The Small Savings Schemes Conundrum

After the December monetary policy review, the focus is on small savings schemes yet again. In what has become an increasingly familiar trend, the Reserve Bank of India (RBI) faulted banks for not passing on benefits of rate cuts to consumers (read cheaper loans). On their part, banks continue to maintain that rates offered by small savings schemes are rather high. Broadly speaking, banks compete with such schemes while raising monies (fixed deposits et al); hence, the cost of borrowing become high, which in turn translates into a higher cost of lending (read expensive loans).

There seems to be consensus on the need to ‘rationalise’ small savings schemes; simply put, small savings schemes need to be made less attractive (typically a lower rate) thereby enabling banks to borrow at an inexpensive rate, and so on. But then, rationalising small savings schemes is easier said than done.

To begin with, there are political implications. Small savings schemes are perceived as (and to a degree rightly so) the layman’s investment avenues. Any attempt to make them less attractive could politically hurt the government. While on one hand, they run the risk of losing favour with citizens, on the other, it is easy to visualize the opposition hurling more ‘suit-boot’ jibes at the government :)  

Furthermore, there is some truth in the theory that small savings schemes are like the proverbial ‘silver bullet’ for a bulk of the population. The combination of low minimum investment amounts, safety (assured returns and protection thanks to a sovereign guarantee) and availability (sold through a vast network of post-offices and branches of select banks), truly make small savings schemes the layman’s investment avenue. Hence, tampering too much won't be a prudent choice. 

Clearly, authorities will have to adopt a middle-of-the-road approach. Here are some thoughts on what could be done:

To begin with, schemes that are targeted at specific investor segments such as Senior Citizens Savings Scheme and Sukanya Samriddhi Accounts will be left unchanged.

There is a school of thought which maintains that Public Provident Fund (PPF) scheme must be suitably modified. The popular scheme received a boost in 2014-15 when the maximum investment limit was increased to Rs 150,000 per annum (versus Rs 100,000 earlier). But I will be surprised if the authorities decide to tinker with PPF. Let’s not forget that retirement planning is yet to find its due acceptance in the country, and PPF features among a handful of genuine long-term investment products available to investors.         

To my mind, the Post Office Monthly Income Scheme (POMIS) and Post Office Time Deposits (POTD) will be put under the scanner. As per data from the RBI, as of Feb 2015, Rs 2,010 billion was invested in POMIS. This amounts to roughly one-third of the total corpus in all small savings schemes. Admittedly, there is a need for investment avenues that yield regular assured returns. Then again, both private and public sector banks offer products comparable to POMIS.  What sets the two apart is the rate of return; while POMIS offers 8.4% per annum, similar products from banks offer annual returns ranging from 7.25%-7.75%. It’s quite likely that the authorities will want to address the disparity.

Another aspect which is no less important pertains to the investor segment benefiting from the POMIS. It is an open secret that several affluent individuals have utilised the upper limit of Rs 900,000 available under joint POMIS accounts. Additionally, the monthly returns are invested in a Post Office Recurring Deposit account to further augment returns. Authorities will be inclined to correct this lacuna as well, thereby enhancing the prospects of POMIS being rationalised.

Then there’s POTD, the fixed deposit equivalents from small savings schemes. These deposits are offered in tenures of 1-year, 2-years, 3-years and 5-years. There’s a stark disparity between POTD rates (ranging from 8.4% per annum to 8.5% per annum) and those offered by bank fixed deposits. The popularity of POTD can be gauged by the fact that as of Feb 2015, monies parked therein (Rs 508 billion) accounted for roughly 8% of total assets held under small savings schemes.

It can be safely stated that by modifying two schemes (POMIS and POTD) which attract a bulk of monies, and leaving others unchanged, the much-desired balance can be struck.

There’s a thinking in some quarters that the way to rationalise small savings schemes is by virtually dismantling the structure, thereby ensuring that monies flow into banking channels. Such thinking is flawed to say the least. The small savings schemes framework serves an important function of offering investment options to the lay investor in the farthest corner of the country. The need of the hour is to create a level playing field between small savings schemes and bank products.

When The Portfolio Manager Quits…

Just when one thought that the debate on debt funds taking credit risk would be the mutual fund industry’s final major event for the year, comes the news of Anoop Bhaskar’s exit from UTI Mutual Fund. Apart from acting as the Head of Equity, Bhaskar also shouldered portfolio management responsibilities. Bhaskar contributed significantly to the equity research and portfolio management functions at the fund company. It came as no surprise that his stint coincided with the performance of several equity funds looking up. 

Investors in funds which Bhaskar ran, are faced with a familiar dilemma—what should be done, now that the portfolio manager has quit. Should they stay invested, is it prudent put fresh investments on hold, or should they liquidate their investments? 

When a prominent portfolio manager quits, fund companies react on expected lines—‘we have strong investment processes’, ‘the exit will not affect the performance of our funds’ and so on. To be fair, what else can they say? On their part however, investors need to be more circumspect. 

One size doesn’t fit all

At the outset, let me bust the myth that there is a standard course of action to be followed when the portfolio manager quits. Each case is different, and investors need to act accordingly. 

