The Mutual Fund Show: What Is The Best Portfolio Strategy For FY23?

Aashish Somaiyaa: (Based on) Whether one looks at the U.S. and rate tightening, or higher input prices, metal prices, commodity prices, food prices, domestic inflation, or what RBI has been saying about our economic trajectory – from all perspectives, it's a matter of time, but when there is an economic recovery, there is a feeling that interest rates are set to go up. In any case, what we witnessed in the last couple of years was unusual circumstances where there is very high liquidity and very low interest rates. Interest rates are set to rise.

Now, when will it happen, at what pace it happens, that is probably impossible to forecast. Keeping in mind these circumstances, for any investor who's looking to deploy money in debt, there is good news and bad news.

The good news is that over the next year or two, when you keep deploying, you are incrementally likely to get better yields compared to what you have got in the past. But at the same time, if you deploy anything today, and the interest rates start rising, if you're in long-term bonds or anything which has interest rate risk, you might see some kind of turbulence and some downside on your investment.

The best thing to do is to be at the shorter end, meaning park money in funds which have six months or 12 months duration. Don't invest in bonds within a 10-20-30 year maturity.

In terms of mutual funds, the categories are either ultra-short term or short term or low duration funds, and maybe a year or two later, when interest rates have seen a sufficient rise and economic conditions are slightly different on the inflation front, you might want to change the strategy. For now, you should be in low duration funds or short-term funds.

Santosh Joseph: When you invest in a debt fund, getting into what we are facing in the inflation scenario, your losses are absolute whereas the gains are relative. Therefore, to avoid such a scenario, you can be on the lower end of the curve, which is from overnight liquid to money market funds.

There is another category of funds that could possibly work for some investors which is Floating Rate Funds. Now if they run true to label and even if they have a year-and-a-half or two year modified duration, if the reset period is well done, you will make slightly better than liquid overnight and low duration funds, to taking the risk in the medium to short-term debt funds.

In a Floating Rate Fund, you are trying to make the opportunity of changing interest rates work for you. In a rising interest rate scenario, you have to buy the newer papers so that the yield is accretive into the portfolio.

But how often you actually have a method to change that determines the outcome on the portfolio in terms of return, because if you don't change, you're actually losing money. If you change, you are going to gain money, but there must be an ideal period for it. This component of change is called reset in a Floating Rate Fund.

Now, some people do have a reset which is at the fund manager's discretion. Some people will reset on a quarterly or half-yearly basis. In the given scenario, a half-yearly reset with a one-and-a-half year duration in a floating rate fund is an ideal situation where you'd be better off than the extremely low yields of the lower end of the duration.

Santosh Joseph: Actually, this is not only safe, but it also gives you maybe 30-40-50 basis hedge between overnight and liquid funds. So, it's a combination of both. While you are being safe, you will get extra bang for your buck.

Aashish Somaiyaa: This is actually biding your time because let's say theoretically, you are close to the bottom as far as interest rates are concerned. When interest rates start going up, bond prices start to have a depreciating tendency. Some think that we are at the lower end of the interest rate spectrum right now and from hereon, interest rates have to rise.

Bonds or mutual funds being market animals, the NAV takes the price of the bond on a daily basis, which means that if interest rates were to rise, the principal value of the bonds would depreciate. But bonds with less or very low maturity either don't depreciate or depreciate minimum. When you invest in an ultra-short term fund or short term fund, the maturity of the papers and bonds you hold is maybe three months, six months, etc.

Conceptually, the way to understand it is that when you are sitting on a seesaw, if the person on the opposite side is extremely heavy, you run the risk of getting thrown up in the air. The best way to prevent yourself from being thrown up is to sit as close to the centre as possible.

When we think interest rates are going to rise, we try to stay as close to zero maturity or as close to short maturity as possible.

Floating Rate bonds may have 1-5-year maturity, but basically the interest rate keeps getting readjusted every three months. So, it functions like a long bond or sitting close to the centre of the seesaw.

We believe right now that we are at the low point as far as interest rates are concerned. From hereon, there is a high probability that interest rates will go up. It is an intermediate strategy, that for the next one to two years, or maybe the next one or one-and-a-half years, it's better that you play this as an intermediate strategy.

A year or two years later, let’s say a ten-year bond is seven-and-a-half percent or 7.75%. Let's say short-term rates are higher and maybe RBI has gone through a spate of four or five interest rate hikes, then you can buy long-term bonds, and maybe change the strategy. But for now, you have to bide your time.

Santosh Joseph: One needs to be in a diversified Multicap strategy. Now, this is irrespective of the markets, whether you are in the midst of 2020 when things were in doom and gloom, or just two days ago when the market seemed to hit all-time highs.

Now, the reason is one does not know what factor or trigger is going to come in at what point of time. Be realistic that we have to be in good quality companies. Whether it is mid, large or small, we don't want to differentiate. A portfolio should consist of a prudent combination of all three. Therefore, the dominant category over here is a Multicap.

