25 August, 2011

Timing the market & investor psyche

With the mayhem unleashed due to the downgrade of US to AA+, markets across the world have experienced correction. In times like these, logical thinking is the first casualty. There are market observers who suggest that there is more pain and the market can trend down. There are those voices which are harping on the popular sound-bite that “Cash is King”. There are other more optimistic ones who suggest that markets have been anticipating this and are already factored into the fall. By implication, what they mean is that the downside is limited and the upside potential is higher.

Now such divergent voices are what cause confusion for the normal investor. As it is, they are scared as the markets are falling. Do they invest now, hold on to what they have or cash out?

Timing the markets has always been a subject of much debate. Paradoxically, retail investors tend to think that they can time the market well, based on what they read and hear. That is surprising as timing the market is virtually impossible, even for the most savvy investors, which includes fund managers.

Ironically, that is the advice investors want today from their advisors. So, what can the investor do…

First, they need not change their allocations now to accommodate the new kid on the block which is firing on all cylinders – Gold. Most people have long-term goals and meeting them would require a consistent strategy. One should not look at changing the strategy overnight, whenever there is some change in the environment. The strategy would have to be revisited only if the events have considerably changed the risk-return possibilities over the period, which calls for such a change. This is not one such event.

Indian stock markets have been considerably driven by FII money and when money moves back to western shores seeking “safe havens”, the markets fall. But, if one looks at the indebtedness of the various countries and the prognosis for their economies from here on, FII money will sooner than later come back to emerging economies with potential. India is one such economy, which has the potential to grow at 7%+ levels. Hence, it is a fact that though there are short-term problems, the medium to long-term outlook is good.

Hence, apart from changing some tactical allocation & tweaking the portfolio a bit, one should let the strategy remain intact. This means continuing SIPs/RDs which are going on, continuing with the investments done in the past to achieve long-term goals and not attempting a major change of the allocation just because Gold seems to be the star on the horizon. Gold continues to be a good hedge against inflation and due to it’s negative correlation with equities, it also reduces risk in the portfolio. The way Gold has run up does not bode well for this commodity and correction can happen in this, in times ahead. There seems to be a bubble building up in Gold but people don’t seem to be recognizing that. There are those who are going whole hog into Gold after liquidating investments from other assets, which is not a good strategy at all.

Since the markets are in correction mode, it may be a good time to invest in Equity and Equity oriented Mutual Fund schemes, for those with a long-term view. Such investors should split their investments and invest in small lots, over time. This will enable them to invest at low market levels and take care of volatility.
Investor psyche comes in the way here… there are those who want to shift their money away from equities and into FDs and other such debt instruments. That again is not a good strategy. Investing in equity at this point would give the best bang for the buck. Whether investors see it that way is another issue. Currently they are running scared – much against their best interests.

Authored by Suresh Sadagopan ; Article published in Moneycontrol.com on 18/8/2011

Assured return instruments, a must in all portfolios

Bhaskar was in a good mood. He was smiling presently and was in an elevated frame of mind. He was showing me his collection of Music & video CDS/DVDs and was explaining animatedly about some of his new acquisitions. I was happy for him. It was not always like this, though.

Bhaskar is one of those high-adrenaline types, who thrives on taking risks. In fact for Bhaskar, nothing look like a risk. For that reason, he has also been pretty successful in his entrepreneurial ventures where this risk taking ability nicely blended with his good eye for spotting opportunities and moving in decisively.
Bhaskar however was a miserable pulp 3 years before – in 2008. He had bet on Equities in a major way and had been doing very well. Like all those who taste huge success early on, he took too huge a risk by betting on various momentum players, with borrowed money. He lost crores of rupees in 2008.

That is when he had come to me. I had to calm him down and firstly make him see the sunny side of things. He was so dejected that he just saw gloom all around. I had to remind him that he had thriving businesses and he would be able to bounce back from the setback. I also told him that we will have to redo the portfolio and bring some sanity into it.

The first thing I had to do was to educate Bhaskar on the need for diversification, appropriate asset allocation, streamline investments in line with the goals, discipline & regularity in investments, investment horizon etc. It was not that Bhaskar was unaware of these… he just ignored all these due to his gun-slinging-cowboy like attitude towards investing.

