Individuals are keen to invest in mutual funds but there is this rampant confusion still prevailing on what exactly is a mutual fund and how does it work. Should one go for direct stocks or an equity mutual fund? The number of mutual funds out there compounds this confusion further.
That’s where I reached out to Rajeev Thakkar, the CIO and Director of PPFAS Mutual Fund, who was kind enough to share his views and provide answers to some of the “top of the mind” investor queries.
Rajeev Thakkar possesses close to 2 decades of experience in various segments of the Capital Markets such as investment banking, corporate finance, securities broking and managing clients’ investments in equities.
Rajeev has been associated with PPFAS Limited (the Sponsor of the AMC) since 2001. He was appointed the Fund Manager for the erstwhile flagship scheme of the Portfolio Management Service, titled “Cognito” in 2003.
He is a strong believer in the school of “value-investing” and is heavily influenced by Warren Buffett and Charlie Munger’s approach. Apart from his technical ability, what distinguishes him from many others is his ability to stand his ground and remain unflappable during difficult times.
He is a regular contributor to Mint newspaper and has also appeared on business channels such as Bloomberg India TV and ET Now.
He is a man of few words but his low-key demeanor often underplays the fact that he is a good listener, a team player and a razor-sharp thinker.
I am glad to talk to Rajeev and get his expert views on equity mutual funds.
VK: Hi Rajeev, this is going to be unlike any other conversation that you might have had before.
You do equity investing. In fact, you manage an equity mutual fund. You are the specialist here and I am the layperson. I come to you to help me understand this thing called an equity mutual fund.
I have questions, which I want to ask you about equity mutual funds. Can I?
RT: Sure, will be glad to answer questions that you may have. There is however so much to learn that I consider myself a beginner at all times.
VK: That’s very modest of you. OK. Here we go!
Several new, young folks have been writing to say, “they want to start stock market trading”. Stock trading seems to be a shortcut to making money, quick and fast. Why is that so? What should these youngsters really focus on?
RT: Well stock market trading is an activity, which is glamourized by the media and popular culture. Just like probably Las Vegas is. I have no moral arguments for or against stock market trading or gambling in Casinos. It is just that, on an average, in both activities, the participants have a net loss. The gainers are Stock Brokers, Casinos and the Government. The odds may be a bit better in stock market trading as compared to Vegas.
The concept is simple. If there is Rs. 100 to be made in aggregate by all stock traders in a day, there should be someone else losing Rs. 100 on that day. Stock market trading is what would be mathematically called a Zero Sum Game. The total of all winnings and losses would be zero. On top of this zero sum game, all the traders combined have to pay brokerage, transaction costs and taxes. Hence the aggregate after costs and taxes is negative. So while there are no moral arguments against trading, the financial argument against trading is that, on an average, it is not profitable.
However please note that I do not say that Stock Investing is not profitable. When an individual “invests” in stocks as opposed to “trades” the investor is buying a business and over time that investor partakes in the profits that Indian corporates earn through their varied businesses. Equity investments, over the years, have a track record of delivering better returns than alternatives like bank fixed deposits, small savings instruments, gold and life insurance policies.
The basic thing that young individuals should focus on is asset allocation and risk cover. A proper financial plan covering areas like asset purchases (eg. a primary residence / vehicle), adequate life, health and personal accident coverage, emergency funds, and asset allocation for investments allocated between debt and equity investments.
VK: I hope the youngsters pay attention to what you have just said. Now, a sort of follow up question is, when should someone invest in direct stocks and when should one hire a fund manager via an equity mutual fund?
RT: The answer for most people would be to take the route of mutual funds rather than direct equity. This is due to various reasons.
Firstly, for small amounts of savings, it is difficult to get adequate diversification (spread out investments over various companies to reduce risk). To illustrate, you can invest in a mutual fund with an amount as low as Rs. 500 whereas it is not possible to buy into say 25 companies with that amount.
Secondly, most individuals are not equipped to analyse various companies and value the shares and invest appropriately.
