Where to invest Rs 10 lakh today? Avoid small caps; just stick to these 2 fund categories, says D Muthukrishnan

D Muthukrishnan, Chennai-based mutual fund distributor and CFP

After Chennai-based mutual fund (MF) distributor D Muthukrishnan quit his job in 2006, he started his MF distribution outfit in January 2007. In about 16 years’ time, Muthukrishnan has become one of the biggest individual MF distributors in south India. This, he says, is despite the presence of direct plans. He stopped adding new clients after 2017. Muthukrishnan, who is also a Certified Financial Planner (CFP), stays away from small-cap funds and international funds. “In India, we have enough opportunities to invest,” he says. He largely invests his clients’ money in flexi-cap funds and aggressive-hybrid funds.

Muthukrishnan, in conversation with Moneycontrol’s Maulik, elucidates why he thinks today is a good time to invest.

Equity markets are at a high. Is this a good time to invest? Are you bullish on India?

I am always bullish on India. But not in the sense where people say that India will be a superpower and so on. That may or may not happen in the foreseeable future. How you define a superpower is also very dicey.

But India will grow at 6-7 percent, with roughly 5 percent inflation. That means the nominal growth will be 11-12 percent. Where in the world can you get 12 percent growth? So, in that sense, I am always bullish on India.

But we can’t time (entry and exit) as excess valuations can last for years together. Undervaluation too can last for years together. So, I generally say, invest when you have the money, redeem when you need money. And ensure that there is a minimum of 10 years’ gap in between. Then, even if you enter at peak valuations, you will at least get single-digit returns after a 10-year period with index funds or mutual funds.

Are you saying we should completely ignore valuations?

I don't look at valuations for investing. I look at the investment time horizon. Of course, people will give many examples – if I had invested in October 2008, then my return would have been this much and so on. But this is all in hindsight. How would I have known that October 2008 was a good time to invest and March 2008 was not a great time?

As long as you have a long-term horizon, I don’t look at valuations. This holds true for mutual funds. Not necessarily, if you invest directly in stocks.

How about making a lump-sum investment when markets are sharply down or pausing your SIPs temporarily when markets are at a high?

What I normally say is that when there is a market crash, if you have money to invest, invest it. What people find blasphemous is that I tell them to invest more when the market crashes but I don’t ask them to redeem their investments when the market peaks. That is because the Indian market will continue to make new peaks in the decades to come.

We don’t time SIPs, we don’t stop SIPs. I never ask people to pause their SIPs even when markets are at a high. But if someone wants to invest a lump sum, I tell them that their 10-year return can be muted. This is only an indication. Suppose there is a big improvement in per capita income in the next 10 years, then markets can behave differently.

If it’s a small sum, I ignore it because there is always some temptation to add money in a bullish market. For example, if somebody has Rs 10 crore in MFs and he wants to invest another Rs 20 lakh, that’s only a 2 percent addition. So, that doesn’t matter. But if they want to invest a sizeable portion of their net worth, say Rs 2-3 crore, then I may tell them that it may not be the best time to invest.

When markets crash, people may continue their SIPs but they lose the confidence to invest big money. They want to come in only when the markets keep going up. Human psychology is hardwired and it's not easy to change it. Where I have succeeded as a distributor is that I have changed my clients’ behaviour to a larger extent.

If someone had Rs 10 lakh today, where would you ask them to invest it?

I would suggest that you select 2 good aggressive hybrid funds and distribute the money equally. That will be good enough for investors because automatic asset allocation happens and you don't face any capital gains tax for the automatic re-allocations that keep taking place in these funds. This is a very underrated product. These funds may give 2 percent points below equity fund returns but that is still very good.

Hybrid funds are good for all market situations. That’s because even if the market falls, they put more in equity, and when the market keeps going up, they book profits.

Allocation to equity is very important because without it you cannot earn inflation-beating, purchasing power-retaining return. For the middle class and lower middle class, the only way to go up in life is through equity because real estate is very expensive when compared to one’s income. You can, at best, acquire one property and if something goes wrong with that single property, it’s a disaster. Whereas with equity, you can invest in 2-3 funds and if something goes wrong you can move out.

