The Mutual Fund Show: The Pitfalls Of Frequent Re-Balancing
Many first-time mutual fund investors may have had an unpleasant experience over the past few years.
Many first-time mutual fund investors may have had an unpleasant experience over the past few years. And that could be on the back of volatile markets.
That has had an impact on inflows to equity mutual funds, which in September fell 28 percent over last month, according to data released by the Association of Mutual Funds in India. Gaurav Rastogi, chief executive officer of the investment platform Kuvera, attributes it to “behaviour gap”, which can have a negative impact on returns and increase associated costs.
Behaviour gap refers to how people analyse data and look at past returns before buying or selling funds.
“An average investor churns his/her portfolio 100 percent every 18 months. That’s a very high rate,” Rastogi said in this week’s episode of The Mutual Fund Show. “Recent studies show that market timing cost the average investors 1.56 percent annually in lost returns.”
Watch the full show here:
Here are the edited excerpts from the interview:
Tell us in a nutshell about Kuvera. What does Kuvera do?
We are an online mutual fund investing platform. We have recently added digital gold to our portfolio. We were the first platform that went completely free so it’s a direct plan platform, but we don’t charge anything from the customers and investors—if they want to use our advisory modules, they can choose to pay for certain features. But otherwise, the platform is free for them to use.
So, anybody who wants to invest in mutual funds directly, can come in through you. Something that Paytm does, Mobikwik does, your platform also does?
Exactly. There are four or five bigger players and there is a bunch of smaller players as well in this space. Like it happens in every vertical in India, it gets hotly contested very soon. So, we are in the race.
You launched in 2016 or thereabouts and you have had prior experience in the financial space. As a result of that, we’ve got this interesting data, which is what we are going to talk about. The theme for the show today is ‘The impact of frequently rebalancing your mutual fund portfolio’. What has history taught you, what has data taught you about this?
There has been a lot of work that is done in the global sphere where data is more readily available and there’s a term which people use which is called the ‘behavior gap’. The idea here is that rebalancing itself is not bad. Periodically, you need to make sure that your asset allocation is along the lines that it should be. Say, you are 60 percent equity, 40 percent debt. Markets change and suddenly you are 80 percent equity, 20 percent debt, then you should rebalance. That’s a good thing. What ‘behavior gap’ specifically talks about is how people churn their data and how you look at the past few years of returns and decide which funds to buy and which funds to sell.
Effectively what happens is, funds that have done well, a lot of AUM flows into that and we’ve seen that. We’ve seen it at the fund level, we’ve seen it at the aggregate market level—when Nifty is doing well, a lot of money comes into equity and when Nifty is doing poorly, a lot of money goes out of equity. Precisely, the opposite behavior. If I had perfect hindsight, I would look at data and I would say, 2008 December is when you should put all your money into equity. That is precisely the point when you look at flows data, the money is running away. And this mismatch where people are too dependent on the recent past years of returns to decide which asset class to go into, creates a churn which also carries a negative return on their portfolio. If you look at some of the international studies that have been done—one is done in the U.S., one is done I believe in the Netherlands. An average investor can lose up to 1.5 percent in annual returns by chasing the past performances. Simply put, if a fund manager delivered a 15 percent CAGR or a 10 percent CAGR, then the investor by trying to time the fund manager’s returns. So, they saw three years of good returns, they said okay get into this one. They saw three years of bad returns, they said get out of this fund—would only end up having around 8.5 percent returns.
On average; this is investors on an average. It’s a big drag—this is 1.5 percent or 1.56 percent to be exact, which is the U.S. study which says that. That’s a pretty big drag in terms of actual value lost or how big your portfolio would have otherwise been if you had not behaved like that.
Those numbers tell you the story, don’t they? At 12 percent return, the Rs 10 lakh would’ve been in five years; Rs 17 lakh otherwise its 16.5. The real number change happens when you do what you are supposed to do; which is, stay invested for a long time.
Of course, it’s the nature of compounding. If we go back to that data and if we look at what happens at the 20-year horizon, the difference in the portfolio at five years is only 7.27 percent. So, you might think, big deal. You keep on doing this behavior for 20 years, you are 32 percent poorer than you would’ve otherwise been had you just said; in thick or thin which a lot of advisers, a lot of people and a lot of bloggers would also talk about. The real power of SIP is actually this discipline, over and above anything else because in time, the market is so hot.
For somebody who I presume has an equity or a debt background and not necessarily only a mutual fund investing background, has it become difficult? They are also equity investors. What they tend to do in individual stocks and get returns, hopefully, they try to mimic that in mutual funds as well. And I presume that it is not a recipe for, if not disaster, then low returns?
It is a very interesting point. When I was a prop trader at Morgan Stanley and if you were trading single name stocks, everyone will tell you about the importance of a stop loss or about cutting your losers. What is true at a single equity level or a single name level may not be true at a diversified portfolio level.
