Interview: Parag S Parikh, CEO, PPFAS Mutual Fund - "Eliminate sectoral funds, upfront commissions. Encourage SIPs"

Parag S Parikh

Parag S. Parikh is the Founder and Non-Executive Director of Parag Parikh Financial Advisory Services Ltd. (PPFAS) and the CEO  of PPFAS Mutual Fund. He is a fellow of the prestigious 'Owner President Management' (OPM) Program at the Harvard Business School, and an M.Com. from the Bombay University. 

A keen learner and a contrarian, he is always looking for new ideas and regularly attends learning programs at the Harvard Business School and other Institutes. He is one of the first Indians to study and put into practice, the concept of 'Behavioral Finance' - an emerging science that studies human behavior towards stock investing and money matters.

His book, “Stocks to Riches – Insights on Investor Behavior” (2005) attempts to simplify the process of investing in stocks and provides the investor with the basic behavioral biases that affect decision making. His second book “Value Investing and Behavioral Finance: Insights in to Indian Stock Market Realities” (2009) attempts to guide investors into making wise investment decisions and not be carried away by the noise of the markets. He speaks to us giving his views on the way forward for the MF industry and the necessity of having a well thought out financial plan.

Diwali greetings to you, Mr. Parikh and the entire PPFAS family!

As we enter a new year, what is your outlook on the economy?

We are not great economic forecasters. Since we recommend investments for the long term, both good and bad economic outlooks would get covered in a cycle.

At the moment things are looking good, especially with crude oil and other commodity prices cooling off and a fall in inflation in India. With oil prices coming off, it should also help in terms of keeping our trade deficit under control.

This however cannot form the basis for near term investment decisions. Geopolitics is unpredictable and the slightest trouble and oil prices could head back up again.

What is your advice to investors for the coming year(s)?

There are two kinds of investments. Those that scare you and those that kill you and both are not the same. The scare comes from volatility of the investment. This is in asset classes like equities. The killing comes from the loss of purchasing power on account of inflation. This is typically in asset classes like fixed income securities.

The relative weights to the two asset classes should come from a well thought out financial plan. Any money that is not needed at least for five years should not be in fixed income securities but rather should be in growth assets.

Mutual funds still a sort of replacement product for FDs, gold, property...

One gram of Gold and the BSE Sensex were both at 100 around 35 years ago. Today, the same gram is Rs. 2,740/- whereas the BSE Sensex is around 26,500. Need I say more?

We see peak retail investor interest for equity funds almost coinciding with market tops. As markets hit highs we also see a spate of NFOs / series of closed ended NFOs with the same theme. Is this the way to grow the industry?

It clearly is NOT. What is needed is

• Eliminate sectoral funds. In my view they do more harm than good. Sure some sophisticated investors would miss them but the general public which buys tech funds at the time of the dot com boom and infrastructure funds in 2007 would be protected.
• Eliminate upfront commissions. This would reduce the allure of closed end funds and curb mis-selling.
• Encourage SIPs

According to the fund’s August 2014 factsheet about 24% has been invested in international securities. This is a huge allocation for a diversified equity fund.

India's share of world GDP is less than 6%. Hence 94% of economic activity is outside of India. Further, some kind of sectors are almost absent in India. Things like IT product companies, Internet businesses, Innovator Pharma companies, Shale Gas companies, Payment system companies (like Mastercard / Visa).

When one invests overseas, one gets additional diversification benefits which are beneficial to the investor. Also we do not take a lot of currency risk as we hedge to the extent of 90% of our currency position. This hedging activity also provides us additional yield on the portfolio because of the futures premium.

We think that every investor should consider having a portion of their investments into international stock. Doing it though a fund that has a predominantly Indian allocation also gives tax benefits.

Do you intend launching any other scheme – for e.g. an ELSS scheme?

As of now we do not have any plans of launching a new scheme.

