Dividend distribution restriction required in equities.

 

Dividend distribution restriction required in equities.

SEBI should come with some restrictive norm for dividend distribution in Equities.

Dividend policy is laid down by company board and management. Generally mid and small companies do not pay dividend but there is no rigid regulation that they can not pay.

Dividend is taken as marketing tools by some companies as many people think any dividend paying company is a good one. They flock for it which encourages more buying activities for such shares and in turn helps the price rise in secondary market.

SEBI should have two norms: (1) Any company which is highly leveraged i.e., has more debt and high interest pay-out cannot give dividend till it is crosses a minimum level of interest coverage ratio (may be 3 times). This level has to be maintained whenever dividend is decided.  (2) Any company should have enough revenue reserves accumulated in their balance sheet which should be some multiple of the annual interest pay-out (may be 3 times). This level has to be maintained whenever dividend is decided.

These steps will help in ensuring lesser NPAs in the books of banks. Companies will also have enough cushion to tide over bad year if any (like this year). It will also ensure the promoters with mala fide intention will not gain at the cost of lenders. It will also help normal investors to stay away from such companies who are getting investors only because of dividend. They will have safer ,more stable and profitable companies to invest. The price discovery in stock market will be with some logics (at least there will be some improvement).

The biggest risk in India is not business risk or economic risk or market risk but integrity risk of Promoters and Bankers.  Common savers in debt (Bank FD) or common investors in equity needs to be safeguarded from any future causality done intentionally to due to mis adventurism of promoters and bankers.   

Zee Business Program 01 Dec 2020, Prakash Ranjan Sinha, Director, Nurtu...

Zee Business Program 01 Dec 2020, Prakash Ranjan Sinha, Director, Nurtu...

Irrational behaviour is dominating the Stock market

Irrational behavior is dominating the Stock market

Stock market touching indices new heights every day. Sensex touched 46000 a all time high level. People are very happy at the gains they are making. Many experts and analysts  in various business channels are  projected as a life time opportunity.  No one is talking of risk which many investors might face at some stage.

Let me explain you with a very logical and practical example.

Whenever you buy anything you pay a price. Two things you always evaluate. Price and Benefit. If you are buying anything at Rs 100 you know what benefit you are getting. Tomorrow if someone comes and ask you to pay Rs 150 will you pay? The first thing you will ask what benefit you have added that you are asking for higher price. If more benefit is explained that justify the higher price you might pay but if you feel benefit is not justifying the increased price you might not pay Rs 150. We prefer to pay only that price which is worth the benefit. We have this psychology in all our buying process but found missing when we are investing in stocks. We question for increase in price when we buy anything in the consumer market. We ask, “why you have increased the price” but how many of us have tried to find the answer in case of equity? How many of us have valid reason to believe that market upward movement is fully justified?

What is the benefit we get for which we are buying a particular stock or share of a company? It is the net profit (PAT) or earning per share (EPS). EPS is Profit after Tax/Nos of outstanding share. Are we aware what earnings we are going to get for the price which we are paying? Suppose there is a stock which was bought at a price of Rs.225 and gave an EPS (Earning per share) of say Rs.13. The historical Price Earning (PE) ratio is 17.30 (225/13). PE ratio means for every 1 rupee earning that person paid 17.30. Now if it is trading 277 how will you know it is worth buying at this price? It is worth buying only when you know it’s worth the benefit (earnings which you will get in future). Looking at Mr X purchased at 225 and got earning of 13 if you buy at 277 that does not mean you will also get earning of 13. You might get less or same or more. But do you know that? So what for you buying at 277?

We all know financial numbers of most businesses are very low due to lockdown and almost every reputed research company have predicted a gloomy picture for current year 2020-21. All are hoping numbers to be much better in 2020-21. But that is almost 6 months to a year from now ( if it happens). Are we ready to believe that market will keep moving upward till that results (growing earnings) are seen? What if the earning numbers fall below expectation? Will the market still move upward? Following anything blindly is the biggest risk.  

Why then market and stock prices are moving up now? Let me again explain with an example. There is a stock A.  It is trading at say 33 and at that time may be 500 people have interest in it. With bull run the prices moves up and becomes 45 in 1 month. it has given 33% return in 1 month (may be one of the best in that period). Now the number of people showing interest for that stock grows from 500 to 2000. As demand grows for that stock ( more people are chasing it) its market price goes up again. One action (price increase and higher return) catalyses another action (number of investors interest increases) which further leads to more demand of that stock and the cycle continues. Everyone investing looking at how in short term people who invested have got very high return. But people have forgotten that for all things their natural behavior is to pay the price which is worth the benefit.

