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Friday, August 29, 2008

Choosing a Mutual Fund Scheme

The three options available in mutual fund schemes to help you choose one.

Most mutual funds offer an option to investors to either receive the dividends or to have it reinvested in the fund. This is an interesting choice that investors have to make while making investments in mutual funds. The investor has to decide whether he wants to receive the amount of income earned in the form of dividends or to accumulate the gains through the growth option. The option of dividend reinvestment can be used favorably by investors depending on their specific needs.

There are three options available for an investor:

• Dividend option

• Growth option

• Dividend reinvestment option

Dividend option

Under the dividend option with a payout facility, the investor receives regular income in the form of dividends as and when the fund declares dividends. In case the investor opts to take dividends, he gets a current income. Also, he gets tax benefits on such a payout. As per the current income tax rules, income received in the form of dividends is tax-free in the hands of the investor. However, it should be noted that the dividends may not be regular and are dependent on the performance of the fund.

Growth plan

In case an investor opts for the growth plan, the gains accumulate in the net asset value (NAV) of the fund. Here, whenever one sells the units, there will be a capital gain or loss. This will be short-term if the units are sold before 12 months and long-term if sold after 12 months holding period. In the case of long-term gains, there is a concessional tax treatment of a flat 10 percent, or 20 percent with indexation benefits.

Dividend reinvestment option

In case of a dividend reinvestment option, investors can keep their amount invested to be the same but still save a bit on the tax front. They can take advantage of the tax benefits that come on dividends while maintaining their total overall investment. Under the dividend reinvestment option, when a dividend is declared, the investor is entitled to the payout. However, this will not be received in cash but would be reinvested back into the scheme at the then prevailing NAV. Due to this, the number of units of holding will go on increasing with each dividend payout, although no amount will be received.

At any time up to maturity, the investor can have these units encashed. The benefit is that there is a dividend being received which is then being invested back into the fund automatically, so the investor does not have to bother about looking for investment avenues.

Choosing an option

The choice of an option would depend on a number of factors which may include the risk appetite of the investor, the need for current funds, tax bracket in which the investor is etc. In case an investor has invested with the basic maim of getting regular income, the dividend reinvestment option is ruled out.

For people in high tax brackets, income by way of dividends may offer some benefits of saving on tax.

Investors who want to invest for a longer period and in no need of current funds, may go in for the dividend reinvestment option. They can plan for the longterm needs by choosing this option. In any case, one should keep in mind the fact that as the time period increases, the risk element also increases.

MFs to beat volatility

Go for mutual funds if the volatility in the markets is too much for you.

The past few months have been an amazing rollercoaster ride. Tears and heartbreaks spared none. Both big and small investors felt the pinch. The fall was across sectors. For sometime, some companies would see unexplainable investor interest, spiking the Sensex. But within hours, selling followed, pulling the Sensex down to newer troughs. The promising markets that were on a constant uphill climb, suddenly betrayed the investors. The fall was predicted by none. It came as a shock. Volatility continues to rule the markets.

The stock markets are considered volatile avenues. Hence, investors are warned of its risks before they take a plunge. What is volatility? It is a statistical measure of the behavior of the market to rise or fall sharply within a time span. Volatility is either measured by using the standard deviation or variance between returns from that same security or market index. The greater the volatility, the greater the fluctuations. This amounts to greater risk. In such a scenario what is the option left out for a small retail investor?

Everything was going good for Rajesh till a few months ago. Around 40 percent of Rajesh's salary is spent on home loan repayments. Another 40 percent goes towards monthly expenses and contingencies. Rajesh judiciously invested the remaining 20 percent in the stock markets. He was excited when he realised that he had almost doubled his investments. But the recent crash and ensuing volatility, has made him extra cautious. He does not want to enter the markets, at least for now. The 20 percent of his salary that he used to invest every month is now idling in his bank account. He is seriously contemplating increasing the repayments towards his home loan instead of buying stocks.

People like Rajesh should not abandon their savings or investment habits altogether. Though you may be debt-ridden, it is wise to keep a small portion away as a part of your savings.

What are the options open for investors like Rajesh who have shunned the markets totally after the recent fall?

Some investors find this an opportune time to fish for good stocks that they were unable to purchase when the Sensex was soaring. If the company fundamentals are good, and if the stocks have fallen to attractive low prices, adding them to your basket may be a good idea. The dark clouds of volatility haven't passed by yet. So the novice needs to tread with extreme caution. Those who aren't market experts are better off not investing directly in the stock markets. Using the mutual fund route is the ideal option for small investors.

When an investor puts his money in mutual funds, the decision to buy/sell and juggling the portfolio in line with latest developments, is the job of fund managers. Fund managers are pure professionals who know how to act when markets aren't behaving favorably. Investors, who panic at every market slide, must keep away from the markets in volatile times. Systematic investment plans offered by most fund houses, are a good means to beat the market volatility. Here, the investor invests a small fixed amount every month, for say three years. There may be market ups and downs. But the impact of volatility will be less and returns attractive over the long term.

So, for those investors who are wondering what next - mutual funds are the way to go.

Choosing a mutual fund Based on Performance

The selection of an existing mutual fund depends on its performance - past as well as expected. How should an investor judge the performance of a mutual fund? What criteria should be used to evaluate and rank a mutual fund? There are a number of mutual funds in the market. New schemes are hitting the market almost daily, with new names and targets. So, it becomes difficult for the small investor to judge the performance of the fund accurately, and to know how his investment his moving.

The performance of a mutual fund scheme is reflected in its net asset value (NAV) which is disclosed on a daily basis in case of open-ended schemes and on weekly basis in case of close-ended schemes.

The NAVs of mutual funds are required to be published. The NAVs are also available on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of the Association of Mutual Funds in India (AMFI). The investors can access NAVs of all mutual funds at one place. The NAV is the most common denominator which summarizes the entire performance of the fund.

The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns/yields over a period of time - last six months, one year, three years, five years and since inception of schemes. Investors can also look into other details like percentage of expenses of total assets as these have an effect on the yield, and other useful information in the same half-yearly format.

In addition, the mutual funds are also required to send an annual report, or abridged annual report, to the unit holders at the end of the year. These contain the details of investments made by the fund in addition to the other financial information.

Various studies on mutual fund schemes, including yields of different schemes, are published. Many research agencies publish research reports on performance of mutual funds, including a ranking of various schemes in terms of their performance. Investors should study these reports and keep themselves appraised about the performance of various schemes of different mutual funds.

The investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity-oriented schemes with the benchmarks like BSE Index, sector index, S&P CNX Nifty etc.

The mutual funds are required to disclose full portfolios of all of their schemes on a half-yearly basis which are published. Some of the mutual funds send newsletters to the unit holders on a quarterly basis which also contain portfolios of the schemes.

