The Mutual Fund Show: What You Need To Know Before Considering Thematic PSU Funds

Thematic PSU funds have performed better in the recent past, leading to increased interest. But are they right for you?

A pedestrian crosses a street in Mumbai. (Photographer: Brent Lewin/Bloomberg)
A pedestrian crosses a street in Mumbai. (Photographer: Brent Lewin/Bloomberg)

As benchmark indices scale new peaks and the rally in equity markets broadens, the spotlight is back on sectors that have underperformed.

State-run utilities have over the past few years performed not as well as their private sector peers. In recent past, though, thematic PSU funds have performed better, leading to increased investor interest.

On this episode of The Mutual Fund Show, BloombergQuint spoke to Amit Bivalkar, managing director and chief executive officer at Sapient Wealth Advisors & Brokers; and Vishal Dhawan, founder and chief executive officer of Plan Ahead Wealth about this category of mutual fund schemes and the reason why advisers have counselled against it.

The duo also spoke about tax-saving funds, investing in index funds, what comprises an ideal portfolio, and asset allocation.

Watch the full show here:

Here are the edited excerpts from the interview:

Thematic Funds

PSUs have come back with a bang over the last couple of months. Thematic PSU funds are up about 20-22% on a three-month basis, which is far better than any one-year, six-month, three-year, five-year or even a 10-year record. Should investors invest in these funds?

BIVALKAR: I think most of the viewers have turned to advisers because they have been lucky last year, making good amount of money starting May and if you look at PSUs, they were deep value, then became value and now they are like growth or momentum. So, if you look at PSUs, they have some advantages. They are into the cyclical core sectors so they benefit from the pickup in economic activities. Over the last six-seven months, almost everything in the market went up. What were lagging were the PSUs and I think it was their chance to get liquidity and they’ve had a good run for the last three months. A lot of PSUs have had a first-mover advantage because of the government’s decision that it will actually allow some of the PSUs to start their business early and they have a unique proposition—either because of access to resources or probably a first-mover advantage. PSUs benefit from the government policies also at times, for example the oil marketing companies. They have been a big beneficiary of what the government is trying to do. One good observation over the last six months is that the return on equity on these PSUs have gone up, simply because you are giving away additional capital by way of buybacks or dividends. And disinvestment, I think this is a word which we have been hearing for the last decade, I think this government has actually started that process in a big bang way. BPCL will be in focus and therefore, this disinvestment actually unlocks a lot of value in PSU. Therefore, you might have seen some run-up there. Needless to say, their valuations are favourable compared to the broader market and I think therefore PSUs as you have seen over the last two three months have performed well.

If you have a three-five year view. If you believe that I should be a shareholder along with the government, then definitely you should buy into PSUs but it should be a satellite portfolio and not a core portfolio.

Vishal, what’s your sense?

DHAWAN: We’ve been suggesting to investors to actually avoid the segment in spite of its strong performance in the recent past and of course everything that Amit mentioned is absolutely true—value, deep value, government ownership, disinvestment etc. I think it’s just that there are two drivers of why we are a little uncomfortable with buying into thematic story like PSUs.

One is that the needs for how the government looks at being the largest shareholder of it in terms of how capital is to be deployed and to be used can be very different from what the minority shareholders might require. So, for example, you might find that a lot of the government needs or that a lot of dividends get paid out because the government needs money to spend on other areas and what you might find in reverse, is that a lot of the requirements of individuals might be that they are investing in equity for growth and for capital appreciation.

Clearly with the way tax structures have changed in the last 12 months where dividends have now become taxable in the hands of individual investors, we think that PSUs are relatively less attractive, especially if they are high dividend paying opportunities.

The second thing that has held us back from going there is that a lot of diversified equity portfolio managers and mutual funds will have PSUs as a part of their holdings, especially in areas where they are dominant players. There is an exposure getting built through PSUs indirectly in portfolios, and therefore we don’t see the need for adding a thematic specific exposure to PSUs in portfolios.

Are PSUs the only ones that you are not recommending or you’re avoiding thematic at large?

DHAWAN: So we do use thematic very frugally in client portfolios and what we do find if there could be opportunities that sometimes get created around areas like banking and financial services because of the growth opportunities that have come there, there could be opportunities that get created sometimes in defensive thematic. But in general we are fairly frugal with making investment decisions in thematic strategies unless we find something that is completely out of whack.

Index Investing

I think a lot of people are looking at what’s happening in the Western world, etc. and start thinking about how index funds might be better suited for in certain cases and I think there’s a case in point being made by individual experts, who track Indian markets, that for a lot of large-cap funds, they’ve barely managed to beat the index, a lot of times just about par and therefore, why should I pay those high costs to actively manage large-cap funds? Let me just stick to index funds. Maybe the argument is not wrong as well. What’s your sense and what quantum of purely the mutual fund portfolio allocation should be done to index investing?

