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Monday, February 28, 2011

Fixed Maturity Plans (FMPs)


Fixed maturity plans or FMPs are closed-end in nature and it does not really protect them against risks including market, credit and liquidity risks. But the two significant risks to which FMPs are exposed to are interest rate risk and credit risks.


FMPs are designed to immunise investor against interest rate risk. However, as a plan is launched and money is collected, interest rates can fall before the money is invested and the funds will have to be invested at a lower rate. The non availability of a forward rate market in India is a chief contributor to interest rate risk in a FMP.


The credit portfolio in the plan can suffer in case of downgrades by rating agencies. Downgrades bring down the price of the securities as investors demand a higher risk premium on the asset leading to higher credit spreads. If the fund manager is forced to liquidate the security if it crosses a threshold rating levels, the scheme will suffer capital loss.


Hence, FMPs have the potential for capital depreciation and investors should take a closer look at the risks in FMPs before making an investment decision.


First step to effective financial planning

One very simple tool is a Financial Scorecard — the first step to effective financial planning. It captures total financial information in one page and comprises the four squares of

A.      Income,

B.     Expenses,

C.     Assets and

D.     Liabilities

A) The Income square has two subheadings of

Ø      Income from active sources and

Ø      Income from passive sources.

Active sources include employment salary, professional income and business income.

Passive sources include property rent, interest on deposits, dividends and capital gains from stocks and royalties. Deductions of taxation, pension contribution and any other source will provide the net monthly income.

B) The Expense square divides methodically expenses into various categories, like food, clothing and housing. These are followed by children, health and transportation related expenses. Appliances replacement costs and discretionary expenses are also added. EMIs for various loans will also be included in this square.

C) The Asset square divides assets into three parts

Ø      Liquidity,

Ø      Safety and

Ø      Yield enhancing

Some assets have to be liquid and readily available for contingencies, even if their returns are low. These will include short-term deposits and liquid funds. Some assets have to be in absolutely safe instruments that retain their value even in adverse circumstances and these include provident fund, government securities, contributory pension schemes, small saving schemes, real estate for own usage (primary residence) and safe fixed term deposits. The third part will be yield enhancing and will include stocks, equity funds, real estate for investment, long term bond funds, commodities, art, antiques and structured products. Only after liquidity and safety have been taken care of, should the remaining assets be utilised in return enhancing asset classes. This square facilitates asset allocation — the most effective part of financial planning.

D) The Liability square lists

Ø      Short-term and

Ø      Long-term loans

Short-term loans, generally with a tenor of less than three years, may include credit card loans, borrowings on life insurance policies, personal loans and accrued income taxes.

Long-term loans include the home loan principal yet to be repaid, loans for investment assets and personal assets like cars. This square renders an easy comparison of interest rates being paid on different loans. Loans like credit card loans may be carried at high interest rates and can be eliminated on a priority basis. It also provides vital information on the assets being financed by loans. For example, a home loan is financing an asset that can produce a rental cash flow and at the same time, show capital gains.

These four squares are interconnected and realising these connections can make financial planning more effective.

The difference between assets and liabilities is net worth, a popular measure of wealth and will be a good indicator of progress.

For example, if assets are giving good returns, it adds to passive income and bolsters the income square. This, in turn, increases savings, which can be utilised in productive assets. Contrastingly, a liability adding heavily to expenses could erode savings, thus decelerating the assets build up. Income and expense squares will show whether there is potential to save more or move expenses to an area which enhances lifestyle.

Armed with the four square scorecard, a planner has total financial information of client on a single page and knows the current picture.

This is an effective tool to judge progress — whether the client is approaching his/her goals or whether the current strategy requires modification.


All About Mutual Fund Investing

Mutual Funds are increasingly being touted as the retail investors' investment vehicle. But the key challenge is to choose the right fund. But it's simple. It only requires a bit of discipline and little time - hardly a cost for a secure financial future. Following are some rules to help invest better and attain your financial goals.

Know Yourself: The first step towards achieving your goals is that you must know yourself. Try to get an idea of how much risk you can handle. Do a tolerance test for yourself. If your Rs 10,000 investment turning into Rs 6,000 upsets you--even though it could subsequently bounce back--an aggressive equity fund is not for you.

Reality Check: What are your goals? If you need to turn Rs 10,000 into Rs 50,000 in two years, a medium term bond fund may not be the right answer. Work on setting realistic expectations for both your goals and your funds.

Know What You Are Buying: Once you discovered yourself, spend some time for a close understanding of the funds. The stated objective of a fund as given in a prospectus is often incomplete and does not reveal much. Based on the readily available portfolio and fund manager's commentary, you can broadly understand the style and strategy followed by a fund. This will help you meaningfully diversify your portfolio. This will also help you assess potential risks. In general, large-cap value funds are less risky than small-cap growth funds.

Examine Sector Weightings: You must know that funds with large stakes in just one or two sectors will likely be more volatile than the more evenly diversified funds. Looking at a fund's sectoral history will help you gain a good perspective. Does the manager move in and out of sectors frequently and dramatically? If so, the fund might get hurt, if the manager is ever caught on the wrong foot.

Check Out the Fund's Concentration: A portfolio with just 20 or 30 stocks or one that puts most of its assets in just a few stocks will likely be more volatile than a fund that's spread among hundreds of stocks. But there could be rewards of concentration. A concentrated portfolio will also get more bang for its buck if its stocks work out. You may want to add a concentrated fund, one that owns fewer stocks or puts most of its assets in the top 10 or 20 stocks, to your portfolio.

But largely, your core funds should probably be well a diversified and more predictable. Though a small allocation to a sector-oriented fund, a more-flexible fund, or a more-concentrated fund could boost your returns.

Assess Performance Appropriately: Past performance is no indicator of future results. Investors should commit this statutory quote from mutual fund prospectus, advertisements and any other literature to memory. It should be recalled more readily than your bank account number. It should be repeated anytime you consider sending money to any fund with a 100 per cent three-month gain.

