Mutual Funds

In investing, be an atheist and have no God; just good rules will do: DSP Mutual Fund President

Anand Kalyanaraman | Updated on May 31, 2020 Published on May 31, 2020

Investing in crisis generates better returns than otherwise, says Kalpen Parekh

A keen student of behavioural finance, Kalpen Parekh, President, DSP Mutual Fund, shares his views on some key behavioural biases in investing, and his thoughts on the market and opportunities amid the ongoing turmoil. Excerpts.

You spoke about ‘authority bias’ during the DSP Mutual Fund webinar on behavioural biases in investing. Can you elaborate on this?

Ever since humanity was exposed to religion, we have been told that when we disobey authority we could be ejected from heaven. This belief has been ingrained in us now for thousands of years. It exists in our lives today, too. There is a thin line between respect and bowing to authorities — teachers, doctors, CEOs, writers, sports commentators, astrologers, politicians, money gurus et al.

Most authorities predict, and we get influenced by such predictions, though we never look back at the track record of these predictions. Movie stars campaigning for votes or selling productsthrough advertisements are another example of authority bias.

In the same vein, if I were to make a junior colleague answer these questions, mostly the interview would never get printed, but the chances improve since I as the President of DSP am answering the questions.

It’s relevant not just today but always in investing. We like to hear from rich investors, money managers (like us), economists, journalists who write or speak well and can give jargonised intellectual views (in 2008, all experts said India will be next China, invest in BRICS; in 2013, all experts said the India story looks over; in 2017, small-caps have speed and will create wealth; in recent times, when world growth has slowed down, India remains an oasis, hence, we would make lots of money in India, to cite a few examples ).

As investors, let’s learn to question — what’s the motive of the authorities? How effective have been their past predictions? Are they themselves disciplined and successful investors? What are their investment rules and not their forecasts? Thus, in investing, be an atheist and have no God, just have good rules.

Which other major behavioural biases should investors be cautious about now?

Some common biases linked to our investing include the recency bias — we assume recent events will last for long. So, we invest looking at recent returns and invest more in asset classes which are at the peak of their performance cycles, most often.

We loved stocks in the 2007 peak when the Sensex was at 21,000 and hated them within a year when the Sensex fell to 8,000. We assumed the recent price fall will last forever.

We loved gold more at that time when gold prices were rising (and we are seeing many comments again about gold and gilts and US funds as their returns in the last few years have been high).

Instead, we should invest by asking which asset class has less risk now (ironically, more often, in asset classes that are cyclical, lower prices mean lower risk, though we think the opposite). Thus, equity funds are more attractive now than one year ago, yet flows in equity funds have dropped from ₹24,000 crore a month to ₹4,000 crore this month.

I would do the opposite because past performance belongs to the past and the future performance of our investments has nothing to do with their past performance and yet we give so much of weight to past half year’s returns before investing.

Another common bias is the outcome bias, wherein we judge our decisions on the basis of the outcome and not the process that created the outcome. Outcomes can be random in investing in the short run (average investment horizons of most investors is around three years and we judge a fund/asset class based on its 1-3-year performance). We rarely ask what was the risk to deliver this performance.

While we talk of gilt funds in recent times, we don’t realise they can be risky if interest rates rise. We loved credit funds due to higher returns, but we aren’t aware that excess returns are a result of excess credit risk.

I am not saying these are bad investments. I personally invest in such debt funds, but after understanding what are their drivers of excess returns and what are the risks the fund’s mandate allows it to take and lastly, what is the process that has generated these good or bad returns.

If the process is sensible and the temporary returns are poor, I would invest in it rather than invest in high temporary returns and poor permanent process.

Process delivers returns,hence, spend time understanding the process and ask more questions around investment processes and not the view of the future, which is anyway so difficult to predict.

How do you handle your own biases in investing?

My investment rules are primarily: invest in a) good asset classes b) at low prices (rarely available since the Fed started printing in the last few years) c) when their past returns are poor d) they are hence out of fashion e) and hence feel great when prices fall.

I am a conservative investor, always in doubt (not a fashionable high conviction investor), hence, I diversify wide across equity funds, debt funds, a bit of international funds and a bit of gold. My long-term returns are not the highest, yet when markets crash, I don’t worry much as diversification protects the portfolio from sharp price falls.

I learnt in 2000 (briefly, on small amounts) and stupidly in 2008 (on larger amounts of hard-earned salary) that a 50 per cent fall in NAV needs 200 per cent rise later to earn basic 10 per cent returns over the full cycle.

Lastly, I don’t let news flow affect my decisions as long as the news flow doesn’t alter the fundamental reasons of my investing in the first place. That’s because most often when we read the news, the market already knows it and it’s in the price.

I evaluate investing decisions around that framework whenever I invest new money or review my investments over time. Lastly, I keep checking for what can go wrong in my investing so that I don’t become a victim of my own biases.