Let me put one more word of caution. Historically whenever stock prices have jumped abnormally high in very short term then corrections have happened. Sometimes the corrections have been so massive that it has taken some years to bounce up. I don’t remember anytime in past when economic realities, business numbers are low and still market just shooting up.

This irrational behavior is beyond any logic. Hope after few months we don’t have many people repenting about losses than some who are rejoicing now at abnormal gain in short term.

 

Gold vs Equity

 

Gold vs Equity

If you hear any Investment expert he will always say Gold is not a true investment asset, Its an alternate asset, best hedge against uncertainty, one should not have allocation more than 5% to 8% of his total portfolio etc etc. About equity it is said, it is the best growth asset, will give you best return in long term, maximum allocation should be in equity etc etc.

All textbook theories do not work in today’s practical world which is becoming impure day by day. How long we will live, talk and believe in old concepts. Why not examine the things in realities of today life. Equity in textbook and in theory is same everywhere but the risk has increased more in India than many developed countries.

When I look at almost 100 years of gold price movement the maximum fall has been from 1962 to 1964 and then rise again ,1997 to 1998 and then rise again, There has been some more occasions where there has been year to year fall in price but marginal but that has risen quickly back to same old level. Only these are the two periods where it took sone 3-5 years to reach back same old price level. When I compare same with Equity (Sensex movement), year to year variability has been much more. The best of the companies index has been more volatile than Gold. In very long term Sensex might have given higher return that Gold but the same can not be said now in long term (10 years period).

My concern is not past but future now. Risk in Equity is increasing manifold times vis a vis Gold. The way integrity of Promoters and Management of many companies under doubt, the way Banks yet to learn lesson on proper due diligence on Corporate loans and above all the increasing number of corrupt politicians and their nexus with corrupt promoters clearly being visible I feel risk in equity is increasing. Text book and theoreticians will only talk of economic risk, business risk and market risk. Where some one is talking of integrity risk? This is the biggest risk. Facts and figures are being manipulated to portray as business and market risk. A profit-making company suddenly default where even the best of auditors have been found to have manipulated the financial statements of the company. The law is so weak that from a naked eye one can see company net-worth has depleted but at the same time promoter personal wealth has grown manifold times. Hire the most expensive lawyer, drag the case for decades in court and live king size life is the mantra what many default promoters are following. With universe of quality company reducing choice risk is increasing.

When I look at Gold there is no such risk as above. Today one has range of products to invest in. From Gold ETF, Gold Fund to Sovereign Gold Bond to Physical Gold to Gold saving schemes. The biggest risk is always of purity but now that is also resolved in whatever way you go. Physical gold is now duly certified one. Investment through financial route takes care of theft, storage etc. With respect to volatility or negative return Gold is less volatile and more stable than Equity. Gold has given stable to good return in mid to long term. Yes, may be if 15, 20 years and above period Equity has given better return but can that be said same going forward? Let’s look at the other risk aspects of Gold more from demand vs supply aspect. Demand has been growing considering existing customary norms (marriage, festivals, gifts etc) catalysed by growing population and their increasing personal income. On supply side it has not been supplemented by discovery of many new Gold mines. So growth in Demand exceeds growth in supply. Based on simple economics principle prices of Gold will have normal growth. It’s the uncertainty factor or flight for safety sentiment factor that accelerates the normal growth in short term ( as seen last 2 years ) which gets corrected later on. So stable return is what one has found in gold in mid to long term

One reason as to why there have been so many advocates of equity and not gold is simply because the fortune of many (Fund houses, Stock brokers) is correlated more with equity than Gold. Gold advertisement has always been passive as compared to equity.

Let’s relook this 5% to 8% allocation myth and need to think if allocation to be increased? As a investor one should look to the asset or investment product which is more suitable in mid to long term as an alternative to equity. In all probability there will be correction in Gold price as has appreciated phenomenally last 2 years but I am not saying to look for short term. May be after massive correction it can become an opportunity for investment with higher allocation.

Senior Citizen को कहां मिलेगा अच्छा Return? 60 साल के बाद खर्चों को कैसे...

