FUND CAFE - CIO
Six of India’s leading fund managers say it is unfair to compare the fund industry’s issues with the banking sector’s woes. They also discuss difficulties in managing investor expectations and why the 2017-19 period will see the debt market maturing
India’s leading money managers talk about issues faced by debt funds and managing investor expectations
What has gone wrong with debt investments?
S Naren: Two years ago when we did any investor event in debt, the only question people had was about the yieldto-maturity of the fund. It was as if a product with a higher yield-to-maturity also guaranteed higher returns.
If I told them I was not willing to take that additional risk for generating the extra yield-to-maturity, people would look at me and say you are an equity guy, and do not understand debt. So, as a fund house, we went through a more difficult time in 2017 than in 2019, as all the risks we were expecting in 2017, kind of played out.
How do you see this as a value investor?
Naren: Coming from a value investing background, the biggest challenge is when markets do very well.
So, like 2007, people say I am a value investor but in 2007 my fund (equity) underperformed the benchmark 15 per cent, but the whole thing was reversed by 2009. In debt funds, when you have higher yield to maturity I would say risks are higher.
The Sebi (Securities and Exchange Board of India) did a brilliant job of creating a category in 2018 called ‘credit risk funds’ and clearly explaining that the highest risk products have to be put into that basket. After that, it was very clear that if you wanted to take credit risk then that was the fund in which you should invest.
The worst is now over. If I manage ~1.8 trillion of debt money, it is not possible to never make any mistake. Investor greed, fund manager patience, and the fund manager’s capability of taking pain are all part of the framework. In 2007-09, we had gone through this in equity, this time it is debt. Equity markets matured in 2007-09, and we will see the maturing of the debt market now.
When the industry has credit risk funds, why do they find a place in other debt and liquid funds?
R Sivakumar: We had some credit issues and liquid funds actually had no problems. We’ve seen tightening after worries in the NBFC (non-banking financial companies) space, but we need to be careful in doing it in order not to create new unexplored risks elsewhere.
Also, you need to have very tight positions limits. Suppose you are building a portfolio of AA or AAA bonds. You can have the same yield to maturity for the portfolio if you buy 10 bonds at a high yield or by buying a larger number of bonds at a lower yield. But if something goes wrong you’d rather have 50 bonds of which one bond goes wrong rather than 10 bonds of which one goes wrong. Part of the chase for yields also led to not adhering to position limits, as many funds took outright positions in some names, which went bad.
Today, the spread between AAA and AA is 150-200 basis points; if I had a 2 per cent loss it wouldn’t even show in my NAV (net asset value). So, it is important to manage these risks and by doing so we should be able to deliver superior experience to the customer in credit products. Other than creditproducts, the industry has done extremely well.
What is the message for investors?
Navneet Munot: In the context of the debt market, there are cycles. A period of stability leads to instability and that leads us back into stability. That is the nature of the beast. So, you have displacement, and then boom and then euphoria, the profit-taking and then panic and then a new cycle lasts. We have always been part of such cycles.
I don’t think there is anything unusual about this cycle. History doesn’t repeat itself but it often rhymes. Every time the industry has come out stronger. You’ve talked about toxic assets, all the mishaps and mistakes that everybody has made. Just look at the three-year returns of the so-called credit-risk funds. Through this most volatile period; in terms of liquidity, in terms of interest rate risk in both the domestic and global environment, if investors earn far better returns than a fixed deposit in a bank, if they have delivered that, then I think we have done a good job.
Prashant Jain: In life we can’t focus only on the numerator and forget the denominator. One, I’m not saying that there have been no mistakes. I don’t think there is anyone who has not made a mistake in life or in their career. I think some mistakes have been made. And, in hindsight, we can say that one could have acted one way or the other.
That apart, if you look at the size of the problem, what is the total stress? The banking industry’s non-performing asset (NPA) ratio is 10 per cent. We are lending to the same (universe) and our ratio would be 1-1.5 per cent. And that is also stressed assets; it is not completely lost assets. So, while there is always scope for improvement, the industry has, by and large, done a reasonable job. It would be wrong to say that this is a situation of crisis. If that was the case, the industry should be losing on AUM. But we see no evidence of that.
Are these apprehensions exaggerated?
