Why ICICI Prudential MF’s S. Naren suggests betting on debt

Naren—known for his contrarian investment styles— oversees ₹4.7 trillion worth of investor assets. In an interview with Mint, he talks about the mutual fund (MF) industry, importance of asset allocation, and how the current market corrections are going to impact the industry. Edited excerpts:

You’ve recently given an asset allocation call in favour of debt over equity. Can you elaborate on this? Also, what is your view on gold?

Over the past 13 years, corporate India could easily borrow at very low rates (close to zero) globally. Today, that is no longer the case, given that rates have risen. Domestic corporate entities, which are rated AAA, may have to borrow locally. The other aspect is that Indian equity valuation is not cheap. When debt demand from corporates and banks rise amid a tightening liquidity environment, it will not allow equity valuations to expand in a big way. So, debt becomes an attractive asset class and a big return from equity will not be easy hereon. Debt funds look appealing right now because of their higher yields due to the high inflation and rising interest rates. Unlike the past two years, we believe investors should start allocating to debt.

Separately, a combination of structural failings in cryptocurrencies, combined with global central banks’ tapering, makes gold and silver interesting. When it comes to gold, the call was that when the US Fed will move on a tapering path, the yellow metal could do well. Another aspect which gives us more confidence is when cryptocurrencies cease to be a source of comfort for investors globally, they will move back to gold. Unlike gold which is not dependent on any central exchange or individuals, cryptocurrencies are dependent on investors.

The multi-asset fund recently completed a landmark year. It has outperformed in the recent past. What do you attribute this to?

If you consider the 20-year history of multi-asset funds, including the fund in its old avatar (dynamic plan), it has been an interesting experience. At ICICI Prudential, we believe that counter-cyclical investing is an interesting way of looking at equity markets and we can be agile in our investment approach. At varying points in time, quality, value, growth, small and mid cap, large cap, PSUs etc. tend to become cheap. Being a multi-asset fund, in addition to equities and debt, we are allowed to invest across silver, gold, Reits (Real Estate Investment Trusts) and InvITs (Infrastructure Investment Trusts). So, this is a fund which is managed by a set of investment specialists at ICICI Prudential. They look at different asset classes which may behave differently under varying economic and market conditions. Each asset class has a performance cycle of its own. We believe that over the coming decades, too, counter-cyclical approach will remain an effective way of investing, but one must be ready for brief periods of underperformance.

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Within equities, are there any segments (large/small cap) or sectors that look attractive?

In terms of market capitalization, on a valuation basis, large caps are better-placed than small caps, and small caps are better-placed than mid caps. Owing to significant selling by FIIs (foreign institutional investors), large caps have seen a significant correction. Meanwhile, mid cap pockets have a record valuation, and small caps continue to offer names which are still available at attractive valuations, making them better-placed from an investment perspective. On the sectoral front, we are positive on banks, IT, pharma, auto and telecom.

You are close to completing two decades with ICICI Prudential AMC. What has been your most successful call, and the biggest mistake you have made?

Our clear success was something that happened over a decade back (after the global financial crisis). We realized that retail investors often fail to gain from the equity markets because of their behavioural reasons, and not because the market is not delivering returns. So, we decided to popularize the balanced advantage category which has a counter-cyclical approach. Today, that category has emerged as one of the most popular and well-received categories among the masses.

From a failure point of view, while we believe that debt mutual funds have a bigger role to play in the MF industry and in an investor’s portfolio, debt funds have failed to capture the attention of investors, who tend to look at past returns without considering the risk-adjusted returns. The thought process even today remains impacted by the negative credit event which occurred with a few fund houses in the past. What investors miss out on is understanding that there were funds which never faced any issues even amid a crisis. For example, at ICICI Prudential, we never had any delays or defaults in the past 23 years of our existence. In 2017-2018, we actively encouraged investments in debt. However, when debt mutual funds started yielding low returns (2020-2021), we did not push investments in this category. Now that debt has become attractive, we are encouraging investors to consider an allocation towards debt but there has not been much traction, at least to the extent we hoped it would have.

