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Ensure portfolio is well diversified before opting for thematic funds, says Morningstar Investment Adviser

As the equity markets have scaled all-time highs we have seen flurry of new fund offers get launched in the market by the mutual fund fraternity. Now there are funds across different categories, there are thematic funds that have come out in the market, we are talking about some new categories thanks to Securities and Exchange Board of India's (Sebi) new market cap categorisation norms.
The question is are these funds really worth your while, should you be thinking of putting your money in them and how do you go about picking and choosing. Kaustubh Belapurkar, director- fund research at Morningstar Investment Adviser answers all these questions.
Edited Excerpts:
It is getting a little confusing because after a big lull suddenly there are ads in the paper and we have been reading and hearing this all along. What is causing this flurry of New Fund Offers (NFOs) over the last few months?
A couple of things have happened, one is clearly like we said the recategorisation that Sebi had carried out and it was completed by the middle of this year. A lot of asset management companies (AMC) are now looking at gaps in their products suite and are identifying some key products where they probably don’t have a product and are looking to launch.
I would say that slightly limited on the equity side more happening on the fixed income side, but we were seeing some asset managers come out with some new sort of standout products on that side.
The other thing and the more important thing you are seeing on the thematic side is that some themes or sectors where managers have underplayed over the last few years are now emerging. You are seeing managers are coming out with themes around it.
So, clearly I think these are two large trends on the equity side that is where you have seen a lot of new funds offering coming in and I can understand it is a little confusing sometimes for investors.
But no reason to worry, right? Because in the past what we have seen is when there is a bevy of NFOs - that is the first warning sign that goes about there in terms of what the market might do next?
I wouldn’t say any reason to worry, but obviously, you would want to look at each offering individually to understand the merits of what that brings to the table. You already have an existing alternative which could really suite you rather than looking for a new offering where there is no track record for that fund. I think that is something investors need to evaluate.
Let us get started, Morningstar has come out with a very exhaustive list of all these new fund offerings and what kind of funds they really are. I want to start with the thematic category first because this is interesting. After a long time, we are seeing interest back in pharma as you are saying. There is a new consumption fund that has come out the BNP Paribas India Consumption Fund. Now let us go step by step- consumption, for instances, is obviously the markets darling theme many of these stocks are already at their 52- week highs. How would you look at a consumption fund at this point when stock prices are really already alleviated?
The first caveat I would like to make is that if I am advising an investor to look at funds such as these is that your core portfolio still remains as it is with equity funds in your equity holdings. These will only be add-ons to your portfolio as a satellite portion and ideally, they shouldn’t form more than 10 percent and maximum 15 percent of your portfolio. That is the way I would play some of these themes.
When you talk about individual theme, now you could either have very sector specific funds like the ones you spoke about which is for instances the pharma theme, where we all know it has gone through its own set of troubles and it has been kind of a beaten down sector for quite a few years now.
But we are seeing that early green shoots of recovery on companies, again it is a very company specific thing, but that is happening. Even managers through their existing funds have been increasing pharma exposure, all be it in a small proportion, but they are looking to increase pharma exposure in their fund.
The two funds that have recently come out is basically looking at kind of bet that pharma is going through.  The fund is not only pharma, it is the whole diagnostics, and hospital play also which is more domestically driven part of healthcare; which is an interesting pie because that is also growing.
So, we talk about pharma where we talk about the domestic healthcare hospital segment that is also an exciting segment to look at. I would say that it could be an interesting play, but what becomes important is the timing. Because we have seen sectors do go through bad times. So this might be a right time to get in but you also need to think about the time that you want to get out of it.
Because when these sectors go off the radar they can go off the radar for a sort of years together. Memories of people who invested in a lot of the infrastructure funds back in the previous boom 2008-2009 those would still be around. But again if I go down to the specifics we are talking about the ICICI Prudential Pharma Fund and we are talking about the Mirae Asset Healthcare Fund. In terms of the people who are managing these funds, how do you rate them? Just overall track record because we don’t have past performance to go by over here?
Let me start with ICICI, if you look at the team at ICICI and specifically S Naren, the CIO has always had that contrarian bet of mind.
He always liked the things that are out of vogue.
Absolutely and he has been, when I spoke about managers increasing pharma exposure, Naren and his team have been doing that. Not recently but they have been doing that for a while now.
Clearly, that team obviously stacks up really well in terms of identifying those ideas. I would say if you take a look at this fund, it would probably be a good idea in terms of just taking exposure to healthcare if you do think you want to take an exposure.
Second fund from Mirae, again Neelesh Surana and his team excellent stock pickers. Just getting that fundamental valuation and the thought process behind a company and its intrinsic valuation they have done a really good job. Their pharma analyst is the one who has kind of also running the fund here. So it helps them get the right person to pick the stock.
Vrijesh Kasera, he is the person running the Mirae Pharma Fund.
I would say both extremely good offerings from two good asset managers. But again like I said if you want to take exposure beware that you need to get your timing of entry and exit right. This is not an evergreen theme that is going to remain, so think about that and don’t over allocate.
