In a detailed conversation with Mutual Fund Insight in July, he shares his experience on how Indian investor as well as the markets have changed and what are the opportunities that lie ahead.
How did you begin your career?
Over the years, I have had the good fortune of being associated with most of facets of business and finance. These experiences have enriched me and I believe that it will hold me in good stead today. Let me start though with my educational background. After my graduation in economics from St Stephens College, Delhi University, I went to the Indian Institute of Management, Ahmedabad. I joined ICICI from campus where I spent four years doing a variety of things such as project appraisals for various industries and some special projects, such as predicting signals of distress for companies and industries. It was a very interesting and rewarding experience.
The financial services boom was starting in the early nineties and I wanted to join a company that was in this industry. ITC was looking to get into financial services; I joined them and invested some of their proprietary funds for a while. Then, I helped them set up their broking business and was also part of the team that helped establish the joint venture with Peregrine. In 1996, I was entrusted with setting up the asset management joint venture for ITC with Threadneedle. When ITC Threadneedle was set up, I moved there as the chief investment officer. Within a year, I was made deputy chief executive officer, with an expat CEO as in-charge.
In February 1998, Prudential signed a joint venture agreement with ICICI covering life insurance, pension funds and mutual funds, and took a stake in the asset management company. I moved to my first CEO position in February 1998 with Prudential ICICI.
I continued to run mutual fund operations in India till the end of 2000. In April 2000, I was given regional responsibilities and I moved to Hong Kong to set up Prudential's regional business in January 2001. I am now responsible for the entire fund management business across the region, comprising of eight countries from India to Taiwan. I oversee the investment function of the life insurance businesses in Asia as well. Total funds under management are currently over $25 billion and on the mutual funds side, we've grown from having about $30 million when we started in 1998 to $10 billion today.
How have you seen the Indian investment environment change over the years?
Let me try and answer this question in three dimensions: asset classes, infrastructure and investor attitude. I have seen various phases in the Indian investment environment where a lot of things have happened. Mutual funds, for instance, were not as big five years ago as they are now. Funds are today much more a part of people's lives than they were five years ago. Of course, we believe, given the low penetration of mutual funds even today, they still have a long way to go. Company fixed deposits, on the other hand, were a big part of the savings pie five years ago, but they are much less significant today.
The stock market hasn't really moved much between the two points in time even though there has been a lot of volatility in between. I remember when we launched our first Pru-ICICI funds in 1998, the BSE Sensex was around 3,300 or so. Even today, it is at the same level. The bond market, on the other hand, has grown considerably and is vastly different than what it was five years ago, in terms of in size and character.
But what has not changed that much in this whole thing is the average Indian investor's attitude to investing. The risk-reward trade-off is still distorted by attitudes and extraneous factors and the approach of using financial planning to build a desired financial profile is still emerging. I see, for instance, that broadly there are two types of equity investors in India. The first set of people will stay away from the stock market completely as they cannot understand it or that they are not interested, or that they don't believe that it delivers anything to them. Then there is the other set of people who are involved with the market, who look at opportunities continuously to use short-term trends and volatility to make money. The longer term investor who uses the stock market as a building block to build wealth is not easily identifiable.
How have you changed as an investor? What kind of an investor were you earlier and how do you invest today?
When I first started as the chief investment officer at ITC Threadneedle in 1996, there was, I think, great focus on fundamentals. We strongly believed that choosing the right companies, and analysing companies and industries made all the difference. I still believe in it and ultimately to survive in this market, you need to have the ability to pick the right stocks, to understand businesses and to be able to choose companies that will win over the long-term.
I see equities as being a discounted earnings stream for a company over many years, and, therefore, understanding the business model and the levers of success is absolutely critical. So, in that sense I don't think I have changed as an investor. However, the issue is that people have become of a much more short-term nature, and that is because the market has so much volatility.
How does India fit in as an investment destination compared to other Asian countries? Do you see more fund flow coming into India?
India is an attractive investment destination if you look at comparative valuations, the choice of sectors and companies available, the level of corporate governance and the operating systems in the stock markets. I keep looking at valuation tables and India appears cheap compared to most other markets in the world—in Asia definitely, and even against Europe and the US.
But India suffers from a structural issue—we don't have the long-term investors in the market that cushion shocks and provide the stability that every market needs. You need long-term players who are willing to invest in this market, who look at dips in the market as an ability to buy because they are standing back and looking at things differently. But that is a chicken-and-egg situation. I think it will be helped when the float in the market goes up.
Now, float is a function of market capitalisation. We can do two things. Either the market just booms and we get higher market cap or we allow large chunks of unlisted stocks, which have potential market cap, to come into the market. If you add both, it is a great combination. The best option is that a couple of big public sector units—further disinvestment for the listed ones—or new PSUs that are not listed keep coming in. This will mean that the market cap will go up and the free float will rise.
