Don’t let the tax bogey affect your mutual fund investments

It’s official. The Finance Ministry has clarified its stance on taxation for non-equity mutual funds regarding the ‘retrospective’ aspect. Also, it is evident that there will be no rollback in other proposals; Finance Bill 2014 has been passed by the Lok Sabha and is now awaiting a nod from the Rajya Sabha. For all intents and purposes, fixed maturity plans (FMPs) have lost the tax advantage they enjoyed over fixed deposits (FDs), and now debt fund investors must have an investment horizon of at least 36 months if they wish to reap tax benefits on long-term capital gains.   

An interesting outcome of this development has been in the form of investment advice. Experts are falling over each other trying to determine which investment avenue is best suited for individuals in specific tax brackets. For instance, statements such as “if you are in the lowest tax bracket then FDs make sense, however for those in the highest tax bracket, long-term debt funds will be the best bet” have become commonplace. Fund houses seem to have been caught up in the frenzy as well. Media reports suggest that some of them are trying to extend/roll over one-year FMPs for a further 24-month period so that investments therein will become eligible for long-term capital gains.

The trouble with this tax-focused muddle is that it contravenes the basic principles of investing. Don’t get me wrong—I’m not suggesting that tax implications should be ignored; however, they certainly shouldn't be the primary basis for making an investment. For instance, a fundamental difference between FDs and debt funds (including FMPs) is that the former offer safety of capital and assured returns, while the latter are market-linked investments i.e. the capital invested is at risk, and there are no assured returns. It is imperative that investors first get a fix on what their risk profile is, and accordingly pick an investment avenue, rather than start off by evaluating which avenue is more tax-efficient.

Likewise, the investment horizon is no less important. Consider a scenario wherein an investor in the highest tax bracket has surplus monies to put away for 18 months. It would not be prudent to invest in a 3-year FMP only because the taxation thereon is more liberal versus that on an 18-month FD. Simply put, investors must focus on aspects such as risk profile and investment horizon, before considering the investment’s tax-efficiency. Failing to do so could result in investors deploying monies in avenues unsuitable for them, and for inapt tenures as well.   

Arbitrage funds to the rescue…

If the aforementioned experts are to be believed, debt funds have lost their appeal for good, and now investors should focus on a new silver bullet—arbitrage funds. Sadly that argument is both preposterous and flawed.

Arbitrage funds operate on the premise of exploiting mispricing opportunities between the cash and derivatives markets. They thrive on market volatility. At its core, it is a straitjacketed approach since it will only deliver in certain market conditions. Furthermore, unlike debt funds which invest in fixed income securities, arbitrage funds operate in the domain of equities—so much for their likeness. If you are wondering why arbitrage funds exist in the first place—the answer is herd mentality. In the NFO-driven era of 2005-06 when a couple of fund houses launched arbitrage funds, others followed suit lest they be left behind. Like most NFOs, the launch of arbitrage funds had little to do with conviction in investment merit.  

So why have arbitrage emerged as the season’s flavour? Because they are treated as equity funds for taxation (read liberal tax rates and provisions) while plying a market-neutral strategy. On their part, investors would do well to steer clear of experts who profess that arbitrage funds make apt replacements for debt funds. 

Admittedly, a higher tax liability on debt fund investments is taxing both literally and figuratively. But trying to circumvent it by investing in unsuitable avenues will only make matters worse. The solution lies in coming to terms with the new scenario and staying the course.

Would you hire ‘Fonzie’ or ‘Richie’?

For followers of the sitcom ‘Happy Days’, the Fonzie-Richie duo is legendary. As similar as chalk and cheese, Fonzie is rough around the edges—a greaser who defies convention, he has a mind of his own; he has been on the downside of luck and yet beaten the odds. On the other hand, Richie is clean-cut and straight as an arrow; he has been sheltered by his loving family and will predictably play by the book. Despite their contrasting personalities, not only are they best buddies, but they always come through.

Here’s a question—if you were hiring, would you pick Fonzie or Richie? Over the years, I have often seen candidates in the Richie mould enjoy an edge over those in the Fonzie mould. An oft-repeated argument is that a Fonzie won’t make a good team player; his personality—opinionated and willingness to challenge status-quo—makes him a bad team player. Conversely, a Richie who is conforming and easy-going is seen as a safer bet. Perhaps there is some merit in that argument. But is that always true, or is there more to it than meets the eye?

An unpleasant truth is that several managers dislike dissenting opinions. A contrasting view (from a subordinate) which may potentially benefit the organisation could be shot down, because the manager believes that his authority has been challenged. Insecurity of being upstaged by a junior stalks and in turn, influences the actions of many managers. Admittedly, the organisation’s culture is an aspect too—some workplaces thrive on a familial structure wherein honchos are deemed to know what is best and juniors are simply expected to toe the line. It should come as no surprise if such entities always pick a Richie over a Fonzie.

