The Mutual Fund Show: The Right Way To Invest In Large-Cap Schemes

Kshitiz Mahajan: I agree with you that there is an underperformance vis-à-vis the benchmark, but it's obvious, benchmark I think, is more active than your active mutual fund. So, the benchmark in itself is churning fast, benchmark in itself is led by a few companies doing well.

When we reached all-time highs in Sensex, out of 30 stocks, 13 stocks had beaten their all-time previous highs but 17 are still trailing. But when it comes to funds, we have been regulated by SEBI that 80% of the stocks has to be in the top 100 stocks, and then you cap by 10% increase in every single stock not more than that.

So yes, I somehow feel that rather than going for a future large-cap fund, one can look at an index fund or a smart beta fund in index itself. So that's what the strategy should be. Having said that, somebody who's already having a large-cap mutual fund portfolio they can stick around, as you know, there are times when fund doesn't do well but you know, it's just a cycle. Sometimes your bets will go right and sometimes my bets will go right, so I think the holdings are very, very good.

For a new investment, whether an index fund or holding to the large-cap fund, I think what you said is the right, the answer is in the question only, one should do STP only. We are at the peak of the market, at these levels 12 to 14 weeks STP is what we are recommending to everyone that let's not be in a hurry to park your money in mutual funds. You have enough time on your side. Take a STP route and look at a low-cost product.

As rightly said, sometimes all these funds over a period of time you say 1.25 plus, 125 bps every year then still the possibility is that we can be in line with the index fund or maybe you can beat the index fund by taking a smart beta fund. So, that’s my submission on how one should approve last year's space. 

Gaurav Awasthy: I think the answer is actually a mix of all the four options that you have given us, and typically for the portfolios that we manage for our clients, the way we are running the portfolio, there's a mix of passive as well as flexi cap.

So typically, the way we look at it is that the risk of not being in the market is possibly greater than you know, being in the market. So effectively, if you do nothing, the index still will give you that return of 12-13-14% compounding over long periods of time and historically if you look at especially the last three-four years, large-cap funds have found it difficult to really beat the benchmark.

We were looking at data as of November end, only about two large-cap funds managed to beat the benchmark. So, the benchmark returns I think, you know, close to 40-50% of the portfolio we run through passives and passives does not necessarily only mean Nifty 50, it can be a mix of Nifty 50 and Nifty next 50.

If you believe that the broader markets are going to do better, you can also look at some of the equally weighted indices, the remaining 50% typically, you know, we are going to flexi-cap mode because we think that the broader markets possibly will do better than large caps.

I think the way that we are getting clients invested is largely that you deploy about 80% of the intended allocation over the next five to six months through an STP route and you keep about 20% aside, which is more opportunistic or tactical in case you get a correction.

Gaurav Awasthy: We like the Canara Robeco flexi-cap fund, and we like the ICICI Prudential flexi-cap fund. What we are really trying to focus on is managers who are growth-oriented because we think large parts of the economy will tend to do well over the next few years. So, we are focusing on people who are bottom-up growth-oriented and these two really fit the bill for us.

Kshitiz Mahajan: On the flexi-cap side, most of them are actually 90% in large-cap only. So, my point is, if I actually want to choose to give that delta to a client, while giving a multi-cap fund, I would like to go with a focus strategy. I like HDFC Focused, and I would like to complement that with a contrarian view of a of SBI Contra.

I like both the fund managers who manage these portfolios. I like the way they have structured the portfolios, like HDFC Focused is 28-29% on the financial side, it is 9% on your IT side and then eventually it has added a lot of other sectors which are doing well.

Whereas SBI is playing on the infra side, on the defence side and many other things and it's a little low on your banking as well as on your IT side. So, I would like to complement these two portfolios because I see from here onwards, where valuations look, Indian markets have done well is a good thing, but I think their valuation looks a little stressed. I think there are a lot of businesses on the value theme that should do well.

So, this is one place where I would like clients to look at these two funds and we are actually liking these funds and we are talking about these funds.

Kshitiz Mahajan: These are good for investments. In fact, you will be surprised, HDFC Focused has put 74% in large cap. I am saying you don't have many options in industry leaders in small-cap and mid-cap space and on smart beta side, I think ICICI Pru low beta is what one can look at. It is a good fund, if you actually want to create a smart side of index side, then you can add 5-7% allocation to that fund.

Gaurav Awasthy: So, if you look at the small-cap figure, it has obviously underperformed as compared to large-caps in the last one year and if even you look from a valuation perspective, it is possibly the cheapest index among mid-cap, large-cap, small caps.

