15 July, 2009

King Louis & the MF Industry

I suddenly remembered the amazing work of Disney in their immortal classic “Jungle Book”, penned by Rudyard Kipling. The immediate stimulus for this sudden recollection was, the abolition of loads in Mutual Funds. In Jungle Book, in one of the scenes, King Louis – a Chimpanzee had kidnapped Mowgli to learn, among other things, “How to make fire”. In the meantime, Bageera the Panther & Baloo the Bear come there, looking for Mowgli. In the melee which ensues, at one point accidentally the temple pillar breaks and the entire superstructure starts shaking. Seeing this, King Louis, goes and stands in place of the pillar. Baloo sees an opportunity here. He goes and tickles King Louis. King Louis is not able to stand steady now and the superstructure comes crashing down. After this, King Louis is shown, still holding, just a small stump. This image of King Louis standing in place of the pillar, flashed in my mind as the Mutual Fund industry is already in that situation. With entry loads abolished, the situation can look like the other image. King Louis standing with the stub. I do not want that to happen to MFs, a promising sector in the investment firmament.
On the face of it, the abolition of entry loads looks like a great idea… Jai Ho Investors and all that. One of the arguments is that in the developed markets ( read US ), entry loads are very low or not there at all. It is true that in US there are lots of funds where entry loads are nil. However, there are 1971 funds charging 4-6% entry load and another 143 funds charging 2-4% entry loads. I also found a fund that charges 8.5% entry load! So, that justification is not tenable. Also, entry loads for direct investments are already nil for all funds here and in that sense we are ahead of the US! Even in the US, funds pay distributor charges, in all these cases where entry loads are present. So what is the provocation here? Is simply justifying this move as an investor friendly step logical? Will investors actually be served better this way?
Clearly not. Mutual Funds are a great way for lay investors to participate in the Stock market. As it is, the penetration of Equity among Retail investors is in single digits. Now, with no entry loads, more investors are expected to participate, right?
Maybe not. Lot of handholding, counseling & advice is required, which the distributor traditionally gives. Now, as per the new scheme, he is to seek a fee from each client investing with him. Think of a distributor servicing a hundred clients. For each and every investment, he has to ask for another cheque, as a fee. Possible, yes. Practical, No. Also, the investor psyche has been to get advice for free. It has to change at some point. But suddenly changing over to an entirely new system could have the effect of wiping out a large chunk of the distributors. I’m again reminded of King Louis.
But Investors stand to benefit as they can ensure good service, right? Probably yes. But that depends on whether they find someone to give them the service. Let’s face it. If distributors are reduced to pan handling, will they stay in this industry? Probably not. They would start selling Insurance, FD, NSC etc., as that allows them to earn with dignity and not be reduced to the state of virtually begging for twenty & forty rupees from investors. So, investors will be forced to go direct to MFs. Investors will be left to their own devices to find out which type of funds to invest in, scheme to invest in, which companies etc. If they approach companies directly for advice, they will try to sell their funds. So, where does the investor get advice from? They need to start reading up on the economy, about performance of the stock markets and stocks, happenings abroad etc., to be on top of things. In other words, by saving the entry load, the investor is back to square one – fending for himself & taking on a whole lot of work on himself.
This proposal seems to be on the verge of implementation, in spite of all the problems that it can potentially unleash. So what is that the investor can do for a win-win relationship.
It may still be workable if the investor understands & follows certain basic rules-
1. First, find a good distributor who can give proper advice & is dependable. If the current distributor is good, stay with him/her. See their past track record, if you have dealt with them; if they are coming from a reference, find out about this aspect.
2. Ensure & understand why a distributor is recommending a particular scheme or sector and get proper explanations. This way, you’ll protect your investments and ensure that the distributor recommends only the correct schemes to you.
3. Find out if they have the software support ( preferably web enabled, so that you could check your portfolio anytime ) to provide you with reports, when you need. Will they advice you & assist you with back-office support while redemption, switching, STP, changes in address/ bank etc.
4. Look at creating a win-win relationship with the distributor. Do not try to squeeze him to forfeit the commissions, just because you now have the liberty to do that. The distributor may not offer good services or may not service you at all in future, if you do.
This way, everyone can enjoy Jungle Book … King Louis tracks will become enjoyable then… instead of looking like the pathetic reflection of the mayhem that could have been.

published in Moneycontrol.com on 13/7/09

Garibi Hatao, Common man & the Budget

Poverty alleviation programs are great on paper. What else could be done to fight this menace