However, should that approach be universally adopted? In an ever-changing and increasingly complex business environment, is it prudent to raise an army of compliant yes-men? What happens when the organisation faces a downturn or say the competition comes snapping at its heels? When the going gets tough, traits such as being driven, out-of-the-box thinking, resilience and courage are worth their weight in gold. Someone who has rolled with the punches is the man for the job. That’s when a Fonzie is better equipped to deliver over a Richie. For those who believe that a skilled manager is all it takes, think again. Even the best of plans (made by a manager) can be rendered useless due to poor execution (by subordinates who can’t rise to the occasion).

Like most things in life, I don’t think there is an unambiguous, ‘one-size-fits-all’ answer to the Fonzie versus Richie debate. But it is patently ridiculous that biases and insecurities result in organisations and managers inflicting damage on themselves. There has rarely been a greater need for a blinkers-off approach while hiring. As in ‘Happy Days’ itself, perhaps there is a case for Fonzies and Richies co-existing and driving the organisation’s success. To quote Fonzie—Ayyy!

3 equity funds you shouldn’t give up on...

From Jan 2014 through June 2014, the S&P BSE Sensex has risen by 20%, while the CNX Midcap index has appreciated by 37%. As with every market upturn, this time around too, the performance of equity funds has come under the scanner. There are several articles doing the rounds, detailing which equity funds and fund categories have fared the best. Keeping with the norm, the investing community has yet again displayed little tolerance for funds that have failed to make the most of rising markets. As a result, funds that have underperformed (relative to peers and/or benchmark indices) are being vociferously scorned.

I thought it will be interesting to focus on 3 equity funds that haven’t had an impressive run thus far, but continue to be strong offerings, nonetheless. To be clear—I’m not suggesting that six months is an adequate time period for evaluating equity funds; neither is that a recommended investment horizon.

However, the fact remains that there is a lot of short-term oriented advice and views doing the rounds. Investors can and do get influenced by such erroneous advice. If anything, this commentary is intended at refuting such short-term views. Here’s a checklist of 3 equity funds that investors shouldn’t give up on.

1. Franklin India Bluechip Fund

It has been a tough ride for the fund, thus far in 2014. On a year-to-date (YTD) basis ending June 2014, the fund (up 21%) has marginally outscored its benchmark index (S&P BSE Sensex) by one percentage point. In a peer-relative sense (i.e. versus large-cap funds), the performance has been found wanting. Here’s why: to begin with, manager Anand Radhakrishnan adheres to the fund’s large-cap nature far more stringently than the category norm; in the present market upturn, small/mid-caps have outscored their large-cap peers. Also, the manager’s top-picks Infosys and Bharti Airtel have detracted from the fund’s performance.

Why you should keep the faith:      

The fund has all the makings of a top-notch offering. Supported by an accomplished investment team, Anand ranks among the best portfolio managers in the country. The investment process is robust—research-driven with an unwavering focus on quality and reasonably valued stocks. The benchmark-agnostic approach coupled with willingness to trade-off short-term pain for long-term gains, only further accentuates the likelihood of a divergent showing versus the norm, in the near-term. However, over the long-haul, the fund remains ably equipped to reward investors. Finally, it helps that the fund is backed by one of best fund companies in the country.

2. DSP BlackRock Small and Mid Cap Fund

Manager Apoorva Shah hasn’t had the best of times in the recent past. In 2013, funds helmed by him had an eminently forgettable year; among other reasons, Shah’s bet on a macroeconomic turnaround didn’t quite come off. As for this fund in particular, despite having bested its benchmark (CNX Midcap) both in 2013 and thus far in 2014, it has failed to match the showing clocked by a typical small/mid-cap peer. In the Jan 2014-June 2014 period, Shah’s investments in a motley mix of stocks such as IPCA Labs, Persistent Systems and Britannia Industries have held back the fund.       

Why you should keep the faith:     

Not many managers can match Shah when it comes to skilfully combining fundamental factors (such as an in-depth understanding of stocks) with elements such as market sentiment and news flow. The investment process though not robust in the conventional sense, is certainly workable. It helps that the manager is at home with the process, and executes it with skill. Over the years, Shah has displayed the ability to rapidly realign the portfolio and recover lost ground. Another factor in the fund’s favour is the fund house which ranks among the better ones in the industry. All in all, the fund continues to be a strong long-term bet.

3. SBI Magnum Global Fund

A cursory glance at this fund’s recent performance might lead one to believe that manager R. Srinivasan has lost his touch. YTD ending June 2014, the fund has appreciated by 31%, and underperformed the S&P BSE Midcap index by nine percentage points; on the peer-relative parameter, the fund fares even worse. Interestingly, while the manager’s top-picks have by and large fared well, select holdings from the financial services, media and health care sectors have taken away from the fund’s showing.

