The Mutual Fund Show: Why Investors Should Consider A Hybrid Scheme
Hybrid funds come in various categories—conservative hybrid, multi-asset, arbitrage, equity savings, and equity hybrid.
For long-term investors, allocating capital into hybrid mutual funds can be a suitable option as it's a lower risk investment with steady returns, according to experts.
"Mutual funds are playing the role of a quasi-bank," DP Singh, deputy managing director and joint chief executive officer at SBI Mutual Fund, told NDTV Profit.
Hybrid funds come in various categories—conservative hybrid, multi-asset, arbitrage, equity savings, and equity hybrid.
"For long-term investors, it has to be the hybrid (fund), starting with conservative hybrid (fund)... I think this is the best bet for people who are having a little risk appetite and having a horizon of three years plus," he said.
Rajeev Radhakrishnan, SBI MF's chief investment officer–fixed income, said an investor should be made aware of the portfolio in a hybrid fund, which has about 65-70% invested in equity, while 25% is debt-oriented.
Hybrid funds are actively managed and the investor base is largely weighted, he said. "So, the internal portfolio liquidity becomes less of a constraint as compared with a pure debt-oriented institutional product."
Fund houses have dedicated mangers for equity and debt portfolio "and within the internal template norms—which basically govern the extent of credit and duration risk that you take in your bond portfolio—the portfolio manager has sufficient flexibility", he said.
Solution-Oriented Funds
Singh explained that among solution-oriented funds, there are two types—children benefit fund and retirement benefit fund.
In the first category, the horizon of investment is either 10-15 years or longer, and hence, the fund manager can take a logical long-term call on the portfolio.
"So, there is no liquidity pressure, there is no redemption pressure. So, you can move into the companies which are going to give very good returns over a longer period... We have seen that the funds generally have given very, very good returns," he said.
About the retirement benefit fund, Singh said as people live longer due to socio-economic progress, their requirements can be fulfilled via the systematic withdrawal plan or the SWP route.
"When we come to solution settings, there are many number of funds and a number of solutions depending on individual needs. We can have so many solutions knitted. So, financial advisors can definitely help the investors in doing that," he said.
Edited excerpts from the interview:
DP Singh, there are several tailwinds, if you can call it that, for a fixed income investor. Yet, there are certain challenges in terms of the post-tax nature. How would you capture the current moment?
DP Singh: First, the tailwinds regarding the yields, etc., we feel that it has peaked. And, from here on, there will be greener pastures only for investors. So, it's a very, very good time to take a call.
When we look at inflation numbers, those are becoming moderated at around 4.8-4.9% for retail. So, if this becomes the case, then 3-6 months down the line we might see some rate cuts. And that will be the time when we can have very good capital gains. So, that is one.
And on your second question regarding the taxation part, yes, that is not there at the moment as things stand today. But that is not the only reason that it remains attractive, because there is a possibility of capital gains. And there's a very, very good probability and possibility of good capital gains.
And in any case, there's a deferment of tax. Even if the tax benefit is not there, in mutual funds, you gain everything in capital gains. One, it (tax) is deferred till the time you're there in the market. And it will get triggered only at the time of redemption. Second, there is a possibility of getting it adjusted against any other capital gains of the same nature.
So, it remains attractive, for not only HNIs (high net-worth individuals) and ultra HNIs, but also for retail investors parking their money, because today, mutual funds are playing the role of a quasi bank. It's not that mutual funds are there only for the equities. There are hybrids of each and every category—starting from the conservative hybrid, to multi-asset, to arbitrage, to equity savings, and equity hybrids. So there is a huge number of categories. And the total number of AUM (assets under management) put together will be almost Rs 4-5 lakh crore. So, that is a play which we need to play. As every individual is busy with his own work, let this work be left to the experts, to the mutual funds, who will take care of it.
What are those tailwinds, with significant upsides and potential down the line that you would identify? And, over what period do you see them playing out?
Rajeev Radhakrishnan: Good question. So, when you're talking about tailwinds, very clearly a few factors come to my mind immediately. One is, how the whole debate about global policy rates is shaping up. When you look at data over the last few months, it seems to be fairly clear that global policy rates have broadly peaked. And now, you don't have the risk that some of the major central banks may have to do additional rate hikes. But today, given that you're closer to a soft landing than what was perceived a few months back and the data in a way is validating that assumption that inflation is getting closer to their targets and growth hasn't completely collapsed, it's still relatively resilient. So, the requirement of additional rate hikes probably is not really there, from a global policy rate perspective. But again, the core debate that rates are likely to stay at this level for a bit longer—that equation does not necessarily change.
So, a shift in that global policy rate cycle is definitely positive from our economic aspect and the other of course, is the potential for a new source of demand to emerge for Indian bonds. And that is where the index inclusion comes in. So we know that JP Morgan has added India to its global bond index. It is quite likely that over the next few months, or may be over a period of time, other index providers will add India into the various indices. We are already seeing the impact in terms of flows coming into government securities.
What kind of flows have you seen so far?
