Mr. S. Naganath is the President and Chief Investment Officer of DSP Merrill Lynch Fund Managers. He joined DSP Merrill Lynch Fund Managers in 1996 as the Chief Investment Officer. Mr. Naganath has also worked in Hong Kong as a portfolio manager with Merrill Lynch Investment Managers and GT Management. He is a commerce graduate from Madras University and holds a Post Graduate Diploma in Management from IIM, Ahmedabad.
In an exclusive interview with Personalfn, Mr. Naganath gave his view on the markets, interest rates and explained the investment philosophy followed at DSP ML Mutual Fund.
Pfn: What is your view on the markets, from a short-term (1 year) and long-term (3-5 years) perspective?
Mr. Naganath: Over 3-5 years, markets are likely to remain positive based on the underlying rate of GDP growth, which is effectively atleast more than 7%. We expect corporate earnings to grow atleast by 15% compounded annually over a 5-Yr period. So if we look at the historical returns for the last 20-25 years, equities have given a return of about 15% compounded annually. Hence, the same projection should hold good for the next 5-10 years.
Over a short-term (1-Yr), I think there are external market factors that will be moving the markets like, hike in interest rates, increase in commodities prices, increase of inflationary pressures and continuous shoot up of oil prices. These are the external factors that affect equities worldwide. From the domestic standpoint, I don’t see anything that is of a particular concern this time; whether it is the momentum of economic growth or corporate earnings growth. In general, I believe that the growth project ratio should be maintained at 7% of GDP level.
Pfn: What is your view on interest rate over the short-term and long-term?
Mr. Naganath: Over a long-term it is very difficult to predict. For the time being, the rates are high, and will continue to rise by atleast another half a percent over the next 3 to 6 months. But it is very difficult to gauge how they will behave over 3 to 5 years.
Pfn: How do you see the Indian economy unfolding? Any significant positives or negatives?
Mr. Naganath: Higher oil prices is one factor that can slow down the growth rate. Also higher commodity prices in general and fuel inflation can have an impact on the same. Around the world, interest rates are rising in order to combat inflation that will again slow down the growth. But I don’t think that it will cause growth to slow down too sharply. It may remain in the range of 7%-7.5%. Thus in my view, even 6% or 7% in an environment where growth around the world is slowing down is a good rate of growth.
Pfn: Your views on infrastructure spending
Mr. Naganath: We are bullish and we think that it will be one of the key drivers of economic growth over the next 10 years. One of our funds i.e., DSP Merrill Lynch India T.I.G.E.R Fund is a thematic fund based largely on infrastructure spending and economic reforms. The momentum we see in many areas of economy with regards to infrastructure spending has just begun.
Pfn: Could you please explain/describe the investment philosophy and style (equity and debt funds) that is followed at DSP ML Mutual Fund?
Mr. Naganath: On the equity side, we adopt a top down cum bottom up approach and our bias is obviously towards growth. Typically we find that our funds have about 65%-70% in large cap and about 20%-25% in small and mid cap, and around 3%-5% of liquidity is maintained. We do bottom up stock selection based on sectors we like, and companies we think in those sectors that will do well. We also overlay macro strategy i.e. where we think in general the overall economic growth is headed, what is the earnings growth across sectors and what is the view on interest rates, inflation among others. I think it’s the combination of both these factors that help us arrive at the right composition in terms of sectoral weightage. We then select stocks that will outperform within the sectoral context.
On the fixed income side, we focus more on the liquidity aspect and building a quality portfolio. Interest rate view is restricted to securities typically less than 1-Yr, and focus is on portfolio quality, liquidity and interest rate analysis.
Pfn: Is the churn in the fund management team likely to impact the performance of schemes from DSP ML Mutual Fund?
Mr. Naganath: I think the process is pretty much well established, and that is how large fund management firms around the world operate. Thus, irrespective of whether somebody is coming or going, as long as the investment philosophy and the process is well established and imbibed by everybody who works, the performance and general approach to investing continues to remain unchanged.
Pfn: In your view how much of a diversified equity fund’s portfolio should be invested in the top 10 stocks?
Mr. Naganath: Our top 10 holdings typically account for around 40% of net assets.
Pfn: In a diversified equity fund, how concentrated/diversified should the sectoral allocation appear?
Mr. Naganath: Again it depends. When we are in a raging bull market, pretty much all sectors participate and obviously the challenge is to find out which sector is better than the other. I would say that on an average, we would have exposure to anywhere between 7-10 sectors at a time. So while we believe in diversification, I don’t think we operate in too many sectors and stocks as then, the fund may end up looking like an index fund. Our objective is to beat the benchmark by a reasonably good margin.
