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Is RGESS better than ELSS for a first time equity investor?

Sunil Subramaniam, CEO, Sundaram Mutual

8th February 2017

In a nutshell

RGESS funds, which are treated as country cousins of ELSS funds by our industry, may actually be a sensible option for risk averse first time equity investors seeking a tax break, given the large cap orientation of these funds.

There is an opportunity for eligible investors with sufficient surpluses to invest in ELSS as well as RGESS funds this tax season

While first time investors' affinity for large cap funds is understandable, there is a strong case for experienced long term equity investors to invest more than the usual 25% in midcaps and less than the usual 75% in large caps, given the higher wealth creation track record and potential of midcaps.

Click here to download fund details of Sundaram Top 100 Series VI (RGESS eligible fund)

WF: How different is the target customer base for an RGESS eligible fund from an ELSS fund? How large is the addressable audience for an RGESS product?

Sunil: The RGESS customer is a first time consumer of Equity products with an income level equivalent of middle to upper middle class. He/ She would be less aware about the nuances of the market and would be more risk averse. The market potential is huge since a substantial percentage of our population is still not investing in equity markets and even a small percentage point tilt every year should help sustain domestic flows and stabilise the markets.

WF: Can an existing MF investor who does not have a demat account qualify as a "new investor" for the purpose of RGESS tax rebate? Can therefore mass affluent investors who have already exhausted their 80C limit be approached with a potential benefit of an incremental tax rebate?

Sunil: Yes, technically they can. However investors should choose a product primarily based on their risk/return profile and asset allocation rather than tax saving which should be the supporting/secondary objective.

WF: You have always maintained, and rightly so, that midcaps is where you get higher wealth creation over market cycles. What in this context would then be the investment argument for a large cap oriented Top 100 product?

Sunil: RGESS is meant to give a flavour of equity to the first time participant. We would like the investor to have an experience of equity markets minus the excess volatility of pure midcaps. Having said that, this is a multicap product given our mandate is to invest between 60-100% in large caps and 0-40% in midcaps. We believe that asset allocation is very important for any investor and this may vary from person to person, however, there should be an appropriate mix between large and midcaps.

WF: Given that there is enough evidence of the higher wealth creation potential of midcaps, what explains the industry's continued skew towards the large caps space?

Sunil: I think it is because of falling into the theoretical trap whereby it has been taught that large caps should be a higher percentage of a portfolio. While this may be true in the Developed markets where the excess returns of a mid and small cap over a large cap is sketchy. However in India the excess return of midcaps over the past 10-15 years has been significant on a risk adjusted basis. This is likely to continue for a long period (25 years in my view) as our economy has still got a long way to go before it becomes developed and during this period there are going to be scores of mid cap companies that will become large cap and the wealth creation of these companies will tend to be manifold vis-a-vis large caps just given the small base (i.e. market cap) they start with. It is also important to point out that this is also a feature of base rates i.e. the number of midcap companies is several times more than the large cap companies and hence there are going to be more mid cap companies outperforming than the number of large cap companies.

Currently a typical investor would have a standard asset allocation of 70-75% large caps and 20-30% in midcaps which means that the pie is skewed towards large caps in terms of market size. Naturally the products would orient towards that space. Also, larger caps have lesser volatility which helps stomach the risk of equity and is easier to sell.

WF: In what ways, if any, would the RGESS mandate restrict the scope of this fund's universe as compared to any other large cap fund?

Sunil: There is no major mandate restriction apart from the fact that we also need to include the PSU's (the maharatnas, the miniratnas etc.,) which actually adds to the universe from a typical Top 100 definition.

WF: What are some of the changes in the team and in processes that you have recently made to strengthen your large cap capabilities?

Sunil: We have hired a senior fund manager exclusively for large caps and have strengthened the research team in terms of bringing in more people. Our ratio of research analysts to equity AUM is probably the highest in the industry. Our investment process remains the same and is well laid out.

WF: In your view, what are the key differences in approach for managing large and mid cap funds?

Sunil: Large cap stocks are typically well researched and thus the amount of ground up research needed on the same is lesser. However, the scope for incremental alpha generation is also lesser. Hence it is more of a top down approach. Mid cap is more bottom up oriented where you track the companies more closely with plant visits, management meets.

WF: What is your outlook on Indian equity markets over the next 12-18 months, now that most of the domestic news flow is in?

Sunil: We are positive on domestic markets for the longer term. Our view is that demonetization has temporarily delayed demand for two quarters and the resultant higher demand later on. Public capex has already started and we are at the start of a virtuous cycle given improving demand, repairing balance sheets and lower interest rates. Quality should be the overarching theme.

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