Interview: Aashish P Somaiyaa, MD & CEO, Motilal Oswal AMC - "Our goal is wealth creation the healthy way"

Aashish P Somaiyaa is the Managing Director & CEO of Motilal Oswal Asset Management Company. He was earlier with ICICI Pru AMC for 13 years. He firmly believes that equities are the way to wealth creation. In this interview, he puts forth his views on why equities are the asset class to be in and speaks with us on the investment philosophy at Motilal Oswal Mutual Fund. He was one of the few voices early in 2013 passionately advocating investment in equities and investors would do good to listen to what he has to say on wealth creation the healthy way…

Aashish, Wishing you and the entire Motilal Oswal family a Happy Diwali and a prosperous new year!

As we enter a new year, what is your outlook on the economy?

I believe we are on a significant growth path as far as economy is concerned. In fact I find it quite funny when people perpetually keep inventing new reasons to postpone their investments. One year back we were fearful of a hung parliament or a third front, Rs 69 to a dollar, high interest rates and inflation, USD 120 oil, and possible “end-of-the-world” scenario for developed markets. Today we have none of these issues and people are still not confident of India’s prospects. We are well on our way to 6, 7 and 8% growth in the next few years.

What is your advice to investors on handling their investments for the coming year(s)?

Buy as much equity as you can possibly afford to buy after setting aside for your liquidity requirements and short term goals. If you miss the next 10 years of India’s growth, you will have missed serious wealth creation. Fear is temporary; Regret is permanent. Let me explain why.

India will be on its way from being a USD 2 tn economy to a USD 4 tn economy in the next 5 years. In this process we will see many small and mid sized companies becoming large and many large companies becoming global companies. The GDP will grow because you, me and your readers will work hard, consume, and save. It will be entirely our contribution which will make the economy grow. Let’s ensure that as we contribute, we must also participate in the growth. Today we are staring at a scenario where over 80% of our market capitalization is owned by promoters of companies and FIIs. So we contribute 100% of the economic growth but the benefit of the profits goes to promoters and FIIs. The only way to participate after contributing is to own equity.

Equity is the only asset class which can create wealth. When we send emails, whatsapp and FB messages we quote how 10,000 invested in Wipro has become 700 crs today, the question is, will we ever try and practice owning equity for the long term or that is stuff only to be marveled at by forwarding on emails and social media?

What is the biggest challenge the Mutual Fund industry faces in increasing penetration – product or distribution or communication?

We have too many products, too few distributors / advisors like you and extremely complicated communication.

Look, when you go to a doctor and he or she decides to treat you, they explain you in simple language why you have the symptoms, what’s the diagnosis and what is the requisite medication. Do they actually explain chemical compositions of the drugs that are being administered? When they have opened you up in the Operation Theater, do they really give you live relay of what they are seeing inside of you and “Oh my God, that’s terrible, how did you get that!!!” kind of statements? Our industry communicates in a very complex manner and we don’t impart enough confidence or trust.

We need investors to know that the only way to create wealth is by investing in the equity of good quality companies with a long term perspective like say ten years. Not because I expect markets to go up and down every three years, that we are saying invest for ten years. I say invest for ten years and above because the best of companies are in business for decades. It takes decades to implement a business plan, exploit a market opportunity to the fullest and to build a scale business. If you think the new kid on the block Flipkart is new, think again – they started in 2006! L&T started in 1946, HDFC in 1970, ICICI in 1955, Infosys in 1981, TCS in 1971 and so on and so forth. There are many examples of long term  investment in companies that has generated outstanding results. If we take a call on the businesses by way of buy, hold and sell recommendations every quarter we will always miss the wood for the trees. This is the limited message we need to communicate; this needs one simple large cap oriented fund which buys todays bluechips and one simple midcap fund which buys tomorrow’s bluechips.

You have decided to convert MOSt Shares M50 into a passive ETF even though it has outperformed the NIFTY over the past 1, 2 and 3 year periods.

Like I said in my previous question, I just felt that people don’t have much awareness about mutual funds in general (I am sure your readers are more aware as a result of your educative efforts and kudos for that). When we have a product like MOSt Shares M50 which is an actively managed ETF, there are layers of complexity we are adding. First of all we are telling people about ETFs which can be bought and sold only by finding a buyer on the stock exchange. People are used to filling forms and cutting cheques or doing an internet based purchase for buying funds while here we are telling them to transact in demat with their broker. Secondly, forget mutual fund, we are talking ETF which is an exotic investment as of today and then on top we are saying actively managed ETF – index rebalanced based on quantitatives of fundamentals. Hence, my decision was a move towards simplification, let’s make it a simple Nifty fund to begin with.

