Rate Cuts, Expert Speak, and Investment Advice

Last week, the Reserve Bank of India (RBI) in its bi-monthly monetary policy review kept the benchmark repo rate unchanged. The move surprised markets which were expecting a rate cut of at least 25 basis points. The consensus was that liquidity in the banking system would improve thanks to demonetisation. This coupled with benign inflation would give RBI leeway to cut rates. 

In the weeks leading up to the monetary policy review, investment experts in media were urging investors to capitalize on the foretold rate cut. Their advice was unambiguous: invest in long-term bond and gilt mutual funds to make the most of the opportunity.

However, RBI’s decision to leave policy rates unchanged meant that bond yields rose sharply. The performance of mutual funds positioned on the longer end of the yield curve took a hit.

Interestingly, experts’ narrative changed overnight. Several experts who were espousing the cause of long-term bond and gilt funds did a volte-face; now the advice was to invest in short-term bond funds.

Let’s consider the case of an investor who relied on the aforementioned experts while investing. Swayed by the flurry of advice centred on rate cuts, he allocates a substantial portion of his portfolio to long-term bond and gilt funds. Expectedly, his portfolio suffers. Subsequently, he is told that short-term bond funds are a better bet. The investor clearly finds himself in an unenviable position.

To clarify such instances are far more common than one imagines. While this time around the event was an expected rate cut, in the past too, experts have been known to dish out advice, anticipating outcomes of events such as elections, political referendums, and union budgets.

Investors who rely on expert speak while investing have a simple rationale: an individual is being quoted in a newspaper or, making a television appearance, because he is an expert. So acting on his opinion is the right thing to do. Sounds reasonable, doesn't it?

Sadly, this line of thought isn’t correct. To understand why, one must understand what investment advice is.

To qualify as investment advice, apart from being accurate, the counsel needs to be customised for the investor. In other words, the investor’s risk appetite, investment horizon, financial goals need to be taken into account. That’s never the case with media quotes by experts, which are at best generic opinions.

Furthermore, often investors are prodded to invest tactically. For instance, in this case, for the ‘advice’ to play out successfully, an event—rate cut—had to occur. Investment strategies whose success hinges on an event such as election results, change in government policy, quarterly results of a company tend to be riskier than those which bank on fundamental reasons such as a macroeconomic turnaround, a company’s robust business model. Simply put, tactical investing is apt for a risk-taking investor.

Another integral aspect is the allocation made. Ideally, a tactical investment should be an ancillary holding (as opposed to a core holding) in the portfolio.

However, such nuances are never (and perhaps cannot be) communicated in a published article or a television appearance.

Hence it is important for investors to appreciate that there is a fundamental difference between investment advice and expert speak in the media.

Investors who need assistance would do well to source the same from a competent and independent adviser. While expert speak in the media can be a source for information, treating it as investment advice can result in unsuitable investments, and failure to meet financial goals.

Of Demonetisation, My Cousin ‘P’, and a Polarized Population

As I write this blog post, television channels continue to beam images of long queues outside banks and ATMs, interspersed with bytes from harassed citizens. Clearly, the surprise announcement demonetising bank notes of INR 500 and INR 1,000 has caught several on the wrong foot, and disrupted day-to-day life.

But while the focus is on disruption, there’s an interesting undercurrent that many have overlooked.

A day after the announcement, I met my cousin whom we shall refer to as ‘P’ (the secrecy is for obvious reasons; I don’t want to be ostracized by my family :)). ‘P’ was livid to put it mildly; he said: “I voted for Modi and yet he has ruined my business”.

My cousin makes a living as a trader in the auto spare parts industry. He conducts a significant portion of his business transactions in cash, and by and large stays outside the tax purview. Now he is apparently engaged in ‘creative’ consultations with his accountant, which include documenting back-dated sales transactions and paying taxes as well.

To be fair to ‘P’, he is a small fry in the larger scheme of things, a minion compared to the big fishes whose sizeable unaccounted cash was the target of the demonetisation drive. However, both ‘P’ and the big fishes represent that section of the population, which firmly believes that they are justified in not paying taxes. To clarify, I’m referring to wilful disregard of law, not ignorance of it.   

On the other side of the spectrum is the ‘cheque and TDS’ brigade of the population. Salaried individuals, for instance, who have over the years accounted for all their earnings, and paid taxes. The ‘cheque and TDS’ brigade, while suffering through long queues and a liquidity crunch, is nonetheless gleefully smiling at the woes of the ‘why should we pay tax?' brigade. Oddly, in the midst of disruption, they’ve found vindication—for paying taxes, filing returns, not possessing unaccounted wealth— for being law-abiding citizens.

The polarization is perceptible everywhere from the streets to discussion boards. On a lighter note, the last time the Indian population was so polarized, was in 2013, when the man who announced demonetization—Prime Minister Modi—was named as the BJP’s prime ministerial candidate for the 2014 Lok Sabha election, and that worked out well for him.

Back to serious stuff. Several sections of the media are carrying reports on the flipside of demonetisation. Predictions range from a short-term disruption in economic growth, to the upside of a good monsoon being wiped off, to a structural damage to the economy and a prolonged bear phase in markets. To my mind, these are educated guesses at best, because we are in unchartered territory. How the demonetisation gambit plays out over the long-haul is anyone’s guess.  

However, what we can be certain about is how the aforementioned segments of the Indian population will act going forward.

First, the ‘cheque and TDS’ brigade. Make no mistake, this brigade will go from strength to strength. Existing members will continue to walk the line; also, its ranks will swell, thanks to new recruits who will see the upside of being on the right side of the law.

Then there’s the ‘why should we pay tax?’ brigade. Sadly, it will be naïve to believe that one brush with the law will instantly reform every unscrupulous individual. But what will change is the way they operate.

Existing systems which help them evade taxes and get away with it, will be disbanded. Instead, they will be forced to manufacture alternative ways and means to continue their corrupt practices. More importantly, thanks to the precedent of demonetisation, such individuals will be forced to constantly look over their shoulder. One can hope that over time, the combination of fear along with more anti-corruption regulations will deliver the desired results. 

As previously mentioned, how demonetisation plays out over the long-haul is anyone’s guess. But if shivering spines of several tax evaders are an indication, demonetisation deserves at least a thumbs up.