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The Mutual Fund Show: Right Portfolio Allocation Key To Good Returns In Samvat 2075

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The right portfolio allocation between various categories could ensure that mutual fund investors make money in Samvat 2075 after they experienced poor returns in the year gone by, according to veterans of the mutual fund industry.

An investor needs to create an all-round portfolio with the right balance between equity and debt, commodity, currency and real estate, said Nilesh Shah, managing director of Kotak Mutual Fund, in BloombergQuint’s weekly series The Mutual Fund Show. “If we get lucky and sensible, then equity will outperform debt over the next Samvat.”

Agreed Kalpen Parekh, president at DSP Investment Managers. He said that mutual fund investors should look at a mix of equity and debt mutual funds to live through volatile times. “You can build portfolios to last if you have the best of both (equity and debt), particularly when interest rates are rich,” Parekh said. Both asset classes, according to him, should give similar returns which means equity should be higher from where it is right now.

Watch the entire show here:

Edited transcripts:

From this Samvat to next Samvat, is there a likelihood that investors will have better returns?

Nilesh Shah: We need to be little bit lucky and sensible. Lucky in terms of oil prices and sensible in terms of getting a stable government. If you achieve those two things, then this Samvat you should be able to make money.

Kalpen Parekh: We should be sensible. Sensibility would be in terms of recognizing that predicting is not easy and predicting may not work every year. Every year in festive occasion, generally predictions are made. What has served investors is better planning and being better investors. While markets will do what it has to do, but we as investors stay disciplined, we know that our time horizon will cross multiple Diwalis and if markets fall, take advantage of it by increase asset allocation towards what is cheaper. If markets rise, stick to asset allocation. That sensibility will help us in all points in time.

Will cricket analogy come in?

Nilesh Shah: People ask that their SIP returns have turned negative and should they stop it. If Virat Kohli goes to bat, he doesn’t hit every ball for a four and six. So, don’t expect fund manager to produce return in SIP every month. There will be months when he will produce negative returns or positive returns. When you combine it together over a period of time, across multiple Diwalis, you will see a good inning where either there is half century or a century or even double century. So, this is not the time to stop your SIP but double the SIP.

Is it time to double your SIP bets as the opportunity is there?

Kalpen Parekh: Lot of bad news have got priced in. We have oil prices at its peak, we have interest rates which are peaking. Right now, you are getting acche prices. As investors, we should recognize that and learn to celebrate not just festivals but corrections also. If we can celebrate corrections, then that switch in mind from a temperament point of view, goes a long way in making investors successful. SIPs are designed for markets like these. SIPs are not designed for only rising markets because then you are only buying at high prices. It is like buying an iPhone every year it launches at 20 percent higher prices. But here equity markets go down as well one third of the time and one third of time they go nowhere. The beauty of design of SIP is that those are the times, you acquire more units and then wait for final destinations where all that you have acquired for cheaper prices becomes fairly meaningful. We have seen 15-25 percent correction in different level of funds in last one year. If I am a 10-year investor, effectively per annum, 1.5-2.5 percent cheaper is what I am getting with this type of correction. We should leverage the corrections and load up. At large, investors are highly under owned in terms of equities. There were lot of money in other asset classes which may not be as productive. So, make hay when the prices fall.

What’s the important thing you have learnt this Samvat?

Nilesh Shah: Personally and professionally, I have learned that truth prevails. Last year, during Diwali time, there were many companies which were going up like crazy. My barometer is my cousin brother. When they start telling me what to invest in, then I believe market has peaked out. They were talking of names of companies which I never heard. And I was wondering what they are up to. Unfortunately, those stocks were rising. The quality was available at discount and kachra was trading at a premium. This thing should not have lasted longer. That finally happened in 2018. Today, more than half of top 1000 stocks have corrected beyond 30 percent. There are stocks which are down 70-80 percent. Finally, fundamental catches up with prices or prices catches with fundamentals and truth prevails.

Kalpen Parekh: It is learning which comes every year but at times we forget when things get very easy. So, after 3-4 years easy investing, you tend to forget that. We forget the prevailing nature of truth. Learning for me is gravity prevails. Anything cannot go to the sky. At some point of time when valuations become extremely stretched then at a point in time, they normalize, and we are going through that phase from last few months and that journey could be there for some time. So, recognize that gravity prevails and recognize that cyclicality prevails. Whether in equities, it is valuations normalizing. In FD, it is interest rates normalizing. So, we have long periods of very low interest rates and periods of high interest rates. So, two years back we were at low interest rates, the cycle reverses back and we are close to 8-9 percent interest rates. Recognizing that these two things will continue to happen and knowing where we are in that space helps us calibrate our exposure to different asset classes, time horizon. So, the learning again and again is we have to make mentally strong to recognize cycles, not get carried away with greed. Last year has been a very painful period for those who were disciplined at the beginning of the year because discipline was hurting you and everything else was going up. But not giving up is very important.

What surprise you the most this Samvat? You said that greed can blind even the most rational person. Is this a case of some rational investors chasing high valued stocks?