Be a Role Model for Yourself

Be a Role Model for Yourself

We see everyone naming some one as his role model . Generally people will name some big celebrity , public figure or their parents as their role model . Role model means , you want to be like that person . Why some one else be your role model , why not you yourself be a role model for your self . Many will be thinking what crazy thing I am saying . Let me give you my logic for it .

When we say Mr X or Mrs Y as role model we need to understand what made us to name them . Is it to do with the success they have achieved in their respective field or Is it to do with they are adored or most followed personality or are very near to our heart and soul ( parents ) or what ? We sometimes are impressed with one aspect or two of that individual that we want to be like them . Do we know all facets of that individual ? What do we know about that person ? How much we know about that person ? There are many aspects , infact most aspects of the life of that individual that we do not know .

Whom do we know most in this world ? Its ourselves only .

Every person born in this world is unique . Each one of us are blessed with some quality . We need to explore them .

In my view “ You are role model for yourself “ . Why some one should motivate you to be like that person whose every aspect , every characteristic you don’t know .

You know what you are now , say in 2020 . Visualise what you want to be 10 years from now . You should imagine yourself as what you want to be . Now You of 2030 is your role model . You know what is missing in you to be what you want to be . list down these aspects and work on them .

For example you want to be a great musician . Now you know what qualities you have , what you lack and what you skill you must acquire to be a great musician . Now lets take a situation where  Mr X is your role model as musician . Do you know what he was when he was young , what problems he faced , what support he got , what resistance he faced ….. . You are targeting a end without knowing the path or what bottlenecks were in that path . You learn about that Mr X from stories through internet or some article . These sources might not be telling everything .

Your life is different from the life of that person . Every one is blessed by God but some have been able to achieve some thing and others not . Its because the first one visualised himself like that and worked hard for that. If some one role model has been Sachin Tendulkar and he wants to be a great batsman like him, he has to practice and play well . Whenever we make some one a role model we only target the success ( runs and centuries scored Sachin ) which he has achieved but what about the whole journey ? . If you really aspire to be like some one great look what are the virtues in that person. Develop and learn that in yourself. You know yourself best , you can mould yourself . But will you be able to reach same height or same achievement ? Thats where you will overstrech yourself and problem starts . You end up burning yourself more than what is possible within your limits .  

You should be learning what qualities are required to be what you desire to be . Develop , learn that . Monitor the progress of “present you” with your “ future you “. The best thing is tomorrow you due to any reason you fell short of your expectation you will evaluate yourself only and not find excuse externally . You will not repent as you know you know you gave your best . Whatever you will achieve that will still make you proud of yourself . You will be much happier relishing your own achievement rather than comparing with that of any other person  .

So don’t compete with anyone but compete with yourself . Be a role model for yourself .

Value Matrix for Distributor /IFAs / IFA

Value Matrix for Distributor /IFAs / IFA

Everyone knows Mutual Fund is a risky product . Simply put returns are not assured and so at times there can be mismatch between expectation and realisation . Distributor /IFA is the first layer of risk management and Fund Manager is the 2^nd layer in risk management of investor’s money . You face the risk from product after you have invested but the entity who makes you understand the risk and guides you to invest is managing the first layer of risk management . Someone not investing or investing totally in traditional products that is also a risk if looked from opportunity cost aspect . Distributors/IFAs are the most important link in the product communication, product positioning , risk communication .

The industry needs to value Distributors /IFAs and have a structured Value Matrix of Distributor /IFAs.  

In application form we have “ I have read the terms and condition……” which many sign without reading  . In addition to it why not have “ I have been apprised / conveyed by Distributor /IFA on risk -return aspect of the fund ……… “ . This will bring more accountability on Distributor /IFA. They will focus on knowledge upgradation and wise relevant communication to clients . This will also make clients more accountable and can not put all blame squarely on Distributor /IFA if their expectation are not met. After all its their money and they also need to be a bit responsible not only in asset choice , product choice but also in Distributor /IFA choice . Now time is to have a structured accountability and evaluation system right from filling an application to on going basis both for client and Distributor /IFA .

I have seen clients suddenly changing Distributor /IFA or going direct after being served by a Distributor /IFA last 5 or 10 years . How can someone become bad overnight and if he was not serving well how come client continued for such long time ?. Its point to ponder . We need to have a transparent system where everyone ( both client and his Distributor /IFA ) are constantly evaluated will all fairness .

Every 6 months or 12 months ( on semi annual/annual) basis every investor has to compulsorily do due diligence of his Distributor /IFA through a structured format. 

