Zee Business Money Guru 02 Nov 2015 Prakash Ranjan Sinha Nurture Indi...

Understanding Return in Investment Products and Risks affecting the Return

Understanding Return in Investment Products and Risks affecting the Return .

We all invest in various investment products .Debt , Equity , Physical Gold and Real Estate are the main assets for investment in India . Everyone wants good return but at the same time does not want any loss . So it is very important to understand how return comes and from where the risk i.e possible loss can come .

Return comes in two form – Regular and Capital Gain . In case of Debt the regular part is Interest Income, in case of Equity it is Dividend income . In case of Real Estate it is rental income. Gold does not offer any regular return if invested in pure physical form. Capital Gain booked when you sell the investment and the gain coming out of difference between purchase price and redemption price forms Capital gain.

Lets take example of Debt .

Return == Interest + Capital Gain.

The risk associated with interest rate i.e may not get interest comes from the credit quality of the company where one has invested . Generally if you invest in good investment grade paper the risk of not getting interest does not exist. So within investment grade also return component from interest gets enhanced by moving from AAA rated to AA+ or to AA or to AA- . The second return comes from capital gain i.e when you sell. This is affected by the duration of the debt securities and the impact of change in interest rate scenario in the economy . If general interest rate goes up you will get capital gain but in case general interest rate in economy goes down there might be capital loss . If the term to maturity is less the impact of capital gain or loss will be less and if the term to maturity is more the impact of capital gain or loss will be more . So the risk to your return component from capital gain side is mainly due to trend in general interest rate movement .

The best way to look for return and also manage risk is to get debt mutual fund product . In case of rising interest rate scenario your investment should be into short term fund or floating rate fund having investment grade securities . In rising interest rate scenario Fixed Deposit and Fixed Maturity Plan are also an option . In falling interest rate scenario  be in long term debt fund or in a duration fund where the fund manager is increasing or decreasing the maturity of portfolio by shifting from short term debt securities to long term debt securities and vice versa. One thing any investor must bear in mind that due to higher tax rate investment in debt in any form reduces the net return post tax . You get some indexation advantage if done in debt mutual fund and the stay is long period (more than 3 years ) .

Lets take example of equity .

Return == Dividend + Capital Gain

Dividend is paid from accumulated net profit . It also depend on the company policy i.e. whether they want to plough back profit for business growth and expansion or want to share with shareholders . So the risk of not getting dividend here comes if the accumulated net profit is inadequate and/or the company policy on dividend distribution . On Capital gain side risk of making abnormal gain or loss emanates from time aspect , economic scenario and quality of asset ( market cap of security ) . In short term all equity securities prices are affected more by piecemeal news and views associated with that company . This news and views may be a fraction of company’s total related information but it creates an impact even for few days. If economic condition is good or stock market rising then even in short term there are more gains than loss . Large cap stocks again rise slowly vis a vis mid cap stocks if stock market is rising but they fall also slowly vis a vis mid cap when stock market is falling . Analysis of piecemeal news and views is not an easy job for a layman . How those things will impact the price and for how long is definitely not a layman cup of tea. So when some one invest directly in stock first mentally he should be prepared for this . Secondly he should have some authentic professional guidance on stocks where he is investing . Your gain or avoidance of loss depends on how quick you respond to price change and also quality of holding . Short term direct equity investment adventure have been loss making result for most . Some of the risk that can affect your return is ( a) selection based on temptation or herd mentality ( b) If trying to time the market end up being less proactive to get in or get out of a particular investment at right time . In long term if the stock you have selected is good one it will give you good capital gain as in long term net earnings of the company gets properly correlated with the price of stock .. The best way to mitigate the temptation risk , time risk, stock selection risk , lack of proper understanding etc is best managed by investing through Equity mutual fund where research based investment decision making is done and the portfolio is constructed keeping diversification aspect so that over all portfolio risk is minimised. Portfolio is managed both with stability aspects i.e investment in good businesses  and also encashing on opportunities provided in short term due to price volatility .

