FinEng met with Nilesh Shah to take his views on the 2009
prospects of the Indian mutual fund industry in light of
the volatility of 2008. ICICI Prudential has been using
Quantis for many years now and is a valued client of FinEng.
Further, Nilesh has provided crucial market inputs and direction
to Quantis during its initial development and has been actively
using the application for almost 10 years.
Nilesh Shah needs no introduction to anyone associated
with the Indian capital markets; he has been with the Indian
mutual fund industry on the investment management side for
over 10 years now, prior to which he was with ICICI Securities,
a JV between ICICI and JP Morgan.
During the course of the interview, Nilesh also touched
upon the factors likely to affect the Indian economy as
well as the global scenario.
Where do you see the MF industry as of 31st December
2009?
I think it will hopefully be better than what it is today.
We should be able to garner our money market funds back
to the sizes that they were earlier. Equity funds will also
probably start coming back into flavor. I think 2010 will
look better than 2009, 2009 will be better than 2008 and
the Index levels will probably be at 2006 -2007 levels.
So things will look better.
Do you feel that the second half of the year is
likely to be better than the first half of 2009?
A lot will depend upon events such as, say the
terror attack responses, the election results being in favor
of a reform oriented government, global credit de-freezing
and flowing back. The second half will then look substantially
better than the first half, and substantially better than
what we can anticipate right now.
A lot of events will drive the future, hence it is difficult
to quantify how much the second half of 2009 will look better
than the first half of 2010.
Let’s break up these events, into those involving
India and those concerning the overseas markets. In India,
do you feel the results of the election will possibly be
the single most important factor this year?
Apart from this, if there is an escalation with
Pakistan on the terror response and that goes really out
of proportion, then that could become a bigger issue. But,
as of today that looks quite unlikely.
So most probably, the single most important driver from
the Indian point of view will be how the government carries
out the process of reform. Can they provide good governance?
Can they provide good leadership so that the country can
jump out of this current turmoil? If those two things happen
or even if they can convince outside investors that yes,
this is how India will be moving forward, we would be able
to see much more flow from overseas investors who are today
getting close to 0% return on their investments in the developed
markets.
But do you feel that there is appetite to invest
from overseas?
As of today, no, but at some point of time people
will start seeing risk aversion getting reduced and risk
taking ability increasing. Japan and U.S.A. are already
at 0% interest rate, U.K. will soon reach 0% or near 0%.
Then what will people do? Holding money in one’s pocket
or in a bank will give them negative returns because inflation
will hit them sooner or later. They will then start looking
at various avenues to invest in. Now at that point of time
I can show them that we are growing at 5-6%, and if they
give me their capital, I can grow at 7, 8, 9%.
You put up an airport in New York, it’s probably
going to get 30% less occupancy. You put up an airport in
Mumbai, its probably going to get occupied from day 1. The
IRR that is there in India will then look substantially
attractive in comparison with the returns that are available
there.
And what about currency depreciation?
If money flows in, then there will be no depreciation,
but if money flows out, then the rupee has no option but
to depreciate. So everything is linked to revenue. One example
is how the Japanese bought Ranbaxy and a stake in Tata Tele
Services. From an insider point of view, from India’s
point of view, those acquisitions probably looked expensive
in terms of valuation, but I think the difference was our
expectations versus the Japanese expectations of returns.
For us, possibly, an IRR of 25% is not a good acquisition.
For the Japanese, 6% IRR is perhaps a great acquisition.
And that’s where the valuation difference created
such a huge difference.
Taking the overseas side, there are so many skeletons
being talked about which could explode like a time bomb
anytime. Do you feel that this is hyped up or is there substance
in what is being said that could explode?
I think what we have seen, is that mood swings
are quite rapid. Prior to 31st December 2008, most people
were bearish on the market, and took a break of about 10
to 15 days. Post 31st December most of them were quite reasonable
and quite optimistic. We did see a 15 day rally which happened
in the first week of January, continued into the second
week of January and then stopped. So something happened
in those 7 - 10 days that probably rejuvenated people and
made them optimistic, but unfortunately it could not last.
Now again, we are seeing a scenario where people are becoming
more bearish, they are probably expecting a recovery in
2010, 2011 rather than 2009 because they are now seeing
the reality of the problem. It is no longer reflected only
in newspaper headlines, but in job losses at home, less
traffic on the road, less occupancy at the airport. Earlier
we were just seeing the storm, now we are experiencing the
storm. So that’s why globally things are becoming
little bit more bearish.
But what about areas like credit cards, people
say that this could be the next big thing that could explode.
What is your opinion on this?
We probably are misfit to analyze that because
as an Indian I will first default on my credit card, then
my vehicle loan and last will be my house. Whereas as an
American my priorities are quite the opposite. I will first
default on my house, then the vehicle loan and then finally
the credit card because I am completely dependent on my
card.