To make this whole process totally objective and no subjectivity a value matrix has to be made on many  parameters ( product knowledge , market understanding , operational knowledge , service quality ………) . Now the Distributor /IFA also knows where he stands , where he need to improve , what his clients expect etc . The weightage of each parameters should be decided to get a holistic balanced view of distribution or advisory services . All parameters are important but may be in not same proportion for different clients or might not every Distributor /IFA be equally competent on every parameter . This gives an opportunity of matching on specific parameter ( client – Distributor /IFA ) if that parameter is key for any client . Distributor /IFA need not spend their time , money and energy only on running after clients to get business ( short term approach ) but position themselves as Value driver and get business on merit ( long term and stable approach ) .

Based on composite inputs Distributors /IFAs need to be ranked as  A,B ,C , unrated category . This will help to differentiate between them . Further once differentiation happens most  Distributors /IFAs will strive to upscale their competence level . The biggest motivator for change is ones own experience or feedback. Some Distributors /IFAs if feel embarrassed at low rating if they request their rank need not be disclosed .  The choice of display or disclosure of rating will rest on that particular Distributor /IFA. Simultaneously any investor will have a complete visibility and assessment on the choice of Distributor /IFA.  Tomorrow they can not blame the Distributor /IFA .

If the MF industry has to grow exponentially then objective value drivers have to be in place where all stake holders have to be given importance . In my view this industry has grown to approx. 25 lakh crore majorly due to continuous hard work of Distributors /IFAs . I can say this thing based on my own experience since 1989 when I entered this industry . As industry owes to them its time to have a structure methodological approach in place where Distributor /IFA grows on his transparent merit and not on someones favour . Its high time Distributor /IFA should also realise their worth and competence and create a space of themselves .

If a fund can be rated , AMC can be rated , Fund Manager can be rated why a Distributor /IFA can not be rated ? It will lead for qualitative improvement and quantitative growth beneficial to all stake holders in Mutual Fund .  

Managing Investment Risk by Yourself

Three things you need to do/have: Strong belief ; Learning from past experience and Understanding present information

Strong belief : “I am going to lose my money” or “I am going to gain from investment”? what is your belief when you invest in any investment instrument or investment product. If its of loss then there is no point of investing in that product. Reason is you will be always fearful and a slight negative can affect you emotionally and you end up taking wrong decision i.e. withdraw when not required.  When you invest, your mindset, your belief system, your conviction should be positive. No doubt, no fear, strong faith.

Learning from past experience: If there is lack of positive belief, conviction why it is so? Is it because of past experience or is it because of what others are saying? Please remember what others are saying could be their own experience which might or might not be relevant in your case. You have to analyse your experience only from your perspective, your action/inaction that led to this experience. Lets say you had a bad experience of illiquidity or loss . Why it happened ? was it because of wrong choice of product or was it because of wrong economic /market condition when you withdrew or was it because you withdrew out of fear as everyone was doing due to some negative factors at that time . You have all those records with you . See how much you got that time and what is the value today . Check what if you had not withdrawn at that time? . would you have lost or gained ? On most occasion one has seen it has been judgmental error. So by now you should know what caution and precaution you need to taken moving forward . One or few bad experience should never be generalised . One need to understand the cause of it .

Understanding present information correctly: Now you don’t need to repeat past mistake . Understand and interpret present information from credible reputed sources in terms of risk (losing) and return(gaining) . You know both psychological and information gap you had which led to past losses . Once you know present information , you need to take a call what will be your reactions . We never remain in same mindset always . It changes with changing scenario . So better you note down somewhere if X ( Worst happen in next 3 month , 6 month ,1 years what will be my reaction ) . This has to be written with all fairness based on what you actually believe you will do . Go through it few times on different day when in different mood to ascertain there is consistency in your belief system.  If you feel you might repeat same mistake as past better avoid such product and invest in safer ones . If you know now with learning you can withstand notional loss, volatility for short term and not panic then no issues you are on right track .

Another point on information interpretation is never believe blindly even if told by a great expert . Understand the notional risk part and its impact on you emotionally , psychologically and even physically ( health wise). Many times we have seen in past many future predictions of experts have gone wrong as no one is God here . Your loss is your loss , your mental distress is your distress and so only you have to safeguard against it .  

