The Mutual Fund Show: Are Thematic Funds A Good Bet Now?

Gaurav Rastogi: So, when interest rates are rising, the biggest risk in any kind of bond is what we call the reinvestment risk. I will take a very short duration example–you have a six-month bond, but in one month the interest rate rises and the bond price will fall.

In a floating rate bond, the rate that the bond pays is linked to some kind of an interest rate proxy. Usually, it will be a government bond, like a Gilt fund or something along those lines. So, what will happen is that in a rising rate environment, it's taking care of that reinvestment risk.

If the view is that most of the rate increases have already happened, then floating rate bonds don't make much sense.

Floating rate bonds only make sense when your belief is that in the next two years, rates are going to rise by 2-3%, and so, you face a huge amount of reinvestment risk in a fixed rate bond.

Calling interest rates is the hardest thing to do. But if this is something that you are really scared about, then short rate bonds also provide you the same level of security. The interest rate impact on short-term bonds is very low.

If it's an overnight fund, or if it's an ultra short-term fund, there is very little reinvestment risk there. So, it's not just floating rate bonds, you can also think about short duration funds if you are not too keen to speculate.

Personally, I am not looking to speculate on what will happen. So, that's another way to play the same environment.

Suresh Sadgopan: As far as floating rate bonds are concerned, I agree with Gaurav. If the view is that for the next one year, one-and-a-half, two years, the interest rates are going to go up–of course, it is very difficult to say that.

(But) You cannot really rule that out also, considering the geopolitical situation and the various other things which are happening out of that geopolitical situation–like your interest rates going up, inflation catching up, and probably a recession, and things like that. So, if that is the case, then probably a floating rate fund may make sense.

One of the challenges as far as a floating rate fund (is concerned), typically, is that there are not enough floating rate funds, which are available as we speak currently. However, as per the mandate given by SEBI, floating rate funds should have at least 65% invested in floating rate instruments.

What fund managers do to cover this is basically go for interest rate swaps, overnight swaps and all that. And then, fixed income, a fixed instrument is converted into something like a floating kind of instrument. It's a via kind of a route and this will work well in a rising interest rate scenario. It will not work well obviously the other way.

So, it is not a surprise that there are not too many funds, and there is not too much investment into a floating rate fund.

Coming to your question, is a floating rate fund a good choice–probably, to some extent of the portfolio, it may be something that we can opt for.

And I concur with what Gaurav says, we can also look at the shorter end of the debt funds. He talked about really short-end, like overnight and those kinds of things. I would probably go all the way to say low duration, money market kind of things also.

As and when the interest rate cycle peaks or if that is our judgment, at that time, we can probably lock it into something else.

For people who have a real long-term view, there are also longer tenure funds which are available, which will have a roll-down strategy or which will have a target maturity strategy.

For people who are not really looking at income from that or have a typical long-term view, and want a good tax-adjusted return, these kinds of funds also are something worth considering today.

Suresh Sadgopan: This is one of them. There are also combinations of SDL and some other products. So, that is available 60:40 from a PSU bond and SDL. If you're sticking to the maturity profile and holding to maturity, you are going to get a certain return, irrespective of the volatility.

Suresh Sadgopan: The world in which we are currently (living in) is a very turbulent world. There are lots of geopolitical risks which are there. Born out of those geopolitical risks, there are actual hard knocks which we can expect at the economy level, at the common-man interest level, inflation level and all that. So, it is very difficult to call out at any point in time which particular sector may probably benefit from what is going to happen.

So, my sense is that, we are not really great proponents of sectoral funds or thematic funds in any case for the very same reason.

In any market, it is difficult and in this kind of flux situation, it is very, very difficult. So, I would suggest investors consider Diversified Equity Funds and allow the fund manager to do the job.

If the fund manager has a view that these 1-4 sectors are the ones which probably can do well in the next six months or one year, that is exactly what they will do. So, we should relinquish that particular choice and give it to the fund manager and allow them to do the job.

Gaurav Rastogi: I agree with everything that Suresh has mentioned. Timing is hard; regardless of the amount of time someone is willing to put in, they will not put in the same number of hours that the fund manager is putting in. And that’s their day job, assuming that the fund manager is doing their job, which I presume most of them do.

If you are a long-term investor–your investment horizon is greater than 10 years, you are open to taking volatility as in, you have gone through one cycle of volatility and you have not sold–then small-cap SIPs is always a very good idea.

Small cap doesn't get the respect as a theme that it should get. A theme need not be very exotic or like a momentum or something like that.

Themes can be things which are very simple. If you are a very long-term investor, maybe you know 15-20 plus, a value SIP makes a lot of sense.

So, there are certain factors or themes, which have been tested across multiple markets globally, and do a really good job in a very long horizon period with, of course, more volatility than the normal market. That has to be expected.

