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Amit Bhosale, Head- Risk Management, ICICI Prudential Mutual Fund, talks about credit investment philosophy in the Mutual fund sector at Outlook Money Conclave 2020.
#AmitBhosale #OutlookMoney #Money #OutlookGroup #OutlookMagazine
#OutlookMoneyConclave #OLMConclave2020 #5TrillionEconomy
Amit Bhosale, Head- Risk Management, ICICI Prudential Mutual Fund, talks about credit investment philosophy in the Mutual fund sector at Outlook Money Conclave 2020.
#AmitBhosale #OutlookMoney #Money #OutlookGroup #OutlookMagazine
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NewsTranscript
00:00 [MUSIC PLAYING]
00:03 Ladies and gentlemen, please join me
00:08 in welcoming with a very warm round of applause,
00:11 Mr. Amit Bhosale.
00:12 [MUSIC PLAYING]
00:16 Good afternoon.
00:26 And first of all, thanks to Outlook Money
00:29 for giving me this opportunity to have
00:32 an interaction with you.
00:36 My presentation today is essentially
00:40 on what we believe on the credit investment philosophy.
00:46 And my background, as she just mentioned,
00:50 has been primarily in banking for past six years.
00:53 I have worked at ICCA Prudential Asset Management Company.
00:58 Now, when I first came to this industry,
01:02 I think the biggest difference I observed
01:05 was that everyone inside the organization outside,
01:10 they were just enamored with these three letters called YTM.
01:15 So it would just end of it all once you look
01:19 at any investment opportunities.
01:22 And in one of such interactions with our distributor partners,
01:27 I had one of them asking me this question, raising his hand.
01:33 He asked me the question that, how long banks have
01:36 been in operation in India?
01:40 The answer is more than 100 years.
01:43 And how long mutual funds have been in operation?
01:46 And I mean, seven except one exception of the state-owned
01:53 asset management company.
01:54 The most others have been in operations for 25, 30 years--
01:58 20, 25 years.
02:00 So he asked me this question, and that got me thinking that,
02:03 why you think mutual funds will be
02:05 able to avoid mistakes which banks
02:07 haven't been able to avoid?
02:09 And that got me thinking, and that's
02:11 why I put across this particular construct.
02:18 And I'm comparing it with banks, because banks
02:20 have been the prime source of credit in this country.
02:25 And mutual funds, insurance companies, provident funds,
02:29 they have been coming-- pension funds
02:31 have been coming in a certain manner over the past few years.
02:35 So I think the first and foremost important thing
02:38 is that mutual funds, in their construct,
02:41 don't have capital of their own.
02:44 So it is basically sort of pulling enough investments
02:49 from the investors and trying to invest it
02:54 in profitable opportunities, generate a return, charge a fee,
02:57 and then pass on those returns to their investors.
03:02 So clearly, any credit investment
03:04 which one tries to make, there is an investment thesis.
03:09 There is a rationale behind it.
03:12 And as one is investing, one hopes
03:16 that that plays out over a period of time.
03:19 And there is a hard stop in terms of the maturity.
03:24 So there is absolutely no leeway available as far
03:27 as the unexpected losses are concerned,
03:31 if you're looking at it from a mutual fund perspective.
03:34 Banks have their own capital, because they
03:37 have to have, as per the RBI guidelines,
03:41 they have to have their own capital adequacy.
03:43 So to that extent, their ability to take shocks is much higher.
03:48 The second point is that all the mutual funds,
03:50 we are on the MTM regime, the mark-to-market regime.
03:54 And essentially, what it entails is
03:57 that we have to fair value all our investments every day.
04:01 And that's how we publish our NAVs.
04:04 So to that extent, it is actually
04:06 a good thing for the investors.
04:09 But it also presents certain challenges.
04:12 Because not all, as I mentioned, that behind every investment,
04:16 there is a thesis or a rationale that has gone into it.
04:19 Now sometimes, for factors beyond the control
04:22 of that particular borrower or the issuer,
04:26 there may be certain situations which may actually
04:29 need patient handling.