Some mutual funds send the portfolios to their unit holders. The scheme portfolio shows investments made in each security i.e. equity shares, preference shares, debentures, money market instruments, government securities etc, and their quantity, market value and percentage of NAV. These portfolio statements are also required to disclose illiquid securities in the portfolio, investments made in rated and unrated debt securities, non-performing assets (NPAs), etc.

On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme. Apart from the past, one should also look at the future expectations from the funds. Past may not be a true indicator of the future.

Wednesday, August 27, 2008

Control your emotions, Learn from Mistakes

IT WAS greed that got the BSE Sensex to 21,000 points. Investors were willing to pay any price for a stock expecting that stocks would go up forever. They turned a deaf ear to any sane advice. Now, this greed is replaced by fear. There is so much of fear that the investors have become loss averse. They want to get out of stocks. Why a sudden change in sentiment?

First, it is due to margin trading. Investors had become so greedy that they bought beyond their capacity through the futures and options. The brokers encouraged this and now when the client cannot pay the margin calls and they are liquidating the positions at a substantial loss.

Second, investors borrowed from banks against shares. Now, since the value of shares is going down, banks are selling stocks in the market to reduce their losses.

Third, investors are stuck with declining or non-saleable stocks. To nurse their losses, they need to liquidate. Most of the stocks being unsaleable due to price circuits, investors are forced to sell good stocks.

Fourth, loss-averse investors are going for their mutual fund redemptions, forcing mutual funds to sell good stocks as the other stocks in the portfolio are not saleable due to circuits.

What does one do in such times? Is it the right time to buy? Yes. Buy value stocks with caution. Some stocks are available at good valuations. A stock, which was Rs 500 and now available at Rs 200, is not to be confused as value. Valuation of a stock is all about understanding its business, whether it is run by credible management, whether it has sustainable business model, a sustainable flow of earnings and the price one has to pay for those earnings.

Investors’ next choice would be to go for mutual funds. Here is a word of caution. The NAV is calculated on the closing prices of stocks. We have so many stocks which are in selling circuits and not saleable. An investor could end up paying for stocks, which would again go down the next day or are unsaleable. Choosing a mutual fund in these times is very important. Looking at a fund’s portfolio will tell you a lot. Investors need to be cautious and optimistic about the future. B u l l and bear markets follow each other. Control over your emotions and learning from your mistakes is important.

Monday, August 25, 2008

Invest in ETF to diversify long-term portfolio

They can be bought and sold throughout a trading day like any stock

An exchange-traded fund (ETF) is a basket of securities that are traded on an exchange. They first came into existence in the US in the early 90s. Initially, these were looked upon with suspicion. However, of late, these funds have been attracting the interest of investors globally.

ETFs are different from mutual funds. ETF units are not sold to the public for cash. Instead, the asset management company that sponsors the ETF takes the shares of companies comprising the index from various categories of investors like authorized participants, large investors and institutions. In turn, it issues them a large block of ETF units. In case any dividend is accumulated for the stocks at any point in time, a cash component to that extent is also taken from such investors. A large block of ETF units called a 'creation unit' is exchanged for a 'portfolio deposit' of stocks and the 'cash component'.

Unlike regular open-ended mutual funds, ETFs can be bought and sold throughout the trading day like any stock. These funds rely on an arbitrage mechanism to keep the prices at which they trade roughly in line with the net asset values (NAV) of their underlying portfolios. In order to let the mechanism work, the potential arbitragers need to have full, timely knowledge of a fund's holdings.

ETF units are continuously created and redeemed based on investor demand. Investors may use ETFs for investments, trading or arbitrage. The price of the ETF tracks the value of the underlying index. This provides an opportunity to investors to compare the value of the underlying index against the price of the ETF units prevailing on the exchange. If the value of the underlying index is higher than the price of the ETF, the investors may redeem the units to the sponsor in exchange for the higher priced securities.

In case the price of the underlying securities is lower than the ETF, the investors may create ETF units by depositing the lower-priced securities. This arbitrage mechanism eliminates the problem associated with close-end mutual funds - premium or discount to the NAV.

The number of outstanding ETF units is not limited, as with traditional mutual funds. It may increase if investors deposit shares to create ETF units, or it may reduce on a day if some ETF holders redeem their ETF units for the underlying shares. These transactions are conducted by sending creation or redemption instructions to the fund. The portfolio deposit closely approximates the proportion of the stocks in the index together with a specified amount of cash component. This 'in-kind' creation/redemption facility ensures that ETFs trade close to their fair value at any given time.

Due to the unique structure of ETFs, all types of investors, whether retail or institutional, long-term or short-term, can use it to their advantage without being at a disadvantage to others. They allow long-term investors to diversify their portfolio at one go at low cost and insulates them from short-term trading activity due to the unique 'in-kind' c re at i o n / re d e m p t i o n process.

They also provide liquidity to investors with a shorter-term horizon as they can trade intra-day and can have quotes near NAV during the course of a trading day. As the initial investment is low, retail investors find it simple and convenient to buy/sell. They facilitate foreign institutional investors, institutional buyers and mutual funds to have easy asset allocations and hedging at a low cost. They also enable arbitrageurs to carry out arbitrage between the cash and futures markets at low impact costs.

Most ETFs charge lower annual expenses than index mutual funds. However, you have to pay a brokerage to buy and sell ETF units. This may turn out to be a significant drawback for those who trade frequently or invest regular sums of money. Many investors prefer to hold the creation units in their portfolios. Others may break-up the creation units and sell on the exchanges, where individual investors may purchase them just like any other shares.

Friday, August 22, 2008

Are the days of 9% plus GDP growth rate over in India?

While FY09 may be a crunch time for India, given the situation of a rising current account deficit and lower capital flows, the pressure could ease a bit from FY10

IT IS difficult to make a call on how FY10 is likely to pan out, but one thing is clear, the days of 9%+ growth are over, believes Citigroup. As per a recent Citigroup Global Market report, India has lost the opportunity to sustain those levels for now, with growth coming in around 7%+ levels in FY09-10.

With supply side measures not really being effective in bringing inflation down, Citi expects RBI to continue to raise rates to temper demand-side pressures. Much further monetary tightening however poses downside risks to both Citi’s FY09 and FY10 GDP estimates of 7.7% and 7.9%, respectively.

Rising interest rates and input costs are also likely to result in a deceleration in investments to 10.4% and 7.9%, respectively. But what could possibly offset this are the low real interest rates and improvements in productivity. While higher rates will impact growth, the Citi report maintains that today corporate India is in a better shape, productivity has improved and savings have risen.

While nominal interest rates have gone up, real interest rates are low. Productivity has increased and ICORs (incremental capital output ratio) in India are relatively lower. Indian corporate is significantly underleveraged as compared to the past. Most sectors other than perhaps retail/ real estate, investments are being carried out to meet existing demand rather than that of the previous cycle — in anticipation of demand and work in progress on big-ticket projects in areas such as oil and gas, minerals and metals and infrastructure are unlikely to get completely derailed as most of the projects have escalation clauses and back-to-back supply arrangements, the report highlighted.

