Mutual Fund

ICICI Prudential Nasdaq 100 Index Fund: What you should know!

Recently, ICICI Prudential has come up with the NFO for their new Index fund mimicking the US based Nasdaq composite Index. The media has been buzzing and the number of articles about why you should invest in the fund are available in abundance. This is probably the 3rd or 4th fund which enables the Indian investor to take exposure to Nasdaq Index [Other options are via Motilal Oswal & Kotak AMCs]. To save time of mine as well as yours, I’m not going to talk about what this fund is all about & it’s benefits. You can refer to the literature produced by the AMC in their presentation[Link]. We will try to discuss few specific points, that should enable you to decide, if you should add this fund in your portfolio or not. The fund is quite attractive from the perspective of potential ownership of the Big Tech names and next gen Innovative companies. Though as usual, I can not predict the future but I can look for the longer historical track record to make some reasonable expectations. We will try to look through the lenses of Risk & Return and it’s benefit to overall portfolio.

Caveats: Before we jump into the detailed numbers/ charts, Let’s understand that data I used is from the google finance for Nifty 50 Index, Nasdaq 100 index and Currency values. As the market operations differ in both countries, I tried to take the base as Nifty 50 & everything is calculated in the INR terms. The dividends are not included as it’s not the TRI data.

Let’s talk about returns first, I would use the rolling returns data and not the point to point returns as most of the articles and presentations are sharing. I am also going to look thorough the returns for a longer time horizon, Since Jan 2000 to Today a good 20+ years of history. One thing that flags from that analysis is that the last decade has been dominated by Nasdaq vs Nifty 50, though 2000-2010 has Nifty as a winner. Both these returns are in INR terms and do not include impact of Dividends. Overall If we take the Geometric mean of all the 1year rolling returns, Nifty takes the lead with 11% vs 8.6% of Nasdaq. Therefore, If the recent outperformance of Nasdaq is luring you to this fund beware of the lure. Please note that this is based on historic data so we do not know if this would hold true for Future or not.

In terms of risk, The returns of Nifty as well as Nasdaq has been quite volatile. Nifty returns have ranged between +99.4% to -55.5% vs the Nasdaq returns range of +95.5% to -64.3%. In terms of Max drawdown during the analyze period, Nifty had the worst drawdown of -59.4% vs -75.5% for the Nasdaq. Yes, That’s correct the Nasdaq had lost 3/4th of It’s value during the Tech bubble burst in 2000-01 period. In terms of Standard deviation, Nasdaq is slightly better off with 21.9% vs 25.6% of Nifty. Based on these data points, Nasdaq is less volatile but has higher drawdowns & swings to negative.

This does not make a great case for investment in Nasdaq 100 index as the mean returns are lower and risk parameters are comparable if not worse. Though we should not stop here on our decision, As I flagged in my article on Modern Portfolio Theory even if the standalone assets are risky the combination might have the diversification benefits. For e.g. I made the case to have gold in your portfolio for diversification benefit. In 2020, when markets had large drawdowns the rally in gold has cushioned my portfolio a lot and gave me confidence to deploy more money in equities at that opportune time.

Risk (Std Dev) on x-axis & Returns (Mean of RR) on y-axis

I am in awe of the above chart as it’s shape matches with the efficient frontier we have learnt during academic years. replicating something similar with real data & example is a great experience 🙂.

In the above chart, I have plotted 11 portfolio combinations, P1 is 100% Nifty to P11 is 100% Nasdaq. As you move across the Portfolios, you would notice that we would keep on reducing the volatility with increasing mix to Nasdaq and sacrifice some returns in process. This characteristic appears due to lower correlation (approx. 0.5) between these indexes rolling returns over the analyzed period. P4 (70% Nifty : 30% Nasdaq) has a similar volatility to Nasdaq index but adds +180bps on the returns, This means the investors should have higher exposure to Nifty to get a better risk adjusted returns. In real life, the correlations are not constant but dynamic and the realized benefit might be lower than expected as per the above chart.

Based on the above data points, I would say that Nasdaq is a risky proposition as an individual investment with higher drawdowns & lower mean returns for Indian retail investors like me & you . It definitely provides the diversification benefits but that would need an exposure of 20%+, If you plan to invest couple of % points or say 5-10% then you can give it a skip. We might be better off with taking global diversification using other options like S&P 500 or Developed world Index funds, though I have not analyzed so not recommending that yet.

Don’t jump on all the NFOs hitting the market, Follow the broad thoughtful portfolio which needs less changes to be a successful investor over a long term. Happy Investing!

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Mutual Fund

Investing in a T.I.N.Y. (There is No Yield) World

“Every portfolio benefits from bonds: They provide a cushion when the stock market hits a rough patch.” – Suze Orman

Indians are obsessed with fixed deposits. As per the latest data by RBI, 55%+ of financial assets by Indian households are held in form of deposits with banks. In the recent years the rate of deposits have come down drastically, 2years back I was able to make the deposit with the bank @8% returns but now that interest rate has come down to ~5%. The fixed deposit investors are out scouting the other better avenues and Debt Mutual funds are getting explored by many. We can not deny the importance of Debt as an asset class in our portfolios but managing it well is also very important. Today we will try to workout, possible good alternative options to build the debt exposure using Mutual Funds.

Though First thing first, Should you opt for Debt Mutual funds or not. This point need more attention and I tried to cover a lot over the last two years in How to Build the debt fund portfolio.