04:31 But since we are on this MTM regime, our ability,
04:34 as an industry, our ability to address those
04:37 is relatively lower.
04:39 The third aspect is the whole definition of default.
04:42 One day delay is a default, period.
04:45 So once it comes to capital markets,
04:47 there is absolutely no interpretational issues
04:50 or grace period available, which banks have.
04:53 So their ability to work with a borrower who is beleaguered
04:57 is much higher compared to mutual fund.
05:00 And the last, most important thing, in my opinion,
05:03 is actually the access to stable liquidity pool.
05:08 So mutual funds, we have given in any open-ended scheme.
05:11 You can basically have a one-day put option
05:14 given to the investor.
05:16 While the banks have access to stable retail deposit pool.
05:21 So their ability to actually take shocks is, again, higher.
05:26 So if you put all these into context,
05:28 all these factors into context, what
05:29 emerges is that you need to approach
05:32 this particular opportunity, these particular opportunities,
05:36 with a mindset of a test match.
05:41 It is not a T20 game.
05:42 And why I say that is because a good test cricketer,
05:47 test batsman, is the one who tries to play
05:49 as few delivery as possible.
05:52 Because there is no incentive to score off every ball.
05:55 There is no run rate imperative, as far as test cricket
05:58 is concerned, unless seven except only a few situations
06:01 if you are chasing some target in the fourth inning.
06:04 So to that extent, one has to approach it more patiently.
06:08 And there needs to be a cautious approach to underwriting.
06:13 Now, once we talk about test cricket,
06:15 there are two aspects which people often talk about.
06:18 That there is one aspect of technique.
06:21 The other is temperament.
06:22 Now, technique involves the skills available,
06:25 or basically which are with you.
06:28 And temperament is your mindset.
06:30 So if one takes a look at both these things,
06:34 one needs to put in place the architecture or the structure,
06:38 how actually you will translate this global goal you have
06:43 of approaching the whole investment paradigm from a test
06:49 cricket kind of a situation.
06:51 So the first thing is, basically,
06:52 in terms of the portfolio construction,
06:55 there has to be a segregation in terms of risk and investment
06:59 functions.
07:00 While the deal sourcing, the background checks,
07:03 and liquidity management, I think
07:05 this is, again, a factor which is often underestimated,
07:09 as far as some of the recent episodes have taught us.
07:15 But there clearly has to be that segregation.
07:18 And linked to that is basically the independence
07:22 of your underwriting team.
07:24 Your credit evaluation can't be done by the investment team,
07:28 because there is just too much of conflict of interest.
07:31 So while you have inputs coming from all those
07:37 who are involved in decision-making process,
07:39 clearly there has to be an independent team which
07:43 is looking at the due diligence.
07:44 And so essentially, in our fund house at least,
07:48 the limits are set up by a team which is not
07:53 reporting into investment team.
07:54 So there is a clear segregation and an independent reporting
07:58 authority, as far as these two teams are concerned.
08:02 I think another important thing which clearly
08:06 has been highlighted in the past few months
08:09 is, essentially, you have to have four eyes concept.
08:13 What we mean by four eyes is essentially
08:15 more than one person looking at the investment decisions.
08:19 And this is because to just take out the biases one would have,
08:27 and one may not be aware of those biases in his or her own
08:32 decision-making process.
08:33 So once you have got three, four people looking
08:36 at each and every credit underwriting,
08:41 I think those biases tend to get sorted out.
08:44 So clearly, one would need to approach any credit
08:48 underwriting on the pillars of the quantum of investment
08:52 you are proposing, the tenor of investment,
08:56 and the riskiness of the investment.
08:58 So essentially, the rule of thumb
09:00 is higher the amount, longer the tenor,
09:02 and higher the riskiness, it has to go for approval
09:06 to a senior forum.
09:07 And that itself introduces a lot of checks and balances
09:14 in the decision-making process.
09:16 So covering the architecture, once you get the architecture,
09:20 what we believe is there are these twin anchors of client
09:26 selection and diversification, which are actually
09:31 the most important thing as far as any credit investment is
09:36 concerned.