A widening current account deficit and a deceleration of flows will likely result in a net reserve accretion of $6bn in FY09 vs $92bn in FY08. As a result, we expect the rupee to trade in the Rs 42.5-43.5 range. The rupee would have been weaker were it not for RBI intervention and recent measures (special market operations, ECB liberalisation, higher FII investment in debt) taken to hold up the unit.

“As regards bonds, factoring in the fuel price hike, repo rate and CRR hikes as well as the probability of further monetary tightening, bond yields edged almost 100bps higher with the 10-year trading at 9.15% from 8.2% levels last month. Assuming another round of monetary tightening this month, yields could edge towards 9.25% levels,” says the report.

While FY09 is likely to be a crunch time for India, given the situation of a rising current account deficit and lower capital flows, the pressure could ease a bit from FY10, believes Citigroup as the new hydrocarbon discoveries by Reliance, ONGC, GSPCL and Cairn come on stream.

“While the discovery by Cairn is purely oil, those by Reliance and ONGC/ GSPCL are natural gas. Thus, savings would result to the extent that: indigenous crude can substitute imported oil and natural gas can replace naphtha (which can then be exported). We expect India’s current account deficit to decline to 2% in FY10 from 4% in FY09. Though further rate hikes do pose downside risks to the FY09 and FY10 GDP estimates of 7.7% and 7.9%, respectively, some factors might work to our advantage,” Citi said.

Diversify Portfolio for Higher Returns

Take stock of your risk appetite and diversify across sectors in these conditions

Someone recently asked what it takes to be an equity investor. The question was not out of place considering the current market scenario. As the index has been hitting a low at regular intervals, the time has come to define the attributes required to be an equity investor. To simplify, just check out if you have these qualities to consider yourself a good stock market investor in these conditions.

Long-term thinking

Wealth creation is all about systematic approach and that automatically requires patience and discipline. While short-term investment strategies can prove profitable in the short term, it is the long-term planning which helps an investor in capital appreciation. As a result, one needs to look at equity as a long-term investment option and more importantly, an investor needs to stick to his long term approach. Not only will it bring in the much-needed focus but will also insulate the investor from short-term volatility.

For instance, an investor who has signed up for a 10-year SIP is unlikely be get disillusioned with the recent negative performance of the stock market simply because his goal is long-term. Having signed up for a long-term SIP, the investor is aware that he would stand to gain even from the short-term weakness.


If choosing the right stock is a tough call, getting out of it is an even bigger challenge. As you would have noticed in the last couple of months, stocks which have been beaten down heavily are unlikely to regain their old levels in quick time. Investors, holding on to these stocks, are sure to dwell on the missed opportunity.

One of the fundamental guidelines of investing is to sell in rising markets particularly if your stock has galloped in quick time without fundamental backing. While profit-booking at regular intervals in line with goals is a safe strategy, it may not work at all times. Hence, investors need to arrive at a combination of fundamental goal setting and fair valuation to resort to profit booking and the task gets easier when an investor acquires the habit of regular review of portfolio.

Diversified basket

If returns guide the principles of equity investing in early stages for investors, it is the asset allocation which takes precedence at a later date. History has shown that wealth creation is all about diversification through asset allocation, and within equity, you will have to acquire the habit of diversification between sectors and themes.

Take the case of exposure to mid-cap or large-cap. While large-cap stocks assure liquidity and stability, the potential of superlative returns are offered only by mid and small companies, but carry plenty of risk. Hence, an investor has to choose his portfolio with a good mix of both, according to his risk appetite and tenure of investment.

Investment as risk capital

The thumb rule for equity investments is that an investor should be prepared to forego the funds allocated for it. In reality, however, investors constantly end up comparing the portfolio value with their original capital deployed and don't have the stomach for writing off losses. As a result, investors without staying power end up investing in equity and are forced to cut down their exposure due to lack of risk appetite.

As an investor, look at your allocation for equity as a fund to be foregone in the short term and this will help you tide over the volatility. In fact, recent events such as intermittent falls, truly enables the investor to understand the risks associated with stocks. In the long run, this will also help in better understanding of the nuances of stock picking and risks associated with equity investing.

Wednesday, August 20, 2008

Portfolio Management Service - Helps to create Wealth

Investors can use the services of professional portfolio managers if they cannot set aside enough time to manage their investment portfolios themselves

It's quite natural to want to grow one's money. But the process for achieving this simple goal is actually rather intricate, and requires experience and expertise. Preserving and growing capital is as difficult as earning it. In the last four years, we have seen favorable markets. But the recent crash has certainly taught us a significant lesson.

Investing is a full-time activity that entails timely flow of information, and requires thorough understanding and sharp execution skills. When the markets were buoyant, many investors turned into self styled fund managers. But the dangers of this are comparable to self-medication. It would be tragic if they were understood only after incurring a huge cost, like seeing one's portfolio shrunken to half the invested capital.

The way to avoid such a problem is through disciplined investing, selecting the right product, and hiring the right investment manager. For investors who would like to build a quality portfolio, rather than buying stocks on 'tips' and hearsay, the best option is to approach a company that offers portfolio management service (PMS) and let it manage their portfolio.


PMS has caught investors' fancy since 2002, when investor-friendly changes were made to the rules governing capital gains tax, setting stocks on par with mutual fund investments. Currently, there are over 200 portfolio managers registered with the market regulator, Securities and Exchange Board of India (SEBI), offering discretionary and non-discretionary PMS products to clients.

Discretionary PMS allows the company to manage the portfolio on behalf of the client, based on the authority given by the client. Non-Discretionary PMS means that the portfolio manager can only advise the client, and the final call to buy a particular stock comes from the investor - in other words, the ultimate discretion lies with the investor.


Broadly speaking, portfolio managers follow one of two formats. One is the 'pool' format, and the other is the 'direct account'.

In the pool format, every client does not have a separate demat and broking account; rather, they are opened for the portfolio scheme as a whole. They accept funds from investors in the scheme, which are then internally allocated to each individual client account, and each account is managed independently.

This structure should not be confused with mutual fund schemes - in PMS, cash and stocks for each client are managed individually, while in mutual funds, the resources are pooled and performance is linked to the fund's NAV.

The other portfolio management format is the 'direct account'. Here, a separate bank, demat and broking account are opened in the name of each client. The portfolio manager takes up the authority, normally through a power of attorney, specifically to manage the client's portfolio-related accounts.


Portfolio management services offer great flexibility to investors. They offer various products to suit the requirements of a diverse set of clients. A PMS can help you, the investor, build a customized and focused portfolio, with a fund management approach that suits your mandate and risk appetite. It offers greater flexibility in holding cash, allocating investments across sectors, and adjusting for market trends.

If you are an investor with limited resources in terms of the knowledge and skills necessary to manage your investments, why risk your hard-earned money in stock markets that you do not fully understand? PMS allows you to hold stocks directly in your own name, while also offering professional portfolio management.

