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Topic of the first panel discussion was: Are fund managers ready to manage ever-increasing inflows and investor expectations? 

Speakers: 

Lakshmi Iyer, chief investment officer (debt) and head-products, Kotak Mahindra Asset Management Co. Ltd; 

Manoj Nagpal, managing director and chief executive officer, Outlook Asia Capital; 

Navneet Munot, executive director and chief investment officer, SBI Funds Management Co. Ltd;

Prashant Jain, executive director and chief investment officer, HDFC Asset Management Co. Ltd; 

S. Naren, executive director and chief investment officer, ICICI Prudential Asset Management Co. Ltd 

Moderator: Kayezad E. Adajania, deputy editor, Mint Money, Mint

Kayezad Adajania: The past year-and-a-half has been good for mutual funds in India largely because investors have been consistently investing, mainly through SIPs. About Rs5,000 crore worth of inflows come in every month through SIPs. Retail investors have been warming up to debt funds as well. But if there is a market correction, as many experts are saying will happen, are fund managers ready to manage the ever increasing inflows through SIPs? Also, with institutional investors becoming as powerful as foreign institutional investors, will this be the new norm?

S. Naren: The markets are too jubilant when they don’t go down when FIIs sell.To make money, you should be able to buy cheap. It’s good that DIIs have become strong, but volatility in the market has its own use. One of the issues we deal with—because no big correction has taken place since 2011—is that most people believe equities are as risky as debt. When we communicate that debt is a much safer asset class, they are not sure. So while is is good that DIIs are strong, we should have bouts of volatility because my personal experience is that the word ‘risk’ is forgotten if there isn’t any volatility. The belief that SIP inflows are ever-increasing and that the markets will never fall is not good for the investors nor for the industry.

Prashant Jain: I don’t wish for volatility and I don’t deny it either. In the longer term, if domestic flows are consistent, it can lead to lower volatility, which is good for everyone. Indian markets have been more volatile that global markets, because local flows were not consistent. When Lehman happened, or Brexit happened, it had little to do with India. But markets fell because foreign flows suddenly went away. So, while equities will remain volatile, the volatility can be lower because of local flows. Local mutual funds own about 5% of the markets, whereas foreigners own about 4-5 times of that. So, in terms of stock of ownership, FIIs are still four times. So it will be some time before we can say that you are as large as FIIs.

Navneet Munot: The fact is that we may touch a billion dollars in a few months, but in a $2 trillion economy it is not substantially large. We are just 5% of the overall market cap. Supply creates its own demands. And looking at divestment, the government can easily raise Rs1 lakh crore every year. Banks have to raise so much of capital. There is so much leverage in the corporate books that has to reduce. So there is going to be a huge supply of equity. We are still a capital starved country and still in investment mode. So the size of the mutual funds industry can be substantially larger. In fact, there is one company that is reaching (a level) that is larger than all the money all of us put together manage. Apple (Inc.) has a total market cap of $700-800 billion and where are we. As more money comes in, more supply will also come in. even in the available story, there is a lot of scope.

Entire Asia use to have a lot of savings in real estate a jewellery. All over Asia financialisation of savings is happening. In India, a large part of the economy is not even listed. We are yet to see an asset manager listed. Then there is healthcare, education and services sector (apart from IT).

Jain: When we look at issues, we only talk about the numerator; we forget the denominator. Rs15,000-20,000 crore inflows a month annualised is Rs1.5-2 lakh crore. That’s only 2% of India’s market cap. Only 6% of India’s household savings. So there numbers are not very large. Now look at supply. Just from September till November or December, $15 billion or rs1 lakh crore of new stock has been supplied. Also look at the exits of private equity funds; it’s substantial. There is no challenge in deploying capital.

Adajania: Prashant, your fund—HDFC Equity Fund—is about to touch Rs20,000 crore. When you are focusing on large-cap companies, as are the peers, how tough is it to create an alpha trying to stand out?

Jain: the funds are Rs20,000-30,000 crore. Fortunately, we are not the only ones. The largest fund in the country is $3 billion, but 0.15% of the market cap. By what definition is it large? There isn’t any fund in the country that is constrained by size relative to the market. Alpha generation is not constrained by size. Of course, as the market matures, and mutual funds become larges, alpha generation will become tough. In the western mutual funds markets, where they account for maybe 25-30% of the market, alpha is hard to come by because mutual funds have become the markets themselves. Maybe the Indian industry will also reach there, but it may take 1-2 decades.

Adajania: Manoj, when investors trust you with their money and you see valuations are high, how do you translate that for your investors?