Jain: These are isolated cases, and that’s a fact. If you count the number of assets, the industry has lent maybe to a few hundred players. And how many are stressed? You can count them on your fingers.
Toxic does communicate that something is really, terribly wrong; and I don’t think that is the case. Yes, there is stress in some accounts and some securities, but you will see that over time, at least a substantial part of this money will come back.
Are people chasing assets far too much?
Lakshmi Iyer: I don’t think that is true. I think communication has to be absolutely seamless and timely. And more importantly, it has to be two-way communication. What I mean is that, when I’m communicating, the audience also has to be listening. There are, and there will always be cases in the audience, where the eyes are open, but the ears are shut. I think a similar case is seen in the mutual fund industry, where assets have been garnered, predominantly in a legitimate manner, suiting the investment objective of the investor.
However, the narrative changes when things go wrong, and the mutual fund industry gets the blame. The reason for this is that they are used to the cushy world of banking where a fixed deposit is equal to assured return. The rate of interest is known to you, and people have bank accounts since childhood, which is not the case with mutual funds.
Isn’t 17 per cent exposure to NBFCS too high?
Iyer: Why is 17 per cent wrong when we know that not every NBFC can be painted with the same brush? Today, people are afraid of debt and not of equity. Now my question is going back to what Naren said talking about 2017 — out of 10 people in a room, 11 people were invested in credit; in 2018-19 out of 10 people not even half have invested in credit. What has happened? Banks obviously have an NPA issue, mutual funds do not. I think it is a perception issue.
What is your take on Sebi’s classification?
Naren: We converted one of our schemes to being called a small-cap fund, which wasn’t earlier a small-cap fund. So, on this entire debate on reclassification causing small- and midcaps to fall, we only ended up buying mid- and small-caps.
Sivakumar: The churn rate in terms of classifying the mid- and small-caps was high. With certain stocks becoming mid- and small-caps, fund managers were forced to sell. The active calls taken by the fund manager was higher than the index churn. I don’t know if that is a dominating factor, but it has led to creating some alpha opportunities over there.
Jain: My opinion is that this is not correct. You have look at what happened before the correction. Between 2013 and 2017, small- and mid-caps were the highest outperformers against large-caps. I don’t think we can make a case that small- and mid-caps grow faster than large-caps (over the long term). In isolated cases, it is possible.
I don’t think the entire group of small- and mid-caps can grow more quickly than large companies. But for whatever reasons — and we can give various explanations — small- and mid-caps outperformed for three-four years and they had to revert to mean. And, it is just a coincidence that this reclassification happened around that time. I see nothing wrong with what happened either with the regulations or with the way small- and mid-caps have corrected.
A Radhakrishnan: Eventually, the best source of performance of any company whether it is large-, mid- or smallcap is earnings growth. If there has been a disappointment, and there have been significant cases of disappointment visà-vis earnings growth, the stocks have seen corrections. Whether we rebalance or not, the stocks would have corrected because of the disappointment.
If the underlying earnings had been pretty good and if there was a correction, then I can understand this dichotomy or discrepancy. But since the underlying earnings have been pretty sub-par, it is logical that stocks correct.
What about rating agencies?
Sivakumar: We consider rating agencies necessary but not sufficient. Rating agencies are not entirely aligned with you over the lifecycle of a bond.
If you buy a three-year bond on which the rating agency gives you a particular rating; and six months later if he changes his mind and his rating, then you are still holding the bond for three years. Fundamentally, it is very different, the manner in which you analyse the bonds as an owner and the way a rating agency does it.
Jain: Rating is an essential input for us, and we go beyond the external rating. We have been a little more conservative, and any issues seen have been limited. We have avoided highly rated papers based on internal ratings for long periods.
Naren: It is a fact known from the 2008 financial crisis that you can’t depend on ratings alone. Frankly, if you are dependent only on ratings, then you don’t need any fund manager, you don’t need a risk team, you don’t need anything.
I believe everything is countercyclical — if a new rating is given by any credit rating agency today, it is something we should trust. The old rating was made when your caution standards were much lower.
Iyer: If I can summarise, rating agencies are like Google Maps. When you want to get from one destination to another you need Google Maps. If it says 50 minutes, and if you are going to plan to reach exactly in 50 minutes, then God save you. You need to plan according to peak time, or whatever else it is.