The Mutual Fund Show: The Rate Hike Impact On Your Portfolio
Risk-seeking investors should go as far as their risk appetite allows and take as much duration risk as they can, an analyst says.
Another 50-basis-point hike in key policy rates makes a good case for willing investors to take as much duration risk as possible for the next two to three years, according to Rajiv Shastri, director and chief executive officer at NJ Asset Management Company.
Such a hike points would mean that we are “if not at the peak, at least close to the peak of this (rate hike) cycle", Shastri told BQ Prime’s Niraj Shah on The Mutual Fund show.
"You should go as far along as your risk appetite allows and take as much duration risk as you can take," he said. "If it is a two or three-year time horizon, it would end up paying-off fairly well over a long period of time,”
Investors who are very averse to risk should stick to the shorter end of the curve, Shastri said.
“If the rates are high, then they will get a higher rate of return immediately as overnight rates go up, and they will be protected from all fluctuation. But if you are investing for a really long term, then there is an opportunity cost to them. You might not be able to beat inflation. If you try to negate all the risk in your portfolio, you end up negating most of the returns,” he said.
Interesting Time To Build Debt Portfolio
Caution is the mantra to follow for long-term debt investors considering the prevalent trends, but these are very interesting times for anybody looking to build a debt portfolio, according to Tarun Birani, founder and director at TBNG Capital Advisors.
In next six months you could see further volatility, but I feel it would be nice to start averaging it out, he added.
“If you want to build a long-term debt portfolio, you can start doing STPs from liquid funds to long-term duration funds.'' He also said the 5-year space is something he ''likes right now'' as yields continue to be very attractive.
Watch the full interview here:
Edited excerpts from the interview:
Do you guys recommend investing via a Systematic Transfer Plan method, especially in a scenario like this, wherein the odds of the markets correcting versus the market stabilising are almost equal. You would argue they always are, but this time around maybe even more so?
Rajiv Shastri: A Systematic Transfer Plan, I think, is a wonderful way of investing if you are unsure about market conditions, If you are unsure in any way, shape, or form about what the markets are going to look like through probably a near-term horizon. Systematic Transfer Plans don't actually you know, if you were to look at it from a very long-term point of view, they might or may not help, but what they do address is, you know, short-term pain.
If one has a lump sum, one has a large amount of money to invest per se, and if someone tries to invest it all at once, and if the market goes down, there's a lot of short-term pain that it causes.
Long-term and fairly sure that if someone invests by you know, either lump sum or Systematic Transfer or Systematic Investment Plan, SIPs or whatever, you know, if they remain invested for 10-12-15 years, I think they will end up making a reasonable amount of money regardless of how they have invested but in addressing the short-term pain I think is a very, very important part, STP helps you to do that and especially in times of elevated market confusion, elevated valuations, where there's uncertainty with regard to what we do know about where the markets are going to be headed in a in a shorter period of time. I think they are a very, very good way to invest and enter the markets.
Tarun, you want to weigh in on this, just maybe a small explainer of what are STPs and therefore, do you concur with what Rajiv is saying in the current market scenario? Do you reckon STPs are a good way to deploy a pot of cash?
Tarun Birani: Absolutely. I think Rajiv summed it well, but just to give you a background, STP is a method in which investors transfer the defined amount of money from the source scheme to the target scheme. So, we all know, lump sum investing is fraught with uncertainty in the current environment. Nobody is sure how the geopolitical risks will play out. There are so many factors, India decoupling this that, I know we have so many news data rooms right now, so, in this environment, if you ask me, deployment is critical.
Your deployment cannot go at once, it has to be staggered, and what better than Systematic Transfer Plan. Maybe I want to add with a couple of more efficient STP strategies. There are value STPs available, there are some booster STPs available in the market. So, these strategies can really help you invest more when the valuations are much more reasonable. There are plans available wherein let's say you can define a valuation matrix based on price-to-earnings, price-to-book value, market cap-to-GDP, there are various parameters based on which you can invest more when there is more blood in the street. 3x, 2x reacts to it more when the blood on the street is more, compared to currently maybe you would go lesser when you feel you are in neutral or outperformance range.