Thirdly, even if an individual has the basic qualifications and understanding, they may not have the requisite time to track various companies and take the appropriate decisions on an ongoing basis. After long work days in the basic profession, it would not be a great choice to say, spend weekends trying to analyse companies to invest in.
If however someone has sizable sums to invest, has the requisite training and also has ample time to track companies, that person can surely invest in direct equity.
VK: I guess you are right in saying that most investors would be better off choosing a mutual fund. Now, what are the risks one needs to understand while investing in equity and/or equity mutual funds?
RT: When one is investing in equity / equity funds, one is indirectly buying a portion of the business.
As with any business, it usually takes long to get the fruits from investing. Sometimes returns may come quickly but at other times one has to wait. Businesses are also subject to ups and downs. A farmer may be affected by a failed monsoon or low crop prices while a retailer may suffer due to competition from e-commerce companies like Amazon. On the other hand an Air conditioning retailer or a soft drink manufacturer may get a windfall if the summer is long and harsh.
Hence while returns from equity are generally good in the long run, there is no certainty in the short term. In general, if an investor has money, which she has for upto 5 years, it is not suited for equity investments. Even for periods beyond 5 years, there is an element of risk. In India, we had a period from 1992 to 2003 when equity returns were zero to negative. However for periods beyond 10 years (think retirement corpus), equity returns generally have been very satisfactory.
VK: So, the risk is that one has to be ready to face these long periods of no returns. Coming to the question of styles, what is the meaning of growth and value styles that we hear of when referring to investing styles of equity / mutual funds?
RT: I will answer this question in two parts. The first part of the answer gives the popular view, which is also held my many in the profession as well as the media.
This view looks at the growth and value styles of investing as two distinct styles of investing. Growth investing refers to investing in rapidly growing businesses with the expectation that future growth will give very high returns to investors and it does not matter that the current valuations of the company relative to its past profits looks expensive. Think e-commerce for example.
Value investing on the other hand as per this view is all about buying shares trading at low levels relative to past profits, dividends, cash on hand and so on. Such businesses are typically found in mature low growth industries, say utilities.
However, there is a contrary view to this. Warren Buffett has said (and it makes eminent sense to me) that all investing is to buy an investment at a discount to its true value. This applies to high growth companies, low growth companies as well as declining companies. Sure, you can put a value to growth while calculating its true value (intrinsic value). Again all growth does not increase intrinsic / true value. Think Kingfisher Airlines. The company was a high growth company at one point in time but the more it grew, the more value it destroyed.
The only correct approach in my view is to buy companies at a discount to intrinsic value whether it is a growing company or not.
VK: Well, I guess finally we have got to hear something sensible on the question of style. Let me now get to the big pain point. There are so many types of funds out there. Why is that so? What is the answer to one fund that I should invest in? Is it a large cap fund, a mid cap fund, a small cap fund or a multi-cap fund?
RT: This is a real difficulty for investors and I sympathise with them. The job of professional fund managers and asset management companies is to make things easier for the clients and they end up making things difficult.
The first simple rule would be to stay away from sectoral and thematic funds (these are funds that invest in only one or a select few sectors). These may only be suited for those with the expertise of selecting individual stocks.
There are two recurring questions as regards fund selection.
a) How much to put in Large Cap funds vs. Mid and Small Cap funds?
My recommendation would be to go for multi-cap funds. Let the fund manager decide on the most attractive opportunities, which are there, rather than the investor making a choice. There are some advisors / planners who look at Large Cap funds as ‘safer’. I do not subscribe to that view and think that multi-cap funds / diversified equity funds are the right choice.
b) Should one put money in balanced funds?
Balanced funds give mental comfort in terms of their NAV being less volatile. However the same result can be achieved by the investor at a lower cost and with more tax efficiency by investing in equity funds and debt funds in the proportion desired. (Equity funds are tax free if held for more than 1 year; Balanced funds would have tax implications if equity component is less than 65%).**
VK: When does investing in an index fund make sense?
RT: At the time of our discussion on stock trading, we discussed zero sum games. We saw that if some traders had to ‘win’ others had to ‘lose’.