A portfolio management scheme will start out by first making a careful assessment of your personal situation and investment objectives. Based on factors such as investment horizon, return expectations, and risk tolerance, you can select a service that fits your personal requirements. No matter which service you choose, make sure you understand your portfolio manager's thought process, and the organization’s research and fund management capabilities.

There is a common misconception that portfolio management is exclusively for high net worth individuals. But, in fact, many PMS products are offered by asset management companies and brokerage houses, for portfolios as small as Rs 5 lakhs. There is also a wide range of fee structures, ranging from fixed charges to performance-linked ones. So be sure to explore and understand your options before signing up.

Most portfolio managers offer clients online access, which allows you to view your portfolio details - holdings, performances, transactions, bank details, and so on.

To sum up, the recent market crash and ongoing volatility have underscored the need for professional management of our investments. It is prudent to entrust fund management to an experienced and quality portfolio manager, who can help you build a superior portfolio and hedge against adversity.

Monday, August 18, 2008

Balanced Mutual Fund: Creating the perfect balance for the long-term investor

If you want to maintain a simple portfolio and yet have the benefits of diversification, a systematic investment in balanced funds is a great option

AS AN investor, if you are saving regularly for the long-term and want a low-involvement, hassle-free instrument, then balanced funds is the right choice.

Balanced (mutual) funds have been around for over a decade — and manage assets of over Rs 16,000 crore between them. They, by mandate, invest at least 65% of their portfolio in equities, and up to 35% in debt and related instruments. In practice, the equity component of most balanced funds varies between 65% and 80%, depending on the fund manager’s outlook of the markets. Long-term and discerning investors would no doubt have heard of the UTI Balanced Fund, Magnum Balanced Fund and HDFC Prudence Fund. Of course, today, there are over 15 balanced funds offered by different fund houses. They have systematic investment plans (SIP), growth/dividend options, and all the other investor-friendly features provided by ‘pure’ equity and debt funds.

But how effective are balanced funds from a tax, load and performance point of view, compared to, say, investing partly in equities and partly in debt? For those who do not wish to enter into nitty-gritty’s, here’s the simple answer: if you want to maintain a simple portfolio, and yet have the benefits of diversification, a systematic investment in balanced funds is a great option. If you are the more discerning and involved kind, you might want to synthetically ‘manufacture’ a balanced fund type of portfolio instead; by investing in two or more funds, each of ‘pure’ equity and debt nature. If you want some mathematics around, how we came to this, then read on!

For a fair comparison, we consider a Rs 100 investment for three years in a balanced fund on the one hand; and compare it with a combination of two investments for the same duration — of Rs 65 in an equity fund and Rs 35 in a debt fund. Of course, if your desired asset allocation is far different from this (say you are risk averse and want to stay away from equity markets), you should not consider balanced funds. We assume an annualized equity market return of 15% and a debt market return of 7%. Thus, the balanced fund return, ceteris paribus, is expected to be 12.2%, before load and tax.

Nature of portfolio

Balanced funds would invariably invest the equity component of the portfolio in a well-diversified basket of securities, in different sectors. This is ideal for an investor who wants to participate in the long-term growth of the economy, without any active sector or stock preference. Indeed, balanced funds are best suited for such investors. For someone wanting to take sector calls or ride a mid-cap rally, a ‘pure’ (sector or mid-cap) equity fund exposure is called for.

A balanced fund would invest in debt securities of intermediate duration (1-4 years). Thus, they are sensitive to interest rate movements, but not overly so. Hence, as with equity, they are again suitable for investors without a clear researched view on rate cycles.

Transaction costs

In any mutual fund investment, there are two kinds of transaction costs — viz entry/exit loads (for purchase or redemption of fund units) and the expense ratio (annual cost of fund management).

Let us examine each of these in the illustration given above. Most balanced funds, unfortunately, charge the same entry load as equity funds (2.25%). Thus, in our numerical example, of the Rs 100 invested in the balanced fund, only Rs 97.8 would go towards allotment of units. In our synthetic example, the entire Rs 35 would go into debt units (there being no entry load), and Rs 63.57 towards equity units. Thus, in the synthetic case, we have escaped paying entry load on the debt part of the investment. This difference gets magnified with time, due to compounding.

The other major cost — the expense ratio — is (at least currently) similar in the balanced and synthetic fund scenario. In fact, the difference between funds of similar category exceeds the difference between the equity and balanced categories. So, we ignore this term in the comparison.

Tax implications

There are two tax structures in mutual funds, depending on whether a fund is classified as debt or equity. The following table summarizes the currently prevailing tax structure:

Thus, equity funds enjoy beneficial tax treatment. Here, balanced funds enjoy the beneficial treatment of being taxed like equity funds and, in this, they clearly score over the synthetic portfolio we had manufactured, where the debt portion would be taxed at a higher rate.

Balanced funds have higher transaction costs, but are beneficial from a tax perspective. Let us now examine the net impact of all these factors on returns earned by a typical investor.

The accompanying table shows the net impact in both the balanced fund investment and the synthetic portfolio; for the period of three years, given the equity and debt returns as assumed above. As can be seen there, the synthetic portfolio outperforms, but by a very small margin. For all practical purposes, a good balanced fund can easily perform as well as a synthetically made portfolio with similar debt to equity ratio. And we do have such excellent balanced funds in today’s mutual fund market!

As an investor, if you are saving regularly for the long term and want a low involvement hassle free instrument, balanced funds are for you. If you otherwise have a lot of debt investment (Bank FD, PPF, NSC, liquid funds, etc) then you might be better off going for 100% equity oriented funds instead. In either case, you can be comfortable in the knowledge that the benefits of one option over another are not overwhelming; and in most cases not even significant.

Sunday, August 17, 2008

Become a Shooting STAR on the Net

Desperate for your 15 minutes of fame? Here are some art of making home videos and getting the best possible publicity for them online. Where others have succeeded, why shouldn’t you?

LonelyGirl15 is undeniably a legend as far as home videos go. The breakout web hit, shot at home by amateurs, drew a massive cult following internationally and eventually brought lead actress Jessica Rose and the rest of the crew to fame in Hollywood. It is now inspiring young wannabe actors and directors. Internationally, there have been plenty of such homegrown video series that tried to emulate the success of LonelyGirl15, but slowly the bug seems to have bitten creative young minds in India too.

If Rose can make it big in Hollywood with just a webcam and a one-room studio, what’s stopping creative minds from shooting to fame on the internet? With umpteen video hosting sites and dirt cheap video cameras, truly, the world is your stage.

So, if you think you can direct like Karan Johar, here’s a two step process that can turn you into a celebrity overnight.

