Managing risk aka IIFL,ESSEL and DHFL crisis

Whenever a crisis especially in the financial sector looms large or is indicated- what do you do?

Do you simply retract all your steps and go back to ground zero and start again on the drawing board.

At least this is what I observed in the recent IIFL, DHFL AND ESSEL debt crisis.

Most of the investors did not even have any Investments in the affected funds, still, the moment they heard Liquid funds are not safe - they pressed the crash landing button?

Why was that?

Did they even for a moment realise before investing that their fixed income schemes would be risk free.

Would anyone pay a higher premium over the normal rate of return if there wasn't any risk.

Isn't there a risk even in FCNR deposits- that of exchange rate. Or the fact that if they are forced to liquidate their deposit even a day earlier than 365 days- they get no interest.

Risk and return are two sides of the same coin whichever walk of life you move.

The same job that we do on board, carries lot less remuneration on land. Do we stop sailing? We just take risk mitigating factors .

So what steps should we have taken before investing in debt funds ?

Before that we must ask what the risks were.

The first risk was that of interest rate. Any rise in interest rates could have led to the returns falling.

And second risk was that of liquidity itself. Which means that the underlying papers could not have been sold.

In the same series third risk happened to be that of the default by the debt issuing company itself which finally happened.

But how could somebody not see such a big default happening?

To answer this I must tell you the story about a famous neighborhood Lala who was in the business of collecting money and paying interest on it and also lending money to the weaker section and charging interest on that.

Despite being well educated my father and grandfather followed his scheme and deposited weekly installments to get a return to the tune of 18% in 1970s. To cut the story short both the money and the Lala just vanished.

Add to this various chit funds and committees which are regularly defaulting in repayment of their debts.

So does that mean that we stop investing in the fixed income assets and stick to bank fds , Post Office schemes or other supposedly safe avenues.

No absolutely not.

We must realise that it is the our investment in the fixed income assets which actually form the backbone of the National  infrastructures projects.

In the same way the companies also fulfill the finance needs from these fixed income assets like the above 3 companies went to the mutual fund industry to get money.

It is not everyday that the companies are defaulting on their payments. But at the same time we cannot jeopardize our hard earned money by taking chance with even one such incident.

So what would I do?

I would most certainly go for a big AMC which has been in the business of managing debt instruments for long time. 

Then again we keep reading articles mentioning that the size of the fund does not guarantee safety or returns either.

Well it doesn't but when we put our money in a fund of the size of about 15000 crores then most certain its exposure to any single company would not exceed 2to3 percent. And this would certainly protect its downside in case of any such default.

If you will see carefully you will not miss the fact that two of the largest AMC are not there in the list of affected mutual funds.

So it automatically follows after selecting an old big and reputed AMC the second thing that I will select is a debt fund of reasonably large size.

The third selection criteria which I will apply to my entire portfolio is...

I will opt for overnight funds liquid funds or Ultra short term funds. The underlying securities or debt papers of such funds have a very short maturity which in essence means that the the borrower has promised to pay the money at his earliest which is within 6-12 months.

So by following these three steps I would reasonably secure myself.

After following such a course of action if I am still faced with a company defaulting then my entire risk would not probably exceed 2 to 4 percent which means that for an investment of 1 crore I would stand to lose a maximum of 2 to 4 lacs.

Apart from the fixed income plans we had also seen prices in the equity sector on account of PNB earlier last year. But even with that a good fund house like HDFC did not suffer more than 2.3 % on the NAV.

But unlike the debt papers, the fund manager went into bye buy additional PNB at the lower rates and benefited once the market and the PNB stock moved up.

So the mantra should be- don't avoid risk.

Manage it.

Fear as an Element In Personal Finance

                                               "Fear is the enemy of rationality"-

In life situations it can be said that fear gives us that nervous energy to do better it can also serve as a deterrent but when it comes to personal Finance of financial planning it may actually serve different ends.
From time immemorial in independent India LIC had sold expensive and rather useless policies based on fear.
In fact even today most of the insurance is sold packaged in a cloak of fear rather than as a risk mitigating tool.
Another aspect of fear in personal Finance is keeping too much savings in liquid form or cash waiting for something to happen which may never happen.
A substantial amount of one's savings remains in cash at home, saving bank account and even low yielding fixed deposits just for this eventuality which could actually be mitigated by some astute specific insurances.
However in the Indian context we do not really believe in in those plans and insist on financing them with our own money.This leads to do some serious opportunity cost.
Opportunity cost of an investment is something which can never be calculated unless looking in the rear view mirror and driving forward.
Nonetheless since so much has already been written about the importance of investing in equity it is important to understand that amount to be invested in equity formats must be substantial part of one's savings.
In the garb of looking at high rate of interest on Savings and fixed deposits we forget a large amount of our money need not be put there at all.
The liquid cash whether at home in savings bank , FDs or even liquid funds must be kept in such a way and balanced at such levels that it takes care of your daily expenses for a few weeks as long as you are working and maybe a few months when you stop working.
But despite the best of advising for consulting this cannot happen unless one overcomes the fear.
This fear also prevents a person from making the best of a bear situation in the stock market. In fact it puts brakes on the investing cycle of a person when he sees the market dropped by 10% and heads straight for the sell button, effectively and undoing the hard work of the previous few years.
Of course the fact that this fear also affects a person in a professional life intervention from taking decisions appropriately...
.... But that's a story for another day.