There are markets globally which have not yielded any returns for decades. Why do you think India stands out and will continue to deliver returns over the next decade?

From an equity investing point of view, 90s was a challenging time. The Nifty 50 had touched a peak in 1994 and the market was at the same level in 2004. So, even we had a lost decade. One of the learnings from this was, if you have political, policy or macro-economic instability, then it is very challenging to generate returns. Currently, the government recognizes that both investors and corporates have an important role and this is a big positive. Another concept is valuation re-rating and de-rating. Currently, Indian equities have been re-rated, while a de-rating occurred in many other parts of the world. In a re-rating phase, it is imperative to be mindful about asset allocation and have judicious allocation to other asset classes like debt.

The MF industry today has a ceiling when it comes to overseas investing. If you had the liberty to launch an overseas fund now, would you do so and what market would you target?

We believe, post the steep correction, global markets present an attractive investment opportunity, but people are unwilling to invest given the recent negative experiences. In our framework, whenever any sector or thematic fund delivers very large negative returns, say around negative 40% in a years’ time, it becomes a good point to evaluate the offering and if satisfied, one can be positive on such an opportunity. It was on this basis, we launched ICICI Prudential US Bluechip Equity Fund in 2012, when US markets delivered no return for close to about 12 years. Over the years, this framework has worked well for us, and we are confident of this approach. That is the reason why we launched a commodity fund and a PSU Equity Fund recently, as we do not worry about past returns being low.

Some of the new age tech stocks listed in 2021 have come off a lot from their IPO prices. Do you see any value in them?

We are learning how to value new-age companies. That’s a challenge, as some of those companies don’t have earnings. So, there is learning involved in valuing such companies.

Are you bullish across the yield curve?

In the current market environment, we are comfortable with moderate duration accrual products as they have good yield to maturity. This is not the phase for big duration risk.

With ICICI Pru MF schemes covering almost every investing style, sector and theme, how do you signal a strategy to investors? For instance, you might be bearish on pharma (hypothetically), but you also have a healthcare fund. You might be bearish on large caps, but you have a large cap fund.

Being a large AMC, we offer multiple offerings which are managed according to different investment styles and objectives. So, it is not a one- model kind of approach. There are schemes like thematic advantage, wherein the fund manager has the flexibility to invest in varying themes which we believe stand to gain but otherwise every fund will run in accordance with its own mandate. For example, in the last one year, technology and pharma had underperformed, while banking delivered good returns.

How do you stay focused on your bets, especially the contrarian ones, when there is likely to be a lot of negative news flow?

The advantage of working for over three decades is that it enables you to cut out the noise. At a fund house level, we have created a framework of hiring analysts who are freshers, and slowly develop them with fund management responsibilities rather than hiring fund managers from the industry. Today, most of the investment team members who are managing various strategies successfully are internally groomed. The team is also adequately resourced. All this enables us to create a good culture and handle counter-cyclical investing by getting them exposed to experiences where the initial phase of investments does not necessarily generate returns but, with patience, most calls work out in the long run.

For example, we bought metals in 2018 which didn’t work for two years but delivered returns thereafter. Similarly, we bought power and telecom in 2018, it again didn’t work for two-three years, post which the call played out.

The absence of biases and better investment culture allows budding investment professionals to absorb counter-cyclical thought process, which otherwise could be very challenging given the emotional problems associated with such an investment thought process.

In the large cap space, do you see active funds continuing to generate alpha?

Here, the challenge is that we must take active share, be patient and allow the investment to generate returns. In this manner, one can create alpha. On the other hand, if you go close to the benchmark, it won’t work. The challenge to a large cap fund emerges from flexible mandate strategies like ICICI Prudential India Opportunities Fund which has a very high active share and has generated good alpha for investors over the past three years. This is also the kind of offering which may go through phases of underperformance. Thus, it is going to be difficult and a continuous battle, which itself creates space for passive strategies to coexist.

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