Step 1: Shoot well

Lets face it. No matter how cute you think your baby videos are, there is no way these will land you a plum project in Bollywood, let alone Hollywood. Creativity and content is the key if you plan to attract any kind of viewership. Here is a rundown of ‘must haves’ for your masterpiece.
a) Pick your weapon

First off, get this straight: You don’t need a high-end camera to shoot a video for the internet. LonelyGirl15, for instance, used normal web cameras that come for about Rs 1,000. A slightly better picture quality won’t hurt, however, so it’s a good idea to invest in a miniDV camera that captures 720 x 480-pixel footage.

b) Storyline is a must

Endless inane shots of you lounging by the seaside might be good for your holiday videos but if you are planning to create a web-series, and then make sure you have a tidy story idea in place.

It’s not necessary you create your own stories or rope in high profile script writers to do the job. You can very well pick stories from books, magazines or real life—just make sure you give proper credit to the source (sometimes authors prefer that you take prior permission, check for cases like this).

c) Get clear shots

The quickest way to lose your viewers is through jarring, blurred shots, so if you want people to follow your show, keep it steady. Creative angles now and then are OK but shake too much and you’ll shake off your audience too. A tripod is definitely in order. If you don’t have one, find a flat surface to rest your camera on.

In cases where it’s imperative you lift the camera in your hand, lean against a wall or tree to stabilize yourself.

It’s also a good idea to get as many shots as you can from as many directions as possible. This is called coverage, and it makes your film more visually appealing.

d) Audio has to be crystal clear

Audio is another important ingredient, and no, the built-in mike on your video cam won’t do! Get yourself a tie clip type of mike and tag it on your actors while you shoot, or pick one of those external variety and hang it near the crew.

For scenes that don’t have any dialogues, dubbing music is a good idea.

e) Light your subjects

Imagination just doesn’t cut with viewers, so if they can’t see your cast it’s a quick goodbye. Indoor shoots have big problems with backlighting and shadows, so shoot outside as much as possible.

While shooting inside, use white thermacoal sheets to bounce off light to fill in shadows on faces, if need be. Put up extra pair of table lamps and place them depending on the camera angle for extra effect.

f) Chop them to size

Lastly, editing your video to a crisp size is a definite make or break.

Use free programs like iMovie or Windows Movie Maker to splice the best takes into a final video. And yes, remember you are living in the world of instant gratification, so keep your show under 10 minutes—that’s the max your viewers can stand.

Step 2: Share it right

OK, so you got your film in the box, now comes the next big part of actually airing the show and luring viewers. Here are a few checks to make your show is air-worthy.

a) Check for size

Size is very important if you are looking at uploading the video. Save your video in a web-friendly size and format—MPEG-4 is a good option, while size should be just under 40 to 50 MB.

b) Pick a host

There are options galore. While you pick a host, keep in mind the size limits and the kind of viewership the host site flaunts.

c) Spread the word

Finally, it’s most important to spread the word about what a great video you have made. To do this, put links of your video in your blogs, email your friends and ask them to pass it on.

Submit your film to as many directory websites as possible. Some good places to start off with are iFilm (, Google Video ( and Revver (www.revver .com).

Another good idea is to add your RSS feed to video pod cast directories at the IdiotVox, Yahoo! Podcasts, PodNova and such. Most of these sites also let you review and rate the show.

It’s a good idea to tell your friends and relatives to vote. And lastly, monitor your viewer comments regularly. Be responsive to suggestions and incorporate changes if and when you can. Remember, a good word on the internet spreads fast.

Friday, August 15, 2008

Gold is Gold - DSPML World Gold Fund

DSPML World Gold Fund invests in stocks of companies engaged in gold mining & production. The fund's assets have more than doubled in a span of 6 months, all thanks to the returns it earns...

DSPML Gold Fund's returns have given investors reasons to cheer

The previous year gave investors of the DSPML World Gold fund many reasons to smile. The fund, which listed in September, last year, has delivered 42 per cent returns since its launch. This year (till February 1, 2008), the fund, which is part of the Equity Specialty category has delivered around 8 per cent returns compared to the category's 11 per cent loss during the same period. The Sensex and Nifty were down 10 per cent and 13.4 per cent respectively during this period. In the December 2007 quarter, the fund's returns at 16 per cent were much ahead of the benchmark FTSE loss of 0.15 per cent. However this is less than the Sensex's gain of 17 per cent in that quarter.

The DSP World Gold fund does not buy gold directly but invests in stocks of companies engaged in gold mining and production world over. It does so by buying units of Merrill Lynch International Investment Funds-World Gold Fund (MLIIF-WGF). In fact MLIIF -WGF forms over 97 per cent of the fund's portfolio. The fund's good returns can be attributed more to the fact that the gold prices have peaked to a 30-year high, resulting in a bonanza for the companies in this field. A weakening US dollar and an unprecedented rise in oil prices have also made gold an attractive investment avenue. However, investors looking to invest in gold must not confuse this fund with gold exchange traded funds (ETFs), which invest directly in gold. Another difference between DSPML Gold Fund and other ETFs is that the former is managed actively.

According to the DSPML website, DSPML World Gold Fund has invested over 80 per cent in gold followed by platinum (9 per cent) and silver (5.10 per cent). As per the December 2007 portfolio, Australia based Newcrest Mining is the top holding of the fund accounting for 8.4 per cent of the fund's assets, followed by Barrick Gold (7.50 per cent), Kinross Gold (5.50 per cent) and Lihir Gold (5.20 per cent).

So far, many investors have flocked to this fund. The fund's assets under management, which stood at Rs 692 crore in September 2007, have more than doubled to over Rs 1487 crore in December 2007.

Wednesday, August 13, 2008

Fancy frills in Life Insurance covers - Don't fall

How many of you would use a mobile phone predominantly as a calculator? I guess, not many. In fact, you would be wondering if there would be anyone in this world who would answer in the affirmative to this question. Now, if I were to offer a phone without SMS or address book facility, but with a scientific calculator functionality attached, would you still buy it? Not really. Surprisingly, in the world of financial products and services, it is not the case.

Assume the margin for the distributor in selling calculator-enabled mobiles were 10 times that of selling plain vanilla mobiles phones. What would he do in such a case? Most likely, he would only sell phones that had a calculator feature attached — whether or not the customer wanted it. He would wax eloquent about the advanced nature of the calculation facility. Only if a knowledgeable customer insists, would he even show him / her the ‘simple’ phone.

An unwary customer would be subjected to a barrage of ‘features’ and ‘benefits’, without educating her on the real costs extracted by the company and distributor in providing these features. She would be shown unrealistic projections and growth rates of her corpus.

The blatant falsehoods in many of these claims would come forth only years later, by which time the agent would have long gone. The main objective of insurance, which is what the plan is meant for, would typically be given a go-by.

Welcome to the world of financial services. We all know that we need life insurance, much as we have now come to need mobile phones. Now, life insurance in itself is a complete product, where the company takes a premium from the customer, and pays a lump sum to the family in the unfortunate event of the customer’s demise.

Almost every single life insurance company has this insurance scheme — called a ‘term plan’. But for the distributor or insurance agent, this is not where the juice is.

The high-margin business for an agent is what is called unit-linked insurance plan or ULIP. Here, investment is the ‘calculator’ of our analogy, the red herring thrown in to confuse the customer. The agent would sell ULIP as a great investment plan, which also provides insurance.