Why? Chances are that a few months of boom will be followed by bust, as it has happened in 2000. All the ICE concentrated funds, which were topping the charts fell flat on their face. There was just no escape when their NAVs started declining like nine pins. What should an investor do? Do not concentrate your mutual fund portfolio or invest in a concentrated fund. And, above all, don't focus on short-term returns. When choosing a fund, look for above-average performance, quarter after quarter, year after year.

Know Your Portfolio: Look for areas that are over-represented and for those that are lacking. For example, will your portfolio be overly concentrated in the large-cap equities or too much in highly rewarding but wildly volatile infotech stocks? Will you be missing investments in small-cap stocks?

Be A Disciplined Investor: After you've chosen some funds, stick with them. Don't be afraid to go aga


Right Investment can counter high inflation

Here's how you can offset the impact of soaring prices and aspirational lifestyles on your long-term savings

   EVERY week, newspapers talk about rising or falling inflation. It could be just Wholesale Price Index (WPI), Consumer Price Index (CPI) or food inflation. In economic jargon, inflation, which is usually measured in percentage terms, refers to a sustained rise in prices of goods and services. There are various aspects to this simple economic indicator which reflect the value of money as of today. For example, you could buy a movie ticket for 20 paise in the 1960s, which will cost you 200 today. That's the effect of inflation which has reduced the worth of your money by increasing the cost of the ticket.

   In India, inflation data is announced by the Union ministry of commerce every Thursday. India is possibly one of the few economies that still follow WPI instead of CPI, which has less relevance today. You should look at the components such as at primary articles and fuel items, which have a direct impact on your disposable income.

How Does Inflation Impact You?

Inflation is measured against a basket of commodities. Recently, the WPI fell below 8% but the prices of vegetables are still touching new highs. The vegetable vendors blame it on unseasonal rains. So, how do you describe this anomaly? Food products are only one component in that basket. If the prices of other components fall and those food items keep rising, the index will still show an overall decline.

   Secondly, inflation has taken the food product prices to a higher plateau. Inflation measures the increase in prices over time. If tomatoes cost 30 last year and this year they cost 32, the inflation will be around 6.66%. It may sound reasonable. But it is on a high base of 30 per kg.

   But why do you feel the pinch? It is because you cannot cut down on basic consumption needs. Moreover, if your salary has not increased in line with inflation, you will have to spend much more to buy the same quantity of goods today. For example, if you spent 15 for a litre of milk last year, the same packet will cost you 20 this year. So you end up spending 5 more to buy the same quantity and quality of milk today. If your salary in this period has gone up by 33.33%, you are spending the same amount of money on buying milk for a single day. If the rise in the salary is lesser than 33.33%, you are spending more, taking a hit on your finances. The demand for basic necessities like food is inelastic to price rise. Hence, even if food prices go up, they will eat into your savings as you can't cut down beyond a point on such needs.

Lifestyle Inflation:

There are two versions of lifestyle inflation. As your income increases, you tend to acquire some expensive tastes and desires. The other form of lifestyle inflation is very specific in nature. For example, if your hobby is to travel and explore the world, then it is an expensive pursuit, considering soaring oil prices. Earlier, the concept of lifestyle inflation was not prevalent. This was because the growth in income of most individuals was usually 5% over and above inflation. Consequently, there was no surplus income in the individual's hands. Things have changed now. The income grows a minimum of 10% in excess of the inflation. So, affordability is much higher, which makes people succumb to aspirational and peer pressures.

   But it has other implications. On the one hand, a higher disposable income allows you to pamper yourself with a lavish lifestyle. On the other hand, you realise that your retirement benefits have reduced. This means that you have to save higher to be able to maintain that lifestyle, post retirement.

   It's crucial to provide a certain mark-up at the planning phase itself. For retirement planning, every individual has to do a certain loading on numbers today based on their lifestyle to get the required future value. Again, this loading has to vary from period to period so as to reflect true value. For example, let's assume you are 30, with a monthly expenditure of 25,000 and you want to maintain the same lifestyle after 20 years. Considering inflation of 7%, you will need 96,742 in the first month after 20 years. Which means the future value of present 25,000 will be equal to 96,742 after 20 years, considering an annual inflation of 7%. If Mr X wants to retire at that point of time and the inflation is assumed at 7% thereafter, he should have at least 3 crore. The other assumptions are life expectancy of 80 years and returns of 8% from his corpus of 3 crore.

Inflation & Investments:

On the savings side, inflation eats into the value of idle cash lying in your bank account. The annual return of 3.5% can actually have a negative value, thanks to double-digit inflation. You must also compute the real rate of return on investments to assess inflation's impact. Fixed deposits, PPF or National Savings Certificate assure safe returns but are not capable of beating inflation. Gold has been an effective hedge against inflation and so are equity and real estate over a period of 10 years, financial advisors say.

   Inflation simply erodes the value of your investment. Let us assume you invested 1,000 in a one-year fixed deposit at 7%. The value of the deposit would be 1,070. But if inflation touched 8% that year, the value of 1,000 decreases by 80. The net value of your money will be 990 only. So, the net gain after computing the loss of value due to inflation is actually negative. Whenever you invest in an instrument, compute the future value after accounting for an inflation of 8-10% to get accurate results.

   Retail investor should invest in investment vehicles like equity mutual funds or PMS products. Even risk-averse investors should include some equity investment in their portfolio. Products like MIP (monthly income plans, NPS (National Pension Scheme) or structured products can be a good choice for investors who have low risk-appetite. Property investments and rentals from them can also, to some extent, help in mitigating the problem of inflation. Data shows that asset classes such as real estate and equities have outperformed inflation.


Mr X AGE: 30 yrs Inflation Rate: 7% p.a.