09:38 Now, the first and foremost amongst them
09:41 is essentially the bottom-up approach.
09:45 So while you would have heard many of my colleagues
09:49 from equity side saying that they
09:52 are bullish on a particular sector,
09:54 and that's why they go and invest in, say,
09:57 three companies from that sector,
10:00 because ultimately, sector is a summation of companies.
10:03 But in credit, actually, the devil
10:05 is in the minutiae or the details.
10:09 So that famous Tolstoy quote that all happy families
10:12 are alike, every unhappy family is unhappy.
10:15 In its own unique way.
10:16 So every unhappy borrower or an issuer
10:19 is unhappy because of the issues which are more or less
10:23 firm-specific.
10:24 And if you want to highlight those,
10:26 then you will have to approach them
10:27 from a bottom-up perspective.
10:30 The second aspect-- and here, I would actually--
10:33 I'll spend a minute or two over here why it is important.
10:37 Because A, the lack of depth in debt capital markets
10:42 clearly hurts many of the investment theses,
10:46 should they not go according to plan.
10:51 So in a sense, it is like if you want to deal with--
10:55 always ask yourself the question that how
10:59 would that particular borrower or issuer would behave,
11:02 should things do not go according to what you plan?
11:06 And if you are still comfortable dealing with that person,
11:10 then maybe you can look at it.
11:12 That's one of the filters, I would say,
11:14 for client selection.
11:15 Because then you are essentially relying on--
11:18 so there are two aspects of any credit investment--
11:21 the willingness of the borrower and the ability of the borrower.
11:24 While ability, you can try to gauge through your due
11:28 diligence and assessment of his financial strength,
11:31 the business operations.
11:33 But about willingness, it is still more a touch and feel
11:36 kind of a thing.
11:37 So this is one aspect.
11:38 Whereas I would say that any risk assessment would
11:43 essentially be on a continuum of if one side we
11:46 say that it is total art, and the other side,
11:49 if we say it is total science.
11:51 Actually, I feel it is somewhere in between.
11:53 It is a confluence of art and science.
11:55 So like willingness aspect, it is very difficult
11:58 to gauge ab initio.
12:00 The good part is most of the mutual fund borrowers,
12:04 so the people who come to debt capital markets,
12:08 typically, at least in India, they
12:09 have graduated from banking.
12:11 So new to credit, issuers are very few as far
12:15 as the mutual funds are concerned.
12:17 So that is actually a good thing to have,
12:19 because you know that there is some track record with the banking
12:22 sector before they come to borrowing from a mutual fund
12:27 or from an insurance company.
12:30 The second aspect is while there are different securities,
12:33 different covenants, actually they
12:36 will, in a time of stress, there is a funny correlation which
12:42 can get developed between these things which you have thought
12:47 about from a certain perspective.
12:49 And actually, there may be some unintended consequences
12:52 which could emerge.
12:54 And for both the borrowers as well as for the lenders,
12:58 there may be some unintended consequences or compulsions
13:02 which may emerge at that point in time.
13:04 So we have to be very aware of that
13:05 before we stipulate any of such covenants or security
13:09 requirement.
13:10 Again, on the matter of security,
13:11 you would typically see-- this is
13:14 one question which is often posed to the mutual funds
13:16 is that what kind of collateral do you take?
13:20 Now, here is where there is slight difference
13:24 between how a banking professional would approach
13:27 a typical collateral in form of, say, plant machinery,
13:31 the fixed assets, or a hypothecation
13:33 of the current assets.
13:35 Essentially, it is because we are on this mark-to-market
13:38 regime.
13:39 And if there is a deterioration in credit profile,
13:43 essentially we want collateral which
13:45 we can get our hands on and liquidate and get our money
13:48 back.
13:48 But in most of the cases, when you can get hands on,
13:51 especially all these fixed assets and current assets,
13:55 is essentially when the firm has defaulted.
13:58 Now, once the firm defaults, you already
14:00 have the mark-to-market impact.