For instance in early 2014, when K.N. Sivasubramanian (CIO-Franklin Equity and portfolio manager) exited Franklin Templeton Mutual Fund, it wasn’t as sharp a break as it might have seemed. For those tracking the fund company, it was evident that Anand Radhakrishnan was being groomed to take over from Sivasubramanian. Furthermore, the presence of a skilled and stable team of managers and analysts meant that investors’ interests were safeguarded. Expectedly, the transition was smooth and on that count, investors had no reason to review their investments.

UTI Mutual Fund’s case is rather different. The fund company has in its ranks skilled and experienced managers such as Swati Kulkarni. However, to my mind, no one stands out as the heir apparent to Anoop Bhaskar. The replacement will have big shoes to fill. 

That said, at present, there is no cause for investors to hit the panic button. But there is certainly a case for closely monitoring developments. It will be interesting to find out who is chosen to head up the equity management function, and if that alters the working of the function.

Change can be multifaceted  

When a new manager takes over, fund companies are known to go the extra mile to convince stakeholders (investors, distributors and advisers) that the fund’s character will remain unchanged. That’s an area which must be scrutinised on an ongoing basis.    

For instance, a large-cap fund which under the erstwhile manager was a benchmark-hugger, could turn into a benchmark-agnostic fund under the new manager. Likewise, a mid-cap fund wherein the erstwhile manager deployed a value-styled approach could mutate into a high-growth styled fund under the new manager. 

In both cases, while the funds’ market-cap profile didn’t change, their intrinsic character underwent a makeover. From an investor’s perspective, there is a need to evaluate if the fund in its new avatar can continue to play its predesignated role in the portfolio. 

In conclusion, the portfolio manager’s exit is an event that merits investor attention. Investors would do well to neither panic, nor be indifferent. Finally, they must seek assistance from their adviser to help gauge the impact of the exit, and decide on the future course of action.

A Layman’s Guide To Successful Investing

A rather widespread misconception suggests that investing is a complex activity meant only for experts. Admittedly, certain investment products and strategies are complex, but investing per se need not be complex. More importantly, one doesn’t have to be an expert, to become a successful investor. Indeed, even a layman who is willing to be disciplined and diligent can become a successful investor. Here’s a layman’s guide to successful investing.

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. Whether you are an intern surviving on a measly stipend, a rookie in his first job or a senior executive, you must save and invest.

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. For those who claim 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 capitalise on the power of compounding, and grow your wealth.

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 decisions.

For instance, when your adviser/financial planner lays out choices, being informed will enable you to deliberate and make a choice that is 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. Identify your areas of interest, and read up as much as you can.

Be resilient

While investing, the importance of having a sound temperament cannot be overstated. This is especially true for investors in market-linked instruments such as equities and mutual funds. Market fluctuations can and will test your resolve as an investor.

For instance, when equity markets are on a downward spiral, one might be tempted to cut losses by selling-off investments. However, a resilient long-term investor will typically use a 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.

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 a friend dabbles in derivatives, or your colleague invests in small-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 a doable task. This is where being informed about various investment avenues and aspects of investing helps.

A major upside of developing an 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 succeed, and navigate such periods without panicking.

Avoid unnecessary 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 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 friends and acquaintances.

You will do yourself a big disservice by making such comparisons. For instance, if someone else’s investments have fared better, it is likely that they were invested in different avenues suited for them. As long as you have met your goals, you are no worse-off.

Happy investing!

When Investors Are Intolerant Of Their Advisers’ Views

Let me clarify at the outset: I’m neither weighing in on the ‘intolerance debate’, nor do I have an opinion on what to do with awards :) Recently, I ran into an acquaintance who is an investment adviser. Expectedly, the conversation veered towards markets, clients and investment avenues. The gentleman had a rather peculiar complaint. He said “my clients engage me for investment advice, and I am paid a fee for the same; oddly, some of them simply expect me to reinforce their views”. To further complicate matters, his dissenting views were not only met with resistance, they even led to investment decisions being delayed.

This phenomenon is more common than one would imagine. Over the years, I have encountered several investors whose expectations from their investment advisers are no different. At the risk of hazarding a guess, perhaps such investors have an opinion on where to invest, and need advisers for validating their views. Conventional wisdom suggests that the adviser is an expert on investment-related matters; furthermore, he is engaged to help investors achieve their investment goals. Hence, it makes sense to be receptive to his views. 

I’m not suggesting that investors should blindly follow everything their adviser recommends. Not at all. I have always maintained that investors must actively participate in the investment process. An integral aspect of the same is to be informed and to thoroughly discuss the adviser's views and recommendations.  That said, expecting an adviser to simply reinforce the investor’s preconceived notions defeats the purpose of engaging an adviser. Investors and advisers who find themselves in such a scenario have much to mull over.

On their part, investors must evaluate if they are capable of handling investments on their own. If the answer is affirmative, then such investors are better off dissociating from their advisers.

Now for the more tricky one—investors who need investment advice, but are unwilling to accept any from their adviser. There is a need to assess why the relationship isn’t working. It could be a case of losing confidence in the adviser on account of failed recommendations, or perhaps the investor realising (with the benefit of hindsight) that his views on investing are not in sync with those of the adviser. Sadly, this conundrum doesn’t have a one-size-fits-all solution. However, investors owe it to themselves to go to the root of the problem and resolve it. 

