The Mutual Fund Show: When To Consider Balanced Advantage Funds
India’s equity benchmarks have rebounded to record highs after the worst selloff in more than a decade earlier in the year. While the market is not cheap, the rally is becoming broader and broader, according to Nimesh Shah, and the stocks that haven't done well in the last five years can do so in the next three to five years.
In a narrow rally, mutual funds will not perform because by they are diversified, the managing director and chief executive of ICICI Prudential AMC said in this week’s The Mutual Fund Show. But schemes with diversified themes are likely do well in the time to come, he said.
Shah said balanced advantage funds may be a good option for retail investors who can't withstand market volatility. The fund house has launched a new fund offer for its ICICI Business Cycle Fund in this category.
“In a scenario where interest rates are likely to go up, investors won’t make money in the near term. Hence, ICICI Prudential AMC isn’t advocating a fresh investment immediately in the current scenario,” he said, adding that the period to invest in duration funds is over.
Exposure in accrual funds, which benefit with rising rates, might work with a minimum of three-year perspective, the fund manager said, urging investors to benchmark return expectations against risk-free rates.
Shah personally invested in debt funds. “Post Templeton (scheme wind-up), I invested in my credit risk funds and my medium-term plans in March-June. I’m not taking them out now because I will have to pay tax," he said. "If I keep them for three years, it would be much more beneficial."
Watch the full show here:
Here are the edited excerpts from the interview:
What are those one or two key things that stood out for you in terms of learning for the year 2020?
Shah: I’ll narrow it to only one, it’s not even two. Its macro, macro and macro. In 2020, like 2008, we have been seeing it since a long time, but 2020 has made it very clear that micro bottom-up is very important, but you cannot lose sight of macro. And macro investing is extremely important because the government or the world decides a policy. What is happening in 2020 is you could not have made your calls right and you could not have done anything right if you did not have an eye on macro. The kind of money that has come in, the kind of money that is printed, and if you didn’t have an eye on that, the central bank balance sheets around the world have moved from 20 trillion to 26 trillion, you could have in no way anticipated that these kinds of inflows can come into the market which can cause this kind of a rally. Let’s go back to March. If you see March 2020, the way market had discounted, there was nothing wrong in that. All our industries were struggling, the factories were closed and what the market reacted, it was a perfect and a logical thing to do — that bottom up every EPS during the year has been affected and if EPS has been affected, then the market should go down and that’s what happened in March. It would have been very difficult to take a call at that point of time that in the next three months by June, as the market reached 26,000 we came on your channel and gave a big buy call. That’s what we did on 26,000-27,000 but at 35,000, we started reassessing ourselves that whatever the market had reacted, the markets had gone down from 40,000 all the way down to 26,000 and again the markets had come back to 35-36,000, what do we do with our buy call? But we did not want to give a hold call or a sell call at 35,000 again because we could see a macro trend coming up that central banks are expanding their balance sheets, printing money left, right and centre and you cannot fight a central bank. Though the fundamentals were not in place in India, in June, July the fundamentals were not in place, but we did not have the guts to fight the central banks of the world. Today, the markets are being run by the central banks of the world and one should not take a position against the central banks of the world whatever micro might tell you. That’s what the reality is, that micro can tell you a different story, but you cannot ignore the macro. So, 2020 has been a great learning. We at ICICI Prudential are always talking about balanced advantage fund etc. But that balanced advantage fund is also to an extent taking allocation on equity- and debt-based on macro fundamentals.
I think 2020 should be remembered as a year where macro investing in India has come into play.
How does that set us up for 2021? We don’t seem to be out of the crisis but we are in the throes of the vaccine, or in fact it is being administered as we speak. In India, even if we might be a bit far away from the vaccine, I think we are doing remarkably well compared to the rest of the world, especially the Western countries. How does the macro therefore set us up for the early part of 2021?
