‘Equities seem attractive from a two- to three-year perspective’

‘In uncertain times, one can invest via MFs, AIFs, ETFs’

June 22, 2020 10:52 pm | Updated 11:04 pm IST

The biggest risk that equities face is that of a rise in COVID-19 cases even as economic activity resumes in many countries, said Sundeep Sikka, ED & CEO, Nippon Life India Asset Management. He said one could invest in equities through mutual funds, AIF and ETF routes, while gold ETFs can act as a hedge given the current uncertainty. Excerpts from an interview:

Do you think the stock markets have reached their bottom or are trading very close to their bottom levels?

The short-term direction of the market is difficult to predict as we are amid an anomalistic event. The COVID-19 crisis has come as a shock and while several economies are showing promising signs of recovery, there is a risk of COVID-19 spread as economies open up. We believe equities are attractive from a 2-3 year perspective, but in the near term, are likely to be volatile.

What are the key factors to watch out for in the coming weeks that will dictate market direction?

One of the biggest factors is the risk of rise in COVID-19 cases as economic activity resumes in many countries.

Further, the aggregate response of global central banks will definitely have a big impact on markets. In general, some countries have already administered aggressive monetary easing steps. The government’s fiscal policy will also be keenly followed by markets.

In the current market, what avenues should a retail investor look at?

We believe equities are very attractive from a 2-3 year perspective. Historically, increasing equity allocation when economy is under pressure, has produced superior returns. One can invest in equities through mutual funds, AIF and ETF route. Gold also looks attractive as a hedge in uncertain times and gold ETFs are a suitable way to invest in this asset class. For debt, we believe high grade, short to medium term products are attractive.

Do you think this is a good time for retail investors to invest in debt schemes?

A sharp deterioration in business and financing environment, accompanied by some large issuer/group issues and topped recently by a redemption freeze by a fund house has raised some generic but fundamental worries across investor classes on the debt products offered by MFs.

But first, more than 80-90% of MF products and/or investments have not been impacted at all by any of the above events. Two, debt funds have generated returns even higher than equity funds across some categories, both in the near and medium term. Third, asset allocation is the largest driver of overall returns in the medium-to-long term and hence debt allocation through MFs always has a place in an investor’s portfolio, given the edge of transparency, return efficiency and liquidity.

Investors should follow three simple rules: 1) Understand the product / category before investing 2) Should not stretch risk appetite by sticking to products that matches their risk appetite 3) Time horizon of their investment should be critical in choosing a relevant debt product.

Was the recent episode at Franklin Templeton Mutual Fund an isolated one or do you expect more such events in the near future, given that the lockdown has hit cash flows in most businesses?

Ever since the IL&FS issue happened in late 2018, debt funds, particularly the credit-oriented debt funds had come under pressure. It had been unprecedented times for the MF industry in terms of the number and scale of the credit events. It did dent the confidence of investors. Having said that, it must also be remembered that credit-oriented funds account for a small percentage of fixed income assets. More than 90% of industry assets are in extremely high-grade securities, with the highest rating. Different events keep happening in capital markets — some of them rarely could also be extreme. What is important is how quickly the industry learns, and how it responds to the market context.

As money managers, we are supposed to operate through cycles and reorient our portfolios to reflect potential risk and returns in a dynamic manner. If the current environment requires us to be more conservative than usual, we will be happy to embrace that approach. In line with the challenging environment, our board has mandated us to make incremental investments only in securities rated AA and above, in all funds except two, which have a specific credit mandate.

What is your view on Credit Risk funds given that we have seen such funds facing a crisis at regular intervals?

The last 18 months have been difficult for the economy, and some very fundamental presumptions around refinancing risk, pace of deterioration in balance sheets and the relative illiquidity of bond markets have come to the fore. The good news is that, the industry has already imbibed these lessons. There are things that will change going forward. In credit funds, we will focus only on those names where cash flow visibility is very high and structures are self-liquidating in nature, particularly in high-yield bonds. This way, we are not at the mercy of balance sheet vagaries and do not have to rely on refinancing.

We will also focus on avoiding concentration risk—something we have suffered from both in terms of illiquidity and bigger impact from a credit event. The overall composition of the portfolio will have to undergo a change, maintaining reasonable allocation to high grade bonds to manage liquidity going forward. We maintain that this is a viable category, and will come back into the reckoning sooner than later as a more robust and durable asset category.

Do you see fund houses increasingly moving towards safer paper - higher rated - in their debt schemes due to the recent events and also may be investor preference shifting towards good quality paper?

The near term investor and fund preference will definitely be towards high grade exposures, and any exposure to higher credit risk will be confined to the Credit Risk Category. The overall risk appetite will also remain low given the uncertainty around the macro and corporate balance sheets. In such a scenario, the credit selection has to be very discerning. However, we also think beyond MF products, we will finally see Credit AIFs come of age, where investors with specific/discerning preference, will start seeking high risk, high return opportunities in these product categories as well.

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