Remember the famous proverb at Railways Stations “Passengers please take care of your own luggage”. Same way in investment  “ Investors please take care of your own money “ . So please follow the three stated principles to safeguard your investment interest.

Understanding “Atmanirbhar “ as a Layman

Understanding “Atmanirbhar “ as a Layman

Lots of economic stimulus package given to help all segment of society and economy in general. Different experts have different view on it. Some are praising and some finding shortcomings . There is political affiliation also in individual expert or economist view point so one can not say if it is devoid of any bias or prejudice . If a layman reads two  divergent view reports he will get confused on which to believe as both from highly learned economist and expert .  

I have tried to explain to the layman with a layman perspective .

Indian government has already deposited a huge chunk of money directly in the banks account of crores of poor still many find it quite less . Some Opposition leaders and even economists aligned with them advocating of more and more money to be given to poor .

Assuming we have 10 crore poor families in about 35-40 crore total families  Indian government  decides to put total of 100000 crore ( 1 lakh crore ) in the bank accounts of poor . How much to put in each account . lets say 10000 in each so that each of 10 crore poor will get 10000 each . how long this money will last ? 1 month , 2 month ? what after that ?. Will government again shell out another 100000 crore ( 1 lakh crore )? . Its getting into an unending cycle of transfer of money every month . With revenue growth already under stress  is it a viable solution ?. Yes its very bad time for poor and they need to be ensured of 3 time meal at least but it is bad time for revenue generators ( business ) in the economy as well . We need a balanced approach to fight present crisis .  

Lets see this with an example . A family requires 10 litre of water in a day for drinking . for that they store it in a bucket of say 100 litre . If they just keep consuming this reserve will  be over by 10^th day . what will they do then ?. So if there is continuous consumption, simultaneously there has to be regular filling of bucket also . From where water will come to fill the bucket on daily basis ? It simply means there is another (3^rd ) much bigger storage with much larger capacity not only to fill 1 bucket but many buckets daily and not keep providing consumption requirement of 10 litre to one family but to many families . That BIG STORAGE is what we call ECONOMY .

Now lets understand Atmanirbhar . In simple layman words it is allocation of capital to all sectors of economy to boost consumption ( cater to demand ) , to boost production (cater to supply ) . Supply and demand are two end of same thread . Job and People are vital ingredient in this thread . In my view it’s a very holistics view with a balanced approach to get out of economic slump where people , money , job , livelihood , companies , industries all integrated together .

We need to make labour as productive asset ( providing job/self employment  and making them to earn ) and not a liability asset ( make them idle and just keep feeding them 3 times of food ) .China has made its huge population as productive asset and is a economic giant today and India has followed making population as liability asset (feeding them and not making every individual Atmanirbhar )   . So this is Atmanirbhar all about . Slowly every citizen has to become a productive asset and self reliant and make India a self reliant economy which develops a capability to withstand all economic shocks like USA , Japan and other developed countries .

How Diversification helps in reducing the Portfolio Risk

How Diversification helps in reducing the Portfolio Risk

Many people feel that they can also construct a portfolio on their own or manage risk on their own. This thought comes when (1) market is having a bull run and one makes money in almost all equity stocks (2) when they see return going down and feel risk has not been managed so why to invest through a professional manager.

Diversification is not just buying securities from different industries but much more than it.

This article is to make them aware how risk is managed through diversification which a normal person howsoever learned he may be, can not do the way the professional fund manager does. This article will talk on those aspects.

·        Investment process – (1) security selection based on risk –return of available investment alternatives (2) best Portfolio selection from the set of feasible portfolios.

·        Having an Optimal portfolio in any given situation. Optimal Portfolio is one which gives maximum return at a given level of portfolio risk OR has minimum risk for a given level of return.

·        As per fund mandate, Portfolio is made based on type of security. Security is selected after security analysis based on fundamental and technical factors with due emphasis on economic and industry analysis.

·        Business Cycle is forecasted:  The current state of the business cycle gets incorporated into asset prices. Fund Manager makes decisions based on future economic conditions. It is important to evaluate and also forecast changes in economic variables.

·        A strong relationship exists between the economy and the stock market.

·        Security markets reflect what is expected to go on in the economy because the value of an investment is determined by (1) its expected cash flows (2) required rate of return (i.e., the discount rate). Both gets impacted by economic situation.

·        Stock prices consistently turn before the economy does. Stock prices are forward looking. Stock prices reflect expectations of earnings, dividends, and interest rates. Stock market reacts to various leading indicators. Very important to assess, understand and analyze the trend which only a professional can do well.