So, I think those are also some of the strategies, maybe somebody who wants to deploy a large sum of money, the deployment can be done much more sharply.
Tarun, there are some new terms out here as well, in the current scenario, the current landscape whether it's a value STP or a booster STP, what is it that you recommend and what is that particular kind of STP, then I will of course, ask Rajiv about whether there are such offerings within their stable as well or not but first to you if you believe a value STP is a good one, what is the value STP and why is it good currently?
Tarun Birani: Yes, valuation driven strategies are strategies which helps you stagger your money. So, there are two kinds of STP, one is a simple STP wherein let's say if you have Rs 10 lakhs to invest, what you will do is Rs 1 lakh every month for 10 months on a defined date, first of every month or on a weekly basis you can do it.
A valuation driven strategy will define that maybe Rs 1 lakh is your monthly limit. But what you will do is right now from a valuation point of view, you feel that markets are overvalued, maybe you will only go Rs 10,000 or Rs 20,000 that index will decide and maybe third month, like a March ‘20 kind of scenario, when the markets were down 30% instead of Rs 1 lakh, you can go Rs 3 lakhs in that month.
I think in a normal STP you will consume all the money in 10 months, so, maybe on a 13th month if there is a big fall in the market, you don't have money to invest. Maybe valuation driven strategy can help you get allocation in those blood in the market kind of period and behaviourally, I think, we as investors don’t invest at that point of time. This could be a beautiful way to manage your behaviour and let the algo run it, the valuation metrics run it.
Would most MF houses offer such options, Tarun?
Tarun Birani: I don't think many have that, but I think valuation strategies are available with many asset managers. We have these balanced advantage funds are again in a cosy way to increase and reduce the equity portion in the portfolio but in a pure equity way, there are some fund managers who are offering this.
Are there some products which are of this nature, if not valued in some other way and what would you believe would be a good way to deploy this STP money play, is STP good enough? Do you guys give some options at NJMC, as well?
Rajiv Shastri: So, I will divide the answer into two parts. Number one is you know; the first part is a normal STP versus a value STP as Tarun explained. We have a balanced advantage fund which automatically allocates money between debt and equity depending on market conditions you know, what happens or take into account a lot of parameters. So, you know for investors who are actually looking to kind of time the market but not really time the market. This is a good alternative to have with the you, based on valuation, the money keeps on moving in and out of equity in a very tax efficient manner.
In volatile market conditions, it's very difficult for people to take money out of the market without booking a profit and incurring a tax event. So, balanced advantage funds offer all of that happening within the scheme itself. So, there is no cost to the investor, there's no tax cost to the investor, that's a big advantage that we have.
The other part of it is value STPs. There are value STPs that are on offer in the industry I believe, what they would apply largely to 100% equity products. So, if you are keen on investing in 100% equity product and remain invested for the long-term in that particular 100% equity product, then a value STP would be a good way to do it. But, you know, in general we see a lot more people gravitating towards balanced advantage funds, balanced funds, because they kind of end up balancing the risk without creating too many tax events for the investor. So that's what we have been observing.
Now, the second topic, a lot of you have written to us, have commented on the shows about how the large-cap fund returns haven't been great. The SPIVA scorecard lays out how passive strategies have beaten, or almost being parallel to actively managed large-cap funds for a long time and in a lot of cases as well. So, our question to both our guests today and this I will start with you Tarun, an active large-cap fund versus a Nifty ETF versus a passive index fund, what should an investor choose and why?
Tarun Birani: So, to start with the Nifty ETF as well as the passive index fund, according to me there is not much in difference in the underlying asset. ETF is just more way to buy index directly through a stock exchange and index fund basically you buy through a mutual fund. So based on the investor convenience, one can pick and choose.