A similar argument is sometimes made as regarding investment performance. Say the overall equity returns from the markets are 15% p.a. for a 5 year period. Now if some fund manager ends up making 20% returns, it is logical to say that someone else would have earned lower than 15%, say 10%.
Out of the total returns that the equity markets gives, one has to deduct all the fees and expenses, say 2% for actively managed funds. Hence, proponents of index funds say that one should go for low cost index funds with an expense of say 1%. The lower cost of 1% p.a. would, in theory, add up to higher aggregate investor returns.
This argument holds true as more and more investments are routed through mutual funds and mutual funds become a substantial portion of the overall market. After all, the group of mutual fund managers cannot outperform themselves (the whole market) since one person’s outperformance comes at the cost of someone else’s underperformance. In developed countries studies have shown that most actively managed funds tend to underperform the indices.
What is true of the developed economies has not held up so far for the Indian markets. The reason that I can think of is that Mutual Funds are a small segment of the overall market. Mutual Fund managers have, at least, so far been able to outperform other investors on the whole (comprising of FIIs, retail investors, Insurance companies and so on.)
In fact I remember reading about a discussion on this on your blog and how index funds are only about 1% of the overall equity funds in India.
VK: That is true. Index Funds have not been able to catch the fancy of investors specially when actively managed funds have outperformed them by quite a margin.
OK, I have a broader question for you. What should I look at when building my mutual fund portfolio? Not just one scheme, but may be a set of schemes.
RT: Mutual funds are excellent vehicles for regular savings. In fact a Systematic Investment Plan works very similar to Provident Fund savings or recurring deposits. You should have your asset allocation plan in place and then stick to it. Each equity scheme invests in stocks, which can number from 20 to 200. Because of this, the investor can put her investments in 3 to 5 equity schemes and does not need to have 10s of equity schemes to invest in.
VK: What is the one thing that an investor should NOT do when investing in equity mutual funds?
RT: Most of the misery in equity and equity fund investing comes from investing at the time of euphoria and exiting investments at the time of pessimism. Hence we see a lot of people getting carried away and investing huge sums of money in a year like 2007 and panicking in a year like 2008 and exiting equity investments. This thing is to be avoided at all costs.
The best course of action would be “to be greedy when others are fearful and be fearful when others are greedy” as Warren Buffett says. However this is not easy to do. Hence the next best alternative is to save regularly through Systematic Investment Plans and stick with investments through good times and bad.
VK: What would you see as warning signs / red flags to reconsider a mutual fund investment?
RT: At the beginning, investors should resist exotic mutual fund schemes being sold to them. These would be sectors / themes which have performed well in the past few years and which may be at peak valuations. Examples would be tech funds in the late 90s or commodity, real estate and infrastructure funds in 2007.
For ongoing investments, rapid churn of staff and or promoters of a fund should raise red flags for investors. It is unfortunate that fund houses promote long term investing and they themselves enter and exit or buy and sell asset management companies in 3 to 4 years.
VK: Several investors swear by the fund managers and invest their money with “a” fund manager. Does the fund manager (as an individual) have such an important role to play? Is that kind of dependence on a person healthy?
RT: If the investment is a passive investment (index funds) or if it is formula / algorithm driven, the fund manager does not matter. It is only the process that matters. However given that bulk of the money in India comes to actively managed funds, the question arises as to how much does an individual fund manager matter?
To be sure, most fund managers are assisted by a team of analysts and it is hardly ever a one person activity. However the final decision about an investment in terms of go / no go or the weightage to be given to an individual stock usually comes to the fund manager. There are some organisations that have tried a committee structure but the experience is mixed over there. Regardless, most organisations also have some broad guidelines and rules in terms of maximum exposure to a particular company / sector and cash levels.
Most well known mutual funds/ hedge funds / investment companies have one or a few individuals responsible for taking key decisions. This is not necessarily a bad thing.
To give an analogy from a different sector, Apple Inc would have a huge research staff. However, key product decisions would be made by Steve Jobs and his trusted lieutenants.
