DNA Conversations: Mutual Funds are the way to go
The markets have tumbled sharply. Almost all the stock indices are down. When such things happen, mutual funds (MFs) which are after all derivatives, which take value from existing markets, are bound to reflect the doom and gloom around.
But some funds have done well, especially liquid funds, which are invested in debt instruments. As interest rates rise, and the demand for money moves us faster than supply, yields on debt instruments, especially the government of India Treasury (T) bills have offered great investment opportunities.
Then why have most common investors shied away from MFs? Why is it that some people believe that Mfs are no longer relevant for the common man?
To find out the answers DNA invited some of the leading experts in the field. They included, in alphabetical order) A. Balasubramanian, chief executive officer, Birla Sun Life Asset Management Company, Arvind Sethi, managing director and chief executive officer, Tata Asset Management Ltd, Nimesh Shah, managing director and chief executive officer, ICICI Prudential Asset Management Co. Ltd, and Suresh Soni, managing director and chief executive officer, Deutsche Asset Management (India) Private Limited.
At this conversation, moderated by DNA's R.N.Bhaskar (with editorial support from Parnika Sokhi), each of the panelists emphasised that the need was for more investor education, and the probability of the industry becoming a lot more vibrant.
Given below are edited excerpts:
DNA: The markets are in a terrible shape today, and it’s at such times that mutual funds get hammered badly. What are your views on the state of the industry now?
Soni: We have a country which has got saving rates of about close to 30%. And we also have a very high inflation of about 8 to 9% per annum – probably, 10% some times. So we are a very unique country, which requires investors to invest their savings effectively in order to just keep pace with inflation – even though the hurdle is very high. At the same time, it is unfortunate that financial literacy is relatively very low in this country.
So while we are a great saver-country, we are not a very great investor-country. So you find people, while they save a lot, a large part of that saving either goes into some physical assets, which in turn is causing some of the problems that we have currently on the balance of payment side, or some part of it goes into unproductive areas, or it doesn’t go into the real productive areas which can then be channelised by the economy into a higher growth mode, much of it goes into bank deposits.
But, from a macro perspective as a country we need a lot more money to go into investment avenues. We’re doing a great job of saving. So, as a country, we need to do a lot better on the investment side.
Balasubramanian: The industry has gone through such a crisis earlier. During the last two decades, we have seen [such crises] at least four or five times. And after seeing four, five times, a similar turn of events, but of a different nature, the industry has continued to grow in size.
Second, in the last two-and-a-half-years, especially in the absence of large pool of savings coming into equity, we’ve also witnessed inflows into the fixed income schemes of mutual funds.
Thus, at every point of time, after every volatility that you have seen, the industry is only getting better.
And this time around, since the last two and odd months have been a period of extreme volatility, one needs to measure and assess the behaviors of investors, the distribution community and the mutual fund players.
I would assume that the industry is actually getting better in all the three aspects. Understanding the importance of an asset class, pursuing that investment for a longer term, and meeting their goals and point of view. That, I think, is a great sign. It is good to see a sense of stability coming in.
Sethi: Your opening remark was “mutual funds have been hammered”. But which investment hasn’t been hammered? It’s a vehicle for investing. And I firmly believe that it’s one of the best ways of doing so. For a small fee, you can pool your investments and get expert people to manage it.
If equities do badly, your equity fund will do badly. But if you’ve invested it in a fixed maturity plan, that will still, hopefully, give you the return it does. So my point is that a lot of people somehow think that if you want to make a quick buck, invest in a mutual fund. The fact that investing in MFs requires understanding, financial literacy, maturity. At the end of the day, the fund will only give you the returns that the asset class gives.
And I can’t think of a better way to do it because you do it in an open-ended fund, in a very regulated market, and you have liquidity. But everyone, as Suresh said, for a variety of reasons, just expect to make a quick return. Just listen to what they used to say: “Oh!, you never lose money in real estate.” Well, ask the same people now. And ask the people who have invested in projects, which never got completed, or a commercial property, which no one wants to take on rent.
DNA: Very true.
Sethi: So no one talks about that. But if you look at even the returns any decent equity fund has given you over 10 years, they beats anything. It’s a 20% compounded over 20 years.
DNA: So, effectively, are you also saying that when you look at mutual funds, look long term; don’t look short term?