BIVALKAR: I think the underperformance in the large-cap funds what you were referring to in the last year has come because of one stock which is Reliance. SEBI does not allow any mutual fund to go beyond 10% for a single stock exposure while the index itself had a 14% exposure and you would have seen the stock moving from 860 levels to 2,400. If you have such kind of a move in one single stock which is the market leader and which is 14% of the index, then definitely your large-cap funds will actually underperform. Needless to say, index funds definitely are cheaper in cost compared to large cap, but not certainly at all points of time you will find the index beating large-cap funds. The adviser alpha as well as the fund managers alpha definitely works well when it comes to managing open-ended actively managed funds. Second thing is, we should not get tied down only to the indices which is Nifty or Next Nifty or Sensex. I think there are huge opportunities in an IT index, pharma index, a consumption index and if you want to play the economy, I think you also have something called the private bank ETF. So, I think index funds or ETFs are definitely a good choice.

You need to really look at whether my fund manager is not able to add alpha, then I should go and buy index funds. Otherwise, if you stick around with open-ended actively managed funds over three-five-year period you will always see an alpha created by the fund manager for you. How much will that be? History says it’s about 2-3% on a year-on-year basis. Therefore, this argument of cheap versus costly on index versus open-ended is put to rest when you have an alpha of 2-3% as CAGR over three-five-year period.

Are you saying that you’ve seen that happening in large-cap funds in the last five years compared to index?

BIVALKAR: Yes. If you do a five-year rolling return, instead of point-to-point or a calendar return you will find that data.

Vishal, what are your thoughts?

DHAWAN: So our thought is that actually indexing should not be considered as just a Western trend coming into India. There is now enough data to show us. There have been multiple SPIVA reports over many years that we’ve been tracking. So, after you eliminate the survivorship bias that exists, which means that effectively the funds that don’t do well get merged or closed down, there’s a very strong case for index investing to happen in India at this point in time. It’s even stronger in the large caps in terms of an overall approach. So, it’s not just the cost around it but also the performance aspects. We’ve been allocating about 20% of portfolios already to indexes and what I just want to add to here is that when you’re looking at an index strategy, I think it’s also a good idea to diversify portfolios internationally and there are now index products available for an investor to buy into, which invests globally as well. I would say that both domestically and internationally, bringing index into portfolios will not only help lower cost but probably also end up becoming core parts of portfolios going forward. So, we only see this 20% increasing as time passes rather than staying static or coming off.

BIVALKAR: One point, what I wanted to add here is that if you look at the BSE IPO Index that has the standard deviation which is equal to the Nifty but has outperformed the Nifty, so I will see some mutual funds coming out with a BSE IPO Index ETF, and people might actually invest there as well.

Ideal Portfolio

Vishal, consider an average person with more than 50 years of age and enough risk tolerance. What is the lowest risk-free rate of return the person can get and how do we stagger it out? What is maybe the maximum that somebody like this can hope for and what are the products that would suit each return category?

DHAWAN: I think in general, fixed income returns for these investors will range anywhere between 4.5% and 7% overall and therefore, that’s a fairly low number considering the fact that inflation is itself ranging between 6% and 7% for quite a while now. Therefore, there’s been this natural tendency to want to move towards adding some elements of risk into individual portfolios. I think a good starting point for a lot of investors would really be to look at dynamic asset allocation products in the portfolio for two reasons.

1. a lot of these run with models that automatically adjust the debt and equity mix basis how different valuation parameters throw up. So, for example, they could have a price-to-book basis or a price-to-earning basis. They could be using a whole bunch of either momentum or fundamental indicators to decide on what their debt equity mix is and because they are very disciplined and remove the emotion out of investing, I think it works well for investors to look at participating in them.

2. The contrast cyclical behavior that a lot of individual investors need to be able to display tends to be very hard to do. So, for example, as of now with equities running up very strongly in the last few months, it is very natural to want to add more equity into portfolios. What dynamic asset allocation funds might be doing is they might actually be reducing risk at this particular point. So, I think it’s great that these products can do it by themselves and that’s why I think it’s a good starting point.

I will only caution investors about two things if they choose this category. One is, be mindful of any sort of credit risk that has been taken on the debt component of these portfolios, and second is to spend a little bit of time understanding the basis on which they rebalance between debt and equity because a lot of products have different models in place and therefore just looking at past returns may not be the best way to do it.

Amit, your thoughts?

BIVALKAR: I think, at the age of 50 typically a person or a woman, they have given away their housing loan, and they are thinking of the property for their sons or daughters to inherit. We have to change this mindset instead of the property we should actually ask people to inherit equity portfolios over 25-30 years’ time and this myth of at 50 I should go from equity to debt, I don’t think so that’s very much true today because my aspirations, ambitions and everything are actually going up even after 50. You’ve got many tour operators who actually take you to Switzerland and the U.S. and places which actually cost a bomb. So, if you want to beat inflation and if you want to be on the right side of double digits, I think there is no option but to go into equity. Only thing is, if you have a five-year horizon and if you want a 70-30 kind of a debt-equity mix over a five-year period that 70 becomes 100 and your capital gets protected, while the 30 what you have in equity, probably will give you that extra return what you always dreamt of. The client base what we have of above 50, they only tell us one thing that we want a better post-tax than a fixed deposit return and therefore a simple product like an MIP (monthly income plans) or a 70-30 debt equity should suffice if they have no liabilities and they are sufficiently so covered on the Mediclaim part.