When that happens, India will start becoming a larger component in the international indices and people will take more interest in it. Today, India has about 2-3 per cent weightage in most regional indices whereas Malaysia, Hong Kong and Singapore all enjoy greater weightage in the indices because of the free float in their markets.
This then becomes a vicious cycle of low weightage, which bring low flows and keep markets down and so on. Somebody investing in regional markets today can easily take a view that if I don't invest in India, it is not going to affect my overall performance against the benchmarks. That is what we need to change. Unless we change that, we don't get large doses of institutional money. Unless we get institutional money, we don't get stability in the market and the long-term trend that we are looking for.
How do you think mutual funds penetration can increase in India?
Historically, in the US and the UK, the industry grew at a reasonable pace for a while but the big change—the real step change—typically, came about when there were tax-mandated or some other regulatory changes, which led to a huge growth.
Look at retirement contribution plans like the 401(k)s—after they were introduced, the industry grew on a completely different trajectory than earlier. In the UK, the introduction of PEPs/ISA (Personal Equity Plans/Individual Savings Accounts), which are again tax-incentive schemes, saw the fund industry leap up from earlier levels.
Mutual funds in the US and the UK are longer-term forms of savings, and thus create stability of money in the hands of mutual funds (from an investing viewpoint) and less expectations of short-term performance. The growth of assets in these two markets over time is incredible though it did take a while for the growth to kick in.
In India, I think we now have such an opportunity as we set about creating pension schemes. If we assume that it is a voluntary, individual-contribution pension fund that emerges, mutual funds can be attractive vehicles. Pension funds can completely change the trajectory of the fund industry. Another opportunity is geographical penetration. In the big cities, there is a fair amount of adoption of mutual funds now, although we still have a long way to go. But look at the top 21 cities, which used to have regional stock exchanges, where people understand what investing is and there is a fair amount of money that is available to be tapped.
Another opportunity is liquid funds. There are very few markets where you find that a liquid fund gives you so much more returns than a savings account like in India. In any other market, the acceptance for such funds by retail investors would have been three-four times what it is in India now.
What about the penetration of equity funds... it still remains pathetic.
Again, it is a chicken-and-egg problem. You can expect pathetic penetration if returns are pathetic. The proposition after all has to appeal to people. If markets have a sustained rise, I think you will see the equity culture, especially in today's low-return environment, pick up considerably. Having said that, though the market has not grown in the last five years, investors in, say, our growth fund in India (and in some other equity funds) have seen attractive returns relative to alternate asset classes.
Unfortunately, the typical investor psyche is to get interested in equity only after, say, the Sensex has gone to 4,000-5,000 points but they won't be interested in buying at 2,800 points, when it is actually cheap. That is a function of awareness and appropriate communication. Increasing equity penetration, therefore, is as much about appropriate communication and positioning as it is about the markets generating attractive returns.
How different are other Asian markets compared to India in terms of products, regulations, distribution practices, investor awareness and behaviour and the investment scenario?
In terms of products, the Asian markets can be grouped based on the degree of openness of the market. So, in Hong Kong and Singapore, most of the funds are offshore funds or funds whose investment objective is investing in foreign assets whereas in China, India and Malaysia, the funds are largely local funds or funds that invest in domestic assets.
As far as distribution practices are concerned, every market is unique in the channels that work for customers and so you see agency being the largest component in, say, Malaysia while the company-owned direct sales force dominate the distribution channels in Taiwan.
Can you give us some examples of structured products that are doing well?
One example is the simple capital-protected fund. You will get your capital back in this product, say, at the end of four or five years. However, there will be an upside based, on, say, an index, or a bunch of stocks, or a group of commodity and oil and stocks, or things like that. Because you use derivatives and you structure it, these products have been able to appeal to people's preference for capital preservation while giving them some upside to an asset class they are willing to take a view on.
In a worst situation, you get no returns and only your capital back. However, when interest rates are as low as they are today, people don't mind that. Their attitude is that this is better than, say, a bank deposit where I get nothing. The proposition here is that there is some upside with no downside.
We are looking at introducing such products in India. But a lot depends on the options and futures markets, the kind of derivatives available in India, access to offshore markets and things like that.
You have managed investment portfolios for a long time in your career and in the last few years, you have been running the business. Which part do you enjoy the most?
Well, clearly there is joy in both but the two are very different jobs. I would also add that my training as a fund manager helped me in my business role as I look at business issues differently.
I think I am a typical fund manager in that I enjoy running the business much more than running a portfolio. I like the aspect of working with a big group of people in business, setting a strategic vision and working with teams to deliver it.
Success is also defined differently in both. In portfolio management, it is defined by beating competitors, meeting investment objectives and all the rest of it. In business, the ability to create something valuable out of nothing, to create a franchise of lasting value to society and to provide people with a challenging and fun work environment is a different level of satisfaction.