Never mind, that it only provides ULIP service to insurance, just as a phone without SMS or address book would be useless as a mobile phone! Also, never mind that there are better investment plans available in the market (like good standalone scientific calculators) at a much lower price than ULIP.

There is no breach of law here. After all, it is the customer who has the responsibility of reading the fine print and being knowledgeable about various products and associated costs. The distributor would only work to maximize his income; the customer should try and protect her interests.

Thus, if she goes to a mobile store (insurance), then might as well buy a simple and effective mobile phone (term insurance policy at competitive rates). It is worth going to the adjacent shop (electronics) to buy the calculator with desired features (the investment plan). An agent who claims to fill both spaces through his product, only ends up filling his own coffers instead, at the cost of the customer.

Use UILP either as insurance or as an investment. Do not club both into one policy. If you opt for higher life cover then most part of your returns will be eaten away by mortality charges – so compromise on returns. In the same way If you want high returns then you get less life cover. So use it wisely as investment or as insurance according to your needs.

Monday, August 11, 2008

Rationale Buy v/s Rent comparison

Planning to buy your dream house? Take a look at rental rationale as well

BUYING a house is “simple”. All you have to do is to ask for an advice. And voila, they come in dime-a-dozen. Besides, if you look around, you’ll find real estate portals, hoardings and various self-styled real estate gurus advising you where and how to buy your dream house. But in this commotion, you may often overlook a simple calculation — the buy v/s rent comparison. Here’s a reality check on what should really influence your decision.


Personal finance experts believe that emotions, family and personal reasons all come into play in any home-buying decision. Also, there are lots of non-financial factors that affect this decision, including your hobbies, lifestyle, and personal psychology. Even before you plan to buy a house, it’s better to assess if you want to live in that city. If it’s your first house, then you should see it as a long term investment. After all, you want to spend your rest of the life there feels that renting can be a better option if you are at an early stage of your career and you need temporary accommodation until you’re well settled in your professional and personal life. “Renting is also suitable for a frequent traveller as moving in is easier as well as cheaper. Also, the maintenance and repair of the apartment is the landlord’s responsibility. Renting also provides simplified budgeting as the monthly expense (rent) is fixed. The scope for loss of investment is minimal,” he adds.


Despite these non-financial considerations, often the choice comes down to money and what makes the most financial sense. To get a clear picture, it’s pertinent that you should do a cost-benefit analysis before buying a house. It’s better to buy a house in the first year itself, rather than to pay rent for the first few years and then buy a house, since the total value of financial assets created is higher in the first case. Rental yields are currently low, at 4-5% of a property’s value. But if you’re paying rent as high as 10-11%, the rental option is not feasible. It’s better to buy a house instead.

Experts say you have two routes to get your dream house. First, you invest prudently for a given timeframe and use accumulated funds to buy the house. The second is to secure a loan and pay EMI (equal monthly installments) for a given time period. When choosing between the above two options, one should not only look for affordability but also consider the impact of decision on his other financial goals. Buying a property, which is way beyond your price range, could affect your financial planning for other important aspects of life such as retirement, children’s marriage/ education.


Home ownership gives you a great sense of achievement, pride and security but it can often lead you into a debt trap. Analysts hold the view that higher repayment of loans can lower the liquidity for your household and other expenses. You should avoid considering a loan which extends beyond 50 years of age so that all the debts shall be repaid before retirement. It is important that you should also figure out the cost of maintenance, repairs, insurance and utilities, which were not there when you stay on rent. “In the current scenario, the real estate market is highly overpriced and when you’ll do the cost-benefit analysis, staying on rent may work out to be cheaper. It is important that you should stretch only to the extent where you realistically foresee your financial position improving in a given time frame. “Home-buying mentality is something we’re deeply ingrained with, and is the number one financial goal for most people. We pay a big premium for feeling that pride of home ownership after all.

Well, if you don’t want your dream to turn into a financial nightmare, it’s advisable to do a reality check before you venture into realty.

Friday, August 8, 2008

REMF - SEBI's Guidelines on Real Estate MFs

The Securities and Exchange Board of India (SEBI) has given its final go-ahead to Mutual Funds to launch 'Real Estate Mutual Funds' (henceforth referred to as REMF).

1) According to the newly issued guidelines, existing Mutual Funds are eligible to launch REMF, if they have adequate number of experienced key personnel/directors.

2) Add to it, sponsors willing to set up new Mutual Funds, for launching only REMF should have been carrying on business in real estate for a period not less than five years.

3) Besides, they have to abide by other eligibility criteria applicable for sponsoring a mutual fund.

4) All REMF shall be closed-ended and their units shall be listed on a recognized stock exchange, thereby providing investors, much needed liquidity. The regulator took a daring step by asking fund houses to declare NAVs of such schemes daily.

5) As far as the composition is concerned, at least 35% of the net assets of the scheme shall be invested directly in real estate assets. Balance may be invested in mortgage backed securities, securities of companies engaged in dealing in real estate assets or in undertaking real estate development projects and other securities. Taken together, investments in real estate assets, real estate related securities (including mortgage backed securities) shall not be less than 75% of the net assets of the scheme.

6) On the valuation front, SEBI has directed fund houses to get each asset valued by two valuers, who are accredited by a credit rating agency, every 90 days from date of purchase. Lower of the two values shall be taken for the computation of NAV. To avoid concentration risk, caps have been imposed on investments in a single city, single project, securities issued by sponsor/associate companies etc.

7) No mutual fund shall invest in any real estate asset which was owned by the sponsor or the asset management company or any of its associates during the period of last five years or in which the sponsor or the asset management company or any of its associates hold tenancy or lease rights.

Tuesday, August 5, 2008

Eight Mistakes To Avoid While Investing

From over confidence, to over-enthusiasm to panic selling, there are many mistakes that an investor should avoid while playing in the stock market.

Investing is not just about picking winners, but also about avoiding mistakes. Retail investors can be better off if they avoid making the following mistakes.

• Overconfidence — Don’t be unrealistically optimistic

A bull market makes retail investors believe that they are geniuses — after all, anything they put money into goes up. This overconfidence in their own abilities leads to a complete disregard of the risks involved. Every new generation that invests in the market ignores past experience. These new investors wrongly believe that stock prices only go up. Don’t be overconfident and don’t start believing that you have superior skills compared to the market. Recognize that in a bull market you are benefiting because the whole market is going up. If those around you are getting unrealistically optimistic, start managing your risk accordingly. Remember that sometimes markets do come crashing down.

• Over enthusiasm to trade – Not every ball should be hit

Good batsmen realize that some balls outside the off-stump should be left alone. Similarly, professional investors realize that sometimes its better to just stand still than to rush into a stock. Retail investors often make the mistake of “flashing outside the off-stump” because they cannot resist the temptation to trade in every opportunity. And, like an inexperienced batsman, they suffer the same fate. Too much trading will lead to a lot of churn, extra commissions to your broker and huge tax implications for you. Some of the world’s best investors follow a buy and hold strategy — you should too.

