Investment Objectives & Advice

The most critical part of investment journey!

let me share a story, I have come across recently, to set the tone of today’s topic.

Jack Bogle was talking about “Buy & Hold” to some investment advisers, and one adviser complained, “I tell my investors to do this, and the next year, they ask what should they do, and I say, do nothing, and the third year, I say do nothing. The investor says, ‘Every year, you tell me to do nothing. What do I need you for?’ And I told them ‘You need me to keep you from doing anything.'”

Over the years, I have shared cases and my pertinent advise to specific queries. One such case was in 2019, I wrote my view and analysis for the Aditya Birla Sun Life Pure value fund. After the discussion, the investor has paused his SIPs in the fund and moved the new money to a better risk aligned fund for himself. As I suggested him to not sell off the current investments at the bottom of the cycle. He held on and today after 2 more years of wait, they fund has delivered a great return (Details below). He is happy now and Ok for him to make the exit as well.

Source: Morningstar India as of Aug 31, 2021

In a similar instance, last year lot of people hit me with the questions about the future of ICICI Prudential Equity & Debt fund. They tried to pick me on this fund for its underperformance as the fund category (Aggressive Hybrid Fund) is widely recommended by me and this specific fund was also part of my shortlist of funds to be in my portfolio (When I replaced my HDFC Hybrid Equity Fund after 10+ years of holding). One year since then, The fund has came back with roaring returns and my two cents of analysis are vindicated again. In below table, You will see that the fund has +10% outperformance vs the Category & ~20% outperformance vs the Index on YTD basis.

Source: Morningstar India as of Aug 31, 2021

The reason, I brought these two cases back to light due to my recent conversation with a friend about “What should he do for his underperforming fund?“. I have often given the specific advise but realized that a generic checklist would be a better solution and can be applied by the wider population. If the fund has been underperforming, Analyze the reason of the underperformance:

  1. Is it driven by the style or category being out of favor? or
  2. There has been any change in the fundamental attributes of the fund? or
  3. The fund manager has been changed and causing the rejig of portfolio? or
  4. etc.. etc..

If the change is cyclical in nature, you might be better of waiting for cycle to turn and then move out at the top of the cycle. Though when fund starts to perform back, you might forget that you wanted to move out of this fund therefore make a record of it for a 6monthly review. If the changes are permanent in nature, like heavy loss of AUM, loss of star fund manager or substantial increase of TER etc. You should plan your exit in optimal manner, check the exit load implications as well as the tax treatment of the accumulated capital gains. If you can not determine the reason of underperformance, do not hesitate and speak with a competent financial advisor who can help you with the process. Any good advisor would be worth the fee they would charge.

Lastly, If you hate the periods of underperformance than it is an apt situation to explore the passive funds to get the closer to index performance. This would not only eliminate the anxiety of the underperformance but also take away the effort in fund review/ selection. Let me leave you with these lines from the Netflix series “THE CROWN” as it reflects the most critical part of investment journey “Buy & Do nothing” unless the reason to sell is one from the list.

To do nothing is the hardest job of all. And it will take every ounce of energy that you have. To be impartial is not natural, not human.

Happy Investing!

Mutual Fund

Contagion Effect of FT debacle & Debt Investing!

“Collective fear stimulates herd instinct, and tends to produce ferocity towards those who are not regarded as members of the herd.” Bertrand Russel

The announcement by Franklin Templeton on the eve of 23 April, 2020 about winding up their yield oriented 6 debt fund schemes. Total Aum of INR 26,000 Cr (~USD 3.5bn) was locked in these schemes. The investors in these schemes can neither buy or sell into these schemes. All transaction including SIPs/STPs or SWPs have been cancelled. In my investing career, this is first of it’s kind incident. 11 days before the incident, I wrote the article about one of these schemes and had warned about the redemption pressure causing the distress in the fund (Franklin India Ultra short bond fund – is it time to exit?). Though I had not envisioned the dire situation and possibility of fund closures.

There is enough debate/ articles and news posts about the postmortem of the situation. As usual very few people throw the warning shots about these schemes and till couple of years back the CIO Fixed Income for Franklin Templeton was hailed as the Star fund manager generating exceptional returns while managing the risk.

Post this announcement, There has been an immediate risk-off sentiment. It was obvious from the way industry and news put all the blame on the credit risk exposure in funds towards AA/A rated papers, the credit risk funds were brought to the front of this crisis. People dumped their holdings without any considerations or understanding, it was just fear driving from the front seat. 9/16 debt fund categories saw decline in AUM in April vs March 2020.

AMFI Debt Fund AUM Apr 2020

Credit risk funds lost >35% of their AUM in April month. Though the surprise fall had been in the Medium duration Bond fund category, which has seen the AUM decline of 23% in Apr 2020. Even if both these categories completely shut down, MF industry will come out saying that it is just 5% of Debt funds AUM etc. It will be devastating for the people investing in these funds and have large exposures (Including myself). There are some funds, which has lost upto 37% of AUM within last 2 weeks. This is quite concerning and should be watched out for.

AUM Change in Medium Duration Funds

This is one of my favourite category and it has helped me earn ~9% XIRR returns over the last 5 years of investment period in debt funds. let me explain what this fund category is and how it is beneficial for general debt MF investing. Medium Term bond funds as prescribed in SEBI guidelines are funds with Maculay duration of 3-4 years. I have written about debt fund portflio building earlier in How to build debt fund portfolio  and Historic vs Future Returns. Though it is never enough to explain the investing landscape, let me try with the yield curve for this.

yield curves

The above chart is for yields as of Apr 23, 2020. The blue line represents the govt bonds of different maturities and how much return one should expect from them on annualized basis. There are two main things to observe and understand:

  1. You will notice that for shorter duration (6months to 1yr) returns are lower and longer duration (5-10yr) the returns are 1-2% higher. This is what we call duration risk/ interest rate risk. When the interest rate changes the price of bonds change in opposite direction. Higher the duration, larger will be the change. This is one reason why Long term debt funds are more volatile vs short term funds
  2.  The credit risk/ default risk is zero in Sov/Govt bonds, when you take more risk by investing in AAA papers you are roughly getting 1.5% extra returns over a 6 months period. For the higher risk, higher returns you get A+ bonds have 5.97% yield over 3.7 return on Govt bonds

If I am investing in Debt funds (Other than my emergency money), It only make sense for higher tax bracket people to invest for 3yrs+ to get tax benefit due to indexing. It will not be rational to invest in a short duration/ liquid funds and let go your extra yield of 1-1.5% due to duration risk. Also, If your risk profile permits you can opt for schemes with higher exposure to AAA or AA papers for another 1% yield. In normal scenario, I would suggest to invest in funds with >=60% exposure in Sov/AAA or A1+ rated papers. Though in the current risk off sentiment and given Covid situation, hightened risk of credit defaults, one can invest in funds with medium duration and >=85% exposure to Sov/ AAA or A1+ papers. 

The funds like ABSL Medium Term Bond funds have ~42% exposure towards AA or Below rated papers. Which will increase with the redemption pressure. The fund has a YTM of 16%, this is only reflecting that some of the bonds it is holding are trading at deep discount due to hightened default risk. You should get out of such fund when you can. On the other hand, funds like IDFC Medium term bond which has all holdings of Sov/ AAA or A1+ ratings are having negligible credit risk and can be used for Debt funds investing.

Stay Safe and Happy Investing!