The Mutual Fund Show: How To Identify The Right Scheme For You

What are the boxes investors must tick while deciding on which mutual fund schemes to invest in?

A customer browses homeware at a Muji store in New Delhi. (Photographer: Prashanth Vishwanathan/Bloomberg)
A customer browses homeware at a Muji store in New Delhi. (Photographer: Prashanth Vishwanathan/Bloomberg)

The average investor is almost always on the lookout for the best performing mutual funds schemes. And those that have already made investments are usually wondering—should I book profits now or are my investments underperforming their peers?

While these are important questions, there are a few more factors mutual fund investors must bear in mind. A number of changes in the mutual fund landscape have occurred recently on the back of interventions by the markets regulator. These should ideally be taken into account.

On this episode of The Mutual Fund Show, Ajit Menon, chief executive officer of PGIM India Mutual Fund, speaks to BloombergQuint about what investors need to bear in mind while choosing their mutual fund investments in the new year.

Watch the full conversation here:

Outflows have been strong from the last three-four months on the trot. How is January turning out so far for the industry and for you?

AJIT MENON: I can say for ourselves that we’ve had a fantastic 2020 in terms of business, we’ve been month-on-month net positive in terms of equity flows. For the year of 2020, we closed with upwards of Rs 1,000 crore of positive equity net sales, just as the industry has seen outflows and redemption.

That trend for us at least continues in January, I’d suspect that as far as the industry is concerned, one thing that we have seen is that when markets recover from very sharp corrections, like the one we saw in March, investors tend to redeem and then take the next steps and their next decisions.

Therefore, much of the redemptions that we’ve seen across the last couple of months would be related to that as customers start keeping their capital safe and wondering what to do next or also book profits.

We’ve also seen strong flows coming into SIPs in December. I think January holds a little bit of the same trend. We will probably see negative net flows in January as well but the trend has been that those numbers have been going down. November was about Rs 14,000 crore negative, December was Rs 10,000 crore. I’d suspect that January will probably end a little lower for the industry.

For us as I mentioned those flows have been positive, thanks to most of our funds doing extremely well on the lead tables of performance and I hope that, that will continue.

Ajit, what should an average investor approach GILT funds?

AJIT MENON: So firstly, we don’t see too much of retail investors, investing into gilt funds; much of the fixed income allocation tends to be in the shorter-end categories with low duration.

In December, I think we did see large outflows out of the gilt funds. The reason for those outflows would probably be that the market has a sense that the rate reduction cycle is at the bottom and what’s likely to happen now is probably for rates to move up. There’s of course some time for it, but that’s I think what the market is sensing and therefore we’ve seen people profit booking out of the gilt segment.

For retail investors who’d like to allocate money to fixed income, we’re obviously recommending that they stay short—on the short end of the curve, which means the shorter-end products which have maturity up to one year.

So those are likely the ultra-short-term funds or the money market funds or the low duration funds or the short majority funds, funds which have an average maturity, or duration in the one-to-two-year bucket. That’s what we’ll be recommending to investors because going a little longer and typically gilt funds for instance would tend to have longer maturities and longer durations. With the trend that interest rates could continue to sort of move up or tick up, there is danger there of making losses.

So, the recommendation is that to stay with high quality funds on the short end.

Typically, investors tend to think of tax savings during December and January, and they invariably rely on rankings to identify funds. Put yourself in the shoes of an investor. What would you do if you had five funds, two of those funds came off in the ranking and you have been advised two-three funds, you are looking to invest in them. How important would the ranking of those funds play a part in your decision?

AJIT MENON: Ranking is I’d say would be a very small factor as far as the decision making for which funds to go for would be. What is important is that these rankings are based on certain methodologies and would be giving certain weightage to performance of those products across time frames. Much of that could be the last one year’s performance or the last three years performance and a bit about the last five years’ performance. It’s always better to look and compare your funds on at least a five-year basis or a three to five year basis to get a sense of whether you should be abandoning some of those funds or continue with it because in the very short term, the portfolio allocation to sectors and stocks depending on what the fund manager believes is going to work in the near future, is what’s going to decide where those funds rank.

So, I would say that the primary thing would be to consider what your timeframe of investment is, talking to your financial advisor if you have one. If you don’t have one, do get one to talk about your goals and figure if the risk that these funds are taking are actually right. So rather than just the plain vanilla ranking of the products that seem to be going around, it is better to think about how risk adjusted are the returns that you’re getting from these funds, how the downside protection portfolio characteristics of the funds that you’ve invested in.

Understand through your advisor of course, a bit about the process that these fund houses are following. If you’re comfortable with it, I think you should just keep staying invested in those funds. To give a simple example, as you asked me what would I do? My review with my advisor is always focused on what is the overlap between the different schemes that I’m invested in. What we don’t realise is that we think that we’ve invested in five good schemes, but if you really look at the underlying portfolio, you’re probably likely to find that the stocks and the sectors are pretty much all the same. So, if we know that diversification is what is critical for good investment outcomes, it’s more important to look at what the overlap of these portfolios is.

The real advice is that, look for portfolios that have less overlap, of course, because otherwise they’re just duplicating it even if you have five funds; and then look at timeframes; and then look at things like rating and ranking to get a sense because your advisor can help you with all of those.

Are there some simple ground rules that you keep in mind when you are either investing your money or advising your near and dear ones?

AJIT MENON: Yes and thank you for asking that question. It’s a very important one. What I follow for my own investment journey and what I recommend to friends and family is, your number one criterion is to look at whether your protection is taken care of—your insurance, essentially your life, your medical insurance as well as your general insurance. That is really the number one task and especially in markets like this a lot of people ask me for instance that the markets have run up, should we book profits? What should we do? We’ve been recommending that yes you should book some profits to make sure that your asset allocation is what it is and use those profits to make sure, number one, that your protection requirements are adequate and if not, fill those gaps.

