The recent launch of four index funds (tracking the Nifty 100, Nifty Midcap 150, Nifty Smallcap 250 and Nifty Bank) by Motilal Oswal AMC, known best for its active manager reputation, marks the fund company's second foray into the world of passive investing. It launched India's first smart beta ETF way back in 2010, followed by a mid-cap ETF and an offshore one. Ashutosh Gupta spoke to Aashish Somaiyaa, MD & CEO, Motilal Oswal AMC, to understand the reasons behind the company embarking on this journey and the way forward.
You've always been known for running actively managed, high-conviction portfolios of just about 30-35 stocks or less. In that context, your decision to come up with passive products, that too owning baskets of 150 or more stocks, seems odd. What are the reasons?
Our purpose of launching these products is based on our understanding of two things: the rising interest in equity with the entry of many first-time investors and the digitalisation of most businesses. The combination of these two trends inevitably demands simplicity.
Even before being able to choose a fund house or a fund manager or a particular investment philosophy, people should be able to invest in a simple and easy manner. I believe that you understand the nuances of alpha and beta, investment approaches of different fund houses, etc. only after you become an investor. With the launch of our index funds, our whole effort is on bringing this simplicity to investing and making equity investing effortless.
As an active fund manager, we have a philosophy; we have a process in place and we seek alpha. But the driver for this index-funds business has got more to do with simplicity and cost-effectiveness aimed at certain segments of intermediaries and clients.
So going by what you said, is it fair to say that you would advise a nuanced investor to go for Motilal Oswal Multicap 35 Fund and tell a novice to buy Motilal Oswal Nifty 500 Fund?
I will give you a very honest example. We launched our Multicap 35 in 2014 and since then, our investment philosophy has been 'Buy Right, Sit Tight', where 'Buy Right' means buying companies which demonstrate quality orientation, growth-orientation and longevity.
Having said that, if we now claim that all investors understand our philosophy, then we will be fooling ourselves. This is because the reality is that while there are many nuanced investors in the industry, there are a large number of investors who have a high propensity to chase past performance without understanding the underlying reasons. These people probably don't understand what they want to buy.
While the reason of performance could be adherence to a particular philosophy or a process, there are certain market phases which will and which won't support that specific philosophy. But a fund won't suddenly change its process and become deep value or cyclical. So, those who don't want to understand any of this and are just chasing past performers are better off buying the index.
In the market, there are two things that will happen repeatedly - winners will rotate and investing styles will fall in and out of favour. So, what you do to generate alpha will at times be the cause of some alpha being snatched back. Active funds should be evaluated over a full cycle of more like five years and investors should avoid chasing last years' winners. If ultimately investors are going to make less than the return on investment itself and if chasing past is so common, they might as well buy the market.
In the mid- and small-cap space, even with basic due diligence you can avoid buying quite a few poor businesses. But that's not possible if you are blindly buying the index. How do you view passively investing in the mid- and small-cap space in this context?
Yes, that's a shortcoming of passive investing versus active investing, but index investing has to be agnostic of worries about, say, stock number 490 or stock number 500 turning out to be fraud company. Though such an occurrence will happen every once in a while, one should also be mindful that such stocks will be holding an insignificant proportion in the portfolio in terms of their weightage.
Another point is that the beauty of index funds lies in their inherent survivorship bias. The poor performers keep shedding their weightage and eventually get churned out so you don't keep holding onto a loser.
The charm of small-cap investing is in picking a winner early enough and then gaining big from its growth when it breaks away towards becoming much bigger. But in the case of small-cap index investing, the moment a small cap breaks away, you need to sell it as it is no longer a part of the index. In this sense, actively managed small-cap funds at least have a window of 35 per cent allocation to bigger companies to ride through the growth of a breakaway small-cap stock. How big a limitation is that?
Generally, one expects smaller companies to have higher growth rates than the larger ones. When a small-cap company becomes large, you expect a decline in the incremental rate of growth. The journey of a company from a small to a mid cap is far more rapid in terms of returns versus when it moves from being a mid cap to a large cap. So, instead of being preoccupied with holding onto winners, the idea behind small-cap investing should be that you are investing in a rapidly growing space. That's what you can achieve by investing in a small-cap index.
Look at it in another way, particularly in the current context. Many believe that owing to the underperformance of mid and small caps, investing in this space will be good. So, for those who do not know what to buy in here, the simplest way is buying that specific index.
Are there any concerns on the replicability of the mid-cap and small-cap indices? If we go by the average daily trading volumes, apparently some stocks in the small-cap index may not be able to support a fund size of more than Rs 1,500-2,000 crore? Do you see any liquidity issues?
Basically, we have to be mindful of two things. First, as you rightly pointed out, is the evolving liquidity and the capacity that can be managed by the index fund. The second is the inflow and outflow in terms of the daily volume that can be added.
On both counts, we have already done some homework and have our own sense of how much can be managed on a daily as well as on a full AUM basis. Rest assured, we will be closely tracking the daily volumes and the total fund size.
We have done simulations and back testing on what can be executed, so everything is taken care of.
Will any cash allocations be required to meet day-to-day redemption requests?
Cash is only subject to daily inflows and outflows. So, there is no endeavour to maintain cash.
What's your view on the level of churn in these indices? Of the current 250 constituents of the Nifty Smallcap 250, 64 weren't a part of the index in July last year. Passive is not all that passive?
I will have to double-check this but my sense is that in the last one year the churn has been a bit higher. This is because indices like Nifty Midcap 150 got prominence and a lot of these things have been done after the mutual fund recategorisation happened, where we have had a lot of changes. So, my sense is that this is a characteristic of this particular point in time and I don't feel that this will be an ongoing occurrence.
How does Aashish Somaiyaa, the investor, prefer to invest - through a focused, high-conviction investment strategy that Motilal Oswal AMC is known for or through the broader buy-the-market approach of your latest offerings?
My personal money is in the active. This is because of my belief in my company's QGLP (quality, growth, longevity, price) framework. But if I believe that my company should be run only for investors like me or that everyone will have the same belief and, more importantly, the patience to stay with a strategy as I do, then maybe I am not 100 per cent right. Secondly, nowadays, what is the process being used to identify the right fund manager and fund house: descending-sort in MS Excel or some browser on last one-year return?
We do track the evolution of the industry and participants and come up with insights on industry developments, the digital and regulatory trends, and segmentation of intermediaries and customers according to their needs and expectations. Everyone seems to think that the passive vs active debate is all about alpha. Our research tells us there are a handful of investors who understand alpha and the rest are seeking simple asset-allocation solutions to beat fixed income and to meet some goals.
Beyond alpha, what drives the passive thought process is the digital DIY ecosystem, which demands simplicity and ease of choice, and regulatory trends that are looking to move the industry towards advisory practice, lower product cost and ability for advisors to charge fees. By bringing these passive products, we want to create easy entry for new and DIY investors and enable intermediaries to build cheap asset-allocation solutions. These products are like building blocks and will help them build advisory solutions.