Brexit and India; How are we placed in the current crisis !!

Last week United Kingdom voted in favour of exiting the European Union, which was kind of surprise to the world as most of us were expecting that it will remain with Euro.  Due to this surprise globally almost all the markets reacted negatively and Indian market was not different. Reacting to this news Indian market fell more than 2% on Friday, Rupee fell by 70 paisa against dollar, and FIIs were net sellers. Pound is trading at it 30 year low against dollar. Gold, Silver and Crude prices went up. So what will happen going forward, is this the end of the world, how Indian markets are placed, can we face this situation? Indian investors have all these questions in mind. So lets try to find out the possibilities and likely situation.

Let’s first understand the negatives:

1.  This will open a Pandora box of exiting from the European Unions. Many other countries like Greece, Ireland etc. may also follow the UK style voting. Various groups opposed to the EU membership in other European countries have already started demanding their own referendums. This will increase in risk aversion when it comes to investing. 
2. Britain votes for exiting then businesses in Britain will be at a disadvantage, and London being the financial capital will lose a lot of sheen.
3. This sudden increase in global risk aversion will have negative impact on the inflows from foreign portfolio investors (FPIs) to emerging countries and India will be impacted due to this. Money will move out of Britain and will affect currencies including INR (£ will weaken and $ will strengthen) and in turn affect the global economy.
4. European Central Bank has its limitation to fight this situation, with interest rates at rock bottom, some of them even negative, there is a limit to how much further stimulus central banks in developed markets can give their economies; 
5. India exports a range of goods and services to the UK, including apparel, motor vehicles, pharmaceuticals, IT services, and gems and jewellery. Indian bilateral trade will be impacted due to fluctuating currency and global stock market volatility. Indian companies having base in Britain will have a smaller domestic market, rest of EU will become an unprotected export market
6. The other major global even is US Fed raising rates, however due to Brexit it may not happen soon but this risk will remain on the global markets.
7. For India the upcoming Foreign Currency Non-Resident (FCNR) fixed deposit redemption due in September is a major currency risk. However as per RBI governor and other experts this FCNR redemption in September should not be a big worry.
8. For India, Inflation is slowly moving up and will have impact on the economy. Rising Crude oil and food items prices will restrict RBI to cut rates from here onwards. This will have impact on the markets. Any further weakness in the rupee will also tie the RBI's hand in reducing the rates.
9. Indian banking sector is facing a challenge on account of huge NPAs and needs a serious policy directios for the regulator.

So, how are we placed in this scenario and can we face this situation, lets understands the positive factors also in the current environment

1. Indian economy is much stronger than it was 5 years ago thanks to sound monetary policies by the RBI, softening of commodity prices which ensured fiscal discipline, stable and able Government at the Centre and reforms initiated by them.
2. Though UK has given its referendum, the Brexit will not be happening overnight. Its a gradual process which will take at least 18–24 months to complete as the new UK Government will have to strike new deals with other countries.
3. Brexit has driven away fears of a US Fed rate hike at least for the time being and could lead to lower commodity prices, which would be good for the commodity importing countries like India.
4. The immediate impact of Brexit has seen the US dollar appreciate and this usually sees commodities with strong links to financial markets weaken. Since money gravitates towards the appreciating dollar, commodities take a back seat. A sharp drop in oil and other commodity prices will benefit a number of companies India.
5. Although Brexit will have impact on Indian GDP growth but still Indian economy is the fastest growing economy although it may have some impact due to Brexit but it will remain at top on the GDP growth.
6. Higher GDP Growth rate, fiscal deficit within reasonable limit and lower current account deficit is seen stabilizing the economy.
7. Lower base, benign commodity prices, government policies along with increased capex could help earnings to improve going forward.
8. A good monsoon will help in reducing the food prices and also help to boost up the demand from rural India.
9. A good monsoon and high GDP growth/corporate earnings will be a positive for the Indian market. Especially domestic oriented companies may do well in this scenario 

So what a long term investor should do in this scenario:

• Markets always have a habit of obsessing about one or the other factor over a short term, be it Brexit, Grexit, terror strikes, Iran issue blah blah blah…so for a long term investor its not necessary to react for everything and anything.
• A long term investor should learn to ignore every form of macro information and just stop trying to predict them. Nobody knows exactly what is going to happen. And everyone is trying to give their opinion, and someone is bound to be right just out of sheer luck.
• As happen in past no news continues to be a news forever similarly in few months nobody will even talk about Brexit (now the official news is here), however, it is also true that something new will pop-up on the horizon soon. Something related to oil OR China OR NORT KOREA OR IRAN OR US OR Fed OR COMING ELECTIONS whatever, and there will be talks going on everywhere
• If we have selected right stocks/mutual funds and have confidence on them and have surplus funds, its always wise to buy when everyone else is selling so go and buy more in uncertain and volatile scenarios.

