The Mutual Fund Show: What You Need To Know About Motilal Oswal, Edelweiss AMC’s New Passive Fund Offers

OSWAL: So, far, not yet. But essentially, there’s not a lot of innovation that has happened on the active side, and on the passive side there’s a lot more to go. So, we have a jam-packed 2021 happening and hopefully by now people are used to it.

OSWAL: As you said, we’ve done a whole bunch of NFOs in the last year and a half. This is my ninth or tenth one and I think it’s purely because there was really not that many options for investors to invest in passive funds and out of the eight funds that we’ve done, seven of them are brand new. But the biggest question that I get from investors is, what fund should I buy? Now it’s a simple solution, we’ve created a solution on top of the passive funds that we launched over the year and half, and these are essentially portfolios that investors can invest in where they get access to four different asset classes which are completely uncorrelated. So, you get the benefits of diversification. All four asset classes are passively managed, you don’t have to worry about manager risks and you get a lot of low costs associated with it and you’re also getting different risk options. At a portfolio level for different allocations, some of them are very aggressive, some of the mare very conservative, so I think it’s very important for investors today to invest as per their risk profile. We actually don’t have one, but we have two funds that we’ve launched. We have the aggressive option, which is a higher equity component, I think 70-75%. And we have the conservative option which is about I would say 40-50% equity, and we also have a moderate option where we combined those two and get a simple 60-40 portfolio. So, we are actually giving investors asset allocation and these are not dynamically managed. So, in a traditional multi-asset hybrid fund, the fund manager can decide whether to be aggressive or whether to be conservative depending on the market scenario whereas in this fund the allocations are completely static over the lifetime of the fund. So, whether you buy this fund today versus 50 years from now, the allocation will not change. So, essentially what we’re trying to do is give the investor, a simple portfolio that could really in essence, replace or be as good as what they’re managing and we also offer rebalancing as well. So, that’s essentially two products that we provide.

OSWAL: I think what we spoke the last time was about the power of asset allocation. In fact we had, a similar conversation I would say last year, where I argued that one fund is enough in a portfolio. We had a back and forth out there, so I do believe that these two funds are actually, and I would love to have someone counteract me on this case but essentially just to give a primer of these funds, both these, the conservative and aggressive funds, have four different asset classes. So an investor can get access to domestic equity, they get access to debt, they get access to international equity through the S&P 500, and they get access to gold. What we’ve seen is that almost never in history have all four asset classes gone bad together. Essentially if one or two asset classes go badly, you have the other two to counteract and hence, your portfolio becomes a lot more stable if you look at it from a very long-term perspective. If you look at the returns of these two funds, the returns are decent but what is really impressive is that the returns are rarely consistent. Today if you look at Nifty if you held it from a three-year perspective, maybe the returns are not good 10-year perspective maybe not good but if you see from a 19-year perspective, Nifty returns have been absolutely phenomenal and the same with gold too. Gold has been good for the last three years, 10 years haven’t and S&P 500 as well. The last 10 years have been great, the last 20 years have been okay. Essentially getting a portfolio which is very consistent in returns, the returns are decent and you’re also getting like a lot less volatility. So, your standard deviation or your portfolio becomes a lot less volatile by 20-40% depending on which fund you buy. So, that is the mean base case for these two funds and I think the power of asset allocation comes in the allocation not on the fund selection. Today there’s a study which says that 90% of your overall returns over the very long time period, does not really depend on market timing, what you buy and when you buy. It really depends on how you allocate your asset classes. So today if in my equity section I replaced a Nifty 500 fund which we have today with any other fund that really does not make a difference to your long-term returns. So, I think how you choose to invest in these asset classes is really what determines a lot. So, these funds basically cater to the 90% which is where I think what determines long-term returns.

OSWAL: That’s a good question and I did cover some of that by saying that I think more than the decent returns of this fund, the most important fact is that it’s very consistent. If you see this allocation returns from a one-year or three-year or five-year or 10-year or 20-year perspective, it’s pretty much in the range of 12-15%, depending on which fund you buy conservative or aggressive, that’s number one.

Number two, what about poor performance? We’ve done something called rolling study. So just to put that in very simple terms, if you hold this fund for a minimum of two to three years at any point of time, even if you’re investing in peaks or in any valuation, what we’ve seen is that the chances of you making negative returns or even below 8% is 3-4%. So, out of the thousands of scenarios that you could have invested this fund in any given period for a minimum of three years, there’s a very low chance of you making very poor returns. So, I do think that the multi-asset approach is very effective because when you’re having a poor performing asset class, you also have a high performing asset class in a portfolio which counters some of the bad performance in case it happens in equities. So, when equity markets do badly, you have gold which has done really well last year, you have international equity which has done very well last year and even debt has done phenomenally well over the last five, seven years. Now obviously you’re seeing some reversals. I think by having these multiple asset classes, it’s actually maintaining that growth curve over many years.

