The Mutual Fund Show: What's Better Now: Long-Term Debt Or Floating Rate Funds?
Should investors switch from long-term debt to floating rate funds as interest rate rises?
Should those invested in long term debt switch to floating rate funds as interest rate rises? Or should they invest aggressively in equity funds? And what about lump sum investors?
"If we have long-duration fund, negative impact because of mark-to-market (loss) can really hurt our portfolio,” Anant Ladha, founder of InvestAajForKal, told BQ Prime's Niraj Shah's on the Mutual Fund Show. He suggests focusing on floating-rate funds as interest rates are rising, with portfolio concentrated towards low-duration or accrual-based funds.
Floating rate funds invest in debt instruments whose interest payments change with the underlying rate. As rates rise, the fund manager also invests in high-yield securities, thus averaging the overall returns.
For hawkish investors, it is the best time to be aggressive on equities, Ladha said.
For lumpsum investment, Nirav Panchmatia, founder and chief executive of AUM Financials, recommends either 25-to-30-week systematic transfer plan packed into liquid funds or equity diversified funds.
Or as Ladha suggests, simply increase the amount to existing SIP portfolio instead of trying to reinvent the wheel.
Watch the full show here:
Here are the edited excerpts from the interview:
Nirav, if people want to make a switch in their SIP portfolio, and you will have to make some assumptions here because there is no standard size that fits all... then what are the SIPs that you would recommend that this investor switches out from and goes into what?
Nirav Panchmatiya: SIPs are the best way of attacking low volatility. SIPs are the best tool to allow you to take advantage of something known as a rupee-cost averaging or dollar-cost averaging.
Second, don't do SIPs in thematic funds or sector funds because sectors are seasonal. SIPs are for medium to long term. We have seen over the last three years, many sectors have come into favour and gone out of favour.
When you are investing with a three-five-seven- and 10-year horizon, avoid themes, avoid sectors. Go into equity diversified fund. An ideal mix would be a mix of large, mid and small cap. I would say a ratio of 50-60% in large cap, 30% in mid cap and 20% in small cap would do wonders with your SIP portfolio.
We can take any amount, let's say, somebody has one lakh to invest every month in a SIP. I would say 50,000 you do in a large cap and or a flexicap fund, another 30% in one or two mid-cap fund and another 20% in small-cap fund. If a particular investor, now it depends on a risk profile, is having thematic sector funds, I'll say stop and go into equity diversified fund. You don't become a fund manager, you don't take a call on which sector is good, which sector is bad, because the sectoral calls keep on going wrong. Experiences has told us that it is very difficult even for an expert to take a sectoral call.
I guess this is an answer for all seasons. You are not saying this but for the current season?
Nirav Panchmatiya: This is an answer for all seasons, and it holds true for this season also, all the more.
Okay. I'll come back to names as well, Nirav, you wanted to finish your point?
Nirav Panchmatiya: Yes, and the period, you know, this was a very interesting period from Jan. 14, 2020—the last Sensex peaked around 42,000—we fell 38%, we went back 130% on the Sensex level and again we are down 15%. So, Jan. 14, 2020 to June 20, 2022—we have seen two rises, we have seen two falls and again we will see a rise. So, if a particular equity diversified fund has done well in this period, it will do well in any period. This was a laboratory that we will talk about it later during the show.
Anant, where is it that people should put a halt on their SIPs because the time may demand so and switch into something else that might be more pertinent at the current point of time?
Anant Ladha: I will give you the direct three to call actions or three pointers which we can immediately take action on.
First, supposedly, if we have some SIPs which are going on or if we have some amount which is pledged in long-term debt, and we are trying to take a duration call, I feel currently we should be more focused towards floating rate funds and we should keep our portfolio concentrated towards low-duration funds or accrual-based funds.
Why so?
Anant Ladha: Since interest rates are rising and as directly communicated by the Fed we can at least expect two more rate hikes in such a volatile period. If we have long-duration fund, negative impact because of M2M can really hurt our portfolio. When an investor is investing in debt fund his main purpose is to make sure that there is no capital loss. To ensure that, it is better to be placed with floating interest rate fund, especially in the rising interest rate cycle, because as interest rate rises, probably your fund manager will also put his amount in high-yield securities and your overall portfolio returns will be taken care of.