Sethi: No. I am saying look at mutual fund as a means of investing for your financial goals. If they are short-term goals, there are certain products which are available for the short term. If your goals are long term and you can stomach volatility, there are products for that. If you can’t stomach volatility, also, there are products for that.
But it’s not a place where you go and make Rupee one into Rs.2 in a few months. That’s where I think the problem is.
Shah: One fundamental thing which I feel we have been explaining to people for a long time is that we are only relative return players. If benchmark goes up, we go slightly more than the benchmark and when the benchmark goes down, we should go down less than where the benchmark has gone. That is what we’re designed for. We are not players – whom Warren Buffett described and finding out who is naked when the tide is down.
In fact, mutual funds are required when the times are tough. If in life also and in mutual funds also, if you’re able to protect your downside better, you will do well in life. So when we design our products, we do not design our products in a manner that they will make a lot of money in the short run.
Since we manage other people’s money and our brand is at stake -- the only thing that we try to do as a fund house and as an industry is that when the tide is down, you are able to do better. If India -- statistically also if you see over the last 10 years -- on every downside if you’ve protected yourself better, you tend to do much better. So what is true in life might be true in mutual funds. And mutual funds are designed for that. That is when you require mutual funds, you require experts, when there are problems in the system.
DNA: How do you see the industry?
Sethi: As I said earlier, we just invest in different asset classes. So if it’s equity that you want, we provide it. Now whether you called it safe or not is a matter of your investment timeframe. What I’m saying is, it’s not necessarily a safe place, but, yes, it is a place where if you have asked someone to manage your portfolio then, hopefully, you have a professional who is doing a good job with it.
And, in that sense, they are trying to fulfill a mandate that you have given to them professionally and in a judicious manner. But if your asset class is a jumpy one, then, you know, that's the risk you’ll have to play with. And in terms of where the industry is, I don’t know, I think it’s very well regulated, maybe overregulated.
The fee structure perhaps could do with some changes, which could help the industry grow. But otherwise, it’s only a matter of time, with maybe financial literacy, education, etcetera, the industry should do much better. Maybe it’s a part of the evolution of the market.
But there is nothing wrong with the industry. You’ve got good honest players who are doing by and large an honest job, you’re getting a lot of transparency now. It’s well managed.
Shah: I think after the change in regulations, we have some of the most beautiful products that one can have. Can I invest my friend’s money into it? My basic test is, will I put my own money into it?
And I find it a very beautiful product to invest in with the benefit of transparency as well. Less or more is a different issue. But it is very transparent.
There is no packaging involved. Everybody knows that this is the charge, and that is it.
Second thing, it’s a derivative product. If the country does well, if equity markets do well, then we’ll do well. If the country is not doing well or the equity markets are not doing well, then this product should not. Because we’re against benchmarks. What we have learnt is that we’re not a hedge fund. We are a mutual fund.
Mutual funds should be plus or minus the benchmark. We can't be anything else. We do a lot of business outside the country as well. In fact, they will get very worried, if our performance is too much higher than the benchmark. It has never happened in India that I have to defend that.
People don’t want us to take more risk. They want a product which is plus or minus the benchmark. I’m only on one thing. So if the markets go down, we are supposed to go down. It’s a – that's how the product is supposed to function, and we’re doing it exactly. I have got a mandate. I have taken money from you which you want me to invest in a large cap fund. So, I have to remain invested in a large cap fund. And if the country is not doing well and the large cap equity indices don’t do well, we are not supposed to be doing well either. It’s a derivative product. It’s not the main product.
DNA: If you are supposed to be benchmarked against the economy, or the markets, why shouldn't you invest in an index fund?
Shah: That's why I'm saying, I should be benchmark plus. What are you paying me for? That is what we tell our fund managers. We don't have any other expectations of them. There are no absolute returns, because then I'll be very worried. If my fund manager wants to do well when the markets go down, we don't want them to do that. We want them to make 300 basis points more than the benchmark.
DNA: The other issues is fees. Mutual funds are for small investors. Yet your fees were higher for small investors and lower for the big investors till SEBI ordered a correction.
Balasubramanian: It was part of the evolution. It has got better over the past two years along with the increased level of transparency.
The effort that industry needs to make – in terms of channeling their financial savings, both from the top 15 cities and below and increasing the level of literacy through the investor education – is large. So these are the steps, which are being taken to support the industriy to pay for its growth. The evolution of the industry is from the phase of load regime to the no load regime.