14:02 So while I'm saying that, that can't
14:04 be your basic thesis for investment.
14:06 That collateral, you have adequate collateral,
14:09 can't be your basic thesis.
14:12 This is actually a good-to-have thing.
14:14 This can work as a deterrent should your investment
14:16 thesis not play out.
14:19 The third thing which has been currently--
14:22 which has got a lot of news coverage
14:25 is the role of credit rating agencies.
14:29 And rating, credit rating, as the input
14:32 to your client selection process.
14:34 There, I would say that one has to approach it
14:37 like one of the inputs and not the sole determinant
14:41 of your credit underwriting.
14:43 And that is because I'm not--
14:45 for a moment, I'm insinuating any lack of competence
14:51 on part of rating agencies.
14:52 They are doing their job.
14:53 They have got certain constraints.
14:55 And they have to rely on published information.
14:59 So to that extent, obviously, if those financials are not
15:05 trustworthy, obviously, the input,
15:08 if it is going to be volatile, the output
15:10 will commensurately be volatile.
15:12 So we would say that rating, you can use it
15:17 as one of the inputs but not the sole input.
15:20 And that links-- that gets me to the last point on this slide
15:23 is essentially the market perception.
15:27 Now, market perception is still a very strong tool
15:32 as far as client selection is concerned.
15:34 You would have--
15:35 I mean, let the rating agencies call any paper by issuer
15:39 by whatever rating they want to convert.
15:41 But the market has its own collective wisdom.
15:44 And over a period of time, while there
15:45 will be some short-term mismatches in terms
15:48 of demand, supply, and all, which may actually
15:50 color the spreads for that issuer,
15:53 over a longer period of time, these anomalies
15:56 tend to get ironed out.
15:57 And you may have a fair representation
16:00 of the actual creditworthiness of that particular issuer.
16:04 So to that extent, market perception
16:07 does play a role and should play a role.
16:09 While we are not in a very deep market,
16:12 like, say, US or Europe, wherein actually you
16:15 can observe the market spreads and then
16:17 try to swing it on to the probability of default
16:20 or expected default frequency and have it parameterized,
16:23 because the volumes available in our market
16:26 are substantially lower.
16:27 But clearly, the markets are good--
16:30 market knowledge is good in picking up the trends.
16:33 So if there is going to be deterioration in any credit
16:37 profile of any issuer, surely market or bond markets
16:40 tend to pick it up faster than any other source
16:44 of information.
16:44 So that is one clear case for actually observing
16:50 to the market proxies or market parameters.
16:54 In fact, recent SEBI guidelines have also dwelled into that.
16:58 And they have asked the mutual funds, at least,
17:00 to factor these market proxies into their assessment.
17:04 The other thing is still the debt funds are--
17:09 there is a preponderance of institutional investors
17:12 in most of the debt funds.
17:14 So what happens is some of these investors
17:16 have got their own investment constraints or guidelines
17:21 with which they are governed.
17:23 So to that extent, that also forms
17:25 a part of what would be an acceptable credit
17:29 or what is not.
17:29 So that, I think, is one of the factors one
17:32 has to be aware of.
17:36 It's funny that I am invoking Comrade Lenin in a discussion
17:40 related to capital markets.
17:42 But I thought that's the most appropriate thing
17:44 as far as the event risk is concerned.
17:47 So event risk is essentially any risk,
17:50 I have been issued a probability of which you are not
17:52 able to ascertain.
17:54 But clearly, it has got a huge impact on your investment
17:59 theses.
18:00 And so most of the times, it will be binary.
18:03 Either that event will happen or that may not happen.
18:05 In fact, if you look at recent past,
18:08 there have been many events which
18:09 you would have accorded a very low probability.
18:12 But they have actually materialized.
18:15 So to that extent, we have to be cautious
18:18 of this particular aspect.
18:21 And again, we are talking about debt investments
18:25 wherein the upside is essentially capped.
18:29 So all stars were to align, everything going right.
18:32 Then you would have your spread, which you can get it.