Pfn: In an economy like India, which is in a growth phase, do you think value funds can outperform growth funds over the long term?
Mr. Naganath: Well it depends how you use the term value and growth. It would be fair to say that India is in a growth phase as you have pointed out. In value funds you take a long-term view on the markets and adopt a buy and hold strategy. The portfolio turnover might be lesser than in an opportunities fund which is more dynamic in terms of sectoral allocation. So, if the equity fund is seen as one that takes a strategic view of different sectors or has strategic position on different sectors, the opportunities fund is more tactical in nature. This is the distinction between these two funds in terms of investment approach.
Pfn: One school of thought believes that investors give money to a fund manager to invest in stocks and not for holding cash. Others believe that market conditions should determine the corpus held in stocks and cash respectively. What is your view on the same?
Mr. Naganath: As long as you are running an open-ended equity fund and have a benchmark index to beat, the objective is to stay reasonably fully invested. I think the typical cash holding should be between 3%-5%. But if you are going to be evaluated against an absolute return benchmark, then I think you can moderate the cash holding in a different fashion. Hence, for a mutual fund that is benchmarked to an index; the approach is that you should normally be fully invested most of the time. In our case we generally don’t go beyond 10% cash and on an average we have nearly 3%-5%. The decision to stay invested in equities or not, or to stay in funds or not is that of the investor.
Pfn: When we look at a value fund, we expect the fund manager to only invest in the market when there is a value?
Mr. Naganath: Don’t look at in terms of nomenclature. For example, DSP ML Equity is a value fund, which is a diversified equity fund and as I said, the intention is to take a long-term view and to ride that view over atleast 12 months or more and in that context we will see a lesser portfolio turnover than in an aggressive equity fund. Its benchmark is the S&P CNX Nifty (which is also the benchmark for DSP ML Opportunities Fund).
The fund has done well, during the secular trend in the markets like we have had over the last 3 years. Some times there is great merit in just staying fully invested and not rapidly turning over the portfolio and that is one reason why the fund has done extremely well.
Pfn: Have the new norms for balanced funds forced you to take on higher risk in your balanced fund offerings? Do you think there is a void in terms of a low risk balanced fund, which can invest 50%-60% of its corpus in equities?
Mr. Naganath: That’s the new rule and obviously all balanced funds have to follow the 65% (of net assets) equity rule in order to qualify as equity-oriented funds. To the extent that it is different from an equity fund is that, in an equity fund the equity holding is normally around 95%-97% whereas balanced funds have equity holdings hovering around 65%. Thus, it is able to distinguish itself from a typically diversified equity fund. The median invested amount for most balanced fund was about 60%. To the extent though it is now at 65%, I think it’s only a marginal difference from the earlier scenario. I don’t think it will make a major difference to the balanced fund category. We do have a range of funds with a bit of equity like the DSP ML Savings Plus for instance (that has three plans with equity components ranging from 10% to 30% of assets).
Pfn: Sector/thematic funds (like infrastructure) made a come back of sorts during the 2005-06 bull run. Your views…
Mr. Naganath: It depends. Sometimes sector funds are in flavour and sometime they are not. One cannot just launch series of funds because they are in flavour at that point of time. We also have to look at the shelf life and creditability of the fund. That’s one reason why even in the market place we haven’t seen a series of sector and thematic funds. From our standpoint we have launched these fund 2 years ago and we haven’t had any fund launches in 2 years now. We do it only when we think that there is a product gap in our own portfolio that we need to fill or there is also a particularly enduring theme that we think will sustain over a longer period of time.
In case of the DSP ML India T.I.G.E.R Fund, it is a very well known brand. I believe in the mutual fund space and the theme that it seeks to address, which is infrastructure and economic reform; it will remain an enduring theme for the next 5 to 10 years.
Pfn: Any new funds on the anvil?
Mr. Naganath: It’s little too early to talk about it. Our team is looking at different new ideas, and hopefully at some point in the next 3-6 months we may come out with a new product. Like we said, we don’t believe in just launching products but we believe in launching products that will fit into our family of products and are in line with the investor’s requirements.
Pfn: What kind of books do you like to read?
Mr. Naganath: I am a great fan of books on business economics.
Pfn: Where do you invest your money?
Mr. Naganath: Actually I am a very conservative investor in that sense. I have some money in mutual funds (like schemes from DSP ML Mutual Fund), equities and debt instruments.
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