25 Years ago on 21st June 1991, PV Narsimha Rao took oath as Prime Minister along with Manmohan Singh as FM. Sensex on that day was 1360 and today it is 26,400. Growth of almost 20 times in 25 years.

Now let’s go in flash back and see what happened during this 25-year period.

The Babri Masjid demolition and subsequent riots...the worst foreign exchange crisis, Mumbai Serial Blasts, Harshad Mehta Scam, Nuclear tests, Kargil war,  The IT bubble, Ketan Parikh Scam, the 2008 housing bubble, Satyam Scam, European Crisis, Droughts/ Worst Monsoon,  All time high crude oil Prices, Inflation in double digit, 26/11 attack etc.. etc...

All these events by themselves are good enough to scare the hell out of anybody. But wouldn't we made money by forgetting about them and believing in the power of trade and commerce instead? As we have seen in the past the business goes on even if there is a bomb blast in neighbouring country, the ticket counters at the multiplexes are crowded as ever. Businesses at fast food restaurants remains as brisk as ever.

So let’s concentrate more on picking the right stocks and schemes and focus to remain invested for long term as per our own financial goals rather than worrying for anything and everything in this world.

Mutual Funds: New is not always beautiful

We all have obsession of new things/ new items and believe that when it is new it should be better as compared to the old ones. Same logiv applies to the mutual funds, people feel that new funds with new ideas and lower net asset value (NAV) are cheaper and will be better as compared to the old ones.  Sometimes sales people say like ‘The NAV is just `10’ so let’s grab it now. As a result, investors flock to new fund offerings (NFOs) to exploit this so called cost advantage. However the truth is that NAV is totally irrelevant and should not even be considered when making an investment.

Let us understand more by an example.

Let’s say there are two funds have identical portfolios. One has been around for a while and the other is a newly launched fund. As the values of their (identical) holdings increase, the NAV will rise by the same percentage. So, investors in both will benefit equally.

Let us understand it more through an example. Mr Ram is obsessed with new funds and invests in a new scheme called as ABC while Mr Shayam invests in existing mutual fund scheme named as XYZ.  let’s say the NAV of fund ABC is Rs.10 and NAV of Fund XYZ is Rs. 50.  Mr. Ram has invested Rs. 10,000/- in ABC fund while Mr Shyam has invested same amount in XYZ fund.

No. of units to be allotted = Investment Amount/ NAV per unit

So:   No. of units to be allotted to Mr Ram = 10,000 / 10 = 1000 units 

        No. of units to be allotted to Mr Shyam = 10,000 / 50 = 200 units

Now say after six months the market goes up by 10% and since both the schemes have similar portfolio so the value of each scheme also goes up by 10% accordingly the NAV of these funds will rise to Rs. 11 and Rs. 55, respectively.  Lets calculate the portfolio value of Mr Ram and Shyam

Portfolio Value = Current NAV  X  No. of Units

Hence: 

Portfolio Value of Mr.  Ram (after six months)  = 11 X 1000    = 11,000/-  

Portfolio Value of Mr.  Shyam (after six months) = 55 X 200   = 11,000/-

So, it might appear that one has just risen by a rupee while the other by Rs. 5, but, in reality, they have both shown a 10 per cent rise. Of course, the number of units held would differ. A low NAV would imply a higher number of units and a high NAV would indicate a lower number of units.  However The ‘cost’ of a scheme in terms of its NAV has nothing to do with returns. What you want to buy in a scheme is its performance, not its NAV. The only instance where a higher NAV may adversely affect you is where a dividend has to be received. This happens because a scheme with a higher NAV will result in a fewer number of units and as dividends are paid out on face value, a higher NAV will result in lower absolute dividends due to the smaller number of units. But even here, total returns will remain the same. So, from whichever angle we see it, NAV makes no difference to returns. Mutual-fund schemes have to be judged on their performance. And the simplest way to do so is to compare returns over similar periods. The confusion over NAV arises simply because investors view a fund’s NAV like a stock’s price which is absolutely not a truth. The current price of a stock could be much lower or higher than its actual value. But the NAV just reflects the current value of the portfolio as it is.

There are certain advantages of old/existing schemes like:

• ·        There is performance history of the old scheme; although past performance may not repeat in future still it gives an idea about the mutual fund and its fund managers track record.
• ·        We get to know what all securities/stocks are in that scheme whereas in case of new scheme the fund will start buying the securities after closing of the NFO and we have no idea what securities and how much quantity the fund manager would be buying.
• ·        Existing schemes can be compared with the other similar schemes available in the market and accordingly get the idea about their performance vis-à-vis others while for new schemes it’s all new without any benchmarks to know how will they perform as compared to thers.