All Flexicaps are also Multicap, whereas the Multicaps have a little edge around it, that it has a static reserve for large, mid and small caps. Consider this as your all-weather portfolio strategy as far as equities are concerned and just let it go because you have got mid cap, large cap and small cap well-chosen and picked by the portfolio manager working for you. Don't worry about selecting specific large cap, mid cap or small caps. Then you will be timing and chasing performances. A good Multicap, Flexicap strategy is an all-weather strategy.

Santosh Joseph: Flexicap, as a category, was forcefully bought in about a year-and-a-half or two years ago, when we had to meet the regulatory requirement for what was the definition of a flexi and a multi. All these Flexicap funds were actually masquerading as large cap funds, in excess of 85-90% large cap. We might as well have done a large cap fund.

Flexicap was to give the investor the benefit of being in one fund, where the fund manager has the luxury to change. If the fund manager is not going to exercise that leeway, that means he is running two large-cap funds with two names. One is called Flexi and the other is called large cap. Therefore, if a Flexicap fund is done well, you don't need a Multicap. Therefore, the difference between both arises. If a fund manager was to be prudent, they will do sound assessment and judgment between large, mid and small cap which will work well for the investor.

Santosh Joseph: What I like right now is this Flexicap, Multicap strategy because I don't want to be running several funds in mid, large and small cap. So, I choose between Flexi and Multicap, knowing what the portfolio manager is doing.

For the non-aggressive part of the portfolio, I prefer a Balanced Advantage Fund where I will give one or two chances to different fund managers, where they have a difference in strategy.

Some people follow the momentum strategy, while others follow the defensive strategy, and some follow the inverse-of-the-yield curve. Whatever the strategy is, they have their own methods to make it work.

Now, the advantage over there is I get equity taxation. I get fixed income exposure and also have a dynamic factor built in, which chooses to go between debt and equity.

Therefore, at an overall portfolio level, I got equity sorted, I got fixed income sorted, and also have an autopilot in place so that when February or March 2022 happened – with the Russia-Ukraine crisis – there was a chance for equity to rise within the portfolio.

Aashish Somaiyaa: I completely agree with Santosh’s points. You should have a mixed large cap, mid cap and small cap. He is right in pointing out this whole Multicap conundrum because they were meant to be large and mid and small. But everybody converted their Multicap into a large-cap fund, and that caused all the confusion.

I don't expect anybody to have that kind of foresight where they will be in small caps at the right time and move to large caps at the right time. You take the BSE 500 as a benchmark and you do what it takes to outperform by stock selection, not by necessarily trying to say that ‘I can forecast which segment of the market will do well’.

If I have to devise a portfolio, I will have three or four components, assuming that I am targeting 12% to 15% and not targeting 6%, 8% or 10%.

Let's say that I'm somebody who has a risk appetite and wants double-digit returns. I will put 40-50% of the money in a fund which has large, mid and small. I'm not deliberately putting a label. I'll put it in any Multi or Flexi fund which is a mix of large, mid and small.

I would put another 20-30% into international funds, clearly for an Indian investor. International funds, according to me, are in two buckets. One is investing in emerging markets, which offer something which India does not offer. For example, there are some emerging markets, which are commodity-driven. There are emerging markets like South Korea or Taiwan which are tech-driven. So, emerging markets also offer some diversity. The third is the U.S. You cannot make an equity portfolio with the U.S. being absent in it. So, the U.S. is clearly the centre of all innovation and where most global businesses of the world are listed in the American stock exchanges.

If I were somebody looking at a 12-15% kind of return, I would ensure that about 70% of my portfolio is in the Multicap India Fund, Global Emerging Markets Fund and the U.S. Equity Fund. You can give or take 5%. Around 30% would be debt.

That 70% and 30% depends on the type of volatility I am experiencing, on whether I am running ahead or behind my return target, and depending on what is happening in the market. I would use that 30% to sometimes allocate when there is an opportunity or take profits when I have made lots of money. So, I would run it like 70:30. 30 is a balancing factor – the need for money, urgency, emergency funds, a pot of money to balance or take benefit of opportunities, etc.

I'm not a big fan of trying to maximise returns on debt. So, for me that 30 would be a three-to-five-year corporate bond kind of portfolio because conceptually, I don't understand high risk debt and don't see why one should try to maximise return in debt. So, I would put it in three-to-five-year corporate bonds with a good rating.

Aashish Somaiyaa: It's a very good concept. The situation doesn't warrant having long bonds in the portfolio. So, if you are somebody who is happy with 7-8% or maybe 8-9%, or it can land up anywhere between 6-10%.

There is some confusion with respect to Multi-Asset Funds; some have 60-70% equity. In my opinion, that beats the purpose. In my opinion, Multi-asset Funds should be beating fixed income; they should give some options to the fixed income plus kind of investors. In my previous role, I did try to create such a fund and I am happy to know it's done well.