Having said that, obviously small-caps are far more volatile. So lump sum is never really a great idea unless valuations are very compelling. While valuations are cheap, they are not that deliciously compelling right now. But STP makes sense. I think, provided that you have a longer-term horizon of three to five years to small cap.

I think for the investor it would be better off if there is a correction that will help him get better valuation. So, in our sense, small-caps are not overpriced, they are probably the most attractive part of the market, but the valuations are not so compelling that you do a lump sum. You do an STP, and we think you will make reasonable returns on small-caps over the next three to five years.

Gaurav Awasthy: Here what we look at is the Nippon small-cap fund and the Kotak small-cap fund. 

Gaurav Awasthy: So typically, both these funds have long track records. We really love the style of the fund managers and if you look at the category today, most of the funds have become large because of, you know, previous performance. I think you would rather go with people who have seen the cycles and have the ability to really manage the larger funds.

Kshitiz Mahajan: I would not like to recommend small-cap to average investor and obvious reason is that when you buy a multi-cap on or a focused fund or let’s say a large and mid-cap category fund or a mid-cap pure fund also, you get small-cap exposure. And I agree with what Gaurav has said, that it comes with a lot of risk, you know, somebody who's looking at 7-10 years of horizon while parking funds can actually look at participating in a small-cap and mid-cap fund.

Sometimes the gestation actually becomes very long. If you remember 2017, small-cap index has given a return, I am talking about the index not the fund, had given the return of 56% and mid-cap was 48% up. In 2018, when the new regulation came, and we had the SEBI regulation about the fund categorisation and that year it was minus 67% and then it took almost till 2021, post the first wave of Covid that small-cap started moving up from August-September onwards. So, I have a view that it's meant for people with a high-risk appetite and a long horizon while investing.

I like the category, I have my participation in small-cap but I have long horizon for my small valuation, I don't mind keeping for 10 years. So, I think you get exposure there and the type of return which generates 2-3% delta over let's say large-cap or multi-cap over a period of time.

I think that the type of risk which you take is much higher. At the end of the day, you have to evaluate what type of risk you are taking to allocate funds, and the type of return you want to generate. If you believe in the power of compounding, other people make 15% also, your work is done. You may have made it two times in 10 years. So, I am saying I would like to give small-cap to people and we give who have little high-risk appetite.

Kshitiz Mahajan: We like SBI small-cap and Kotak small-cap fund. Both funds we like very much and for obvious reasons. One is the consistency of performance over a period of time, size is very adequate because it's small category if you put in Rs 14-15,000 crore and let's say if you would like some idea, one idea is to buy 750 crore, that type of liquidity is not available in market.

So, the third very important reason is especially for SBI, they have on numerous numbers of time, they have stopped subscription to their funds, right now also, you can’t park lump sum whenever their fund size goes high. And whenever they see opportunities in small cap, they open it for some time. So, that's what I like about these fund houses, they are very clear. Like yes, if they don’t see the appetite for growth, they don't accept the money.

If you see in small-cap space, also the funds with bigger sizes over the last 10 years, I have not bought anything, but one can go and check, has given for 15-16% in the morning but funds with adequate size or in this category is able to deliver over the last 10 years 18-20% amount. So, I think that's one part which we look at.

Kshitiz Mahajan: So, it's very interesting time for fixed income, the curve is flat from three months to six years, five years, if you actually see to get the same type of yield from 7.15-7.45% in that bracket, and interestingly, if you see the benefit, right now if somebody is coming in and stay there for three years and three months, you get more indexation, so whatever money which you are seeing as return will be a tax free because you get indexation benefit, long-term capital gain benefit. So that's how it is.

I think somebody who wants to put a lump sum money right now on the fixed income side, and someone who is at a high tax bracket, this can give you 10.5-11% pre-tax. If you actually add up the tax part and you're getting post tax 7%. We can look at short-term bonds or corporate bond funds. There's 100% ‘AAA’ allocation which is there, one that can look at that.

And if you want to put lump sum money over a period of time, then as we have done this calculation at our end, five years rolling returns in any five years, gilt funds have not given less than 7% return. So rather than doing an RD, where you get 6.5% and you pay tax as per the tax law, just do SIP in a gilt fund for let's say 2027-28 maturity IDFC Crisil gilt 2028 fund and a Bharat bond fund offer from Edelweiss.