  

Next time when we are evaluating a fund we should take a good look at the portfolio and returns over various time periods and also vis-à-vis other schemes.

Always Remember, the returns/performance is determined by the stocks that the fund manager has invested in. The value of the NAV is immaterial.

Debt Mutual Funds: A Smart solution for risk averse investors who needs regular cash flows

As the interest rates are falling and FD rates are moving southwards, It is becoming increasingly challenging to find out other option which can be safer and also provide better returns from Bank FDs. Investors especially retired persons who wants safety of their investments and also regular income finds market volatility too hot to handle hybrid funds with Systematic Withdrawal Plans (SWPs) set up for regular cash flow could be better option which can still help investors fight inflation. Further a smart option could be setting up SWPs on accrual funds, especially with funds that have waived exit loads for SWPs.

Generally risk averse investors continue to choose bank deposits as their preferred investment option. Conservative people normally go for FDs after retirement, as the comfort of a regular, predictable cash flow is very necessary at that stage of their life. However in current environment where the interest rates are low and going further downwards while inflation is sticky, , in the quest for safety of capital, people land up unknowingly losing the fight against inflation, consequently see the purchasing power of their fixed income eroding over time.

The challenge in SWPs from hybrid funds

We all understand that an element of equity in the retirement corpus can help retired people in the long term to win the battle against inflation quite comfortably. However we should not forget that the long term is also actually a series of short terms.  Generally we wish that the equity component of our investment would first appreciate so that we get a buffer and also insulate us from significant market volatility so as to have a corpus which can fight the inflation. However the equity market does not behave in such a simple and systematic way and if the market moves up people may take out that money and again put in FDs so as to get the required regular monthly Cashflow.  The returns and appreciation from Balance and other Hybrid funds may not be stable and hence quite challenging to continue SWPs (Systematic withdrawal plans) from these funds, especially when the corpus has gone into negative territory. For any investor the first priority is always to resolve the anxiety of today rather than worry about what may happen 10 years down the line in terms of reduced purchasing power.

In this type of situation what could the best solution in these circumstances?  In this type of situation Debt Mutual Funds could be an ideal option which are not complicated but have the potential to give better returns than FDs and also have some, though not fully but have scope to face the war against inflation. In Debt mutual funds an investor may not create wealth, but at least may not erode his capital due to a combination of inflation and taxes.

What are Debt Mutual Funds:

1.   Debt mutual funds invest in Government Securities, Bonds and Corporate Debentures etc which promise regular fixed income on monthly quarterly annually or on maturity.
2. Unlike Fixed Deposits interest, Dividend form Debt mutual funds are completely tax free. FD interest payments on the other hand attract tax Deducted on Source (TDS).
3. Any Profit an investor make from Debt Funds after three years are adjusted for inflation and get the tax benefits of Long Term Capital Gain Tax.
4. Debt funds are often classified as low or medium risk investments. This means the possibility of losses is low means safety to the capital.
5. However all said done, debt funds do not promise a regular income. When interest rate rises prices of fixed income securities i.e. bonds falls. This could even lead to losses, leading to fall in overall returns.

The ideal option for an investor who wants regular cash flows could be an SWP from a low maturity debt fund. The primary objective of this plan is:

1. Little volatility in returns and marked to market valuations
2. Low taxation, Since tax is only applicable on the gain on the units redeemed every month not on the entire withdrawal amount
3. Growth of principal over time
4. Low reinvestment risk as fund managers manage the average maturity of the fund and don’t take high duration risk
5. No exit load on SWP amount, hence no charges for monthly SWP
6. Complete or partial liquidity as funds withdrawal is possible within one day notice.
7. Flexibility to increase or decrease the SWP amount based on a person’s requirement and funds performance
8. The other investment options with similar objectives are: Corporate Bonds, Corporate Fixed Deposits, Tax Free Bonds and LIC annuity plans. 