The relationship between an investor and his adviser must be symbiotic. While the adviser is expected to pitch in with independent and credible advice that is apt for the investor, the investor must diligently act on the advice, and compensate the adviser as per agreed terms.  An investor-adviser relationship operating on the extremes—either the investor following the adviser blindly, or the investor being cynical of everything the adviser recommends—is bound to fail. The key lies in finding a common ground.

On a parting (and lighter note), apparently my acquaintance has decided to practice intolerance by discontinuing dealings with his unreceptive clients.

Debt Funds: Liquidity Matters, But Managing Liquidity Is The Key

Recently, I read an article written by an individual who is considered an expert on mutual funds. Weighing in on the ongoing debate of debt funds taking credit risk, he came up with an interesting solution--modify the structure of funds investing in illiquid securities, whereby redemption requests don’t have to be met immediately. The rationale being: the combination of investments in illiquid securities and an immediate redemption facility is at the root of the crisis. Hence the solution lies in permitting fund houses to make delayed redemptions. 

On the face of it, the recommendation seems reasonable. But scratch the surface, and the solution will appear simplistic. Here’s why:

To begin with, in a mutual fund, a portfolio manager’s role is not restricted to just identifying lucrative investment opportunities, and making timely investments. His ability to proficiently managing liquidity in the portfolio is no less important. Skilled portfolio construction can enable a manager to navigate unexpected market events (and handle redemption pressure) without unsettling the portfolio, or with minimum disruption to the portfolio. In other words, the presence of illiquid corporate debt in the portfolio need not make the portfolio illiquid. Indeed, liquidity management is one of the parameters on which the manager and his investment process must be evaluated. It is inexcusable for a manager to compromise the portfolio’s liquidity in a bid to clock higher returns. To my mind, such a scenario portrays the manager’s investment skills in poor light.

Furthermore, defining what constitutes a liquid investment is easier said than done. For instance, to suggest that only corporate bonds are illiquid wouldn’t be accurate. A cursory glance at data for trades in the benchmark 10-year GOI bond versus those for other GOI bonds reveals a telling picture. Market conditions and sentiment can significantly impact liquidity. In buoyant markets, the corporate debt segment can be more liquid than in a downturn. A parallel can be drawn for equity markets as well, wherein small/mid-caps typically tend to be more liquid during an upturn. Clearly, defining which funds invest in illiquid instruments (as has been suggested in the article) is more complicated than it has been made out to be.

Finally, there’s a need to discuss where the onus must lie: should investors be asked to tone down their expectations on the liquidity front, or should fund houses be responsible for performing better on the liquidity management front? 

In many ways, the financial crisis of 2008 proved seminal for the Indian mutual fund industry. Several debt funds (including close-ended products such as fixed maturity plans) witnessed extraordinary redemption pressure. Subsequently, SEBI put safeguards in place by prohibiting fund houses from providing premature redemption for close-ended funds and defining the investment profile for liquid funds, among others. Some fund houses and managers went back to the drawing board and re-evaluated their investment philosophy, especially for the debt funds segment. In turn, this equipped them to better manage liquidity in their portfolios. 

Present regulations governing redemptions are not only comprehensive, but reasonably indicative of how investments should be made. Hence, there is no valid reason for creating a third structure (a middle ground between open- and close-ended funds) to make up for a fund house/manager’s incompetence. As for fund houses which can’t make the grade, the ‘perform or perish’ maxim is apt. 

Should Fund Houses Fear Big-Ticket Investors?

Media reports suggest that a questionnaire from the country’s largest bank -- State Bank of India (SBI) has sent several fund houses running for cover. Apparently SBI invests substantial monies in debt mutual funds; last week, the bank sent a questionnaire to fund houses, seeking information about their investment practices and policies. Among others, SBI has asked for information on fund houses’ policy for compensating investors in the event of a loss incurred due to a default or downgrade. Clearly, the JPMorgan Mutual Fund episode continues to rankle investors.

Investors wanting to know more about a fund house’s investment practices is understandable. Indeed, one expects them to perform such due diligence before making an investment, rather than after investing. The curious part pertains to seeking compensation in the event of a loss. It doesn’t take a genius to figure out that mutual funds are market-linked instruments; hence the possibility of incurring a loss cannot be ruled out. Given that fund houses operate as pass-through structures, expecting them to compensate investors for a loss incurred in the normal course of investing seems farfetched. So why would a behemoth like SBI seek such information? For the answer, let’s step back in time.

Hail big-ticket investors!

The mutual fund industry’s fondness for big-ticket investors (institutions and high net-worth individuals) is no secret. Over the years, this liking has manifested itself in various forms: institutional plans with liberal expense and load structures (versus retail plans), launch of fixed maturity plans that enabled a handful of big-ticket investors to make quasi-PMS investments. In the 2008 meltdown, several fund houses did their best to protect large investors in debt funds, by transferring illiquid securities to equity funds. In effect, liquidity was provided to large investors at the cost of retail investors (who largely invest in equity funds). Over time, it took intervention from the market regulator SEBI (in the form of abolishing differential expense and load structures, and instituting the 20-25 rule, among others) to create a level playing field. 

