Kalpen Parekh, President of DSP Investment Managers, shares his insights on performance, passive investing and mutual fund flows.
Lately, DSP Mutual Fund has been launching quite a few passive funds. Are you taking the passive funds route because active funds have found it difficult to beat benchmarks in the last year?
Not at all. Once in every seven or eight years, there will be polarisation in the markets that leads to the index doing better than active funds. Our decision to launch passive funds is not an outcome of the last one year’s developments. We launched them because the market will want it whether I like it or not.
The basic premise of active funds is that you are eliminating some stocks and selecting others based on a style or mandate. This framework should deliver if the fund manager is disciplined, operates around a system and tactical enough to constantly evolve. But the reason why this fails and alpha gets killed at times, is because of human bias. Humans might at times make errors of judgement while the index does not have any such biases. That’s why you need passive funds.
Two, provident fund money in India has begun to come into equities and they are seeking passive products. They invest every month. This is patient money, in contrast to the typical equity money that active funds in India receive which only stays for two to three years. So, it is important to be ready for these flows with passive products. We started this eighteen months ago with the Nifty Equal Weight Fund.
Equal weight over long periods of time has always beaten the market rate globally as well in India and so we went with this fund. We followed up with Nifty 50 and Nifty Next 50 products and a Liquid ETF. So, it is not that our passive fund launches are a recent trend. We put a lot of thought into them. It is more about filling a gap and meeting investors’ needs.
There’s a lack of passive options in the mid- and small-cap segments. How about funds tracking those indices?
There are two challenges. One, if we launch a mid-/small-cap index fund or ETF, we will have to buy stocks figuring below the top 100 in the market. In many of those, liquidity is relatively low. There are days in these stocks even if you buy 50,000 shares, there is huge impact cost.
Two, as you move lower down the market-cap scale, the mortality rates for companies are higher. So, in mid- and small-caps, stock selection is more important than mere participation.
The entire debate between active and passive is around costs. Over the last few years, overall expenses have come down for equity funds as size has grown and now SEBI also has reduced fees for different slabs. The difference between active and passive funds has narrowed.
What is the impact of the SEBI move to reduce total expense ratios on DSP Mutual Fund?
Most of our funds are between ₹2,000 crore and ₹6,000 crore in assets. So, the impact for us will be somewhere in the middle of the pack, may be 10-12 basis points of reduction on a weighted average basis. On first of April we will have a better understanding.
In India, there seems to be a lack of variety in the indices on which ETFs can be built. Do you see scope for innovation?
There is definitely room for differentiation. The NSE in the last couple of years has brought out quality, value, low volatility indices, etc. It is possible to have indices constructed by blending fundamental investing with a passive strategy. At DSP, we are working on our first fundamental rule-based model to launch a new fund.
What we have tried to do with DSP Quant Fund, is to try and capture the fundamental attributes that our investment team uses to create alpha. Basically there are six to eight factor groups that can explain the risk and return performance of stocks, for example, — value, size, growth, quality, liquidity, momentum and volatility, and we are trying to blend three of these into a multi-factor product.
We found that quantitative models have often failed in the past because realistic costs and liquidity were not considered, and models were at times designed around recency principles. We have tried to address those flaws. In essence, we have created a rule-based model that captures the wisdom of good fund managers.
Lately, data has shown falling flows in MFs. The retail investor seems to be cooling off, just when a new rally is starting...
This is universal. I don’t expect that this pattern will change anywhere in the world. Scores of new investors will chase the past returns for some time, creating bubbles in some pockets and then the cycle turns. As one- or two-year returns turn negative, investors start exiting. While we can attribute this to uncertainties and macro events, it is basic human behaviour. The extent of slowdown in flows will vary from fund to fund. but, the direction is universally the same.
Having said that, investor awareness has enhanced over the years. If we look at data from volatile market periods a decade ago, the slowdown in inflows was even more and a very large proportion of investors even stopped their SIPs. But now many investors understand differently and are also guided better by advisors.
Why did the performance of DSP Smallcap Fund, which was very popular, see a setback in 2017 and 2018, after you gated the flows into the fund?
We underperformed during 2017 as we were cautious. We found this segment of the market to be expensive and took time to deploy cash, which caused us under performance. In addition to this, few of our high conviction bets in chemical sector underperformed. In 2018, we saw some of our building material and infra-related stocks underperforming as the economic recovery was not on expected lines. We also had a few other companies which didn’t perform as per our expectations and this added to the underperformance.
We have clearly articulated our strategy for this fund in a note. We say that, as a style, we do not hesitate in holding on to a sector or a company that is going through fundamental business consolidation. We have increased exposure in some stocks where our conviction is higher and trimmed the ones that were outside our framework. There is a recent improvement in returns, but it is still early days. Hopefully this should generate great returns in the next cycle.