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Retail Investor Will Be Back With a Bang

Dileep Madgavkar, CIO, Prudential-ICIC MF shares his opinion on the mutual funds, the markets and investors psychology in an interview with Mutual Fund Insight

In four years, Dileep Madgavkar has gone from managing Rs 160 crore at Prudential ICICI to managing over Rs 10,000 crore. Prudential-ICICI, a joint venture between ICICI and Prudential Corporation Plc. It has product basket ranging from a plain vanilla equity fund to a an exchange traded fund which was launched recently. As on February 28, 2003, its amongst the two AMCs to have a 14 per cent market share (excl UTI) of the industry.

Being the CIO of a fastest growing AMC, Dileep is of the strong view that the retail investor will come back to the stock market via mutual funds route. In an interview with Mutual Fund Insight during December 2002, he tells volumes about how the AMC started off by striking a direct cord with investors, by being different in its performance, service standards and level of communication with investors.

Tell us about your career, and how you became the chief investment officer of India's largest private mutual fund.
I'm a product of many schools—I've studied in ten schools—since my father had a transferable job. I finished school in Calcutta and then did my college and CA there. I moved to Mumbai in 1988 where my first job was in the Bank of America treasury. That was a very interesting experience.

At that point of time, treasury was just about becoming an important facet of Indian banking as a revenue earner. Till then, there were only small treasury operations for foreign exchange but domestic treasury operations were just evolving. From Amex, I moved to ANZ Grindlays, also in treasury.

After the 1992 scam, the markets had become extremely restrictive; they were just drifting along and very little was happening. I decided to do something on my own and became a consultant. I set up treasuries for companies and for banks; I consulted with them about organising their trading activities and managing their money better. After three or four years of working independently, I met up with Prudential ICICI. I thought the mutual fund industry had a great future, even though it did not have much activity at that time. I also had the advantage of having worked in both the debt and equity markets during my time in bank treasuries.

Prudential ICICI was an exciting place with a fresh bunch of people and the very able leadership of Ajay Srinivasan. I began by managing the debt products and subsequently moved to managing the entire portfolio. When I joined we had two funds with about Rs 160 crore and today, four years later, we have funds in excess of Rs 10,000 crore.

Why did the market respond to your fund the way it did?
I think the market was waiting for some activity in the fund industry. We just came as a breath of fresh air. I have the greatest possible respect for the existing players at the time but I do think we did something different. We communicated with the investor differently, our service standards were different, our performance was different. And one definitely needs all three to succeed. I think we were in the right place at the right time with the right set of people and that's what clicked.

Some actual examples of the things you did differently?
We had much more interaction with the investor. We made it a point that even though I was the investments person, I would talk to investors directly. The investor is an extremely astute and analytical person and can figure out who you are and where you are coming from and I think that helped a lot.

What is the fund management structure like at Prudential ICICI?
I head all the investments, every rupee that comes in—with the exception of the portfolio management services—which is managed separately. I have four fund managers in debt, and three fund managers and one dealer in equities.

We don't have analysts; the fund managers are their own research people. We do have one person who covers credit analysis in debt but he also looks after his own fund. We have found this to be a very successful structure.

What is the process that you follow while evaluating companies?
We have an initial screening process that is based on various quantitative measures. The companies that pass through this form the universe that we will cover. Of course we also depend on secondary research sources like broker inputs but we also visit all these companies ourselves. It is a very strict and rigorous regime where each one of us, including myself, has an average of 200 management meetings a year. This helps us a lot. These meetings are not about numbers. These meetings are a way to assess vision, process, trends not only in the company but also in the sector. It is a way of judging how managements are reacting to various events and how dynamic they are. We meet people at all levels; in fact, one of the keys is to meet people at different levels right up to the managing director. This is necessary to get a holistic view in terms of strategy and vision.

How does an index fund—a passively managed fund—fit into your menu of offerings?
My belief as a fund manager is to be able to adhere to the objective of a fund. It is not up to me to say whether a particular objective is superior or inferior—I must manage according to the stated objective. Now if you were to ask me whether a passive fund is better than an actively managed fund then my answer would definitely be a no.

I believe that in India, given that the markets are inefficient, there is huge scope for actively managed funds to outperform passively managed funds. And that gets proven in the numbers—this is not hypothetical, this is something that we have proved consistently year after year. However, we must offer a whole array of products. After all, an investor may want to believe that he is more comfortable with the index than with a fund manager, and he is entitled to that.

You launched the Prudential ICICI Dynamic Fund recently. How would you decide when it should be an equity fund and when a debt fund?
It is all a question of valuations, but valuations have to be looked at in a dynamic way and not just as one single ratio like the PE (price-earnings ratio). One has to look at the PEG (price-earnings growth), with the growth prospects of not just the company but of the whole sector and even the whole economy.

Look at the current situation—interest rates have come down drastically and corporate earnings are looking up. You would expect equities to have moved up. Instead, we are in this very enviable position—from an equity investor's point of view—of interest rates having come down and yet, equities being available at very attractive prices. Today, equities are a screaming buy.