When I had suggested that he rebalance the portfolio and have a decent allocation towards debt instruments, he had glared at me. He was incredulous that I was even suggesting this, I had to spend time…

Investing in instruments which give high returns were fine. But in one’s portfolio, there has to be a good mix of all kinds of assets from low risk-low return instruments to high risk-high return ones. The low risk instruments tend to be debt instruments, which are not very exciting for a person like Bhaskar. He infact made me say that the post-tax returns in debt instruments may not even beat inflation. But still, I insisted that these instruments will ensure that the capital is safe and some returns accrue from them. In fact these kind of instruments should form the bedrock on which one’s portfolio edifice needs to be built. These instruments are the ones that steady the portfolio.

Again there are different debt instruments and one needs to make appropriate choices. PPF will be a great choice for those with a long investment horizon. This will be suitable for accumulating one’s retirement corpus, children’s education / marriage requirements etc. Also PPF gives a decent 8% post-tax returns. PPF was started with the objective of giving access to a Provident Fund like account ( which is available to Organised sector employees ) to others who do not have access to PF. PPF was created with the mandate to assist individuals to build their corpus for their retirement needs.

Post office MIS helps those who want regular returns. Kisan Vikas Patra is another product with a 8 year 7 month duration, which doubles the money in this time frame. In the current regime, it is not all that attractive. Bank FDs themselves are offering 9.25-10% returns for 1-2 year tenures. There are Bonds & NCDs which are coming out with attractive rates too. Company Fixed deposits are offering between 9-11% pa. But in all these instruments mentioned, the interest income is taxable.
That however does not diminish the merit of having these in one’s portfolio as one requires stability too. The others which can potentially offer better post-tax returns are Fixed Maturity Plans from Mutual Funds. Apart from this there are several debt funds which could offer good post-tax return as the interest rate cycle is expected to turn sometime from now. Dynamically managed funds are best bets at this juncture. Apart from this, in times to come, Income funds with longer maturity papers and Gilt funds themselves would pose good opportunities.
The main point that I wanted Bhaskar to appreciate was that having these in the portfolio improves the chances of the goals being met, not the other way round. I had to hammer it across, that equities, though it offers good returns, carries high risk. He was not very convinced, though he reluctantly gave the go ahead to redo the portfolio. He did buy some equities after that too! And now they are trading at at a loss. But Bhaskar is not bothered. He has now understood the importance of his debt portfolio, secure in the knowledge that nothing can affect at least this portion. It helps that I had suggested 45% in debt instruments for him as he anyway takes high risk in his business. So you know why Bhaskar is atwitter now!

Authored by Suresh Sadagopan ; Published in The Financial Chronicle on 24/8/2011

11 August, 2011

It’s a good time to invest in debt funds…

Investors at this point are running scared from the Equity markets into the arms of their evergreen love – Bank Fixed Deposits. Bank FDs are giving between 9-9.5% for one to two year tenure. There are very few banks which are also giving around 10%. If the investor is a senior citizen, they can get another 0.25% - 0.5% extra.

So, is that the best place to invest if you want to invest in debt instruments? It may be if are not paying tax at all or you are in the 105 bracket. But for those in higher income tax brackets, FDs are not the most appropriate instruments to invest in – for the post tax returns would make it less attractive and other competing. Think again, if you thought that there is no competition to the bank FDs, which are offering better returns as compared to NSC, KVP, Senior Citizen Savings Scheme ( SCSS ), PPF etc.

You have debt funds from Mutual funds. For various durations, you have good investment options.

If one wants to invest for short term, one could look at Quarterly Interval Plans ( QIPs ). The instruments which go into these namely CDs and CPs are offering now about 9.1% & 9.4% respectively. Factoring a 0.4% as expenses, the returns come to 8.7% - 9%. It is always desirable to choose the dividend option as the Dividend Distribution Tax (DDT ) is 13.5% now. Taking that into account the post- tax returns would come to 7.53% - 7.79% returns! Not bad for a 90 day investment, where banks offer between 4-7% pretax returns. In fact the returns from even the one year FD for a person at 20% tax slab are between 7.2-7.6% post-tax and for another at 30% tax slab, it is between 6.3- 6.6%. The post-tax returns from QIPs are on par or beating even one year FD returns! So, why not simply invest in QIPs, keep the liquidity intact and keep rolling over, if money is not required. This makes sense especially if you want to invest for the short-term.

