ICICI Prudential MF K S. Why Naren suggested betting on debt

Naren—known for his contrarian investment styles—supervises 4.7 trillion worth of investor wealth. In an interview with Mint, he talks about the Mutual Fund (MF) industry, the importance of asset allocation and how the current market corrections are going to impact the industry. Edited excerpts:

You have recently given an asset allocation call in favor of debt over equity. Can you elaborate on this? Also, what is your view on gold?

In the last 13 years, Corporate India can easily borrow at very low rates (close to zero) globally. Today, this is no longer the case, given that rates have gone up. Domestic corporate entities, which have been rated AAA, may have to borrow locally. The flip side is that Indian equity valuations are not cheap. This will not allow equity valuations to rise substantially when the demand for credit from corporates and banks rises amid tight liquidity environment. Hence debt becomes an attractive asset class and bigger returns than equity will not be easy here. Debt funds look attractive right now because of their high yields due to high inflation and rising interest rates. Unlike the last two years, we believe that investors should start investing in debt.

Separately, a combination of structural failures in cryptocurrencies, coupled with the tapping of global central banks, makes gold and silver interesting. When it comes to gold, the call was that the yellow metal could do well when the US Fed moves on a bearish path. Another aspect that gives us more confidence is that when cryptocurrencies stop being a source of comfort for investors globally, they will move back to gold. Unlike gold which is not dependent on any central exchange or individuals, cryptocurrencies are dependent on investors.

The Multi-Asset Fund recently completed a historic year. It has done better in recent times. What do you attribute to this?

If you consider the 20 year history of multi-asset funds, including the fund in its earlier avatar (dynamic plan), it has been an interesting experience. At ICICI Prudential, we believe that counter-cyclical investing is an interesting way of looking at equity markets and we can be agile in our investment approach. At different points of time, quality, value, growth, small and mid cap, large cap, PSU etc become cheaper. Being a multi-asset fund, apart from equity and debt, we are permitted to invest in Silver, Gold, REITs (Real Estate Investment Trusts) and InvITs (Infrastructure Investment Trusts). So, this is a fund that is managed by a group of investment experts at ICICI Prudential. They look at different asset classes that may behave differently under different economic and market conditions. Each asset class has its own performance cycle. We believe that in the coming decades as well, the counter-cyclical approach will continue to be an effective method of investing, but one must be prepared for short-term underperformance.

Within equities, do any segments (large/small cap) or sectors look attractive?

In terms of market capitalization, on a valuation basis, large caps are better placed than small caps, and small caps are better placed than mid caps. Large caps have witnessed a significant correction, owing to significant selling by FIIs (Foreign Institutional Investors). Meanwhile, mid cap pockets have record valuations, and small caps continue to offer names that are still available at attractive valuations, making them better positioned from an investment perspective. On the regional front, we are positive on Banks, IT, Pharma, Auto and Telecom.

You are nearing completion of two decades with ICICI Prudential AMC. What’s been your most successful call, and what’s the biggest mistake you’ve made?

Our apparent success was something that happened a decade ago (after the global financial crisis). We realized that retail investors often fail to benefit from equity markets because of their behavioral reasons and not because the market is not giving returns. Hence, we decided to popularize the Balanced Profit category which has a counter-cyclical approach. Today, that category has emerged as one of the most popular and well-received categories among the masses.

From a failure point of view, while we believe that debt mutual funds play a major role in the MF industry and in the investor’s portfolio, debt funds have failed to attract the attention of investors who look at past returns without considering them. Risk-adjusted returns. The thought process is still affected today by the negative credit incident that happened to some fund houses in the past. What investors fail to understand is that there were funds that never faced any problem even in the midst of a crisis. For example, at ICICI Prudential, there has never been any delay or lapse in the last 23 years of our existence. In 2017-2018, we actively encouraged investment in debt. However, when debt mutual funds started giving lower returns (2020-2021), we did not focus on investing in this category. Now that debt has become attractive, we are encouraging investors to consider allocation for debt, but there is not much attractiveness, at least to the extent we expected.