I learn a lot from peers and seniors in the industry who have been rational investors themselves and ask their reasons for their views with data and facts. I prefer asking real experts for the reason for their views more than their views and do get influenced when views are based on facts and data and not narratives and recency trends.

I invest only in mutual funds as they give me access to all asset classes with best tax efficiency and liquidity. Also, it frees up lot of time to focus on my core work and keeps me unaffected from short-term price fluctuations. My current investments are well-diversified.

Equities: not expensive, but not very cheap too — hence 45 per cent (tempted to increase as all conditions of rules are getting tick-marked) to Indian equity funds

Bonds: interest rates are very low now — largely short-term and dynamic bond fund — 40 per cent

Gold: via gold mining fund and gold bonds — 10 per cent

US and world energy companies funds – 5 per cent

What investment approach do you usually follow — value, growth, momentum, blend, any other? Is there any change in the present conditions?

I don’t believe in these labels and stereotypes. Different literature defines each of these labels differently.

My investment approach is rules-based dynamic asset allocation between asset classes that have low correlation over long periods between each other.

Within equity funds, I invest in funds that own good companies that are leaders and survivors in their sectors. In today’s times, such companies are called Quality, and since they have done better than other companies in the past 10 years, these investments can be labelled Momentum, too. But such companies are more expensive than their past history.

Hence, I balance their valuations by having more debt in my portfolio.

The only changes I made in recent times is increased investments in mid-cap funds (high-quality stocks where prices fell) by switching marginally from debt funds as interest rates fell (leading to higher bond prices).

Where do you think the opportunities are in the market now?

This is not an easy market as I can’t put the current lockdown effects in any framework and I humbly would like to say I don’t know. Facts indicate that we could face weak economic trends and poor returns for the next few quarters.

However, anecdotally, history has taught that investing in crisis generates better returns than otherwise.

Over last few years, there have been immense opportunities created in sector leaders that have become less popular due to recent events. For instance, auto companies, solid banks and NBFCs where their prices have fallen. Eventually, the leaders will bounce back.

On the other hand, there are good companies in healthcare, technology, select manufacturing and telecom companies which are likely to grow faster in the post-Covid era.

Also, there are many energy and metal companies that look attractive when seen through the lens of valuations, and we need to be patient and wait for some growth triggers to see re-rating.

Since the near-term future in this era of a global lockdown is so difficult to predict, I would spread investments across each of these themes via a diverse set of mutual fund schemes and not put too much of conviction on any one theme.

Many are wondering why the market has rallied since March-end when the economy seems to be in deep trouble? Is there a disconnect?

I am not so surprised with the April rally as it was a convergence of low valuations and high liquidity and flows.

I am more surprised with the above-average valuations all through in the last few years due to large domestic mutual fund and global flows. Interest rates, again, are trending to life-time lows world over and in India.

Such low rates are like low gravity, which could make asset classes float higher for long periods of time.

It is now a fight between slowing fundamentals and higher liquidity at very low rates. Fundamentals won’t let markets rise and low rates/flows may not let it fall too low. Hence, the rebound in April.

By when do you see a recovery in the economy and the market?

While all central banks and governments are working together to support the economy and markets, we are yet to see bad news in July — negative earnings across many sectors and companies, negative GDP growth, rising infections as mobility across States is restored, emergence of the next wave (of Covid-19) similar to what’s seen in China, Japan, Singapore.

We have to deal with the migration of labour that’s at play currently and get them safely back to work in the next few months.

On the other hand, at some point, we will start seeing the effects of lower interest rates, lockdowns getting lifted and businesses gradually normalising.

Most governments and central banks are constantly looking for monetary and fiscal solutions. Yet, I would stay cautious for the next few months and prefer to act on more clarity than speculate with incomplete information.

What are you advising your investors and clients at DSP Mutual Fund now?

Our message to investors is to survive and last this slowdown. To last, you need comfort and safety of debt. So, have good exposure to short-term bonds.

As stock prices get cheaper, build equity exposure via SIPs.

Growth in India has been slow for long and, hence, also invest in the best companies in the world. Diversify outside India.

The world is more uncertain than before, so don’t be aggressive in any one segment.

The recent turmoil in debt funds has shaken the confidence of many investors. How much of a setback is this to the industry and AMFI’s (Association of Mutual Funds in India’s) plans to promote debt mutual funds?

Barring the credit-risk segment, most debt funds across categories have earned healthy returns, taking advantage of the fall in interest rates. Debt funds remain as relevant as ever before. I made my first debt fund investment in 1999 when I joined the fund industry. It would have earned almost 11 per cent returns across all market cycles.

While the credit events of last two years have captured headlines, I wish we throw more light on simple short-term funds that have helped investors earn steady returns across all market cycles in the last 15 years, despite credit events now or interest-rate shocks in 2013.

Our efforts as an industry to communicate risk and rewards of investing in debt funds will continue and so will the growth in assets as alternative investment options also see a fall in yields.

Published on May 31, 2020
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