What matters is whether the organisation has a good investment culture and depth of talent to take over in case the key fund manager in not around.
VK: Is the concept of profit booking applicable to mutual funds? Should I be going in and out of mutual funds often?
RT: Absolutely not. Trying to time the market or book profits and re-enter is among the worst things that can be done. Apart from increasing transaction costs and taxes, most investors will enter and exit at the wrong time or be left holding excess cash / debt over the long term and they will have a sub optimal return.
VK: Tell us more about how do you go about the process of investing / managing the mutual fund. How do you go about picking your stocks? What is a typical day like?
RT: When it comes to selecting stocks, the first thing to do is to imagine buying the entire company at the current market valuation. Would it make sense?
To answer this question, the first thing to know is “Who is running the company?” If the company is being run by a crooked or incompetent promoter or manager, it is best to avoid the company even at the cost of missing out on some short term gains. To quote Thomas Phelps “A person who will steal for you, will steal from you.”
Having decided that the management quality of a company is good, one has to come to a judgement whether the business is worth carrying out in the first place. For example if the company over the years is not able to generate even the bank interest rate on its invested capital it would be a poor investment. Hence financial ratios like Return on Equity Invested are important.
It is important to be able to understand the business the company is in and to have some visibility as to how the business will look 5 to 10 years out. Investing just based on past results is not advisable. It would be like driving a car only looking at the rear view mirror. One has to also look out of the windshield.
Finally when you have a business you like and run by honest and competent managers, the only thing that remains is the right price. For example, Infosys was a great company at the time of the dotcom boom but an investment in Infosys at peak valuations would have turned out to be a very poor investment.
We like to buy high quality companies at reasonable prices rather than moderate quality companies at very attractive prices. We like to say that our investment approach is to buy a five star meal at Udipi prices rather than buy street food at low prices.
As far as day to day of fund management is concerned, it is pretty boring. Investing for us does not mean a lot of activity. I don’t have terminals on my desk to monitor market activity, as someone would imagine to be. In fact, if someone were to ask me what happened in the market on a particular, I might not have an answer to it, because I don’t know.
I spend most of my time in a day reading about companies, industries, annual reports, attending conference calls, etc. There are days when we don’t do even a single trade.
VK: “Equities are risky”, “Stock markets are a casino” are some of the common refrains we hear. What do you have to say to that?
RT: Mr. Amit Trivedi, who is a trainer and also an author, likes to say this, “There are some investments which will scare you and others that will kill you and both are not the same.” He is of course referring to the fact that volatility in equities scares a lot of people and causes them to make statements like “Equities are risky” or “Stock markets are a casino”.
However when one looks at equity indices performance and mutual fund performance over time, one sees that equities have been able to beat inflation and create wealth whereas the more sedate and seemingly secure debt investments, in many cases, have eroded purchasing power. Hence the right approach is to have an appropriate asset allocation and not to overdose on debt investments as that would kill purchasing power.
VK: What type of funds do you invest in?
RT: I have investments in a single equity scheme and that is the one I manage, PPFAS Long Term Value Fund. This forms a very significant proportion of my family’s investments. Our fund house discloses the investments by Promoters / Directors / Employees on the website and it is there for all to see.
VK: Ah, we have a cook who eats his own cooking. Finally, what books or any other learning resources would you recommend to an investor?
RT: I would recommend watching the video “One Idiot” by IDFC Foundation with the entire family (including kids). The book Rich Dad Poor Dad is another good resource. The Intelligent Investor by Benjamin Graham is a good book for getting a framework on equity investing. Common Sense on Mutual Funds by John Bogle is a good book on Mutual Funds.
VK: Thank you Rajeev. This was some phenomenal learning.
** SEBI might get balanced funds to behave like one with nearly equal equity and debt allocation. Here’s a note on the same.
Disclaimer: This above content is purely for educational purpose. The above views are in no way to be construed as investment advice or promotion of any particular investment or fund. Please consult your investment advisor to know what best suits your profile.
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