Monthly expenditure in...
2010: 25,000 2030: 96,742 Total corpus needed after
20 yrs: 3 crore
Future Value= (Inflation Rate/100) n × Present Value Of Your Corpus Note: n stands for the number of years


When to go for term plan over whole life insurance

A term insurance plan is suitable for young people, the reason being it offers high-risk cover at a very low cost

LIFE Insurance is essentially a long term financial arrangement to provide financial security to dependents. Various products are available in the market. Among them, term insurance is the purest form of life insurance.

Life insurers have over the years observed that it is very difficult to market a financial product under which no financial benefit accrues to the person who pays the price.

Therefore, products like endowment plans and Ulips have been devised.

Though term insurance policies do not provide any return to the person who pays the premium, they offer mental peace and comfort about the future of spouse and children. Term insurance does not have any saving component and, hence, it is the cheapest insurance product.

When a young man starts his career and family life, he suddenly finds himself committing to several obligations towards his children, spouse and ageing parents. He faces huge financial burdens of setting up a home and committing to high EMIs to own a car, a house or both. Most of the times, the situation becomes alarming and threatening for the young man and he starts feeling insecure. This is the time when he feels the need of a life insurance more, but finds the same unaffordable.

A term insurance plan is suitable for young people, the reason being it offers high risk cover at a very low cost.

It is perfectly suited for people in their 20s and early 30s.

The premium for a term insurance plan rises steeply above the age of 35 and becomes above the age of 35 and becomes very high thereafter. At a later stage of life, term insurance is not the right solution, because having lived through the most critical stage of life any person would already be having some savings or assets for their family members to fall back upon.

Whole life insurance policy (WLP) is yet another solution that provides comfort to a policyholder with regard to financial protection for the family at a relatively low premium.

The premium for a WLP is higher than that of a term insurance policy.
But it is lower than an endowment plan, maturing between the ages of 60 to 75. Another advantage of a WLP is that insurers attach higher bonus to such policies, which are marketed as with-profit products.

WLP is a very good tool for saving as well. Insurers normally allow loan facility as well as surrender value to the life assured for meeting urgent financial requirements during their lifetime. The premium for a WLP at an early stage of life is very low and it continues to be moderate if somebody goes for such a plan in his 30s.

Therefore, a WLP can be opted for when a person is somewhat financially stable in his life and needs life insurance protection for his dependents without shelling out large sums of money. WLP also serves philanthropic purpose better. If a person desires that a part of his wealth could be diverted to charity when he is no longer there, he can take a WLP and assign it in favour of any welfare organisation. Sometimes, senior people also go for a WLP and for their own satisfaction, earmark it for the benefit of the society. For such purposes, WLP can be purchased even beyond the age of 60.


Debt Mutual Funds: Returns similar on dividend, growth options of debt funds

Dividend distribution and capital gains taxes may impact returns

AT THE time of investing in debt funds it is not uncommon for investors to get confused when choosing between the growth option and the dividend option. The main area of investors' concern is the affect on returns considering the key differences between the two.

An FCRB analysis, based on Capitaline NAV database, of the returns from the growth and monthly dividend options of 12 shortterm income funds, which provided both these options to investors, starkly brings out a negligible difference between the two in all the 12 funds (see table). The returns analysed, however, did not account for taxation.

Dividend option provided for periodical payments (daily, weekly, monthly and quarterly) from the scheme's assets, which are either paid out to the investor or redeployed as fresh investment in the scheme as per the investor's choice.

The fund manager sells a part of the assets to pay the dividends and net asset value (NAV) of the scheme gets depleted by the extent of the payout. Growth option does nothing. It stays invested in its debt portfolio till such time as there are redemptions.

As returns based on NAV growth and dividend payouts for dividend debt funds and returns based on NAV growth for growth debt funds do not vary significantly, investors would find it difficult to choose between the two.

Expected duration of a debt fund investment and the applicable tax impact should be looked at by an investor.

Dividend-oriented debt funds have to pay a dividend distribution tax (DDT) on the dividend payouts. This is around 14 per cent for non-liquid debt funds. On redemption, since the NAV rise is less by the dividend payouts, the short-term capital gains liability is almost negligible and the DDT is the only tax cost to the investor.

If you are going to hold your debt fund investment for less than a year then you are better off by bearing 14 per cent DDT than a short term capital gains tax to the extent of 30 per cent if your income is in the highest tax bracket.

Short-term capital gains tax on equity investments is 15 per cent, but that on debt investments is based on the highest level of an individual's tax bracket.

Long-term capital gains tax being nil, investors are better off choosing the growth option in debt funds if they decide to stay invested for a minimum of one year.


Saturday, February 26, 2011

Balance Your Portfolio to maximize your returns

   As a financial planner, my prayer to the Lord is that everyone should get one good jolt early in life with respect to their finances. That will ensure that they realise what money is and be more careful with it. Many people have wrong conceptions about money. They confuse speculation with investment. And God forbid, if they taste success early on, they continue to make blunders. And they keep increasing their stakes, just like a gambler, till one fine day it all crashes down like a pack of cards.

   Balance is difficult to achieve. In one of the movies, a drunkard rummages through his kitchen for something valuable to sell and support his addiction and starts picking up spoons and ladles, as all other valuable things had been sold. Some are addicted to equity shares. For them, investments start and ends there. For them, investment means buying in the morning and squaring off in the evening. Many others do that several times during the day. There is no question of diversification. These "investors" do not want to consider other assets, as that would not give the returns that equities do.

   There are others who swear by property. For them, buying land and houses is second nature. These people, again, don't have the faintest idea of a balanced portfolio, where other asset classes also need to co-exist. In their case, to compound the problem, there may be huge loans, too. There may be a customary PPF here or an FD there, but that is only till they find the next plot of land, when it gets liquidated too. That is what happens when people get attached to particular segments like property or equity.