But then old habits die hard. Perhaps some big-ticket investors have a sense of entitlement which leads them to believe that mutual funds should be structured as  risk-free (at least in part) investments for them.           

The counterview 

Data from AMFI reveals that as of Sep 2015, debt and liquid funds accounted for roughly 67% of mutual fund assets. In both the segments, a lion’s share (62% in debt funds and 92% in liquid funds) was held by institutional investors. Simply put, a bulk of mutual fund assets come from institutional investors. Fund houses can claim that they are obligated to offer these big-ticket investors preferential treatment. But such thinking is flawed.

Any serious fund house knows that long-term assets are the key to survival and growth. Yet again, data reveals that fund categories wherein retail investors dominate tend to display longer investment horizons versus categories wherein institutional investors dominate. Hence, it is in the interest of fund houses to offer retail investors a fair deal.

If fund houses find themselves in a vulnerable position, they must shoulder at least part of the blame for having failed to democratize investments. Several fund houses have been guilty of chasing short-term institutional monies and failing to develop a strong retail investor base.

It will be naïve to believe that any fund house will offer to compensate SBI for losses incurred in its schemes. It’s high time self-respecting fund houses send an unambiguous message: The era of offering preferential treatment to big-ticket investors (and treating retail investors as second-class citizens) is over. It is in the best interest of fund houses to come to terms with this realisation and act on it at the earliest.

Don't Treat Debt Funds Taking Credit Risk Like Pariahs

The JPMorgan Mutual Fund episode continues to reverberate in the investment community. The focus has seemingly shifted from the two affected funds to the investment strategy of taking credit risk (also referred to as high-yield investing). Media reports suggest that market regulator SEBI has sought details on investments in lower-rated securities from fund houses; also, it has been reported that SEBI has asked fund houses to not rely solely on credit ratings while investing in debt securities. Consensus suggests that fund houses have erred by taking credit risk, and as a result, investors’ interests have been compromised with. But this line of thinking is both myopic and fundamentally flawed.

To begin with, let’s understand what the strategy of taking credit risk (or high-yield investing) entails. The portfolio manager invests in securities with a lower credit rating. Such instruments offer a higher coupon rate (versus securities with a higher credit rating); furthermore, there is a possibility of the bond price appreciating if the credit rating is upgraded. Does this investment strategy entail risk – yes, it does. There is risk of the issuer defaulting on the payment of interest and/or the principal amount. Often such bonds can be illiquid which further accentuates their risk profile.

Given the risks, did fund houses and portfolio managers err by adopting a credit-based strategy? No, and here’s why: The strategy of taking credit risk is as legitimate as any other. Several managers have plied it successfully and delivered pleasing long-term results for investors. That the strategy entails risk doesn’t make it faulty. Some experts have claimed that investors are better off investing in debt funds that follow the duration strategy. That’s a weak argument because failing to accurately read the direction in which interest rates will move can also lead to losses.

The only reason funds with credit risk are in focus at the moment is the JPMorgan Mutual Fund episode. Oddly, over the years when these funds delivered attractive returns (and inherent risks didn’t surface) no concerns were raised. Therein lies the crux of the matter. Mutual fund investing is not without risk. Sure, some strategies are riskier than others, but risk is omnipresent. 

Treating debt funds with a credit strategy like pariahs is a knee-jerk reaction. A prudent approach will be for investors to acquire an unambiguous understanding of the risk involved, and then decide if they are comfortable taking on the same.

For instance, before investing in a debt fund wherein the credit risk strategy is employed, investors must ask themselves the following questions:

• Does their risk appetite allow them to invest in the fund?

To gauge one's risk-taking ability, it might help to visualize a scenario wherein testing conditions (read more downgrades and underperformance) prevail for a prolonged period. If investors believe that they are likely to push the panic button, then these funds aren’t for them. 

• What is the apt allocation for the fund in the portfolio? 

An investment advisor/financial planner can help decide if the fund should be utilised as a core holding or a supporting player in the portfolio. Clarity on this front will also help pragmatically evaluate performance, and decide on the fund's continuation in the portfolio.

• Is the portfolio manager adept at taking credit bets?

Not every manager has the skills to successfully ply the strategy. It is pertinent that the manager’s skills are in sync with the strategy. Seek managers who have conviction in the strategy over those who deploy it because it is the flavour of the season.

• Is the fund house trustworthy? 

Notwithstanding the kind of fund investors are seeking, the importance of being invested with the right fund house cannot be overstated. This aspect is only accentuated in times of adversity. Investors should select fund houses which have a track record of being investor friendly.

Investment Lessons From The JPMorgan Mutual Fund Episode

In the recent past, JPMorgan Mutual Fund has been in the news for all the wrong reasons. To begin with, it was reported that two of its debt funds i.e. JPMorgan India Treasury Fund and JPMorgan India Short Term Income Fund have suffered substantial losses on account of investments in an auto ancillary company—Amtek Auto. The latter is facing a financial crisis of sorts; in its communication with stock exchanges, it has mentioned a decline in operational performance, cash flow mismatch and steps being taken to counter the same. To further worsen matters, in Aug 2015, CARE (a rating agency) suspended its ratings of Amtek Auto stating that “the company has not furnished the information required by CARE for monitoring of the ratings”.