Number two is to have an emergency fund. So, if you’ve had some money put aside for emergencies if it’s like three months’ worth of your expenses, our recommendation is to have an emergency fund of at least six months to a year of your monthly expenses. You can do that in a high quality ultra-short-term fund or short end products of mutual funds or just leave it in the bank. That should also be okay. Depending on how conservative you want to be six months to one year of your monthly expenses, is your second goal.

Your third goal is to look at your existing portfolio and look at what I mentioned earlier, which is, are your funds really having too much of overlap between each other. If they are, make sure that you’re spread out on your asset allocation, not just within equity and fixed income but try and include other asset classes as well.

Personally, in my conversations with my advisor what I have done in the last couple of months, is to buy gold bonds. So, I’ve increased my allocation a little bit to that asset class as well. We’re now considering putting some more money into real estate investment trusts, so that we can get an exposure to the real estate investment class. I am also invested in international funds and I’m increasing a little bit of allocation to international funds because my daughter is set to go study abroad and it’s good to have something where your rupee investments are pegged to the dollar. So, it moves in tandem and you don’t get some bad surprises. So, having international funds give you equity exposure and it also gives you currency exposure. So that’s what I’ve been doing with my advisor and that’s what I recommend to people.

Make sure that you have your asset classes covered—equity, fixed income, gold and precious metals, commodities, real estate and currency.

Ultra-high net worth investors and high net worth investors also have a seventh option, which is called alternates—which could be things like private equity, investing in paintings and sculptures and things like that, a legitimate asset class but for the retail investor, I think if you are spread around at least four or five asset classes, that is your objective. In all of this, I have been very well supported by my advisor. So, I would say that having a good advisor is probably fundamental to getting all of this right.

The other thing is, since we talked about ground rules for investing, I just want to talk about a few things that come into effect in 2021 compared to 2020. So, there will be a risk-o-meter in place, which will be for the entire year, which is something new that SEBI has enabled, and I thought it was a good thing. I think rules for mutual fund investing from a fund’s perspective changes quite considerably and I think the NAV calculation methodology also from an annual perspective is different compared to 2020. Which of these would have the most profound impact on average investors portfolio, if at all, according to you?

AJIT MENON: The risk-o-meter coming in is one of the five changes. NAV calculations being on the receipt of funds in the account is another. The change from choosing whether you want to be in the multi-cap category for equity or the flexi-cap category for equity is the third. Inter-scheme transfers have been further clarified by the regulator. And the fifth one is a small one which is about re-labelling dividend options as income distribution options.

Of these five, I think the fourth one which is inter-scheme transfers, will have the biggest impact as far as investors are concerned. It’s a good move, it’s a move to protect investors, it is a move to further clarify what fund houses and fund managers can do when they’re thinking of inter-scheme transfers of a bond from one portfolio to the other.

It was obviously something that was allowed, so what SEBI has done is, it has further clarified on the do’s and don’ts of those inter-scheme transfers and they have made it very clear for instance, how it would be in closed-ended funds and open-ended funds.

The fact is that if you’re doing an entire scheme transfer, you should first do the highest quality one and you’ve got to have a very strong rationale for the buying scheme, as well as the selling scheme so that no investor gets the wrong end of the stick.

Now, when I say that this will have the most impactful on investors, one factor is that it increases transparency—that’s always a good thing; two is that it gives a very clear mandate in terms of what you can expect your portfolios to do. You do know that it’s not going to take any additional risk without a very strong rationale for that risk and I would say, more importantly than all of that is what happens on the back end for fund houses to make sure that they follow this and ensure they have a very strong process in place for liquidity. Which means, if you face an issue of redemptions or liquidity, how are you going to deal with it? How are you going to liquidate your portfolio? Those are things where there is going to be a lot more focus and I think that is probably therefore, the best thing to protect investors and give a smoother experience over the long term.

Ajit, you guys have come out with a new fund offer. Tell us a little bit about it.

AJIT MENON: Yes, our NFO is already on, this is one of the first full-fledged NFO coming from the stable of PGIM India Mutual Fund.

I’ve always been an asset allocation champion like most of us in the industry and what we have launched is the PGIM India Balanced Advantage Fund in that category. According to me this is like an anchor in every retail customers’ portfolio. This is the only category in mutual funds where you will automatically increase and decrease your allocation to equity and fixed income based on different sectors or models that each of these funds follow. It’s the only category that does that and therefore, what it does is, it takes away that stress from the investor of trying to time the market.

Is it expensive now, is it cheap now, should I get in or should I get out. Well, all of those decisions will be taken by a model which looks at the expensiveness or the attractiveness of the market before taking those allocation decisions. For us, we’re excited because it’s an existing model that we had which we are embedding into the balanced advantage fund. It’s very important for models to have zero discretion to fund managers because what’s the point of a model otherwise?

We have zero discretion in our balanced advantage fund in terms of the allocation and our model basically looks at a 15-year rolling long term average price-to-earnings on a 15-year basis and then compares the absolute short term the last 20 days P/E to that long term average to decide whether it’s expensive or cheap and then decide on equity allocation. The single most differentiating feature is this rolling average P/E because even if I’m not in the company 15 or 20 years from now, the model will remain absolutely relevant as Indian markets continue to mature and the P/E levels, keep rising. Many models in the market are static models so we felt that a rolling average would make the biggest differentiator.