Can you tell us about yourself, how you became a fund manager.
I am a chartered accountant by profession. I was born and brought up in Mumbai and graduated from Sydenham college. I did my cost accountancy, articleship and chartered accountancy. I then moved to the merchant banking division of ICICI, I-Sec, in April 1992 where I had my first experience in corporate finance. I worked with corporates, helping them raise money in IPOs. This was the post-1991 per-iod when government control on capital issues had just been abolished. It was a per-iod of great learning. The way capital markets started pricing things immediately after liberalisation, it was out of touch with reality. Every single issue that we managed at ICICI failed to make any money for investors. It was a complete track record of failure. There was such euphoria in the market that promoters could price issues at any level they wanted. Today, when I look at things from an investor's point of view I realise it wasn't right to generate that kind of euphoria.
From late 1993 onwards I worked mostly on debt markets at I-Sec. We were trading in PSU bonds and trying to distribute government securities. At that stage, my job involved research, sales as well as trading. None of this was exciting and I was basically getting bored. Around the time I got an offer from Templeton.
I was part of a group called Templeton Global Bond Managers which was trying to find people who could look after the Southeast Asian region. Around April 1997, I moved to this group, looking after the entire region, including India. As luck would have it the Asian crisis happened around the time. The entire market, barring India, just disappeared. And that was when our journey to develop the Indian debt fund industry began.
We were fortunate to have a falling interest rate regime, a competent Reserve Bank of India (RBI) and a benevolent finance minister. Around 1999 I took charge of equity also. When my fund house acquired Pioneer ITI, I went back to managing just debt.
What is the range of investor expectations that you see?
Investors can be divided into categories. There are educated investors who understand that with the coupon income at 6-6.5 per cent no fund can deliver more than that on a sustained basis. On the other hand, there are people who say that last year you delivered 17 per cent and you have been saying that returns will come down, so, give me 10 per cent... that's sufficient. That's because he thinks how can you come down from 17 per cent to 6 per cent in just one year. You have to come from 17 to 10 and then to 8 and then maybe to 6.
A third set of investors is the one that says that every year you tell us that returns will be lower and you still deliver over 10 per cent. So, now when you say that returns will be lower, why believe you now?
It is scary because the expectations are unrealistic. Investors believe we will do magic and continue to generate returns. They are not willing to accept the reality that we have been lucky to have a falling interest rate regime. Obviously, this cannot last forever. I cannot exceed coupon income over the life of a bond. The fourth category is of totally uneducated guys who just read a brochure and see that income funds gave 13 per cent and gilt funds gave 17 per cent and they think that this is like a fixed deposit scheme where you put in your money and you'll start getting these kinds of returns.
It is scary to manage their money. If they are dissatisfied they'll tell everyone that investing in mutual funds is bad because mutual funds don't deliver what they promise.
You manage two big bond funds, Templeton India Income Fund and Templeton India Income Builder Account. What is the difference between the two?
It's a tricky issue. If you see their history, Templeton India Income Fund delivered great returns in its first two years. After that we became conscious of the fact that we were almost a pure debt fund house and this was our flagship product.
Our focus was on protecting the brand image. So, we concentrated on managing risk and generating consistent, rather than high returns. Templeton India Income Builder Account, on the other hand was always aggressively managed and delivered higher returns... maybe at a higher risk.
Templeton India Income Fund was always consistent and had an investor base who appreciated that. Whenever prices fell the fund moved up in the first or second quartile, even though it didn't remain there. Over time, the two funds have developed an investor base that accept this behaviour. And this is the way we will continue to run these funds.
The number of funds you are managing have gone up substantially. How does this add to the complexity of fund management?
We concentrate mainly on the flagship funds. Two income funds, one gilt fund, two liquid funds, one floating rate fund and one short-term fund. These are the seven funds that are very important for us. The rest are looked at on a fortnightly basis.
If there is a lot of volatility in the markets we look at them on a wee-kly basis. These are the kind of funds where there is no active churning of the portfolio—the monthly income plans (MIPs) and the balanced funds. There, once you've positioned yourself, you don't need to change things. Like in MIPs, the objective is the coupon income and not trading profits.
So once we have loaded the portfolio with corporate bonds—slightly lower-rated corporate bonds, there is no active management required.
There has been no growth in the number of units of your two main funds for two years now. What could be the reason for this?
The probable reason is that a lot of institutional money moved away from income funds to liquid and short-term funds due to volatility in this period. For various reasons, there have been repeated periods of volatility. First there was September 2001, we recovered from that and then by February 2002 corporates were struck by budget blues and they moved money out. Then in May 2002 we had the Kaluchak incident in Jammu and the heightened tensions with Pakistan which again created problems. Only between June 2002 and January 2003 did money really flow into income funds. But then again starting January 2003 many people withdrew money. So, we haven't really had a sustained period where corporates and institutions stayed with income funds.
Well, it always hurts to sell at the wrong time. Every time there is volatility, investors panic. But when you look at their side of the story you realise that they too have constraints within which they operate. I may think that this is the best time to buy but if their stop-loss limits are triggered they have to honour it. And that's where we work with large investors to help them have a proper asset allocation strategy. When gilts are doing well don't put 90 per cent into them because the volatility will kill you... put 30-40 per cent in short-term funds, 30-40 per cent in income funds and 20 per cent in gilts and then you can follow an active strategy of moving from liquid to gilt and back depending on the market.