What is the personal rule of somebody who follows? If you are getting into concentrated thematic fund then should we cap at 10 percent of your holdings portfolio?
I would say overall sectoral fund exposure, thematic exposure should be more than 10 percent and maximum 15 percent and at a fund level probably each theme would be like 5 percent. If I am playing a couple of themes I will go for 5 percent for each theme.
I am going to move to the next theme and that is BNP Paribas India Consumption Fund. Now consumption is a boom word, it is a buzz word and it is an evergreen theme in this country, how do you rate the team at BNP Paribas and whether consumption fund specifically makes sense to you? I am sure almost every stock in this fund would already be at multi-year highs?
I will talk about the theme first. If you look at the theme and like you said it is the theme that has been playing and it is the darling of the street. But even if we speak to the managers today they are still loading up on the consumption theme.
It is not just your urban consumption or your rural consumption it is just picking up more and that is where you see even on the stock picks of diversified equity funds you have a lot of these consumptions stocks coming.
You are getting more and more stock listings on that, some of the luxury names. I think this is a slightly more evergreen theme from an India perspective where you can look to play for a slightly longer time period.
It is not something that is going to go, obviously, valuations have run-up but we would expect that this should continue. Again the team while we don’t really track them very actively but Anand Shah the CIO is a very astute manager. So, you would expect them to do a really good job when it comes to running this fund.
Let us come to the Sundaram Services Fund, again it is a new offering. What is the thought process rationale? When you say services that is really loose term right, so I am wondering what all this fund will look at?
Again, like you said the service theme is pretty broad-based. The first starting point is when you look at services as a sector it is the most dominant sector in terms of the GDP of the country.
But when you look at the representation within the stocks it is not necessarily all your pure service sort of companies and the ones which are the largest, they are kind of underrepresented in terms of services the ones they were looking at.
There is services catering to retail and individuals and things like that, communication services, tourism, hospitality and various segments like that. So, again there is a fair bit of play that you can get here. You could see new listings or smaller companies actually growing their share of the pie, getting into the retail, one segment which is growing.
But it is not completely kind of institutionalised in that sense. It still smaller players that are there but that is where you could actually see a lot of these plays fructify.
So retail is finding a lot of exposure within this fund. That brings me to the IDBI Banking and Financial Service Fund, now this one has lots of existing competitors already, why should I look at this fund, this NFO then?
Like you rightly said, I think it is more of a case of the asset manager creating a product which was missing in their basket. There are already enough banking and service fund and run for many years by a much larger fund house.
So, this is again a segment of the industry which is slightly more evergreen. We have seen the banking theme play out, it is going to part in India’s growth.  Consumption services, banking and services are the themes that I would want to think.  But there is a plethora of 20 plus funds that you can choose from. Then you need to really look at the pedigree of the fund managers that have been running it and their track record.
Coming to exchange-traded funds (ETF) because as a category its awareness is growing, people realise that these are cheaper options and if you are just going to mirror an index, why not look at ETFs. The Bharat 22 ETF was launched some time back, the second tranche. We understand that there is Bharat 22 Fund of Funds that have come through, could you explain the concept and product?
If you look at the traditional ETF, it is as the name stands exchange-traded fund – investor typically buys it on the exchange.
You need a demat account to actually purchase these securities and sometimes you do not get enough liquidity or the price you wanted at on the exchange. An ETF allows you to buy it at almost at life price but it also comes with some of these disadvantages.
This will change as ETF market grows and becomes much and more liquid. But for the pure retail investor who has traditionally been used to either signing a form or going online and buying a fund, the fund of fund becomes an easy platform to do it.
Essentially, the fund of fund is subscribing to ETF but operationally it becomes little easier for the investor to do it just online or sign a form and subscribe to the ETF.
This ICICI Prudential Bharat 22 ETF Fund of Funds is going to be an open ended fund, so you can write a cheque at any point an invest in?
We have also seen the UTI Nifty Next 50 Index Fund – this based on NSE’s Nifty Next 50 Index, which is the index of the next fifty big companies after the Nifty 50 companies. Are there any other such existing products on the market?
Yes there is one from ICICI already and it has got pretty good track record because that segment of the market has done well, that is where UTI has looked to fill the gap – they have Sensex and Nifty ETF but it would be nice for them to have Next 50.
With regards to the launches, what are the things to keep in mind because the composition of the online stock is going to remain the same? So, is costs the biggest factor? So, when you have similar ETF products on the market how do you pick and choose?
The cost becomes the most deriving factor because if all things alike, if you are mirroring the index, the cost is going to derive how much tracking potentially you would have.
Now we have seen most of the index/ETF providers drop cost significantly, so they would be in the range as low as 10 basis points going up to 25 basis points. There may be some outliers for differentiated ETFs which are higher than that. For instance, DSP had Equal Nifty 50 ETF which is not a pure play on the Nifty, rather they do an equi-weight of all 50 stocks that gives you a different flavour but your traditional bread and butter ETFs which mirrors the index, the cost becomes an important factor.