   A proper balance among assets is essential. Asset allocation can vary from person to person, depending on their station in life, years for retirement, income levels, whether there are one or more breadwinners in the family, the risk-bearing capacity, current status as far as investment/insurance is concerned. It is intuitive to understand that a basket of investments is less risky as compared with concentrated investments. This is one of the important tenets to bear in mind.

   Usually, an investor is advised to choose asset classes that s/he can understand. The legendary Warren Buffett does that. There is no point going into equities, options and derivatives, structured products, complex insurance plans and so on. A lot can be achieved by simple investments. Growth investments can be through mutual funds and some property investments. Debt investments can be made through FDs, PPF, FMP, senior citizen savings schemes, bonds and debentures. You can go for insurance through simple protection products. If all this is done in an appropriate mix, you have done your job for this life. It is better to consult an advisor, rather than getting these wrong.

   Reaching goals depends on these simple actions.

Investing In Stocks Before They Hit Market

Investors like Deepak Mehta swear by this investing strategy. It sounds simple, as well. Buy an unlisted stock through wealth managers or brokers for a discount, and exit at a profit after one year.

Mehta has reasons to be happy. Last year, he invested in Oil India shares, prior to the company's listing at `700 a share. And, the stock was trading at `1,433 on Thursday — over a 100 per cent profit in slightly more than a year.

Primarily, companies look at pre-initial public offering (IPO) placements to fund their working capital requirements. There are other reasons for placements as well. They may want to improve their market image by roping in big names in private equity (PE) or investors.

How to go about it?

Such deals are mostly routed through investment banks, entrusted with pre-IPO collection mandates. The banks, in turn, approach interested private equity (PE) funds or individual investors, mostly ultra high networth individuals (HNIs). The ticket size of this investment starts at `25-50 lakh.

Individual investors can also purchase stocks held by employees of the company through their brokers. In this case, the transfer process is simplified, if the stocks are in demat form.

If they are in physical form, the employee selling the stock as well as the buyer must sign the transfer form. And then, send it to the company for effecting the change of ownership.

Irrespective of the form, you must check if the transaction is legitimate, according to the employee's contract with the company.

Broker or private equity?

Investing through a PE fund is less risky than going through a broker, because a PE fund manager does the necessary background research. However, it comes at a cost. There is a flat fund management fee of two per cent annually. In addition, the profit is shared, typically in an 80:20 ratio by the investor and the fund.

The profit sharing can be applicable on the profit earned in the excess of the specified hurdle rate (usually 10-11 per cent). Or, there may be a catch up clause. So, if the fund earns a profit in the excess of the hurdle rate, the entire profit is shared.

In the case of a broker, the investment required is much lesser at `5-10 lakh. The quoted price of an unlisted stock is an all-inclusive price. It is arrived at by the broker after adding his/her commission. On average, it ranges from one-three per cent of the total price, but there is no fixed basis for determining the broker's commission.


Unlisted stocks lack a secondary market and are an illiquid investment. Hence, if a firm does not end up listing, there may be no easy exit.

Even after the listing, the Securities and Exchange Board of India's mandate reads that any investment at a pre-IPO stage will carry a 12-month lock in period after the stock's listing. So, investors must have a longer investment horizon.

All these factors, coupled with the lack of an established price, make the avenue risky for ordinary investors. Probably why, Mehta feels, only savvy investors who have the ability to analyse stocks, their future growth and the potential should invest in unlisted stocks.

Friday, February 25, 2011

Mutual Funds: Sectoral funds

The three popular categories of equity mutual funds —

Equity-linked savings scheme (ELSS),

Sectoral funds and

Thematic funds


Sectoral funds. These schemes invest in a particular industry or sector to benefit from its growth. For instance, an information technology (IT) fund would invest only in IT stocks. The fortune of a sectoral fund depends entirely on the sector it invests in.


Sector funds are the riskiest funds in the equity funds space as their fortunes hinge on the performance of a particular sector. They outperform the broader market in good times, but fall faster during unfavourable periods. Go for these only if you are confident of a sector's future performance.

Company Quarterly results – What to look for?

Make sense of the reams of numbers that companies publish every quarter to sharpen your stock-picking skills

   WHEN it comes to investing in the stock market, investors emulate other investors who, in turn, copy other investors and so the cycle continues.

   John Maynard Keynes, the most famous economist of the twentieth century, equated this phenomenon to what average opinion expects average opinion to be.

   Keynes, an avid stock market investor himself, compared stock market investors to the readers who participated in newspaper beauty contests, which were extremely popular during the time Keynes lived (essentially first half of the 20th century). Such contests required readers to pick up who, they thought, were the five prettiest women from a long list. The choices made were aggregated and the five prettiest women were picked up from the lot. Those readers whose list matched with the five prettiest women were rewarded by the newspaper. So, for the readers, to be anywhere close to win the prize, their choice was not on what they thought were the prettiest women, but on the women other readers were also likely to vote for.

   As Keynes wrote, It is not a case of choosing those [faces] that, to the best of one's judgement, are really the prettiest, nor even those that the average opinion genuinely thinks the prettiest. We have reached the third degree where we devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practise the fourth, fifth and higher degrees.

   Keynes died way back in 1946. Sixty-four years hence, things haven't changed much. Stock market investors continue investing on the basis of a recommendation from a friend, a broker, a relative or even a television anchor for that matter, and keep trying to figure out "what the average opinion expects average opinion to be".

   Moral of the story: "We are like this only". Investors do not use their own brain while deciding which stock to invest in or for that matter whether they should sell or continue to hold onto a particular stock.

   All this despite the fact that there is a lot more information available on companies now than there ever was. One way to gather information about the company is by looking at company results which are announced at the end of every three months. Listed companies are mandated to disclose their financial results within 45 days of the end of a quarter.

   So, by now most corporates have declared results for the second quarter (July-September, 2010). This gives investors an idea of how companies are performing, and also helps them to take a call on whether it's worth investing in a stock or to continue holding it. Investors can access the results on the websites of the Bombay Stock Exchange and the National Stock Exchange. Several companies also post financial results on their websites.

