The equity funds from your stable saw a good run last year. In a tough year, what did you do differently?
We have used the transition of the last couple of years to revisit the basic principles of what generates alpha. We have tried to document internally our own beliefs and principles and made it available to the world. By doing this, we have made the shift of making ourselves accountable to these principles in a significant way. Internally too, on a quarterly basis, we measure how we are in terms of the framework for each product. We have focused a lot on strengthening the investment framework, constantly challenging and back-testing what drives the alpha and what doesn’t. A bit of stillness too worked for us. In the period of transition, we chose not to make any material changes and our portfolios did not see any turnover. Holding periods are important and holding on to companies and ideas that you believe in is also valuable, and that seems to have worked for us.
Is there a compelling case for passive funds to take the lead in investors’ portfolio in India? How do you see them fit into DSP MF’s product strategy?
Our focus on alpha doesn’t come at the cost of offering a set of beta products. Alpha too has seasons, and there are phases in which passive portfolios do well and others in which active portfolios do well. If you look at calendar year 2018, a lot of funds had negative alpha. At the end of 2019, on the contrary, most of the funds that delivered negative alpha generated 7-12% alpha. All investors will have some allocation to passive strategies that will be a function of their belief led by their view of the portfolio, time horizon and risk appetite. It is also a function of what the trend is in alpha generation by the mutual funds industry. In the global markets, over a period of time, the trend has been established that passive funds do better and so money moves towards the passive strategy. In India, I still feel we have not reached that stage yet and it is more a situation of both active and passive strategies finding a place in the investor’s portfolio.
There is a view that the classification of mutual funds has made it difficult for active fund managers to generate alpha, especially in categories like large-cap. There is also the view that it has made certain market segments more volatile. Do the classification rules warrant a re-look?
The classification has brought in transparency, objectivity and uniformity in terms of bringing authenticity to product labelling. Investors can now identify the true risk-reward ratio for each product class. It is a practical framework that also gives significant leeway to fund managers in constructing the portfolio. It has been just a year and half and in this period, markets have been volatile for many reasons. I have not yet seen evidence to support the argument that the classification has made the mid- and small-cap segments more volatile. I think mid-caps were more expensive than they were in any cycle in the last 20 years. Smaller companies are growing at a lower rate but the valuations were much higher and that has been normalizing. I would want stability in the framework but no fundamental change.
What are the challenges and opportunities that the industry faces today?
I think the industry has a very long runway and I will focus on the opportunities. India has a large middle class with rising per capita income but the penetration of mutual funds is low. The middle class is aspirational and wants to improve the standards of living, and needs to save and beat inflation. Mutual funds can fulfil the need because of the wide range of asset classes, products and features they offer. The industry needs to capture the opportunity by simplifying the products and the on-boarding process. If we aspire to get the next 100 million investors, the best way is to on-board digitally. The cost to reach the consumer otherwise becomes too high and we need to balance between the cost of running the business and acquiring customers. There will be the usual bouts of volatility in the asset classes and the risks and rewards of investments, so the need for longer investment horizon has to be communicated to the investor through constant, authentic education.
What are the challenges that a mutual fund investor faces in the new decade?
Interest rates and inflation have come down and investors need to reset their expectations. If I say DSP equity fund has given a 20% CAGR in 23 years, it also includes a phase when rates were 12-13% and inflation was 11-12%. Today, interest rates are 6-7% and inflation is 4-5%. The returns of the next decade are likely to be lower than the returns of the last two decades. Actually, the last decade is a good template for what the investor can expect in this decade. From the market peak in 2008 to now, the average market return is around 7-8% and well-managed equity funds have given 10-12%. But when we look at a 20-year period, the returns are higher because of the start point. The other imperative for investors is to accept the inherent volatility of any asset. Those investors who understand this are likely to remain invested for the long term and be able to take advantage of it.
Volatility continues to be high. In the last 10 years, interest rates have been reset significantly lower than what the world has been used to. Any normalization of interest rates can increase volatility in asset classes. Investors need to be mindful and conscious of that and respect asset