Gold presently look to give capital loss in short to medium term. Yes if someone is linking it with need based ( for marriage , gift etc) after 10 years from now then he can look for investing in Gold ETF through SIP ( Systematic Investment Plan ) . The proportion of Gold should be 5-7 % of overall portfolio value in all economic scenario . Gold has very less reproductive value and its price movement mainly depends on demand supply factor . Supply side has limitation but demand will grow either for investment reasons or sentimental reasons or family function compulsion reasons .

Real Estate is good and has given good returns but again has liquidity problem, requires large corpus for investment . One risk is at many places the price has almost stagnated last few years so one needs to evaluate the location risk . Real Estate investment is good when one does not require money in short to mid term and also enough other liquid investments ( Debt/Equity/ MF) to take care in case money is required. Else the notional return i.e return on paper is inconsequential in real terms as it is not going to help you when you require money for meeting some important need .

So pl always remember Investment is nothing but deferred consumption and fine balance on Liquidity , safety and return to be made as per your overall need and requirement.

Market is jittery so what the Mutual Fund investors should be doing ?

Market is jittery so what the Mutual Fund investors should be doing ?

Last some days Indian stock market seeing some big downside followed by some small upside and then game of upside , downside continuing . Reasons are Chinese and US market impacts about which we can do nothing . What will be happening is days to come , how long we will see the volatility , Is there more fall expected in market levels etc , these questions must be coming in the mind of Indian Mutual Fund investors . Experts have been airing their opinion . I have always held a view that these opinion on market levels in short to mid term are very difficult to predict . My observation has also been that looking at last very few days trend and news these experts air their view . How far they prove to be correct on continuous basis is again something which has not been always proved with full accuracy . My concern is not about market levels or experts prediction but what’s going in the mind of Mutual Fund investors and what their mindset should be .

Firstly when we say Equity MF is a long term investment i.e must have a minimum investment horizon of 3 years plus or 5 years plus ( for those who are more conservative ) it means that the short term volatility risk is well covered in this minimum time period . There are two type of transaction happens – first you invest i.e buy units of the equity mf scheme selected and after more than 3/5 years you redeem i.e encash your units purchased .

One mistake which most investors do is when they buy they look at market level or at least influenced by the rising market level and when they sell either it is due to need or to book profit or may to save the loss if market falling . Investment in Equity MF looking at market level is the wrong approach .

I will give you an example of onion which had caught the attention of whole India due to rising price. Suppose onion is priced Rs 6 per kg or Rs 60 per Kg or Rs 200 per kg . Does this changes the quality of onion or the taste of onion ? Definitely not . I might be buying less or more due to price but quality or taste is independent of it . Price is affecting my buying behaviour  . The benefit in terms of taste that the product gives is independent of the price. Lets assume in above example that price is reducing ,then will you buy less or more onions ? 

When you are investing in MF again market level or NAV is something which can affect you psychologically but you must understand that you are investing for the coming benefits i.e the growing earnings of the companies where fund manager has invested on your behalf . It will never happen that companies are growing in terms of earning and its market price will not grow . So in long term with rise in valuation of companies  stocks which are in portfolio , NAV will grow and so will grow your return. Generally most of the money invested by fund manager is with mid to long term view and some / few with short term view where he wants to take advantage of price/market volatility . What should affect you is the quality of portfolio or earning ( profit after tax ) generation capability of the companies . If that is what getting affected then yes there is a point to worry . If the earnings of the company is externally determined rather than internal ( domestic ) demand then yes some area of concern as investor . But even in the worst of recession situation ( 2008-09 ) we did not see any downswing in consumption patterns in India . When our economy is consumption led economy then the industries /companies catering to local demand will be less affected .

Indian investors who are investing in equity MF schemes should not worry about market levels as that reflects the instant buying and selling behaviour of the market participant which is in no way related to the earnings of companies . Ultimately as MF investors you will gain till earnings keep growing so be calm and stay invested . Don’t get affected by short term views of experts . It is more for day traders in equity and not for long term equity mutual fund investors .  

