An article in the U.S-based business magazine Forbes earlier this year stated that net $35 billion was pulled out from U.S. equity funds in 2009, whereas $421 billion went into bond funds. The columnist had an interesting comment to make on what she called such “unsophisticated money in bonds”. She wondered if “investors understood how miserable things could get when the low interest rate party ended”. Thanks to what is happening in Europe, the party does not look like it is going to end soon, something even the columnist could not predict. However the point is interesting. The stampede into bonds funds was not just about low short-term interest rates but about individuals who could not handle the volatility of the stock market. Which brings us to our next issue: Before you plunge into a debt fund, ask yourself why you are putting money there in the first place.
Debt, like equity, is an asset class. And for the purpose of diversification, some amount of your investments must be in this asset class. Having said that, you definitely would have some amount of savings in fixed-return instruments like fixed deposits (FDs) or Public Provident Fund (PPF) or National Savings Certificate (NSC). So if you put money in debt funds, you should do it for specific reasons: either because the tenure of the instrument matches your need, the tax incidence is lower when compared to other fixed returns instruments or the return, in comparison, is higher. But don't view any mutual fund debt product as a quasi fixed return instrument. Debt funds do carry a fair amount of risk, some more than others. You could lose money here too.
Intrinsically, debt instruments imply a fixed tenure and a fixed return. In that sense, they are assured. However, once you invest in a mutual fund, other factors like interest rate movements, the fund manager's call on their direction, his trading skills and also the intrinsic quality of the portfolio play an important role. The last factor is especially crucial. The greater the magnitude of low quality paper in the portfolio, the higher the returns that the fund manager is in a position to generate. For instance, one could broadly say that the difference between AAA and AA rated paper could vary from 25 to 50bps (100 bps = 1%). Unfortunately, it's not that simple. Let's talk about paper from companies in different industries. The difference in AAA Manufacturing and AA Manufacturing would be 25bps (the lower rated paper giving the slightly higher return despite both being from the same industry). If the industries change to AAA Manufacturing and AA NBFC, the difference could be 1-1.5 per cent. On the other hand, if it was AAA NBFC but AA Manufacturing, the latter would still offer a lower return and the difference could be around -75bps.
In extreme scenarios, the difference between a AAA Manufacturing and AA Real Estate would be around 5-6 percentage points. But if the paper was BBB Real Estate (theoretically speaking), it would give around 12-15 percentage points higher than what a AAA Manufacturing paper would offer. So if a fund is offering fabulous returns, there could be a compromise here. And compromises always leave you vulnerable.
Even if fund managers pack their portfolios with high rated paper, there is the interest rate risk if they get their call wrong. This is all the more prevalent in funds of longer tenure. For instance, let's assume that Bond A has a coupon rate of 8 per cent. Now let's say there is an increase in interest rates and Bond B has been issued with a coupon rate of 9 per cent. Now the price of Bond A will fall (since it is offering a lower interest rate) as the yield of Bond A will adjust higher (since bond yields and prices are inversely related). Consequently, debt funds that hold Bond A will be impacted. If there are many such bonds in the portfolio, the cumulative impact on the NAV would be negative.
While at any given point of time, all these risks exist (see: What risks does your fund manager take?), there are different phases in the interest rate cycle and in the debt market history where different risks have been played out more prominently. During the period from 1997 right through 2003, huge money was made on interest rates because during this period rates came down from 14 per cent to 5 per cent (10-year yields). From then on till 2008, money was made by taking credit risks when BBB rated companies were borrowing at 14-15 per cent. In 2008, it was liquidity risk that took centre stage, though credit risk was also prominent.
