The Mutual Fund Show: How To Diversify Short-Term Risk As Global Volatility Persists
While Indian markets are faring better than global peers, investors shouldn't be complacent as global uncertainty persists.
While India's stock markets are recording new highs, faring better than global peers, investors shouldn't be complacent as global uncertainty persists. And debt is one option they can consider to lower risk and diversity portfolio in the short term.
That's the view of three investment managers and advisers BQ Prime spoke with in latest The Mutual Fund Show.
Everything about India is great but the external environment is not as rosy, according to Aashish Somaiyaa, chief executive officer of White Oak Capital Management. "On a relative scale, we are looking better, but stock markets are not isolated."
A many parts of the world are in trouble, there is negative news flow that could trigger a correction, he said, citing the example of June lows. And such a situation, an investor looking to park money for up to six months can consider ultra-short term funds, he said.
"If it is my money, this is what I will do you: put it in an ultra-short-term fund and then see how it can drip into equity (through systematic transfer plans), depending on what type of opportunities are available, because I don't see fundamentally too much going wrong right now. But just that the external environment could give us some kind of correction, along the way."
Poonam Rungta, a certified financial planner, also advises such schemes as they are safe and not subject to interest rate fluctuations. Besides, she said, they can generate 1-1.5 percentage point more than fixed deposits.
"If you have a horizon for say three months, we can park it in liquid fund, we can park in ultra-short products where there is no exit load, where there is a quick flexibility. You redeem it today, and you get the money T+1 day or T+2-days maximum."
While Anant Ladha, founder of InvestAajForKal prefers ultra-short-term category over liquid funds as they offer yield to maturity between 6.85 to 7.35% with a modified duration—a measure of by what percentage bond price will fall if rates rise by 1%—of 0.30 to 0.40.
For someone investing for six months to up to year and a half, he suggests two options. Arbitrage funds as they are taxed at 15% plus surcharge, which is lower than debt that attracts 30%, and offer effective returns of somewhere around 5 to 6%. And floating interest fund where YTM is between 7.25 to 7.75% and modified duration of 0.50 to 0.70.
Watch the full conversation here:
Edited excerpts from the interview:
You are launching schemes, you are going out and meeting people, you must be getting a pulse of what people are doing and you have seen multiple cycles. Do you believe people should be risk averse and diversify accordingly, looking at what's happening around the world?
Aashish Somaiyaa: I think over the number of years, I have seen that investors have become more and more discerning. This is obviously people with experience. Well, we know the construct of our market is such that practically every day, every week and every month, there are new investors who are joining the world of mutual fund investing and equity investing and capital markets in general.
But over the years, I have seen that there is a critical mass or a larger number of people who are becoming more discerning, more experienced, and more seasoned. Frankly, while we are discussing it right now, whether people should be risk averse or not, if you really see the data and my interactions also, clearly shows that people are becoming a bit more cautious right now.
Two or three things, I think, one obviously the narrative on India, at every level seems to be positive, whether it's our economy or corporate performance. But on the other hand, if you see the global environment, I am sure that's what you are quoting. So, if you see the global environment, I don't think many people are buying into that too much because economies and corporate sectors, one can always argue that we will have different levels of correlation or isolation.
But as far as stock markets are concerned, you know, beyond a point, maybe you fall less, or maybe you recover faster, or maybe you outperform, but you can't be really, you know, you can do relatively better.
But absolute numbers, you can see last one year, there's no return and October 21, was 18,400 but as recently as June 2022, we were at 15,000. So, that 18-20% was not a small number. So, I think yes, you know, people should be risk averse, people should be careful and cautious, and I can already see it in people’s behaviour.
For somebody who is a small-cap investor, should he choose mid-cap or flexi-cap funds. Somebody who is a flexi-cap investor generally, should she or he choose large-cap funds and when somebody is a large-cap investor, should she actually move to the debt side because they want to be ultra conservative or conservative than what they usually are?
Aashish Somaiyaa: You know, clearly everybody has a risk profile and everybody has an asset allocation or at least everybody should have an asset allocation, which is in line with the goals that they want to achieve and clearly that asset allocation should be devised as per the risk-taking appetite.
So, from that perspective, you are right, that everybody is in a different position relative to each other clearly. And when you look at your asset allocation, let us say you are somebody who is supposed to be 50% equity and 50% in debt, let's take an example and you will find that, you know, in the recent times that 50 has become 60 or 65 because there has been in last couple of years, things have been on an upswing, last one year not so much. But clearly, in the last couple of years people have made some appreciation.