How much Equity and how much Debt should be in a Portfolio

How much Equity and how much Debt should be in a Portfolio

There is a thumb rule that Debt investment percentage should = age and Equity investment percentage should be 100-age . The more younger you are you should be more in equity . Alternatively the older you are your investment should be more in debt. We should take not take the mathematical proportion with complete rigidity but rather than evaluate profile of the individual . Thumb rule is relevant only when the networth or income level is inadequate to meet the day to day livelihood  . Does investment in debt make any sense for Mr Amitabh Bacchan or Mr Ratan Tata who are not young .

Income and Job stability is the key thing before thinking on portfolio allocation in debt . Lets take an example of an individual working in Government organisation , PSU and in a big reputed private sector brand like TISCO, TELCO , Infosys . Does he carries income risk or job risk . In my view No. His monthly income is there to take care of his routine expenses . For such investors opportunity of maximising gain should be the investment decision making .

Many experts also say when you have retired your investment should be almost all in debt . Again we need to look why . Its because may be you are dependent on that money in form of either dividend or withdrawal to meet your both end meet . Lets take present day example. Equity is giving or expected to give higher return than debt . So till that is happening or expected to happen  why one can not be in equity mutual fund and opt for monthly Systematic Withdrawal Plan from Equity MF scheme rather than investing in debt mf scheme and opting monthly SWP from debt MF . Take an example -- equity mf is giving a return of 13 to 18 % CAGR and debt MF 8 to 10% CAGR .  You are adding some 3 to 5 % extra return in Equity fund which creates a bigger base on year to year and money grows faster vis a vis debt fund . Also for same amount withdrawal from both type of schemes the corpus left in debt will reduce faster than in equity fund i.e when in equity fund sustenance period is longer .

Proportion of equity is not what someone should decide while doing asset allocation. Its the minimum proportion of debt to meet basic need and also giving a mental comfort level to be decided  . Rest all should go to growth asset. Minimum requirement will vary from individual to individual but the basis of decision should be similar. You should have debt investment to ensure you get the quantum of amount you require in short to mid term . Any need of money required in next 3 year should not be left to market risk but to be safe . For a period 3 to 5 year again one has to look at the market situation and take a call . So decision can range from debt to hybrid to equity i.e perception on probability of loss  due to market risk . Beyond 5 year no reason to worry on asset risk but go for equity. Having said all these there is a need to evaluate year to year performance of both asset i.e debt and equity. If equity showing a declining trend for 2 consecutive year then you need to understand the factors which is leading to that. If the factors are there to stay for long then still keep safety rule of 3-5 years and not beyond that . 

Zee Business Money Guru 06 July 2015 Mr Prakash Sinha Director, Nutur...

Drivers of business mobilisation for an AMC

There have been 3 drivers of business mobilisation for Mutual  Fund in India   - brokerage ,performance and value add .

Now with AMFI putting  cap of max 1 % on upfront brokerage and trail calculation on a defined formula i.e making a consistent percentage every year based on total expense ratio,  chances of differential payout is now less until unless AMC wants to circumvent the AMFI guideline . So again scope of creating a differentiating factor on brokerage front for AMCs is now almost over . 

Performance can be variable . Past performance can be taken as yardstick for consistency or volatility but cannot be taken as benchmark for future return .  A fund  can not be a top performer always  nor do all the funds of the same AMC be the best performers.  Creating a positive differentiating factors on basis of historical performance may not be always easy for an AMC and moreover performance is not always in AMCs control .

Now the only driver where an AMC can structure and strategise for big positive differentiator for business mobilisation is Value Adds . With brokerage shrinking , performance being market driven , client ‘s long term loyalty a major influencer for business sustenance , growing competition (from non risky traditional products , tangible assets and Insurance products ) there has to be enough motivation for distributor for selling MF products . This is where AMCs role comes in big way .