   Half-yearly numbers are an important tool for analysts as they give them a sense as to where the company is headed in the next 3-4 quarters. But that is as far analysts go. What should you, as an investor, look out for in these financial numbers?

Basics First:

Investors should start by looking at sales and profit growth. If sales are sluggish, then you need to look deeper and analyse. Similarly, if profit margins (profit expressed as a percentage of sales) are under pressure, then you need to find out why is that happening? One simple way of doing this is to compare the results of the first six months of the current year, with the first six months of the previous year. Also, you need to look beyond numbers. Take the case of ACC. For the three months ended September 30, 2010, sales were down 15% at 1,759 crore. Profit after tax fell 79% to 86.31 crore. According to a statement from the company, the volume of clinker production and cement came down due to the shutdown at Wadi II for hook up and commissioning. So, the company did not do well because a major plant had to be shut down. But that does not mean that cement, as a sector of investment, is on its way out. Cement, as a sector, had a bad quarter. However, the worst is over and the sector could see better days ahead. Increased focus on infrastructure and a good monsoon could help the sector grow in the coming years.

   Take the case of companies in the FMCG and the consumer durables space. You can look at what has been the response to new product launches. In case of IT companies, it makes sense to look at whether the company has been adding new clients.

Look at the Big Picture:

To get a complete lowdown on where a sector is headed, at times, it may be useful to take a look at the leading company in the sector. Take the case of State Bank of India. Its profit for the period from June to September, 2010, went up 0.5% to 2,501 crore. Now that, to some extent, tells you that banking, as a sector, is headed for trouble as interest rates go up.

   The SBI result indicates that profitability will be under pressure in the coming days. The days of low-cost deposits are over. Similarly, if you look at the results of Hero Honda, profit after tax fell 15% to 505.6 crore. Raw material prices, especially that of steel, have started moving up, which will have an impact on profit margins.

   The other learning from this example is that a company's input costs play a major role in determining which way profits are headed. So, if steel prices go up, margins of automobile companies could take a hit. Rubber prices are on an upside. This will affect tyre companies. Similarly, if the price of crude oil goes up, it will affect airlines adversely and higher prices of agri commodities impact FMCG companies.

Beyond The Good & The Bad:

Take the case of Ester Industries, which manufactures polyester films. Profit after tax increased 535% from 5.8 crore to 36.7 crore in September 2010. According to a company release, A few thin polyester film plants were converted to produce industrial products like LCD screens and back panels of solar PV cells. This led to a huge demand for polyester film which, in turn, led to an increase in prices globally. As a result, Ester Industries was a beneficiary. In such cases, investors need to understand whether this demand is likely to sustain for the next few quarters and accordingly take a call. "Many a times the stock price will go up in anticipation of the results and investors need to take that into account.

   On the other side, you have stocks like Mahindra Holidays and Resorts, that reported lower profits numbers for June and September 2010, compared with the previous year. The company is going for a higher upfront fees from members, and reducing freebies, which is an excellent move from investors' perspective, Clearly, this seems to be a short-term initiative which will benefit the company in the long run.

   So, keeping pace with quarterly results will go a long way in helping you spot future winners.


Here's what you should do when looking up financial results:

Compare like to like. For example, if a strike affected a company's output last year, it is safe to assume that this year's quarterly numbers will be good

Get sector-savvy. Look at how different companies in a particular sector operate and how they cope with the different factors affecting the industry

Watch out for pledges. Promoters have to disclose pledged shares with quarterly results. Try to find out why the promoter has pledged shares

Look for analyst insight: Some companies put analyst presentations on their websites. They can offer a useful insight on the company's outlook

Think before you act: Don't jump to a conclusion if one quarterly result is bad. Take a closer look before forming an opinion


Mutual Fund dividend is your own money being returned to you

Take the growth option if you want your investments to grow

   ON NOVEMBER 25, 2010, the net asset value (NAV) of the growth option of Reliance Growth fund was 491.56. On the same day, the NAV of the dividend option of the same fund was 60.26 or nearly 88% lower. Similar is the case with HDFC Equity Fund. The NAV of the growth option of the scheme was 292.07, whereas the NAV of the dividend option was 82% lower at 53.68. What explains the huge difference?

The reason is simple but important. While in the growth option the NAV keeps on growing, in the dividend option, a part of the profit made is given back to you as dividends which leads to a fall in the NAV.

The dividend from a mutual fund scheme, unlike stock dividend, is your own money coming back to you.

Why The NAV Slips:

MFs give out dividends by selling the shares they hold against the investments made by investors. This leads to the NAV of the scheme falling. So, let us say the NAV of a scheme is 12. The MF decides to give a dividend of Re 1 per unit. In order to do that the MF will have to sell shares held against the investments made and give out a dividend. This will lead to the NAV falling by Re 1 to 11.

   And that's what happened with Reliance Growth Fund, which has been declaring regular dividends over the years.

   If you invested in the growth option of the scheme, you would get an NAV of 491.56. If you chose the dividend option, periodically, some of your invested amount would be paid back to you (by calling it dividend) and, hence, the market value of your unit is 60.26.

MF Dividend Is A Misnomer:

An equity fund manager recounts the story of an MF investor who kept buying more units using the money given out as dividend by the MF. "He would invest the dividend he got in the scheme again, thinking that the NAV was reducing and so he thought he was investing at a lower price," the fund manager recounts. But all the investor needed to do was to choose the growth option of the MF and see his investments grow. In the growth option of an MF scheme, the amount invested keeps growing and no dividends are paid out.

   In the strictest sense, the term dividend is a huge misnomer when it comes to MFs. Let's take the example of a stock priced at 200 where the company announces a dividend of 5 per share. Here, the dividend will be is over and above the stock's price and serves as a means of distributing additional money to shareholders from the company's reserves and surplus.