So, if you were overweight, if you were holding money in equity, but you have had some loan to repay on the other hand, at an asset allocation level it is better that you are neutral to your desirable weightage. You know, hopefully in these kinds of scenarios where we are talking about being cautious, you should clearly not be overextended, that is one thing. Like I briefly alluded, if you are investing at the cost of repaying some loans or something like that, you know, you might want to prioritise that.
Coming to your other question, you know, obviously, so that naturally dovetails with what you are saying, which is that if you are somebody who invests in equity regularly, but then what you are finding that it is time to be cautious and maybe you should be in a large-cap fund or a balanced advantage instead of going at the extreme end of equity.
You briefly mentioned that we are launching products at this point in time. Now clearly, we go through a whole regulatory process and as and when we get approval, we get products out. But you know, our objective is always to beat our corresponding benchmark.
We are not controlling individual investor’s asset allocation, and when people are subscribing to any fund you know, we assume that either they are self-adviced or they are advised by somebody else, who is helping them whichever way. So, we have to assume that people are taking care of their asset allocation. So, when we launch a product, we are not going to take cash calls, our mandate will be to beat the corresponding benchmarks. On the other hand, as far as investors and advisors are concerned, they should be mindful of the desirable asset allocation.
Maybe it's the wrong question to ask because you run an AMC, but if you had a choice as a retail investor to put out an ideal asset allocation currently, it may be for a period of one year and then you might pivot towards either a more risky or even more conservative as the case may be, but under current circumstances, what would be your be your ideal allocation?
Aashish Somaiyaa: Very briefly, since we are talking about caution and, you know, be careful about asset allocation etc. Just to contextualise basically, my worldview, or at least our worldview, is that you know, everything about India is great, we are not debating that. But our market obviously is operating in the context of an external environment and the external environment is not as rosy.
Different parts of the world have different reasons and they have their own problems. On a relative scale, we are looking better, but stock markets are not isolated. So basically, when so many parts of the world are in trouble, the chances that you know some or the other could precipitate, or some of the other negative news flow, some or the other impetus for a market correction and like I said, as recently as June we have been 20% lower than where we are. None of those reasons have gone away and we are making new highs all over again.
So, let's just say that risks are rising, and we should not be led into complacency. So, what does this mean, what does this translate into as far as your question is concerned. I would basically say that today when ultra-short-term funds and you briefly alluded you know, you are going to talk about this in your next segment like you mentioned, you know, short-term rates are at 6%. You know, to the ultra-short-term funds, liquid funds are giving 6% and by the way, our running yields are somewhere in the range of 7%, you give or take 20-30-40 basis point expense on a growth option and ultra-short-term get 6.5% today. So, short-term rates have really gone up; interest rates have gone up across the spectrum.
On the other hand, we have already discussed equity. So, if it was my money what I will do today, I will park all that money in ultra-short-term fund on a running basis. Six months back it was giving nearly 4%, today it is giving 6-5%. So, I will park all my money in ultra-short-term funds, and I would register it a systematic transfer over a kind of slightly long systematic transfer. Usually people transfer money in two-three months, but I would register a systematic transfer, put money in an ultra-short-term for next six months and when you will drip the money over six months or if there were to be a correction in the market, let's say we were to go back to 15-16,000 then I would kind of accelerate the move.
So, if it is my money this is what I will do you know, put it in an ultra-short-term fund and then see how it can drip into equity, depending on what type of opportunities are available, because I don't see much fundamentally, not too much going wrong right now. But just that the external environment could give us some kind of correction, along the way.
Like you mentioned that external environment is not working away but India seems to be doing okay. There are some very bright notes that are being hit etc. If you had a choice of a thematic fund, where is it that you believe your house will launch a thematic fund?
Aashish Somaiyaa: I think that the whole financial space is one. Talking about banks is beaten to death, not debating, not discussing that, but in the broader sense of financials, you know, everything to do with capital markets, whether it is exchanges, deposits, wealth managers, asset managers, you know, the whole space because I think that that is what has changed dramatically in the last five years. I think for the next few years, that is what will continue to accelerate, according to me, that is one area.
The second thing is, if you really ask me, consumer durables or discretionary because you know, when we are talking about thematic it wouldn't make sense for me to say okay, IT has underperformed a lot and I think next in six months will outperform because I imagined that when you when we are talking thematic we are not talking about a six-month mean reversion kind of thing. So, we are definitely talking about, you know, at least a fund which you need not close in three months or which will go on for the next five or 10 years.
I will say that beyond banks the broader financial and consumer discretionary. I think these are two areas, which are maybe sustainable.