Second, this is a somewhat aggressive call which I am personally taking. If you have some amount or some SIPs which are going in BAFs or balanced advantage funds and if your suitability permits you I think right now is the right time to allocate some amount to equities and be aggressive on equities. If you want to really make money in markets, you have to be aggressive on equities when things are tough. Currently, things are actually tough. From November 2021, we are seeing some kind of volatility. So, if your suitability permits, probably this is the right time to invest in equity, SIPs or equity funds.
Third and final point. Suppose if you have a goal for which you were investing from long time and it is due in next three years, now this money has to be either in FDs or in simple floating interest funds. That's it, don't take equity risk for short-term period. These can be simple three call to actions.
Anant, can you give us some names which people might also think about. The standard disclaimer is that the names given by either of our guests are not necessarily their exhaustive list. They may have probably in their mind five funds, but they might recommend one or two. There might also be more that you can think of and you need to do your own research before you try and even think of going for the recommendations that have been given, either in the terms of the call to action or in terms of the funds.
Anant Ladha: I will start with multi-cap fund.
Nippon Multicap Fund: I know it is a comparatively newer fund, but it is beautifully placed. Salesh is managing that fund quite well. Its PE ratio is around 20-21. PB ratio is somewhere around three. It is comfortably placed, heavy weighted on financial services and capital goods. These are probably some of the sectors where impact of inflation is comparatively limited. It's a multi-cap fund so you get exposure of both large, mid and small cap. So, this can be one fund which we can study.
For the next two funds, I will try and give each from small-cap and mid-cap category. If I talk about small cap Tata Smallcap Fund is very interesting, but that is comparatively an aggressive fund. If I talk about valuations, PE ratio is somewhere around 18. It has a good portfolio of 40-45 stocks. PB ratio is somewhere around 2.3-2.4, services and capital goods are heavy weighted in this fund, and this is obviously managed by Satish who is even managing Tata Midcap Fund quite well. But because of the size of Tata Smallcap Fund, I find it really attractive, and its co-fund manager is Chandra Prakash.
If I talk about the third and final fund, that will be competitively defensive fund in the mid-cap space, ICICI Midcap Fund, especially because it is taking care of drawdown risk comparatively better—PE ratio around 23, PB ratio around three, 60-65 good stocks.
When you are talking about getting out of the long-duration funds, for example, the first recommendation that you made looking at the current times and getting into short-term funds, are there any funds that people should keep in mind from that perspective?
Anant Ladha: It think ICICI Floating Interest Fund has a good amount of AUM and a stable floating interest fund with a duration less than 0.7. This can be an interesting fund to look at in that category and even HDFC is good in that category.
Nirav, you had mentioned getting out of thematic funds and getting into a portfolio allocation of sorts. Now, let's try and think about the maximum allocation that you mentioned, which I presume 50% was to large cap funds, if I'm not wrong, in that category. Are there any funds that you recommend and why?
Nirav Panchmatiya: As I said, I will recommend a bouquet, a bouquet which will consist of one flair of flexicap, one large cap and mid cap and one small cap.
So, the large and flexicap you asked to in the large-cap category, I recommend a fund from the Canara Robeco fund house—Canara Robeco Large-Cap Fund. I believe it is a very stable performer over a very large period and especially the period between June 14, 2020 and June 22, 2022. Very well diversified fund, extremely good fund manager. Another fund that I recommend in flexicap category is Parag Parikh Flexicap but actually flexicap fund has proved that it has taken the test of time very brilliantly, in spite of not being allowed to invest in international equity, the Indian portfolio is managed based on value style or on a dart style and has done phenomenally well. So, these two would be, you know, the basis of any equity portfolio. I mean, these are the main key funds that you should have in your portfolio and then to add alpha to the portfolio, you can go for a mid- and- small-cap fund.