Nilesh Shah: We were told that love is blind. When we came into market, the statement which we should have have been taught is that greed is blind. There are certain global investors whose newsletters I have read for last 20 years. I have respected them immensely for the knowledge they have provided. When I saw them buying into the stock of particular IT company, I wondered what they have taught me for 20 years and why are they not applying. That’s where you realize greed can sometimes be blinding. Each one focuses on momentum in his moment of witness. Fundamental goes for a toss, performance takes over, price takes over value and then the best of the investor can end up committing an error. So, the learning of last year is do your homework. Just because that bhai has invested, doesn’t mean that you should follow him. Even the best of the bhai could be a blind because of his greed.

The thing that surprise you the most is the squeeze in system liquidity and continuous valuation expansion in first half of the year. Why it was so surprising for you?

Kalpen Parekh: It was surprising because it was crossing certain natural boundaries which we have always seen in last cycles. Some parts of market becoming more and more expensive and the market polarizing 35-40 percent weights towards the entire financials as a segment. We have seen cycles every 7-8 years like in 2008, 2018. The valuations kept on going up, flows kept on chasing those valuations. Flows had become a fundamental factor. All of us were taking for granted and extrapolating it far ahead. That extension for too long was a bit surprising for first half of year.

Second half of year was not just the sentiments reversing but overall system liquidity and flows gradually correcting or compressing. In mutual fund flows, it was Rs 20,000 crore in first half of the year on monthly basis normalized to around Rs 7,000-8000 crores. These are flows coming from retail SIP pool. Lumpy flows have paused for a moment. It is reaction. If past return slows, flows also slow. So, ideally it should be the other way around. We like to buy high prices and we not like to buy at low prices.

For next Samvat, equity versus debt, what should an average investor prefer?

Kalpen Parekh: I would say both. It is right to do. We don’t have to worry about what will happen to markets every day. FD are at 8-9 percent yields which is compelling versus what it was at 6 percent at some point of time. We all know that over long periods of time equity is your best compounder. But to live that long we have to pass through the journey of uncertainty and volatility. None of us are wired by evolution to live through volatility. If two months returns are poor, we panic, and we exit. At that point of time, we have cushion of FD. Our aggregate portfolio may not drop by 10 percent but by only 5 percent, thus giving us comfort to stay invested. Blend the two as it gives you lasting power. Rather than growing fast, it is better to last. You can build portfolios to last if you have best of both, particularly when interest rates are rich. It allows you to build your five-year bond portfolio of current prevailing rates of 8-9 percent. At the same time, we all know that markets will go through its round of volatility. We have a year packed with events. In a battle, sword is used to attack which is equity, but you need a shield to defend. You can’t win a war, if you can’t defend yourself when you die.

Long term compounding is always equity, but our behavior doesn’t allow us think long term because we are feeded with information every minute and we like to react. Let’s recognize that barrier. If you can invest and go for long ten-year holiday, then let everything be.

You said that equity might be it. Will you elaborate on it?

Nilesh Shah: If we get lucky and sensible, then equity will outperform debt over next Samvat. A combination of lower oil prices in stable government can push equity to deliver higher returns than fixed income. Again, with that caveat, you need Rohit Sharma and Virat Kohli to score runs but you also need Bhuvaneshwar Kumar, Hardik Pandya to get the wickets. If you have only batsmen, then you will score lots of runs but won’t win the match because there are no bowlers to defend that run. If you have all the bowlers, then you will bowl out the opposition very quickly, but you won’t have batsmen to score the runs. One can say that why not create eleven all-rounder team. But you don’t get them that often. So, you need to create an all-round portfolio with right balance between equity and debt, commodity and currency, real estate. Combination of that asset allocation, that discipline of asset allocation will give you return.

If we are lucky and sensible, then is there outside chance that small caps might do better than multi caps and large caps?

Nilesh Shah: On January 16, 2018 when small cap index peaked out, it was 33 percent premium to its 10 year’s prices to book average. On 31st October, it was at 4 percent discount. From being available at premium to significant premium, now small caps are available at reasonable discount. It is not cheap market where you sell your house and go and buy small cap, don’t do it. But this is a market where you can increase allocation to small cap. Small cap will be volatile. God forbid, if we are not lucky or sensible, then small caps from being available at discount might be available at significant discount. With that caveat and volatility, I still think small cap is the place to be over next 12 months provided we are lucky and sensible.

Would you veer towards small cap or do you think small caps and large caps are better bets?

Kalpen Parekh: We have started small caps, but we only encouraged SIPs, in spite lot of time and demand saying open it for lumpsum. Purely, respecting the reality that we don’t know whether we can get lucky at times. Hence, SIP is the best way to build a portfolio in volatile asset class. My bias will be multi cap and that’s how I invest my money. Multi-cap, by definition, gives 35 percent exposure to small and mid-cap portfolio. So, let the fund manager pick the best small and midcaps over and above 60-70 percent in large cap. For days like this, let the fund manager take that call. If there is more volatility which comes through in course of next few months, if this type of discount elongates. If you go back in 2013, 10-year return of large cap was higher than small caps. Look differently. 10-year return of small caps was lesser than large caps. This is against the principal that small caps should give higher return and 10 year is a huge period. But that was the time when the whole mid cap prices and everything happened. We are somewhere getting there this year. At a point in time, this year we will get those opportunities to build for next portfolio.