18:35 I mean, I still haven't come across any credit or debt
18:39 investment which have returned some 10-bagger, 20-bagger.
18:42 It is impossible.
18:44 I mean, it is a wide avenue issue.
18:46 So to that extent, if your upside is going to get capped,
18:48 why you want to get exposed to downside?
18:51 So to that extent, it makes sense
18:53 that you basically spread your risk.
18:57 And while we talk about diversification,
19:00 intuitively, everyone is aware of the diversification
19:05 on the investment side.
19:07 But I think equally important is the diversification
19:10 on your liability base.
19:13 So as I said, preponderance is of institutional investors.
19:17 And considering your investment side,
19:18 you will have challenges if they were
19:20 to liquidate their investments.
19:22 So to that extent, at least in accrual funds,
19:25 one should have a very granular liability profile.
19:28 Ideally, one should put an absolute maximum investment
19:33 cap for investment from a single investor.
19:35 That will give rise to a very granular liability base, which
19:38 can be much more stable.
19:41 So just to recapture what the messages which
19:45 I wanted to communicate is, essentially,
19:48 this is a game of patience.
19:51 It has to be approached like a test cricket.
19:54 Technique and temperament, both sides are important.
19:58 In fact, if you ask me, more than technique,
20:00 it is the temperament which will play a crucial part
20:04 in your portfolios being risk-free.
20:08 The second aspect, again, the twin anchors
20:10 of client selection, essentially not relying
20:13 on a single metric for your investment decisions,
20:18 looking at it from a perspective of a segregated and independent
20:22 team, which is looking at every investment proposal
20:26 once you are trying to originate and onboard it.
20:29 And this most crucial aspect of diversification,
20:33 wherein you are not putting all eggs in one basket.
20:36 And there is a logic behind that, because your upside
20:38 is capped.
20:39 So I think, in a nutshell, this would be the broad thought
20:43 process with which one would approach credit investment.
20:47 So that is pretty much what I wanted to communicate.
20:52 I'm happy to have any questions answered.
21:03 Yeah?
21:03 [INAUDIBLE]
21:10 To what extent does this distort the credit rating business?
21:31 [INAUDIBLE]
21:31 I would say that I'm on the questioning side
21:41 rather than answering side.
21:42 But let me at least take--
21:44 I think, as I mentioned during my presentation,
21:48 that I'm not, for a moment, insinuating
21:52 that there was a lack of competence,
21:54 or clearly they missed out some of this thing.
21:58 See, I look at it this way.
22:00 As a mutual fund professional, all of us
22:02 have got this fiduciary responsibility.
22:05 All of a sudden, then, we have got other people's money,
22:08 which we are managing.
22:11 To that extent, there is alignment of interest,
22:14 as far as the investor and the mutual fund are concerned.
22:19 Once you generate return, then only you'll get, basically,
22:23 incremental flows and all.
22:25 So to that extent, regardless of whatever rating agencies
22:28 may be saying, we have to do our own due diligence.
22:31 There is just no substitute to that.
22:33 On your point of aligning the interests of the rating
22:38 agencies with the kind of business imperatives
22:42 they have, I don't know, but I have read a thought process
22:45 which was emerging after the global financial crisis in US,
22:50 that what, essentially, the SEC was trying to do
22:53 was asking the rating agencies to invest part of the fees
22:58 which they were generating by rating that issue
23:00 into those issues only.
23:02 So if you are saying that it is a risk-free instrument,
23:05 it's fine.
23:06 You will get that once it matures.
23:08 So I don't know.
23:09 There may be some merit in pursuing those things.
23:13 But again, it's beyond my remit to advise on that.
23:17 So the question on a portfolio which
23:26 has these instruments, out of which one becomes
23:29 un-tradable or the market now knows
23:31 that there is some problem going to come in this particular
23:34 company's paper.
23:35 Let's just take Vodafone just as a name, as an example.
23:38 So you have a credit risk fund out of which 3% of your
23:41 portfolio is Vodafone.
23:42 Now you know that it's not saleable because nobody's
23:45 buying it in the market.