Mid-2009, credit opportunities (crop) funds began to catch the fancy of investors when yield spreads (difference in yields between benchmark sovereign paper and corporate bonds) widened to up to 200-300bps. The credit market presented an attractive risk-return profile as even good companies found it difficult to raise debt. Such funds are designed for risk-taking investors since they invest in high-return, low-rated paper. In such funds, the credit risk and liquidity risk run high. Right now there are a few options in the market: DWS Cash Opportunities, Religare Credit Opportunities and Kotak Credit Opportunities. While their profile could be riskier than that of other funds of similar duration, none of them take very high risks. They tend not to go below A-rated paper, stretching it to probably AA-. Says a fund manager from one of the fund houses which runs a crop fund: “If you look at the credit rating history of CRISIL over the past 15 years, there has been no default from any AA-rated entity over a 1-year period.” In fact, a number of measures are put in place to ensure that these funds are not taking undue amounts of risk. Not going for paper rated below A, being cautious on the reputation of the paper issuer, lower investment ticket sizes and portfolios with shorter average maturity duration. If you are willing to take a slightly higher risk with your debt portfolio, consider such funds.
What risks does your fund manager take?
Interest Rate Risk: When interest rates rise, bond prices fall. So if the fund manager has his portfolio stacked with lower interest rate paper, the prices of his holdings will fall resulting in a lower NAV. On the other hand, if interest rates fall then the price of his holdings rise and so does his NAV.
The longer a bond's maturity, the greater the interest rate risk. A bond fund with a longer average maturity will see its net asset value (NAV) react more dramatically to changes in interest rates as the prices of the underlying bonds in the portfolio increase or decline.
Credit Risk: Bonds carry the risk of default, meaning that the issuer is unable to make further interest or principal payments. They are rated by individual credit rating agencies to help describe the credit worthiness of the issuer. Higher the credit rating, lower the risk and lower the returns. Lower the credit rating, higher the risk and higher the return.
Liquidity Risk: If the credit rating gets downgraded or the current interest rates are much higher than the coupon rate, then the bond would face liquidity issues because finding a buyer would no longer be easy. Liquidity risk describes the danger when one has to sell a bond in the secondary market but is unable to find a buyer.
This article appeared in the June 15 - July 14, 2010 issue of Mutual Fund Insight
(source: valueresearchonline.com)
Mutual Fund News update from Nishit Doshi (9824021680) a leading MF Advisor based in Ahmedabad. Gujarat.
Tuesday, August 10, 2010
Dependence on NFOs Must Go
When Paul Vrancken, COO, Canara Robeco Mutual Fund, visited India in 2005, it was his first trip to the subcontinent. The then Vice President and Head-Corporate Development, Robeco Group, had the task of scouting the land for a mutual fund partner.
He narrowed in on Canbank Mutual Fund, amid a fair amount of scepticism. The joint venture between Robeco and Canbank Mutual Fund took place in less than two years and in August 2007 he shifted base to India and stayed on as the Chief Operating Officer.
Now, three years down the road, after Canara Robeco has left behind its dreary past, he is moving on to a more senior position in Hong Kong. Here he speaks of his experience of the fund industry in India and what made him narrow down on such an unusual candidate.
Canbank Mutual Fund was virtually written off by many. What made you narrow down on it?
It was certainly the potential, not the company per se. The company was not in very good shape, performance of schemes left much to be desired, net sales were limited and market share was shrinking. There were issues related to brand, investment process, systems, infotech, etc. It was not a platform for growth.
We looked through the problems and the seemingly lack of potential but yet saw a future with Canbank Mutual Fund. We visited the branches and spoke to the branch managers of Canara Bank about the potential of such a distribution network. We felt we could turn it around eventually.
Actually, Robeco was not that interested in the company itself. We believed we could change it. The key to success is looking at the potential of two joint venture partners coming together.
What were the aspects that stacked the odds in favour of Canbank Mutual Fund?
We looked at the other players that came in on their own and realised that it took a while for them to obtain the licence, so our main focus was on picking up an asset management company (AMC) that had a licence.
In addition, the sponsor company - Canara Bank - has a huge network across the country. It is one of the largest banks in India. That was the potential we were going after - the immense distribution network.