Manoj Nagpal: In terms of net inflow, we track it as a percentage of AUMs. So even back in 2007, which was the last bull market, we used to typically see net inflows of 2-3% of the total assets that the industry managed. At this point, we see that increasing to 5-6%. The trend of financialisation is part of a long-term structural change that is happening. Sadly, valuations have not been accompanied by volatility. This may have been a lower-volatility year. So there is comfort seeping in that we may not see a huge correction. There is complacency from investors’ side and also from the industry’s side that these inflows will keep continuing. One of the big trends we are seeing is that in some of the larger funds, for example HDFC Prudence Fund, the number of stocks in the portfolio are now 90-100 from 50-60 earlier. Will that create alpha for investors is a question we debate over as well.

Adajania: Is there a liquidity factor also? What happens if there is an outflow and one needs to liquidate?

Naren: the way we structures after the markets became much more expensive is to recommend more defensive products that have a lot of cash inbuilt, like the dynamic asset allocation category. Market falls are opportunities for us. We believe that when markets are higher and valuations are not dirt cheap, it is time to invest conservatively. Ten years back if we had said we are going to keep cash in the fund, they (customers and distributors) would have said next day I will redeem my money. That phase is gone. Today, we are able to tell people that we have more defensive funds and we will invest when the market goes down. Currently, the issue is not a correction but that when you have invested when the valuations are not cheap and the earnings cycle hasn’t come yet, what return will you make in the long run, and in the short run when the earnings come. The bigger problem is that there haven’t been earnings for 3-4 years and markets have gone up. We all believe earning will come in 2-3 years. Frankly, we expected earnings to come back, for example in a sector like metals, 2 years back. And earnings have come back in a big way. But it’s not come in the rest of the economy. The government has taken some good long-term steps with short-term pain. Be it demonetisation or GST. We will wait for the earnings to come. The challenge is that markets look over-valued on earnings-based multiple. The real challenge will come when the earnings come and the markets go up.

Adajania: Lakshmi, debt funds are being recommended actively now and investors have very high expectations of debt funds, especially when they are switching over from fixed deposits. This is happening at a time when we have seen some accidents in the credit side. How do you look at the expectations?

Iyer: Three-four years back, we had to tell investors to put money in equity. Now we have to tell them to put money in fixed income. In a recent Twitter poll I conducted, i asked who invests largely in equities, largely in fixed income, a blend of both and in gold and real estate. Surprisingly, 2% said they invested in real estate and gold, and 4% voted for fixed income, 655 said equities, and about 35% said blend of both. This tells you that fixed income in today’s market is contra play, and not a growth play. We are not faced with a problem of plenty. You mentioned banks cutting deposit rates, and demonetisation leading to a trigger. But India is largely fixed income in nature—a banking industry of Rs90-95 lakh crore vis a vis Rs20 lakh crore mutual funds, of which one can strip off Rs7 lakh crore, leaving Rs13 lakh crore. So the real meat is not more than Rs4-4.5 lakh crore, if I exclude the liquid and ultra short-term category. That is a category that has started seeing growth in the past 2 and two-and-a-half years. We have barely scratched the surface of this. The money is coming mostly in the short-term category and corporate bonds. Even in that, bond short-term is predominantly institutional driven, topped up by retail or HNI. whereas in the accrual or corporate bond space, it is predominantly retail and HNI driven, topped up very selectively by institutional investors. The numbers are not that large. In the past 3-4 months, Rs7,000-8,000 crore net getting added to this category. In the span of about 6 months about Rs17,000-18,000 crore getting added. These are not big numbers to reckon with. The accidents you mentioned are free cases. They will not prevent investors from investing. They are exceptions to the norm. If this category is managed well—i.e, without greed, without chasing returns from investor management fraternity—there is enough scope for moving money from a traditional banking fixed deposit sources, which are not even allowing you to beat inflation. So, this category can explode in the years to come, and in a legitimate way.

Adajania: There is enough money waiting to be invested, but is there enough supply for debt funds to be able to invest all that money?

Iyer: In the issuer space, for most part they were all wedded to banks. Now, there is swayamvar phase—they can actually choose to be wedded to a bank or a mutual fund or an insurance company or a PF (provident fund?). The capital market is also booming. So, the issuer is out looking for the best rates. So there could be a rate war, which could be a risk. One has to manage this more responsibly. In the pure corporate bonds space, the credit piece is just about Rs1.2-1.3 lakh crore. The short-term space is close to Rs2.5-3 lakh crore. This is the bedrock of corporate bond investments. In this space there are many instances from the past 2-3 quarters where entities, who were mostly bank borrowers, went into IPOs in the equity markets, but just before the IPOs they diversified into the mutual funds or capital markets space. So for a bank loan book of upwards of Rs70-75 lakh crore, we in the mutual funds credit space are barely at Rs2.5-3 lakh crore. So there is a plethora of opportunities.

Adajania: Manoj, would you advise debt funds to investors without worrying about liquidity or other challenges?