• Missing the benefits of compounding of capital — Learn from Einstein

Albert Einstein is reputed to have said that compounding of capital is the 8th wonder of the world because it allows for the systematic accumulation of wealth. Even though any one in class 5 could tell you how compounding works, retail investors ignore this basic concept.

Compounding of capital can benefit you only if you leave your money uninterrupted for a long period of time. The sooner you start investing, the bigger the pool of capital you will end up with for your middle-aged and retirement years.

Don’t wait to start investing only when you have a large amount of money to put to work. Start early, even if it’s with a small amount. Watch this grow to a very large amount with the passage of time.

• Worrying about the market — But there is no answer to your favorite question

Smart investors don’t worry about the direction of the market — they worry about the business prospects of the companies whose stocks they own. Retail investors are obsessed with the question “Where do you think the market will go?” This is a wrong question to ask. In fact, no one knows the answer.
The right question to ask is whether the company, whose stock you are buying, is going to be a much bigger business 10 years from now or not? Don’t take a view on the market, take a view on long-term industry trends and how your chosen companies can create value by exploiting these trends.

• Timing the market — Around 99% of investors will fail in this strategy very,

i.e, enough to buy at the absolute bottom and sell at the absolute top. Professionals understand that timing the market is a wasted exercise. Retail investors always wait for that elusive best opportunity to get in or to get out. But by waiting they let great investment opportunities go by. You should use systematic or regular investment plans to make investments. You’ll have to make fewer decisions and yet can accumulate substantial wealth over time.

Selling in times of panic — You should be doing the opposite

The best opportunity to buy is when the markets are falling and there is fear in the minds of investors. Yet, many retail investors do exactly the opposite. They sell when the markets are falling and buy only when the markets are high. This way they end up losing twice – by selling low and buying high, when they should be doing exactly the opposite. If nothing has changed about the long-term outlook for the company that you own, then you should not sell this company’s stock. Use this opportunity to buy more of the same stock in falling markets. Some of the world’s biggest fortunes were made by buying when others were selling in panic.

• Focusing on past performance — Its like driving forward while looking backwards

It is a very common perception that because a stock has done well in the past one year, it’s the best stock to invest in. Retail investors do not realize that often the best performers will under perform the market in the future because their optimistic outlook has already been priced into the stock. Don’t go after hot sectors that are currently producing high returns. Don’t let greed drive your investment decisions. Look forward to see whether the gains produced in the past can get repeated or not. Short-term trends of the past might not get repeated in the future.

• Diversifying too much will kill you – Investing is all about staying alive

Beyond a point, having too many names in a portfolio can be counterproductive. You might end up duplicating, or end up taking too much exposure to a sector. Over-diversification can upset your portfolio, especially when you have not done enough research on all the companies you have invested in.

If you are an active investor in the stock market, maintain a manageable portfolio of 15-25 names. Instead of adding new names to this portfolio, recognize ideal ones. Then back them with more capital. In the long-run, this will produce better returns for you than adding another 20 names to your portfolio.

Investing is all is about patience and discipline. By avoiding mistakes you can improve the long-term performance of your portfolio, whatever the economic conditions prevailing in the market.

Monday, August 4, 2008

Diversify Your Life beyond ESOP

A considerable proportion of people investments are in the form of the stock options. As it happens, this company is prone to periodic rumors about being in trouble of one kind or the other. In recent weeks, just as all of peoples' investments have fallen, those of his employer (and other potential employers) have fallen the most.

Then there are many couples who both work in a large IT company. Predictably, a good amount of their investments are in the form of their own company's stock options. They are now coming to grips with the possibility that if the rupee keeps gaining strength, employment growth in the IT industry could slow down and perhaps even sharply reverse. That's a double problem.

1) Realization dawns that the permanently bright future that their industry was supposed to have may not exist.

2) And, at the same time, their investments in their own employer have declined to less than half in about an year's time. Like many IT stocks, their employers' stock too hardly rose when the markets were rising but fell with great speed when the markets fell.

From America comes the news that around 30 per cent of the stock of the almost-failed Wall Street firm Bear Stearns was held by employees. The value of this stock declined by about 96 per cent in a matter of hours just as many of these employees were facing up to a future without jobs.

The point that is made here should be obvious by now. Diversification is supposed to be the most important part of any investment strategy. You are supposed to spread your investments spread across different sectors and industry so that bad times in one may be offset by another. However, today when Employee Stock Options (ESOP) is a big part of some people's exposure to the stock markets, diversification must start with diversifying one's life, not just one's investments. Your career is tied up with a particular industry, so your stock investments must necessarily be as far diversified from that industry as possible.

However, for a variety of reasons, the reverse seems to be true. The biggest reason seems to be that many of the employees of who receive ESOPs are otherwise not stock investors. They never buy any other stock or mutual fund and thus have 100 per cent of their investments in their own company. What's worse we hear that some companies have a culture of bias against selling ESOPs and employees face a subtle pressure against selling. Even worse, talking to some ESOP-holders about their investments, one will realize that even when they diversify, they have a tendency to buy the stock of other companies in the same industry, probably because they feel they understand the industry or they admire another company in the same industry. This is illusory diversification. Maruti employees buying Tata Motors stock or Satyam employees buying Infosys stock may feel like they are diversifying but they are not.

So what should you do with your ESOPs? Whether you otherwise invest in stocks or funds or not, the logic of diversification is very clear. You must sell your ESOPs as soon as you can. There's a huge range of alternative investments that you can choose from. Tying up both your career and your savings to the well-being of the same company (or the same industry) is clearly a case of putting all your eggs in one basket. And that's never a good idea.

Sunday, August 3, 2008

Exposure cap to act as ULIP insurance

Unit-linked insurance plans (ULIPs) - which are similar to mutual funds in design - will soon get prudential guidelines that are in line with those applied to mutual funds. The Insurance Regulatory & Development Authority (IRDA) is set to unveil exposure limits that will place caps on how much of ULIP funds insurers can invest in a single company.

The IRDA is vetting a proposal to make prudential or exposure norms mandatory for ULIPs to mitigate possible risks arising from investments in a few companies. "Although the investment risk in ULIPs is generally borne by the policyholder, minimizing the contagion risk is a regulatory concern," a senior official said. The policyholder makes gains or losses on the investment, depending on the performance of the fund. Most insurers offer a wide range of funds to suit the policyholder's investment objective, risk profile and time horizon. Different funds have different risk profiles. The potential for returns also varies from fund to fund.

When the IRDA first unveiled its investment guidelines, ULIPs were non-existent and most investments by insurance companies were in government securities. However, the introduction and sudden popularity of ULIPs has changed the scenario. In recent years, most of new money coming into insurance goes into ULIPs with many policyholders choosing the equity option. ULIPs are similar in design to mutual funds and have an added insurance cover for which the premium is paid through cancellation of units.