A mutual fund is already a diversified portfolio—25 stocks, 50 stocks, 100 stocks, right? It has much lower volatility. The ability for a mutual fund to take an impact and absorb it is much higher. Simple example, you are invested in a single name stock, bad news comes out, you could lose 80 percent of your equity. Fair enough? It has happened in the recent past, it has happened before, it will happen again. It is the nature of the markets. For a mutual fund, if I own 50 stocks in a mutual fund, each stock is only 2 percent. Bad news comes out that stock is down 90 percent but impact on my overall portfolio is only 1.8 percent, which you could very easily absorb. So, the whole concept in mutual fund that you should cut your losses, it is a very different ballgame when you are talking at the portfolio level versus when you are talking at a single-name level.
I think there is some data which also suggests that at times people tend to make this mistake of trying to time the market and getting out exactly at the wrong time because the returns that come, following a period of depression not necessarily a year but maybe 18 months, maybe six months. But a period of depression and again, you can probably only get it if you have a perfect hindsight. But those returns are magnified simply because the base has started getting down.
It’s one of the hardest impulses to counter. As a professional trader, we used to talk that everyone has a breaking point. 10 percent, 20 percent, 30 percent, 40 percent, 50 percent but at some point, the investor says that this pain is too much. Nifty is down 60 percent, your rational brain, all the long-term studies are telling you that this is probably the best time to invest everything into equity—I am talking about the 2008 scenario. But at that time, you’ve just taken too much pain. For you it is almost like, either let’s just stop it and fight another day. Some people think along the lines—maybe I can get out now and I can then enter when it is much lower. So, what happens is, you get out now, but then get back in much lower is a much harder trigger to pull. A falling market and you’ve lived through a few of them and I have lived through a few of them— they are scary. We can tell people what has happened historically, we can educate them a lot about this behaviour yields this return, this behaviour yields this return, but every individual has to go through that journey and learn it for themselves on their own. An adviser can help you, something like our platform can help you and we can show you all the relevant data, but you have to go through that journey. I am not going to sell out or even better, I am going to add now. It is something that we say pretty much all the time. If at 12,000 Nifty starting a SIP was a good idea, how can it be a bad idea at 10,800? How can it be a bad idea at 10,000? At 12,000, you are willing to buy something but at 8,000 suddenly it is untouchable.
A lot of people say this that, yes I know it is at 10,800, but I believe due to whatever I have heard or otherwise the Nifty is on its way to 10,000 or even lower and therefore I will start my SIP then. I will time the market. Precisely what you’re trying to say causes a loss of 1.56 percent.
Which is why the example — I am going to sell now but I am going to enter later. Sell now is done but the enter later because when the Nifty goes to 10,000 then your view has also shifted. Now you think 9,200 is lighter. Nifty comes to 9,200 and again you validated but your views are again shifted. Now you think that 8,400 is better. So, both cases happen, and effectively what happens is, you don’t deploy the capital at the right time, a lot of fund flows data shows that. A lot of fund flows data into equities show that. That causes the difference of 1.56 percent per annum in investor return. So, it’s significant right? When you think of it.
Should an investor have just a one trick pony to counter cyclicality or just to enhance returns? Like having a set of mutual funds investments whether it is debt or equity or may be combined portfolio of various instruments or a couple of things including gold and equity which give you better returns? I want you to dwell a bit on this simply because almost every single advice that comes in across platforms speaks about this possible right thing if you are indeed investing for longer than seven-eight years then you can choose to invest one in equity funds because history has shown that they have developed superior returns.
Sure, and it might sound a bit surprising that both your statements are true. That’s because there is a ‘if’ in front, you said if you stay invested for nine years equity is good investment. I will not deny that. For a period of 10-20 years, I will not deny that. So, longer the frame, better.
When the market falls, you are no longer invested and that is the problem. The simple idea of diversification is, you want a bunch of assets which each have a positive-expected return. For example—your equity expectation could be 8-12 percent, for debt it could be 6-8 percent, for gold it could be 8-9 percent, so the expected returns are positive. You don’t want to be investing in negative return assets, but the returns come in different time periods. So, when one asset is performing the other one is not performing. The benefit of having diversified portfolio is that the losses are not as sharp, so you are able to ride it out.
If you say that I am going to start these five SIPs choose the fund you want as long as they are well diversified, ballpark and everything is good. Just don’t go for sector and all those specialist funds and if you have that fortitude to tell yourself that 20 years done, not going to touch it. I agree with you, your expected returns will be higher. But returns are not something on piece of paper, they have to be earned. They must be lived through and that living through when your equity portfolio is down 40-50 percent is the hard part.
That’s when if you have some fixed income in your portfolio, some liquid funds, debt funds or gold in your portfolio which is a very good hedge if you look at the 2002-2003 time period or 2008-2009 time period your losses are, instead of your portfolio being down 40-50 percent, it down 20-25 percent. The probability that you are going to live through that downturn and not stop investing is much higher.