Expectedly such developments can hurt the price of the company’s debt issuance, and in turn the performance of mutual funds invested in these papers. Furthermore, the fund house decided to limit redemptions in the aforementioned funds “in the general interest of the unit holders”.

This entire episode has been curious to say the least. However, it offers some important investment lessons.

1. Evaluate the fund house’s character

Mutual fund investors are often guilty of not evaluating the fund house’s character before investing. This can prove to be a costly miss. The fund house’s character will go a long way in determining its policies, attitude towards investors and even the long-term performance of funds. While it would be unfair to draw conclusions on JPMorgan AMC based on a single incident, the asset manager’s decision to restrict redemptions does not portray it in a good light.

It must be clarified that the Scheme Information Documents of both funds explicitly state that the asset manager can restrict redemptions. Hence JPMorgan AMC’s actions are in line with stated policy. The trouble is that both funds are open-ended in nature wherein the implicit assumption is that investors are free to liquidate their investments at market price when they choose to do so. In the Indian mutual fund industry, this is the norm. On this count, the AMC has let its investors down. 

If investors in the fund are willing incur a loss, while liquidating their investments, that choice should be available to them. More importantly, if the AMC is truly concerned about investors’ best interests, it can compensate them for the losses incurred with their own monies. Conversely, limiting redemptions while they put their house in order amounts to penalizing investors for the AMC’s mistakes. A crisis will typically reveal true character, and in this case, JPMorgan AMC doesn’t come out smelling of roses. Hence it is pertinent that investors pay attention to the fund house’s character before investing. 

2. Debt funds are not risk-free investment avenues

A popular misconception suggests that debt funds are risk-free investment avenues. Admittedly, certain debt fund segments do expose investors to less risk versus say an equity fund. But treating them as risk-free investment avenues is plain erroneous. Being market-linked investments, debt funds are prone to risks such as interest rate risk and credit risk. Investors who wish to invest in risk-free instruments should stick to avenues such as small savings schemes (which are backed by a sovereign guarantee). 

Let’s focus on credit risk which is relevant to the case. Debt fund managers are known to take credit bets (invest in lower rated securities) to deliver outperformance. While the investment strategy is commonly deployed, as is often the case, some portfolio managers are more skilled than others, resulting in varying results. Clearly in the case of the two JPMorgan funds, the results were less than desirable.

It isn’t uncommon for some distributors and advisors to present debt funds as risk-free investment avenues. Irrespective of the reason – ignorance or mala fide intent – investors can and do end up being misled. Hence, they would do well to understand the true nature of debt funds before investing.

3. Participate in the investment process 

Yet again, this episode reinforces the need for investors to actively participate in the investment process. Admittedly, that is easier said than done. But investors should find motivation from the fact that their personal wealth is at stake. I’m not suggesting that investors become investment experts. Then again, being completely uninvolved is not prudent either.

For instance, while it helps to engage the services of an investment advisor, blindly acting on his advice isn’t recommended. Quiz him on his recommendations—enquire about the rationale, the risks involved, alternatives and how they stack up versus his recommendations. Additionally, it would help to read up about investing from independent and credible sources. The intention is to become informed investors. Apart from making better investment decisions, this will also help investors deal with testing periods in an assured manner.

How Investors Can Make The Most Of Market Volatility

Equity markets have been on a roller-coaster ride this week. After posting one of the largest single day falls (roughly 6%) on Monday, today markets staged a minor recovery of sorts. Not surprisingly, business channels and newspapers are dissecting every market development in great detail. Experts are busy predicting where markets are headed next. On their part, investors are tuned in with rapt attention.

While investors’ engagement with the external environment is understandable, this is indeed the right time to do some soul searching. The latter can prove to be the proverbial silver lining in this phase of market volatility. Surprised? Read on.

Equity investing is not without risk given the uncertainties involved; over shorter time frames, the risk is further accentuated given that even extraneous factors can significantly impact stock prices. As a result, while investing in equities/equity-linked products, one needs to be able to take on a certain degree of risk. This in turn necessitates an accurate assessment of one’s risk appetite. Sadly, that is easier said than done. When markets are rising, investors can erroneously start believing that it is easy to make money in the markets. This can lead to an inflated notion of one’s risk-taking ability. 

Harsh as it sounds, a volatile phase like the present one can provide a much-needed reality check. Now is the time to revisit your assessment of the risk you can take on. Ask yourself if you are yet as comfortable with equity investing as you were when markets scaled record highs earlier in the year. While an investment advisor can help with this exercise, you will have to play the most important part. If an honest introspection reveals that you have jumped the gun, don’t worry. All you need to do is rejig the portfolio so that it aptly reflects your risk appetite.

This is also a good time to evaluate if you’ve fallen prey to the ‘Keeping up with the Joneses’ blunder. At times, because a friend, relative or colleague claims to have done well with his equity investments, investors feel the urge to emulate his investments. The trouble with this approach is that it violates a basic tenet of investing. At its core, investing is a personalised activity. Investments have to be right for the investor in question. Hence, adopting the ‘one-size-fits-all’ approach can lead to unpleasant results. 