Technology is one sector people can start looking at in terms of SIPs. I think Nasdaq, after this correction, is not as expensive as it used to be.

But I would 100% agree, think about broad-based thematics which have a history of outperformance in multiple markets globally, across multiple time periods rather than focusing on the new things.

Who knows whether the EV basket will outperform or not. So, the new stuff, which is the shiny stuff in which probably people focus more, I would agree with Suresh.

It is very hard to time. We all know what happened with ARKK, the money came in absolutely at the peak and it was supposed to be the next one that's going to make everyone a lot of money.

But there are these theses–time-tested, thematic, maybe boring, maybe not as exciting–but that do work over multiple business cycles.

Gaurav Rastogi: Definitely. This problem with small caps is that they come into focus only in the peak of the markets. In 2017, end of 2017, everyone's launching a small-cap thematic basket and small caps are everywhere; and in 2018, January, they peak.

These are thematics that people should have gone through at least one volatile cycle and have not sold. It's a very high bar for who should think about small caps. For the majority of the investors, I would say Nifty 50, Nifty Next 50, and invest for 40 years and be the best at your day job. Make more money to invest more money to become really wealthy.

That's the easiest kind of flywheel that an individual can control. But if someone has interest and someone's gone through a cycle and they know that 2018 small caps started crashing and actually went down closer to 60-70%. But they didn't sell, and they kept on buying through the down cycle and are still investing in that. So, definitely, it's something worth considering.

Suresh Sadgopan: Typically, small caps are recommended only for people who have a high-risk appetite, long investment horizon, and the stomach for volatility. So, basically these three things are important ingredients.

They should invest in with a fund manager who has enough track record, a good picking style as far as small caps are concerned. Because in small caps, it is all about stock-picking and probably shuffling the stocks as you go along. So that's very important.

If one has the risk appetite and is willing to stay for the long-term, then small caps are fine in SIP mode.

Gaurav Rastogi: It's fantastic data. People are looking at this data and they are like, in July, equity inflows are down 42%.

A lot of people and sometimes we are also very critical of the retail investors. We miss out on the larger story–the larger story is India did not have an equity culture, and for the longest time we used to talk about India not having an equity culture.

Now, that we finally have an equity culture, we are arguing on the merits of are they able to time the market well, or are they not investing big amounts because of where the market is.

When I look at the AMFI data, when I look at mutual fund inflows since October, I think there was some data that Kotak published from October till July, FPIs has sold close to Rs 2,50,000 crore. That was the net investments of foreign investors.

Investors through mutual funds bought about Rs 1,97,000 crore. So, this is what retail is showing is finally an equity culture. This is what equity culture will look like.

What you want the equity culture to look like is for people to buy enough…, people to buy in down market, people to buy in sideways markets.

And for the longest time that is what we have been saying: India doesn't have any equity culture. Now, when we finally have an equity culture, (we are) looking at this data and kind of… trying to pick points on it. I look at this data and I only see good things.

Suresh Sadgopan: As far as equity investments are concerned, there can be some highs and lows in certain months. And we want to say that it is down by 42% compared to the previous month, but the fact is that it is positive. In such a turbulent situation also, it is positive.

So, I would say that is very good. Overall, it bodes well for the investors per se. The second thing is if you look at the SIP, people have not stopped the SIP just like that. So, it is still hanging over that Rs 12,000 crore mark per month, which is very creditable for all the retail investors. A lot of applause for them.

As far as debt portion is concerned, it was negative Rs 92,000 crore and now that has also turned positive. So, we don't know where it will go, we are not very sure but it has turned positive, and it bodes well for the mutual fund industry as a whole.

Mutual fund industry as a whole is within kissing distance of Rs 38 trillion now.

We don't know, we cannot predict but it looks like it is probably on a march onwards because if you look at the India numbers and what we have heard from various sources, it looks like while there are problems, we have reasons to be cautiously optimistic at least in the near term.

Gaurav Rastogi: If I look at the last six months, to be very honest, nothing much has changed. We see a lot of investments in our platforms like top five funds, usually two index funds…

We did see some small-cap activity, but that was last quarter of last year. This year, it's gone back to diversified large-cap funds and mostly, that's where we are seeing a lot of investments coming in.

The SIP book hasn't changed much at all. People are religiously doing their SIPs. There hasn't been the same growth that we have seen in the last six months of last year. But it's not like people are closing their SIPs and leaving the investing world in a hurry.

Suresh Sadgopan: No, there has been no major change, in a matter of say last few months, that way.

In our case, we are into pure advisory. So, in our client’s cases, it is going to be client-specific, situation-specific, their risk profile; it's going to be based on that.

So, it's a slightly difficult thing for me to answer this question. From our side, nothing really has changed.