Canara Bank also fit the profile that we were on the lookout for. Rabo Bank, the parent company of Robeco, is an AAA conservative player. Ditto for Canara Bank. Look at the crisis the banking industry went through in 2008. In such moments of stress, Rabo Bank had adequate liquidity as clients added to their Rabo deposits, instead of withdrawals, which was the mainstream picture in the industry. And public sector banks like Canara Bank too received inflows from clients. Both these brands convey the value of trust and such intrinsic value of the brand is a great asset.
At the time when we were surveying the market, Sundaram Mutual Fund was in the process of tying up with BNP Paribas. The other standalones were not interested in a joint venture partnership. And neither were we interested in a much smaller AMC.
We wanted to get into India, we wanted a player with a licence, a certain amount of assets and funds to begin with, and we wanted a reliable partner who shared a similar vision of where we both wanted to end up. And Canbank Mutual Fund fit the bill.
In the end, I think our choices have been right.
Did you ever entertain the thought that this joint venture may fail?
No. It never came up. It's impossible to succeed when you are entertaining the thought that you might fail.
What was the market perception when you were closing the deal?
I remember at that time people were quite sceptical. Actually, there were two broad opinions when we spoke to people in the market. On the one hand, we were told that it would not take us anywhere and it was more or less a hopeless cause. On the other hand, we were told that it would require a lot of work but in the long run its potential could be realised. No one in-between, it was very black and white.
What of this business has left you disappointed? Something that did not move as you would have liked it to?
I feel retail equity distribution could have moved faster.
When I look at the overall fund scenario in India, a lot of money has come in through new fund offerings (NFOs). But the ongoing schemes do not really attract fresh investments. At most it is churning within the existing unit holders - moving from one scheme to another. So one AMC will face a redemption to the benefit of another AMC where the same investor will move to. So all existing schemes take money from each other, so to speak.
Over the past 10 years, all new money that has come in has been via NFOs. The fund industry has to find ways to get fresh retail money come into the existing schemes - a task that is far from easy. From a business plan perspective, this has been a setback.
If I look at the bank per se, it has taken a while but we have things in place now. Canara Bank has 500 investment officers dedicated to selling mutual funds and insurance products. They are placed in bank branches across the country. Now they have plans to double this figure. So it has taken time, but the potential to employ the bank as a distribution network is immense.
What do you find difficult about working in India, especially since you are not in a standalone venture? When you took over, was there a lot of resistance?
A difficult moment was at the beginning when the joint venture took place. We went through major changes in the organisation. Half the staff opted for a voluntary retirement scheme (VRS). The half that stayed back was mainly on the operations side. This has been a key success factor for us. Our operations staff has been the backbone which the company could depend on in times of need.
When one works in India as an expatriate, one aspect that stands out is the particular way of coming to execution, in terms of preparation, decision making process and execution itself. For an outsider, it may look like this process is somewhat ad-hoc, with a single person responsible for decisions, while the execution can sometimes wait till a late moment. But I do know that when there is a problem, it gets fixed. Not necessarily through a process or a system, but it gets fixed, and there is complete alignment in the organisation at those moments. However, one cannot rely on such a system for everything and all the time.
One of the things we have done is put committees in place because we wanted more involvement from everyone and we want them to be aware of the consequences and repercussions of a decision. So we now have a products committee, an investment committee, a risk management committee, an IT committee and a Canara committee. This way there is consensus and no confusion on decisions taken. If we did not have it then we would have to rely on a more obscure decision making process.
My impression of Indians has been that they are very entrepreneurial, open and wanting to connect. Moreover, they are very business minded, a great combination to grow and succeed globally.
What do you see as an area of concern in the Indian mutual fund industry?
When I came to Mumbai in August 2005, it was just after the flood and the consequences of the flood were clearly visible during my trip from the airport to the hotel. But what caught my eye was the billboards across the city with NFO hoardings. And I wondered how it could be that the mutual fund industry could be so in-your-face, so thriving and vibrant? Of course, AMCs were launching NFOs and the costs of up to 6 per cent of expenses could be charged to investors as fund raising expenses. But now that has stopped because the regulator stepped in. I think the direction that the regulator has taken is very good. A lot has changed since my first visit.