NPS- National Pension Scheme and The Marshmallow Experiment

It's been almost 72 years since India became independent and all the while the general public suffered from one basic aspect and that was The old age pension system and a social security system.

Traditionally up to 1991 the earning populace was so used to putting their money in FD and RD at 12% that it never really mattered for them to look anywhere beyond NSC or other post office schemes and of course the omnipresent LIC.

Last was the Ocean into which the public was throwing away its money which spoiled the investment culture so badly that people would rush to them for princely returns of 5% over 20 years and more.

Just like the story about frog who was put into a pot of water and slowly it was heated;  in a similar way the government kept reducing the interest rates on all small savings PPF and fds and to add insult to injury also introduced TDS on the fixed deposits.

Around this time something deceivingly spectacular made its way into the Indian market and it was called ULIP.

ULIP came riding piggyback on the mutual funds which had already made an entry about eight years  before.

Mutual Funds were not so aggressively sold so less than 1% of the investing public invested their hard earned money in them.But the ULIPs were being sold heavily at mind boggling commissions and hence were thrust down the throat of the higher income group.

Slowly few people caught on to the mutual funds and started making money with the return in excess of 15% on rolling basis.with this kind of return the people did not even mind losing the money to Ulips as they had tasted blood.

It seems very automatic to them that putting money in mutual funds was a sure shot way of gaining minimum 15% next year unless of course Y2K and 2008 happened.

The Dotcom bust in year 2000 and the global subprime crisis of 2008 pulled away a lot of people from the equity market.

Around the same time in 2009 NPS was introduced after being tried out for Govt employees in 2004.

It was supposed to be a path breaking plan backed by government of India and controlled by PFRDA.

NPS was supposed to be sold on the back of infinitesimally low expense charges , in fact fraction of what Mutual Funds were charging but having the same 8 fund houses as the fund managers.

The mechanics of NPS is a little complicated. You have 3 streams or asset classes to allocate your money to viz Equity, Government bonds and Corporate bonds. As a conservative gesture the government did not initially allow more than 50% allocation to equity (now it is max 75%). After a lock in upto the age person could take out 60% of the Corpus on his 60th birthday but 40% minimum would be allocated to buy annuity from insurance company . Annuity in simple language meant that 40% of the Corpus would be given to the insurance company of your choice who will continue to give you a monthly pension at a fixed rate which was not very high until subscriber’s death. At the time of death  the pension could be continued for the nominee or the annuity sum would be returned to the nominee.

What was important was that NPS was opened not only to the organised sector but a it also replaced the government pension scheme and was open to anyone who wished to open NPS account.

The next 10 years brought in a lot of changes and another asset class was added as Alternative Investments or AI. 40% of the Corpus which a person withdrew was made tax free and the lock in period or the period till which a person could defer its annuity was extended upto 70 years of age.

As things stand today there are 8-9 fund managers and NPS operates in Tier 1 and Tier 2 mode.

Tier 1 mode is compulsory with a minimum of 1000 rupees subscription and can be used for tax saving under 80C up to a sum of rupees 2 lacs. The lock in up to 60 years of age is in Tier 1 only.

Tier 2 also operates exactly like Tier 1 except that there is no lock-in and you can distribute your money into various asset classes.It is important to note that as soon as the funds appear in Tier 2 you can withdraw them anytime at a short notice.

The Unpopularity: the Indian middle class who had tasted the returns of mutual funds had become used to the instant liquidity nature of various types of funds.

Some of them preferred MFs over FDs also which is a very good thing.

The main thing which was pulling away the Indian public and even those who did not have any retiral benefits for gratuity and pension were not in a mood to keep their money locked in for such a long time till the age of 60.

This is precisely why I have written this article.

I am a self made mutual fund investor who started with the first mutual fund introduced in India. I have made my portfolio in due course of time but I would say one thing at this stage that, if something like NPS was available to me and everybody 30 years ago then probably Mutual Funds may not have been so popular.

In addition to the lock in the people refuse to believe in anything which is backed by the government or is sovereign in nature. This mistrust comes on the back of the famous US 64 debacle , through which the government royally cheated the investors.