Beyond ETFs we have seen some interesting launches in the Hybrid category – the Kotak Balanced Advantage Fund and Invesco India Equity and Bond Fund. With regards to the Invesco Fund what kind of hybrid fund is that?
As per Sebi’s definition, this is what they call the aggressive hybrid fund -- essentially what this fund would do is buy equities in the range of 60-80 percent.
This is what the erstwhile balanced category was called, there are lot more other funds that are already available with long established track records. Invesco is kind of filling the gap in their products weight.
Coming to the Kotak Balanced Advantage Fund, the balanced category and it gives the AMC or the manager absolute flexibility to move either way the allocation can shift between debt and equity depending on market conditions. How would you rate this Kotak Fund because almost every AMC has a balanced advantage fund?
A: Quite a few of them do. If you look at the category, it is essentially the manager taking a call and looking at the equity valuations or whatever parameters they want to look at and deciding what the equity and debt allocation should be.
The flexibility is immense, as the mandate says you can go from zero to hundred in either of these asset classes. I do not expect such dramatic swings to happen but essentially the idea is that when investors are coming in, if they do not know what time is right to cut equity exposure, a fund like this could potentially do that for you. Either a manager takes a call on basis of his conviction that equities are undervalued/overvalued or some of them like ICICI run some models where they look at PE and price to book and take a call looking at its history -- is it into the overvalued or undervalued or fairly valued zone and they would decide their exposure.
So, this allows investors without having to do anything, actually dynamically get equity exposure which professional manager decides. It might be good for certain investors who do not want to take a call on asset allocation. Or more if they want to take a dynamic asset allocation call.
Morningstar came out with a report on the global analysis of mutual funds. In that report when it comes to fees and expenses, India is below average.
The report compares 25 geographies across the world on different parameters. So fees and expenses is one part of it but it also looked at regulations, sales practices and other thing.
This is an investor experience study, so India actually ranks average on an overall basis and we are top of the pack in terms of disclosures - portfolios being disclosed, transparency to investors. We are amongst the best, just along with the USA.
On the fees and expenses aspect, there are a couple of observations. We tried to compare all 25 geographies but with few caveats. If one reads the report in detail, we say for equity funds and balanced funds, India has amongst the most expensive expense ratios in the world.
We are one of the few geographies where the expense ratio is in excess of 2 percent. However, at the same time when you look at the money market and fixed income, we are fairly competitive.
So that is why India does not get the bottom grade on fees and expenses. The other reason is we have all bundled expense ratio and that is where some of the debate started around.
What we mean by bundled expense is that there is a management fee component, which the asset manager charges along with other costs that he incurs and there is distribution component that is imbedded into the expense.
Which now we are supposed to be told – that should also be a clear disclosure as to how much of that expense is actually going to distribution and commissions right?
Yes, it is more about each individual getting to know what his distributor makes through his portfolio. But the point I was making is the entire fees is one flat fee. So an investor, I can just go to a distributor and I get charged the expense ratio of the fund, I need not pay anything above that.
In some of the other markets, and that is what is happening globally now they are trying to break the two up and that has happened in most of the larger markets where you say we are unbundling the expenses, which to our mind is a better experience for investors.
Basically, you break up the management fees, you breakout the distribution commission per se. So when you get into the fund you are paying the management fee, which is a lot lower than the overall expense and then you pay an advisory fee or platform fee as per the services that you get.
If you are getting a pure execution, you will end up getting only a platform fee. If you want advice or you want some level of financial planning; so the value that you derive is the fee that you pay.
Right now from our context, we can understand that India is still a growing market and investors are still opening to the idea of MF investment. And these products are still being pushed through distribution channels.
That is where we have acknowledged that India is still higher than others. But the same time the regulator is asking is that once we are growing – like there are two elements – distribution fee - distribution is still hard to reach, you are still getting down to the lower levels or the smaller cities, so there is a cost involved to that.
But I think where the regulator is also coming as the assets grow. The management fees their economies of scale really kicks in that is where the regulator is trying to look at.
As you said India is one of the few geographies where the expense ratio is in excess of 2 percent. So, right now, we would be in the range of 2-2.5 percent?
It depends on the fund size. Some funds would be about 2.2 percent and it would come down marginally because the regulator has reduced expenses on one element by 15 bps but on an average when we talk about investor experience what an average investor pays is still in excess of 2 percent.
So we are in the below average category at 2-2.25 percent – the above average countries or average countries what is the fee there?
A: If you look at just the expense ratio of the fund, it could be as low as 60-70 bps in countries like the US, which is top-ranked but some of the average countries would be in the range of 1-1.50 percent.
The other point to articulate is the direct plan. We have all the ammunition to become a cheaper country. The study was meant to look at on an average what investors are paying to buy a fund. And in India, traditionally most of the investors have been in regular plan and if you look at the numbers, about 86 percent of equity investors are in the regular plan and that is understandable given that we need hand holding but the direct plan also needs to start picking up now.
It is almost five years since the direct plan was launched and there are enough savvy investors in the country who do it themselves.
The question we need to ask as an industry expert is what are we doing enough to promote direct plans, at least investors need to be aware of that.

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