The Hindu Business Line : `It is important that debt funds be redefined as funds' — Mr Sandesh Kirkire, Kotak Asset Management

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`It is important that debt funds be redefined as funds' — Mr Sandesh Kirkire, Kotak Asset Management

Aarati Krishnan

SANDESH Kirkire has completed 12 years with the Kotak group, completing stints in corporate finance, investment banking and debt fund management, before taking over recently as the CEO of Kotak Asset Management. In an interview with Business Line, Mr Kirkire talks about why he thinks it is time for investors to come back to long term debt funds and shares his views on the equity market.

Excerpts from the interview

Which class of funds should a debt investor hold in his portfolio, at this juncture? Should it be floating rate funds, short term plans or long-term debt funds?

Investors with a one year-plus investment horizon can invest in long-term debt funds, with the expectation of a 7 per cent return. Over the past one year, long-term debt funds have already earned a 6 per cent return; the level of returns has been even higher for the past nine months. Typically, fund managers base their return expectation from a debt fund on the "carry" return (coupon rates carried on the securities) on their portfolio. Today, the carry return on the portfolio is above 6.5 per cent. In addition to this, a fund manager can trade on volatility (in bond prices) to improve this return. We expect such trading gains to make up for the expense ratio on the fund. So a 6.5 per cent to 7 per cent return from a long term debt fund is quite possible.

What about interest rate risks in the long-term debt funds?

It is important for debt funds to be redefined as funds for investors with a long investment horizon, rather than as funds that invest in long-dated securities. Debt fund managers have also acquired a better understanding now, of what investors expect from them. All of us have now become quite cautious in terms of managing volatility. Between May 2004 and November 2004 there was a bloodbath in long term debt funds. After that, I remember meeting a CFO in February 2005 and telling him that we had outperformed five-year corporate bonds and gilts. He simply looked through me and asked whether we had outperformed the liquid fund. That drove home the point about what investors expect from debt funds.

In a debt fund, customers want the fund manager to show an absolute return, unlike an equity fund where it is enough to outperform the benchmark. We foresee a volatile interest rate scenario. In this scenario, you cannot commit a large sum to longer tenure. We look to create portfolios with securities carrying a 1-1.5 year average maturity. When we see volatility, we may allocate 5 or 10 per cent of the fund's portfolio to long term debt for additional gains. We book profits on this portion whenever there is a profit.

This is why I suggest that if an investor has a one-year plus investment horizon he should be in the long term debt fund.

There is actually no comparable debt product now for long term investors that offers a 6.5 per cent plus return with good liquidity. Investors with a horizon of 3 months to a year should go for short-term plans.

At the level of your fund house, do you see investors shifting from debt to equity investments?

The movement from debt to equity has to happen. In the last three years, the retail liabilities of the country have dramatically increased — car, housing and other loans are now common. In the past, the investor did not care about where his assets were invested, even if they earned a return below inflation. He didn't care because he had cash flows to take care of his expenditure.

But now, with EMIs taking away a substantial portion of his cash flows, he has to focus on wealth creation. No doubt equity funds have created tremendous wealth for investors over the past ten years. Investors need to be made aware of this.

In the US, mutual funds' debt and equity assets are roughly equal. In India, debt is much bigger and it is dominated by corporate investors. Corporate investors too, do not have the risk appetite to invest in equity funds. We are trying to convince corporate investors to reinvest the income they earn from their debt investments into diversified equity funds.

The equity markets have seen a steady inflow of liquidity over the past few months. Are valuations getting too stretched to offer reasonable gains over the next couple of years?

The market does not look in any way stretched. We see a broad-based growth across sectors. Many large caps are available at low double digit multiples. That does not suggest a market that is stretched. With the economy set to grow at a 6.5 per cent plus level, you can expect returns of 15-20 per cent from the equity market. But this return will come in spurts, so you have to look at wealth creation from a long-term perspective. Global investors are far more confident about India than we are. Retail investors are hardly participating in the equity market. I have data that shows that the top blue chip stocks are now held mainly by foreign institutions and mutual funds; retail investors hold only junk stocks.

The stock market has become so wholesale in nature that it is bound to be more volatile. It is difficult for retail investors to participate in it. But we cannot ignore wealth creation any longer and investors must participate through the mutual fund route.

But even investors who come into equity funds seem to come in with a very short-term view. They believe in booking profits ever so often... .

Yes, that is happening. Barely 30 per cent of the money today (in equity funds) would be one-year money. But investors would eventually realise that churning does not really add value to them.

I know analysts who have bought Infosys at Rs 85 and sold it at Rs1,000 thinking they have done a phenomenal job! But imagine the returns if they held on! Investors should realise that the fund manager is paid to churn the portfolio on their behalf. It would take time for investors to realise that churning doesn't work; but this is going to be a slow process.

Kotak Mutual Fund has recently lost key people. Have you appointed new fund managers?

The exits have not really affected us because we have considerable management bandwidth within the organisation. The Kotak group has been in this business for over 18 years now and we now manage about Rs 4,000 crore in equity assets across our domestic and offshore funds and portfolio management services.

We have recently brought all of our investment businesses under one umbrella. These will be overseen by Mr Nilesh Shah, the President of the asset management company. Then we will have individual fund managers who manage each scheme. We are now operating with a team of about eight people.

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