If you have something which is 20% domestic equity, 10% international equity, consistently have 10% to 20% in gold, and then have stuff like real estate investment trusts. Gold is a commodity now, and you have silver as an option also. So, you need to do your arithmetic and get the model right.

Such a fund can generate about 8% of average return, and in bad times, it will definitely not break the bank. In any quarter or six months period, I don’t think it will give negative results, at least that's what my experience of the data tells me.

Santosh Joseph: I would go with about 40-50% in equity and about 50-60% (in Balance Advantage) because when you mix it up as a whole, you'd still come closer to 70:30.

We have benefited in India by being in Multi Asset Funds. Now, whether it's gold, U.S. investing or international equity investing, thanks to the dollar denomination, the last number that I can remember is the 10-year excess return made due to rupee-dollar depreciation is almost 3% CAGR over the decade.

Why would you want to miss that extra return while getting diversification and reducing the standard deviation of the portfolio? That is the actual essence of diversification.

Aashish Somaiyaa: On a lighter note, I can tell you what not to do which is to read the first couple of pages because they are full of news. In our industry, we have a penchant for publishing a lot of data and news about what happened in the last month and the last quarter. It doesn't serve much purpose. So, don't read all the market updates.

Fact sheets come in 30-100 pages, so don't get distracted. Focus on the fund in which you have invested.

Definitely look for the performance update, in terms of what is the trend. Don't look at performance as in the last one month or last three months. The point is that are they outperforming the benchmark? Is it something which is consistently happening, or is it that in recent times the trend has changed, and they are struggling to outperform?

The fact sheet cannot tell you everything, but the next time you meet your advisor or fund house person, it will atleast tell you what to ask. It's a good tool for engagement, and it slowly builds education. Don't look at data at this point in time alone.

The other thing to look for is some of the statistics like what is the volatility of the fund and how is the beta of the fund compared to the market?

I may tell you that this fund is investing in high quality companies and defensive high governance, or that this is a value fund. The label doesn't say anything; the data actually tells you whether this guy is doing what he said he would do. So, use the fact sheet as a tool to engage, and not necessarily to make conclusions there and then.

Santosh Joseph: Skip the excesses. If you go to the actual content, in a single page, you have got enough information about a particular fund to be an informed investor.

To begin with, you have the scheme objective. Many people get carried away between the name of the scheme and what the scheme is supposed to do, because they have not read the scheme investment objective.

Secondly, know your portfolio manager – what did he study, what is his background, how long has he been with the firm, how long has he been managing that particular fund and then you have so many metrics.

If you are watching a cricket match and a new batsman comes in, you will get a photo of the player, key stats, how many centuries he has scored, how many 50s has he scored, how many ducks he has scored, what is the strike rate, etc. Essentially, that's what a fact sheet is. If you are reading it for the first time, you can be bogged down with information.

If you see it in month one, give it a break and come back after the third month or fourth month. You will notice the difference and you will appreciate certain things. See it after one year.

There is something called the portfolio turnover ratio which means how many times the stocks have changed. You can compare from Jan. 1 to Dec. 31, as to whether the stocks and percentages have really changed. Does that mean my portfolio manager is an active guy – one with the stock, second with the weights. Then look at how your performance is, have you been able to beat the benchmark?

For example, in the calendar year 2021, Nifty gave 24% return. How many of your funds gave you in excess of 24% return? Did it beat the benchmark or not?

Santosh Joseph: I wish we had a standard. We have such a wide gamut of funds. Now, a large-cap fund will have lesser turnover.

The average is 30-40% for any category because that means there is a churn, because there is a lot of redemption. There is also churn because you want to increase or decrease the weightage, depending on the flows and maybe even inclusions in Nifty or the indexes. So, 30-40% in an actively managed fund is a given. Now, if it's 100% and 150%, then you should look at whether the portfolio turnover and the excess returns generated match. Even then, it's worthwhile but otherwise over 100% is a bit much.

Aashish Somaiyaa: It's our duty as investment professionals that we manage money such that we meet the objectives of our investor, which is basically to make a reasonable return and consistently outperform the benchmark.

But all of your professional aptitude will come to naught if investors are not engaged with you and don't stay the course. One of the issues with our industry is that we get money when performance is good and markets are booming, but we lose money when markets are bad or when performance is dipping. Over the last year, and year-and-a-half has seen maturity. Generally, funds expect people to stay invested for five, seven or 10 years – as long as possible – but then funds also go through their patches.

Communicate perspectives which will ensure that investors can stay the course. My preference is to communicate behavioural aspects or provide perspective on numbers – if a fund is doing something the way it is doing, why is it behaving the way it is behaving, what is the perspective, what should you be telling investors so that they can see it in the right light and stay engaged.

There are many funds which have delivered spectacular returns over the years, but people didn't stick to the whole journey.

It’s well known that investor return is not equal to the return generated by the investment itself. Why does that happen? It happens because people come at the wrong time, go at the wrong time and get disengaged somewhere in the journey. So, my preference is that a fact sheet should communicate things which keeps people engaged.