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You have placed overall limits on the number of securities that your funds can hold. MOSt Focused Midcap is limited to 30 securities. Isn’t there a concentration risk especially if your AUM grows?

At Motilal Oswal AMC, we believe in BUY RIGHT : SIT TIGHT. That’s not a marketing mantra only, it’s a way of life. One of the fundamental tenets of sitting tight is to have focused / concentrated portfolios with meaningful allocations to the equities on which we have high conviction. You ensure the portfolio manager has meaningful positions on each stock by having an upper limit on the number of stocks that he can hold. So in our portfolios typically the top stock has 8 to 9% weightage and the smallest stock has around 3% weightage. I don’t understand why mutual funds needs to have 50,60,70 or at times 100 stocks where the top stock is still a respectable 5%, the top 10 stocks are say 25 to 30% and then there is long long long tail with some stocks being 0.1%, 0.2%, 1% etc etc. How does that make returns for the investor? Its completely unproductive!!! If you have 1% in a stock that doubles its market value, you end up giving 1% return to the investor. On the other hand if you had done some serious homework and ensure that a stock with this kind of potential had more significant allocation, you could have created wealth or your investor.

Whenever an NFO closes and a fund makes a new portfolio they may start with 25 to 35 scrips. How does it every become 50,60,70 or 100? The reason could be that one started buying a stock but then the price already moved up, one was holding a stock but its value seriously declined and didn’t want to sell at a loss, or you have a “spray-and-pray” something’s gotta work kind of strategy. Look, investing is not financial democracy or a socialistic practice. Investing demands thorough work on understanding the earning power – earnings and earnings growth potential of companies – and then making a meaningful allocation to those companies in your portfolio. Even if you have 100 stocks in your portfolio bulk of the returns comes from top 15 stocks. So why not just have 15 or 20!!! How does the long tail help? And its investors money after all! We are paid fees to ensure very rupee is gainfully deployed and is in play in the wealth creation process at all times.

The number of stocks also increases because there is  a tendency to book profits on the winners and hold onto the losers to avoid losses. That’s the biggest mistake one can every make. You need to hold on to the winners and cut losses on the losers. Investing is about making decisions under uncertain circumstances with incomplete information. Anyone who buys stocks will get a few right and a few wrong. If you sell the ones that worked, you will again have to buy that many more and you will again have few winners and few losers. If you logically extend this process, eventually you will end up with lesser and lesser winners and more and more losing ideas in which you forcefully become “long-term” investor!!! That’s not how wealth is created. Wealth is not created by the “selling”, it is created by the “sitting” after having bought good quality companies with superior earnings powers.

Motilal Oswal Mutual Fund is a no-load fund. Please give your views on exit load in mutual funds and the adding of 20 bps to the expense ratio.

According to me exit loads are being deployed for two reasons:

·          >  To ensure investors invest for the long term and they don’t react to short term volatility or a significant dip in the markets. To that extent exit loads ensure that the psychology of loss aversion is controlled and investors stick to their long term goals. Handholding in times of market falls and educating investors on the nature of equity investing will cure this problem once for all. It doesn’t need loads. Also mostly loads are for one year, now the impact of short term capital gains is good enough deterrent not to sell within one year so I don’t see what purpose the load will serve.

·       >  More often than not, load is also used to ensure investors stay in the fund for a while such that any commission paid for raising the money is recouped by time spent in the fund and expense charged over that period. This again can be resolved by ensure commissions are trail based – in the long run it benefits investors, fund managers and the intermediary doing the fund raising.

You are not launching any series of closed end NFOs? :)

It’s a very unique skill that we don’t possess honestly. Isn’t it difficult to again and again identify a set of stocks that will deliver returns in exactly 3 years!!! :))

And then what does the investor do, if exactly one quarter before the maturity the market goes into a long term decline and falls 10-20-30% from peak value? Also what does the investor do if the investment was made for long term, but what can one say about emergencies? Emergencies are just that, if you need your funds, you cant be locked in whatever your original goal might have been!!!