   The tragedy, of course, is that most MF investors think that dividends given by mutual funds are like dividends given by companies on stocks. They think dividend is new money being given to them and fail to realise that it is their own money that the MF is returning to them.

The Lure Of Dividends:

You feel happy when you get a substantial dividend of say 30,000-40,000 on an investment of 5 lakh in case the dividend declared by your mutual find is 9-20%.

   Usually, dividends are declared annually There are also people who aim at profit-booking in the form of dividend as they think market can't go perpetually high and so take a dividend option.

   However, calculations reveal that money grows faster under the growth option than with the dividend option. In equity schemes, in a market environment which is bullish, the growth option will give you a better upside. Take for instance, 1,000 invested in the Birla Sunlife Dividend Yield Plus Plan. The money in a growth fund would have increased in three years to 1,812 and to 2,914 in five years. The same amount invested in the dividend option of the scheme would have grown to 1,715 in three years and to 2,300 in five years.

The Regular Income Myth:

Let us look at the number of times that some of the equity funds such as Birla Sunlife 95 and HDFC Equity Fund have given dividends. In the 10 years since its launch, HDFC Equity Fund gave 14 dividends, mostly once in a year and on rare occasions twice a year, especially when the markets had run up.

   HDFC MF pays dividends in fixed months. It has been following that system for years. So, next year, it will give dividends in that very month. Accordingly, one can plan the expenses and the cash flow from dividends. But there is a slight problem in the argument. One never knows how much one would receive and when. In other words, the MF may decide not to distribute the dividend at all. Or, it may decide to distribute much less than what you need. Typically, equity schemes declare an annual dividend but there is no guarantee that you will get dividends. This is because the dividends are dependent on how the markets are moving.

Growth Is The Way To Go:

So, given this, what should an investor do? He should invest in the growth option. And as far as dividends are concerned, There is a simple solution. Ask for the dividend yourself. To put it differently, when the MF pays you money, it is called dividend. When you yourself withdraw an equivalent amount, it is called capital gain.

   So, basically, whenever you need a dividend, just sell a few units of the MF. In the dividend option, as we explained above, the MF is returning you your own money, which is what you do when you choose to sell the units of the growth option as well. The value of your investment remains the same, whether the dividend is paid to you by the MF or whether you redeem units of an equivalent amount.

   So, moral of the story is, go for growth, if you want your investments to grow.


1 dividend MFs give by out a selling the shares that they hold
2 scheme The NAV falls of the by as much as the dividend declared

3 sell You the can MF units to give yourself a dividend anytime

4 for Hold one the units year before selling to avoid paying taxes Those who
5 want regular income should know that MFs do not pay dividend frequently


How to Increase your loan eligibility?

  Lenders compute loan eligibility to ensure that the borrower can comfortably repay the loan amount, and reduce the probability of default.

Factors having a bearing on loan eligibility:

Ø       Applicants with a stable income and steady job are preferred over people who switch jobs often

Ø       Those close to their retirement years may find it difficult to get a long tenure loan. Younger borrowers are preferred by lenders

Ø       If an applicant has a history of defaulting, his credit score is likely to be poor.

Ø       Borrowers who have defaulted on their previous loans may find it very difficult to get a new loan sanctioned

Ø       Education and financial position also have a bearing on eligibility


Enhancing eligibility

The simplest way to enhance loan eligibility is by clubbing your income with that of your spouse, father, mother or son. Joint loans enhance loan eligibility. If a husband and wife apply together, their combined income could be double, making their eligibility double too. Co-owners will be eligible for tax benefits separately on the home loan repayments in proportion to their shares in loan liability.

Managing finances    

Clearing previous debts will allow a borrower to keep a sufficient chunk of his salary towards repaying the home loan debt. Avoid new debts. Clearing older debts like personal loans or credit card debt will make you eligible for a greater loan amount.

   You can also enhance your home loan eligibility by opting for a higher tenure. The longer the loan tenure, lesser will be the monthly EMI burden too.


How to gauge the risk profile of your mutual fund portfolio?

MUTUAL funds are considered to be an investment option for those who do not generally devote a lot of time to monitoring and managing their portfolios.

Investors experience both good as well as tough times as far as mutual fund investments are concerned.

But while evaluating the portfolio of their equity mutual fund holdings there are a few points that one should check to know about the level of risk that they are facing. Often there are situations where there is a higher risk than what was estimated initially.

Here are a few ways to evaluate various risk levels.

Individual holding exposure:

The portfolio of the equity fund where one has invested or plans to invest needs to be scrutinised to see whether the risk levels are such that could lead to a larger volatility in the holdings. Depending upon this factor and the risk taking ability of the investor the choice about a particular fund as an investment should be made.

One key point to watch out is whether there is a large exposure to just a few stocks. In a diversified equity fund there is a limit of 10 per cent for exposure to a single stock.

But if there are four to five stocks where the exposure is high, or around 9-10 per cent, then it could be that these holdings determine the performance of the fund. Several investors might not find such a situation suitable for their needs, while others who want some concentration for an outperformance would welcome such a mix.

Sector exposure:

There also has to be a limited exposure to a particular sector in the portfolio. There is a tendency among fund managers to increase a fund's exposure to a few particular areas when they are doing well. This can be a dangerous as it could lead to a situation where the movement of an entire fund is being dictated by a particular sector. Usually, MFs have internal limits.

For example, some limit a fund's exposure to a single sector to not more than 20-25 per cent and so on.

Another risk is where the exposure is spread across more than one sector, but are often linked in terms of performance. For example, automobiles, tyres and auto ancillary sectors are linked, so a deterioration or improvement in the condition of any one will impact all the other related sectors.

This can have a big impact on the portfolio as a whole. Another example is the construction field that would include real estate, cement and steel sectors among others.

