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HISTORY REPEATING ITSELF IS HISTORY'S OLDEST STORY - STEVE WICK
There have been many conflicting & confusing articles in media (http://goo.gl/yTdCK3, http://goo.gl/kl2D2u & http://goo.gl/PMkNxY) about whether there is any story brewing in Duration schemes. In the recent past, this call was given in January 2013 with some disastrous results. In spite of that industry had once again started giving an aggressive investment call in Duration theme in mid-2014. Post that, RBI cut interest rates on 2 occasions. However, interest rates have only inched up thereafter. Unfortunate part of this whole saga is that AMCs as well as Advisors invested funds of retail investors in this theme; thereby bringing only volatility in their portfolios with negative bias over short to medium term.
Those who have been in the Mutual Fund industry since 1995 will relate to what I have to say below.
Let us put bond markets in perspective (from 1995-2003)
Interest rates were hovering towards higher double digit figures since 1995 (since MFs started becoming popular in India). Since 1995 to 2003 interest rates were on downward spiral as RBI was cutting interest rates almost every quarter (this was the only structural Bull Run in debt markets). Interest rates touched a new low in November 2003 @5%. Since then to end 2004, interest rates (for the first time) inched up to 7%; thereby generating negative returns for that year. Till 2003, Income funds were sold as safe havens.
Above table shows that since 1998 to 2003, Income schemes did extremely well with no negative observations on daily 1 year rolling & with a very high average returns of 13.42% p.a. This, as I mentioned earlier was true structural Bull Run in debt markets.
Above table shows data from 1998 to 2003 of 12 schemes (in existence since 1998). In percentage terms, 98.66% of total 967 observations posted returns higher than 10% during this period (with no negative observations over daily 1 year rolling in the same period).
Since then to now, long bond funds (duration call in industry parlance) has never made money for the investors on a consistent basis. It is more like a trading call & one needs to be aware of when to give disinvestment call (disinvestment calls are more important than investment calls). Though Income funds have not generated negative returns on 1 year plus investment horizon (except for those investors who invested in 2003-2004 when interest rates went up from 5% to 7% in one year); 1 year rolling returns analysis of top 12 Income schemes which were in existence since 1998 will throw some startling figures on how these investments have done.
What the above table show cases is that those who invested in Income schemes between 2004 till 2015, minimum returns generated was -3.97%, maximum of 18.18% with an average returns in all 12 schemes (with number of observations as high as 2545) of only 6.24% p.a.
Was giving investment calls in Income schemes with such average returns worth it?
Following break up will further justify my argument of not investing retail funds in these schemes & why these are more of trading calls:
Above table shows data since 2004 till 2015 of the same 12 schemes (which were in existence since 1998). These schemes had generated negative returns only 1.57% of the total observations (these observations were witnessed for investments between 2003-2004 as mentioned above). Returns between 0-6% p.a. were observed in 55% of total observations, 6-8% returns were in 12.69% of total observations & above 10% only 15.32% of total observations.
With such low probability of earning double digit returns; logic defies me as to why does the MF industry fall prey to this trap time & again & does not learn from their own past mistakes?
Since then history has repeated on a number of occasions; wherein industry gave an investment call in duration without giving timely disinvestment calls. Something similar happened in 2008-2009 & 2013.
We (MSJ Capital) gave an investment call in Income funds in November 2008 when 10 year benchmark yield was at 7.50%. It came down to 5.50% by December 2008; thereby generating almost 20-25% absolute returns & 100-150% annualized returns over 20 day holding period. MSJ Capital gave an aggressive disinvestment call in December 2008 whereas the rest of the industry gave an investment call in Income funds in January 2009 when interest rates went down marginally from 5.50% to 5% & then started inching up beyond 7% in the same year.
Again in January 2013, industry gave investment call in Income schemes. This call generated 12-15% p.a. till April 2013. Fed announced tapering off of QE in May 2013. Funds started flowing out of emerging markets, INR started depreciating, there was a threat of imported inflation (due to import dependency of India on crude) & hence instead of cutting interest rates, RBI increased interest rates. During these months of May & June 2013 when the above negative story was panning out, industry was in denial mode & maximum collection in Income funds happened between these two months. (Following data will highlight these facts). Again history repeated itself & investors suffered in the bargain.