I was attracted to this topic, thanks to our budget. It set me thinking on the whole “Garibi Hatao” plank of Congress party. Investment consultants would advice you against averaging, when the investment inherently is not good. They would advise that you would be throwing good money after bad. Averaging as a concept works well if one wants to eliminate the timing risk, not the asset risk. With so much rhetoric, sound & fury on poverty alleviation, why is not going away… especially, when gargantuan amounts are being thrown at it? Some success can be rightfully claimed, though. But, that is like saying that I sowed a bag of seeds & 10 saplings did sprout. It is such a waste.
So, poverty is as much a reality as is Taj Mahal! At least, Taj Mahal was temporarily made to vanish by P C Sorcar. Alas, he can’t do that for poverty, even for an instant!
Poverty is well entrenched
We have had a socialistic mindset and have been wanting to “Garibi Hatao”, for about 62 years now. But Garibi is well entrenched. There are various figures bandied about – from two thirds to 80% of the population living on less than US$2 a day.
So, where is all the money that has been spent on poverty alleviation, since independence? Government machinery is like a sieve – most of it passes through and very little is left. Rajiv Gandhi had once said that only 20paisa of every rupee spent reaches the beneficiary. He had been optimistic. It is the middle men & politicians who benefit from these and what is left is not targeted very well. So, why is the government persisting on the same formula, though it is not working? Political & personal gains, partly answers that. Then, there is the charade of keeping up the pretence of doing something for the poor. If such “Garibi Hatao” ideas work, West Bengal would be a rich state, being under communist rule for over three decades. But, it is one of the states in India where poverty is pervasive.
So, why keep doing the same things to eliminate poverty?
For one, “Garibi Hatao” connects with these people as it at least states what needs to be done. Hence, being seen as a doer of good is important than doing good.
National Rural Employment Guarantee Scheme ( NREGA ) is assuring 100 days of work and the allocation for the same is Rs.39,100 Crores. Fine. But it is essentially manual work. And this amount needs to be spent y-o-y. Will there be work y-o-y for a population that starts depending on these? Under National Food Security Act, the Government intends to give 25 kilos of rice or wheat for BPL families ( about 25% of the population ). Are these sustainable ? Will it really help them in the long run? Give a man a fish and you solve his problem for a day; teach him how to fish and you solve it for a lifetime, goes a Chinese proverb. How true.
What could be done
Education & Health - Is it not better to ensure that the schools in these areas have teachers and the health centres, doctors do come in? Education & better medical facilities are only there on paper for these people. But proper delivery will make all the difference to them. Fixing these through proper implementation & oversight could be the answer, instead of throwing more money at it. It would be a far better idea to upgrade the human capital through proper education & allow them to progress & upgrade in life, rather than putting them on life-support systems endlessly.
Training - Is it not a better idea to train them in Vocational courses? Indians are good entrepreneurs. Why not train the rural population through such courses that will empower them to start their own micro businesses ? And do this pan-India vigorously to help create jobs.
Financing & Empowerment - Government is supporting Women’s Self Help Groups, which is good. But what about encouraging micro-financing and assisting in development of this sector, instead of trying to lend more and more and incurring bad debts. Private microfinance institutions like SKS Microfinance works on a for-profit basis. Grameen Bank in Bangladesh is another such institution, that has made a huge difference to the poor. Still, these institutions are profitable and delinquencies less than 1%, inspite of servicing an “unbankable” customer base. Why not provide such institutions access to cheap credit ( currently, they are all from private sources ) so that they can expand their geographical coverage ? Government will help in poverty alleviation better if it were to support such efforts which already exists.
Borrowers do not pay back the banks as they feel there will be a loan waiver somewhere on the horizon. Past Loan waivers have created an incentive for those who do not pay. Hence, it will lead to more and more bad loans in future, which have to be waived off.
Agro-processing -Much has been said about this aspect. The current budget gives Investment linked incentive on Cold chains & ware houses for agro-processing. Since bulk of the people in India live in villages, agro processing should be given priority and incentives extended to such industries. It would be a good idea to have a agro-mission for seeding the country with such projects and assisting & guiding entrepreneurs to set up such industries.
Tax incentives to those who empower - Imparting appropriate skills to the people across the country is a mammoth task. Corporates who are present throughout the country could be roped in offer appropriate skill training in rural areas ( where their factories are located ) and can be allowed some tax rebates for doing that. That way, corporates will have an incentive to train the people, will be able to employ some of those trained & will get a tax break.
“Garibi Hatao” is a noble intention. Implementation is the key. Government could walk with others who can help in it’s mission of achieving a poverty free society by 2020. And save a lot of tax payer’s money.