For instance, the friend (whose investments you have copied) may have a portfolio dominated by equities, since he has an investment horizon of a decade; conversely, you may have an investment horizon of just three years. In such a scenario, replicating his investment pattern wouldn’t be the best option. Yet again, it takes a bout of volatility to expose this inherently flawed investment practice.

Admittedly, market volatility can be a bitter pill to swallow. But the fact remains that while investing in equities, it comes with the territory. Rather than fretting over it, investors would do well to embrace volatility, and use it to their advantage by sharpening their investments.

Why Mutual Funds Must Stop Peddling Surrogate Advertisements Under The Guise Of Investor Education

This week, the front page of a business daily carried an advertisement from a fund house. The full-page advertisement had been issued to ‘educate’ investors about the benefits of SIP investing. On the next page, appeared another mutual fund advertisement; ‘issued in public interest’, this one spoke about investing in equity and debt schemes to balance the portfolio.

Both advertisements had apparently been issued to educate interests. But it was evident that they had little to do with investors’ education or interests. Rather, they were surrogate advertisements for promoting fund houses, with names, logos, websites and toll-free numbers being prominently displayed. Sadly, this practice has become the norm in the Indian mutual fund industry. When market regulator SEBI mandated that mutual funds spend monies on investor education, this is not what it intended.

The SEBI circular

In September 2012, SEBI issued a circular wherein it was stated that “Mutual Funds/AMCs shall annually set apart at least 2 basis points on daily net assets within the maximum limit of TER as per regulation 52 of the Regulations for investor education and awareness initiatives”. 

Ever since, fund houses have been at their creative best using various media to promote themselves under the guise of investor education. The pattern is predictable—throw in a line or two about investing such as “ELSS can help you save taxes” or “Debt funds can help you achieve your goals”—followed by a prominent display of the fund house’s name, logo, website et al. A classic case of killing two birds with one stone: fulfil a statutory requirement and yet indulge in self-promotion. 

As per media reports, at a recent seminar, SEBI chief Mr. U. K. Sinha was quoted as saying that only 18% of the investor education programmes conducted by fund houses had genuine investors. 

It will be interesting to find out what portion of the monies earmarked for investor education, has been spent by fund houses on surrogate advertisements aimed at self-promotion.

Fund houses’ perspective

It’s quite likely that some fund houses believe that they have been given a raw deal by being asked to spend on investor education. A fund house is a commercial enterprise whose primary activity is to manage investors' monies for a fee. Hence the thinking that they should try to get maximum bang for the buck by promoting themselves while spending for investor education. The trouble with this approach is that it displays myopic thinking and a poor understanding of the investment environment.   

Wary mutual fund investors

To better understand why fund houses’ approach is flawed, let’s step back in time to 2011, a year that proved seminal for the mutual fund industry. After equity markets turned around sharply in 2009 and the continued to fare well in 2010, came the downturn of 2011. Markets posted a loss of roughly 25%; for investors, this proved to be the proverbial straw that broke the camel’s back. Perhaps painful memories of the 2008 global meltdown were refreshed.

Over the next 24 months (Jan 2012 through Dec 2013), the equity mutual funds segment (equity funds, balanced funds and ELSS) witnessed net outflows of roughly INR 275 billion. Such was the pessimism, that investors even ignored the fact that over this period, markets posted a gain of 36%. 

Optimism returned only when general elections approached and expectations of a new government were omnipresent. On the back of markets scaling record highs, the equity funds segment saw net inflows of INR 1,285 billion from Jan 2014-June 2015. But as is often the case, a bulk of the monies came in after the markets had already run up sharply; in effect, yet again investors missed the inflection point.

The need for informed investors

The numbers say it all. The 2011 downturn deterred a substantial number of mutual fund investors for the two subsequent years. Later in 2014, when a ‘hope’ rally set in, investors were willing to return to mutual funds. This isn’t the investment pattern one would expect from informed investors. It wasn’t just mutual fund investors who lost out; declining assets also translated into loss of revenues for fund houses. 

Had the average investor been better informed, the scenario could have been significantly different, and better for both investors and fund houses. Hence the need for fund houses to adopt a more pragmatic approach while spending on investor education. While the present approach of surrogate advertising could yield short-term benefits, it is unlikely to amount to much over the long-haul. 

Don’t get me wrong. I am not suggesting that it is the sole responsibility of fund houses to educate investors. Far from it. The biggest onus is on investors themselves. But fund houses must do their bit as well, because it is in their interest to do so. Simply put, if not philanthropy, commercial interest should motivate them to act aptly. 

For far too long the Indian mutual fund industry has depended on monies from institutional investors who largely invest in debt funds. It is time for fund houses to start paying more attention to retail investors who account for a bulk (roughly 84%) of the equity assets. Not only are equity assets stickier, they also generate more revenue for fund houses (versus debt funds). Prudent investor education initiatives can go a long way in creating a breed of smarter retail investors.   

One of my former bosses used to say “if the investor wins, we all win”. It’s time the mutual fund industry took some inspiration from that quote and treat investor education with the gravity that it rightfully merits.

