Mutual funds suffered heavy redemptions in 2008 as investors headed for the exits in a year that saw the Sensex, the BSE bellwether, plunge by more than half. No one escaped unscathed, but some funds emerged less bloodied than their peers from the carnage on the markets....
::Best equity fund house::
Reliance Capital Asset Management Ltd (RCAML), the country’s largest mutual fund house by assets under management (AUM), has been named “Equity Fund House” of 2008 by Morningstar India Pvt. Ltd, the Indian arm of Morningstar Inc., an independent research provider on mutual funds, hedge funds and other investment alternatives.
RCAML, owned by Reliance-Anil Dhirubhai Ambani Group, managed in excess of Rs70,000 crore at the end of 2008, and about 28% of the corpus was in equity funds. RCAML manages almost one-fifth of the total equity AUM of India’s mutual fund industry, which was Rs1.1 trillion at the end of the year.Ten of RCAML’s equity schemes were considered for the assessment, along with those of other fund houses that were in contention for the award. Under Morningstar’s evaluation system, only open-ended schemes with at least three years of history are considered. On a relative basis, every fund from the RCAML stable, barring Reliance Equity Opportunities Fund and Reliance Tax Saver, seems to have performed well at a time when the market is in a bear grip. Overall, equity funds had a poor run in 2008, with the Bombay Stock Exchange’s bellwether equity index, the Sensex, losing 52% in 2008 and foreign institutional investors, the main driver of Indian equities, pulling out at least $13 billion (Rs66,950 crore) from Indian stocks.
Madhusudan Kela, 40, head of equity investments at RCAML, has been with the asset management firm since 2001. His funds, though all down by at least 40%, still outperformed peers last year. In an interview, he spoke on the philosophy underlying RCAML’s equity market investments, the cash strategy he employed in 2008, and his outlook on equity markets. Edited excerpts:
Many fund managers were caught unawares by the impact of the financial crisis that started elsewhere, but quickly spread to India. When did you start realizing that things were not quite normal?
In hindsight, we should have been less greedy. And maybe now, we need to be less fearfulInternationally, things turned out to be far worse than what we anticipated in January 2008. And it became even worse following the collapse of Lehman Brothers Holdings Inc. in September 2008. As a fund house, we had a cautious stand from January, which became even more cautious post-September 2008.
How many of your equity funds weathered the storm in the markets? How did they cope with it?
A majority of our equity funds have weathered the storm. However, I would have liked them to do better. Most of our funds have been in the top tier compared with their benchmarks and peer group. We have been bottom-up investors, and that is what helped us produce extraordinary returns between 2002 and 2008. The fall has to be looked into in that context. As I said, we have been cautious and that is reflected in our cash holdings of more than 25% for the fund house as a whole—more than Rs5,000 crore of cash on an asset base of Rs20,000 crore. Needless to mention that this also helped us cope with the gigantic fall last year.
If you were to talk about one unique philosophy you apply to managing all equity funds, regardless of themes, market capitalization, etc., what would that be?
The core philosophy is buying the right companies at the right price with a long-term view on investments. As you can see from our portfolios, there are stocks we have held for more than five years, and which have been part of our core holdings. We will not hesitate to take the right risk if the corresponding returns justify taking that risk. For instance, we might be buyers of mid-cap companies today, which are completely out of fashion, as we can see that risk-reward is in our favour.
What is your view on the markets?
The global situation has become far worse than what we had anticipated. And it still remains very uncertain. This obviously has an impact on India, both in terms of fund inflows into the country and risk appetite for equity investments in emerging markets. Hence, this will continue to be an important part for the markets.
On the domestic front, the outcome of the elections will play a very important role in framing an outlook on the market.
What is your strategy to make sure your funds remain in the top quartile?
Most of the uncertainty...is reflected partially or fully into stock prices, and hence we would like to make stock-specific investments in these uncertain times to take advantage of the opportunity. As a matter of fact, Reliance Growth Fund’s net asset value was Rs12-13 in 2002 and it went beyond Rs500 in 2008. Obviously, lots of investment in that fund was made in uncertain and challenging times (2002-2003). And that helped us generate these kind of returns.
Which are the sectors you are comfortable with?
The pharma segment looks good from a two-year perspective. There is clarity and visibility in earnings in this sector. Most of the companies have more than one engine of growth; have large cash flows compared with their market cap; and by and large, have good promoters and corporate governance.
In these uncertain times, people will take note of this sector. What about the untouchables?
I wouldn’t say anything is untouchable in the stock markets. Most of the stocks may offer value at a particular price.
What are the lessons from this downturn?