You are giving up something as an absolute return, you absolutely are, I mean that is true for an equity-debt portfolio also. When someone say 70 percent equity 30 percent debt portfolio over 10-15 years. It’s a similar concept, it is just that you have keep on adding asset classes which are not co-related. People have long talked about, there is also something called all-weather portfolio, which is basically equity, debt, real estate, gold. Real estate these days in India of course doesn’t get much return but there was a time real estate was performing, and equity was not. That is good diversifier. That time when gold is outperforming and equity is not performing, that’s a good diversifier.
That’s the entire idea but to your statement if you can write on a bond paper that you are not going to be selling your equity portfolio and you are going to be investing in SIPs for 20 years, you are right.
Golds recent performance has brought smiles to the faces who bought into gold funds, not funds but also gold ETFs because those have done remarkably well in recent past. What is your take?
This happens in every period of equity turbulence. It is driven by global factors; it is driven by wars and financial factors. It is a safe heaven. It has been for centuries. It is a commodity but also a currency in its own right. It is one of the few things which is accepted globally.
Another interesting bit is the Association of Mutual Fund data. While liquid funds saw massive outflow, it is a quarter-specific phenomenon but the month-on-month equity flows overall went down. Two numbers stood out for me: One, data is showing 28 percent downtick; two, SIP numbers are still strong at around Rs 8,000 crore. What do you make of this data?
We have to wait for the trend to develop but if I take a nearly read, as you rightly said month-on-month, the equity data is down by 28 percent, you look at any kind of social indicator and how people are thinking about the market one thing is really clear that there is fear. There have been some bad news flows about banks, NBFCs. There is a lot of pain that has already been taken in certain parts of the equity market namely small and mid caps. So, there is some kind of fear already there and some of this behavioral gap could be manifesting itself. I’m not 100 percent sure about this but at one point we are seeing that the net inflow is down by 28 percent but I am also seeing that the SIP flow is fairly constant. I think at some point that SIP number will also start coming down.
The net inflow numbers are down 28 percent if I look at it the same levels that goes around in May and June, so it is not something that is too much off the charts. If you draw a trend line, there the trend line it will already start showing a downward trend and the behavior gap is something like that. We can talk about it but it always manifests itself. Even in the U.S. and global markets where people claim that the financial literacy is very high all of these studies have been done in those markets. There as well you see that at different levels people will either stop investing or actually take money out of the market.
But you reckon that continuing SIPs is good idea at current point of time despite the fears that exist?
That’s the whole thing. If you were invested for 10 years that’s the same ‘if’ right now and if you don’t think 100 percent equity is how I want to go, you have to answer that question as a yes every time.
Erstwhile Reliance Nippon management which Nippon life is essentially the majority owner in the name change that has happened. Why it becomes important because there are numbers of people are invested in these funds. Does this name change signify anything from an investor’s perspective? How people will view this in terms of stability of funds, other flows coming in? What do you make of this?
I won’t say that it is a landmark event of sort. The mutual fund industry is set up in India and there is custodian in charge of your assets so it is not like that the mutual fund industry has carte blanche that they can do what ever they want to do.
So, the money is safe but yes perception plays a very big. Especially,in credit funds because in credit fund you can have a scenario. In credit funds,there is possibility that if there are redemption pressures, I will sell what I can sell. And what I can sell are the good assets. The problem is less inequity. May be in the small- and mid-cap space there are a few lemons but in credit funds that is a real possibility.
In that sense as a perception thing. It matters immensely. Like you have one of the largest life insurance companies from Japan coming in. It is a huge word of confidence what Reliance has built over the years as their asset management business and to the mutual fund industry in India. Is the timing a bit too correlated? Of course, if you were in those shoes you would probably also say let’s get the name change out as quickly as possible but in terms of is this something of which people should be very worried about? I don’t think so.
I think the name change is a positive event. It brings in a pretty big well-funded organisation as a mutual fund owner in our country.
For a lot of people nowadays who look to invest direct: your platform gives them options. What is the best way for a person to do that? How do I choose the fund? Is there a right mix for this?
We have been a very big proponent of index-led investment, starting from very early. If you do goal planning on our site, we will tell you exactly the portfolio you should invest in and 60 percent of it is invested in index funds—the Nifty Next 50 fund and Nifty 50 fund.
In effect, we say that it is a diversified portfolio. It is a bet on the country at large. Selecting a fund manager is as hard as selecting which equity will outperform. There are so many funds and there are so many fund managers and this is not a testament against the fund managers. They are all very smart people, but they are competing against each other and it is very tough market out there.
There are 40-plus AMCs. We think for an early investor, index is a great way to start. Get some sense of not what risk looks on paper but what risk feels like when you go through a downturn. When you are not going to make for one year and then you are going to send mail to somebody saying that I have not made any money and fixed deposit would have been better, that talks more about your risk appetite and how you talk about risk. And you have to live through that. So, index fund is a very good place to start. It takes away a lot of these kind of questions, there are a lot of these kinds of issues out and purely focuses on can you be invested for long term.