Unless earnings catch up, mid caps could further correct

By Morningstar |  24-08-18 | 

Bismillah Chowdhary, chief investment officer at Edelweiss Tokio Life Insurance, talks to Ravi Samalad about where he is finding value now, and why ULIPs are more attractive.

Advisers say that it is better to buy a term plan and invest in mutual funds. Why should individuals invest in ULIPs?

I would have had to agree with this statement a few years ago. In the last 5-6 years, there have been plenty of changes in regulations which have made ULIPs as attractive as mutual funds. Equity should be seen as a long-term investment. A Ulip Linked Insurance Plan, or ULIP, forces you to be disciplined since it has lock in period of 5 years. If investors see positive returns, they are tempted to book profits. The longer time the investment remains, better are the returns. Investor’s money is working for more years because of the lock in.

How competitive are ULIPs now vis-à-vis mutual funds in terms of expense ratios?

In case of ULIPs, there is a small amount of mortality charge, fund management fee, and administration charge which gets deducted from premium. Mutual funds charge expense ratio which can go up to 2.5%. In ULIPs, the fund management fee is around 1.3%. So there is close to 80-90 basis point edge year on year. In the initial years, the mortality charges are higher. Our research shows that the expense ratio of mutual funds vis-à-vis ULIPs, including all charges, gets net off after few years. Further, you get insurance after few years without any cost. The newer generation of ULIPs not only offer low cost structures (including the insurance cover cost) but are directly comparable with mutual funds which make them more lucrative. The premiums are tax exempt and more importantly the maturity proceeds are tax free (provided the Sum Assured is 10 x premium) which provides an added advantage.

How often do you typically reshuffle your portfolio?

We are constantly looking for quality companies with good management which have shown consistent growth.  For instance, a company which has the potential to become a market leader or has carved out a niche for itself in the industry. We try to assess a company’s future prospects based on a scrutiny of its financial statements. We try to project its future earnings and based on them, estimate its value. The company is added to the fund based on its risk-return objectives. We have always followed this strategy and it has worked out almost every time.

How are you looking at REITs as an investment option?

We keep evaluating new instruments. If it fits in our scheme of things, it will find a way in our portfolio. REITs when it comes to the market and allowed by IRDA could be an interesting proposition to be looked at by the insurance companies as it could provide diversification and help in asset liability management. As per current mandate, at least 80% of the REITs’ assets will have to be invested into revenue-generating and completed projects.

We always seek to invest in assets which have long duration given the nature of our products. REITS satisfy most of these criteria.

Have you invested in any recent IPOs?

The IPO space in India has been interesting and will continue to be interesting. As capital markets mature, new themes/companies will go public. Over the last 2-3 years, many new businesses like insurance, asset management, diagnostic firms, and staffing agencies have got listed. It’s a beautiful opportunity for retail investors to participate in these issues through institutional investors. We evaluate any new IPO on its merits. We have participated in most of the good IPOs.

How have you positioned your debt portfolio given that RBI has hiked the repo rate?

We have turned bearish on the yield over the last nine months. Our positioning is lighter in duration vis-à-vis benchmark currently. We see a lot of headwinds in terms of fiscal slippage, elections, rising crude, depreciation of rupee and rising inflation. All these factors don’t augur well for yields. We’ll rather be on the short end of the curve.

There are different portfolios in insurance.  There is policyholder’s portfolio and a ULIP portfolio. In policyholder’s portfolio, the liabilities are long term in nature. We do asset liability management against these portfolios. In policyholder’s portfolio, irrespective of our view, we have to align our portfolio to meet long term objectives. If a policy has duration of 12 years, we have to invest in a security which matches this duration which helps us avoid reinvestment risk. That doesn’t mean we are bullish on yields.

In ULIPs, we are more benchmark driven. If our benchmark has duration of X, we have little less duration than the benchmark.

How do you ensure to offer guaranteed returns in some of your products?

We tend to avoid asset liability mismatch. If we have guaranteed a liability, we try to match it with an asset. We invest in assets which will generate appropriate cash flows for us to meet the future liabilities and generate guaranteed returns for the policyholders.

 How is your PE fund currently positioned?

It’s a contra fund in some sense. As the market goes up, we reduce the equity exposure and vice versa. If you do that over a long period of time, your expected return is better than just following the market. If the market is close to PE of 11, the equity exposure will be high. Historically, the PE band of Nifty has been in an approximate range of 10 to 25. If the market PE is close to 25, we will reduce the equity exposure. We have back tested the model and arrived at appropriate levels to make the decisions.

Alpha in the large cap space is diminishing, mid caps have seen a correction. How are you tackling this?

There is such a high dispersion of returns within the benchmark - 80% of the Nifty returns driven by 5-6 stocks in the recent past. Given that, it has been difficult for most of the funds across the industry to outperform the benchmark. This isn’t sustainable in the long term. The breadth in the market will improve and other stocks will catch up. A fund has to be evaluated over a longer period of 3-5 years for its capability to outperform benchmark.

Mid-caps have been always been a bottom up story. Historically, they have traded at a discount to large caps from a valuation perspective, while currently they are trading at a premium to large caps. If earnings don’t catch up, there could be room for more correction in mid caps. Having said that, there are always opportunities in the mid cap space.

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