Our best ideas are already populated in our three open ended no load funds i.e. MOSt Focused 25 (Large Cap); MOSt Focused MidCap 30 (Small and MidCap) and MOSt Focused MultiCap 35 (all cap / multi cap). These portfolios already contain what we would buy with objective of wealth creation and multiplication in our investors’ portfolios. I don’t think I would buy different set of stock if I had to managed a series of closed ended funds – so why create them!!!

If you went to a restaurant and you were unmindful of calories, cholesterol, sugar etc., then you would be thrilled to have a wide menu with plethora of choices. But if you went with the intent of eating healthy, the wide menu serves no purpose other than that of distracting you from the right path. We want to offer a focused menu and our goal is wealth creation the healthy way. It doesn’t need too much rocket science. BUY RIGHT : SIT TIGHT. 

My two cents on exit loads in Mutual Funds

Recently there was an article in the Business Standard - Exit Load is good for investors. A lot of conversation followed on twitter following this. My take on the subject:

Background

     

      A.  Briefly put, an exit load is a charge, given as a percentage that AMCs charge investors who redeem their units within a time frame mentioned. Recently, some AMCs have increased the periods for applicability of exit loads to 3 years and exit loads of up to 3% are being charged. This would mean that upto 3% can be deducted from your fund value if you redeem early.

B.  Recently SEBI has made it mandatory that AMCs plough back the exit load collected to the scheme, which would mean that when an investor exits the scheme, the exit load would be added to scheme assets, increasing the NAV. This per se would mean that existing investors are benefitted.

     C.  Twist in the tale: In view of the above, SEBI has allowed AMCs to increase the expense ratio by 20 bps (0.2%) !! This would mean that every investor in the scheme would, if the AMC decided, pay an extra charge of .2% to manage his funds!! It would seem that the amount charged to investors is far, far higher that what is collected from exit loads and in fact investors are on the whole losing out due to this.

Any discussion on exit loads would have to take all 3 points above into consideration.

Benefit of exit loads

Exit loads per se are beneficial to both the AMC and investors. It discourages trading in Mutual Funds. Transaction costs and impact costs of untimely sales have to be taken into account when there are redemptions by those who basically “trade” in funds. These costs end up eating into the NAV and reduce the gain of disciplined long term investors. Speculators time the markets at expense of long termers in absence of a load and therefore, in reality it is a good thing to have exit loads. The argument for exit loads is nicely put here.  Rajeev Thakkar writes: In India, people willingly lock in money in PPF, Life Insurance Policies, Tax Free Bonds etc. The REITs which will be introduced will also be close end structures. However when it comes to Equities, easy come easy go is almost seen as a birth right. Equities are among the long gestation asset classes and one needs a long term view to come here.

A lot of what is done by the Mutual Fund sector may be wrong. That needs to be criticized. However increasing EXIT loads on equity schemes is not one of those wrong measures. It is an honest attempt to inculcate the right behaviour through the means of incentives / penalties.

Also, from point B above, the exit load is ploughed back into the scheme and increases NAV for investors.

In the case of short term bond funds, an exit load would allow AMCs to invest in securities that match the load period.

In short, exit loads will inculcate more disciplined investing and better fund management by AMCs.

But what has happened…

From point C above we know that AMCs could have used this regulation of SEBI to increase the expense ratio by 20 bps. This can infact negate every benefit of having the exit load. The linking of the plough back of exit load amount to an increased expense for investors is what is incorrect. While higher expense ratios may be a separate topic, it is linked directly here to this rule of exit loads. It is only in this context that I look at exit loads negatively.  A higher expense ratio can severely impact your gains over the long run. Just see the benefits to ‘Direct’ investors who have benefitted from lower expense ratio. Investors can gain > 1% annually investing in lower cost Direct Plans. Extending this, a higher expense ratio due to this 20 bps makes a big difference. Adds up to a lot in the long run.