Mutual fund schemes are subject to exposure limits by the Securities & Exchanges Board of India (SEBI). In terms of the guidelines, a mutual fund cannot invest more than 10% of its capital in a single company. Also, a mutual fund cannot hold more than 10% of the shares of a company. Such measures are aimed at ensuring that unit holders are protected if an invested company goes bust.

Sources say that similar exposure limits are likely to be introduced for insurance companies too. Even today, insurance companies have to provide their internal investment guidelines when they launch a new scheme. It is only after the regulator is satisfied that all risk management measures are in place to protect the investors that the product is cleared. He added that the new guidelines are likely to put in place exposure limits in a structured way.

For investing in very large companies, the exposure limits are not a problem. The limits are a constraint when it comes to investing in small companies where even a tiny investment could be more than 10% of the company's equity capital. Already, ULIP funds of insurance companies figure among the top investors in some listed companies. If IRDA puts in place an exposure limit based on the investee company's paid-up capital, insurers may be forced to avoid small companies.

Saturday, August 2, 2008

Insurance best retirement tool for Indians

Indians find life insurance the most suitable retirement planning tool, followed by bank deposits. As much as 75% of the working population and 55% of retired respondents in the country cited life insurance as their primary retirement plan tool.

Indians are pretty clear that they do not want to take risks as far as their retirement planning is goes. Therefore, life insurance and bank deposits, which virtually do not have any financial risks, are the most popular. However, two Indians out of 10 find high-risk, high-return products more appealing.

This annual study was launched in 2004. This year’s research compares findings in 26 countries that were surveyed. The research has India as a first-time participant.

Respondents from Mumbai, Delhi, Kolkata, Chennai, Bangalore, Hyderabad, Ahmedabad and Pune included both working and retired population in equal proportion. As many as 839 persons were interviewed in India, about 400 retired and another 400 working.

This is an extract of the study conducted by Bharti AXA Life Insurance is a joint venture between Bharti Enterprises and AXA. AXA Asia Pacific Holdings (APH) holds 26% in the Indian entity, while Bharti Enterprise holds 74%.

Friday, August 1, 2008

Seven Moves To Beat Competition

In spite of their size, small and medium companies can beat the biggies. The need is to implement certain unconventional ‘opening’ strategies

CHESS is composed of three distinct phases: an ‘opening’, a ‘middle game’, and an ‘end game’. Successful players learn early that while logical methods help them win ‘end games’, these are entirely inappropriate during earlier stages of the game. Across every field studied – from chess to sport to music – scientists have confirmed again and again this fundamental dilemma: ‘What helps you win in the end is not what helps you start winning at the beginning’.

Yet in the field of business we seem to have missed this lesson. Like novice chess players, we tend to cling to logical methods. The business best seller list is stocked with books that deal only with ‘end games’. They show big companies how to play in mature industries with established players following accepted rules. You can summaries the lessons to the three-move playbook. To sustain their advantages, large companies can choose from essentially three non-exclusive choices.

1. Lock up customers: Microsoft, for example, leverages its large base of committed users to sell new offerings.

2. Lock up resources: Reliance Industries leverages preferential access to significant share of regional oil to maintain its competitive advantage.

3. Lock out competitors: Nearly all large global companies (Intel, Sony, Wal-Mart, etc.) seek economies of scale to achieve cost advantages that smaller competitors cannot match.

Small companies rarely enjoy large captive customer bases. Neither can they afford access to proprietary resources, nor match the scale of larger competitors. So how do small companies compete if the three most important sources of competitive advantage elude them? We know it is possible. Ten years ago, Nokia was 1/10 th the size of Motorola. Today it outsells the one-time leader. Hero was a bicycle company that knew nothing about motors. Now it is the world’s largest motorcycle producer.

Traditional strategy tools cannot explain how small companies overtake large ones; these tools nearly always give the odds to incumbent. The reason for this can be explained by any good Chess player: while incumbents are playing ‘end games’, attackers should be playing ‘openings’ and how you win ‘end games’ is fundamentally different from how you win ‘openings’. For example, Reliance Industries chose a creative ‘opening’ that put the establishment off-guard. It is through creative ‘openings’, not rigorous logic, that small companies can transform themselves into large ones.

A studied conducted to calculate the 100 most competitive companies of the decade: 100 publicly-traded companies from markets across the globe that triggered a decade-long period of abnormally strong growth, profitability and value creation. The list contains several breakthrough Indian firms including Infosys, Wipro, Reliance Industries and Hero Honda. It is found that size plays no meaningful role in your ability to overtake competition. What matters more is the size of your growth ‘playbook’. Using a well-tested set of thirty-six competitive plays, It is classified how each of the 100 most competitive companies of the decade accounts for its success. Through this exercise seven ‘openings’ emerged as most important for strategists seeking new growth. By studying these ‘openings’, you may begin to see new ways of unlocking disruptive growth and profitability.

1. Ally with a partner outside your market:

By partnering with a player your competitors classify as outside your market, you can catch your competition off guard. For example, the largest motorcycle company in the world – Hero Honda – was born out of such a partnership. 21% of the hundred companies I studied sited using this move.

2. Move early to the next battle ground:

By identifying when and how your market will evolve, you can establish a defensive position and wait for your competition to realize the future has changed. This ‘opening’ has established many of the world’s most dominant companies including Wal-Mart and Frontline Ltd, the world’s largest owner of oil tanker freighters. Another 21% of the companies sited using this move.

3. Lock up resources:

By identifying critical pinch points in supply, you can restrict your competitor’s access to resources thereby pre-empting their ability to resist your expansion. When Apple launches new products, it also depends heavily on this tactic. 17% of companies studied sited using this move.

4. Attack from two fronts:

By using one business to provide cover for another, you utilize a well-established principle of conflict; by forcing your competitor into a two-front battle you can win with greater ease. Virgin Airway’s success against British Airways and Starbucks’ dominance over coffee shops across the US are examples of this scheme at work. 16% of companies studied sited using this move.

5. Introduce a new piece to the game board:

By creating a new entity you can disrupt competitive dynamics in your favour. Because your competition is often thinking only about current industry players, ignoring possible new ones, you may take your competition by surprise. Reliance Industries grew from a one-man fabric trading company to India’s largest conglomerate by repeated application of this strategy. 13% of companies studied, grew by applying this move.

6. Coordinate the uncoordinated:

Your strength is less a function of the assets you own than that of the elements can call into formation. By organizing independent players into a coordinated front, you can simulate greater power with less investment. Wikipedia and open source software are good examples. 13% of companies analyzed have applied this move.

7. Embrace what others abandon:

When your market abandons something – an old business model, technology, etc. – you can take advantage by adopting it. As the market has moved on to something more ‘new’, they may hesitate to return thereby affording you an advantage. RIM’s Blackberry was born from this counter-intuitive tactic. 13% of companies analysed sited using this move to some degree.

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