·        So, what a professional manager does – (1) Analyses Economic situation and predicts probability of different economic scenario (2) Allocation of capital accordingly for best possible return (3) sector rotation (4) security selection (5) strategy and style for better performance of fund

Let’s take an example of a portfolio management in a span of time say 5 years and how diversification helps in reduction of risk.

·        Few things we need to understand in all these 5 years, economic condition might not remain the same. For some months it can be very good and some months normal and some months could be very bad (like present situation).

·        For simplicity sake and for quick understanding let’s take a portfolio with 2 securities.

·        Portfolio risk is measured by Portfolio variance of return and Portfolio Standard deviation of return.

·        Portfolio variance of return and Portfolio Standard deviation of return is less than that of individual securities ?

·        Its because of Covariance and Co-efficient of correlation.  

·        Portfolio return is weighted average of expected return of individual security but Portfolio risk is not the weighted average of expected risk of individual security but the interplay of two securities also play a role and that where diversification helps in reduction of securities.

·        Co movements or interplay between returns of securities are measured by the covariance (an absolute measure) and coefficient of correlation (a relative measure)

·        Covariance reflects the degree to which the returns of the two securities vary or change together

·        Positive covariance between 2 securities means the return of the 2 securities move in same direction (positive or negative) whereas negative covariance between 2 securities means the return of the 2 securities move in opposite direction (if positive in one then negative in another and vice versa)

·        Coefficient of correlation is simply covariance divided by product of Standard deviation of the two securities

·        Coefficient of correlation is from -1 (perfectly negatively correlated or perfect co movement in opposite direction) to +1 (perfectly positively correlated or perfect co-movement in same direction). 0 means no correlation or co movement. If Coefficient of correlation is -1 it means if return of security A is x then return of security B is -x and vice versa. Similarly, If Coefficient of correlation is +1 it means if return of security A is x then return of security B is also x and vice versa

·        For Portfolio risk we need information on weighted individual security risk and weighted co-movement between the returns of securities included in the portfolio

·        Portfolio Risk in case of 2 security is:

Variance = σ_p² = w₁²σ₁² + w₂²σ₂² + 2 w₁w₂σ₁σ₂ρ₁₂

Standard Deviation = σ_p = (w₁²σ₁² + w₂²σ₂² + 2 w₁w₂σ₁σ₂ρ₁₂)^1/2

(σ_p² is the Variance of the portfolio return, w₁ and w₂ are weights of security 1 and 2 in portfolio, σ₁² and σ₂² are the variance of return of the of individual security 1 and 2 and σ₁σ₂ρ₁₂ is the covariance of the returns on security 1 and 2)

·        Fund Manager will ensure that covariance between the two securities and Coefficient of correlation has been negative . That has helped the reduction of Portfolio Risk .

·        It’s a not possible for a normal investor to calculate these complex variables, select securities keeping them in mind and construct a portfolio to give least of Portfolio risk (Variance and Standard deviation in portfolio return)

.

Lets see a portfolio with more than 2 securities

·        In a portfolio you have many securities, may be 10, 15 , 22, ….. If there are 10 securities portfolios then it will have 10 variance and 90 covariance (10*9). If say there are 30 securities then it will have 30 variances and 870 covariances (30*29). Is it possible for a normal investor to calculate so many covariances?.

·        One thing also important to note as the nos of securities increases the impact of individual security variance (individual security risks) becomes less and impact of covariance increases in overall portfolio risk

·        Hence the Portfolio Risk (Variance) of a well-diversified portfolio is largely dependent on Covariance. The lower it is, risk gets further reduced. If it is negative that is the best situation. This is where role of diversification helps in reduction of portfolio risk

·        With more securities added in portfolio the portfolio risk keeps reducing, reaches a minimum level (not zero). For each type of portfolio there could be maximum number of securities desired to make Portfolio risk to a minimum level. Beyond that if more securities added will not help in further reduction of portfolio risk. Its not easy for a common person to know what is that maximum number of securities.

·        Portfolio total risk cannot reduce beyond a certain level because there exists systematic risk also (from economic and market factors) also along with unsystematic risk (company specific risk).

·        In an Equity fund portfolio since asset is same, they will have positive covariance. But there also diversification can be done considering the nature of business and effort is to reduce the covariance as far as possible.