In mid-cap category, I choose a PGM India Midcap Fund. Again, it has stood the test of times, it has been an outperformer through and through even on the downside. If I first see the drawdown while selecting the fund and then I go for returns. The risk-adjusted return is what you should look at and not only returns, so PGIM India Midcap has weathered the storm very well. On the small-cap side, I will go with a very unique proposition from the Quant fund house—Quant Smallcap Fund.
Anant, can you tell us whether people can now invest into the international schemes or no? If so, should they do it at the current juncture or are they better off sticking to the domestic schemes?
Anant Ladha: If you are thinking of investing in the U.S. market just because in last decade—that is from 2011 to 2020—the U.S. market has outperformed the Indian market, I would like you to rethink about it because it has always happened in history that what has performed for 10 years, probably it underperforms in the coming decade. Starting from 1980s to 1990s, Japan was outperforming. What happened with Japan post that, we all know 90s to 2000, gold was outperforming; 2000 to 2010 emerging markets like India outperformed; then 2011 to 2020, the U.S. markets have outperformed, so just because it has performed in last 10 years and you are a retail investor with a limited amount, and you are randomly thinking to invest in the U.S. market, I think there is no need of it.
But if your portfolio is sizable, for example, if you have 50 lakhs of portfolio and if you want to diversify it, obviously you can choose some of the international funds and you can have limited exposure. If you don't know anything about international market, I think for a no nothing investor even index funds is a good solution for investing in international markets. For example, investing in S&P 500 funds. But your purpose of investing in the U.S. market should be diversification and not just because it has given good returns in the last 10 years.
Okay, but people are allowed to invest in international funds now. Change of rules that has happened right?
Anant Ladha: They are allowed with limited restrictions.
Nirav, do you have some clarity? What kind of funds are available and should people do that or stick to domestic?
Nirav Panchmatiya: For the next decade, one of the best asset classes would be Indian equity. So, no two thoughts about its next decade belongs to India, GDP wise, economy wise, post Covid India comes out as a much stronger and much better economy than any other developed economies or even including China. So, if you are not betting on Indian equity via the mutual fund route taking professional advice, you are going to miss out on one of the best asset classes. You can never say it really the best, but it will be a top quartile asset class in the world.
Having my 80-85% portfolio in Indian equities, there is always room for diversification. So, 5 to 7 to 10% is the maximum that I would recommend somebody to have exposure to international equity. Among international equity, U.S. equity as an asset class has been phenomenally well and especially because there's been a huge correction.
As we are talking Nasdaq is down 33%. Some of the tech stocks are down anywhere between 70 and 90%. This is the opportunity that Warren Buffett always waits for. So, I would recommend a small exposure, especially when it was ironic that the international fund window was closed exactly when the U.S. market was falling, so this is the time actually you should allow Indian investors. I believe the period would be very limited. The RBI has not increased the limit of for mutual funds to invest internationally. It is only because of some of the redemptions and its ironical people have redeemed when the market has fallen, those redemptions shouldn't have happened, but it comes as an opportunity for investors who couldn't get an entry into this market.
I would suggest Mirae Assets Fund or any of the Nasdaq index fund. People should take exposure in a limited way, not more than 5-8% of your portfolio, and you should do it in two or three tranches or buy via the STP and forget it because we are being Indians, our children are wanting to go abroad. If you don't have dollar assets and rupee depreciation is going to take away some of your Indian equity returns. Only from that perspective, we should all have exposure to international equity, but don't go overboard with it.
Anant, did you give me a fund name recommendation, or I missed it?
Anant Ladha: My first choice is S&P 500 Direct index. Second, DSP US Flexicap is interesting. It is kind of a multi-cap fund for international equity. So, that is something which I really find interesting.
Nirav, a lot of people might get their bonuses or raises become effective in the current season. So, people might get a slightly higher lump sum than what they might need. If they have that, instead of a fixed deposit or maybe a fixed deposit, I don't know, but let's assume from a mutual fund perspective, is there an avenue where you recommend that people made that lump sum investment and why and where?