Why you should keep the faith:     

In the small/mid-cap segment, few managers can hold a candle to Srinivasan. The manager relies on intensive research to ferret out growth stocks. The emphasis on business competencies further underpins the process. Over the years, he has displayed an uncanny ability to pick winners ahead of the curve. Another positive is Srinivasan’s willingness to back his conviction bets, and adhere to the fund’s small/mid-cap nature. At an asset size of INR 10.7 billion (as of June 2014), capacity—a typical area of concern in small/mid-cap funds—isn’t a worrying aspect as yet. The fund’s long-term credentials remain untarnished.

On a concluding note, just as near-term underperformance doesn’t dent an inherently strong fund’s long-term prospects, a strong showing clocked by a mediocre fund on the back of rising markets, doesn’t enhance its long-term prospects either. Be wary of such short-term wonders.

Data Source: Websites of fund companies, www.bseindia.com, www.nseindia.com

Why Union Budget 2014-15 isn’t bad for the mutual fund industry

Union Budget 2014-15 has produced its share of diverse reactions. On Budget day, equity markets were at their volatile best. While bigwigs from opposition parties slammed the Budget, industry leaders hailed it. Diverging opinions notwithstanding, one area where consensus has emerged is that the mutual fund industry and investors have been done in by the Finance Minister (FM).

Proposals pertaining to long-term capital gains on non-equity oriented funds (read debt mutual funds) and dividend distribution tax (DDT) are being seen as spoilers. To be fair, a higher tax liability does hurt and negative reactions aren’t surprising. But to suggest that these provisions will spell doom for the mutual fund industry is far-fetched. Debt fund segments such as liquid funds and fixed maturity plans (FMPs) which account for a significant size (roughly 41% as of June 2014*) of industry assets are likely to be most affected by the aforementioned provisions. The theory doing the rounds is that the stringent tax provisions will result in investors shunning these segments in favour of bank fixed deposits.

What critics need to consider is—was the tax arbitrage (versus avenues such as bank fixed deposits) their only draw? To my mind, debt funds operate on the premise of offering market-linked returns and high liquidity at low risk. Critics will argue that higher tax will result in lower post-tax returns. That’s where the mutual fund industry needs to step up to the plate. To begin with, fund houses can make debt funds inexpensive by lowering costs. Then, there’s scope for paying more attention to the investment management function.

For instance, it is an open secret that most FMPs operate on an auto-pilot mode with minimal intervention from portfolio managers. To be fair to portfolio managers, given the large number of FMPs that a typical fund house launches, there isn’t any alternative but to treat them as mass-produced commodities. But a modified approach, wherein the number of FMP launches is rationalized, managers invest more time and effort, coupled with competitive costs, will keep the segment competitive even in the new regime. It would be safe to assume that better returns will translate into investor interest and asset flows

A constant rhetoric from fund houses is that individual investors should use liquid funds (roughly 22% of industry assets as of June 2014*) as an alternative to savings bank accounts. However, it is an indisputable fact that liquid funds continue to be a domain for corporate and institutional investors (as of March 2014, 88% of assets in liquid funds were held by corporates and institutions*). Why the skewed holding pattern? It’s simple: corporates and institutions represent a ready clientele which will bring in big monies, so fund houses are happy to cater to them.  

Conversely, tapping into retail monies is an arduous task. To begin with, retail investors will have to be educated and sold the idea of investing in liquid funds. Also a smaller ticket size means that fund houses will have to reach out to a large number of retail investors. But is it realistically possible for fund houses to become more retail-oriented? Yes, it is, and here’s how: fund houses will help their own cause by making sensible and honest use of the mandated investor education monies rather than plastering cities with surrogate advertisements under the garb of investor education. In the long-term, fund houses must reduce their unhealthy reliance on corporates for assets.

Speaking of long-term, here’s something to cheer about. Most seem to have overlooked that the limit for tax-saving under Section 80C has been enhanced to Rs 150,000. Equity Linked Savings Schemes (ELSS) from mutual funds are eligible for tax sops under Section 80C. The interesting bit is that these are equity funds (on which fund houses typically make more money versus debt funds); additionally the investments are subject to a 3-year lock-in from the investment date (read sticky long-term money). For cynics who believe that ELSS will become a thing of the past when the long-awaited direct tax code arrives, wait and watch! All recommendations of the erstwhile FM may not find place in the new direct tax code.

The Budget highlights mention “uniform tax treatment for pension fund and mutual fund linked retirement plan”. In a February 2014 press release, market regulator SEBI alluded to the mutual fund linked retirement plan. It would be safe to assume that guidelines for such products will be issued shortly and that mutual funds will be able to attract retail long-term monies from such products too. Comparable tax treatment with similar products from the insurance industry only further sweetens the deal.

To my mind, the Budget has done enough to facilitate flow of long-term monies into mutual funds. The onus to make most of the opportunity on hand lies with the mutual fund industry.

On a related but distinct note, five years ago, around the same time, SEBI abolished entry loads on mutual funds. Even then naysayers had predicted that the mutual fund industry was doomed. Guess what, it’s still up and running. Likewise even now, it would be best to take those predictions of penal tax provisions seriously hurting the industry with a pinch of salt.