Nagpal: As equity is dominated by volatility, debt will have some part that goes bad at some point of time. I think mutual funds have done a great job of controlling the credit space. Sebi has also played a strong role in having their own internal credit rating. As the size of the industry increases, these instance may also increase. But at this point investors need a fixed deposit-plus type of returns. In our view the bigger risk is investors jumping directly to balanced funds. Flows into debt will also keep on increasing. In my view, the risk control measures are strong enough.

Adajania: Naren, this year too many closed-end funds have been launched. What was an opportunity in 2013, does it still exist?

Naren: Unless you give a good investment experience, you will not succeed in asset gathering exercise. My experience over the last 13 years has been that money comes during booms, and not during busts. So, if people said closed-end funds delivered the best experience, it would be so if you knew when to buy and sell. The best way to judge if we have done the right thing with closed-end funds is after tight turns. If you see the portfolios of our closed-end funds of this year, you will find that we are cognizant of the fact that this is not a cheap market territory, and over the next 3 years there are many event risks. Can some of this go wrong? Yes, but we are acutely conscious that 2013 was an early cycle and 2017 is mid-cycle. We will be able to answer you in 2020 or 2021. The problem is years like this one when markets become expensive, we have to be cautious even in our open-ended funds.

Adajania: When inflow is high, and markets are high, is there a possibility to stop taking money from investors or giving it away to them?

Munot: We have about 6 million investors and each will have different return expectations, risk appetite, time horizon… For one AMC to decide for all people is tough, but yes there are times when we say markets are over-values or one asset class is looking more attractive. Even when Nifty was at a high of 8,000 and investors were putting money, there were fund managers who said markets have run ahead, but someone who has waited for it has already lost 25%. As Peter Lynch once said: Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost in corrections themselves." Plus, a large number of people are yet to have any exposure to equity. But I have to say that valuations are high and return expectations have to be moderated. But it is contextual. Interest rates are where they are and inflation target is 4%, and if you believe the government and RBI are committed, India will have a long period of lower-to-stable inflation, and return expectations have to be moderated. One of the best things happening in the industry—thanks to regulators, the industry and people like advisers and people like you—is that this time expectations are moderate. One small thing that I worry about is that a hard core fixed income investor, with no ability to take any drawdown, and with very little expectation of volatility, buying an equity fund thinking that it will deliver a monthly return.

Adajania: Why don’t we hear more fund managers cautioning investors to temper their investments?

Jain: It’s a perception that markets are high. We for one have not shied away from saying so in black and white when we thought markets were expensive. We did so in 1999 and 2007. But I don’t feel markets are expensive at present. The CAGR of the index for the last 10 years has been 3-4%. The nominal GDP growth for last 10 years has been 12-16%. India’s market cap to GDP is near all-time low. We are forgetting a very basic attribute of equities, that this is a long-term asset class. There are 50 funds whose NAV are between Rs500 and Rs1,000. In the last 25 years, there have been periods when P-Es have been high and low. The smartest investors are those who have remained patient. If you buy something at 20 or 30 P-E, it is expensive. But what if earnings double in 5 years? So, in a growing economy, P-E becomes irrelevant over time. One year from today, which P-E will we look at. In March 19, at today’s index levels, markets are trading at 16-17 times. What P-e are you paying for a 10-year government bond? At 6.55% yield, the P-E of zero growth for a government security, the P-E is also 16. If you remove just one or two sectors from the Sensex, in the large-cap space, there are no sectors in which P-Es are not reasonable. In my opinion, about 25% of the index is indeed expensive, but that’s in every market. If the index has delivered 4% CAGR for 10 years and nominal GDP is growing at 15%, market cap-to-GDP is near lows. There are 3 sectors where earnings have been destroyed, and these are cyclical sectors—corporate banks, metals and capex. As capex recovers, as NCLT resolves these NPAs, and as earnings come back, you will see earnings grow. In the current year, the aggregate earnings were less because the pharmaceutical sector has disappointed.

Point No.2—how much of households is coming into equities? It is in single digits. So where is the case for people going overboard and buying equities. India saves $500 billion a year.

Adajania: What advice do you have for people who have discontinued their SIPs thinking markets are expensive; those who are continuing; and those who are still waiting?

Nagpal: SIPs have become a way of life. The SIP book is going to surprise everyone on the upside. A structural change is happening in the savings habits, especially of the younger generation. If equity is 3-5-year product, then an SIP is a 10-year product, and it is getting accepted that way. There are many investors who are waiting on the sidelines, apart from the SIP book also. The concern is will the people be able to adjust to volatility on the way. Are distributors and advisers gearing them up for that? This is an area that needs work. On ground we see that people are expecting 18-20% CAGR, which we think is a wrong assumption. People should brace themselves.

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