There are markets globally which have not given any returns for decades. Why do you think India is different and will continue to deliver returns over the next decade?

From an equity investment perspective, the 90s were a challenging time. Nifty 50 had touched its peak in 1994 and in 2004 the market was at the same level. So, we also had a lost decade. It also learned a lesson that if you have political, policy or macro-economic volatility, it is very challenging to generate returns. Currently, the government recognizes that both investors and corporates have an important role to play and this is a big positive. Another concept is assessment re-rating and de-rating. Currently, Indian equities have been re-rated, while de-ratings have taken place in many other parts of the world. At the re-rating stage, it is imperative to be careful about asset allocation and make a prudent allocation to other asset classes such as debt.

The MF industry today has a ceiling when it comes to foreign investment. If you had the freedom to launch a foreign fund right now, would you do so and which market would you target?

We believe that global markets present an attractive investment opportunity following a sharp correction, but people are reluctant to invest given the recent negative experiences. In our framework, whenever a sector or thematic fund makes a large negative return, say around negative 40% over a one-year time frame, it becomes a good point to evaluate the offering and, if satisfied, such Can be positive on occasion. It was on this basis that we launched ICICI Prudential US Bluechip Equity Fund in 2012 when the US markets did not give any returns for almost 12 years. Over the years, this framework has worked well for us, and we are confident in this approach. This is the reason why we have recently launched a Commodity Fund and a PSU Equity Fund, as we do not worry about the dilution of past returns.

Some of the new age tech stocks listed in 2021 have come down significantly below their IPO prices. Do you see any value in them?

We are learning to value new age companies. It’s a challenge, because some of these companies don’t have earnings. Hence, there is a need to learn in valuing such companies.

Are You Bullish on the Yield Curve?

In the current market environment, we are comfortable with medium term accrual products as they have good yield to maturity. This is not a phase of long term risk.

With ICICI Pru MF schemes covering almost every investment style, sector and theme, how do you indicate the strategy to investors? For example, you may be bearish on Pharma (hypothetically), but you also have healthcare funds. You may be bearish on large caps, but you have a large cap fund.

Being a large AMC, we offer a range of offerings that are managed to suit different investment styles and objectives. So, this is not a model type approach. There are schemes like Thematic Advantage, wherein the fund manager has the flexibility to invest in different themes which we believe will benefit but otherwise each fund will run as per its own mandate. For example, technology and pharma underperformed in the last one year, while banking gave good returns.

How do you stay focused on your bets, especially contrarian ones, when there is likely to be a lot of negative news flow?

Working for over three decades has the advantage that it enables you to reduce noise. At a fund house level, we have put in place a framework for hiring new analysts, and gradually inculcating them with fund management responsibilities, instead of hiring fund managers from the industry. Today, most investment team members who are successfully managing a variety of strategies are internally prepared. The team also has enough resources. All this has enabled us to create a good culture and make counter-cyclical investing exposed to experiences where the early stages of investing may not necessarily generate returns, but with patience, most calls work out in the long run.

For example, we bought metals in 2018 which did not work for two years but gave returns after that. Similarly, we bought power and telecom in 2018, it again did not work for two-three years, after which the call came.

The absence of biases and a superior investment culture allows budding investment professionals to absorb the counter-cyclical thought process, which can otherwise be very challenging given the emotional problems associated with such an investment thought process.

In the large cap space, do you see active funds generating alpha?

The challenge here is that we must take an active part, be patient and allow the investment to generate returns. In this way, one can create an alpha. On the other hand, if you go too close to the benchmark, it won’t work. The challenge for Large Cap Funds emerges from flexible mandate strategies like ICICI Prudential India Opportunities Fund, which has a lot of active stock and has generated good alpha for investors over the past three years. This is also the kind of offering that can go through phases of poor performance. Thus, it is going to be an uphill and an ongoing battle, which itself makes room for passive strategies to coexist.