* Data sourced from www.amfiindia.com

Investment lessons from Rocky Balboa

Years ago, when I first saw “Rocky”, I was hooked onto it immediately. Since then I have watched the entire series umpteen times, and it has never failed to impress. While few would dispute the entertainment (remember I am a fan), the Rocky fable also offers some handy investment lessons. Read on.

It's about how hard you can get hit and keep moving forward

At its core, the Rocky saga is a tribute to the indomitable human spirit. That makes it the greatest underdog story of all times. Let’s not forget that Rocky is a boxer who is on the wrong side of age with a bad eyesight. But what he lacks in physical attributes, he more than makes up for in determination. To quote Adrian: “All those fighters you beat, you beat them with heart not muscle”.

Likewise while investing, it is undeniably important to be well-informed of the nitty-gritties of the economic environment, market conditions and investment avenues. But alongside the aforementioned, investors must also possess the ability to be resilient at all times. For instance, they should succumb neither to temptation (take on undue risk to make a quick buck in frothy markets), nor to panic (in down markets when fundamentally robust investments are trading in the red). Investors who can detach themselves from the noise in the markets and resolutely stay the course are often best placed to succeed over the long-haul.

Nobody's ever gone the distance with Creed. All I wanna do is go the distance

Throughout his boxing career, Rocky is unambiguously aware of his goal. Also, his unwavering focus and willingness to do all it takes to achieve the goal are noteworthy. For instance, when he first goes up against Apollo Creed, he simply wants to last the entire match, but in the rematch he focuses on beating Creed. Against Clubber Lang, it’s about regaining his confidence and the title. For taking on Ivan Drago, Rocky choses to train in testing conditions in Russia.

At the risk of using a cliché, investing without a goal is a bit like a journey without a destination; you never know where you will land up. Before investing, investors must decide what their goals are i.e. what they intend to accomplish and how much monies are require for the same. This in turn will help them figure out their investment horizon, avenues to consider and even the sum of money to be invested. Having pre-set goals also helps evaluate if investments are panning out as expected, and if not, corrective action can be taken.

Because I’m a fighter. That’s the way I’m made

In the Rocky series, the protagonist dabbles in vocations ranging from a thug for a loan shark, trainer to a restaurateur. However his true calling is to be a boxer and that’s where he is at his best. This is a classic example of identifying one’s true self and then sticking to it.

On their part, individuals must identify what kind of investors they are. They should find out how much risk they can take i.e. are they fine with risking money invested in a trade-off for higher-than-average returns? Or, do they put a premium on preserving capital, even if it means foregoing returns? Likewise, investors should try to determine if they are comfortable trading around, or is a long-term oriented buy-and-hold approach more apt for them? Such insight into their psyche will aid investors devise an investment philosophy that they are most comfortable with. It is no less important for investors to consistently adhere to their philosophy.

I wanna thank Mickey for training me

Admittedly it’s Rocky who wins all those glorious bouts in the ring, but he is always backed by a strong team. To begin with, he is mentored and trained by Mickey; subsequently it’s Creed and Duke who take on training duties. Let’s not forget that Adrian and Paulie are omnipresent in Rocky’s corner. Simply put, it pays to have a strong team.

There’s a plethora of investment advisers and financial planners who can help investors manage their monies. Then there are investment-focused publications and websites which can also aid investors. Investors would do well to make the most of the available resources. Expectedly, investors must ensure that the chosen adviser is competent, experienced, has a proven track record and always acts in their best interests. Likewise, before relying on a website or publication, investors must verify its credibility.

It ain’t over till it's over

In his career Rocky goes up against some formidable opponents–Creed, Lang, Drago, and Mason Dixon to name a few. Have you noticed how each opponent is more fearsome than the previous? Sure, Rocky does beat most of them, but nonetheless, each time a new opponent shows up, and the Rocky saga continues.

It's no different with investments. The investment process never comes to an end, not even for investors who may have an ideal portfolio in place. Factors such as changing market conditions, and investors’ needs and finances necessitate a constant review of the portfolio. For instance, often when one need is fulfilled, a new one crops up. At times, existing needs change with passage of time. Hence, investors must understand that investing is not a one-off activity, rather it’s an ongoing activity that they must devote adequate time to.

5 simple steps to successful investing

A rather widespread misconception suggests that investing is a complex activity meant only for experts. Admittedly, there are certain investment avenues and investment styles which are complex, but investing per se, can be a simple activity. Also, successful investing is not beyond a lay investor who is willing to be disciplined and diligent. Here’s a checklist of 5 simple steps to successful investing.

1. Start early

Let me confess: When it comes to investment advice, this is a cliché, but it is spot-on, nonetheless. It is never too early to start investing. If you haven’t already started investing, get started now! An often-heard excuse for not investing is—“I don’t have sufficient monies now. I’ll invest when I have accumulated enough”. This is a cardinal mistake. Start investing with what you have, and then keep adding to it, as and when you can. For those who maintain that they can’t save at all, scan through your expenses and you will come up with ways and means to save money. Starting early means you have time on hand, which in turn will help you capitalize on the power of compounding, and grow your wealth.