Conclusion:

·        In a scenario where there are so many economic variables which impacts industries, securities and security market in different way the best way to manage risk and get optimal return is by investing through a professional Fund Management like Mutual Fund.

·        Why Mutual Fund – (1) Research is the key in Fund management (2) Top Down approach (Economy – Industry -Company) is followed methodically (3) Security selection more on fundamental factors (4) tactical allocation done more to take short term market advantage

Evaluating Mutual Fund Performance ( JENSON ALPHA )

Nurture India Consultant Risk Management Series for Financial Literacy

Evaluating Mutual Fund Performance ( JENSON ALPHA )

I have always been an advocate of managing risk and not about chasing return. Its just like one is more concerned about speed and reaching destination quickly whereas a sensible driver will manage the accelerator and brake in best possible manner looking at road and traffic situation. Second driver concern is not reaching fast and quickly with risk of accident but reaching safely even taking few minutes more. Managing risk in mutual fund should be like 2^nd driver and not 1^st one.

We have been seeing most investors, analysts, experts evaluating fund on return given or risk managed but vis a vis what???? Market or Peer group. Ideally it should be vis a vis the risk taken by that fund manager itself.

Alpha: For most people it means Fund Return minus Benchmark return. So within same category say Multicap Fund if 3 funds (A, B, C) have given return of say 12%, 13% and 15% and benchmark (same indices) has given say 10% return then the alpha as understood by many investors is

Fund A = 12-10=2%

Fund B = 13-10 = 3%

Fund C = 15-10 = 5%

Its looks C is best, B 2^nd best and A is the last performer in the three.

Do we know how smartly the fund manager has been able to judge economic and market trends and factors , what industry sector weightage in the respective portfolio  , similarly weightage in different companies . Looking at the economic and market condition fund manager will increase or decrease industry wise and company wise allocation. How frequent and how much he is buying and selling (Portfolio Turnover Ratio) to manage the risk and return etc etc .  

Its not easy for a normal investor to track on too frequent basis and so the easiest way to judge between good and bad performer for most is above stated Alpha and trend of the alpha in different time duration.

We always say “higher the risk higher the return “. But does this apply only for investors? In my view this applies for Fund Manager also.  if a fund manager has taken higher risk then he should generate higher return also.

Now when I evaluate the fund performance it will not be alpha over benchmark but alpha over the risk which the fund manager has taken which is called Jenson Alpha.

Any investor who invest expects (1) at least a minimum return which the economy can give ((risk-free return i.e. T Bill or G sec yield ), (2) market risk premium over risk free return otherwise what was the sense of investing in risky market related investment i.e. (return of benchmark/indices - risk-free return). But the larger issue is how the economic and market risk has been managed (sector weight, company weight, portfolio turnover etc). As an investor I need to be compensated for that i.e. if the risk has been taken more I need more return (Higher the risk taken by Fund Manager higher should be the return) . That risk is measured by fund beta .

Now Jenson Alpha is = Fund Actual Return – Fund expected Return (based on risk taken)

Fund Expected return (based on risk taken) = Risk free return + Beta (Benchmark return - Risk free return)

Now let’s assume Risk free return is say 6%, benchmark return is 10% and Beta for A, B, and C is 1.1, 1.2 and 1.8.

Now Expected return will be as follow (in percentage)

A = 6 + 1.1 (10- 6) = 10.4

B = 6 + 1.2 (10-6) = 10.8

C = 6 + 1.8 (10-6) = 13.2

Now Jenson Alpha for the 3 funds are

A = 12-10.4 = 1.6

B = 13-10.8 = 2.1

C = 15-13.2 = 1.8

Now just see Is the performance same as earlier as done by most investors . Now B looks as best performer of the three and not C .

(Pl note – The above example is just a hypothetical one just to explain the concept of correctly evaluating the fund)

Understanding Risk and Return if investing in Equity Today

Understanding Risk and Return if investing in Equity Today

Many investment experts are telling to invest in equity as many stock and indices are 30 % to 40 % down from its peak ( Nov – Dec 2019 ) level . Can we superimpose past mathematical facts and calculate forward return ? . This time Risk is different from all risk what we have seen in the past. Last such similar type of health related risk (Spanish flu) was 100 years back . Sensex , the oldest indices came into existence in 1980. All previous recession was not having risk of today so just on the basis of past market indices data and movement we can not tell exactly by what time “x” return will come  . Yes but one thing is for sure that there will be upside but from when , how much can not be told.