Definitely, ETFs would be much cheaper compared to index funds, but from a convenience point of view, index fund can offer much more convenience, so investor can decide whatever is the best method for them to pick up. Now, let's talk about the passive fund versus the active large-cap fund debate and I think we are more and more seeing that keeping the best trend in India also we are observing almost 70% and based on the SPIVA study you are talking about, the 10 years SPIVA study on the rolling returns shows that 67% of the funds have underperformed the large-cap funds, that active large-cap funds have underperformed the index. So that's a large number and this again, shows that the survivorship rate has been low for these funds for a long period of time.
So, keeping that in mind, I think markets are becoming more and more efficient. SEBI is working on I think there is a re-categorisation which SEBI brought in. The fund managers have to work under a framework which is very common for all of them. So, under these circumstances, I think to find extreme value in this environment I feel is extremely difficult, and I don't think I want to bet my money on chances. I want more visibility on a reasonable basis over a long period of time where my behaviour is driven more out of a passive way wherein behaviourally, I am more correct, in terms of let's say, a DLF 10 years back was part of my portfolio Nifty, from the fund manager perspective, I will continue to own because if there is a 50% fall, all the fund managers will continue to own that stock. But I think the index will quickly take that away because I think there is a churning process which keeps happening in the index. So, from that point of view, behavioral point of view index is a very beautiful way and what better than betting on a Nifty which gives you access to top 50 companies in the country. So, I feel time has come wherein at least the large-cap allocation can start moving into index funds.
Rajiv, you guys may have a large-cap fund, excuse me for not knowing that, but with the presumption that you do, what is the argument for somebody to come to a large-cap fund versus passive index strategy?
Rajiv Shastri: Okay, a couple of things, we do not have a large-cap fund but to my mind, you know, this debate between large-cap funds and passive strategies, I think you know, at root , it is not debate between active and passive, it's a debate between large-cap and active investment. Sure, the true opportunity for a fund manager to generate excess return lies outside the large-cap space because let's be clear, you know, the large cap space is the top 100 stocks has been defined by SEBI, if 80% of your investment have to be in these over-researched, over-participated 100 stocks and there is very little alpha that you are going to get over there. So whatever fund manager has to add, has to be outside the large-cap space and there you see a lot of fund managers.
So, from a general mutual fund point of view, a flexi-cap fund, you know, would work best that is probably the best interpretation of a fund manager's vision of generating of how he or she would manage money more than anything else. Now, coming to us, we are rule-based active investors, we invest based on factor-investing and our approach to investing is completely based on data and past track record of stocks. So, we are straddling the space between discretionary active and passive in the sense that we create our own rules. We don't replicate somebody else's rules like an index fund, we create our own set of rules which we believe you know, have shown the potential of adding alpha and something which has proved to add alpha over a long period of time, these factors are very basic ideas about investing basic themes of investing.
So, you have value, you have momentum, you have low volatility, quality. So, you try and select companies based on the already published data which reflect these characteristics and include them in a portfolio and, you know, try to create whatever alpha you can from it. It's worked very well in developed markets, as you know, fund managers they are all so discretionary active managers. They also have, you know, been struggling for a long period of time primarily because the factor-investing part of it, the maths part of it, was explaining a lot more of the return that they were generating as time passed, so, you know, a lot more of the return that they were generating was explained by maths and the space or perceived expertise shrank quite dramatically over a period of time.
So, there's been a large movement of money, you know, funds from discretionary active funds to rule-based active funds, which are, you know, you can call them quant funds, or whatever you want to call them, but there is a large amount of money that has moved here. Now, when it comes to active versus passive, that's a much larger discussion. Active versus passive is not just about active large-cap versus passive. It's whether you should manage money actively or should you just replicate anything.
Yes, I agree, but for the purpose of this show, our conversation was bent towards the large-cap space simply because a bunch of people are questioning the return efficacy that large-cap funds have shown vis-a-vis what passive large-cap funds have shown and which is why the debate was narrowed and that's why at least for this show, that was the argument that should we choose that versus the other?