2. Educate yourself 

Sure, there are investment advisers and financial planners who are equipped to manage your investments. But it will help in no small measure, if you equip yourself with investment-related information. The intention is not to become an expert or step into the shoes of your adviser, rather it is to enable you to make informed investment decisions. For instance, if your adviser/financial planner lays out choices, being informed will enable you to pick one that is most apt for you. Moreover, as an informed investor, you will be better equipped to manage your investments and finances. There are several investment-related websites and publications; select your areas of interest, and read up as much as you can.

3. Become resilient

While investing, the importance of having a sound temperament cannot be overstated. Let’s consider some scenarios to better understand this. In mid-2013, when equity markets were engulfed by volatility, were you tempted to discontinue your ongoing SIPs and exit your equity investments? Likewise, at present, when equity markets are soaring to record highs, are you tempted to invest all your surplus monies in equities? If the answer is ‘yes’, then there’s a case for changing your investment temperament.

A resilient long-term investor will typically use a market downturn to add to his investments. Likewise when markets enter frothy territory, he will be disciplined and not go overboard. The ability to block the noise and maintain a sharp focus on the basics of investing at all times, is worth its weight in gold.

4. Develop your investment style

Investing is a personalised activity. Your investment decisions must be guided by what is right for you. For instance, simply because your neighbour dabbles in derivatives or your colleague invests in micro-cap stocks, there is no cause for you to follow suit. Admittedly, it takes a while to develop one’s investment style, but it is certainly a doable task. This is where being informed about various investment avenues and aspects of investing helps. 

A major upside of developing your own investment style is that it makes investing a stress-free experience (as it should be). If you are at home with your investment style, you will be able to identify situations when it will not deliver, and navigate such periods without panicking.

5. Avoid superfluous comparisons 

The purpose of investing is to achieve investment goals. For instance, you might invest to accumulate wealth, set up a retirement corpus, or provide for your children’s higher education. If your investments help you to provide for those goals, you have succeeded. Do not complicate matters by comparing how your investments have panned out versus say those of your relatives, friends and acquaintances. 

You will do yourself a big disservice by indulging in such comparisons. For instance, even if others’ investments have fared better, it is likely that they were invested in avenues suited for them; perhaps those avenues offered a higher risk-return trade-off (versus your investments), and it paid off. But so long as you have met your investment goals, you are no worse-off. Investing isn't a cricket match where the team scoring more runs wins.

What HDFC AMC must do now...

HDFC Asset Management Company (AMC) is in the news, and sadly, not for the right reasons. If media reports are to be believed, the AMC has been served a show cause notice by market regulator SEBI. The front-running scandal which first surfaced in June 2010 has returned to haunt the AMC, with apparently more instances of questionable trades being uncovered. The popular belief that the matter had been laid to rest when the AMC and its managing director settled charges by paying fines was obviously incorrect.

There is a legal aspect to the episode which the fund house's legal team will undoubtedly deal with. However, to my mind, there's another side—pertaining to the AMC's stewardship—which is even more significant. In the mutual fund business, the importance safeguarding and acting in investors' interests cannot be overstated; likewise, it would be imprudent to undermine the significance of investor confidence and trust. On those counts, now is the time for HDFC AMC to step up to the plate.

The need to act is only accentuated by HDFC AMC's standing in the industry (remember the Spider-Man credo: with great power comes great responsibility). Not only is it among the largest fund houses, in my opinion HDFC AMC easily ranks among the best players in the Indian mutual fund industry. A disciplined investment process and a consistent long-term focus have contributed to the fund house's sterling reputation in no small measure. In an industry where high manager turnover is the norm rather than the exception, the AMC has been successful in both attracting and retaining talent over the long-haul. Performance-linked compensation structures ensure that the investment team's interests are aligned to those of long-term investors. It can be safely stated that the fund house fosters an investment culture rather than a marketing culture.

All the positives notwithstanding, it is disconcerting to hear that there is a likelihood that more questionable trades may have taken place, and that the AMC finds itself on the wrong side of the law yet again. HDFC AMC must assuage concerns of its stakeholders (read investors and distributors). And here's how they should go about doing so. 

To begin with, the AMC must start communicating. Instead of learning about the developments from the media, it would help if HDFC AMC were to communicate with its stakeholders and offer its side of the story. Don't get me wrong: I'm not suggesting that nitty-gritties of the legal proceedings or confidential matters be placed in public domain. But the AMC can and must offer its stance to let its stakeholders know that all is in order. If is as being alleged, questionable trades did indeed take place, then an apology is in order. All it takes is an unambiguous and forthright note from someone in the top brass, which can be put up on the AMC's website.

Then there's compliance; presumably, the AMC has already taken steps to ensure that irregularities such as front-running do not recur. It would help if the same are communicated to investors as a part of the confidence-building measure.