I think over time, 70-30 on a debt-equity with balanced advantage funds or MIP-sort of a structure, you can definitely beat a fixed deposit post-tax kind of a return. Remember to not only inherit the property to your sons and daughters but also your equity portfolios because over 20-25 years they make much of a return.

Asset Allocation

Amit, should people think of equity versus debt with the rising market levels? A lot of people have put in the question that should they move out some money from equities and park into debt because the market levels are so high. I know the balanced advantage funds will do it automatically. Are you telling your clients to take some money off equities and put it into fixed income?

BIVALKAR: One is the expectation management of the client. He is typically happy with a 12-15% kind of an equity return. So, clients definitely have an asset allocation model in place. Once you have an asset allocation model what we do is, we probably at the review, have a particular date in mind every year for the client and we’ll definitely skim off the top on the equity if we find that the asset allocation ratio has changed more in favour of equities. So, we go and stay in debt. If it’s the reverse, we move from debt to equity. Look at your asset allocation number between debt and equity and this time around, we have actually moved from equity to gold.

It’s not always that it has to be equity and debt but we feel probably there should be a 10% allocation to gold. So, we booked profits in equity and we have moved some of the clients to gold as well. Asset allocation is the key. Decide a particular date in a year and rebalance your portfolios. It does not matter whether it’s Jan. 1 or April 1 but do it religiously and I think asset allocation will pay you.

Vishal, have you done any such reallocation because of the market levels?

DHAWAN: Absolutely. I think we’ve been rebalancing fairly aggressively. I think more aggressively than our clients would like us to, considering that fixed income returns are fairly low at this point. So, there is a natural tendency to want to go towards potentially higher return assets at this point. I think there’s a strong reason why we’re doing this. I think we do believe that it’s very important to protect capital during certain periods of time and we could well have actually seen a lot of front-ending of returns happen in 2020 in anticipation of a recovery post-Covid and post a lot of other events that have happened globally. Therefore, we think it’s a good time for investors to start to protect capital and reduce their equity exposure. A lot of them are actually getting reductions in equity recommended which is even beyond their strategically agreed asset allocation and we could technically be going underweight on equities at this point. What we are of course doing exactly like Amit mentioned is looking at gold as well in portfolios because there’s a very strong case to be built to have gold in portfolios, especially with a weakening dollar.

And last but not the least, I think they need to be globally diversified. It remains as relevant today as ever because a lot of the flows that are coming into India are probably tilting the recent returns towards India outperforming global equities and therefore there is a tendency to want to put more into India as compared to other parts of the world. We think that if you have a single event risk; whether that risk will come from the budget whether it comes from some other event that takes place, I think that if you want to protect investor portfolios it’s very important to be globally diversified.

BIVALKAR: I have one observation here. Whenever we have the PPF rate actually lower than the housing loan rate, you always see a scramble for real estate. I think more of our clients we have advised them to prepay their housing loans, but more people are actually thinking of buying another house because that rate of loan is at probably 7.1-7.2%, while your PPF is below that. So, every time your housing loan rate is below your PPF rate, you see a rise in realty prices and therefore people are also moving from equity into real estate at our end as well.

Best Tax-Saving Funds

What are the best options in tax-saving funds?

DHAWAN: We think there’s a lot of options available. I think both Mirae Asset Tax saver and Axis Long-term Equity have consistently performed very well and demonstrated that they’ve kind of been good choices for investors. I think we’d still like to suggest that even though it might be January, you can stagger your investment in over three months rather than putting it in lump sum and we therefore are suggesting that next year onwards maybe do it over longer periods of time assuming that tax laws don’t change in the next budget but if you do it this particular year and you’ve clearly opted for the tax regime that was rolled out because I think one of the decisions that a lot of investors need to make is the choice of tax regime that they want to implement for the financial year 2020-21 because the ELSS or 80C investments are only available if you are still in the old tax regime. So, assuming you’ve opted for it, we think Mirae or Axis are both good choices and just stagger your entry in over three months.

BIVALKAR: I agree with Vishal here that we also have Mirae-Axis along with Canara on the tax-saving part. If you are already full with your PPF, housing loan and LIC, then I don’t think that you need to be in any tax-saving fund. In fact, you can be in open-ended funds. People do a lot of SIPs into tax-saving funds and mind you every instalment what you pay into a tax-saving fund has a three-year lock-in. So, whenever you are investing in a tax-saving fund, remember these two things—if your 80C is already full, you don’t need to do that and second thing is if you’re doing an SIP, then your every instalment actually gets in a lock-in for three years. Don’t look at last year returns for tax-saving funds to invest this year. Look at a quartile-two performing fund over the last five years and I think eventually they will become quartile-one. So, as Vishal also said, we have Canara, Axis and Mirae which our clients invest into when it comes to tax-saving.