Rajeev Radhakrishnan: So far, in this calendar year, the F.A.R. (fully accessible route) securities have got something like 6.2 billion. And on a net basis, the G-Sec and corporate bonds put together have got something like 5.5 billion and this is compared to negative flows over the last few years. As we go closer to the index inclusion, very clearly, it's likely that may be to some extent, that might even sync with the global rate cycle also. So, you could potentially see active flows also coming into our market. So the big story over the next few years would be this added source of demand coming into the government bond market. And that should have a beneficial impact, in terms of lower yield over a period of time. But for the very near term, it looks likely that we still need to solve the challenge of higher inflation... That's why the RBI is keeping the interbank liquidity fairly tight. But once that phase is over, you will get the benefit of these tailwinds, both from the global perspective and then your demand source that is emerging from offshore flows into our market.
In the run-up to the general elections, generally, the government kind of loosens the purse strings a little bit. Will the domestic borrowing programme at all be a factor to watch for a retail investor or is that something that you shouldn't bother about at all?
DP Singh: I don't think we should bother about that, if you look at the fiscal position of the country and the kind of tax collection which is happening. As far as opening the strings of the wallet are concerned that has already started. That is visible and it's continuous and I don't think it will impact the borrowing in a big way and moreover, Rajeev will be a good person to talk in detail about this. But on the face of it, it doesn't look like any big problem.
We have seen a very sharp deceleration or decline in global bond yields, particularly in the U.S. The expectation is that the Fed is done, and the data seems to be supporting that finally. Where does that leave us, here, in India? We are still not too far away from that 7.3%-mark on the top.
Rajeev Radhakrishnan: The reason why we have not reacted as much to the external drop in yields is very clearly due to the domestic factors. RBI continues to be very focused on getting inflation back to its midpoint target that is 4%, the growth in India is relatively resilient compared to the estimates of the central bank. So there is no reason for us to drop our guard immediately on inflation, but that is why we have not reacted per se in a significant manner as west and today. Liquidity in the interbank market is fairly tight. When you look at over the last three months or so, our policy rates have not changed. It's at 6.5%, but the effective rate that matters on the interbank is 6.75%. Because of tighter liquidity, effectively it's like a de facto rate hike that has actually been done by the central bank. So, the liquidity dynamics in the market remain tight. I think that's the reason why we have not really seen a significant downward move.
The other angle of course is inflation, because there are comforting factors also there. The core inflation number has actually started to decelerate, but headline is the target and that is what matters and there are a lot of upside pressures which are basically recurring, different items at various points in time and this is what the RBI is quite worried about. That in a way is impacting the market as well. So there are some of these factors from a fundamental perspective that are important when you see why our yields have not reacted to that extent.
But yes, it's a question of eventually getting that visibility, that we go closer to the midpoint and that I think will happen over a period of time. I think, for this rate cycle to pan out, probably the next 12-18 months is when you can potentially see the full benefit of the rate cycle easing, and that again will be in, I would say, coterminous with the flows that will come in because the index flows will start to come in over the next year and by that time, we will expect that the economic cycle also will warrant to lower the rates in India.
We have established, at this point in the conversation, that it's a good time to contemplate investments into fixed income. But is pure fixed income the best way to do this, DP Singh, or is a conservative hybrid approach or another hybrid approach the best way to do this?
DP Singh: We have strong opinions that hybrid is the best approach, not conservative hybrid.
You mentioned tailwinds in the fixed income side, but there are very visible tailwinds on the equity side as well because a lot of money is flowing into this. If you look at the Rs 16,000-17,000 crore coming through the SIP (systematic investment plan) route and the FPI (foreign portfolio investment) money and FII (foreign institutional investors') money, which have started coming in and the kind of business numbers—the profit numbers that are coming in—definitely, the investors are in for good returns over a long period of time, say three to five years. So, hybrid definitely becomes a good approach. If you leave aside the tax part, the conservative hybrid for first-timers is utmost necessary, because there you don't have the tax benefit of equities or anything which is 25% or less, but for those people—who are in the lower tax bracket, or those entering the tax compliance area, or for those who are yet to join the bandwagon of mutual funds—the first step can be through conservative hybrid as there is not too much about the taxation, because this tadka of equity will definitely give them a better return over a longer period.
For long-term investors, it has to be the hybrid (fund), starting with conservative hybrid (fund). But of course, you move forward with the multi-asset allocation fund with three years of horizon and with the 35% plus in equity category, which includes equity as well as arbitrage. I think this is the best bet for people who are having a little risk appetite and having a horizon of three years plus. In multi-asset category, this is the sweetest spot for any investor. People who are feeling that the equity markets have run up, even for them, because you will get the best of both the worlds.
Of course, other categories are definitely there and we always say leave the solution of this allocation in between debt and equity at any point of time on the fund managers, stay focused on whatever you are doing and concentrate on that and don't spend too much time on this. Just leave it to us. We will take care of asset allocation.
When you mix both equity and debt, the worry is that you're not necessarily taking into account the risk associated with equity. Is that something that you feel more investors should be educated about?