Finally, the AMC must also chart out a plan to compensate investors for losses suffered as a result of the alleged irregularities. The obvious solution would be to credit a sum equal to the loss suffered into the respective funds' assets. It may not be a bad idea for the AMC to go the extra mile, and consider issuing bonus units to all investors in affected funds.

At times in the world of investments, perception is as important as reality itself. No responsible AMC can afford to be perceived as having a cavalier attitude when it comes to investors' monies or dealing with irregularities. Hence, now is the time for HDFC AMC to stand up and be counted!

Beware of investment advice which reads...

Markets are in a celebratory mood. Election results not only met but surpassed expectations with the BJP-led NDA gaining a thumping majority. With markets surging northwards, it comes as no surprise that the performance of mutual funds has started looking up too. Pick up any business daily, and you are likely to find articles extolling virtues of mutual funds, discussing their performance and favoured investment areas. And then, there are experts dishing out advice on what investors must do. While some of the advice is sage, there is also a lot of rather disconcerting advice doing the rounds. I have chosen three pieces of investment advice which are at best half-truths, and at worst completely incorrect.

1. Dynamic bond funds work like a silver bullet

Will the RBI governor cut rates in the forthcoming monetary policy review or won't he? That seems to be the million dollar question at the moment. And this in turn, has led to a lot of discussion regarding dynamic bond funds. Simply put, the latter have a fluid investment style wherein the manager takes active duration bets, based on his assessment of where interest rates are headed. The manager's flexibility to position the portfolio across the yield curve is seen as a silver bullet. Sadly, there is a difference between plying a flexible approach and being successful at it. There are enough instances of even skilled bond fund managers woefully misreading the direction of interest rates. 

A case in point was mid-2013 when RBI's steps to bolster the weakening rupee spooked debt markets; at a time when consensus suggested that rates would soften, they rose sharply. As a result, several managers who had positioned their bond fund portfolios for a softer interest rate regime were caught on the wrong foot. Don't get me wrong--I'm not suggesting that dynamic bond funds are without merit. All I'm saying is: don't think of them as a magic potion for all woes. Even conventional short-term bond funds (which admittedly operate in a narrower band of say one-three years) are capable of adding value to the portfolio. Don't dismiss seemingly plain-vanilla products (read short-term bond funds) in favour of dynamic bond based on a misconception.

2. If the manager follows a consistent approach, the fund will perform

To be fair, a consistently plied approach is a positive as it infuses predictability. But to suggest that the same in isolation is a surefire recipe for success is naive. It takes a lot more for the fund to succeed. To begin with, it helps to have a skilled portfolio manager who is playing to his strengths. As for the process, it needs to be a robust one which is executed with skill. 

To better understand this, consider a process that relies heavily on making the most of mispricing opportunities between the cash and derivatives markets, or one that results in a substantial structural bias for certain stocks/sectors, or one that relies solely on momentum to deliver. These are examples of processes that aren't inherently robust, and ones that will succeed only in specific market conditions. Their consistent application won't automatically make the fund better equipped to deliver. Execution is no less important: consider a process which is rooted in valuation-consciousness and a long-term orientation. The robustness of the process notwithstanding, should the manager keep getting snared in value traps due to poor execution, the consistent approach is likely to be of little help.

3. Evaluate funds based on their holding pattern in top 10 gaining stocks

This one's rather bizarre. If it wasn't bad enough that investors were being misled to evaluate the performance of equity funds over shorter time periods like 1-year and 3-years (with scant regard for the risk-adjusted return showing), now apparently whether or not the manager was invested in the top 10 gaining stocks is a parameter to consider. To my mind, this demonstrates a poor understanding of both--the working of a mutual fund and what one must expect from it.

Funds are run based on their investment mandate and the manager's investment philosophy. A number of parameters such as market capitalisation, nature and quality of business, and valuations, among several others come into play. An investment universe is drawn out and stocks chosen from therein. Though it would certainly help if the best performing stocks were to feature in the manager's picks, it is certainly not obligatory. Let's not forget that in a sharp market upturn, it is often speculative, high-beta fare that fares the best. And the latter need not be the kind of stocks that every manager wishes to invest in. 

Broadly speaking, the test of a manager and his strategy should be the ability to score over the fund's benchmark index and comparable peers over longer time frames (read at least five years) across the return and risk-adjusted return parameters. Whether or not the manager is invested in the top 10 stocks is of no consequence.

In conclusion, there’s a lot of investment advice available in public domain. Investors on their part would do well to be discerning and act on advice that is apt for them.

Why election investing isn’t for all

To say that general elections 2014 have captured the public’s imagination would be stating the obvious. It’s not every day in a cricket-crazy country like ours that the IPL is relegated from the front page to the sports page. The magnitude of the election frenzy can be gauged from the fact that it has now spread to the domain of investments. Business dailies and channels have a plethora of ‘election investing’ tips to offer. Investors are being advised as to how they must position their portfolios to benefit from the impending election results.

What’s driving election investing?