The first issue I am concerned about is how retail money is going to come into this industry. Investor education has to increase and eventually the investor must be made aware that he can, and should, pay a price for the value he receives from the distributor's advice.
The other issue is that new retail flows are not being channelised into the industry but find their way into another industry. This is putting a strain on the fund industry.
How different is it in Holland?
In Holland mutual funds are popular amongst retail investors. Over there the bank will evaluate your risk profile and suggest products accordingly. The concept of churning is not really there and distributors earn mainly through trail commission. There is no NFO mania, so to speak. Investors prefer a tried-and-tested product.
Is Canara Robeco now in the AUM race? Any plans to be in the Top 10?
I am not sure if we can call it chasing AUM but every business will have ambitions of growth. We would like to be in the Top 15 by March 2011. When the joint venture was signed, Canara Robeco was No. 26, today we are No. 16. But do note that when we were at the 26th spot, there were just 32 players. Now there are around 40 players and we have managed to inch our way upwards. Now that we have our risk management measures in place and performance has picked up across the board, we want to grow continuously without too many ups and downs.
Robeco has a strong presence in Europe. With that in mind, what plans do you have for Canara Robeco?
We want to expand domestically by penetrating the Canara Bank network and increasing retail sales. But we also want to grow internationally. From August we will start Robeco India dedicated funds and function on an advisory basis. Our first institutional mandate came from Taiwan. Another mandate from a European pension fund is due to go live in July. What our potential investors in Europe like is that we have the local India expertise as well as the international brand and global infrastructure. We have sales offices across the globe. These offices are already servicing institutional pension funds, insurance firms and sovereign wealth funds. So all the processes and mandates are done via our European offices and we provide advisory services in India
(source: valueresearchonline.com)
He narrowed in on Canbank Mutual Fund, amid a fair amount of scepticism. The joint venture between Robeco and Canbank Mutual Fund took place in less than two years and in August 2007 he shifted base to India and stayed on as the Chief Operating Officer.
Now, three years down the road, after Canara Robeco has left behind its dreary past, he is moving on to a more senior position in Hong Kong. Here he speaks of his experience of the fund industry in India and what made him narrow down on such an unusual candidate.
Canbank Mutual Fund was virtually written off by many. What made you narrow down on it?
It was certainly the potential, not the company per se. The company was not in very good shape, performance of schemes left much to be desired, net sales were limited and market share was shrinking. There were issues related to brand, investment process, systems, infotech, etc. It was not a platform for growth.
We looked through the problems and the seemingly lack of potential but yet saw a future with Canbank Mutual Fund. We visited the branches and spoke to the branch managers of Canara Bank about the potential of such a distribution network. We felt we could turn it around eventually.
Actually, Robeco was not that interested in the company itself. We believed we could change it. The key to success is looking at the potential of two joint venture partners coming together.
What were the aspects that stacked the odds in favour of Canbank Mutual Fund?
We looked at the other players that came in on their own and realised that it took a while for them to obtain the licence, so our main focus was on picking up an asset management company (AMC) that had a licence.
In addition, the sponsor company - Canara Bank - has a huge network across the country. It is one of the largest banks in India. That was the potential we were going after - the immense distribution network.
Canara Bank also fit the profile that we were on the lookout for. Rabo Bank, the parent company of Robeco, is an AAA conservative player. Ditto for Canara Bank. Look at the crisis the banking industry went through in 2008. In such moments of stress, Rabo Bank had adequate liquidity as clients added to their Rabo deposits, instead of withdrawals, which was the mainstream picture in the industry. And public sector banks like Canara Bank too received inflows from clients. Both these brands convey the value of trust and such intrinsic value of the brand is a great asset.
At the time when we were surveying the market, Sundaram Mutual Fund was in the process of tying up with BNP Paribas. The other standalones were not interested in a joint venture partnership. And neither were we interested in a much smaller AMC.
