‘Equity fund-of-funds is a prudent investment’
Retail investors often try to time the market which is not the optimal strategy most of the time, says Jimmy Patel, MD & CEO, Quantum Mutual Fund. In an interview to Saikat Neogi, he says investors should map their equity allocations to their long-term financial goals and stagger their investments to achieve the best results from equity. Excerpts:
Equity-oriented funds saw over Rs 22,000 crore of net sales in July, the highest so far in 2021. Do you see the positive sentiments in equity markets aided by robust NFO collections continue for some time?
The sharp rise in markets and overall improvement in the economic environment has led to investors putting more money in equity mutual funds. The mutual fund industry has also gone into overdrive and has been launching a slew of NFOs. However, it is best to advise caution to the retail investors. With valuations at a premium, especially in the mid-cap and the small-cap side, there is a significant possibility of new investors facing disappointment (in terms of returns) in the near term and pull out money at the wrong time, out of fear; if the markets correct sharply. Over the long term, as the understanding of equity as a long-term asset class (and not a short-term speculative avenue) increases, flows to the equity mutual funds should improve structurally.
Many conservative investors have opted for hybrid funds. How do you see such funds growing in the next one year?
Many conservative investors are opting for hybrid funds now to compensate for lower returns in fixed deposits, as well as to get a flavour of equities. We may see this trend continue going forward. Even balanced hybrid funds and dynamic asset allocation funds tend to be equity-biased as and when they try to generate better returns and alpha. While achieving these objectives, these hybrid funds invariably end up taking more risk, which may not always match the risk profile of conservative investors. If these preferred hybrid fund categories are not able to provide downside protection through the stock market volatility as expected, conservative investors may not be comfortable staying on.
Floater funds have been witnessing positive flows owing to the uncertainty around interest rates. Do you see that changing after some time?
Floating rate bonds are a good investment choice in a rising interest rate environment. As market interest rates move up, coupon rates on these bonds reset to higher levels. However, there is limited stock of quality floater securities available in the Indian debt market and secondary market liquidity is much desired in this segment. So, it would be extremely difficult with an increase in the AUM size in this narrowly focused category to not compromise on the portfolio quality.
How should a long-term investor build a portfolio between large, mid, and small-cap funds?
Investors often buy different equity mutual funds to diversify but inadvertently buy funds with similar strategies and portfolios. Diversification in the mutual fund portfolio needs to be backed by proper research. Ideally, 15% allocation should be towards a well-managed value fund, 15% to an ESG focused equity fund and then a layer of 5-6 equity mutual funds diversified across caps and styles.
Value funds aim to ignore short-term market movements and wait patiently for value to emerge as it allows them to generate steady returns over the long term and limit downside risk. What gives ESG funds an edge over other equity mutual funds is that the companies that are strong on ESG have relatively better long-term financial prospects. Whereas, an equity fund-of-funds is a prudent investment option to build the major portion of your equity portfolio by investing in just one fund. This fund gives investors exposure to funds that are actively managed and lets them rely on the fund manager’s capability to take advantage of the correction and build a robust portfolio.
Why are investors chasing stocks of mid-and-small cap segments irrespective of fundamentals? Also, has the current mid-cap rally turned a little frothy?
Since May 2020, the midcap index has not given a negative monthly return (month on month basis) till July 2021. Even the small-cap index has given negative monthly returns only once (month on month basis) in the past 13 months. This has created a sense of FOMO (fear of missing out) among the retail investors.
Macro-economic shocks over the last few years like demonetisation, hastily implemented GST, IL&FS crisis and Covid-19 induced lockdowns have helped the large companies become larger and stronger, helped by scale and balance sheet strength. The smaller companies however have weakened and lost market share. In this backdrop, as Covid-19 related uncertainty still lingers on, the mid-cap valuations are at close to all-time highs. Markets are choosing to ignore the risks associated with investing in smaller companies, but this ignoring of risks could reverse quickly if global liquidity dries up or we face a Covid-19 third wave.