Why do you like hybrid equity funds more than pure equity funds?

Hybrid funds fall comparatively less when the equity market falls. And a market fall is inevitable at some point. Equity markets go through various phases - rise, fall, euphoria, and so on.

We have to structure portfolios in such a way that investor psychology remains intact.

We predominantly recommend flexi-cap funds, aggressive hybrid funds, and some good mid-cap funds. I don’t recommend large-cap funds because that’s as good as investing in index funds.

Why do you dislike small-cap funds?

I never invest my money in small-cap funds and also never recommend them to my clients. Today, small-cap funds are top-notch performers but people don't know what the 10-year return for small-cap funds looked like in 2013/2014 and what small-caps went through in 2008.

Perhaps small caps may continue to do well. But when they fall, they come down heavily. I wonder if people can stomach the volatility.

You need to see whether your strategy will help you reach your destination (goals). It is not only about returns. What matters is whether the returns are sustainable. If I can help generate around 12 percent for my clients, that is good enough because a decent return over a long period of time will do wonders to your portfolio and also to your peace of mind.

A 30 percent notional loss versus a 60 percent notional loss makes a huge difference. In a bad market, as happened in March 2020, a flexi-cap fund can fall, say, 30 percent but a small-cap fund can lose 55-60 percent. If someone’s Rs 10 crore becomes Rs 4 crore, that is not easy to digest.

Any one particular market cap can always have a lost decade. So a flexi-cap fund is better that way because it has the flexibility to move between different market caps. I generally recommend only flexi cap funds. I don’t compare and analyse. I just pick large good fund houses and pick their flagship funds (schemes).

So, there is no secret sauce. The only secret sauce is client behaviour.

What do you think about international equity funds?

I don't understand international funds and international markets. I have some understanding of the US market. But that too I do not understand to the same extent as I do India. Only if there are no opportunities in India, you need to look out.

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I'm not saying you shouldn't look out. If somebody in Japan or Italy is looking out, that’s because they don't have an opportunity. In India, we have opportunities and there’s no currency risk if one invests in India. So why should you worry about some other country? There is no need.

I don't recommend international funds. There are people who have burnt their fingers in China funds, Brazil funds, and even those who invested in US funds in 2021 got burnt in 2022.

What are some common investor mistakes that you have come across?

The biggest mistake people make is that they don’t stay invested. Mutual funds data shows that 60 percent of investments get redeemed in two years or so. A few years ago, Prashant Jain (former chief investment officer of HDFC Mutual Fund) had said that only 2 percent of mutual fund AUM stays invested beyond 10 years. And my entire clientele will belong to this 2 percent.

People chase performance. If they think the pharmaceutical sector might do well, they invest in pharma funds. If they feel gold is going to go up, they invest in gold ETFs. But in a flexi cap fund, the fund manager will take the appropriate sector calls.

I think flexi cap and aggressive hybrid funds are good enough. What matters most is that you remain invested. What I'm saying is that go for a good fund, one with a long-term record. Go for a fund manager who doesn’t take undue risk. These are the things over which you have control, and then you give them time, that’s it.

Do debt funds make sense after the removal of the indexation benefit?

Earlier, I used to recommend hybrid debt funds. These were known as Monthly Income Plans, or MIPs. Not that these investors wanted or needed a monthly income; they just didn’t want to invest in equity. So, I thrust 20% equity exposure on them (these schemes invest up to 20 percent in equities) because without any equity, they would not get a decent retirement income.

But generally, I tell my clients to keep their money only in liquid funds. I ask them to do this online and not come through us because then it's very easy for them to redeem them.

Ultimately, over longer periods, say over 10 years, liquid funds would have given 6-7 percent return and other debt funds would have given 8-9 percent. For 1-2 percent point extra, exposing yourself to huge volatility in debt funds is not worth it. In liquid funds, go for bank-sponsored fund houses because such fund houses have large and stable sponsors, backing them.

Even though now indexation is gone, accrual is not taxable in debt funds whereas in fixed deposits, you will be taxed at your slab rate. For liquid funds, you pay tax only on what you withdraw.

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