Rajeev Radhakrishnan: To an extent, yes, because you know, these are products where you have an element of equity exposure. Now, depending on the product range, it could vary. Now a hybrid, which is equity-oriented, has about 65-70% always invested in equity, while the debt-oriented has 25%. So that is something that an investor should be aware of, in terms of where the investments are going. But from a manager's perspective, it does not really come into the equation because eventually the debt portfolio and the equity part are managed separately. So, we have a dedicated equity portfolio manager and a dedicated debt portfolio manager and within the internal template norms—which basically govern the extent of credit and duration risk that you take in your bond portfolio—the portfolio manager has sufficient flexibility. So I would consider that this is actively managed, very similar to any other pure actively managed debt product.
The only leeway, if I were to compare unlike some of the pure debt funds, where liquidity becomes a very important consideration on the portfolio side, in most of the hybrid products, the investor base is largely weighted and we typically tend to see that the investment horizon is slightly longer. So, the internal portfolio liquidity becomes less of a constraint as compared to a pure debt-oriented institutional product. That's the only difference. Beyond that, I think it's as actively managed as any other debt portfolio within the internal template norms.
How do very large investors look at investing through the solutions you offer in the fixed income category? what is the perspective that they have when they invest? Are they looking more towards the hybrid, or do they say, look, I don't mind the taxation of fixed income because the benefits are significant?
DP Singh: The institutional corporates are not too much into the hybrids, because they take separate calls for equities.
But not institutional, necessarily only just to clarify, but I'm talking about the larger investors.
DP Singh: Larger investors, family offices—they definitely take a very, very big call on the hybrids. They suit them the best, because they are long-term players. They want to lock in the money for three to five years and as Rajeev said, they get the benefit of illiquidity premium also, because you don't have to keep the portfolio very, very liquid. And there's illiquidity premium, the pricing of which is good.
On the pricing side also, especially if we talk about SBI Mutual fund, we keep it very dynamic. Just to give you an example, if we talk about the conservative hybrid fund, 25% is equity, 75% is in debt. Our general policy is that we should not be charging in a regular plan more than 10% of the gross yield on the debt portion. The remaining whatever is allowed by the regulator in the equity portion. On the weighted average side, it comes to around 1-2% as on date, we are charging. If you look at the competition, people are charging as high as 2%. So, today, the debt yield to maturity in the fund is around 6.5-7% to 8% whatever you say, but there was a time when the yields were as low as 4.5-5%. So, it continued to charge 2% on that, that is 30-40%. So, we took a call. We reduced the expenses from 2% to 1.1%. So, today, we are applying the same formula in the fund so that the net return for the investor is good. So, we believe in the very, very good responsible investing for the investor. We are also aware that while investing in the hybrid funds, individual investors, retail investors, or large individual investors or family offices, do so in trust. So, the quality of the portfolio is always kept in mind. So,both ways this is good for them. You can have best of both worlds in the hybrid funds.
Solution-oriented products, at this juncture, form a relatively small part of the Rs 50-lakh-crore of AUM that the industry handles. But you, as a fund house, are talking more and more about them, and that investors should take them very seriously. Why is that?
DP Singh: See, anybody having surplus money, has long-term goals, short-term goals, and medium-term goals.
When we talk about solutions, there are two parts—one is solution-oriented funds as categorised by SEBI and one is knitting solutions within the existing open-ended funds.
So, first I will talk about the categorisation. In the solution category, there are two—one is the children benefit fund and another is the retirement benefit fund.
As far as the children fund is concerned, most of the time, the horizon of investment is quite long, which is 10 to 15 years or even longer than that, because you can continue till the time it is required by the customer. So, when the fund manager knows that the investment horizon is quite big, he can take a very, very logical long-term call on the portfolio. So, there is no liquidity pressure, there is no redemption pressure. So, you can move into the companies which are going to give very good returns over a longer period. And India is just starting as a manufacturing hub. There are so many new businesses which are coming up. And generally, I have seen that though it is not a rule or a condition, fund managers are taking long-term calls, they are putting money in those companies, small companies, which are available at a very good valuation, which can create very good value over the longer period. So that's one part.
And then, you can create very good wealth for the people, for capital creation. We don't say that this is for the education of a child, or marriage of daughter, or marriage of the child. It can be for anything. When children grow up, they have to follow their passion. Somebody would like to be an astronaut, or somebody would like to be a sportsperson, somebody would like to go to the theatre (arts). Everything needs money. And even if you want to start up your own business, there's some capital requirement. Parents don't have to dip into their own capital in their businesses and do it. So, creation of capital is very important. We have seen that the funds generally have given very, very good returns. So, when there are fewer buyers at this point of time, our fund, which has grown three times in three years, has a corpus of Rs 1,500 crore. But the idea is not to push it. Let people understand that the fund managers are doing a great job of creating wealth for their customers.
The second category is the retirement benefit. People need to accumulate money and create wealth. People are living much, much longer than ever before. So, their requirements can be fulfilled via the SWP (systematic withdrawal plan) route and then this SWP is a solution-knitting category. So, when we come to solution settings, there are many number of funds and a number of solutions depending on individual needs. We can have so many solutions knitted. So financial advisors, they can definitely help the investors in doing that. In mutual funds that is possible.
