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Bullish on Indexing

Swati Kulkarni, Fund Manager, UTI Asset Management, says investors will look for low expense/load funds as the excess return may not compensate higher expense ratio of actively managed funds

After doing her Masters in Financial Management from Narsee Monjee Institute of Management, Swati Kulkarni worked with Reliance for a year before joining UTI Mutual Fund in 1992. She worked in the research and development department mainly handling market and macro research and product reviews, before moving on to fund management in 1998, where she acquired hands-on experience of analysing companies across industries. In 2001, she managed an off-shore fund for a year and subsequently moved to domestic funds in 2003. Excerpts from an interview:

What's your view on the current levels of the market? Do they look scary?
The valuations appear fair. However, investors with medium-term horizon can still take home good returns from the current level. I believe that the multiplier effect of infrastructure investment will continue to have a favourable impact on other sectors. The growing working class population with rising income levels, domestic orientation of the economy, increasing contribution from services sector and reducing dependence on agriculture for economic growth are structural macro positives that would continue to attract investment in equity over medium- to long-term. I don't think the market is scary. But, there could be pockets of correction depending on the liquidity movement in the short-term. Domestic flows to equity have been plentiful and so are from the FIIs. Long-term support in terms of retail participation is expected through systematic investment plans and pension reforms.

Having said this, I expect equity to deliver returns in line with the earning growth of 15-18% over a period of time, which could be still better than the return expected from the alternative investment avenues. It will be unfair to expect super normal returns, like the recent past, from current levels.

Are there pockets or sectors where you see a bubble and which you would like to avoid right now?
I don't think there is a bubble forming in any of the sectors right now. Expectations of growth and investment horizon could be different among the market players and hence there could be difference in valuations assigned by different people. For example, those who perceive higher growth and have longer investment horizon would be comfortable with current higher multiples.

I, would probably hold on to existing exposure and look for taking fresh exposure if there is a correction in the engineering and capital goods space at this point of time. I would avoid ferrous metal since I feel there could be pressure on price consequent to increasing supplies.

Which sectors are looking promising to you?
The banking sector should do well despite the near-term pressure on account of rising interest rate and gradual loan re-pricing due to competition. India is moving to a higher growth trajectory and banks provide excellent proxy to ride the economic boom. Opportunities in retail financing will continue, as retail finance still forms a small percentage of GDP compared to the Asian average. I expect the FMCG sector to do well as organised retail format gains prominence on the back of growing working population.

The oil sector could be an excellent bet from a long-term perspective. Other promising sectors where there is visibility of earnings growth are information technology, infrastructure, textiles and pharmaceuticals.

Tell us about your research team and stock selection process.
We have nine analysts tracking various sectors, covering more than 180 companies. In addition, each fund manager has at least one assistant fund manager who is actively involved in individual fund strategies. Besides this advisory support, the fund manager is free to take exposure to other stocks after a detailed analysis encompassing the valuations, competitive strength, growth potential and management's ability to deliver. We insist on meeting/interacting with the management before taking exposure in such stocks. In general, the stock selection takes into cognizance the investment objective and fund positioning.

Unlike other asset allocation funds, your UTI Variable Investment Fund is heavily into debt…you are not taking advantage of the equity rally.

There is a basic difference in the structure and the way these asset allocation funds are managed. UTI Variable Investment Scheme follows a disciplined asset allocation approach linked to the Sensex levels. The Sensex band is set up-front every year and is applicable for the ensuing year. The band that is in use at present was set in November 2005 (when the Sensex was hovering at around 7,500). Accordingly, allocation to equity will range between 70% and 90% below the BSE Sensex level of 7,150 and it will gradually reduce in stages to 10% to 30% beyond the Sensex level of 9,900. Historical PE ratio, constituents of Sensex and their consensus earnings expectation, general market and economy outlook etc. are the factors that are considered. The idea is that the fund books profit in a rising market and invests again at lower levels. The equity allocation is passively managed by replicating the Sensex. All through the year, we have remained invested at the maximum level permitted in equity at then prevailing Sensex level, only recently we have turned neutral.