There is a comparison below with various fixed income products:

Apart from Retired persons there could be other people/organisations who may also have similar requirements and find the debt mutual funds a better option those could be:

1. Charitable Trusts and hospitals, who have large trust corpus and need regular cash flow for meeting their obligations
2. Gymkhanas and Clubs who have a large membership corpus and require monthly income for meeting regular expenses for events, maintenance and salaries
3. Cooperative Housing Societies who have a deposit corpus and need monthly income for meeting maintenance expenses
4. Real Estate investors who look for rental income. Here no hassle of finding tenants, following up for payments and paying various taxes on the rent
5. Corporates who have cash holdings and require a regular income for various statutory expenses
6. Individuals and families who have received an inheritance or sold a property and are looking for a steady income
7. Life insurance claimants, who have lost the breadwinner. The insurance claim can be used to earn a steady monthly income

Correct Asset Allocation is the key to achieve financial goals

Planned and systematic investment through proper financial planning is the best way to start investing into the financial assets and get the best out of it but unfortunately most of us have been adhoc investors all our lives. Although Indians are one of the highest savers in the world historically still financial planning doesn’t come to us naturally. Therefore, we tend to invest in whatever asset that come our way and that has been the story of most of us if not all!

We all know and heard since childhood that ‘Don’t put all your eggs in one basket’ but how many of us follow the same when it comes to our own investments? If we go by the words, it is actually a very wise saying which demonstrates its relevance in our financial planning process. We all dream of being crorepatis and very rich and want our investments to yield us some magical returns which would help us fulfilling this dream of ours. But how many of us achieve this dream? Does your financial portfolio yield a good return in accordance with your requirements? If not, where are we going wrong?

Asset allocation is the magical mantra if you want to generate optimum yields from your investments. Allocating your surplus cash to the various investments instruments based on your requirements is what determines asset allocation. It is a simple word holding a simple meaning and not rocket science. Let us understand this in details.

1. What is asset allocation?

It is a strategic approach to handle our finances where we invest our money across various financial instruments based on our life goals and risk taking ability.

2. What does asset allocation depend on?

Allocating our total funds across various investment classes depend on three major factors:

·        Our risk-appetite?

·        For how long would we stay invested?

·        What are our life goals?

3. What are the benefits of right asset allocation?

If we can allocate our funds in various investment classes properly we would be able to:

·        get most optimum yields

·        Match our financial goals to the investments

4. Does your portfolio show asset allocation?

So whether we actually have a diverse portfolio or are we just think of it without have any clear idea what should be actually diversified portfolio be in our case? Let us understand this through an example -

Mr. Mehra aged 35, always proud of his investment acumen skills and says that he has a good appetite for risk and his Equity Mutual Fund holding has given him exceptional returns. However, when we actually checked the entire portfolio we found he has only 10% in equity! So even if he gets amazing returns from Equity Mutual Funds, how much difference does it really create on his overall portfolio?

On the other hand, Mr. Shah aged 50 had about 90% of his investments in various Equity Mutual Funds. So when the market corrected the valuations eroded so steeply that it was almost difficult to fathom!

So a skewed asset allocation is the first step towards financial disaster! Even 80-90% exposure in real estate *which most of us have not by choice but due to high real estate prices) can be a high risk to the portfolio in liquidity terms. Thus, the intelligent way to take your first informed step towards healthy financial future is by assessing our risk appetite and gauging the current asset allocation and then trying systematically to achieve the ideal asset allocation through informed investment decisions.

5. Steps of Financial Planning

Financial Planning has 6 basic steps:

1.  Identification and prioritization of Investment objectives as realistically as possible along with timeline.

2. Gather all relevant information about present investments, risk appetite, investment objective, etc.

3.   Analyze the information according to your risk profiling and ideal asset allocation

4.  Go through the recommendations properly based on the ideal asset allocation versus present asset allocation and maybe some tactical allocation based on current market scenario

5.   Consolidate the current investment portfolio consolidation towards ideal asset allocation as best as possible

6.     Review the portfolio regularly by tracking ongoing progress

As mentioned above, asset allocation comes into the primary stages of financial planning right after analyzing your risk appetite.

6. Understanding the ideal Asset Allocation:

Before finding out what is ideal Asset Allocation for someone, we need to find out Risk Profile. It is usually a simple set of questionnaire which determines a person’s risk taking appetite as far as the investments are concerned.

The risk profiling is scored and the total of the score is classified into different bands which determine the intrinsic risk appetite. Each question has a number and the total numbers adds upto for getting total score.

Let us take an example of a standard risk profiling questionnaire:

A. Age of the person:

1.     Above 50 years

2.     Between 40 to 50 years

3.     Between 30 to 40 years

4.     Less than 30 years

B. How long will you stay invested, i.e. investment tenure?

1.     Less than 2 years

2.     Between 2-5 years

3.     Between 5-10 years

4.     More than 10 years

C. No of Dependents:

1.     More than 3

2.     Between 2 to 3

3.     Only 1 other than myself

4.     Only myself

D. Past Investment knowledge

1.           No Exposure/ idea about financial products

2.          Basic knowledge of Investments

3.           I have an amateur interest of investing.

4.           I am an experienced investor

E. What is the primary objective for investment?

1.     Preserve the Investment

2.     Generate Income

3.     Grow the value moderately

4.     Grow Money Substantially

F. Which Portfolio would you prefer?

1.     I cannot consider any loss

2.     Maximum 12% and Minimum -2% return

3.     Maximum 18% and Minimum -8% return

4.     Maximum 24% and Minimum -10% return

G: Volatile investments usually provide higher returns and tax efficiency. What is your desired balance?