So if the credit card default actually happens, that will
probably be the end of the world! Looks quite unlikely that
this will happen, but then someone mentioned that in America
there are 2 classes, the poor class and the rich class.
There is nothing as such as the middle class. It is the
middle class that provides the shock absorption capacity
in a country like India. Something like this is missing
in the US.
So you are saying that the way we treat our house
here is the way they look at credit cards there….
Yes, so hopefully that kind of dire situation will not come.
In India, do you think the turning point or rather
the feel good factor will happen when you actually start
seeing some inflows coming in…
Precisely…
What would be some of the things that could happen
for that feel good factor to take place or would it be just
largely be one or two events?
I think the building blocks are already getting in place,
interest rates are moving down, liquidity is slowly but
steadily moving up, oil prices have started coming down,
inflation is coming down, employee turnover is reducing.
There is a lot of pressure on employees, hence probably
the productivity of the employee will start improving. The
kid walking into office today does not want to become MD
tomorrow, he is now willing to go through the grind. So
all these things have started happening. We will not see
the impact yet, but at some point of time all this will
come into play.
On the other side, industries have started liquidating
their inventories, so high cost input inventory has already
been liquidated and losses booked. The December ‘08
results are quite pathetic, earnings are down almost 30%
excluding banks but then it is not that earnings will be
down 30% on a regular basis. It is just that there was one
item on inventory liquidation which probably was worth 15%
to 20% of this drop. Now that will not be repeated in March.
A lot of de-stocking would have happened in the system because
everyone was expecting the prices to fall. Now, that de-stocking
has to be converted into re-stocking. A lot of building
blocks have already been established for things to improve.
Today there are 3 fears that are probably driving investors
from not going full-blown into investment mode. One, the
terrorist stand in Pakistan, most people now believe that
it will be more of the talk rather than an actual showdown.
Two, the election results, will it be a reform oriented
government or will it be a coalition government not going
anywhere and three, the corporate governance stand post
Satyam.
If these three things can be tackled over a period of time
then most of them will certainly get either solved or diluted
by the passage of time. When all these building blocks come
into play, things can start looking up in the second half,
and the market will start discounting it a little bit ahead
of actual recovery.
Coming to the mutual fund industry specifically,
a) What would be the kind of strategies that would
materialize?
b) Would there be a lot of consolidation that will take
place?
The whole of 2008 was fairly volatile. Equity was the flavor
of the season at the beginning of the year, and then within
15 days that just broke off. Through out the year people
lost huge sums of money in equity funds and while funds
did outperform benchmark schemes they were still down 50-60%.
It does not give any solace to the investor that we have
outperformed on the way down. There has been a fair amount
of loss of credibility in that sense for the mutual fund
industry and the investment industry in general, to the
investors.
Fortunately for us, 2008 didn’t not end completely
on a bad note because towards the fourth quarter, we could
swing people into income funds and income funds did deliver
significant returns.
There are many customers whose portfolio as a whole between
income and equity has yielded positive return in 2008, even
though they lost significant sums of money in equity. Because
traditionally people are far more overweight in debt and
far underweight in equity, so even if you were 80% in fixed
income and 20% in equity, that 20% became 10% so one lost
10% but on 80% you made 25%, so your overall return was
still quite comfortable. And the full 80% was not always
in fixed income. Some of it was in liquid also. So overall
people made marginal positive returns and hence their entire
experience with mutual funds was not as disastrous as with
equity.
In 2009, we have to first improve on that confidence and
the most critical thing is that at some point of time fixed
income rally will get over. If people remain invested in
income funds then that 30% return will become 20% and then
10% and then may be even 8%. So we need to shift that from
fixed income into something else.
But, what else…
What else could probably be equity, somewhere around when
the election risk is priced into equity risk. Maybe that’s
the time to shift them into either hybrid funds or into
pure equity funds, over a period of time. Not at one go,
maybe on a piece-by-piece basis, so that somewhere towards
the end of 2009 they again end up having a positive experience.
Maybe couple of months more…
My feeling is that April-June will be the period to shift
people into equity, in anticipation of a better ending 2009.
You make about lower double-digit returns in the fixed income
side in the first six months. Then you try to capture some
similar amount from the equity side, which is not an unreasonable
anticipation. Overall on a portfolio basis you still end
with a decent return and that will erase the bad memories
of 2008, give far more confidence to investors and then
we are back in business.
Do you feel that the overall structure of the players
will largely be similar or that there could be some changes
by the end of 2009?
I think the contours of the mutual fund industry will change.
A lot of people in the industry were playing valuation games
of ‘let me just gather assets’. Now probably
people will be valued on the brand they have created, on
the basis of their profitability. This will probably result
in consolidation within the industry, it will also result
in some players going out of the industry especially at
the smaller/lower end.
How does one exit in a mutual fund situation…do
you just return the money to the investors…
No, you just put yourself for sale. Someone will come and
buy you
Can there be scenario where you just return all
the money…
No, most people at a certain price will be able to give
it to someone else to manage. I think the industry will
stabilize with 4 or 5 large players because those large
guys have the necessary infrastructure to support investors
and pass through the downturn.