Data sourced from: www.amfiindia.com and www.bseindia.com

Let Portfolio Managers Eat Their Cooking, But Don’t Force-Feed Them

It has been reported in the media that Kotak Mahindra Asset Management Company (AMC) has ruled that its employees who wish to invest in mutual funds, shall henceforth do so only in the AMC’s funds. The reports also suggest that employees will be penalized if they make fresh investments in funds from other AMCs after the policy comes into place. 

The rationale behind the move is to introduce the concept of ‘skin in the game’. The concept is far more common in the West, than in India. For instance since 2005, the U.S. Securities and Exchange Commission has required AMCS to annually disclose how much portfolio managers invested in the funds they run. 

To clarify, Kotak Mahindra AMC is not the first Indian AMC to institute a ‘skin in the game’ policy. While some AMCs pay (a part of) bonuses to their investment teams in the form of mutual fund units, others pledge that their top brass invest in funds from the AMC. What differentiates Kotak Mahindra AMC’s guideline is that perhaps for the first time, employees across the board who wish to invest in mutual funds, have been told to compulsorily do so, in the AMC’s funds. 

Why ‘skin in the game’ matters 

From an investor’s perspective, is Kotak Mahindra AMC’s guideline necessarily a positive one? I don’t think so.

To clarify, I have been a propagator of portfolio managers eating their cooking i.e. investing in funds they run for a while now; also, I believe there is a case for disclosing managers’ investments in funds they run. To understand why I am not convinced of the guideline in question, let’s delve further into the ‘skin in the game’ concept. 

At its core, portfolio managers investing in mutual funds they run is all about inspiring confidence in investors. Portfolio managers who invest alongside their investors show a conviction in their investment approach and a confidence in their investment acumen. It’s a classic example of putting one’s money where the mouth is.

Coercion versus free will

The trouble with Kotak Mahindra AMC’s policy is that there is an element of coercion. Employees (including portfolio managers and analysts) who wish to invest in mutual funds, will invest in funds from the AMC because they are being forced to do so, not because they want to. For an act to inspire confidence, it must be voluntary and not compulsory. Even if managers claim that they have invested in funds from the AMC voluntarily, that argument is unlikely to find many takers, given the existence of a policy which dictates such investments.

What AMCs must do

  

If Indian AMCs are serious about building investor confidence, they must adopt the ‘skin in the game’ concept in letter and spirit. Apart from voluntary investments by portfolio managers, AMCs can explore avenues such as offering a part of the compensation in locked-in units from the AMC’s funds, or periodically disclose investments made by managers in funds they run. 

Most importantly, AMCs must appreciate the importance of free will for ‘skin in the game’ to have the desired effect.

You're in Trouble if Your Manager is…

In his book ‘The Dilbert Principle’, author and cartoonist Scott Adams writes “The basic concept of the Dilbert Principle is that the most ineffective workers are systematically moved to the place where they can do the least damage: management”.

Anyone who has spent a reasonable amount of time in a corporation will vouch for or at the very least, empathise with Adams’s satirical view of the corporate world. While I can’t claim to have undergone the wrenching experiences that Adams may have (which in turn perhaps inspired him to create the iconic Dilbert) I have had my fair share of eclectic managers and bosses. I thought it will be interesting to put out a checklist of manager traits that should set alarm bells ringing. In other words, you are likely in trouble if your manager is any of the following:

1. The PowerPoint enthusiast

As the name suggests this manager loves to make presentations. He is an expert at using tools such as PowerPoint. The trouble is that instead of using tools to effectively communicate his subject matter, he uses them to make up for lack of subject matter. The thinking is simple—“I’ll dazzle you with so many slides, graphs and images that you will not realise that in fact I had nothing worthwhile to say”.

For instance, watch out for managers who make presentations on annual revenue projections wherein a 50% jump in revenue is projected with absolutely no clues as to the strategy or plans that will be deployed to achieve the projected growth.

2. The Sir Humphrey Appleby clone

In the legendary BBC comedy ‘Yes Minister’, Nigel Hawthorne plays Sir Humphrey Appleby, a bureaucrat who is skilled at talking nineteen to the dozen without committing to anything. There’s a cult of managers who model themselves on Appleby.

A manager of this variety often sits on the fence when faced with an executive decision. However, he does ramble endlessly making liberal use of jargon, leaving his subordinates thoroughly confused on the apt course of action. Should things work out well, the manager swoops in to claim credit; on the contrary i.e. in the event of things going wrong, subordinates take the flak for failing to follow instructions.

3. The Teflon manager

This manager has turned passing the buck into an art form. He will typically thrive in a workplace wherein there are multiple reporting lines (and expectedly multiple teams/departments too), so that he has several targets to point fingers at. To be fair to him, he spares no corner of the universe while attributing failure; should he run out of elements inside the organisation, he will point to external factors such as markets, regulations, technology and competition to justify why he missed the mark.

The ‘Teflon’ approach is on display while dealing with subordinates too; for example, juniors complaining of poor compensation despite achieving targets, will be convinced that the CFO and the HR department are to blame. 