FMPs used to make sense too. But with DTC looming on the horizon and impending changes in LTCG, it may be a good idea to roll over the QIPs till March 2012 and then invest in an FMP which matures after April 2013. There are 3 -6 month FMPs too, which one could invest in the dividend mode. Investing in QIPs & 3-6 month FMPs will be beneficial as the Dividend Distribution Tax ( DDT ) is 13.5%. Short term capital gains ( STCG ) on the growth option is at one’s Income tax slab rates and will be suitable only for those in the 10% tax bracket or who do not have to pay tax at all.

For LTCG treatment, the investment has to complete one year from the end of the financial year in which it is invested as per DTC. So if you invest in March 2012 and the investment matures in April 2013, it will be eligible for LTCG. However, though indexation is allowed, the income would be taxed as per the tax slab. This will be positive for those in the lower slabs and will entail higher tax for those in the 30% bracket. QIPs and 3-6 month FMPs maturing in Feb / Mar 2012 can be used for investing in FMPs which mature after April 2013, to claim indexation benefit.
The other debt funds to look out for are Income funds and actively managed funds, for those with a medium to long-term horizon. The interest rate cycle has more or less run the course and income funds will particularly do well. If the investment horizon is 1.5- 2 years or more, this will be a good investment option. Don’t panic if it shows negative returns for a few months though. It will, till the interest rate cycle turns.

The other safe bet at this point would be actively managed debt funds, where the fund manager takes a call on the duration of the papers invested, the type of instruments in the portfolio, timing of the investments etc. Well managed active funds can again reward the investors handsomely. Also, the fund manager would ensure that you don’t slip to negative territory due to the calls he takes. Again the suggested investment horizon would be 1.5-2 years.

Both income and actively managed debt funds have the potential to offer double digit returns. These are indeed better options than bank FDs!

Authored by Suresh Sadagopan ; Published in moneycontrol.com on 12/8/2011

10 August, 2011

Has anything changed after the MF transaction fee introduction?

The entire MF industry has been waiting with bated breath for the new Chairman of SEBI to release them from the vortex of downward spiral, it has found since the past two years. Distributors have deserted the system as it was no longer remunerative enough. This resulted in too many orphan cases – investors who are not being serviced by anyone at all. No wonder that tens of lakhs of equity folios have been closed, in the past couple of years.

The abolition of entry load was positioned as the ultimate investor friendly step and media went to town, buying into this story hook-line and sinker. The simple fact is that for any market to function, one will need a functional system where all participants perform their function effectively and they all get their due. A win-lose relationship seldom works. It is a utopian idea that distributors will work for free. Distributors deserted the system as they were unable to charge a fee and the entire business had turned unremunerative.

Now, SEBI has brought in a fixed transaction fee for sale transactions - Rs.100 per existing folio and Rs.150 for a new folio, for investments of Rs.10,000/- or above. This does not cover any other transaction like STP, redemption etc. For SIP transactions (any amount / any tenure), it would be the same fee collected in three to four instalments. This has been ostensibly done to incentivize distributors penetrate the retail segment in small towns.

So, will this help? Let’s see. The awareness in smaller towns about MFs will be lower than in Metros and bigger cities and consequently more time and effort needs to be spent on an investor. After spending time, the distributor may still not get anything out of it – as the investor can invest direct, in which case there are no transaction charges and can also invest less than Rs.10,000/- through the distributor, without charges. This could pose a problem to a genuine distributor trying to suggest MF investments to potential investors.

Also, even if the distributor gets the charges, it is the same for Rs.10,000 or Rs.1 Lakh. It is fairly evident that an investor investing a few thousands will want a lower level of service as compared to another investing Lakhs of rupees. This fixed transaction fee will hence not be of much use, as, for a Rs.10,000/- investment in an existing folio would give the distributor 1%, whereas it will give 0.1% if the investment amount is Rs.1 Lakh. It is obvious that fixed charges have their limitations.

