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Aarati Krishnan

"Buy, and hold for the long term — - is not a practical strategy for fund investors," may be unexpected advice, coming as it does from the CEO of one of the oldest mutual fund houses in the Indian market. But Mr Krishnamurthy Vijayan, Chief Executive Officer of JM Mutual Fund, has quite a few unconventional thoughts on the way investors should manage their mutual fund investments. In this interview with Business Line, he talks about what investors can now expect from debt funds and shares his views on recent industry trends.

Excerpts from the interview.

Debt funds have generated high returns of between 14 per cent and 18 per cent over the past couple of years. Going forward, what kind of returns can investors expect from them?

Even today, I expect a 50-75 basis point decline in interest rates. Given that, I think returns of over 8-10 per cent should be easily attainable for a good fund manager. But as the band narrows, there is a possibility of event-based volatility. I think a conservative expectation from a debt fund would be a return of 2 per cent over and above the fixed deposit rate. Short-term funds should be able to earn a return that is 1-1.5 per cent lower than debt funds; liquid funds 1-1.5 per cent less than short-term funds. A gilt fund should be able to earn 1 per cent more than a debt fund. These are just estimates. Anything over this would be a bonus.

Is it not an anomalous situation, where funds that invest in corporate bonds offer lower returns than funds that invest in gilts?

This is a peculiar situation caused by the declining interest rates. The prices of gilts are more responsive to a change in interest rates than the prices of corporate bonds. This helps gilt funds earn higher NAV appreciation during declining interest rates than those that invest in corporate bonds. In a stable interest rate scenario, this will reverse. Corporate bonds will offer higher returns than gilts.

There has been a sharp ramp-up in the size of your debt funds over the past year. Would availability of debt securities pose a problem when a fund expands beyond a point?

So far, size has not been a problem. In today's scenario, even a Rs1000-crore fund is not viewed as a big one. As the debt fund assets have expanded, so has the basket of corporate and government debt issues. But this could become a problem at some point in time. If foreign money continues to pour into the debt market on the back of unrealistic interest rates, it could become a problem. There is tremendous offshore interest in Indian debt.

Over the past month, FII inflows to the debt market have been high. Is FII money flowing into mutual funds?

No. It is flowing into the banking system. But the banks, in turn, invest significantly in mutual funds. Today, you can borrow money in, say, Singapore and invest it a fixed deposit in an Indian bank. You can still earn a spread of 2 per cent! So it is money for jam. But there are a good number of FIIs that are looking at mutual funds. A key deterrent to direct investments in mutual funds is the fee of around 1 per cent that the MFs charge to their investors. This is perceived as steep by foreign investors.

Are FIIs investing directly in gilts?

To a small extent. But investing in a bank provides them with an assured interest rate. But in the gilts market they will have to contend with volatility. Second, it is not too easy for FIIs to directly enter the gilt markets due to procedural difficulties.

The corpus of your debt funds also appear to have turned more volatile, with large inflows and outflows. How do you manage volatility?

I would say volatility today is lower than it was a couple of years ago. After September 11, for instance, 70 per cent of our corpus flew out within one-two weeks. Across the industry, the average outflows were around 20 per cent. Whereas, in the latest episode of volatility, in the last quarter, the outflows amounted to 8-10 per cent. I think the MFs now are catering to very aware investors, such as corporate treasuries and high net worth individuals, who are very clear about their investment horizon. They choose a liquid fund if they are investing just for say, a week. For a period up to six months they may invest in short term funds. They enter a debt fund only if they are looking at a horizon of over six months. Yes, investors may switch between these products, but they tend to stay with the fund. Second, most investors now tell us at least a week in advance when they are planning to exit. A week is a long time to liquidate your investments to meet a redemption demand.

In your debt fund, which is invested in corporate bonds, is it not difficult to manage liquidity?

It is more difficult than in a liquid or short-term fund. But the volatility has reduced on the debt fund due to better investor awareness. Today, relatively few investors come in and punt on the fund. If an investor uses a fund for punting, it may lead to negative returns and corporate treasury managers are very averse to negative returns. So our debt fund corpus has been quite stable across various types of market conditions.

Some fund managers say that even investors in equity funds actively manage their portfolios. They enter a fund, book profits based on target returns and then exit. Have you had this experience with your equity funds?

We have not aggressively marketed our equity funds. But this may be true. Investors who today come into equity funds are well-advised investors. They have a good financial adviser. So they tend to set a target return, book profits, and plough in some of the money back into an equity fund.

But investors in equity funds are generally advised to buy and hold for the long term. And to ignore short term fluctuations...

I don't think that is realistic. My advice would be that investors have to review their investments every six months, whether invested in equity or debt. Every six months, see if you have got extraordinary returns. If you have got extraordinary returns, book profits and come back in with your principal. Re-deploy the profit portion in a safer avenue. Ultimately your target is wealth-accumulation. Second, be very conscious of the fact that this business is dependent heavily on people. As a fund manager, I may not be able to put my hands on the wheel for a couple of months because I am sick. Or I may be very bullish and may take extraordinary risks, which you are not comfortable with. So investors have to check to see if a fund is within a comfort zone and decide accordingly.

Even if you stay with a fund for a 10-year period and the fund manager does not change, his investment style may well change. I would not invest in the same way at 40, as I would at 30. So the fund's portfolio is essentially a mirror of what is happening to the person behind it. So investors have to review their investments frequently to check that it is in line with their objectives.

With returns from debt funds declining, expense ratios look quite high. Do you see scope for reduction in the expense ratios?

Expense ratios must come down. But the psyche of investors in itself prevents it. Despite a ban by SEBI, rebating is still rampant and retail investors still expect to receive a cash incentive when they invest. You see, in India, there is a tendency to look for bargains. An investor typically likes it if a product comes at this price, but is offered to him, at a special discount of 50 per cent!

If we reduce the expense ratio, all investors will benefit uniformly from it. Investors are usually not impressed by that. So the industry is unable to reduce expense ratios to a level where rebating won't be possible. With institutional investors, there is no rebating, and so expense ratios are also lower. Institutional investors are more wary of accepting rebates.

Can't you prevent this by lowering the compensation you pay to the distributor?

A fund cannot do this individually, but we can do this as an industry. We are trying to do this.

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