4. The Headquarters specialist

You will find this manager in an offshore location away from the headquarters. His claim to fame is mastering the art of ‘headquarters management’. The manager couldn't be bothered about trivialities such as poor sales numbers, employee turnover or the fact that competitors have stolen the march over his enterprise.

Instead, he focuses all his time and effort on managing relationships with the who’s who at the headquarters (HQ). He latches onto each and every initiative launched by the HQ, even if it’s not relevant to his office. If you spot a manager who has won accolades for a project on ‘client satisfaction’ at a time when his office has lost clients by the dozens, you've met the quintessential HQ specialist.

5. The ‘Because I Said So’ manager

This one’s my favourite: a manager with the God complex, who would like you to believe that his presence on planet Earth is for the betterment of mankind. In any given situation, his modus operandi is frightfully simple—do what I say, because I said so. In his dealings, there’s no room for inconsequential things such as ideation, reasoning and common sense. Don’t be surprised if he constantly expects you to deliver the most inconceivable results with no resources, and then celebrates every time you fail.

Scratch the surface and you will discover that his driving force is good old fashioned ‘insecurity’. His outward grandstanding notwithstanding, deep inside the manager is acutely aware of his own shortcomings vis-à-vis his subordinates. However instead of utilising a skilled team to his advantage, he chooses to put them down at every given opportunity.

Will Offshore Funds Prove to be the Domestic Mutual Fund Investor’s Achilles’ heel?

Earlier this month, market regulator SEBI released a document titled “Consultative paper on managing/advising of Offshore Pooled Assets by Local Mutual Fund Managers”. The paper makes a case for removing certain restrictions existing under section 24(b) of the SEBI (Mutual Funds) Regulations Act.

At present, if an Indian asset management company (AMC) wants to manage or advise offshore pooled assets or funds, and for the purpose appoint a fund manager who is currently managing its domestic funds, the AMC can do so subject to: both domestic and offshore funds having the same investment objective and asset allocation. Furthermore, both portfolios must have a commonality in holdings of at least 70%; finally, the offshore fund must pass muster on the 20/25 rule applicable to domestic mutual funds. SEBI has proposed that for offshore assets classifying as Foreign Portfolio Investors (FPI) investments these restrictions be scrapped.

It’s not difficult to understand what’s driving SEBI. For a better part of the last five years, the domestic mutual fund industry has struggled to clock a healthy growth in terms of assets under management. With expectations of a strong economic revival and buoyant markets, India has resurfaced on global investors’ radar. The opportunity to freely manage/advice global funds can prove to be a significant opportunity for Indian AMCs.

To be fair, the present set of regulations though well-intended (more on that later) were restrictive for Indian AMCs. Let’s take an example to better understand this. Consider a global fund house which wants to launch an India-dedicated fund and hand its reins to a domestic AMC, which in turn has a skilled fund manager with a proven long-term track record. Expectedly, the global AMC would want it’s monies to be managed by the same fund manager. His track record and presence will be the new fund’s USP. However, the present set of restrictions (especially ones related to 70% commonality in holdings and the 20/25 rule) made it operationally difficult to have the Indian fund manager at the global fund’s helm.

Conflict of interest

If the aforementioned restrictions are done away with, life will become significantly easier for both Indian AMCs and fund managers. However, the flipside is that it could lead to a potential conflict of interest situation with domestic investors on one side and investors in global funds on the other. Global funds, by virtue of their asset size can prove to be lucrative for Indian AMCs, and the possibility of fund managers paying more attention to these funds at the cost of domestic funds cannot be ruled out.

Even SEBI recognizes this prospect and has provisions wherein AMCs are required to make a disclosure in the scheme information document (SID) that there exists no material conflict of interest across its activities and other like measures. Perhaps some of the restrictions which are now proposed to be scrapped had their origins in protecting domestic investors’ interests.

A quick glance at how AMCs reacted to these restrictions in the first place reveals a lot. There were cases of AMCs withdrawing their leading fund managers from domestic funds and instead utilising them to run/advice offshore funds. To placate distributors and investors in India, a standard (but off-the-record) refrain was that though the said managers no longer run domestic funds, they do ‘influence’ the local strategy. In 2011, when SEBI came up with the present set of regulations permitting managers to be named on both domestic and offshore funds, while some of the 'absent' managers returned, others yet chose not to do so. All in all, it isn’t difficult to see which piece of the pie Indian AMCs prefer.

Skin in the game

Admittedly, there is no foolproof method to ensure that domestic investors’ interests are not compromised. But what SEBI can do is institute a framework which prods AMCs and fund managers to act in a fair manner. To begin with, provisions requiring AMCs to invest its personal monies in new fund offers must be expanded to include all its domestic funds. Furthermore, SEBI should make it mandatory for fund managers to invest in every domestic fund helmed by them. Ensuring that AMCs and managers have their skin in the game, is perhaps the best way of ensuring that domestic funds aren’t neglected. Also, these investment must be periodically disclosed.

Another disclosure which will help is that of performance and portfolios of offshore funds being managed/advised by fund managers. This will help domestic investors track and compare the manager’s activities on offshore funds versus domestic funds. 

At their core, these measures can go a long way in revealing the true character of AMCs and fund managers. Using the former as inputs, the onus of making informed choices will rest with investors.