Can the mood and levels be better than where we are right now?

Nilesh Shah: Definitely. Apart from luck and sensibility, we also need planning. Foreigners invest based on the MSCI Emerging Market. India’s current weight is around 8 percent and most people are overweight India. So, they will be probably 50 percent overweight at 12 percent. That worth of $400 billion rounded of investments in India. China has played and planned to increase their weight in MSCI Emerging Market Index. In fact, that index is going to become MSCI Emerging Market China index and other country’s index. Their weight will jump from 28 percent to 50 percent. Correspondingly our weight will go down from 8 percent to 6 percent. These are all dynamic numbers and it will change. But this is the direction. People who are overweight India will become extreme overweight if that changes happen. People who are underweight China will become extreme underweight if that happens. Already Indian market has outperformed China by almost 75 percent plus in US dollar terms. In last three years, we are up 26 percent dollar terms, China is down 50 percent dollar terms. We have outperformed them by 75 percent.

Look at the dilemma for foreign fund manager. He is extreme overweight in a performing market and extreme underweight in an underperforming market. It is likely that there will be portfolio transition. If I assume that fund managers decides to maintain same overweight on MSCI emerging market in India weightage, then it will still result into $100 billion of selling. From $400 billion of market value positions, they have to bring it down to $300 billion to maintain similar overweight. That means either there will be no FII flows or there will be FII selling. This transition is not happening in this Samvat, it is happening over multiple Samvat. But it shows roughly what kind of challenges we are facing and what corrective action we need to take. We need to plan to maintain weightages in MSCI Emerging Market Index. That along with lack of sensibility will be the triangle to determine where equity markets will go.

Do you believe that the factors and valuations leave us some room to be happier, this time around next year?

Kalpen Parekh: A large part of froth is behind us. So, the volatility should be lower. Because I mentioned I have exposures to both the asset classes, I presume both should give similar returns which means equity should be higher from where it is right now. But we shouldn’t be greedy to expect sixes and fours. If it does its gradual compounding, I would be happy.

So, an average mutual fund investor should expect just above normal or normal returns for next Samvat?

Kalpen Parekh: There are many years where I thought X or Y has happened or -X has happened. I will still put by bets and both should give similar returns.

What is the biggest risk for mutual fund investors over the next 12 months?

Kalpen Parekh: The biggest risk is not being able to live through volatility. Volatility and fluctuations are given. The risk is that a lot of money has come in periods of easy returns and those expectations have been set fairly high. If we go through period of 2-3 years by moderate returns for the markets, the risk is if you misbehave and give up the journey of compounding and not take advantage of the corrections which are going on right now. Then the risk will not be able to compound in next five years. There are brakes and accelerators. These are times to accelerate investments into equity over the next few years. The risk to investor is to not let his temperament go wrong and get out of market looking at events which are short term and could be volatile. It is about normalizing expectations and recognizing that whenever markets are slow or low, it is the time to be happy about if you are investor for the future. I believe that in our country with over two percent penetration almost all of us are investors for the future. We save heavily in FD, gold, real estate for generations. For equity, we track for a quarter or year. The risk is to not change that behavior. If we are to able to make our attitude towards equity as long term as towards other asset classes, we need to love equities as much as others and let it deliver what it is capable of.

There might be chances that next months might have chances of negative returns. So, don’t exit your investments. That’s your biggest risk.

Nilesh Shah: The market is kind enough if you make one error. If you enter at the wrong time, then market is forgiving provided you stay on. Market is cruel and punishing you if you make mistake twice. You enter in wrong time, you exit at the wrong time and then you keep on blaming markets that I can’t make money. My cousin brothers are barometer for that. They normally come at the top of the market and at the bottom of the market, they will exit instead of averaging or leveraging or doubling. Till the next bull run arrives, they will continue to blame the market for losing money. They will say stock market is for manipulators and good persons don’t make money over there. Please don’t blame the market, if you make two mistakes. Market will forgive you for one error, even if you enter at the wrong time at an expensive market but stay invested for long period of time you will make decent returns and not extraordinary. The biggest mistake which investors face today is that last 6-12 months have not been as per their expectations, they will end up taking an exit call in volatile scenario ahead and that will compound their error.

One advice you could give for investors?

Nilesh Shah: Be disciplined. There is no short cut to success. You can’t make money overnight. If you make money overnight, then it will disappear also overnight. If you are disciplined, regular and long-term investor, maintaining asset allocation then wealth creation is quite easy, and it is not difficult.

Kalpen Parekh: To come first, first last. Build portfolios which can withstand good news, bad news and volatility. Bonds, we bond with them, gold, we hold but for equities we quit. Change the last dimension and invest with 10-year time horizon. Respect the T in compounding. That’s my biggest learning for 20 years. The real wealth comes from my discipline and time I give. Markets will do what it has to do. We can’t predict what it will do. So, go inside and become a better investor.

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