Poonam, for somebody or let's say I am using myself as an example, I have some money, which I don't know whether I will need immediately or not, lying idle my bank account, I want to invest for a very short-term. Now can you define what this short-term would mean from a mutual fund perspective, the products available and what are the kinds of returns that people can expect from this category or these categories?
Poonam Rungta: That's a very valid question and a lot of investors have this kind of confusion in their mind. First of all, everybody thinks mutual fund is only for equity, which is not so, mutual fund is in fact a core product where you have exposure to every investment avenue and every investment opportunity which can be seen in a financial market.
So, when you talk about the short term, people usually jump to the fact, I need money only after three months, let it be in a saving bank account or maybe do a short-term FD and generate some returns over there. But here I would like to point out, like you said, that start like a layman. There is an option in mutual funds also, we have a debt category. 100% debt just like how you will invest in a bank savings account, not invest sorry, park, I will use the word park. You park the money in the savings account and not bother so much about the interest, just keep about the safety of your investment like my capital is safe and I can use it whenever I want. So similarly, we have products in mutual funds which have short maturities, which are safe, not subject to interest rate fluctuations.
So, if you have a horizon for say three months, yes, we have a product. We can park it in liquid fund, we can park in ultra-short products where there is no exit load, where there is a quick flexibility, you redeem it today, and you get the money T+1 day or T+2-days maximum.
So, invest investors’ money in these products, which doesn't have interest rates fluctuations, like treasury bills or commercial papers and you know, market papers like that, which have very short maturity, they are not subject to interest rate fluctuation. So, that kind of products are available in which if the investor parks money, instead of keeping it in a bank savings account, you can generate more returns than bank FDs which is like even if it is 1-1.5%, you can generate more it makes some sense.
In the same way going forward, first of all in mutual funds, it is very important to understand that time period which you have in your hand. So, you can foresee that you know, your money is available for three months or six months or one year, it is better to have a specific arrangement to park your money. So, from there we can take it from ultra-short-term or liquid funds to you know, a little bit bond funds or medium-term or something like that which can generate better returns in the period available to an investor.
Anant, for people who have money for let's say less than three months, up to six months and up to one year because I believe over one year that's a slightly longer-term horizon. What are the kinds of options available? What are the kinds of returns that can be expected?
Anant Ladha: Firstly, randomly saying that mutual funds or some debt products are always better than flexi FDs and FDs, I think it is a vague statement. We have to see the overall scenario. In the rising interest rate scenario, if your money is for ultra-short-term period, even flexi FDs are a good option, and it is absolutely okay.
But looking at where we are today, I am trying to give some options. If your time horizon is below six months, the ultra-short-term category is something which I am attracted towards. Instead of liquid fund I am choosing ultra-short term as a category because there are YTMs that is yield to maturity. That is the interest rate at which those mutual funds have given money ahead is comparatively higher. Right now, we have YTM of somewhere between 6.85 to 7.35% in ultra-short-term category with a modified duration of roughly 0.30 to 0.40 which is still okay. So, for below six months, this is a very interesting category.
If you have a time horizon of 6 months to 1-1.5 years, we have two categories in that time horizon. Firstly, is arbitrage fund, especially if you are a person who is paying interest at maximum rate, arbitrage fund can be a very effective way of getting equity taxation plus getting effective returns of somewhere around 5 to 6% and the second category is floating interest fund where presently YTM are somewhere between 7.25 to 7.75% modified duration is roughly around 0.50 to 0.70 range. So, these are three options which we have.
Anant, I will presume that the taxation in each of these is non equity taxation, so 30% tax?
Anant Ladha: Yes, according to tax law, except the arbitrage fund.
In arbitrage fund, it's equity taxation and which would mean that in the short-term you are paying up to 15% tax?
Anant Ladha: Makes sense. Absolutely right
So, Poonam, for the two categories or the two options that you mentioned, which is either liquid funds or ultra-short-term funds, are all houses giving almost equivalent products or are there one or two which are doing a good job and you might be indicative of them?
Poonam Rungta: Mostly, all fund houses have this category of funds in their debt category. You can choose a good fund house which has got a good rating of their funds also, that's also equally important, where the ratings of the papers held are of good quality then only you get more secure, and you are sure of the good returns. Because even in the debt funds, whether we are sure that capital will be safe, they are also subject to interest rate fluctuations. So, you have to choose the funds which have got a good track record and good papers in hand because we have seen in the past how things went wrong in a good fund house.