  • If you are employed individual investor and investing for retirement goal, EPF should be your go to option. You can increase investment by using VPF & Yes, even after the new rules of tax on contribution in excess of 2.5lacs per year will attract tax on gains
  • If you are investing for your 15-20 year horizon, PPF is next universal venue available to every resident to invest up to 1.5lacs. Married couples can have separate PPF accounts to invest up to 3 Lacs each year
  • If you have daughter of age <10yrs, you can also opt for Sukanya Samridhi Yojana. Even though the maturity profile is 21yrs, but at 18yrs you can take some amount out
  • For elder citizens >60yrs, There are couple of more relevant options for them in form of Senior Citizen Saving Scheme (SCSS) & Pradhan Mantri Vyay Vandan Yojna (PMVVY)
  • If you are in lower income tax bracket of <=10% then it is ok to stay with your traditional options of NSCs, Post office Investing. There is no point of adding risk to the portfolio for smaller gains

If non of the above criteria are met or options available, Which means you have short terms goals up to 10-15 years or your income tax rate is higher and for higher savings requirement you need to add exposure to debt in alternate options. Let me clarify that investing in endowment insurance plans with higher premium is not a wise choice. Mutual Funds are good tax efficient options to manage for such goals specially for people with higher tax slabs.

Before we try to zero down on the category of funds, Let’s understand the two main risks associated with Debt funds; Interest Rate Risk & Credit Risk (For more details: Check This). There are 16 main debt fund categories as per SEBI Guidelines, I have tried to map these on broad basis across the two axis with increasing credit risk (Left to Right) and interest rate risk (down to up). The fund which is farther from the origin have the highest risk, in below map credit risk funds have higher risk of default and also have interest rate risk. Gilt funds invest in bonds from Govt of India with assumed no default risk but they rank higher on the interest rate risk, while the Overnight funds have the lowest form of interest rate risk as well as credit risk. The chart is median presentation so you will have funds in each category which have higher credit risk vs others, so one has to manage and monitor their funds exposure regularly.

After the IFLS, DHFL & Franklins episodes of credit risks in 2018-2020 period, The credit risk funds have been discarded by the investors. Lot of Advisors & Distributors have also become risk averse and prefer advising for funds like Liquid funds, Low/ Short duration funds in majority of the cases or for longer time horizons 8-10yrs or more suggest to invest into Gilt funds to avoid credit risk. Let me state that I am against the suggestion of investing in Gilt funds for Investors who do not manage portfolio regularly.

Gilt funds (Grey bars) vs Money Market Funds (Golden bars)

Check the above chart you can change the reference to Money Market funds return vs Gilt funds returns. You will notice that for multiple period the return of gilt funds go for negative or near zero returns as well as to high double digit returns. Though over a period of last 20yrs history the mean return has been 8.1% but have a high volatility (STD Deviation) of 6.5%. More often, I find people jump off the ship in the period of zero/ negative returns. While the returns of Money market funds over last 20yrs have the mean of 7.3% with lower volatility of 1.5%, Returns have stayed in the zone of 5% minimum to 10% maximum. Therefore, If you do not time your purchase of gilt funds then you might be up for a bad experience in investments. There are portion of interest rate cycle, where investing in gilt funds can be rewarding. Lot of investors, look at the recent history of fund returns while buying the fund which is quite a wrong approach. I discussed the steps to analyze the Yield to Maturity (YTM) of the bond funds in Debt Funds 2.0.

We can time the bond funds by following the interest rate cycle. Two things are required to time, One is our position in the interest rate cycle and another is the modified duration of the available funds. My assessment of interest rate cycle is that we are almost at the near bottom there is very less chance of the further decrease in the interest rates but might increase by 1% or more over the next 2 years. Also the possibility of increase is more certain (Which could be delayed or accelerated by RBI) because of below three pointers:

  • Restoration of cash reserve ratio (CRR) dispensation of 1% of net demand and time liabilities (NDTL) given last year to be unwound in 2 phases of 50 bps each beginning late March and late May
  • Additional 1% of NDTL dispensation given on statutory liquidity ratio (SLR) for availing funds under the marginal standing facility (MSF) extended by 6 months to end in Sep
  • Held to maturity (HTM) hike of 2.5% for SLR securities acquired between September – March, now extended by 1 year to 31st March 2022. Accordingly, eligible SLR securities are now expanded to include securities acquired over FY 22. Importantly, this relaxation will now start unwinding from the quarter ending June 23

To assess the impact of such interest rate increase, you need to check the modified duration of the fund which is published in the fund fact sheet as well as can be accessed on portals like Value Research Online etc. Let’s take an example of gilt fund (Axis Gilt fund), It has given a fantastic return of 12%+ over the last one year. Though if you will check the details, It has a YTM of 5.9% with modified duration of 7.2yrs. If the interest rate increases by 1% over next 12 months, The bond value will decrease by 7.2% and this will result in negative returns (+5.9% – 7.2*1%). If the interest rate increases by 0.5% then also the returns will be very low (+5.9% – 7.2*0.5%). Therefore, It is essential to have funds with lower modified duration & High YTM with lower risk exposures. As the fund like Money Market will buy the new bonds to replace the maturing bonds with bonds of increasing rates, the overall return of the fund over next 3-5 years will be better vs Gilt funds.

Lastly, If you do not want to time the interest rate cycle then that is completely fine. The funds category I have flagged in the center of the Risk Map are evergreen from my point of view (Corporate Bond funds, Banking & PSU funds and Medium Term Debt Funds). Over the last 20 yr period the mean returns of fund have been 8.4% for Medium term bond fund with 4.5% volatility (Higher return vs lower risk in comparison to Gilts). One can buy a good fund from this category and stay invested for long term. In Summary, If you are investing new money into debt funds then stick to Money market or Low duration bonds funds at present to avoid the impact of interest rate risk.

Let me know in case of any questions or feedback. Till next, Happy Investing!