This amount is added to the profits of the AMC. We have seen AMCs paying large amounts of upfront commissions from their own pockets. The extra profits to AMC from exit loads can help AMCs bear higher upfront commissions and thus may encourage mis-selling.

Bottom line

I am all for disciplined investing. However, the time period of 3 years maybe too long to have exit loads. One major plus of investing in mutual funds is liquidity. Let us not hamper that. 

Secondly there should be a relook at the rule of allowing 20 bps to be added to the expense ratio. Some interesting tweets on the subject

Exit load is good for u-really? Because u are too dumb is the official excuse Real reason-to pay higher fees 2 agents http://t.co/afmMZ95o8S
— Samir Arora (@Iamsamirarora) October 12, 2014

.@NagpalManoj Only reason why closed ended funds are being sold is bec agents get 5% from AMC & they will only pay if investors r locked in
— Samir Arora (@Iamsamirarora) October 12, 2014

@NagpalManoj What should be expense ratio is one debate. What should be exit load is another. Unfortunately the two get clubbed. (1/2)
— Rajeev Thakkar (@RajeevThakkar) October 13, 2014

@NagpalManoj Small / midcap bear transaction and impact costs. The speculators market time at exp of long termers in absence of load. (2/2)
— Rajeev Thakkar (@RajeevThakkar) October 13, 2014

Fund Mgrs complain that NAV was hit due to impact cost of ST redeemers.No one says that NAV was helped as ST buyers bought & helped same NAV
— Samir Arora (@Iamsamirarora) October 13, 2014

To attract LT investors, MF manager should state what they mean by long term and show with data that the fund indeed invests 4 the long term
— Samir Arora (@Iamsamirarora) October 13, 2014

@Iamsamirarora @invest_mutual @RajeevThakkar @NagpalManoj It is 2 encourage longterm investing.The load enhances NAV.Existing investors gain
— Parag Parikh (@paragparikh) October 12, 2014

@invest_mutual Published in B/s. On avg 20bps charge is 5 times of exit load credited back to sch @paragparikh @Iamsamirarora @RajeevThakkar
— Manoj Nagpal (@NagpalManoj) October 12, 2014

@RajeevThakkar In that case u shud keep 6-12 mth exit load, Why 2/3 yrs exit load? Is that short? @Iamsamirarora @kayezad @invest_mutual
— Manoj Nagpal (@NagpalManoj) October 13, 2014

@NagpalManoj @RajeevThakkar Great idea Manoj if implemented. Now, there is effort to gather &retain AUM & increase profits thru higher ERs
— Invest Mutual (@invest_mutual) October 13, 2014

@AashishPS @invest_mutual @NagpalManoj @deepakshenoy Ths was d point i was trying to make.AMCs shud leave exit dcsion on investrs n advisrs
— Nishant Patnaik (@PatnaikNishant) October 12, 2014

Setting one's financial goals - make your goals a reality

Greetings on Dussehra!

This is an auspicious day for new beginnings and wishing you success in every endeavour, project. Every new project to be successful requires thoughtful planning and the same is true in our financial lives.

Necessity of financial goals

Any investment leads to an accumulation of assets that are primarily meant to be used, either by the investor or by the next generation. The presence of assets in a household's portfolio is to provide it support and security to deal with financial ups and downs and with income when regular salary or business income stops. 

The financial lives of investors can be divided broadly into the accumulation phase, when assets are built, and, the distribution phase, when assets are used. Typically, the distribution phase also represents a time when investors are unable to add to their assets. This phase is identified with old age and retirement when earning capability falls or completely vanishes. Therefore, building assets in the earning phase would mean a focus on maximisation of saving and investing capability.

Without goals, one will find it difficult to make the decision about how much should be saved and invested and where the the investment has to be made. You move from being a saver to becoming an investor when you define financial goals first and save with a specific purpose in mind. Framing objectives or goals is the first step in financial planning. Here are the important things to keep in mind while doing so.

Goals should be specific

It is important to set specific financial goals. A specific figure to be reached should be in mind. Write down your objective / goal. It should stare you in the face. Work out the desired amount required - "This is what I want in _____ years" . The time / duration in which you have to fulfill the goal should be  defined. Only then will you be able to figure out how much you need to invest and which financial instrument to choose. 