Shah: Right now we are at an all-time high market, but let’s analyse where our market is today and then talk about the next year. Right now, it is an expensive market. Historically, we are at 26 P/E and if you look at forward P/E also we are at 24, while our history is that the forward P/E is around 17-18. So, the market is not cheap, that is very clear. But when we analyse this market, there are 50 stocks in Nifty and when we analyse it further, I will say that the top 10 stocks since January 2018—because in January 2018 the market was high, and let us see the time from 2018, 2019 and 2020. In the three years the market looks good, the market has given a good return, the Nifty return is about 31%. When you go into the details of it, the top 10 stocks have given a 70% return, the next 40 stocks have given actually -10% return. So, I am saying that in the last three years we’ve seen a very narrow rally and in the last three months the nature of the rally is changing. What has happened in the last three years? The expensive stocks become more expensive, the top 10 stocks which all of us know, have just gone out of the valuations and just out of the roof for the top 10 stocks is the remaining market. So, overall, when I said the market looks at all-time high, the forward P/E of 24 looks high, it is only in the top 10 stocks. The remaining 40 stocks even of Nifty do not look as they looked earlier, and in fact the small cap is down 24% from January 2018. But the last three months have shown that the market is getting broader and broader and the rally is getting where it’s not restricted to the top 10 stocks. If you see, metals has come back. So, a lot of sectors are coming back. During the year we have seen pharma coming back. I’ll do another macro call that we may be positioned with what is happening with the metals in the world. We are positioned now for the inflation coming back and what we have been seeing is, in addition to food inflation, we believe the next year or two, we’ll see inflation coming back and inflation coming back is very good for the corporate side. For the corporate EPS, it’s a good sign that it is happening. So, we have seen a market of last five years, where we have seen a CAGR of 11% in the market, but we have not seen any earning per share CAGR. So, earnings per CAGR is a good way to do a huge catch up. So I feel beyond the top 10 stocks, the market does not look that expensive and there are opportunities all there. So, macro call on the flows, that the wider flows have been coming into the country and with the central bank-led rally, flows are expected to come in, we also expect the dollar to peak, we expect that inflation will be back and we expect that the recovery cycle is on in the country and it is doing well. What has not done well in the last five years, can do well in the next three to five years that’s our call.
So therefore, you would believe that the investor of the last three years, who may or may not have seen terrific returns in his mutual fund portfolios, and I’m not talking about the blue chip or select portfolios which have done well, but largely some of the other players which may not have done well, you will see the return to performance from a lot of those portfolios, which might have mid-cap stocks, commodity or economy-linked stocks etc., all of those would actually do well going ahead in 2021-2022?
Shah: In a narrow rally, mutual fund is supposed to not perform because mutual fund is diversified. A typical mutual fund will have 40 stocks. Suppose one particular stock in the index will be 14%. So, will I go and put the investors’ money 14% in one particular stock? I will not do that and be diversified. I’d put what, 2% or 3% in that particular stock, but that stock goes up 100%. Mutual funds are designed to underperform in this kind of a market. I would be more worried if mutual fund outperforms in this market. Only a focussed rally, which has matched with the top 10 stocks, which believes in taking expensive stock, can only do well in this kind of a rally. So, if you see what has happened in the last three months, the value is back, and cyclicals are back and I expect that trend to continue. Let’s look at a sector like telecom. All of us and during our day, we are talking to you based on our telecom network in the country. I have got a good Wi-Fi in the house and I have been able to talk to you. The entire ICICI Prudential has run from their houses in the last nine months. So, if that is possible where I had to bring up daily NAVs every day, telecom has its importance in our life. It is next to roti, kapda and makan. Wi-Fi is also a part of that. Despite that there are only two or three companies in telecom in the country. Do we see that in the next two three years, there will be a growth in the amount that we pay for telecom? Nowhere in the world is telecom as cheap as it is in India. Will we increase the revenue or charges from India? Yes, we will increase it and when this increases, it will show in the telecom revenues and telecom EPS. Another sector is power. If you see some of the prominent companies in power in the country, they are available at a single digit P/E because maybe they are owned by the government and the people are not confident. But in power I can clearly see some of the companies, their ROCEs are decided in advance. Now, as the facility comes into play, there is a fixed return that the government gives them. So, it’s a very good industry to be in where it is in single digit P/E, it is given at a dividend rate which is much higher than the interest rates in the country. So, I think there are a lot of value spaces available in the markets today.
How does an average mutual fund investor take advantage of this? What does an average investor do in such a scenario? Assuming that he believes in the theory that you’re giving.
Shah: What we discussed till now is that it is a flow-based market. And flows can be volatile. With that volatility, if you have seen what has happened in 2010 and in 2011 — in 2010, the markets went up but in 2011 the markets corrected. In 2012 markets went up but in 2013 the markets corrected because the flows were happening that way. So, in a flow-based market volatility, which is very highly valued, is a given. So, retail investors will not be able to withstand that kind of volatility. A strong message from ICICI Prudential is that you must be in balance advantage fund categories, we’ve got a fund called asset allocation fund, which decides what assets to put in which one. So, it is an asset allocation fund, it is a balanced advantage fund and we have come with a very interesting concept of a business cycle fund. These are the three funds that we recommend. Last year I recommended debt and it has played out beautifully. In a scenario when I recommend debt investing, it is only for three years. In a scenario like today, I expect interest rates to go up. You will not make money out of the interest rates going up. So that is why I’m saying that either it is asset allocation fund, either it is balanced advantage fund or the third option is the business cycle fund that we’re coming up with. These are the three things that I see retail investors investing in.