07 July, 2009

Muzzling MFs puzzling

In life, some boys keep getting bullied… they are probably the meeker, weaker ones or those that don’t protest. These boys are taunted endlessly and they become introverted & reclusive. That could be the Mutual Fund Industry, which is facing it’s survival test today. It has been pushed into a corner now and is looking helplessly into a future that looks black & darker shades of grey.

How did it come to such a pass? The various constituents of the financial services industry are under different regulatory bodies like SEBI, IRDA, RBI etc. Now, different regulators have different views of furthering the industry’s cause, investors’ cause…SEBI has been looking at everything from investor’s point of view only.

One of the latest regulations for MFs, was Zero entry loads for direct investments. The logic was that those who did not want or do not avail of any advice need not be made to pay any loads. But it makes better sense in insurance products in view of the much higher commissions. And the same should apply to company FDs, Post office products PPF etc. as advice here is minimum or nonexistent.

Another logic given was that in US entry loads are less than 0.5%. Not true. There are no-load funds as well as other actively managed funds which charge low to very high entry loads. Legg Mason Partners Dividend Strategy Fund ( US$1.6 billion ) charges an entry load of 8.5%. Evergreen Omega Fund A is one of the top funds, according to Lipper, charges Front-end load of 5.75%. US Blackrock Basic Value Fund ( US$3.3 billion ) charges 5.25% entry load. There are 1971 funds which charge entry loads between 4-6% in the US… another 143 funds charge between 2-4%. Even very large funds such as US American- The Growth Fund of America ( US$131.4 billion ) charges 5.75% Entry load. The funds pay the distributors there too.

Then, now we have this proposal for abolishing entry loads altogether, in all funds. We already have a direct route, where there is no entry load. Hence, if the investor did not want any advice, he could save on the entry load. When this option already exists, abolishing entry loads by fiat, reeks of biased targeting of MFs & their distributors. What is sought to be introduced here is a new, untested architecture which SEBI feels is good for the investors and the markets. It is not possible for all distributors to become consultants overnight and be confident about charging fees.

It’s ironical, as MFs are an ideal route for retail investors to participate. Muzzling the industry and tying it up in knots, is hardly the way to facilitate broad investor participation.

One of the explanations is that they want a level playing field for all players, big & small. They say it is unfair that big operators get bigger commissions for doing the same work. It is an accepted practice in intermediation. In any industry ( across the world ), the ones that bring in more business gets a higher commission. As long as the higher commission is paid by the AMC ( entry load in most cases is 2.25% only, whether it is a big or small distributor ), why is it such an irritant? Why does a stockbroker ( also coming under SEBI ) not collect a separate fee and charge a brokerage? Wouldn’t their investors want to pay them based on the advice rendered?

The other legitimization sought for introducing this proposal is that distributors would sell products that give them maximum commissions and not the one that is best for the investors. A distributor can anyway take the money away to a ULIP instead of a MF scheme and that is already happening now, looking at the accretions to Insurance companies. Secondly, investor education is important. They need to know broadly if their investments are going to the right places, if they want to be on top. This is an area SEBI needs to work on. Thirdly, commissions offered are within the framework set by SEBI.

This proposed system will necessitate negotiating with each client about the amount he would pay as fees. This itself is a tortuous process, which will increase the work for distributors. It is not going to be easy for distributors to get their clients to part money, every time they invest. The amount involved may be low, like twenty rupees. There will be hundreds of such small transactions for which a distributor will have to now raise bills, which will again be onerous. Handling fees for SIPs, poses a different level of problem.

This proposal has been put forth with the idea of pushing distributors towards the fee model. But, what about the others? There is no level playing field. All other constituents do not come under this legislation. Hence, immediate upshot would be that ULIPs will get sold more as distributors sell all products and this legislation for MFs will only force their hand to sell ULIPs and others instead. Even NSCs or KVPs will be sold instead of MFs. So, where does this leave investors?

Investors may be elated now, thinking that they can squeeze and get more from their distributor. But any win-lose relationship will not work. Distributors will move on to other areas, if they are not wanted here. Accretion to MFs will definitely be affected. MFs will no doubt come up with some ideas on remunerating distributors, even in this constricting regime. But then, MF industry is now running with it’s hand tied behind. It’s a battle for survival.