It is widely believed that the NDA will form the next government and that markets will respond positively to the same. In fact, some have even termed the recent run-up in markets as a ‘hope’ rally. Others are invoking history, and banking on it being repeated: in 2009 when the UPA gained a majority (defying the odds) markets rose sharply.

But isn’t that speculation...

To be fair, investing in markets is a forward-looking activity i.e. assumptions are made and a hypothesis is built around it. Expectations of what may happen (going forward) are factored in while making investment decisions (at present). 

However, when investors pin their hopes solely on an event such as election results, they are speculating. Effectively, they are emulating soothsayers and trying to forecast not only what the outcome of the election will be, but even how markets will react to the same. 

And for those who believe that market behaviour after election results is a sign of things to come, here’s something to mull over. In 2004, when the incumbent NDA was voted out of power, equity markets tanked; however, that was followed by a strong bull run which lasted until early 2008. Conversely, when the incumbent UPA returned for a second term in 2009, markets skyrocketed; that was followed by one of the most testing periods for equity markets. Simply put, investors who would have based their investments solely on how markets reacted to election results would have been in for an unpleasant surprise.

What investors must do

It comes down to whether one is a long-term investor or a short-term investor. For a short-term investor who bases his investment decisions on momentum, sentiment and news flow, and is willing to trade aggressively, the election period (i.e. days leading up to the result, the result day, and the ensuing period) is undeniably important. There will likely be several opportunities to ply one’s skills and make money.

Conversely for the long-term investor, the election result isn’t particularly important, and he can afford to be passive. To begin with, he doesn’t have to re-align his portfolio in expectations of what may happen; neither does he have to buy-sell at a furious pace to benefit from the volatile markets.

If anything, it might be an opportunity to clean-up the portfolio. For instance, if the markets do indeed rise sharply, it will be a good opportunity to sell investments that aren’t right for the investor, or are overpriced at a neat profit. Conversely, falling markets might offer opportunities to make some bargain buys. But any further focus on election results will be a futile exercise. 

In the long-run, while several factors can have a fundamental impact on the attractiveness of an investment avenue, the election result is certainly not one of them.

Should SEBI be so concerned about size?

Admittedly, “does size matter?” is one of the more tricky questions to answer. Depending on where and when that question is posed, it could evoke different responses from the same individual.

However (and on a more serious note), market regulator SEBI seems to have an unambiguous view on the subject. It is seemingly convinced that bigger is indeed better. Not too long ago, it mandated that the minimum net worth of asset management companies (AMCs) be increased to Rs 500 million (from the erstwhile minimum of Rs 100 million). If recent media reports are to be believed, SEBI has written to AMCs asking them to merge or close debt funds with an asset size of less than Rs 200 million. Reports further suggest that equity funds with an asset size of less than Rs 100 million will be dealt with likewise.

Yet again SEBI seems convinced that investors’ interests will be better served by investing in larger funds. To be fair, larger funds offer certain advantages: all things being equal, they are structured to be more competitive on the price (read expense ratio) front versus smaller sized funds. In certain segments of the debt market, the minimum lot size is on the higher side, in turn necessitating that the fund have a reasonable asset size to be able to operate efficiently.    

But doesn’t it strike as being odd that the market regulator is now even dictating what a fund’s minimum asset size should be? Clearly, there’s more to it than meets the eye. For some time now, SEBI has been trying to make mutual fund investing less complicated for investors. Remember the risk-based colour-coding for funds, or even asking AMCs to disclose fund performance versus an appropriate benchmark index across specified time periods. To my mind, SEBI recognizes that there are too many funds available out there which makes fund selection a difficult task for investors. With this move, SEBI is in fact trying to rationalize the number of funds.

In India, AMCs have displayed a penchant for recklessly launching new fund offers (NFOs), since NFOs do act as tools of asset mobilisation. In this context, while the regulator’s intent cannot be flawed, the approach needs to be questioned. A fund’s asset size in isolation cannot be the barometer of its worthiness. Just as there are several small funds which perform and serve investors well, there are several large ones which are laggards and hurt investors’ interests.

Disallowing smaller funds en masse hardly seems like the right solution. Instead what the regulator must do is force (since they seem incapable of doing so voluntarily) accountability on AMCs. And here’s how:

1.   Make AMCs invest in all their open-ended funds:   

Extend the scope of the recent regulation whereby the concept of seed capital in open-ended NFOs has been introduced to all open-ended funds. Simply put, it should be mandatory for AMCs to invest their personal monies in all their open-ended funds. Apart from boosting the fund’s asset size, this move will (more importantly) also reveal an AMC’s true commitment to its funds. It should come as no surprise if a number of funds are voluntarily closed or merged irrespective of their asset size.

2.   Make the Board of Trustees accountable

The Board of Trustees (BoT) is required to sign off on NFOs authenticating that they are different from the AMC’s existing funds. Truth be told, not all boards have distinguished themselves, else we wouldn’t have had a proliferation of like NFOs. It’s time SEBI makes the BoT accountable by getting them to audit all existing funds on an ongoing basis with a view to weed out both weak and similar funds. The audit report, recommendations made and action taken should be a part of the annual statutory disclosure.