The most important Value Add could be Training , skill enhancement , competency development activities given to distributors . Client management challenges , beating the competition , earning the long term loyalty of clients , growing sustainable revenue all these can be resolved through a structured and focussed training activities which AMC should be taking . In fact my belief is one way of judging the seriousness of an AMC playing its role for industry growth is evaluating their training activities both from qualitative and quantitative perspective .  

I think it is a very good opportunity for each AMC to create a value added differentiating factor . We talk of relationship , bonding with distributors  but the underlying reason now for these are who helps most in developing the sustainable growing business model. 

Investment Advisory regulation has been brought almost 2 years back by SEBI but how many AMCs have really structured their training activities to create Investment Advisors? Why SEBI is not having some incentive for those AMCs who are using the resources meticulously on Training and creation of Investment Advisors . Unfortunately training for most in the business is of least priority as evident from the nos of resources put in force but now that should be something AMCs should be seriously looking to create a competitive edge over others and create a differentiating factor .

Advisors Alpha and Beta Management

When we invest we look at alpha and beta. Simply put, how much more is the fund’s return over normal benchmark and how well has the market risk been managed? Everyone wants a minimum return and alpha gives an indication of return above the minimum realistic expectation. All investment carries some risk and if one goes for more return i.e. through equity fund route, he has to counter the market risk and so beta gives us the measure of how the fund is placed vis.-a-vis. market risk. Tracking of beta not only gives an idea of riskiness of an equity fund but also how well the market risk is being managed.

Let’s use the two terms in an advisor context in a clients investment advice. An advisor who just helps to invest and get an above inflation return or a normal return is providing a positive alpha but is he good enough? A good advisor is one who understands all forms of risks well and helps his clients to manage that risk at the same time.

In reality the understanding of investment risk for a common investor is strikingly different from the text book definition of investment risk. The understanding of investment risk for a common man is loss or something that has probability of loss, whereas, investment risk actually means deviation of realised return from the expected return. This could be on the positive or on the negative side. Movement on either side creates new expectation in the mind of common investor. Unrealistic expectation of return or unnecessary fear of loss is also a form of risk which an advisor has to manage.

An advisor is supposed to do risk profiling and recommending as per clients risk bearing and risk taking ability. How can he judge risk bearing ability accurately? Three years back if an advisor said to anyone that you will get 15 % return in equity fund he would have been very happy but if he says the same statement today will his client be having same happiness? Now he has experienced over 50% return so his expectation might be different now.

Now if the expectation of a common investor grows due to his good experience in the recent past so now an advisor has to tackle a new range of risk i.e. new unrealistic expectation. For the client may be there is no risk ahead i.e. no visualisation of loss but the advisor knows well that if the recent deviation has been abnormally much more on positive side then in short term future the risk has increased i.e. there could be correction in market and stock prices. The more the positive deviation from normal return, the more is the risk on the expectation side. So now how can an advisor correctly judge the risk bearing capacity or risk tolerance level of an individual? Here the advisor with better beta management comes into play i.e. how well he convinces and normalizes his expectation.

An advisor’s risk management ability lies in is his advisory approach and communication- how well he evaluates all types of risks that are directly or indirectly associated with his client. Client can sometimes overlook his own financial status, fall into greed or fear stage. Is an advisor bold enough to differ with his client’s view or for the sake of appeasing the client agrees to what he is saying and not cautioning him with logical explanation? It’s now the advisor’s job again to not do something which can hurt client financially if things go wrong. Impact of notional and real return on clients mindset needs to be properly understood and ways and means to manage it with perfection is the advisor’s beta management talent.

He should be one who is cleaver enough to take the best of opportunities provided but at the same time protect the growth. He should be the one whose intent in long term is capital appreciation but capital preservation at every new stage is equally important.

The investment return growth path he should visualize for his client is not up and down but it could be the stair-case approach i.e. there is a vertical growth but that growth is preserved also. In other words, growth is vertical intent and preservation are horizontal intent at each successive level.