Additionally, it will open the field for unsavory practices too. There is nothing stopping a distributor from splitting a Rs.1 Lakh investment into 10 new folios and earning a 1.5% transaction fee. Investors would not even know what is happening and will be saddled with a huge number of folios. This will increase the number of folios ( especially with investment of Rs.10,000! ) and will seem like a vindication of SEBI’s stand. But it may just be a simple break up of investments, as discussed earlier. It could also give rise to churning, to earn transaction fees. Those could be the unintended consequences.

So, who is going to benefit from this? Some distributors who are into real retail segment and who have not been able to charge a fee of any sort, will benefit as they will get some fee to defray their marketing expenses. The retail investors will also benefit to an extent as now the distributors will again become “available”. But this regulation is hardly a game changer and has as much positives as there are negatives. What actually happens on the street remains to be seen. Caveat Emptor still should be the guiding principle for the investors.

Authored by Suresh Sadagopan ; Published in moneycontrol.com on 9/8/2011

01 August, 2011

Investing tax efficiently can mean whether one meets the goals or not

Most people are super-conscious about tax savings… I mean, they would go to any lengths to take advantage of Sec 80C limit of Rs.1 Lakh. They would want to go for medical insurance just to take advantage of the Rs.15,000/-pa available under Sec 80D. Even if they are in the lowest income tax bracket of 10%, many would still want to invest in infrastructure bonds, though it has a lock-in period of at least 5 years. When people are so keen to save tax upfront, why would they want to pay taxes on the money they are earning, especially if they can structure it in a way, they need not?

Let us take an example to understand this. Ram invested Rs.30,000/- in NSC and Rs.40,000/- in PPF in the previous Financial year. While the amount of tax saved is identical in the year of investment, the interest income accrued from these two, are taxed in different ways. NSC interest is taxable in the hands of the investor, when they get the money after six years. The return would be 30.9% less ( that would be the tax outgo in the highest bracket ), when they get the money back. However, PPF is entirely tax free. Hence, the entire amount one gets is tax-free. Though both of them have offered similar returns, the actual returns they have offered is vastly different. Ram could have invested the entire Rs.70,000/- in PPF and could have ensured a higher return for himself… that is assuming that he is willing to lock-in his PPF investments for 15 years. A simple decision can make such a lot of difference.

Now, look at regular investments… many invest in bank FDs. In fact, it is a vehicle of choice for our citizens, many of whom are risk averse. But, apart from PPF, is there a better, higher yielding alternative of lower duration? The answer is in the affirmative. You have heard them – Fixed Maturity Plans ( FMPs ), the current darling of the MF industry.

These products invest in a basket of securities which include Bank CDs, Company commercial paper, structured obligations, Bonds etc. – meaning, all these are debt products and FMP is a 100% debt product. So, how is it going to give a better yield? Are the components more risky than a Bank FD? If it has other than Bank CDs in it’s portfolio, then the risk profile is going to be higher. Does, that explain the better returns we are talking about? To some extent, that explains a potentially higher yield. But, the other aspect is the tax treatment of FMPs, which is far more benign… if one gets a dividend, it is tax-free. Dividend distribution tax would be 13.52%, which would be paid by the company and indirectly the investor would be paying it… much better than paying 30+% tax!

In the growth option, it can be 10% without indexation and 20% with indexation. Now the 20% with indexation option, used to ensure little by way of taxes. That could change with the advent of DTC. DTC as proposed says that after indexation the capital gains will be subject to tax at the income tax slab rates. Also, Dividend is proposed to be added to income. These could affect the attractiveness. But still growth option where tax applies after indexation is always better than paying tax directly on interest earned.

Why did I not mention Equity MFs and Equity? Yeah. The income after a year in these are treated as capital gains and are currently nil. That makes them very attractive. But they are a different asset class altogether and can give higher returns but come with higher risk too.

In substance, one should look at the tax incidence / savings on the product over the product life cycle and not only while investing. That can mean a difference Lakhs of rupees over one’s lifetime. That could be all the difference between achieving your goal or adjusting & making compromises. If you just get that, you have learned more than enough for a day!

Authored by Suresh Sadagopan ; Published in Moneycontrol.com on 27/7/2011