So, I would recommend in the liquid category you can go for ICICI Liquid Fund, or you can go for Reliance-Nippon Liquid Fund or maybe Aditya Birla Liquid Fund you can go for those. Ultra-short term also I would recommend all these three funds and also you can look at for DSP Mutual Fund and Axis Mutual Fund.
Anant, you added a couple of categories out there, one of them was arbitrage, now this is got an equity angle to this as well, are there's some fund houses which are doing a good job?
Anant Ladha: See, whenever I am selecting debt funds, my simple criteria first is safety. We have to see whom the fund house is giving money to, secondly, what is the track record of the fund house. We have to see liquidity, which means the size of the fund, I want big size fund, especially in debt funds, so that there is no liquidity issues. Third, I look at returns, returns is third priority when I talk about debt funds.
Firstly, if I talk about ultra-short-term category, there is a fund which has Rs 10,000 crores plus stable fund, which is ICCI Pru Ultra Short Term Fund. So, that is one fund which I like in the in that category. The second fund can be Kotak Low Duration Fund, it can be used when our time horizon is from six months to one year.
If I talk about arbitrage category, Tata Arbitrage Fund has off lately done really well, and their AUM has also increased, and they have a sizable AUM of Rs 6000 crore plus stable fund. So, that fund is very good especially because it has low tracking error. In arbitrage fund we have to see that our fund house or the fund is not having high tracking error, so, that is a fund which I like in that category.
In floating interest if I talk about few fund houses, obviously ICICI is really good even HDFC is good in that category, they have really good low duration funds and third can be Kotak Low Duration Fund. YTMs more or less are the same amongst all the three fund houses. HDFC is slightly lower, but ICICI and Kotak are almost the same.
For people who want to invest with the time horizon over one year for sure. But are not confident of above three years. What are the options? What are the kinds of returns?
Poonam Rungta: Again, in this category, looking at the current market scenarios and the high volatility. I don't think that pure equity exposure is recommended.
Certainly, we are talking about a bank replacement, so it has to be fixed income.
Poonam Rungta: So, for that I would like to go on and for investor with a little more risk of debt market so they can go for bond funds, or they can go very conservative funds again, but the maturity papers, which the fund house will hold, has to be a little longer. They can benefit also in the long-term and but of course they are vulnerable to the interest rate risk in the long-term.
But like the bond funds where the diversify edification of the holding of the fund houses is more so the investors’ money is safe, they can look at bond funds because corporate FDs give more returns, more interest than the bank FDs which investor can benefit from or they can go for medium-term funds where, again, the difference is between the maturity of the papers held by the fund house, so they can they can look at that.
Poonam, there's a lot of conversation these days about target maturity funds. Do these become an option in the one-to-three-year bracket?
Poonam Rungta: Definitely, like which we call FMPs or fixed maturity periods, they can be looked at. Their yields are certainly better than the bank FDs but again, there is a lock-in period. If the investor is not sure how much period he has in hand, then he may get a little caught up between the maturity, so if the investor is sure of the maturity period and you can definitely look at those.
Anant, your thoughts, 1-3 years period?
Anant Ladha: If our time horizon is between one to two years then floating interest rates for years once. Firstly, I'm dividing it into parts if it's below two years floating interest rate fund, will solve your purpose. If it is more than two years, I like the category basically, I like accrual-based debt funds. I don't like to take calls on duration.
Would you simplify this for our viewers?
Anant Ladha: So, I want a fund where duration of the papers which that fund is holding is almost equal to the time horizon which I have. But instead of it, if I have a fund which has duration much higher than the time horizon for which I am investing, there comes the interest rate risk.
What is the interest rate risk? It is directly linked between modified duration and the interest rate which is going on in the economy and it is inversely proportional. Suppose if interest rate goes up by 1%, whatever is your modified duration, your returns will be reduced by that percent roughly, it is a rough calculation which I have.
So, I like credit risk fund in this category, especially between two to three years or two to four years, I like credit risk fund, it is comparatively risky fund, but it is pure accrual-based funds and if you are using a somewhat stable fund houses, I think it's a good category to work with, provided you know that what risks come with credit risk funds.
In bonds funds, that is a good category, but duration is slightly high. So, I usually prefer credit risk funds over long-term duration funds or bond funds, that is my view.
Just one question and this is further replacement for money, which is lying in the bank, are credit risk funds a good option for such a need?
Anant Ladha: It is slightly risky. But yes, if we are choosing a fund house which is not giving more than 7-8% money to one party, plus we are choosing a fund house which has a stable record in the past, plus paper’s quality is slightly comfortable.