Having considered both our aspect what I also feel is that with the popularity of the equity market and mutual funds people have lost the concept of pension.

It is a mindset which makes them feel that they can take care of their own Investments.

While this is a healthy thinking but if it is not backed by adequate qualification or determination and discipline it could actually prove to be undoing.

Most of the investors whom I know have invested or started investing in the last 10 to 15 years. In these years also they're on the constant look out for a good and a better fund hence exiting and entering various funds every year. This mindset does not give constancy and in certain cases people exit at a low and enter at a high. They confuse mutual fund investing with direct equity investing and carry the same mindset here.

This I refer to as the marshmallow syndrome.

Most of the investors are in such a bad habit of looking at the returns every week or every month that they cannot digest a little fluctuation in their NAVs.

If the downturn in the market continues for a few months in a year then they are quick to exit instead of investing more. NPS dissuades a person from this.

However much we talk about long term investing and compounding, the investor can never take a look beyond 5 years. The slow and boring process of compounding can produce spectacular returns is something that a person refuses to acknowledge or even consider.  

Considering the NPS as the investment and security avenues I feel that Tier1 should be made as an investment and also a tax saving Avenue and a small amount of money can also be deposited in the Tier 2. 

Tier 2 is exactly like normal Mutual Funds but at a much lower cost than the index funds or the ETFs. The taxation is also of the same level.

Due to low expenses The returns as seen in the last 5 years have been a little higher than the mutual funds in both equity and debt segment.

So what is keeping the Indian citizen away from an excellent pension scheme which has almost equivalent allocation as a equity hybrid fund.

As I have mentioned the first detractor is the lockin which  can be for almost 35 years for a youngster who is barely 25.

The second aspect is the annuity which is actually controlled by the insurance companies as PFRDA does not have a system of managing it on its own.

Strategy for the self-employed or those in the Merchant Navy: NPS provides a much simpler way of managing your savings and channeling them on a long term basis into a relatively secure system.

in my opinion one must open NPS account as soon as one starts working and should start investing smaller amounts equivalent to at least 15 days of salary. The option must be kept with maximum equity allocation which is 75% at present 15% Government bonds and 10% corporate bonds.

As one grows in age one will be able to see the consistent rise in the Corpus and if encouraged by that one can keep increasing the allocation to Tier 1. 

Along with this one can experiment by putting smaller amounts in Tier 2 which one will be able to withdraw as and when one needs it.

As one approaches the retirement age that is from 55 onwards one should increase the allocation into Tier 1.

5 years of increased allocation will boost the overall courses on the back of the returns that one sees over extended period of time.

In my opinion it is the very lock in nature of one's money which will give it the necessary boost even if it is against one's liking.

Since NPS also serves the central and State Government employees it is my feeling that it will never be allowed to be diluted and The returns that one sees will be greatly enhanced.

I cannot see for sure but as a speculation I feel that a part of the annuity could also be made tax free in future.

Hence as the government sector gains on the back of various improvements in NPS the common man should not be left behind.

2018 has seen the large cap return dwindle in the actively managed MF but higher in the index funds or ETFs.

By extrapolating this hypothesis I can say that in future the actively managed funds will continue to generate lower and lower Returns but before the exchange traded funds or index funds beat the actively managed funds , NPS would have beaten them fairly and squarely.

CONCLUSION: I am a fervent supporter of mutual funds and the basis of my propagation of Financial literacy rests on the versatility of Mutual Funds.
Mutual funds are beyond doubt very flexible when it comes to selection and allocation of funds. But one aspect that they severely suffer from is the ability to be purchased because of 47 Fund houses and each having at least 200 odd variety to pick from. Add to this the severe shortage of good advisors and distributors who can advise going beyond personal benefits.
NPS gives a secular platform to the Lowest Common Denominator to start investing his money in a fairly diversified manner, all the while knowing how much he is generating as returns from each asset class.
He has just 8 Fund Managers to chose from and hence choice is simpler even if he has to change the fund manager every year, which comes at a very small cost.
Apart from allocating funds to the NPS Tier 1 and 2, one can for comparison purposes invest in 1 Hybrid Equity fund and 1 Multi Cap fund.
After a few years of sustained investing, he will be able to decide for himself which is the best course for him.

How to build and maintain a Equity to Debt Allocation Ratio

Q.       Can u please suggest how One's portfolio should be allocated when investing both in equity and debt funds in mutual funds. Right now i am all in equity.

In theory everyone would suggest different figure to you but if we only talk about mutual funds and leave alone the FDs and various other schemes that you may be holding then for a youngster, equity to debt ratio of 80 :20 is sufficient.

But the question that arose was that how to arrive at this allocation ratio.

A better question  would be how to start building your portfolio.