Market cap exposure:

The re is often a market-cap driven trend in the equity markets. This would mean a situation where there is a rally in large-cap stocks or where the conditions are weak for mid-cap IT stocks and so on. Often the portfolio might seem to be diversified as there is no concentration on a specific company or sector, but there is another form of risk that is present there.

If majority of the holdings belong to a certain market-cap then a similar risk situation can arise. The investor can find that there is just a one-way movement on several occasions in the portfolio. A fund with a specific market-cap investment mandate, like a mid-cap scheme, will be forced to invest in holdings with a particular marketcap. But in case of diversified equity funds, too, the situation needs to be checked to see the extent of risk in this area.

Group exposure:

There are a lot of ways in which the holdings in various companies can be classified.

The situation could be such that while the holdings are diversified across sectors and also across market-cap, there is a slightly higher exposure to companies from a single business group. This kind of exposure, too, can create a higher amount of risk especially when the performance of group companies on the stock market follows a similar trend.

While having more than one company in the portfolio of a group is not a negative factor, having too much of a weight could lead to a situation where the fund's performance will be magnified either on the upside or the downside whenever a trend like this is witnessed.


The costs associated with loans

Individuals often find it tough when they have to wade through the fine print to get the desired information. You encounter this problem when you go for a loan as it is not easy to know all the information about various conditions as well as charges. The Reserve Bank of India has asked banks to display various details such as the cost of loans on their websites and also to inform customers about it so that they are able to make correct comparisons.


Here is a look at the various details one should take note of:

Loan processing fees: There are several items that will constitute the total cost that has to be paid for a loan and one of the starting point is the processing fee. This is the time when various documentation related to a loan has to be completed. There are several charges that will have to be paid by the borrower, including the cost of stamp papers, processing fees and others. The lender is supposed to clearly mention these to the borrower.

Refundable fees: There are fees that are collected upfront from the borrower when they ask for a loan.

However, there may be a situation where the loan may not be sanctioned or disbursed. In such a case, the borrower will be interested in knowing how she can reclaim the expenses. In such situations, the fees that would be refundable should be mentioned clearly.
Prepayment charges: There is always the possibility that the borrower will come back at some point of time to prepay the loan when she has additional funds. In such cases, lenders often slap a prepayment charge. So, the conditions under which prepayment charges will be applicable and the amount should be disclosed clearly.

Delayed repayment: There can be an opposite situation where the repayment of a loan is not possible for the borrower due delay in cash flows. In such a situation, the charges that would be levied should be mentioned.

This will help the borrower understand the impor-tance of paying the loan on time.
Switching loans: There may also be the need for some borrowers to switch a loan from fixed interest rate to floating interest rate and vice-versa. The lender may seek to enforce a conversion charge in such a case. This will play an important role in the decision to switch a loan.

Interest reset clause: Any change in interest rates might be possible even in case of a fixed-rate loan. If the borrower is not aware of the position, then she may get a shock. This is why banks have been asked to intimate the borrower about such a clause beforehand.

Thursday, February 24, 2011

Some strategies for investors in volatile market conditions

   Currently, the stock markets are showing very erratic movements. The contrast in the market behavior between the first half of November and the second could not have been more. Around Diwali, the stock markets were cruising along, confident of reaching new highs. The 'Obama vote of confidence', combined with positive economic data, created positive market sentiments, which gave the impression nothing could go wrong with the domestic markets. But in a matter of two weeks all that confidence has evaporated.

   Triggered by global factors such as the Chinese rate hikes, the markets fell steeply by almost 10 percent. Suddenly, the picture seems a little less rosy. Despite analysts' inability to pinpoint the exact reasons for the fall, one factor stands out. The markets were highly volatile and this back-and-forth action showed that volatility is central to stock markets.

   Why is this volatility so pronounced now?

   The uncertainties on the economic front increased last month with reports of a potential debt emergency in several European countries and rate hikes in China. Wide price fluctuations are a daily occurrence in the world's stock markets as investors react to various events across the globe, whether it is economic, business or political. So, the market volatility is just an indicator of economic uncertainty.

Arriving at volatility    

When the stock market goes up one day, and then goes down for the next few days, then up again, and then down again, this erratic movement is called market volatility. Volatility is arrived at by calculating the annualised standard deviation of the daily change in prices. Volatility does not measure the direction of price changes, but merely their dispersion.

   Two stocks with different volatilities may have the same expected returns, but the stock with the higher volatility will have larger swings in prices over a given period of time.

Volatility can be measured    

In India, the measure for volatility is called India VIX. India VIX is a volatility index based on the Nifty Index Option prices. Volatility Index is a measure of the market's expectations of volatility over a near term. From the best bid-ask prices of Nifty Options contracts, a volatility figure (in percentage) is calculated. It indicates the expected market volatility over the next 30 calendar days.

   A high VIX appears just before a market rally, and a low VIX usually augurs a slide. Historical data has shown that wild market movements precede a change in the market's direction. Dealing with volatility is not impossible. Investors have to devise some strategies to deal with it.

   Some strategies for investors to beat volatility:

Dividend investing    

One method could be to invest in companies that have a good track record of paying dividends.

   This style of investing is called dividend investing and is usually adopted by investors looking for safe investments. A long-term investment strategy, it withstands volatility.

   Dividends of quality companies have grown at an average annual rate of 18 percent in the last 10 years. When following a dividend investing strategy, investors have to do their homework to ensure that the quality of dividends paid is good and they are coming from excess operational cash flows, and not debt, to ensure sustainability.


Options are good to handle volatility. They can offer high returns during any market condition. They are especially good during times of uncertainty. Volatility is such an important factor in the price of an option that a change of one percent in volatility has a significant influence to the price of an option.

   Options are inexpensive when the volatility is low and expensive when it is high. Option selling plays on both stock prices and volatility. Investors can therefore sell options to hedge their portfolio.

Systematic investment plan    

While most investors know that equity provides an opportunity for better returns than most other asset classes over a longer duration, it is the fear of volatility that keeps investors out of the stock markets. The systematic investment plan (SIP) is one of the most efficient ways to benefit from volatility.