23:46 However, because it has not been segregated as yet,
23:49 smart money takes the money out.
23:51 And instead of selling that 3% which is not saleable,
23:54 you are actually selling more of what sells.
23:56 So the person who's now invested for the long term
24:00 is actually losing out, right?
24:02 This is what has actually happened with the PSU fund,
24:05 credit risk fund, which you said.
24:07 Shouldn't this be corrected?
24:09 There is a problem with this, right?
24:11 The smart money is moving out early,
24:13 and the retail investor is actually losing.
24:16 So we don't have--
24:18 I did not take your name.
24:21 No, and I think it is unfair for me
24:23 to comment on a specific--
24:24 So don't comment on the fund, but as a structure.
24:27 Actually, the approach, again, I am going back to that,
24:31 is first of all, you view it like it's
24:34 a held for maturity investment.
24:36 That's the first thing.
24:37 If you're comfortable holding that during the lifecycle,
24:41 have it.
24:41 There will be some event risk, right?
24:44 I think the only antidote, as far as I can think of,
24:47 is managing the concentration.
24:49 I'll give you an example, just hypothetical,
24:51 for ease of calculation.
24:52 Suppose your portfolio ITM is 10%.
24:55 Suppose you have got 2% of that--
24:58 let's assume 2 and 1/2% of one particular paper
25:02 in that portfolio.
25:03 Assuming you write off the entire thing,
25:06 still, one quarter's return would recoup your principal.
25:11 The situation changes the moment you have got, say, 8%.
25:15 So there is a clear this thing, and I'm not, for a moment,
25:18 saying that--
25:19 this is, again, a common thing that people say that I'm God.
25:25 I think that there is no God, as far as knowing everything
25:29 is concerned, and there is no dog either.
25:32 Most of us are in a continuum between dog and God.
25:35 So how to preempt this particular event risk?
25:39 To me, the only mitigant is avoid concentration
25:43 at all costs.
25:44 Again, what are you going to get?
25:46 I mean, the equity guys can have a conviction,
25:49 but if that call plays out, then you
25:51 have got above-average returns to make.
25:54 Here, and all of a sudden, debt mutual funds, at least,
25:58 benchmark is not looked at, even from an investor perspective.
26:02 It is basically absolute return, which they're looking at,
26:05 while the equity guys have got that imperative also in mind
26:08 that they have to beat benchmarks.
26:09 So to that extent, I think, if I'm
26:11 not sure of whether that event will materialize or not,
26:15 it's better to be safe than sorry and avoid concentration.
26:18 But there are a lot of portfolios
26:19 who actually became from 2.5 to 8 because of what I told you,
26:22 because a lot of money moved out.
26:24 Then the other antidote which comes in
26:26 is the diversification of the liability side.
26:28 And that's why I made that point.
26:30 While everyone looks at the investment side,
26:33 this what you call the so-called smart money, that
26:36 is basically the money which is coming in a chunk,
26:39 and it will go out in a chunk.
26:40 So the antidote to that particular situation
26:43 is to have a well-diversified liability.
26:45 Yes.
26:45 I'm Sanjay Singhania from Riddhi Siddhi Financial Services.
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28:41 There is clearly an increase in the AUM which the mutual funds have got.
28:47 And the most logical place wherein a new investor can come in is essentially a liquid fund.
28:53 So you basically park your surplus, build a traction of good experience with these funds
28:59 and then evolve into other this thing.
29:02 I think as the natural progression of economy happens, some of these issues will automatically
29:07 get addressed.
29:08 They have been by the way.
29:11 And I think somewhere the whole focus on the digitization, which is coming in from all
29:16 quarters of government and banks and mutual funds, I think that is going to help this
29:22 process to expedite this process.
29:26 So whatever impediments, the constraints which were coming in, I think they are slowly slowly
29:34 getting ironed out.
29:35 But ultimately the transparency will be one big calling card as far as mutual fund would
29:41 be concerned.
29:42 Again, as I said that I am not the absolute authority to opine on that.