3.   Enhance quality of distributors

This is admittedly a long-term initiative: the Indian mutual fund industry needs more informed and better-equipped distributors. Sadly, there are a large number of well-meaning distributors who would like to do what’s right for the investor, but are ill-equipped to do so. For instance, when an AMC offers them a fund with a poor investment proposition, they are unable to see through it. The answer lies in re-visiting the criteria for empanelling distributors. Also, SEBI should mandate that a part of the monies meant for ‘investor education’ initiatives (we all know how that is really utilised J) be used for training distributors.

Finally, the market regulator must recognize that if it wishes to attract investors and build investor confidence, there is a need to make systemic changes in the mutual fund industry. Targeting smaller sized funds is unlikely to help on either count.

Of Sangakkara, Yuvraj, and Prashant Jain…

In the recent World T20 final, southpaw Kumar Sangakkara’s blistering knock helped Sri Lanka triumph over India. Playing his last international T20 match, Sangakkara had had a rather indifferent run coming into the final. But on the day, his batting display meant that all skepticism surrounding him vanished and the clichéd maxim “form is temporary, class is permanent” was back in circulation.

In the same match, another southpaw Yuvraj Singh had a bad day at the office. To put it mildly, he was woefully out of sorts with the bat. As a result, he found himself at the receiving end of a barrage of criticism; even as I write this post, critics are busy writing his cricketing career’s obituaries. Though Yuvraj has proven credentials as a match winner, not many seem willing to offer the “form is temporary …” defense in his favour, at present.

To my mind, the diverse reactions can be attributed to a recency bias. The accolades for Sangakkara and criticism for Yuvraj have more to do with their performance in the final match, rather than an accurate evaluation of their cricketing prowess. Both Sangakkara and Yuvraj are unquestionably talented batsmen with impressive careers to show for. But for now, most believe that Yuvraj is a 'has-been', while Sangakkara is a 'class act'. And what’s driving this belief—the players’ showing in the most recent match.

The recency bias can manifest itself in investments as well. If markets have been on an upswing in the recent past, investors are more likely to believe that they will continue to move northwards going forward as well, rather than otherwise. Likewise, a stock or sector which has hit a purple patch lately will often inspire more confidence in investors rather than one that has underperformed recently.

O Prashant, Where Art Thou?

In the latter part of 2013, I was addressing a gathering of mutual fund distributors, advisors and investors. Things became interesting when the conversation veered towards funds run by portfolio manager Prashant Jain i.e. HDFC Top 200 and HDFC Equity. To clarify, I thought (and continue to think) highly of those funds and the manager in question. But then, I was in a minority. The funds were having a terrible run in 2013, underperforming both their respective benchmark indices and comparable peers. The audience was at its vitriolic best: Theories such as the manager doesn’t churn the portfolios enough, the funds are too large to perform, and the manager is a spent-force were put forth by the audience to rationalise the underperformance.

Prashant Ahoy!

Oddly, at present (i.e. roughly six months later), Jain and his funds are being eulogized by the same set of distributors, advisors and investors. And what has changed between then and now–the funds have clocked a strong showing and emerged among the best performers in a peer-relative sense. Is that surprising? Not really. Broadly speaking, the manager has been betting on a turnaround for a while now and had positioned his portfolios accordingly. Expectedly, while the funds struggled for a better part of 2013, they staged a comeback of sorts in the present market upturn.

Is it Heads or Tails?

Here’s what makes the funds tick: Jain easily ranks among the best portfolio managers in the country; he plies a robust investment process and is backed by a fund house which has a reputation for safeguarding investors’ interests.

The aforementioned factors existed when the funds were underperforming, and they continue to be present now too, when the funds are outperforming. All things being equal, a year or so of underperformance doesn’t turn a good fund into an inferior one; likewise, outperformance over a six-month period doesn’t convert a mediocre fund into a superior fund.

Yet, we have seen the manager and his funds go from vilification to glorification in a six-month period. This is irrational behavior at its best which can be attributed to the recency bias. I shudder to think of the reactions that will follow, if Jain’s funds were to underperform over the ensuing six months.      

What investors must do

Resist succumbing to the recency bias while investing. Think about it: you might exit a sound investment avenue with solid long-term prospects because of short-term underperformance. Conversely, by blindly chasing an investment which has fared well you may run the risk of making an overpriced buy or even one that is unsuitable for you. Maintain a long-term orientation while investing; it will help you block out all the noise which prevails in the near-term.

Also, learn to look beyond just performance while making investment decisions. Rather focus on what makes the investment avenue tick to better understand when it is likely to fare well and otherwise. This in turn will help you make informed investment decisions, independent of recent performance.

On a lighter note, a word of caution for those writing off Yuvraj based on one poor showing—the humble pie isn’t particularly palatable!