A lot has happened in the interest of investors. Then the necessary support was given in the form of increasing the fees marginally to help the industry to grow in the derivative markets.
And while this is being done, the exit load needs to be written back to the schemes to the best interest of the investors.
If somebody actually moves out of a scheme out of his own chjoice by paying an exit load, this exit load goes back to the schemes, which essentially means that people who are staying with the schemes for a longer term tend to benefit more.
So all these regulations have come largely in the best interest of investors. At the same time, the mutual fund industry players have been given a bit of a leeway, to help it expand the market.
Ultimately, all asset classes are bound to be volatile because they are all mark-to-market on a daily basis. Whether it is equity or debt or any other instrument, into which investments are sought to be made. This means that the true value is reflected on a daily basis. We also ensure instantaneous liquidity for any investments that you make. But if every investors looks at the mutual fund as an asset allocation product, keeping in mind the long-term goals, then it’s one of the most safest among asset classes. First, from the point of view of transparency; second from the point of view of honesty in terms of managing to the objective of the schemes’ objectives; and third is risk management practices.
DNA: Would it be fair to say that, in a declining market, a liquid fund, which has invested in government securities would be more profitable because small investors can’t buy securities and the yields are very attractive? Would that be right?
Shah: What you're saying is just pointing towards the range of option that the mutual funds offer. So, while you made the remark “are the mutual fund doing badly?” I would say that question needs to be dissected based on the asset class.
Mutual funds do not represent equity markets alone. Mutual funds cover a range of products and that range of products can actually span all the way from liquid fund as you have pointed out, fixed maturity plan, income funds, equity funds and international equity funds.
And all these asset classes don’t move in unison at the same time. And so the beauty of this proposition is that you can actually pick and choose the pockets that suite your profile, that suit the market condition, that suit the time-horizon that you're looking for and your liquidity requirement.
So in a market where you are uncertain, indeed where the yields are going up or when you are confused by what is happening to the Indian economy, where the equity markets are going down -- I don’t know what happens to the corporate profitably – maybe the best option – till the time you make up your mind – is to put some part of the money, at least for the near-term, into liquidity options.
But then again, I think, I would just want to caution, that whatever you do, one view we can take is a very near-term view.
The other way would be to focus on “What do I want to achieve as financial goal over a period of time?”
If my objective is to create a wealth basket, I should probably be buying equity…
DNA: Because it’s nearer the bottom?
Shah: It entirely depends upon the time horizon you are giving yourself, the goal you're defining. But if you are a guy who is scared of volatility, and you have short-term money then certainly look at the options which are consistent with the time horizon.
But the beauty of this proposition is that it offers you such a wide range. So, don’t confuse mutual funds with just equity market. It’s a range of option that you're looking at which allows you to do your financial plan beautifully across asset classes, in a very efficient manner.
It is one of the most transparent instruments you can get. It also offers you liquidity at all points of time without any major penalties of the kind that you'll suffer anywhere else.
Balasubramanian: You talked about liquid funds. Just look at the beauty of the fund structure. From a period where we had the flexibility to invest in one-year instruments in liquid fund, today we have the option to to invest only up to 60 days maturity.
So that itself reduces the risk of interest rate volatility substantially, at the same time gives a better experience than what you would get otherwise in either in the current account or in the savings account of a bank. So that's the beauty of the product.
And it also comes with the least possible expenses, where the expense ranges from 20 basis points to 40 basis points. It moves along with the overnight rate that prevails in the market.
Short-term rates are high because it is also a beneficiary of the liquid fund, except the volatility which you'll see at an intermediate period is for now two days.
But that doesn’t mean that there is a significant amount of risk that exists. This is because most liquid funds do not invest in more than 60 days maturity. The same time they do not have instruments having average maturity of more than 25 to 30 days in a normal course actually. So that's the beauty of this product.
DNA: What about gold ETFs. Will that die out?
Shah: Lots of AMCs had gold funds…
People who wanted to allocate money towards gold would have allocated that. So that investment phase is complete. So whoever has allocated money to such funds is still out over there.
DNA: But fresh money won't come in, right?
Shah: Right. So, a lot of money today is is instead coming into FMPs. Investors have also become smarter. I'll tell you what they are doing. There are some value funds in the market. People understand that when the markets are down, it means that mid caps have been beaten up. Investors have become much smarter, They understand that there are some stocks in the market which are going quite cheap. On the liquidity side the market is very cheap if you remove the top 12 stocks.