We wanted to get into India, we wanted a player with a licence, a certain amount of assets and funds to begin with, and we wanted a reliable partner who shared a similar vision of where we both wanted to end up. And Canbank Mutual Fund fit the bill.
In the end, I think our choices have been right.
Did you ever entertain the thought that this joint venture may fail?
No. It never came up. It's impossible to succeed when you are entertaining the thought that you might fail.
What was the market perception when you were closing the deal?
I remember at that time people were quite sceptical. Actually, there were two broad opinions when we spoke to people in the market. On the one hand, we were told that it would not take us anywhere and it was more or less a hopeless cause. On the other hand, we were told that it would require a lot of work but in the long run its potential could be realised. No one in-between, it was very black and white.
What of this business has left you disappointed? Something that did not move as you would have liked it to?
I feel retail equity distribution could have moved faster.
When I look at the overall fund scenario in India, a lot of money has come in through new fund offerings (NFOs). But the ongoing schemes do not really attract fresh investments. At most it is churning within the existing unit holders - moving from one scheme to another. So one AMC will face a redemption to the benefit of another AMC where the same investor will move to. So all existing schemes take money from each other, so to speak.
Over the past 10 years, all new money that has come in has been via NFOs. The fund industry has to find ways to get fresh retail money come into the existing schemes - a task that is far from easy. From a business plan perspective, this has been a setback.
If I look at the bank per se, it has taken a while but we have things in place now. Canara Bank has 500 investment officers dedicated to selling mutual funds and insurance products. They are placed in bank branches across the country. Now they have plans to double this figure. So it has taken time, but the potential to employ the bank as a distribution network is immense.
What do you find difficult about working in India, especially since you are not in a standalone venture? When you took over, was there a lot of resistance?
A difficult moment was at the beginning when the joint venture took place. We went through major changes in the organisation. Half the staff opted for a voluntary retirement scheme (VRS). The half that stayed back was mainly on the operations side. This has been a key success factor for us. Our operations staff has been the backbone which the company could depend on in times of need.
When one works in India as an expatriate, one aspect that stands out is the particular way of coming to execution, in terms of preparation, decision making process and execution itself. For an outsider, it may look like this process is somewhat ad-hoc, with a single person responsible for decisions, while the execution can sometimes wait till a late moment. But I do know that when there is a problem, it gets fixed. Not necessarily through a process or a system, but it gets fixed, and there is complete alignment in the organisation at those moments. However, one cannot rely on such a system for everything and all the time.
One of the things we have done is put committees in place because we wanted more involvement from everyone and we want them to be aware of the consequences and repercussions of a decision. So we now have a products committee, an investment committee, a risk management committee, an IT committee and a Canara committee. This way there is consensus and no confusion on decisions taken. If we did not have it then we would have to rely on a more obscure decision making process.
My impression of Indians has been that they are very entrepreneurial, open and wanting to connect. Moreover, they are very business minded, a great combination to grow and succeed globally.
What do you see as an area of concern in the Indian mutual fund industry?
When I came to Mumbai in August 2005, it was just after the flood and the consequences of the flood were clearly visible during my trip from the airport to the hotel. But what caught my eye was the billboards across the city with NFO hoardings. And I wondered how it could be that the mutual fund industry could be so in-your-face, so thriving and vibrant? Of course, AMCs were launching NFOs and the costs of up to 6 per cent of expenses could be charged to investors as fund raising expenses. But now that has stopped because the regulator stepped in. I think the direction that the regulator has taken is very good. A lot has changed since my first visit.
The first issue I am concerned about is how retail money is going to come into this industry. Investor education has to increase and eventually the investor must be made aware that he can, and should, pay a price for the value he receives from the distributor's advice.
The other issue is that new retail flows are not being channelised into the industry but find their way into another industry. This is putting a strain on the fund industry.
How different is it in Holland?
In Holland mutual funds are popular amongst retail investors. Over there the bank will evaluate your risk profile and suggest products accordingly. The concept of churning is not really there and distributors earn mainly through trail commission. There is no NFO mania, so to speak. Investors prefer a tried-and-tested product.
