“Mutual Funds work like Virat Kohli” – Mr. Nilesh Shah, MD Kotak AMC

Mr. Nilesh Shah in an interview with Mr. Parimal Ade, Co- Founder, Team Yadnya

Introduction

“Mutual Funds work like Virat Kohli” – Mr. Nilesh Shah, MD Kotak AMC and Chairman, AMFI said in an exclusive interview with Team Yadnya. Mr. Shah shares his perspective with Mr. Parimal Ade, Co- Founder, Team Yadnya about the current stock market and the economic implications of the COVID-19 pandemic. This distinctive interaction with Mr. Nilesh Shah would be helpful to the retail investors.

“Mutual Funds work like Virat Kohli” – Mr. Nilesh Shah, MD Kotak AMC

• Mr. Parimal Ade :
  • Sir, How do you rate the current downturn as compared with 2008-09 Crisis? From the Quantitative analysis angle, how painful this journey will be for the investors? 
• Mr. Nilesh Shah :
  • 2008-09 was the Financial Crisis. While 2020 is a perfect storm, where a Medical Crisis has resulted into the shutdown of economic activities, that in turn is prompting a Financial Crisis.
  • So, as compared to 2008-09 Financial crisis, 2020 is far more greater being a combined effect of Medical Crisis + Economic Crisis + Financial Crisis.
  • And more importantly, we can not gauge the pain of this COVID-19 pandemic, because we are still suffering through it. If we want to survive through this crisis, we have to learn how to live with the virus. So, the cost or the pain, we will come to know much later.

• Mr. Parimal Ade :
  • Can we rate the current downturn as the Recession as per the definition?
• Mr. Nilesh Shah :
  • Undoubtedly it is a Recession. Due to the enforced lockdown, where the economic activities shuts down, the growth is bound to be negative. Government has 2 choices : Protecting lives or Protecting Businesses. Losses of life can’t be recovered, whereas the Business Losses can be recovered. Obviously, the Government has chosen the right choice of saving lives.
  • Due to it, we will have a negative GDP growth for the first time since FY1980. If we look at the historical economic outlook of India, Recession had always come mainly because of Monsoon Failures. Adverse impact of Monsoon failure on Agricultural output, had resulted into the negative GDP growth.

This is for the first time, because of the Medical Crisis, India’s GDP growth rate is going to be in the negative zone. So, undoubtedly, India is in the negative growth trajectory for FY2021.

• Mr. Parimal Ade :
  • What kind of Redemption Pressure are you witnessing from the Mutual Fund Investors? Both in Debt & Equity?
• Mr. Nilesh Shah :
  • Equity Mutual Funds have seen marginal declines in the new inflows in April and May. The inflows which were around Rs.11,000-12,000 Cr in March-20 dropped to around Rs.6,000 Cr in April-20 and around Rs.5,000 Cr in May-20.
  • In Debt side, March month has witnessed a quite higher redemption because of the Quarter-end. However, Combined inflows into the Debt Mutual Funds for April-20 and May-20 is above Rs.1 Lakh Cr.
  • The winding off of the 6 Credit Risk Funds by Franklin Templeton Mutual Fund created a great panic among the debt investors. A lot of rumors regarding the debt funds were spread on the social media, by using Credit Risk Funds and the Debt Funds interchangeably. Debt Funds comprise of a wide range of category from Overnight Funds to the Gilt Funds. and there is no issue in any of the other categories across the debt funds universe.
  • In case of Credit Risk Funds also, only few companies’credit risk funds witnessed issues. Due to the lot of panic spread among the debt investors, we have witnessed some redemption in the Credit Risk Funds. The redemption was higher in April-20 and moderated in May-20. We have witnessed the panic redemptions by the investors mainly from Credit Risk Funds and possibly due to the Financial Emergency.
  • Post heavy redemptions in April-20, the Credit Risk Risk reported the 2-3% returns in May-20. So, the investors who have made the panic redemptions in April, missed this 2-3% returns in just 1-month.
  • To summarize, few redemptions were due to the Financial emergencies and the few were due to the panic created post Franklin Crisis. But, the inflows are going on in both Equity and Debt.

• Mr. Parimal Ade :
  • Which Sectors will be the front runners in the upcoming Economic Revival? 
• Mr. Nilesh Shah :
  • Within one sector, how the promoter of different companies run businesses matters a lot. We have look at the Company Management.
  • People’s preferences and the behaviours are changing due to the COVID-19. The companies which will be able to adopt such changing behaviours, are going to be the preferred by the investors.
  • In the current scenarios, revenue of the company can decline, because of the shutdown of business activities. And if the company is having a leverage, where interest cost is going on, can ruin the company’s financials. So, Non-leveraged companies over the current downturn will sustain better. The leveraged-companies, where debt-burden is higher, the problems may come.
  • Thus, Leverage, Company Management and the Adaptability of the company’s Management should be the key focus areas for the investors.
  • The necessity-based sectors will keep going well, while the Luxury-based sectors may get impacted. The demand will continue for the value-for-money products, while the demand for the Luxury products may fall.
  • In current scenario, below sectors should create money for the investors :
    1. Building Material
    2. Financial Services
    3. Consumer Staples
    4. Contract Manufacturing
    5. Chemicals & Speciality Chemicals