OSWAL: Yes.

OSWAL: Absolutely. I do believe that 100% equity is a perfectly good strategy. Although the only problem, in my experience in the last 10-15 years, I’ve seen very few people who are able to take their volatility that is associated with equity. I think a lot of people haven’t really seen the losses that have come in through the dotcom bubble or the 2008 crisis. So, it’s not a bad strategy, it’s somewhat what I do as well on the side, personally, but I do feel that in terms of just ability for people to hang on to equity as a category during periods when you are losing 50-60 or 70% in a very short time period, that can really be nerve-racking for a lot of investors which is why I do recommend having maybe a small debt portion. What we’ve also seen is that having 100% equity portfolio versus having instead an 80-20 really makes almost no difference to your returns, it makes a marginal difference. You probably might make a little bit higher but you’re taking a lot more excessive risk so I think the standard of an aggressive investor globally tends to be 80-20, and I would recommend investors to be there if they’re aggressive but obviously an 100% equity strategy is also fine.

OSWAL: Yes, it is an extremely important point, and investors should know, as for regulations, unless you have like a 95% exposure to equity then it is taxed as debt. So, all these funds aggressive and conservative will be taxed as debt instruments so investors should ideally be looking at this from a minimum of three-to five-year perspective. Otherwise, it will be taxed as short-term gains. It’s a very important point that you should look at this from a very long-term perspective and not only play this from a one year or a two year perspective. Obviously, just to add to that, investors hold this for three years, then they can get benefits like indexation where they can essentially increase the purchase price by inflation, which reduces the tax outrage dramatically.

OSWAL: When we obviously went and designed the product we designed it for someone who’s not really very savvy when it comes to equity investing, someone who just wants to put in Rs 500,000 or Rs 5,000 or Rs 10,000 a month and doesn’t want to care about which funds to buy, how do you allocate the money, how do you rebalance your fund. That is typically what we’ve designed the product for—something which is extremely simple and we can offer a portfolio to an investor at a very low cost passively managed, all of that. That is a segment which I would like to appeal this fund towards. Also I think a lot of people today maybe look at the markets which are pretty expensive yields and debt are also pretty low, international markets are very expensive, gold was the highest performing asset class last year. That’s very confusing and a lot of my clients were also holding a lot of cash. So, this could be a good way of deploying money in a low risk, low-cost way where you’re ensuring some downside protection because you’re buying multiple assets. So, I think these two categories would be essentially where we’re getting good traction from.

GUPTA: I think the commonality I have with your previous guest is both of us are launching passive funds but from different AMCs. It’s a long name, unfortunately for a very simple product but incidentally, this happens to be actually the first debt index fund to launch in India, which is exciting. I’m just going to go back to a previous product line which was Bharat Bond. The whole concept of debt passive products came in and target maturity funds came in. Target maturity products were ones where you have a defined time period, whether it was three years, five years, etc. and you just held a buy and hold strategy. It worked really well for the investor because they knew the portfolio, they knew the indicative yield and even in this by the way, the yield rally none of them kind of worried. Now that was a PSU segment product. We decided why don’t we expand the basket and make it a 50% PSU and 50% state development loan basket product. It’s a very simple product, it takes off from the success of that but makes the portfolio 50-50. SDL is state development loans, just like the Government of India has borrowings which we know as G-Sec, SDL is the borrowing of good quality states. It’s also sovereign rated and usually SDLs, they trade above government yields or below PSUs because it is sovereign rating. Today, because of the circumstances around us and the borrowing, SDLs are actually trading at higher yields than PSUs. So, for the investor there is a very good risk adjusted return ahead, where you’re getting better yields than a pure PSU product but at actually a very good credit risk profile. So, that was the idea and this is a 2026 product and it comes at a time yields have been elevated. So, investors are coming in at a very good time.

GUPTA: If you look at the charts there’s some interesting stuff in our presentations. Our products have always been hold to maturity products but tactically yes it is a better launch time. If you looked it at maybe 12 months ago, SDL yields were below PSU yields. Right now, they’re elevated so for the end investor there’s an absolute level of yield that looks good plus SDL relative to other things also looks good.