2020 has also seen this very peculiar characteristic... the average retail investor who was parked in mutual funds for the last two-three years, maybe suddenly is looking to the west or just taking advantage of the bottoms etc., probably shifted some of that portfolio into direct investing as well. Do you reckon that mutual funds over the course of the next two three years, as the cycles move the way that you expect them to, would be able to show outperformance at large? I mean, frankly, except for a few schemes, maybe because of the very nature of the product, mutual funds over the last three years haven’t quite given the returns that people would have anticipated. Do you think that the next two three years can be different?
Shah: It’s very good that a lot of people are getting into direct equity. I am not sad about that because a lot of digital channels are getting people into it but this has happened earlier as we have seen in 1992. All of us have now spent 30 years in the market and we have seen what happened in 1992, we have seen what happened in 2002, we have seen what happened in 2008. Whenever there is a rally, a lot of people have believed that they are smart investors and they do come in and it is healthy that they come into the markets. Over a period of time they’ll realise that they make money in two or three stocks and five stocks they might lose money. Let’s see a complete cycle. We have seen only six months of this cycle. People started coming into the market in February-March and they made a lot of money. So, a lot more money is coming into direct equity. So, good for them, that they have made money and a lot more money is coming into direct equity. We will remain diversified because risk management for us is very important. Mutual funds will be diversified vehicles and in narrow rallies, we are okay that some of the mutual funds would not have performed to the extent that markets have performed. The last three months has already changed. So we are three year or five year planners and you should come into mutual funds only if you are three and five year players otherwise you should not be in mutual funds. So, all those people who are getting into direct equities, if they have the knowledge and they can over a sustained time manage performance, that is good... So, I am not hassled at all of what has happened in the last three years. In fact, it is a very healthy sign and that’s how I’ll put it.
The last two three years have also been in a way event-specific from a debt fund perspective as well and it’s kind of culminating with the Franklin Templeton key voting processes well. As you know that was kind of the poster boy of 2020 when it comes to debt news. So, what do you reckon a debt mutual fund investor has in store? I also ask this because you make this very interesting comment that you believe in the next two three years, we might see the return of interest rates moving up and therefore debt investing will be different than what it has been in the preceding five.
Shah: What I say will gel or not gel with your retail investors I’m not sure, but I have always been saying that in debt, we can invest in a fund like ICICI Prudential Credit Risk Fund or ICICI Prudential Medium Term fund. I’m saying that there are times when you invest in accrual, there are times when you invest in duration. Duration is when you expect interest rates to go down, you make money out of it. That time is over and now, you cannot be investing in duration now... When I say debt investment, I’m not talking about opportunistic people that put in today and get out in seven days. I’m not talking about that. I’m talking that it takes three years to get a tax advantage. So, if somebody comes in, I always say that he will be staying for three years. If you’re staying for three years there’s no point in investing in duration funds of ours but you should be investing in accrual funds of ours. While I understand that there’s been an incident in one of the mutual funds in the country and there were some other credit events also in the country and some of the mutual funds that got affected but from the ICICI Prudential Mutual Fund side, there has not been a single person with whom we have invested and he has been delayed by a single day till date. We have been in this business for more than 20 years and we’ve not had a single day’s delay in any of our instruments. In fact, these particular three years, have showed which mutual funds you should be investing in, on the debt side. Ultimately, you need to have those kinds of processes in credit side, that will make you decide where you will invest on credit and where you will not invest on credit. Investing in AA rated companies, investing in A+ rated companies is the only way you can make some money out of debt. By investing money in AAA companies—today AAA companies are borrowing at 3.5- 4% for three months. You will not make any kind of alpha if you keep on investing with AAA companies because the spreads have just gone at a toss. So, AA companies of India are good, they are good investment options, we have always been investing and we will continue investing in good AA rated corporates of India as we have not had a single negative experience till date. I am not saying that in future also we can’t have but if there is an incident, it will be the first thing as I have got a risk management practice in place, whereby we are able to decide where to invest and where not to invest on the debt side. We are going to integrate it. See, my CIO equity is also the CIO for debt—it’s a common CIO. So, I believe that equity guys can look forward while debt guys can analyse the past well. Mine is an integrated team with the debt analyses things quite well and equity is able to take a call that ultimately all of us sign off when we invest in debt. Anything less than AA, anything has to be signed off and all of us get into signing off. There are six people who are using their mind and signing off on this one, so that has also helped us. For accrual funds, I think ICICI Prudential Credit Risk Fund or ICICI Prudential Medium Term Plan would be a good investment with a three-year paradigm but please realise that fixed deposit rates in the country have gone down. Don’t look at my last one-year return because say, a medium-term plan would have given a 14% return. I myself have invested and I have got 13-14% return in the medium-term plan. That is not possible because from March to now interest rates have just gone down but that is not going to happen. You’re not going to get those fancy returns. Look at the fixed deposit rate of the banks and we will try to get something more than that, that is what our endeavor is.