The answer to this ;for those who work on shore and have a regular flow of income even if a little less would be to start a SIP in a few funds and keep building it.

Such people naturally have FDs and also invest in NPS,  PPF,  EPF and other avenues which makes up for the debt portion of the portfolio.

But for unfortunate people like us who just get a few lacs every month and 6 months of leave to do what we like there is a different strategy.

This strategy like most of my colleagues are aware is the header tank on expansion tank strategy.

And this is no different then a normal STP.

Select 5 to 7 good equity funds in different AMC s and start with putting 1 lakh each in liquid or Ultra short term funds with those AMCs.

Then simply set up a weekly STP from this liquid or Ultra short term fund in to those equity funds in such a way and with such a amount that the liquid fund or the Ultra short term fund ( which can be called the source fund) does not deplete during your leave and before going back to the ship.

This part... of the source fund not getting over is more important than choosing a higher value of STP. Because under all circumstances your STP must go uninterrupted for as many years as possible.

Once you have started moving your money from the liquid or Ultra short term funds to the equity funds your exposure to equity will keep on increasing and the debt portion will keep on reducing and in roughly 4-5 years the allocation ratio of 75 equity and 25 debt will be achieved automatically.

During these 5 years if you are lucky the share market will go down and your further investment will be able to buy more units in equity funds than in a bull run. Furthermore after this downturn in the stock market when the market will start looking up your allocation ratio will automatically start leaning towards equity.

At this stage you will be able to evaluate your risk appetite and will be able to decide exactly how much percent you want to have in equity.

This process will be a continuous one ... and whenever you find that your portfolio has skewed more than 5% on either side of Equity or Debt- you can make a corrective action of shifting it to the opposite  asset- Equity or Debt.

QED

What to do after I have set up my investment process.

 What to do after I have set up my investment process

A common question that I am often asked after one starts doing his customary as it is in STP into equity Mutual Funds is what do I do now?

Well !!! To start with, first accept my congratulations because you have done something which most of the country and even the world does not do.

As one moved from different type of political systems and economy  to the one of liberalization and privatization of high salaries and longer working hours, collecting millions - before one reached his 30s and getting that coveted house in the hills much much before the retirement. As We moved through all the above we forgot one thing that violent fires do not last long and heavy torrential rains come to abrupt stop and in the same way the highest salaries that we see in the beginning of a careers or towards the mid career and not forever.

The situation does not last long not because of many other reasons. But simply put, while running in that fast track race a person gets tired faster gets a lot of problems which add up to one’s adverse physical and mental condition much earlier. Hence  the very organisation which actually pushed you for all those mind-blowing achievements at a such a young age is further on the lookout of even younger blood all the time.

Hence right from day one when you enter the fast track career with higher compensations, it becomes imperative that you do not forget that's saving is important and putting that saving to work harder in form of investment is even more imperative.

It would not be an over statement if I say that you should have made your billion rupees much before your 40s.

…and now by the virtue of you having started on the road of investment in whatever small measure it may be… you need to understand a few things.

Firstly it should be remembered that what you have started investing in all probability is a small percentage of your salary and you need to step it up as soon as you have faith in the system and methodology of your investment.

Secondly you should remember to keep on the track without deviating much as different schemes which are both attractive and unbelievable comes along.

Just because you started 25000 SIP into equity mutual fund does not give you the right to start going for IPOs or NFOs or closed ended funds all get quick rich forest schemes, ulips, endowment plans money back plans of various insurance companies or some chit funds. Don't look at any of them just stick by your standard 7 golden rules and keep on your investment track.

Thirdly you have to remember that every year as your salary goes up by way of increment all the forex fluctuation you must try to divert the increased funds towards your Investments.

Fourth point, That I would like to stress is that somewhere in the middle do not start believing that real estate will give you a better return.this will not only take away and important portion of your savings but take it into an uncertain BLACKHOLE, out of which you will find it very difficult to come out as long as you invest and stay in India.

Fifth point that Comes along is most important of all and that is stop tracking the market everyday. Do not start subscribing to that pink newspaper start watching the CNBC channel everyday.

Just by investing a few lacs in mutual funds or direct stocks does not make you an expert on the Indian economy or give you the right to start discussing it at dinner parties. In fact it is definitely a good idea to start learning about your country in some small measure. Read newspapers to see how different projects are taking place across the countryand which companies are involved in it and what is the quantum of money being spent. You should try to read how different discoveries and inventions are coming up in the world and how they are expected to change your life.

The last. To be kept in mind is simply a extension of Fifth one and that is do not listen to the noise and cacophony that happens around you which tells that how the US economy is going down and further on the Indian economy will go down. Believe me at a lot of people … the leaders of the country, the governors of the central banks have lot more at stake than just a few lacs rupees and they will do something right to keep their own position intact even if not the economy at large.