See, my first thing is that I want safety. So, in credit risk fund also we have some funds which are comparatively safer because they are not taking, or they are not running after returns. So, in those types of funds, I think we can choose, and we can take an aggressive call.
I know it is not for everyone, especially after the Franklin thing but just because of one case we cannot completely ignore the complete category, which provides you stable accrual-based returns.
What are some of the examples since you mentioned that you choose fund houses which have had a good track record etc. What are the credit risk fund options and of course the other category that you mentioned, options out there too?
Anant Ladha: In credit risk, I have two fund houses and two funds in mind. Firstly, is HDFC Credit Risk Fund, a very stable fund. They don't have high YTMs of 9-9.5%, but they have stable YTM of 7.6-8.1%.
Second is ICICI Credit Risk Fund, both these funds have had a superb track record and are comparatively stable and the fund managers are also having good track record with managing debt and in floating interest categories same funds which we were using earlier that is Kotak Low Duration Fund and ICICI Floating Interest Fund.
Poonam, you are of the opinion that in certain cases if the person knows about the duration, then target maturity might be a good option, but otherwise, you were going with the bond funds largely. What are the examples and what are the kinds of returns that a person can make here?
Poonam Rungta: In our dynamic bond fund or corporate bond fund category, they can get interest of between 6-7% very easily and depending on the interest rate fluctuations and the corporate structure, they can make more money, up to 9% as well. I would recommend HDFC Corporate Bond Fund in the category and also Kotak Bank.
Okay, and what about target maturity?
Poonam Rungta: Target maturity keeps coming in the market and they are not open ended. They have to be looked upon, so SBI has got good, fixed maturity plans coming in over and again so you can look at SBI Fixed Maturity.
Final round and that is on somebody who's got a fixed deposit, let's say four years duration or what have you, or beyond that, and he's looking for options wherein she can earn better returns with an almost equivalent amount of safety is there an option in the mutual funds side?
Poonam Rungta: For that, my all-time favourites are saving funds where they are very small proportion of equities, where the proportion is as less as 20 to 30%, they can get the equity participation as well.
Because the time horizon is more than three years and the investor is conservative, they can take 20 to 30% risk of the market and the rest of the money is in the debt fund, they sometimes categorise between arbitrage also and debt funds also. So, arbitrage as Anant pointed out, has equity taxation. So, the whole scenario works very well with mutual fund investors.
What are the kinds of returns that one can expect?
Poonam Rungta: I have seen in the recent past, the return going up to double digit more than 10%
Okay, so these are equity savings funds you mentioned.
Poonam Rungta: Yes.
Anant, same question to you, duration over three years
Anant Ladha: I think, if you are looking at alternatives of FD, medium-term funds can be a good alternative and some portion of credit risk fund will also work in this category.
What are medium-term funds?
Anant Ladha: They have slightly higher duration somewhat above 2.5-3 years, which is almost matching to your time horizon. A stable portfolio comparatively, decent size of ‘AAA’ funds and ‘AAA’ rating parties to whom money is given and we can expect somewhat stable returns of 7.5-8% with taxation benefits obviously.
Can you just explain that the taxation benefit because you are not mentioning any equity product at all? So, what is the taxation benefit? Can you mention this because our viewers would love to know?
Anant Ladha: Normally, in FDs, taxation is almost equal into whatever tax slab you are in. In debt funds, whenever your time horizon is more than three years, you get an indexation benefit, that is your cost is getting increased with the rate of inflation number, inflation index, which government is releasing every year. So, because of which we can say that effectively, your taxation is almost 20% as compared to what you would be paying in normal FDs.
Poonam, may I come to you for the names, so what are the funds that you have seen have done a good job in the equity savings category?
Poonam Rungta: Kotak Savings Fund is one fund I will highly recommend, and you can also look at the ICICI Savings Fund.
Poonam, you are comfortable recommending these equity savings fund for somebody who's wanting a replacement purely for money lying in a bank or a fixed deposit?
Poonam Rungta: Again, it will depend upon the risk appetite of the investor because it does have a little bit of equity in it. But because you're saying more than three years, then I would really want my investor to park their money.
Okay, you will do that with your money.
Poonam Rungta: I will.
Anant, the final question to you on the show again, examples of the fund houses or the fund schemes.
Anant Ladha: I would give an important disclaimer, you might see that almost fund houses are getting repeated because whenever we are selecting funds in debt, we want a stable fund house which has high AUM that is why we are seeing repetition of fund houses, no hard feeling to any other fund house. In this category, SBI has good fund, medium-term ICCI, Kotak, HDFC. All four fund houses are of stable size, good medium-term funds.