There will always be some investors who will panic because of some internal limitations but on the whole investors are much more mature now. When bank rates were hiked for the first time in 1998 and NAVs dropped, it came as a shock to everyone. It was as if we had committed a crime.
Weren't you guilty to an extent? We've seen that fund managers are always very good at predicting rate cuts but never are able to anticipate rate hikes!
The reason is clear. In the US, the Fed (the Federal Reserve Board) has a policy document that makes it clear what inputs to the interest rates are, what are its decision points and what kind of decisions to expect. Therefore, in the US, one can construct a complete model through which one can predict the trend, if not the exact number. The RBI does not explain the complete logic so that one can construct a model. The central bank has been improving its communications but it is not of the level whereby I can use its logic and data to arrive at a conclusion about what it will do.
The first time when the rate hike happened, in January 1998, it came as a complete surprise—I don't think anyone could have predicted it. July 2000 was something we could have foreseen but we were expecting something in September or October but the RBI moved quicker than we had anticipated.
Where do you go from here? The last three-and-a-half years have been a party...a special period of high returns that has led to the prosperity of the fund business. What can one expect now?
Clearly, if liquidity was the driver for interest rates to fall in the last three years, we are probably going to see inflation driving interest rates over the next three to six months. Liquidity is now taken as a given. We could see inflation down to 4-4.5 per cent, although the RBI is putting it in the 5-5.5 per cent range. Maybe they are putting a bad monsoon into the equation.
I feel that there is still some room for interest rates to come down. In the US we could see a cut in the Fed rate in June. The ECB (the European Central Bank) has virtually said that it will cut rates. There is extra liquidity all over the world. Today, Indian corporates can borrow money internationally at LIBOR plus 0.5 per cent or 1 per cent. This is a total cost of roughly 2.5 per cent or 3 per cent. Even if you fully hedge this, your cost is no more than 4 per cent. So, why should these corporates borrow at 6 per cent in India. We feel that rates will come down but if inflation goes up, say to 8 per cent, then I don't think rates will come down.
How will investors take these lower rates?
For us, the management of investor expectations is the most critical issue. Whether we deliver 5 or 7 or 10 per cent, it will be of no consequence if investor expectations are different. They have enjoyed the benefits of the rate-cut party for three years when debt funds have given equity-like returns. Clearly, this is not going to last forever and at some point in time coupon income will take precedence.
Different investors behave in different ways. Many things are happening today because people have lost confidence in the system. If they hold on to a stock till the next morning they think it is long-term. In the case of income funds if they stay invested for a month they think it is long-term.
The guy who is sitting in equity—and should be a long-term investor—suddenly sees that debt is running faster and he jumps in the middle of the journey without realising that in the long-term, debt can't complete the journey that he set out for.
Are investments in India fungible in this way? Does money flow into one asset class from another so easily?
It is beginning to. Large investors' money always was but now even the middle class investors are starting to do this. There is little effort at proper asset-allocation. Although now, the distributor networks that are being put into place give some advise on the proper way to allocate assets.
You mean that many investors have now started drawing up asset allocation plans?
Drawing up a plan, yes. But following it is very difficult. We see SIPs coming into equity funds and suddenly it stops because the markets have tanked. We get many investors who just want us to tell them which investment will do the best over the next six months so that they can park all their money there. They don't realise that we can't predict the future. If I could see the future so clearly I would have run my own proprietary investments. We are making an intelligent guess and I hope my guess will be better than the rest of the market because I do this job 24 hours.
In a way, the investors' viewpoint is also valid. They say that the inflation that is hitting them is actually 8-9 per cent so we should think of a way of getting them at least 10 per cent.
Now there are some ways of getting those returns. It could come from high-yield bond funds that invest in lower-rated assets. Another possibility—if SEBI permits it—could be a leveraged fund. If I could leverage my funds in the derivatives market or the repo market, I could generate double-digit returns in debt funds. Of course, it would be a high-risk, high-return product but as the market matures there could be room for such a product. There could also be products based on equity derivatives that would effectively be fixed income products.
In times of low interest, most funds will have fairly similar returns. How will you differentiate your funds from others?
Either funds can commoditise their business, or they can specialise by providing comprehensive solutions. We will choose the path of specialisation where USPs will come in terms of investors' expectation management. It will also be in the form of service, where I can give investors access to all kinds of facilities that enables ease of investing, easy availability of information, etc. It will also come from maintaining contact with them on a continuous basis. For example, if a client has given me his portfolio, I can send him a reminder saying that you are now overweight in equities or debt. So, the USPs will come from the total customer experience. It will be very difficult to attract clients by saying that I have given 7 per cent while that guy has given 6.5 per cent and that will probably be the difference between the best and the worst performer. The differentiator will have to be in terms of service, brand, trust, image and such things.
You have over 50 funds. Isn't this a little too much? Isn't it a problem differentiating between various products?
India is such a diverse country and people have very different views. And they want products that can meet that particular requirement. For example, there are people who want a growth option in MIP. When we say that's almost what the income fund is, they say no that's more risky—I want MIP but I want growth. There are investors who say that they don't mind a bit of equity but that they would want only 10 per cent equity not 50 per cent. So, we need a large number of steps on the risk-return ladder, from a low-risk liquid fund to all the way up to a heady sector fund.
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