GUPTA: The construct of the fund is thoughtful. It’s a 50-50 and it’s equal weighted. So, you have a pretty wide basket. The index actually has 21 securities between PSU and SDL and that’s why we have kept 50% SDL. We have also because it’s an index; the methodology is such that you want to keep the best quality and most liquid SDLs out there. So, people should know about that. The other thing people should know is that SDL carries a sovereign rating. So, while states may have their issues and state borrowings are higher, this is a sovereign rating product.

GUPTA: I think that’s a great question. One is that you don’t know whether yields will go up or down I mean nobody could have predicted what happened in February. We do two things. Yes, one there will be short-term volatility in yields and all target maturity funds. We’ve seen that in our previous line of data and we’ve seen Bharat Bond products go below the 1,000 NAV and sit at 990. Your investor has to know that he’s coming in for a whole maturity period. However, we did do one interesting scenario analysis that let’s say you wanted to invest for a three-year period. This is a five-year fund but suppose you wanted to get out over three years and yields rose a percent, because you don’t know what will happen in three years. People say yields will fall yields will rise nobody knows. Say yields rose a percent instead of getting the index yield of about 6.3, you will probably get something closer to 6.1 because you will accrue the interest but you will have a little negative mark to market. That 6.1 is still better than investing in a three-year product today. So that’s why we tell investors that even if you’re if you’re coming for a five-year product if you have a three-year horizon, your risk reward is not bad.

GUPTA: That’s absolutely right. So, indexation in essence is basically the returns over inflation is what gets taxed. The presentation assumes an inflation of four, which is actually super conservative so you pay tax on the 2% incremental return and yes you land up at a post-tax number of 5.9 odd versus a traditional instrument of sub-4. Also, because this is a passive product compared to active funds, this is very competitively costed. So, even the total expense ratio and we are very cognizant as a house that in a low interest rate environment, you can’t have large TERs eating into end customer returns. So, I think the taxation profile, and the TER profile will also help that.

GUPTA: You’re asking me to compare two children of mine. But I think if you look at the vision for the Bharat Bond programme, it was to kind of kick off a movement of debt index funds and ETF products and not just in Edelweiss AMC and we happen to be leaders in this space there are more people coming on but with target majority funds. I think one that that is fantastic moving from FMPs and not transparent roll down structures to clear transparent communication of when things are maturing and what the portfolio is, which is so necessary in the debt market. So, the more of these quite frankly, the better. In comparison to Bharat Bond as I said that was a pure PSU product, this is an SDL product. The most similar product to have in the market in the Bharat Bond series is 2025. That’s actually a four-year product and that’s pure PSU. This is five years; the yields will be higher because it has the SDL element. So, it’s got one year more, and the yields are higher, and our endeavor is just like you have a Bharat Bond range as you said, of products and more will come out in that programme, you will have a PSU-SDL range of products and who knows maybe you’ll do pure SDL, maybe you will do corporate bonds or AAA corporate bonds. So, we want to open the market to as many consumers as we can. The Bharat Bond programme is 30,000 crore in a year, and I hope this programme rolls just as well.

GUPTA: About 20 basis points higher net.

GUPTA: The very important thing for debt investors is to remember these are not short-term products, and there will be fluctuations in the yield, and you can’t panic. I’ve always said this many times in your show that we don’t react to fixed income fluctuations as well as we do to equity fluctuations. When there’s a 20% cut in small cap nobody comes and gives me a call but when yields move a little 1% in debt, suddenly you get take the fixed income very seriously. I think that’s very important. As long as you’re coming in with a three-to-five-year kind of goal because it’s a five year maturity and we’ve shown you three year math on that, I don’t think you need to worry but realise that, that three year journey also is not going to be smooth, smooth, smooth in the sense. So, that if you can keep in mind and just hold on and that’s what you’ve seen in Bharat Bond, but we don’t see too many complaints when people come. As long as you invest with the right expectations, I don’t think you will have a bad experience.

GUPTA: Yes, it opens on the 10th and it shuts on the 16th and it is slightly structurally different from Bharat Bond—that was an ETF and it had a fund of funds. This is an index fund, I think one of the things we found in the Bharat Bond experience was that the fund of fund vehicle became very popular. It went from 1,000 crores to 6,000 crores this year, a lot of retail investors liked the format of not having a demat account, and like a mutual fund doing an SIP into funds like this. So, it met a lot of those goals. So hence we thought we would bring the index fund format, we’ve done that with some of our other equity funds also. The index fund format is a very retail friendly format.