One lesson that has formally got reiterated is that the markets are all about greed and fear. Maybe in hindsight, we should have been less greedy. And maybe now, we need to be less fearful. The second point is that you have to live the markets, literally 24/7/365. You have to be extremely alert and can never afford to take your eyes off it. Third, one has to realize that there are a few good years and a few bad years in the markets and nothing will keep perpetually going up or going down. Hence, having extreme views does not deliver performance in markets.And finally, 2008 taught us that whenever the markets make a story around every stock in the listed universe, trying to justify their valuations and making an investment theme around them, it’s not the best of times to be in the market.
Do mutual funds deserve awards this year?
No, mutual funds do not deserve any award this year for their performance.
::Best debt fund house::
ICICI Prudential Asset Management Co. Ltd has won Morningstar’s award for the best debt fund house.
Debt funds are those which invest in fixed-income securities such as corporate bonds, government bonds, debentures, certificates of deposits and commercial paper. Such funds have Rs3.9 trillion of assets under management. This is about three-fourths of total assets managed by the mutual fund industry in India.Despite delivering more returns than equity funds, debt funds—especially short-term funds—suffered on account of heavy redemptions. At one point of time during the liquidity crunch triggered by the collapse of Lehman Brothers Holding Inc. in mid-September, investors withdrew as much as 30% of the total debt assets management. Since then, money has flown back into debt as the Indian central bank repeatedly cut rates and investors regained some confidence.
To be sure, one-year returns of debt funds ranged from 8.62% for very short-term liquid funds to 26.38% for long-term government bond funds. In contrast, almost all equity funds have seen returns shrinking.
ICICI Pru has some 22 schemes managing Rs46,000 crore in its fixed-income portfolio. Its short-term bond fund and short-term gilt fund have both topped in their respective categories.
Nilesh Shah, 41, deputy managing director of ICICI Prudential Asset Management, spoke on how a conservative strategy enabled his fund house to beat the market downturn and why debt might still be a good asset class for investors. Edited excerpts:
What has been the impact of the collapse of Lehman Brothers on the mutual fund industry?
The world before Lehman and world after Lehman is totally different. The world before Lehman was based on the trust and confidence that banks don’t fail. The world after Lehman raises doubts that even banks can fail. Now this results in stoppage of flows between banks, restricts credit flows from banks to customers. In a sense, speed breakers have been created for smooth flow of credit in the financial system.
How have many of your debt funds weathered the storm?
Our philosophy for debt fund management is SLR—safety first, liquidity second and returns third. So, we were conscious of credit risk in our portfolio since the beginning of 2008…almost since the middle of 2007.
We gradually reduced or eliminated even from our conservative standards names we believed could face a tough environment. Even though we invested only in AAA and AA rated securities and there was no question of any default or delay in payment of interest or principal, we ensured that we didn’t stay invested in any instrument that could potentially face a rating downgrade.
We weathered the storm because our foundations of SLR—safety, liquidity and return—were strong.
What has been your investment strategy?
Our philosophy is unique and we apply it to all our debt funds. My mandate to my credit analyst is very simple: If there is a default in any of our obligations, both of us will lose our jobs. So he is conscious of this risk whenever he sanctions any credit limits.
Any change in your investment philosophy?
I think our philosophy is not going to change. Philosophy is like a mountain; it doesn’t move. We will continue to monitor the markets so that our customers get the best return.
But don’t you think that the good times are over for debt funds?
There may not be any more deep rate cuts.I don’t think that good times are over for fixed income funds. Our belief is that markets today are pricing the government’s large borrowing programme and hence bond yields are higher than what they were before the rate cuts. At some point of time, the Reserve Bank of India will give confidence to that market that notwithstanding the size of the government borrowing programme, the central bank is committed to lower interest rates by doing open market operations, unwinding MSS (market stabilization scheme) bonds and giving rate signals. We still believe that there is reasonable opportunity for the yield on 10-year government bonds to go below 5.5% if RBI (Reserve Bank of India) takes decisive action to support a low-interest rate environment.
What’s the lesson from this downturn?
I think one has to always keep their feet on the ground and never move away from reality. Probably beginning last year, we all got carried away by the blue sky scenario and started believing too much in the future. The businesses are cyclical and environment is cyclical and after every up, there will be a down. We need to be prepared for the upside as well as the downside.
What’s your view on the overall financial markets?
The financial markets are facing a fair amount of volatility and uncertainty. But one advantage of the current environment is the fact that the media has brought everything upfront to the investor. The information travels very fast and hence a lot of bad news are getting discounted quickly.
Do mutual funds deserve awards this year?
Yes, because we have all done our jobs in line with the mandate given to us. The markets have fallen and hence we have also fallen, but we have fallen less than the markets even if it has caused losses to investors. In debt funds, reasonable returns have been generated last year. We have followed a process, a method, and I still think that if investors give us a longer time horizon, they will not be disappointed.
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