Dust had still not settled down on 2013 fiasco. Once again industry started talking aggressively about investing in duration schemes in mid-2014 onwards. RBI cut interest rates twice during this period when 10 year benchmark had eased to 7.65% or thereabouts. Post the cuts, interest rates have started inching up due to crude prices going up by more than 40% from its historic lows of $50/bbl. There is every likelihood on US halting its soft stance on interest rate (due to improved data) & actually increase rates at some time in future. Globally interest rates in some countries have touched their historic highs form their recent lows.
All the above factors & domestic issues of unseasonal rains, likelihood of below normal monsoon, inflation inching up (post base effect impact getting over) & other political issues will keep interest rates choppy, volatile with some upward bias over short to medium term.
Now Let us analyze expectations of Retail Investors
Investors are happy with 6% post tax returns (9% on FDs less tax of 30%). That's why there are almost 82 lac crores of FDs in the system v/s only approx.1-1.50 lac crores in Long & Short Term bond funds (not including FMPs & Liquid fund category).They are looking at predictability, regular cash flow & lower volatility. However, MF industry is hell bent on selling them story of higher double digit returns (that are not sustainable over longer periods of time); thereby increasing volatility & lesser predictability. If underlying securities earn only 8% returns, for how long can income funds generate double digit returns on a sustainable basis? (Unless we were in structural bull run in debt space like from 1995-2003).
I have been shouting from the rooftops (whenever I conduct workshops for IFAs across the country) that you need to take Long Term Bond funds (duration calls) out of your system & whatever maybe the temptation or industry call, do not sell these to retail investors who have not come to you for trading on their behalf (as mentioned above, these calls are more trading in nature than investment). Investors lock in their funds for 3-5-10 years in FDs.
Hence, do not overreach your investor mandate. Put income schemes (duration calls) in negative list & should never be for the consumption of retail investors.
I hope at least now, after so many failed attempts at outguessing interest rate scenarios & trying to outguess what RBI Governor is likely to do, industry learns from their past mistakes & not sell duration story to retail investors.
Let this story be sold to savvy investors like Corporates, Institutional investors & HNIs who have the risk taking ability & can take an informed decision on investing in these themes. This is with the assumption & hope that their advisors will give them timely disinvestment calls (unless they have invested under DIRECT mode & are depending on AMCs to give disinvestment call - which is unlikely).
Please note that I am not suggesting through this note about the possibility of Income Story panning out or not. That only time will tell. All I am suggesting through this note is that:
Advisors should give investment call in an asset class (especially duration in debt schemes & sector calls in equity schemes) only when you are capable of giving disinvestment calls at the right times Retail investor portfolios can surely do without this asset class & reduce volatility in their portfolios. Their investment mandate starts from the premise that they were happy with 6% post tax returns without any volatility Both AMCs & Advisors need to understand as to which segment of investors these duration calls are targeted. If sold to retail segment (which as I have been saying should never be done), explain the RISKOMETER before coming out with these calls
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Mr. Bond is shaking his head with disbelief. Yet another round of bond market volatility, yet another round of retail investors feeling uncomfortable in duration funds that they bought into in the quest of double digit returns, and yet again calls to add duration into portfolios. Adding duration in portfolios is absolutely fine says Sunil, provided you know when to exit. Buy calls will come from fund houses, but advisors must learn to take their own sell calls, as duration strategies are essentially trading bets, not long term investments, he stresses. And, if you as an advisor don't know when to tell your retail clients to exit, please don't make them enter duration funds in the quest of higher returns, he urges. Sunil traces the history of bond market returns over the last 20 years to reinforce his argument that duration funds are only good for advisors and investors who are savvy enough to take their exit call proactively and independently. For the rest, Mr. Bond's message is simple : please stick to accrual strategies and ignore duration calls from fund managers - they are not for you.