Lets remember Risk is not dependent on  return but return is a function of risk . So we need to understand risk. 

Valuation at any point of time reflects all the risk incorporated by the market . But more than Valuation important is the trend of valuation ( falling/ rising  ) as that reflects the mindset ( fear/greed ) of market participants .

Valuation at any point is a static variable whereas trend of valuation is dynamic in nature i.e. changing regularly. Apart from Valuation level one should also give importance to trend in valuation.

The risk in Nov-Dec 2019 was not the same as what the risk is today and risk will not be same 6 month or 1 year or x year from now . Risk changes every second , every minute , every day . Change in Risk leads to trend ( fall/rise ) and the valuation .

In Dec 2019 – there was hardly any risk from Covid 19 .

Today – Covid 19 impact . heavy sell off from FIIs . The mindset of FIIs is aligned more with the Covid 19 impact in their economies . Stock market falling there . In india -- Domestic investors still holding by and large . Have we seen the worst of Covid 19 in India ????? . Has Indian Stock Market factored Covid risk in India . Please remember up till now its Indian Stock market impact is more from external risk and not from internal risk .

Tomorrow ( Short term ) – Much depends on Covid 19 impact ( external and internal ) . God forbid nos in India remain less and under control . But if that not happens then our stock market will factor this risk also .

Its not a question of 30 % discount sales but what’s ahead in short term and post Corona .

Post Corona Situation – (1) Since all countries are affected their economic policies will have domestic orientation. Will then FIIs and FDIs will invest in India and how much they will invest ?  (2) Banks were already under asset stress pre Corona . With businesses getting beaten , earnings will dip and chances of more NPAs in bank Balance sheet (3) Government will have lesser Corporate tax so will impact Government spending (4) Retail Individuals spending priority will change . Luxury and discretionary expenses will see reduction and impact on such industries . (5) Govt might resort to borrowing through G Sec and surplus money will move there (6) Even Corporate expenditure will see overall reduction and prioritisation w.r.t various head of expenditure and that will impact sales, revenue and profit .

A lot depends what will be government economic and industry policies and that will decide how quick India recovers back to normal level .

Best Strategy – hold cash as no one other than God knows if we have reached bottom .  Also your next 3 to 5 year defined planned major expenditure should be ensured by debt investment . If not done first do that .

After that If  have excessive surplus of cash and want to invest then invest in large cap with clear limit order . Go for stop loss or profit booking strategy . Put limit order with spread on bid/ask price . The spread should be realistic and realisable.

MF is the best Option – As managing the risk is key to investment there can not be better option than Equity Mutual Fund . Most of the risk and strategy which has been mentioned above will be taken care better here than direct investing . Whether evaluating Govt policies, industry wise exposure , Company wise allocation, Cash position , Tactical calls etc a research driven professional fund manager will do better than any other individual.  

SIP helps you to get invested in staggered way at different valuation level  . If you have lumpsum that one can invest in staggered way . say 10 % now . If fall of say 5% then next 10% and so on . But in either case the investment horizon must be minimum 5 year or more.

Rather than trading in direct Equity better will through MF ETFs with same stop loss, profit booking strategy with limit order with spread on bid/ask price .  

Stay Invested Don’t Panic

Stay Invested Don’t Panic

There is panic in market . Heavy selling leading to sensex , nifty and major indices tumbling down . One should evaluate this with a little bit of common sense .

·         Is this due to permanent or temporary reason . Its because of temporary reason – Corono virus .

·          How long the world can see the impact ( health wise ) of corono virus – difficult to say but definitely not beyond few months . No virus has stayed for very long time .

·          Why this impact in terms of business and market – Business Travels , business meetings , business conferences almost at a standstill pace . Impact on Order Book of any company . There is a gap when order booked and business realised and accounted in profit . So going forward there will be a big dip in revenue ( 1 quarter for sure , may be next 2 quarter there could be cautious wait and watch approach ) . Now with reduced future earning clearly visible and that on the back of already slowing economy short term problems have compounding negative effect psychologically .

What will happen once after few months Corono virus does not exist  --- Reverse of above . Business travel meet , order books everything will grow . The moment increased sales realisation happens market will revise the earnings upward and beaten valuation will again scale up .

Only one suggestion I can give – Don’t redeem your equity investment in panic . Have patience and stay invested . Valuations will move up because it went down because of temporary reason and once that temporary reason is gone it will move up.

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