‘RBI should revise limit on overseas investment by MFs’

Nilesh Shah, Managing Director (MD) of Kotak Mahindra Asset Management Co. Ltd, believes that the only solution to the current volatility is asset allocation or a Kumbhakarna type sleep where you don’t worry about market returns. In an interview with Mint, the mutual fund industry veteran spoke about the right way to approach the market, limiting overseas investments and the underperformance of their flagship capital-flexible fund. . Edited excerpts:

There was high volatility at the start of 2022. After two years of strong rally, what is the solution for investors?

The only solution is asset allocation or Kumbhakarna type sleep. Now we don’t know if in the Ramayana Kumbhakarna invested in Mutual Funds (MF) or not but if he had invested and if he saw his Net Asset Value (NAV) today , he probably would have woken up. So the only solution is asset allocation. There is no mechanism to protect against declines and achieve a full upside. The best investors can do is asset allocation.

Is the Balanced Benefit Fund (BAF) the answer to asset allocation?

The Balanced Advantage Fund is not the only answer. There are asset allocation funds, which split between gold, debt, equities and offshore assets. Then there are asset allocation funds that divide within these asset classes based on a conservative, medium-risk, or aggressive investor. But BAF is probably the first step in creating a solution where investors can split between debt and equity. People aren’t necessarily looking for returns and they don’t like complexity. They want products that are easy to understand and they want products that they can understand in a meaningful way. BAF is the first step, then additionally, investors can have an asset allocation fund and then even a solutions-focused fund. BAF is intended for all investors who wish to take the first step towards asset allocation.

The industry-wide freeze on overseas investment by MFs is in effect, with some exceptions. Will the cap be raised soon?

From an investor’s point of view, this is not a problem because he can still use the liberalized funds transfer system (LRS) to invest abroad. The cap is more of an MF issue. Today, with $630 billion (foreign exchange reserve), India has the capacity to provide outward remittances. It is therefore preferable that a very small part of the large reserves of RBI be given to MFs, which allows us to invest abroad. Hopefully, we will be able to generate better returns, albeit at higher risk, which, in turn, will generate better returns on India’s overall currency position. We did an analysis some time ago – the average return on offshore funds, including debt and equity, was around 13%. Six-month returns were negative, but the weighted average of long-term returns was around 13%. The return of the RBI will be around 1.3%, probably because their risk is low. We need to increase the limit so that we can generate better returns on the foreign exchange reserve. Moreover, risk is not on the RBI’s balance sheet, it is on an individual’s balance sheet. We very much hope that the limit will be revised.

Why did Kotak MF’s flagship program, the flexi cap fund, underperform the category average in 2020 and 2021?

We performed this analysis, relative to the benchmark as of December 31 over a three-year period. There are a number of stocks (SRF, Bharat Electronics, Jubilant FoodWorks, ICICI Bank, UltraTech, BalKrishna Industries) where the program produced positive alpha, meaning my process isn’t all bad. Then there are stocks (ITC, HDFC, Maruti Suzuki, Yes Bank and Coal India), where I am underweight and where the program has generated positive alpha. On some stocks (GAIL and RBL), we were overweighted but that didn’t work. So we cut our losses and moved. It shows that we are not rigid about anything. On some stocks (Petronet LNG and Axis Bank), we were overweight and they did not deliver but we are still holding. So why am I clinging to Petronet? Because we believe that this title downgrade is not justified and that it can rebound. Same with Axis Bank, we think this bank will be re-evaluated. Now on some stocks we are underweight (Asian Paints and Adani Group) and they gave negative alpha. And then there were stocks where we were underinvested (Bajaj Finance and RIL), we realized that we had made a mistake and we became either an equal weight or I became a neutral weight. Should I make an improvement? Yeah, I have to make sure I don’t go invest in stocks where I’ve been overweight and it’s giving me negative alpha. Will I change my process to incorporate this into my portfolio? The answer is no. Because we don’t know when it will fall. We are comfortable with our process, whatever small adjustments are needed, we will make it, and will the fund return in terms of performance versus the large cap bias? One answer is yes, we are hopeful.

I noticed the large cap bias in your flexible cap fund. Could you tell us more about the category?

We almost have A 38,000 crore fund and we manage this fund over 75% large cap stocks, 25% small and mid cap stocks. We realized that when you have to move 10-20% of a fund into mid or small caps, the impact costs are very high. When there is a big volume, it is more in the F&O market and not in the spot market. Second, the impact cost for small and mid caps in the cash market could be very, very high. If I’m looking for a 20-30% return and the impact cost gets me 15-20% return, there’s no point in going there. So with impact cost in mind, we said we would position this fund as a 75-25 large cap bias fund at this size is the most ideal position.

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