What about new players, anybody who will make some
impact this year or is it going to be very unlikely?
It will be very unlikely because most of the senior, serious
players are already there. There will surely be some new
entrants that will come in and come in with a grand plan,
but it is unlikely that they be able to make an impact immediately.
It’s no longer going to be a game where you put up
hoardings in 300 cities/places and come into the business
with a big bang. It’s going to be slow and hard, where
slowly and steadily based on your performance, your service
and your track record, you build a brand and then collect
money. I think now people will be more bothered about the
return of money rather than return on money.
And what about product strategy, do you think that
for a year there would be a lot of thrust on trying to get
the equity track going? What about the customers and distributors
side? Is it going to similar to what happened earlier or
is there fresh thinking on that?
I think clearly some things have changed at the margin for
the better. One, the distributors have probably realized
the need to be a financial planner rather than just having
a transaction-oriented approach. Some of the customers have
also realized that it is worth opening up with the distributor
rather than just doing 1 or 2 transactions.
We met someone in Pune and he was able to demonstrate to
most of his customers, a marginally positive rate of return
on an overall portfolio, because he shifted into fixed income.
He could demonstrate this with customers who were open with
him and who had given him proper portfolio disclosures.
He was able to plan things well even though they executed
the strategy only on part of the portfolio. But, there were
customers who only believed in a transaction approach with
him. So while he was investing in an equity fund, this guy
never knew if he was overweight equity or underweight equity
and hence those customers suffered. They thought if I am
dealing with 5 distributors and investing in 5 equity funds
I would be safe. Now diversifying yourself in risky assets
does not increase your return, it only increases your risk.
There would be a lot of confidence if someone can go and
talk to a customer and say look, if you were open and transparent
with me I could have done better planning.
But what would be the strategy from the fund house?
From a fund house I have to service these kinds of distributors
in a much better manner.
One, probably now the distributors have also realized that
it makes sense that our customers remain wealthy and then
we charge fees on that, rather than churning his portfolio
20 times and getting short term commissions. They will also
become far more careful in handling a customer’s money
and giving custody of that to fund managers. Then we will
be evaluated more on not only the basis of what return we
are generating but also how we have generated those returns.
The education about how to generate return and how much
return you have generated will both come into the picture.
The industry at some point will move on the maturity curve.
Investors will become wiser, distributors will become wiser
and hopefully fund managers will become smarter and wiser
too.
Just a snapshot, beginning of the year 2008 versus
end of the year 2008, what would have been roughly the amount
of money which would have gone out? By how much would the
AUM have dropped?
Probably about Rs. 200,000 crores
What’s your guess, at the end of 2009 how
much of that will be recovered?
I think we would recover the entire 200,000 crores
Is it possible to come back?
2009 end will be where we left at 2008
Even though the Index may not be anywhere near
that mark, the assets could come back?
Yes
And is one of the reasons that the asset size could
increase, that banks will start putting money on the money
market funds once again? Or is to going to be largely due
to plain retail?
I think it will still be largely corporate and retail players
rather than banks. Banks eventually will put their liquidity
to customer use whether its retail loans, industry loans
or trade finance. Banks will not wait to get more investments
right now. Yes, they will probably allocate something to
equity, something to fixed income and the money market side.
What about investor confidence? A lot of people
still have money that they want to invest and like you said
they are seeking avenues for various reasons such as tax
purposes or others. But they cannot hold on for another
6 months or 8 months.
The point is that everybody’s confidence is shaken.
If the fixed income markets would not have delivered the
performance which they have delivered, our credibility would
have been zero and no one would have taken us at face value.
Now today because at least on the fixed income side we
have gone right, customers and distributors are gaining
confidence. Nothing works like success. Now distributors
also have to play a role, they can’t run away from
the client.
Yes the client is angry because you have lost 50% of their
money. But you have to go and explain to them on a transaction
basis on how leveraged you were on the equity side.
Now give me your entire picture, I will try to correct
it in such a manner so that whenever an upturn occurs you
will be able to benefit from it. So it’s a process
in which clients will have to understand that they can’t
be expecting magical returns or magical results from the
distributors.
Distributors will have to take the hard way of educating
customers and getting their confidence, and we as the manufacturer
of the product have to keep on informing and educating both
distributors and clients during this tough time so that
they are well positioned for the next upturn.
I still remember in September 2008, we gave our first call
on Income funds, that now this is the time to invest in
Income funds. There was no response. In October 2008 again
the call was repeated, there were some murmurs but no cash.
November 2008 we repeated the same thing with a positive
return track record of September and October, there were
then some fresh new entries. In December there was an avalanche.
Again I can’t blame anyone as in September who would
take me seriously as my equity predictions were all in red.
But in October people started listening and at the end of
December there were huge flows. It’s always that way;
confidence occurs when you are proven.
