“Risks have a very disproportionate impact on returns”
Why did Baroda MF and BNP Paribas MF decide to merge, particularly given the former’s past underperformance? The decision was first announced in October 2019 and received Sebi’s approval in January 2022. What took time?
Mergers and acquisitions are driven more by strategic considerations than anything else. So what prompted this merger was basically these two great global institutions, one, Bank of Baroda, which is a leader in the Indian banking space and the other, BNP Paribas Asset Management, which is a leading player in Europe, coming together to build a strong platform for Indian audiences. Bank of Baroda, being a large national bank, has a very recognizable brand name, tremendous reach and also a very deep understanding of the Indian retail market. On the other hand, BNP Paribas Asset Management is one of the world’s leading players and therefore it operates from the point of view of risk control, industry best practices and asset management know-how. assets.
Now to your performance comment. I disagree with you that Baroda Mutual Fund underperformed. In fact, I will ask you to double-check the data. So if you really look at the performance of Baroda Mutual Fund across multi-cap (5-year fund return of 14% vs. average category return of 14.7%), large-cap (5-year fund return of years of 10.4% versus the category average return of 12%) and midcap (5-year fund return of 15.7% versus the category average return of 13.9%), all have done quite well. They have industry leading performance in one of their products, which is the balanced advantage fund.
Now coming to your question about why the merger took so long. We finally obtained SEBI approval in January 2022 and from March 14, 2022 we operate as one entity. Apart from the SEBI approval, we also needed a number of other regulatory approvals (related to RBI and FDI) and some of them took a little longer given the pandemic situation.
The former Baroda Large Cap Fund and Baroda Hybrid Equity Fund underperformed their peers in their respective categories. Please explain why? What will the merged AMC’s strategy be to reverse this underperformance?
Again, I would say that the hybrid equity fund has done quite well (5-year fund return of 11% vs. average category return of 10.7% and category return range of 6.6 to 15.3%) and that there was marginal underperformance in the large cap category.
Of course, not every fund house can have every product in the top quartile all the time. This is the reality of the business, but overall the funds have done quite well. Secondly, the way we approached the merger is to combine the two investment teams and add more resources and more people and also to implement one of the most rigorous risk management processes available. tracked globally.
We found that much of the investment approach of both teams was similar, both are growth oriented and seek to buy companies that are growing faster than the market. We use the quality of management as a very clear and non-negotiable qualifying filter. So to that extent, fielding the two teams was pretty easy.
What will be the position of Baroda BNP Paribas MF on the credit risk of debt funds? Do you have a limit in terms of the minimum percentage of AAA-rated paper you must have in your debt funds (excluding credit risk funds)? With rising interest rates, what will be your strategy to generate returns?
So, the basic tenets of fixed income securities are safety, liquidity, and returns and in that order. Now, as fund managers, we can add value in two ways. One is on the macro view i.e. taking an interest rate view and the micro view is doing the credit research of the company. In the fixed income industry there are a lot of people trying to be smart, we try not to be stupid. And in fixed income, a good way to outperform is to avoid mistakes, avoid very aggressive calls, and be acutely aware that risk has a very disproportionate impact on return. Now, when it comes to fixed income funds, you need to be very clear that you are managing the funds according to the philosophy of the fund. So where the mandate itself is to – not take credit risk or take, SEBI itself has set certain percentages.
So what about categories such as low, short and medium duration funds where there is no specification in terms of credit risk and it is up to each fund house to decide?
In these categories, the primary performance driver is curve positioning and also identifying some mispricing opportunities you may have in the same credit quality segment. I wouldn’t want to hard code a number here (on what the minimum percentage of articles rated AAA or AA+ will be).
In terms of interest rates, the markets are not waiting for the RBI to raise rates to start moving. So, even though key rates have not increased, you have seen a significant increase in bond yields. So while a rate hike by the RBI is one tool, there are many other indicators due to which the market is adjusting. In the current environment, where key rates are expected to rise, I think the rise would be gradual rather than very steep. So we think there are some interesting opportunities for investors in, say, the short end of the market. So categories like short-dated funds, which would typically have a maturity of 18 to maybe up to 24-36 months, will do quite well because the short-term yield curve is very steep. Thus, even if the rates increase, the regularization is very strong.
The other category that looks interesting is credit risk. Indian corporate balance sheets have strengthened significantly. The credit downgrade ratio is the best it has been in the past decade. At the same time, the mass of money chasing after these papers has diminished considerably. The mutual fund industry in terms of loan fund size was once Rs. 1 lakh crores about 2-3 years ago. Today it is Rs. 25,000 crores. This allows you to select and deploy your capital at good spreads. This is a category that investors can consider if they have a time horizon of, say, a few years or more.
How will your investors benefit from a larger merged AMC? Will they benefit from lower expense ratios?
The few things that change in there, one of course is the combined power of the two sponsors behind us that I explained to you earlier and between them they have a legacy of over 300 years. The other thing is that as we merge, our capabilities, our product suites, our reach, and our investment management capabilities expand.
While our products grow to a relevant size, at the same time they are not too big to affect the ability to create alpha. In most cases, a slightly larger AUM size will result in a slight reduction in expense ratios, but this would be a marginal benefit.
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