Retail investors usually buy equity funds at market peaks and redeem them when valuations are low. This makes for a poor return experience for them time and again. But Kalpen Parekh, CEO of IDFC Asset Management Company, explains how the fund house is trying to change this. Edited excerpts of an interview :
Unlike most of the industry, IDFC Mutual Fund’s view is that equity returns will be muted for the next two years or so. So, as a fund house, what is the asset class you are focussing on?
I think the industry is obsessed with an asset class (equities). I think we should be obsessed with the consumer. It doesn’t matter whether he chooses equity or debt funds.
As a fund house, we do not like to focus overly on market direction.
At IDFC, we believe that we should deliver a good return experience to the investor. For this, it is necessary for us to explain to the investor that equity investments come with volatility. Yes, the reward for that volatility is quite large. But if an investor cannot take volatility, he should not come into equity funds.
So, how are you improving that return experience?
My experience is that the industry generally tends to highlight only the benefits of investing and underplays the risks. So, when the risks manifest, investors get disappointed. Instead, if we can tell investors that equities will fall by 40-50 per cent once in 10 years or so (they do, you can’t get away from that) and tell them how to navigate such cycles, we may have happier investors.
One, we were among the first to design a close-ended fund — the IDFC Equity Opportunities Fund. When that fund did well, ₹10 became say ₹21, we returned most of the money to investors. Two, our flagship fund (IDFC Premier Equity) has remained shut for a long period of time because we believe markets are not conducive. In the last year, when the industry was doing many aggressive equity funds, we launched an asset allocation fund which does the exact opposite of what conventional investors do.
When valuations are expensive, it owns less equity and when valuations are low, it increases equity exposure. Currently, as valuations are closer to 20 times, the portfolio is only 30 per cent invested in equities.
Is an asset allocation fund better than a balanced fund?
We have done a 15-year study of Indian markets, to find out how long markets spend in different valuation zones. From 1999 to 2014, we found that the Sensex PE was cheap (10-16 times) 31 per cent of the time, it was at fair value zone (16-19 times) 32 per cent of the time and it was in expensive zone (19-25 times) over 37 per cent of the time. So, markets give you enough opportunities to invest.
But investors tend to over-allocate in expensive markets and under-allocate in cheap markets.
Why does IDFC MF have labels such as Premier Equity, Sterling Equity, Imperial Equity and so on while others simply label their schemes as large-cap, mid-cap or small-cap?
We believe there are very few funds in India which have created a brand recall. We felt that a differentiated name helps create a brand. We, as a fund house, do not look at market cap as a filter for stock selection. We believe fund management is about buying good businesses. Large, bad companies can give you a bad return experience, the same as small, bad companies. We buy companies that efficiently use capital, whichever segment of the market they are in.
What is your stance on upfront commissions to MF distributors?
A large part of our flows today come in on a full-trail structure. We have to be realistic. In India, mutual funds are an under-penetrated product.
Therefore, distributors need compensation and that can come only from commissions. Directionally, I admit, commissions have only gone up over the years.
The full-trail model is actually very remunerative for the advisor. The advisor’s fees compound with fund returns. So, I would argue against very high upfront commissions.
I would argue for a blend between upfront and trail fee.