Rajiv Shastri: Like I said, like Tarun pointed out again, the fact that you know, SEBI has come up with very, very strict norms that govern the manner in which a fund manager can actually deploy money. The space for outperformance has kind of disappeared, because if 80% of your money has to be in those 100 stocks only, then the space for outperformance has kind of disappeared and that is one of the biggest causes of the phenomena that we are seeing right now.
Tarun, just one follow up, there is no taxation differential between a Nifty ETF versus a passively managed fund, the taxation for both would be similar?
Tarun Birani: That's correct. They are both under the equity structure.
The last conversation point is trying to preempt a little bit of what the Reserve Bank of India would do. I am giving you a hypothesis, Rajiv, I will start with you on this one. I am giving you a hypothesis that the Reserve Bank hikes by 50 basis points, let's say and if you're talking about this on Friday 4 pm instead of Wednesday 4 pm, and you know that the Reserve Bank has hiked by 50 basis points, and the Reserve Bank is not dovish, even if it's not hawkish. What changes would you make to your fixed income mutual fund investments?
Rajiv Shastri: So, the choice of duration now we are talking only duration, we are not talking about credit risk at all, because we are only talking about industry. So, the choice of duration depends largely on the investor's risk appetite.
So, I will make it up in three parts, you know, for a risk-averse investor, someone who is very averse to risk. I think they should continue staying at the shorter end of the curve, because what will happen is the rates are high then you know, they will get a higher rate of return immediately, as overnight rates go up, and they will be protected from all fluctuation, all of that, but if you are investing for a really long term, then there is an opportunity cost to them.
You might not be able to beat inflation. So, if you try to negate all the risk in your portfolio, you end up negating most of the returns. So that's one part of it to the risk-averse investor. So, the risk-aware investor, someone who is pretty much tuned to the kind of risk that they want to take, invest with your time horizon. So, if you are investing for three years by you know, roughly by a 3-year duration, so that you are not carrying any basis risk. Risk between the asset that you want and the liability that you create, that you have created in your mind for potential expenditure.
So, you mean to say choose funds which are maturing according to your needs?
Rajiv Shastri: Around when you need money, if you're planning for a car three years down the line, then choose a three-year product and stick with them. For the risk-seeking investor, I think this you know, if the RBI were to hike rates by another 50 basis points, I think we would be at, you know, if not at the peak, but at least close to the peak of this cycle and I think you should go as far along as your risk appetite allows and take as much duration risk as you can take, because if it is a you know, maybe a two or three year time horizon, I think that would end up paying off fairly well, over a long period of time. So, just into three parts, depending on the risk appetite.
Thanks for putting it out so elusively. Tarun, how would you respond to the same question?
Tarun Birani: Just like equity markets, I feel the debt markets have also more or less priced-in and these are leading indicators so more often than not, I think the expected rate hikes have been already priced-in in the yields what we are seeing right now. So, market is very efficient, and they get this data point very quickly.
But in the end, I feel the major shock can come if there is inflation data coming wrong or again geopolitically, I think there are a lot of developments which are happening right now. If you look at US, there is an inverted yield curve which is playing out, which is clearly telling you that the short-term rates are higher than the long-term rates. So, which is like a clear signal of a recession which is brewing in US right now, across the globe right now. So, these are very, very important developments for a long-term debt investor, but I feel these are very interesting times for anybody who wants to build a debt portfolio.
A nice way would be to build a laddering approach wherein define your requirements and goals. So, let's say if there is a long-term retiree who is looking at building an annuity income, these are very interesting times for building up, there are funds available which are like 15 years rolled-down maturity funds available, which are giving you a 7.5% return with induction session. These are very efficient returns for somebody to build a portfolio like this. Yes, in next six months you could see further volatility, but I feel it would be nice to start averaging it out and if you want to build a long-term debt portfolio, you can start doing STPs from liquid funds to long-term duration funds. But I think 5-year space is something which I like right now, where the yields continue to be very attractive, and maybe the rundown majority 5-year kind of funds are looking very, very attractive and one can start building up there where you have a 7% post tax kind of return possibilities emerging right now.