So the rest of the market being cheap, there are a lot of people who are coming into value funds, right. So the movement is happening. Volatility is here to stay. So people are coming into a set of funds which gain out of volatility.
Soni: I think the investment in gold ETF was a very small portion of mutual funds. It was less than 1% of the industry, in fact it was like Rs.8,000, 10,000 crores…
Sethi: It’s just about Rs.4,000 crore…
Soni: So, a very small portion of the industry and investors actually favored other products like debt or equity mutual funds a lot more.
Sethi: But look at the beauty of the industry. Supposing we wanted to hold gold, what were your choices? And provided you had accountable money as well? You could have bought physical gold and run the risk of storing it somewhere in your house or in the vaults; or you buy it in an ETF. Now even if you wanted to buy physical gold, who would you buy it from? What would you end up buying? Would you get the purity? Plus there will be minimum bar sizes that you have to buy. Here you can put Rs 1,000 rupees in gold.
DNA: Yes. There was greater flexibility.
Sethi: But look at the safety. If you wanted to play this five times as the price moved up and down during the last 10 years, you had a choice of going to your jeweller and buying something. But here you can do it safely through a fund, you write a cheque out, and it comes to you. You don’t have to worry about safety, insurance, etc.
What I'm saying to is that that sort of flexibility, range and convenience the mutual fund provides, whether it’s for debt, whether it’s for gold, whether it is for equity. Or if you think you are smart enough, you can do your own financial planning.
Then you say, I'm going to put X per cent in equity, Y per cent in debt so on and so forth, and then you come to the mutual fund industry which has this menu of different equity funds, debt funds and liquid quasi debt funds. And that’s the way to use and think about mutual funds. It is like having a good GP who is your adviser. We are the ones who produce the pills. So if he says you need something for a headache, and here is a pill for a headache. You have to ensure that you get quality pills, or you could be getting something which is adulterated or which is contaminated.
And look at the flip side, so if I may. Look at the real estate industry. One of the biggest investments people make is in their house. Before the project is even launched, some broker calls you up. You’ve not seen it. You don’t have any offer document to say what it is. You write out a huge cheque. You have no idea what timelines are going to be adhered to. You don’t know how he is going to change the building plan even. And yet people go and put all their money and faith into that.
And here the indust4ry is a very regulated, very transparent one, which is trying to do a good job, is run by professionals and people stay away from it – I mean it’s unbelievable.
Shah: Another area where a lot of money goes, I believe is in international investments. A lot of fund houses have got this option as well. When we manage, we invest in equity in the country. There is also an option to invest in equity outside the country. So say if you've got expenditure planned in foreign exchange, this may be an option. There are people who say that “we've got expenditure in dollars over a period of time -- son’s education expenditure, daughter’s education expenditure -- which is outside the country. Then you can lock into your dollar business -- dollar at that point of time. So, a lot of people have started investing in international funds. Investing across the world.
DNA: Those who invested in foreign funds must be laughing their way to the bank, considering the rupee's fall. . .
Shah: And the ease of doing this is by writing a cheque…You just fill up – or someone fills up – a form.
Soni: But it is very difficult to explain this to people that’s why you [the media] have to do this…
Last year we had come up with a U.S. investment option -- just one year ago, in July 2012. We would have done 40 road shows across the country and I myself did 30 road shows across the country. We were not able to convince people to invest straight into a U.S. fund. Today that fund has given 50% return. Now, after the profits have been made, people want to invest in that fund. That is the problem.
The whole challenge is convincing people about an idea in the first stage when it is in an idea mode, where the returns are not coming.
Balasubramanian: Just prior to what Nimesh mentioned, we launched an international equity fund too with the help of S&P. It’s exactly about five years ago. But in an emerging market investment from a global investor's point of view was gaining momentum. And the whole investment was post the announcement of RBI that up to $200,000 could be invested overseas. So, we launched that fund. 65% of the money is invested in the U.S. equity and roughly about 10% of money invested in developing or developed markets. It is five years since then. It has met its benchmarks. But two and half years ago, there were people who were getting impatient. And incremental money did not come in.
Shah: We were not able to convince people. But that’s probably true of virtually any investment.
Balasubramanian: Any investment.