• Mr. Parimal Ade :
  • For Kotak Mutual Fund, which strategy is preferred ? Top-down approach or Bottom-up approach? 
• Mr. Nilesh Shah :
  • Our main objective is to create money for the investors. For meeting this prime goal, we use all the strategies available with us. So, we use Top-down approach also and Bottom-up approach also.
  • I don’t think so, we do have the luxury with us to ignore any strategy. Only Top-down or only Bottom-up won’t meet our main goal of generating returns.
  • Retail Investors have the hope that if they invest in mutual funds, the Fund Managers will invest their money in the best companies selected with the due diligence.
  • So, the fund managers avoids the mistakes, which the retail investors are prone to commit. So, we use both Top-down as well as Bottom up approach. We don’t focus any specific strategy – Growth investing or Value investing, Fundamental or Technical.
  • Our primary objective is just to create money for our clients.

• Mr. Parimal Ade :
  • New SIP inflows reported marginal declines since March-20. A big hit of market downturn on SIP Returns also. Last 10-years SIP investment’s returns have come down to the single digit.
  • What do you want to suggest / communicate to the Investors?
• Mr. Nilesh Shah :
  • If investors have any financial emergency, so obviously you can stop your SIPs.
  • If we talk about the SIP returns, lets take the example of my fund – Kotak Emerging Equity Fund. The SIP returns in Jan-20, Mar-20 and Apr-20 for the last 12 months and last 10 years are as follows :

• We can see from the above figure, the month when you do gauge the SIP returns matters a lot.
  • In Jan-20, Markets were at all-time highs. So SIP returns were also above 25%.
  • While, In Mar-20, Markets witnessed a sharp correction due to the heavy FII sell-off amid COVID outbreak across the world. So, SIP returns eroded adversely.
  • And in Apr-20, Markets started recovering from the Mar-20 bottoms, so the SIP returns are comparatively better than that of Mar-20.
  • In Recessionary market, SIP returns take a big hit, while in the Rising Markets, SIP returns are on higher side.
  • So, Definitely, when you make an investment through SIP, you have to follow the disciplined approach. Investors should continue their SIPs on higher as well as lower levels of the Markets, so that over the period of time, a good portfolio is built due to the rupee cost averaging.
  • The investors shocked by looking at the SIP returns in Mar-20, should look at the SIP returns in Jan-20 and Apr-20. It will help the investors to understand how the disciplined investment through SIP can turn the tables over a period of time.
  • In case of Financial emergency, it is all right to stop your SIPs. However, one should never stop the SIP just by looking at the returns.
  • In the current scenario, the best companies are available at the valuation well below their historical average valuation. Whenever, the market will recover, the unit purchased in current lower market levels, good returns will be generated.

• Mr. Parimal Ade :
  • The Historical Average Market Cap to GDP Ratio is around 75-80, while the Current Market Cap to GDP Ratio is in the range 60-65.
  • What kind of Contraction do you see in GDP? When the Market Cap to GDP Ratio is expected to reach to its Historical Average Level?
• Mr. Nilesh Shah :
  • As per the projections, India’s GDP is expected to decline up to 5% in FY21. Various Rating agencies and Brokerages houses projected the GDP growth to be around -5% this financial year.
  • So, when we calculate the Market Cap to GDP Ratio, we use the same contracted GDP projected for FY21. The Historical Average of Market Cap to GDP ratio is around 75. And in the current scenario, the ratio is hovering in the range 47-65%. At 7,000 Nifty 50 level, the ratio was 47%, while at 10,000 Nifty level, it is at 65%.
  • So, comparing with the historical average 75, you are investing at much discounted valuations. The regular investment through SIP or STP, will help to average out the investments (between 47 to 65) in the market.

• Mr. Parimal Ade :
  • Sir, What is your suggestion for the investors regarding the Small cap and Mid cap territory?
• Mr. Nilesh Shah :
  • The % declines in Nifty 50 is 20%, Midcap is 40% and Small cap is 65%. Obviously, Midcap and Smallcap stocks have taken a big hit. So, from valuation point of view, it is the right time to invest in the Smallcap and Midcap stocks.
  • However, Smallcap and Midcap stocks are like roller coaster, ride up-down with very high momentum. So, if your risk profile is of Conservative investor, you should invest in Large cap only in spite of the attractive valuations of the Smallcap and Midcap.
  • If your risk profile is of Aggressive Investor, then you can invest in Smallcap and Midcap territory.