People tend to assign random figures for their goals without understanding whether the money saved will be sufficient or whether it will be feasible to put away a big amount. 

Financial planning should not be based on approximations and instinct. Specific goals facilitate a review later.

Attainanble

The goals should be attainable, reachable by mortals. You may not be in a position to hope for a house like Antilla! This also means that the goal is realistic,  actionable and not just a pipe-dream. 

Action Plan

Once the goal is set, an action plan to achieve the same must be clear. One has to save an amount to be invested annually, monthly. Investors have to first plan out how the savings target would be met. Several online calculators are available and you can arrive at the amount you need to save and the time available to achieve each of them. For example, a calculator would show that  Rs 48000 a month is required to be put in a recurring deposit at 9% for three years to save Rs 20 lakh as down payment for a house.

Next, there should be clarity about the investment instrument. As part of the action plan, it is best to automate the investment process i.e. an SIP into equity funds, RD into banks for short term goals etc. 

Every goal has a different time frame. So you need to match the investment avenue with the time available for that goal. If you have less than three years to save for your son's college admission, you should invest in debt rather than equity to ensure the safety of your capital . Your returns will be muted since debt instruments deliver about 8-9% but at least your capital will be safe and available when needed. If you are saving for retirement which is 20-25 years away, you should put a larger amount of savings in equity-oriented mutual funds. Equity investments are likely to yield higher returns in the long term, though there could be periods of volatility in between. 

Prioritise goals

Investors can have a big list of goals. However, each goal should be assigned a level of priority, depending on its importance, time horizon, financial impact on other goals, and the manner in which you will arrange the funds for it. For instance, buying health insurance is a more important and immediate need than buying a car. This will ensure that your other goals remain intact since a medical exigency will not wipe out your savings.

The way to succeed in your financial life is - Plan out your life and work out your plans!

Should you invest in a closed ended NFO…

Taking advantage of the market rally in the last 12 months, AMCs have brought out more than 30 closed end NFOs hard selling these through distributors by paying them super commissions. Commissions paid could be up to 7%, depending on the bargaining power of the distributors selling!! Yes 7%. Read this article in the Mint.

Unsuspecting investors do not even know that they are being sold the same stuff already available. Even a cursory look at the NFOs in the last year show that many are small and mid cap NFOs, diversified equity fund NFOs by AMCs which have performing open-ended schemes of the same class. Most of the time these come as a series of Funds of the same type launched by AMCs.

I give my reasons why I do not like closed end NFOs.

1. You are timing the market

By investing into a closed end NFO, you are basically timing the market. You are jumping in assuming the market will go up. See the below chart and the huge run-up in the last one year. A gain of almost 40%. This is being hard sold to you. Do you feel that the next 3 or 5 years (duration of the closed ended fund) will give you sustained positive results. If you really believe that this will be maintained, do go ahead and invest. Otherwise, you will end up once again being disappointed.

If things do not play out as expected and markets have soured at the time of redemption of the fund, you returns may be meagre or you may even incur a loss!!

2. You are investing a lumpsum for a short period! Wise huh? 

It is clear that you are investing a lumpsum. Is this wise?? Is it part of a financial plan you have thought through. Closed ended funds are for 3-5 years generally. Is this a long term period? We have been reading the benefits of investing through SIP. The lay investor is far better off investing through SIP. Understand the risk in investing through lump sums.

3. You are stuck and cannot re-balance

You simply cannot re-balance or redeem if the market shoots up and you wish to re-allocate as part of portfolio re-allocation. Planners ask their clients to review and do a half yearly / yearly re-balancing as per their desired asset allocation. You may have to redeem a good open ended fund if you are rebalancing and be stuck in a closed ended fund.

4. You are being hard sold funds with no track record

Be wary of hard selling. Mutual funds did not sense any such opportunity in 2012 and nobody was launching closed end funds then. Valuations across all market caps were attractive then!! 

Even now, you must have noted that some fund houses have stopped accepting large lumpsum applications in small cap funds. On the other hand, some others keep coming with a series of such closed ended funds!  Just be aware!

I stay away from these NFOs!