In contrast, most of the other asset allocation funds leave the asset allocation entirely at fund manager's discretion. I believe that going forward, investors will benefit from the disciplined and objective approach to asset allocation, as the markets could remain volatile in the near-term.

You manage many index funds. But what are your views on indexing as a strategy for an Indian investor because indexing has not worked as well as the actively-managed funds in the long term.

It is a fact that in the past, several actively managed funds were able to beat the index funds, but the number of outperforming funds and the extent of out-performance have been going down of late. Investors who do not wish to take risk of active management continue to prefer index funds. It is a matter of time that a growing number of investors would look for low expense/load funds for basic equity exposure, as the excess return may not necessarily compensate the higher expense ratio of actively managed funds. UTI Master Index Fund and UTI Nifty Index Fund have a consistent track record of remaining the top-performing index funds.

Tell us about the funds that you manage. How would you slot them on the risk-return profile?
I manage UTI Dividend Yield Fund, UTI ETSP, UTI MNC, UTI Brand Value, UTI Large Cap, UTI VIS; two index funds: UTI MIF, UTI NIF and an exchange traded fund. In terms of risk- return profile of the pure equity funds, the most conservative will be the dividend yield fund. Then, I would put the index funds, Large Cap, ETSP, Brand Value and MNC Fund in that order. Brand Value and MNC Fund represent a theme and hence could be riskier although historically the volatility in NAV and the portfolio beta have remained lower.

UTI Dividend Yield is yet to complete a year since its launch. It has been performing very well across the time period among the similar funds in the industry and is suitable for investors looking for lower risk and stable returns. The Fund invests in stable businesses, growing cash flows and avoids cyclical bets.

UTI ETSP is an ELSS, where investors avail tax benefit under Section 80 C on investment up to Rs 1 lakh. The fund invests in leading companies across sectors and has given consistent and stable returns since inception.

UTI MNC Fund invests in multi national companies (MNCs) which have the dual benefits of domestic and export growth potential. Indian operations carry a lot more strategic importance today for the parent of MNCs. For e.g. in manufacturing, robustness of domestic demand enables companies to develop supplier base, which in turn is leveraged for manufacturing quality products in cost efficient way in India for meeting global demand. I believe, investors holding a diversified equity fund and UTI MNC Fund indirectly own different set of stocks, thereby efficiently diversifying equity exposure.

UTI Brand Value Fund invests in companies with strong brands, be it in manufacturing or services. Strong brands are typically associated with strong efficient management. Thus, this fund always gives quality exposure to the investors.

But don't you find it difficult to get more and more investment-worthy high dividend-yielding stocks, simply because the prices have been going up and therefore dividend yields are bound to come down despite consistency?
With price increase, the yield comes down due to the inverse relationship between the price and yield. But on a relative basis, we can always have stocks with higher dividend yield than the index yield. The companies with consistent dividend record give steady returns.

Going forward, how do you plan to protect the downside should the markets take a nosedive from here?
Experience in managing equity funds has taught me that stock selection and sector allocation rather than timing the shift from equity to cash benefits the investors. I believe that a mix of growth and value approach to investment should do relatively well should the markets slide. Because, investors prefer stocks where there is a clear visibility of growth and quick buying emerges during corrections, whereas investors will also start looking at value stocks when market valuations turn fair.

In line with UTIMF's investment philosophy, we insist on diversified portfolio without excessive concentration in a single stock/sector. The cash component on account of fresh inflow is invested cautiously at the current level of market. That should contain the volatility should the market start correcting.

I think our policy to give regular dividends across all our schemes would benefit our investors as their funds necessarily book profits in rising market for distribution. The retail investors usually do not move in and out of a fund frequently to take advantage of NAV movements, but every time they receive dividend they are home with a part of the rise in the equity markets.