Nirav Panchmatiya: So, two-pronged strategy for lump sums. SIPs is a no brainer, increase your SIPs till it pinches you, especially in volatile times like that. Second, as far as lump sum is concerned do two-pronged strategy. One, do a 25-to-30-week STP. Park it into liquid funds, choose a target equity diversified fund and do an STP. So, here we are copying what SIP does for you.
The risk with the first strategy of doing an STP is what if this is the bottom in the market. We don't have an answer. But if this is the bottom, we have missed an opportunity.
Another better way, over the last couple of years, we have seen the some of the asset allocator funds. So, we had balanced funds initially over the last 10-15 years, followed by something known as a balanced advantage fund. A balanced fund was a passive strategy—70% equity, 30% debt, 5-10% here and there, but it did not move the needle much. Then there was the balanced advantage fund—a more active and an aggressive version of a balanced fund where the equity component could go anywhere between 40 and 80%. Now, we have the asset allocator and multi-asset fund. So multi-asset an asset allocator fund can invest into equity, it can invest into arbitrage, and it can invest into debt. A multi-asset fund can also invest into gold. So, from time to time, these companies, some of the funds have really mastered the art of allocating the fund at the right time in the right asset class and these products are emotionless, the biggest enemy of any equity investor holder is emotions, we divest when we should be investing, and we invest when we should be divesting. Let it be given to funds, who have done the back-testing and who have really proved their mettle. Do you want me to name the funds?
Yes please.
Nirav Panchmatiya: For the one of the first funds I need to name is Kotak Multi Asset Allocator Fund of Funds. It can invest into equity, debt arbitrage and gold, and especially when I tested this particular product over a period of Jan. 14, 2020 till June 20, 2022, it is almost beating the Sensex. Now this fund on an average is 30-40% in equity, yet it is beating the Sensex. The rule number one it followed was when drawdown happened it didn't go down much. Warren Buffett has these two rules—rule No. 1, don't lose money. Rule No. 2, don't forget rule No. 1. When the market was down 38%, this particular product was hardly down 22 or 24%. So, that was a down capture. It did very well in down capture. When the market went up, it went up 70% of the market.
Another fund in this category is ICICI Pru Multi Asset Fund. Then there is ICICI Pru Asset Allocator fund and there is a Quant Multi Asset Fund. All these four funds have beaten the Sensex during the drawdown. So, they have fallen much less than the Sensex when it fell 32%, they fell 22 to 31%. When the market went up, they captured 70 to 80% of the upmove. So that overall, from Jan. 14, 2020 to June 20, 2022, while the Sensex gave 25% return, they gave anywhere between 40% and 80% returns.
Anant, your view?
Anant Ladha: First, if you have your FD amount, don't shift it to equity, because risk profile of both the products are different. First understand your suitability whether shifting your amount from FD to direct equity is allowed by your suitability or not.
It could well be in a debt product.
Anant Ladha: Absolutely. So, debt product only accrual-based debt fund that too via STP of six months is recommended right now, maybe medium-term kind of a fund. I would personally not favour long duration funds right now looking at the interest rate cycles. That can be a good avenue if you want a tax efficiency in your portfolio. Second, if you have some bonuses, as you rightly mentioned that this is the time where people might be getting some bonuses, it is the perfect time to do your SIP top-ups. For example, if your monthly SIP is of one lakh and you have a bonus of one lakh additional you can probably invest one lakh amount equal to your SIP amount during this market for one particular month, you can invest amount equal to your SIP amount for that particular month. So, this way you are not overdoing it as well and you are not missing the opportunity. And which funds to choose your existing SIP funds? I think over-diversification at times kills a lot of returns. So, there is no need to over-diversify and if you have already selected good four or five funds, you can probably top-up in the same funds.
Nirav Panchmatiya: I have been noticing that people have been doing ‘diworsification’. If you have Indian equities, you don't need cryptos, you don’t need any NFTs, you don’t need any penny stocks. I just wanted to use your show to give across this message, for 13% CAGR return will be practically 95% asset class in the next 10 years, no need to do diversification.