A level playing field is required for all players in Financial services. That will be fair and will ensure that all participants have an equal opportunity to place their products before customers. If investor’s interests are the ones that SEBI seeks to protect, then this legislation is in the wrong direction.

Published in DNA Money on 2/7/2009

Budget wishlist

“If wishes were horses, beggars would ride”, is one of oft repeated proverbs of my friend, Satish. But why not wish. You never know – they may come true. And like Cindrella, a fairy Godmother may make it come true – in this case his name starts with P.
So, Let’s start. One of the cribs that most tax payers have, is lack of tax shelters. Most complain that the Rs.1 Lakh which is available under 80C as a deduction is woefully inadequate. Also, everything from Home loan principal, School fees for children to tax saving Investments, Insurance etc., are under this. Hence, the Rs.1 Lakh figure is seen as entirely inadequate. Earlier, Pension plans were under a separate category, which also got clubbed into 80C.
Government is keen on Infrastructure development in the country, the spending on which will give an impetus to the economy. A win-win solution could be a new class of infrastructure bonds which will save tax, but is in addition to 80C amount of Rs.1 Lakh. This way, the government will get money to spend on nation building and the taxpayer, a much needed tax shelter.
Government has accorded priority to housing sector as it wants people to move towards owning their homes. That is the reason why there is a deduction of upto Rs.1.5 lakhs available on the amount of interest paid for home loan. It will be a step in the right direction if in this budget they allow entire interest on home loans as a deduction, like in the case of Education loan. This is a reasonable subsidy from the government, as it promotes a good cause. And accord Industry status to a sector like Real Estate, especially when it is a sector that has multiple linkages with several sectors ( like Cement & Steel ) and subsectors ( like flooring materials, lighting, claddings etc. ).
A lot of people are concerned about the non-availability of good investment options, for those with low risk appetite. One has NSC, KVP, Term Deposits & Bank FDs. But the post tax returns on all these are less than 6% for someone in the 30%+ bracket. The only option available, which gives 8% post tax returns, is the PPF. But then, one can contribute a maximum of Rs.70,000/-pa and that is seen as a serious limitation. RBI tax-free bonds at 6.5% was an alternative available in the past. A scheme like RBI Bonds would be a welcome addition to the current bouquet of investment products.
In Mutual funds, fund-of-funds as a category has not taken off, primarily because the taxation is like that of a debt fund, even if the entire investments go into Equity funds. This is the biggest dampener. Fund of Funds as a concept is quite good, as it reduces the risk profile for the investor, although the investor pays a higher cost for FOF. Government should rectify this anomaly and help investors to take advantage of this good investment option.
Fringe Benefit Tax ( FBT ) was a stinker that the Government unleashed a few years back. In the process, the corporate bore the brunt of it and in many instances were passed on to their employees. For instance, there is no justification to tax foreign travel done from a business promotion view point. I believe GOI is considering abolishing this, which would be a welcome step.
There are those who are waiting with bated breath to see if the budget increases the threshold for taxation. I would instead be happy if the surcharges & Education Cess were abolished. These levies are supposed to be for a short time frame. But, like toll bridges, these things become permanent fixtures. People are saddled with a lot of tax – direct and indirect. We all work for over 6 months, just to pay all taxes ( apart from Income taxes, there is Sales & Service tax, VAT, Excise Duty, Octroi etc. to contend with ) as there are all those levies on all products we consume. Government should take steps to curtail expenditure. Also, reckless increase in expenditure for Social sectors does not percolate, as intended. Instead, delivery mechanism for various social sector schemes should be tightened and made more efficient. This will ensure that the government is not perpetually hungry for more money and constantly seek avenues to increase taxes.
Home rent, especially in metros is high. There is brokerage & shifting expenses too, every now and then. In the current least-of-one-in-three scheme, these don’t get factored. For giving relief to citizens, it should be higher of the three. Also, one of the conditions – 10% of rent paid above basic – could be modified to rent paid. Also, brokerage and shifting expenses should also be allowable as a deduction along with HRA.
A lot of people are driving to work and the conveyenace deduction is still stuck at Rs.800/-pm. This figure should be moved up to a more reasonable figure like Rs.3,000/-pm.
The wishlist can be endless – but these seem to be the main ones. Yesterday, I sat up on bed in the morning with the uncanny feeling that these wishes had been granted, only to realize that the budget is still to be presented. When farmer loan waivers happens & sops for BPL households ( which don’t reach most ), why not give some relief to the people who pay taxes and are helping the politicians to dole away the largesse. Over to FM.

Published in DNA Money on 30/6/2009