Last week, while speaking at the CII mutual fund summit, G Mahalingam, whole-time member at the c (Sebi), warned the industry that it could face redemption pressure. This, he said, could be triggered by outflows from India if the US Fed follows through on its intent to hike the benchmark rate (it plans to raise it by up to 75 basis points in 2018). His comments may appear incongruous at a time when the industry's assets under management stand at a humongous Rs 22,79,032 crore (November-end). But, besides the industry, retail investors too need to heed the regulator’s warning and bolster their portfolio while the going is good in the markets.
When the US Fed hikes its benchmark rates, the interest rate arbitrage between US and Indian bonds reduces. Also, the dollar tends to strengthen, and this reduces the dollar-denominated returns of foreign investors in India, who then pull out. The impact on equity markets is indirect. “The biggest financial institutions are global asset allocators who invest in different assets of different countries in proportion to their attractiveness and risk. Due to the Fed rate hike, the interest offered by US bonds has increased, so every other investment opportunity across the globe has become slightly less attractive in comparison. This will trigger some re-allocation from other investments
to US bonds,” says Saravana Kumar, chief investment officer, LIC Mutual Fund.
According to financial advisors, retail investors begin to pull money out of the markets when they see past returns turn unattractive. “How retail investors behave depends on the rapidity of the fall. If the returns turn negative very fast, they may not get the time to pull out their money. They then hold on to their investment till it recovers to the level of the purchase price. But if the markets fall gradually, investors stop fresh inflows and pull out their money while the returns are still positive,” says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisors.
Redemption pressure can hit the small-cap category of funds especially hard. “If the fund manager has invested in a lot of illiquid names, he may have to sell at a steep discount to meet the redemption pressure,” says Deepesh Raghaw, founder, PersonalFinancePlan.in, a Sebi-registered investment advisor (RIA).
Investors need to bolster their portfolio promptly to guard against the eventuality of a downturn. They need to have very clearly defined time horizons for their investments.
“If they are saving money for retirement which is 15 years away, they need not panic if there is a market correction that lasts for a year or even longer. But if the horizon is less than five years, they should pull money out of equities right away,” says Dhawan.
Investors should also adhere to their asset allocation. If their exposure to one asset class has increased significantly, for instance, to equities vis-a-vis bonds, or to mid- and small-cap funds vis-a-vis large-caps funds, they should rebalance immediately. They should also diversify their portfolios by investing in international funds (specifically, US funds) to protect them from India-specific risks. Also, if a disproportionate amount of their money has gone into high-risk categories, such as sector funds, they should curtail exposure.
Besides outflows, debt funds can also be hit by redemption pressure due to a sudden bond default. Stick to high credit quality and low duration funds at present. “I feel more comfortable in a fund that is of at least Rs 7,000-8,000 crore and belongs to a bigger fund house. In a bigger fund, the damage from a single default is likely to be limited. Also, bigger fund houses sometimes absorb the loss arising from a default themselves,” says Raghaw.