You were talking about the same thing a year ago…
But a year is nothing in the life of an equity market. One has to take a strategic, directional long-term view. I find investors saying this very often—you said this six months or a year ago. Tell me, which business can you time to the nearest six months anyway? There could be blips but the direction holds true.

There could be various events, we have faced so many event risks this year—a war-like situation, geopolitical risks, political problems with strategic economic decisions and so on. These things will obviously hamper the markets. Markets run on two factors—the underlying liquidity, which is driven by sentiment to a large extent, and, of course, fundamentals. The fundamentals are intact, as I had said six months ago, but possibly I was six months too early.

If it hadn't been for these event risks unfolding, then something may have happened by now. But six months or nine months here or there does not take away from the directional view.

Today, we have a much more efficient corporate sector with results that are defying many people's expectations. It is a very attractive market. It could take time; it could take six months before the valuations catch up but right now it's a screaming buy. So, as far as the asset allocation of the dynamic fund goes, equities look so attractive there is no room for any debate that Dynamic should be an equity fund for now. As the valuations gap closes, I would be more and more willing to take profits and maybe even switch to cash for brief periods of time.

Does the investing world face a systemically higher event risk today?
Event risk is a critical thing today. And not just because of the risk itself but because of the ability of the media to carry it to everyone. Previously, an event that took place in a far-flung part of the world would not impact everyone's sentiment as powerfully as it does today.

Also, when the global economy is under pressure it is that much more vulnerable to event risk. The impact of any adverse event is that much more. So event risks impact both the fundamentals and the sentiment very powerfully today. For most global players, the ability to take shocks is far less than it was a few years ago.

Where is the bond market headed?
I believe that you cannot ignore fundamentals for too long. In the bond market, it is liquidity and nothing else that is driving down interest rates. Otherwise, the fiscal deficit is pretty worrying, state finances are worrying, commercial credit offtake is not much. Most of the borrowing is done by the government. The market would finally have to pay heed, but, as long as the system is awash with liquidity, interest rates will continue to go down. And this is also a global phenomenon. Surely, interest rates can't go much lower than where they have reached now. Maybe, but interest rates have proved almost all of us wrong. We all thought the floor would be a couple of percentage higher than it is today; then we thought it would be one per cent higher, and then we thought it would be what it is today, and we have all been proved wrong. It is very difficult to take a call about what that floor will be.

Suppose over the next six months the repo rate also gets cut—and that could happen—rates could come down to half a per cent lower than what they are today. Its not impossible. There is this huge amount of money flowing into bond funds and because of the special period we are in—the honeymoon period of the rate cuts—you are able to meet unreasonable expectations. Isn't this going to be a problem in the future? That's what I say to investors in every meet—this was history. Don't extrapolate from history; it is a dangerous thing to do.

Do you see growth in equities anytime soon?
Unfortunately, in our country money is not fungible, debt money will not flow into equities. I believe that while there is a reluctance to invest in equities today, this will change in the foreseeable future. Given the low interest rates and the attractive valuations in the markets, there would be a greater interest in equities.

Will the retail investor ever again become a factor in the equity market?
The retail investor would again become a very important factor and I believe it will be through the mutual fund route. It will not be direct. It is far easier, far more lucrative and far less taxing to go through the mutual fund route. The retail investor is going to come back and he is going to come back with a bang.

Do you look at your competition very closely?
We do look at it; we look at it, others make us look at it.

How do you go about chasing the competition?
We don't chase it, there are times when we are ahead and there are times when we are behind, but our intention is always to stay in line with our stated objectives rather than to chase competitive performance. We certainly have the capability to generate extremely high returns—look at Power (Prudential ICICI Power). Particular funds will do well at certain times and others won't do so well. So when a sector is doing well, a very actively managed fund will do well. But when there is a broad market which is catching up with screaming valuations, then even a broad-based diversified equity fund will do well.

Which sectors will provide the equity market with the big push?
We've already seen it. Almost without us noticing it, just see what tech funds have done over the last year. Because of the bearish sentiment, no one is willing to look at this sector which has gone through a very trying period is now coming out of it. And this is not just fundamentals but also in terms of stock performance. The tech funds have done so well but no one is willing to invest. Unfortunately, when valuations are screaming, investors' risk-taking appetite is also at its lowest. The sectors to watch are IT, auto, cement...actually, almost everything is looking very good today. The real trigger to equities' revival has already happened and that trigger is great corporate performance. However, it is going to be a very selective stock market, one that differentiates between the good companies and the also-rans.

What kind of growth do you foresee for the mutual funds industry? Are there any major factors that are holding it back?
What is holding it back is a general lack of knowledge about what a mutual fund is and an inherent suspicion that comes from either losing money or inadequate knowledge. In the zeal to sell, there have been excesses in the past in terms of raising expectations.

Investors need to tune their expectations in line with the objective of a fund. Sometimes, there are unrealistic expectations. I've met companies where their own stock price is a tenth of what it was and the same people ask me how can my fund drop. That's where a disconnect lies—we don't create instruments to invest in. We invest in the market like everyone else. The ability to see that a mutual fund is an intermediary that is dependent on another market is lost somewhere. Investors need to understand that we can outperform that underlying market but have to be linked to it at all times.