These are the few funds which we like and come with very low expenses also. In fixed income, if you are working on the expense side, let’s say, the yield is 720 and you are at 5-15%, your job is done post estimates 7%. So, this is what we recommend lump sum look at short-term, if you want to park for 3-3.5 years do SIP, look at a gilt fund for let's say 2027-28 maturity and you can do a SIP there and if you are looking at parking for a short-term and you can look at ultra-short term fund category or a money manager category, there also we say if you want to keep some powder dry for equity, you are making 6.5-7% which is killer.

Gaurav Awasthy: The world has changed over the last year in fixed income and while we were in a rising rate environment, largely we were staying with passives because we thought that that is the best strategy and typically, we were doing with fixed income funds or Bharat bonds ETFs or you know, index funds.

But our sense today with the inflation readings that have come in India plus in the U.S., our sense is that most of the bad news is already priced in and from here incrementally, interest rates in the medium-term should start looking down. When you look at a scenario like this, we believe that active funds actually start doing well because there are multiple opportunities to very late alpha in the portfolio, from credit spreads to taking duration calls.

Currently, the way we are positioning debt for clients for about three years is that you put about 35% in passive funds, like some of the funds that Kshitiz mentioned, like Bharat bonds or fixed income plans and PSUs in your portfolios.

Today you are roughly getting about gross of 735 and you will get post tax about 7%. We are putting about 45-50% in short-term funds, typically right now, so that we don't really take too much risk on the duration side. But tactically, we are putting about 15 to 20%. We have started putting in dynamic bond funds, where we think that the fund managers can really take a call on longer duration and in a falling interest market, typically these funds start doing well.

Gaurav Awasthy: I think you should do an STP over the next three months pre-April. So, you know, you get the indexation benefits, there is still some volatility in the air on fixed income. So, you can do a three-month STP but close it before April to ensure that you get the indexation benefits.

Gaurav Awasthy: Typically, all the short-term funds, for example, we have Nippon and Kotak with us. On the dynamic bond side, we are aligned right now with IDFC now Bandhan dynamic bond fund. Typically, again, these are fund managers that we have tracked and work across cycles and from a mindset, both from a credit point of view or from a duration point of view.

Kshitiz Mahajan: For 3-3.5 years, they can look at short-term fund, which is ICICI short-term fund we like, HDFC corporate bond funds we like at our end. Then for gilt fund, we can look at SBI gilt fund and IDFC Crisil bond fund 2027-28 maturity.

On the ultra-short-term side, they can look at Tata money manager fund, we like this fund. Bharat bond fund is there with different maturity. So, the beauty of fixed income is, if your tenor is matching your maturity of the portfolio, then there is no risk of market movement because eventually you are maturing as the paper matures. So, your market risk, mark-to-market risk in between might be there but while at the maturity is not there, so decide on the funds which you want to park and just map it with a maturity of the paper in which you are parking.  

So, this is what we do at our end depending on its maturity, we just mark it to the tenor they are doing.

Gaurav Awasthy: As a normal average investor, I would really take as a 50-50. 50% debt and equity to cut his risk as well as you know, get reasonable return. 

Gaurav Awasthy: So typically, at this point of time you see normally based on how valuations play out, this may range between 40 to 60%, we can’t call it neutral where valuations are short. So, at this point of time, the equity part of the portfolio, the way we are really looking at it, is that we would have about 60% exposure to large cap, close to about 15% exposure in mid-cap and 15% in small cap.

We have added about 5% in international funds and tactically at this point of time, we have also added about 5% in you know in a mix of gold and silver funds because we think that the dollar index has really peaked out and precious metals will also do well over the next couple of years.

Debt, as I said in the last question, is typically about 35% in passives, three-to-four-year kind of maturity, about 45 to 50% in short-term and the rest 15-20% in dynamic bond funds.

Kshitiz Mahajan: I would like to give you a 60-40. 60 on the equity side 40 on the debt side. I see that your return irrespective of you being little low on risk, your return should be in the range of close to about the nominal GDP.

So, I would like to have him around 11% of overall returns, where I see that a mix of balance fund in the equity side, index fund and a multi-cap fund. I would not like to give an aggressive portfolio because the markets may go down south while he started investing, he might end up saying that FD is better for me, so I don't want him to be in that situation. I want to give him a little safer bet on the equity side also and on the fixed income side.

As said by Gaurav, it’s a mix of three-to-five-year maturity what I would like to give and it is a sweet spot for people who are participating back on fixed income, you can make 6.5-7% on fixed income and with this type of portfolio, balance, index and focused fund, you can generate 13% for an average of close to 11% is what I am targeting 10.5-10.8% where client can get return post tax on the overall portfolio.