Shah: It’s not that. It’s not only about investing in the U.S. dollar. It is about investing in businesses which are not available in India. If – when you invest outside the country – you might get investment into airline companies, you might get investment into cola companies, which supply across the world.
So, a lot of stability can be possible – global companies, which are present in countries across the world. That itself offers stability of revenues.
So, if India is volatile this opportunity makes sense. If you see the last five years, two years India was at the top in terms of giving returns and two years we were at the bottom, right. So, we are either at the top or we are at the bottom as far as the worldwide returns are concerned year-on-year. So, this kind of international investment gives stability to part of your portfolio.
Soni: When I started the discussion, I talked about financial literacy. Indeed, one of the things that is happening over a period of time is that regulators are addressing all these issues one by one. So I see a special focus from regulators on financial literacy. There we have seen a special focus from them on expansion.
What is required now is to create a pool at the consumer level. While we can very easily say is that, well, the consumer pool will come and they’ll make money, I think that we need to create some financial incentives for people to come into these products.
Soni: So right now, I think if you really see the tax incentives that are available for mutual funds, it’s just a part of that ELSS [equity linked savings scheme] thing, which has stayed at the same number for -- I don’t know how many -- 15 years plus probably. So if you can create some kind of tax incentive for people for investing long-term money -- and it need not be short-term, it can be long-term money -- then it can become a part of the investment plan.
DNA: It will incentivise people to look at mutual funds.
Soni: We have seen the impact of these tax incentives and the other schemes that are announced periodically. Therefore, if some kind of incentive can be created, it can be really helpful.
So while the industry is working on its own to reach out, create awareness, create demand for the products, this just can come in handy.
DNA: That’s a good idea. Any other ideas that you think the government should consider.
Balasubramanian: Another recommendation that has gone from the industry -- this has been pending for quite some time -- is on the lines of 401(k) in the U.S. It is a defined contribution towards investing in mutual fund product and -- which is like our provident fund -- that’s also comes as part of the salary income as a defined contribution towards mutual funds. If and when it comes, it will really increase the penetration of MFs in India. It will also bring into play a large pool of stable domestic retail money.
DNA: Regularly. Almost like a recurring deposit.
Balasubramanian: Correct. It would also help create a vibrant capital market and also expand the industry’s customer base. Today the customer base is somewhere around 3.8 crore to 4.2 crore.
Soni: Something like this is available in Singapore as well. You could easily say that I want to put this money into fund A so much, fund B so much and then every month it keeps on getting deducted. So it becomes a habit.
Shah: In effect, what they are saying is that today we don’t have a proper institutional market. Overseas insurance companies, pension funds can also give their money to be managed by a mutual fund, to an asset manager. Whereas here – because all the regulators are in silos. And I think some regulation there would certainly put more money available for this industry, and also create a genuine institutional market.
Sethi: An insurance company can say, well, here’s a thousand crores, you manage it.
Today their regulations don’t allow it. Whereas, today, the pension funds overseas, there may be large pools of money we can channel – and they can allocate anywhere.
DNA: So that flexibility in regulation is required.
Shah: In the last five years the industry has grown, and now the product is quite beautiful. It is still a challenge for us to reach the final customer. It is a push product. But we have to make it a pull product, so that the customer should be asking for that product. Only two things can bring that pull.
Either there is a tax advantage of investing in mutual funds. Anywhere in the world; mutual funds have grown because either pension money have contributed to their growth, or the granting of tax advantages for investing in mutual funds. If one of the two things happen, it will be great for capital formation and also for the country.
If we need capital formation in this country, we need people to be enthused to invest in capital.
That is when the mutual fund industry will become more relevant. Till then we’ll keep on pushing.
And we have to work with the various media companies, so that we reach the final customer. It is to make him financially literate.
It is, therefore, very important to work with publications as yours, to reach the final customer.
DNA: Are the regulators sympathetic and positive towards such recommendations?
Balasubramanian: We have already submitted this as potential gaps that need to be filled, for the growth of industry.
The reception was pretty good, and given the fact that, at the country level, we have many challenges to handle the fiscal exercise. But I am confident it will come – even if gradually.
Shah: We have created a great product in the industry. Now we should go all out and reach the final customer more and more, and grow the industry and help investors invest better. We have to ensure that savings get converted into investments. Good for the country. Good for the individual.
-DNA/R N Bhaskar