1.  Preferably guaranteed returns, before tax efficiency
2. Stable, reliable returns, minimal tax efficiency
3. Moderate variability in returns, reasonable tax efficiency
4. Unstable, but potentially higher returns, maximizing tax efficiency

7. How to calculate the score:

Score is same as the no. of the option. i.e. if for qns A we have selected option- 3 that the age is Between 30 to 40 years, then we got 3 points. Similarly we can calculate the points for each question.

8. And the scoring is like:

·        If score is below 15 points means the person is a Conservative Investor and his Ideal Asset Allocation should be 50% in Debt Market, 20% in Equity oriented investments and the remaining 20% in Alternate Investments like Real Estate, Gold, and 10% in cash and liquid funds etc.

·        Your score between 15 to 20 means you are a Balanced Investor and your Ideal Asset Allocation should be 35% in Debt Market, 30% in Equity oriented investments and the remaining 25% in Alternate Investments like Real Estate, Gold, and 10% in cash and liquid funds etc.

·        And if your score is above 18, it means you are an Aggressive Investor and your Ideal Asset Allocation should be 20% in Debt Market, 50% in Equity oriented investments and the remaining 20% in Alternate Investments like Real Estate, Gold, 10% in cash and liquid funds etc.

9. How should you go about asset allocation?

As a smart investor we have to determine our risk appetite, financial goals and time horizon. Say for example we have an aggressive risk profile, then we may invest about 60% to 70% of your entire portfolio into equity oriented investments like Mutual Funds provided we have time by our side and spread the rest in debt instruments and cash holdings for liquidity and contingency purposes.

A moderate risk taker with a balanced risk appetite should invest about 20% - 30% of his money in equity oriented investments like Mutual Funds. 10-15% in balanced funds and the rest in debt and real estate with about 5-10% in cash. On the other side, a conservative investor can have a minimal 15% - 20% in equity or balanced mutual funds, 50% - 60% in debt and liquid funds with around 20-30% in alternate investments. Choosing the right portfolio is the first and the most important step towards an informed financial planning which would best suit a person’s requirements along with his financial goals and risk appetite.

10. Difference between Ideal Asset Allocation and present Asset Allocation

When we look at our Ideal Asset Allocation, most of us consider the Asset Allocation ONLY in the present visible investment structure and rarely consider the entire networth. That is where the role of a Financial Advisor is very crucial. Ideal Asset Allocation considers the entire Debt, Equity, real estate and alternate investment Portfolio which may include:

Debt:

·        PPF, EPF, NPS, Gratuity Fund etc

·        Fixed Deposits, Recurring Deposits, etc.

·        Current Paid Up Value of Life Insurance Policies

·        Bonds, National Savings Certificates, KVP, etc.

·        Debt Mutual Funds, Liquid funds etc.

Equity:

·        Unit Linked Insurance Plans

·        Own Company ESOPs

·        Equities or Equity Oriented Mutual Funds

·        Listed and Unlisted Stocks within India and outside

Alternate:

·        Real estate Property, excluding current residence, within India and outside

·        Cash in Savings/ Current Account

·        Investment in liquid Funds for emergency purposes

·        Gold, Gold coins, Ornaments, etc.

·        Watches, Art, other Collectables, etc.

For calculating Networth and the Present Asset Allocation; all the above mentioned aspects are considered. The difference between the current asset allocation and ideal asset allocation is what needs to be bridged for the long term healthy maintenance of the portfolio in order to achieve your financial goals.

11. Finally:

A disproportionate portfolio leaning heavily into equity oriented investments result in high volatility while a higher weightage towards debt oriented investments restricts yield potential. Leaning into alternate investments of real estate or gold limits liquidity and blocks the money for a longer tenure. Having a balanced portfolio based on an individual’s needs is the best course of action as it would ensure ideal returns and aid in wealth maximization while not being very volatile. Since childhood we heard the saying of putting all the eggs in one basket and now it is time we must exercise it in our financial planning process. Planning a portfolio through right asset allocation is a key to financial success. It is always advisable to avail the services of a financial planner throughout the journey of wealth creation.