Interview | Feroze Azeez's top mutual fund picks; says avoid smallcaps

At a time when the growing participation of retail investors is making news, it becomes all the more important to ensure the awareness related to various equity products in the market reach them without them being misled by those with vested interests.

At Money9, it is our endeavour to serve you with information and expert views which will help you in shaping your investment strategies.

As a step in that direction, we got Feroze Azeez, Deputy CEO of Anand Rathi Wealth Management, to decode the complexities related to asset allocation and what should be the ideal mix for various categories of investors.

Edited excerpts:

Q: Markets have hit all-time highs, driven by retail participation. Which themes should investors be focusing on now?

Azeez: Instead of focusing of one or more specific themes, investor should invest in diversified portfolio for generating consistent returns. There are various themes playing out at various points of time in the past few months as in February, PSU/PSB performed post-Budget and privatisation talks. Post that metals and speciality chemicals performed in hope of better Q4 earnings and post that commodities performed. Now as GOI indulge into privatisation of BPCL other PSU/PSB might perform as other companies also in pipeline to be privatized over few months and years. So at various points of time various theme will play out in medium to long term. Market is almost at all-time high level and states governments have started process of unlocking the lockdown as Covid cases reduce and vaccination picks up. So you should invest in below diversified portfolio to capture most themes and generate consistent returns.

Q: Last time we spoke, you mentioned Balanced Advantage Funds should be part of an investor’s portfolio. But recently, the smallcap and midcap stocks and indices have come into focus. Should retail investors consider these?

Azeez: Basis the current valuations, we suggest our clients to maintain a 60% largecap allocation and 40% midcap allocation. This can be achieved by investing into five categories, i.e. Large cap, Midcap, Large and Midcap, Flexi cap and focused fund.

We do not advice investing into smallcap funds for the following reasons:

1. The small cap categories tends to be more volatile, around 5-6%, than other categories such as large cap or mid cap. This can be explained basis the underlying companies which has small size and market share and hence often cannot accommodate any disruptions.

2. Though smallcap can give you superior returns in smaller investment period such as 1 year or below, but as can be seen in the below table, in the longer investment horizon the other categories tends to catch up with the small cap categories.

3. Further, similar returns delivered by the small cap companies at a much higher risk levels indicate that on the risk-reward ratio it fares poorly as compared to the other categories.

4. Also another factor that makes small cap quite risky is the divergence of returns within the category. As can be seen in the below table, the difference between the best performer in the small cap category and the worst performer is significantly high ranging from 9% on 5 year time frame to 17% on 3 year time frame. This means that it’s quite difficult to pick a top performer fund in the small cap category as the returns vary significantly within the category itself.

Q: For someone, hypothetically, with an investable corpus of Rs 1 lakh – what should be the ideal allocation in mutual funds? Which funds would you suggest across the largecap, midcap and smallcap categories?

Azeez: Assuming that the investor has an aim to grow the wealth over longer horizon and has identified the asset classes suitable to meet the goals, then one should look at following funds with mentioned allocation:

Q: Does this ratio change for someone with Rs 10 lakh to invest?

Azeez: The allocation remains same as Q3 given an amount of Rs 10 lakh is to be deployed into equity mutual funds only after identifying of asset allocation.

Q: Lately, there is a trend mushrooming of some investors migrating to smallcases from mutual funds. Do you find smallcases sustainable instruments to outperform mutual funds?

Azeez: What needs to be understood here is mutual fund is an instrument of investment whereas smallsase is an investment platform where ETF, thematic and sectorial portfolios and basket of stocks and gold are offered as investment options. Hence, it is not an apple to apple comparison.

Mutual funds as investment vehicle has proven track record with SEBI addressing investors grievances, pursuing transparency in the product and framing new regulations to safeguard investors interest. Smallcase as a platform has individual investment managers, who have launched their baskets for subscription fees.

After SEBI categorisation, categories with well-defined investment objective are available in market. Categorisation has enabled fund managers to define their universe of security selection which explain risk and return expectation from the fund. This has allowed investors to choose mutual funds effectively to meet their asset allocation and return expectation. For example, an investor who prefers taking risks may go for smallcap fund whereas a conservative investor will look for largecap funds where volatility will be less.

Such flexibility isn’t available for smallcases. Same product is available for every investor irrespective of risk profile.

Also, dividend received can be fully invested in mutual funds which will lead to further compounding while in smallcase, one will receive it in its bank account and has to pay taxes before reinvesting again. Also, one has to pay taxes while rebalancing their portfolios in smallcase.

We must also keep in mind, stock selection and alpha generation is a specialised work. One has to carefully invest in appropriate proportion which will yield maximum returns. In mutual funds, FM looks after rebalancing securities but in smallcases, investors have liberty to tweak proportion of securities which might affect performance.

Q: Is cryptocurrency something you are advising Indian or NRI clients to put some money into?

Azeez: The basic tenet of an investment in a currency is its stability of price. Currencies are used in transactions and hence for them to continue to act as currency, the price should be stable. Crypto currency defy this idea.

If one invests in crypto currency assuming as an asset, it is very difficult to calculate the value because of absence of tangle asset backing the currency.

Recently, we have seen many countries trying to regulate or ban crypto currency related activities. China has banned banks from providing services to crypto currency transactions, trading has been illegal in China since 2019. US is also working to set up policies around crypto currency. In India, RBI has directed banks to stop dealing with crypto currency exchange.

In absence of a global consensus on crypto currency and regulations around it, one should avoid crypto currency.

Q: Sovereign Gold Bonds – six tranches announced for this year. But gold has risen from 45k levels to 50k levels. Right time to invest?

Azeez: The view on gold is not positive because in the past, gold has not given great returns in dollar terms as well rupee terms. Seven out of the top-10 countries (according to their gold reserves in tonnes) have not added gold to their reserves in last five years and are unlikely to add more. Given that the outlook on gold, demand is not promising and the yellow metal is unlikely to give great returns in the near future.

With central banks unlikely to add more gold to their reserves and falling consumption demand, it is unlikely that prices for gold can go up.

But if somebody wants to invest in gold, gold bonds are a better option than physical gold. It should be bought only if it would be needed from a consumption standpoint at a future date. Gold bonds also give 2.5% interest per annum.

Q: You advice the HNIs on how to become richer. Is there a golden rule that the common man can apply and get rich overnight?

Azeez: One should always keep in mind that there is no product that makes one rich overnight. One has to be patient and stay invested through the investment journey with proper strategy, clear objective and assessing the performance periodically.

Asset allocation is the key to generate returns. One should first asses its risk profile and then determine asset allocation which is being followed by investment into suitable investment vehicles. Over or under allocation towards any asset class can lead to sub-optimal performance from portfolio.

There are various products in each asset class available to invest. One should remember returns anticipated by any product is directly proportional to the risk being taken by product. Hence higher the risk, higher the returns expectation. One should always check whether risk profile of investor allows to take higher or lower risk.

Another important factor to grow wealth is compounding. One has to set a long objective and invests accordingly without exiting in between or tweaking the allocation. Volatility is a part of investment journey but one shouldn’t exit out of fear.