Is Canara Robeco now in the AUM race? Any plans to be in the Top 10?
I am not sure if we can call it chasing AUM but every business will have ambitions of growth. We would like to be in the Top 15 by March 2011. When the joint venture was signed, Canara Robeco was No. 26, today we are No. 16. But do note that when we were at the 26th spot, there were just 32 players. Now there are around 40 players and we have managed to inch our way upwards. Now that we have our risk management measures in place and performance has picked up across the board, we want to grow continuously without too many ups and downs.
Robeco has a strong presence in Europe. With that in mind, what plans do you have for Canara Robeco?
We want to expand domestically by penetrating the Canara Bank network and increasing retail sales. But we also want to grow internationally. From August we will start Robeco India dedicated funds and function on an advisory basis. Our first institutional mandate came from Taiwan. Another mandate from a European pension fund is due to go live in July. What our potential investors in Europe like is that we have the local India expertise as well as the international brand and global infrastructure. We have sales offices across the globe. These offices are already servicing institutional pension funds, insurance firms and sovereign wealth funds. So all the processes and mandates are done via our European offices and we provide advisory services in India
(source: valueresearchonline.com)
Rs 3,500 cr net outflow from equity funds
Diversified equity schemes of mutual funds witnessed net outflows for second month in a row as redemptions exceeded fresh inflows by Rs 3,539 crore (including tax saving schemes) in July.
In June, net outflows from equity funds were Rs 1,531crore. Industry experts said equity funds saw redemptions as stock markets regained February 2008 levels. “Many investors, who were stuck with their investments since 2007, have been redeeming their money as the Sensex touched February 2008 levels during the month,” Waqar Naqvi, chief executive officer, Taurus Mutual Fund, said.
However, overall the industry saw net inflows of Rs 31,654 crore in July compared with net redemptions of Rs 1,19,449 crore in June, according to the Association of Mutual Funds in India (AMFI) data. Liquid and money market funds witnessed net inflows of Rs 34,303 crore, while income funds saw fresh inflows exceeding redemptions by Rs 475 crore.
In other categories, gold and other exchange-traded funds saw net inflows of Rs 530 crore, gilt funds witnessed net inflows of Rs 40 crore, while balanced funds saw net outflows of Rs 43 crore.
Meanwhile, the month-end asset under management (AUM) of the mutual fund industry jumped by 6 per cent to Rs 6,68,605 crore as on July 31, 2010 compared with Rs 6,30,185 crore on June 30.
Income funds accounted for 50 per cent of total AUM on July 31, while liquid and money market funds accounted for 16 per cent. Diversified equity funds (including tax saving funds) constituted 31 per cent of the total AUM
(source: valueresearchonline.com)
In June, net outflows from equity funds were Rs 1,531crore. Industry experts said equity funds saw redemptions as stock markets regained February 2008 levels. “Many investors, who were stuck with their investments since 2007, have been redeeming their money as the Sensex touched February 2008 levels during the month,” Waqar Naqvi, chief executive officer, Taurus Mutual Fund, said.
However, overall the industry saw net inflows of Rs 31,654 crore in July compared with net redemptions of Rs 1,19,449 crore in June, according to the Association of Mutual Funds in India (AMFI) data. Liquid and money market funds witnessed net inflows of Rs 34,303 crore, while income funds saw fresh inflows exceeding redemptions by Rs 475 crore.
In other categories, gold and other exchange-traded funds saw net inflows of Rs 530 crore, gilt funds witnessed net inflows of Rs 40 crore, while balanced funds saw net outflows of Rs 43 crore.
Meanwhile, the month-end asset under management (AUM) of the mutual fund industry jumped by 6 per cent to Rs 6,68,605 crore as on July 31, 2010 compared with Rs 6,30,185 crore on June 30.
Income funds accounted for 50 per cent of total AUM on July 31, while liquid and money market funds accounted for 16 per cent. Diversified equity funds (including tax saving funds) constituted 31 per cent of the total AUM
(source: valueresearchonline.com)
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