that we believe that one should look at it as asset allocation strategy for next year.

Balanced fund as a category continues to stay as a part of allocation. Though one may say that last one-year performance was not that great but ultimately in the longer run if you look at it given the fact that it has the same flexibility as the multi-cap fund with respective to the fixed income portion of the portfolio as well as the equity portion of portfolio.

And third of course is the balanced advantage fund where you move between equity and debt as asset allocation category.

Having said that, some of the schemes can always be part of the core portfolio. In our case, we have a theme which is purely running on consumption. But given the fact that they all are secular story and then you have to look at it as a 10-15-year investment such as GenNext Fund or MNC fund—that is another category which we normally say that do not look at the performance—the short time performance could be sometimes good or bad but that doesn’t mean that the theme also goes through similar volatility. The theme is for longer term and therefore one has to play the theme with a longer term in mind. That’s the broad pattern which we are giving advice for 2020-21.

Mahesh: Just to add that I think, there are a lot of pockets of value which are in the market at this point in time and looking at that we recently launched a PSU fund. PSUs have underperformed but if I take two-three year views wherever there is value I think we have seen growth playing out very strongly. Those are more tactical ideas; I mean the larger compounding will always happen in the growth stocks but there are times when you see immense value in the market when the stocks are quoting dividend yields of as low of 5-7-8 percent, when your bond yields at around 6.5 percent, clearly it’s time that you should start good margin of safety over there. I would agree with Bala the core has to be multi cap and the risk reward is fairly well balanced, large caps will continue to do well I mean they are steady, mid and small caps, yes there is some risk which is there but again on the balance the valuations are attractive. So, do the right allocation but don’t go aggressive anywhere that out message is asset allocation.

Balasubramanian: So, fixed income is a 25-year old category, it is not some three-four year category. Credit fund has got track record only of five years and mutual fund actually took the lead in building that credit portfolio by offering alternative to the traditional fixed income schemes in AAA securities or may be take rational call — purely on the basis of interest rates calls, etc. If you look at the mandate of credit funds—look for opportunities and invest in less than AA rated papers—and this is the first year the number of AAA that got downgraded by one or multiple notches is highest ever in the history of bond market. I have been in the bond market for the last 30 years and this kind of downgrade I have never seen in my whole history. Therefore, the year turned out to be unique. Having said that, even the people who come for credit fund come with confusion—interest accrual, interest volatility, thanks to monetary policy, rating migration that caused interest rate to move up and down, and default category.

Then having looked at certain segment of investments below the AA, see whether we can have a diversified portfolio or a concentrated portfolio. One of our lessons was that diversified portfolio would have done better given better outcome. In short term, yes, you will see NAV volatility — volatility has to be ignored as far as there is confidence built up in the next six month or 1-2 years. Second, as we have seen in the case of NPA resolution, one has to be sure that whatever is written is purely used for valuation methodology not that the same value will hold good for ever, majority of money will come back of course, but some will get written off 100 percent. The probability of money coming back more than what is being valued in the portfolio is equally high because everybody will work tighter for finding resolution and so on and so forth. One has to keep in mind that as you write down your portfolio there is always a scope for write back on portfolio so that should help in NAV coming back.

But one point to consider is how many investors are willing to invest in credit risk fund. If you look at the majority of people, 90 percent will come and invest in other funds. Only a small proportion will invest in credit risk fund who are those who understand market quite well.

Mahesh: A key learning is how do you manage risk because whenever crises happens, like what happened after 2008 financial crises, we as a fund house look at risks, where you have to strengthen, what you do so that even if a crisis hits you, you are able to survive. Some impact obviously will be there, but it will be manageable, and you will come out of that. I think, that is something which we need to relook into and we are looking into that whether it is concentration risk or risk to a particular group at large. Even in equity, last year has been a learning curve. A lot of focus on corporate governance, management quality and market has been very discerning in terms of differentiating companies which have got good management and better corporate governance. We have seen companies which have been hammered, companies which have gone wrong with stock prices down 70-90 percent and that’s a big learning and how do you avoid those mistakes because that can take a lot of your total NAV or your total performance.

Balasubramanian: I think, side-pocketing is actually the outcome of the learning that was there not during this period of crises, it was learning which was there when there was issue in the market about Amtek Auto and few other names that happened about few years back. Since then, from 2013, side-pocket has been in discussion. So, how do you find resolution for any credit issue that arises all of a sudden? You have to manage two things—liquidity in your portfolio, take into account the systematic risk, and getting out the bad ones from others so the bad one can be nurtured.

For instance, when somebody does not have money, you can’t expect him to pay the money on the day it matures. But he is willing to pay the money. The intent is good and he can pay the money over a period of time. The only way you can nurture this is through moving to side-pocket. SEBI understood its importance and then gave permission in December. Most fund houses have opted for it. If we get into trouble in future due to some unforeseen reasons or some accident happens then how would you manage such kind of things in such scenarios, that’s side-pocketing.

I think globally it exists in some countries, it is a best way to find a solution for the good assets that you have taken into the portfolio but temporarily you will go through pain period, the temporary pain can be resolved with the side-pocket mechanism.

Balasubramanian: ...Each of the fund houses received clear directions through the circular that when such things arises, if the money manager has to be rewarded less or something has to be looked at, the compensation, all things are left to the trustee side. One has to keep in mind that 2018-2019 is one of the worst periods we have seen in the credit market. As long as one is fair in those kind of assessment, I think industry will take note of what should be done—keeping in mind the investors and building the mutual fund industry from the next level point of view.

Mahesh: I would say for example, management quality, how valuation divergence can happen, and important thing is to stick to your conviction. Markets can force you to do certain things which is not part of your philosophy but try to stick to your conviction. At the same time also respect the market. One can’t take a view which is totally outside the market and because you are managing people’s money. So, some kind of alignment here needs to be done but not questioning your conviction and at the same time sticking to that is right balance how you get that I think is the key from fund manager perspective that is the key learning say for me.

Balasubramanian: In my perspective, staying on top of the job all the time and ensure that you are doing right thing. Nobody knows what is going to be the outcome tomorrow or day after tomorrow, but as long as you are at top of the job and maintain an oversight, I am sure the outcome will always be better.