• Mr. Parimal Ade :
  • How much the Asset under Management (AUM) of a Mutual fund scheme matter?
  • There is a lot of consciousness seen among the Investors and Analysts regarding AUM. Is it Right or wrong?
• Mr. Nilesh Shah :
  • “Mutual Funds work like Virat Kohli”. When Virat Kohli play T-20, he uses one strategy. When, he plays one-day, he uses second strategy. And when he plays Test-match, he uses the third strategy to bat.
  • In the Bowler-friendly pitch, he bats in one way, while in Batting-friendly pitch, he bats in the other way.
  • If the earlier batsman made good runs, then Virat Kohli bats in one way. And if wickets have fallen too early, then he bats in the other way.
  • Thus, Virat Kohli adopt himself according to the different times, different situations. That is the reason, He is the world’s best batsman in today’s generation.
  • The best Fund Manager also plays in the same way using different strategies in different scenarios.
    1. For Big Fund : He will bat like Test Match
    2. For Small Fund : He will bat like T-20
    3. For Medium-sized Fund : He will bat like One-day Match
    4. For Discounted Valuations : He will bat like batting-pitch
    5. For Premium Valuations : He will bat like bowling-pitch
  • Thus, you let Virat Kohli to play his best according to his abilities in the Test Match, T-20 and One-day. In the same way, you should let the best Fund Manager make investments with his own style.
  • The Fund Manager will adopt himself depending upon the situation, depending upon the size.

• Mr. Parimal Ade :
  • Active Investing vs Passive Investing is a big Debate in Developed Markets. The Debate of Active vs Passive Investing is how much relevant in Indian Markets?
• Mr. Nilesh Shah :
  • The Mutual Fund’s performance is compared with the Total Return Index (TRI). The Dividend gets counted in the Total Return Index and not in Price Return Index.
  • According to the SEBI’s Regulatory update regarding the benchmarking of mutual funds and measuring their performance, the benchmark has shifted from Price Return Index to Total Return Index.
  • However, fund manager allocate some portion of the portfolio to cash for the daily redemption purpose. While, there is no such Cash in case of Index.
  • For buying/selling of the stocks, an impact cost is incurred for the Mutual Funds. While in case of Index Funds, there is only one daily adjustment
  • When a fund is globally compared with the TRI, an expense ratio of that fund is added. And then the comparison is done on the net basis.
  • In India, we are not adding an expense ratio to our performance, we maintain cash for day-to-day redemptions which is not counted in Index and the Index doesn’t carry impact cost, but the mutual funds do.
  • Despite all these things, our funds are outperforming Benchmark Indices :

• The SIP returns for 10 years, Kotak Emerging Equity Fund has generated 6% Alpha. The fund has reported 17% returns, while the TRI return was 11%.
• Similarly, in April 2020, the SIP returns of the fund was 11%, while TRI return was 6%, thus posting the Alpha generated at 5%.
• In spite of the a number of factors like impact cost, expense ratio, cash kept aside, Active funds have generated Alpha. And as long as the active fund generates Alpha for the investors, the investor will continue with the Active Funds.
• Investors will consider investing in passive funds, when the fund manager couldn’t generate alpha and couldn’t beat the index.

• Mr. Parimal Ade :
  • In Large Cap space, Do you feel the shift from Active Investing to Passive Investing can be upcoming? 
• Mr. Nilesh Shah :
  • How does a Large Cap Fund able to perform? The Fund Manager keep some allocation to the key Midcap stocks which are the future Large cap companies. And because of this call, the fund manager can able to generate performance of the Large cap fund.
  • In the current scenario, the % correction in Large cap is around 20% and for the Midcap, it is around 40%. While Smallcap stocks have corrected by almost 65%.
  • Thus, the fund manager’s bet taken out of the Large Cap Index turned Negative. In spite of this, many large cap funds are outperforming the index.
  • In future, when the Midcap and Smallcap stocks reach to their fair valuation, these Large Cap Fund will seen to be outperforming the Index.

• Mr. Parimal Ade :
  • What is your Opinion about Gold, as an Asset Class? What would be the Allocation for Gold in the portfolio?
• Mr. Nilesh Shah :
  • Generally, when the interest rates are falling and when there is a lot of liquidity in the banking system, Gold prices appreciate.
  • In November 2008, Gold was hovering around $750 and from there Gold appreciated in the value up to $1,900 in September 2011. Lower interest rates and high liquidity push the Gold prices up.
  • The same situation like 2008-2011 is expected hereon from 2020. So, in such scenario, we do expect the Gold prices will rise.
  • There are 3 ways while investing in Gold asset class :
    1. Physical Gold, where you have to pay a premium denomination for buying gold. The premium for 5 gm, 10 gm, 20 gm gold is around 15-20%.
    2. Gold ETF, where the premium is very low. It also offers you the daily liquidity, can be traded in the secondary market.
    3. Sovereign Gold Bond offers you dual benefits : Capital Appreciation in Gold and the Regular Interest Income per year on the initial investment. Here the investment horizon should be 5-7 years, since the Redemption is allowed after 5th year.
  • So, the investors should invest in Gold in current scenario. Depending upon the flexibility, investors can choose any options among the above 3 options for Gold investment.
  • A conservative investor can invest around 10-15% allocation in Gold. While an average investor can take around 15-20% allocation for Gold.

• Mr. Parimal Ade :
  • As an Investor, How do you make Asset Allocation in your own personal Portfolio?
• Mr. Nilesh Shah :
  • I do have a discipline asset allocation in the Real Estate, Stocks, Debt Funds, Commodities. I do maintain this asset allocation.
  • I didn’t change my asset allocation due to the prices. I have created the portfolio asset allocation according to my risk profile.