   The markets move up and down over a period of time. By investing through a SIP, you have the opportunity to enter at every stage of the market. A SIP works on the concept of law of averages. It makes the average price of the investment a weighted average, thus reducing the average cost of purchase of units.

Track charts    

Investors should track technical charts during times of volatility. During volatile times, they are likely to be more useful and informative than conflicting economic factors that give confusing signals.


Keep a check on your Expenses

Income should not be confused with wealth. Whatever an individual's income, if his expenses take up all or a larger portion of his income, there will be no surpluses left and as a result, no wealth creation. It is only when our surpluses are invested that wealth is generated.

Expenses are, hence, also critical. Two people, despite earning the same income can end up looking very different in a few years - the difference would be as a result of their expenses and their investment. Hence, having a laser-like focus on just the amount of income is misplaced.

Financial planners use various ratios to ascertain the health of their clients wealth. They consider the savings to income ratio, liquidity ratio and the debt to asset ratio of a person. However, intriguingly, even financial planners will leave expenses out of the calculus.


This is a very important indicator of financial health. Let us say, Ram earns Rs 50,000 per month. He spends Rs 30,000 out of his earnings each month and saves the rest. His friend, Bharat, earns Rs 75,000 each month.

His expenses add up to Rs 50,000 at the end of the month and he manages to save Rs 25,000 per month. Ideally on the face of it, Bharat saves `5,000 more each month.

This should add up to a good amount at the end of the year and so he is considered to be better off than Ram.

However, look closer. Rams expenses are Rs 30,000 per month and he saves Rs 20,000 every month. His savings to expenses ratio is calculated at 0.66 (20,000/30,000). In practical terms, with the savings he manages every month, he will actually be able to pay for 20 days of his monthly expenses. Let's compare, the same ratio in Bharat's case. His ratio works out to 0.5 (25,000/50,000). This means Bharat will be able to take care of only 15 days expenses.

But the above observations could be debated by some who may conclude that Bharat may have a better standard of living than Ram, considering his expenses. Even that may not be true if Bharat is supporting a lavish or better lifestyle depending on loans. Servicing more loans does not mean a better lifestyle. One could be servicing more loans to support unwanted expenses.In any case, even if it were a better lifestyle that Bharat enjoys, he needs to save much more to enjoy the same staying power as Ram. With respect to this ratio, keeping the expenses within desirable limits is important, rather than focusing on income alone.


Even while considering one's expenses, looking at the break-up of how much is being spent on which item will be significant. For instance, if out of your total expenses in a month, 40 per cent is spent on paying the equated monthly instalments (EMIs) for a home loan, it is fine. Spending another 20 per cent more to service other loans would also be fine. Assuming that the balance 40 per cent of your expenses gives sufficient leeway for all other expenses. And includes some savings too.

However, say the debt servicing to total expenses ratio is 0.6. In this case, if the instalment component of any loan goes beyond 60 per cent, it would be dangerous as EMIs are non-discretionary. You might end up paying a penalty if you miss paying those.

An ideal debt servicing to total expenses ratio would be 0.5 or lower. However, this works well for those in the higher income brackets (Rs 50,000 per month or more). For lower income brackets, the amount of loan that can be taken would be dictated by monthly or annual expenses, as loans servicing can be done only after meeting the basic expenses.

For instance, for a person who is earning Rs 30,000 per month, if the monthly expenses are about `20,000, then he can use a maximum of `10,000 every month for servicing his loans. Here, the debt servicing to total expenses ratio is 0.33. The general logic of having a ratio of 0.5 at least will not apply here. Similarly, for double income families with a high combined income, this ratio can go up, to even 0.7, as the balance available may still be big enough in absolute terms to meet the basic expenses and saving needs.

Expenses play an important role at the time of retirement and beyond. A muted spending style can stretch the corpus along way. A flamboyant spender may see the same corpus deplete in no time. Expenses, hence, play a pivotal role through out life. Merely focusing on income and investments can be a mistake, a costly one.


While calculating our future expense requirements, we merely consider our current expenses and inflation. However, another factor that would determine your future expenses is the aspiration factor-which we shall call the Delta factor. A hatchback might make one look self assured today. But aspirations also keep galloping. In future, the same person may be aspiring for a car that is considered up-market. Once vacations meant going to hometown and back. Now, vacations take one to exotic locations in India and abroad.

The Delta factor is seldom considered while planning finances. It is true that this is difficult to estimate. Considering, it depends on societal and peer pressures, the future contours of which are difficult to define. It also depends on the strata of society they belong to. What may be "arrived" in one strata may be "passe" in another. How many people would have predicted that they would be sending their children abroad for education, if asked 15 years back? But then, that is what many are doing today.

Building a cushion to accommodate this delta factor, would be a capital idea. It may not be accurate. But then, estimating it and making at least a rough provision would solve the problem to an extent, instead of completely ignoring it.

PFC infra bond hits market today, targets Rs 5,300 crore


POWER Finance Corporation (PFC), a government of India undertaking company, plans to raise Rs 5,300 crore from the public issue of infrastructure bonds.

The issue will open for public subscription on February 24 and closes on March 22, 2011. The issue will not be more than 25 per cent of the incremental infrastructure investment made by the company during 2010-11.

India Infrastructure Finance Company (IIFCL), IDFC and L&T Infrastructure Finance are the some of the other infrastructure finance companies that have launched public issue of infrastructure bonds in recent days. While IIFCL is raising Rs 1,200 crore, L&T Infrastructure Finance is raising Rs 400 crore, which includes green-shoe option.

PFC's bond will be of a face value of Rs 5,000 and would be listed on the Bombay Stock Exchange.

"We are in a position to take advantage of strong growth in power sector," Satnam Singh, chairman and managing director, said at a press conference.

Investors can avail tax benefit of Rs 20,000 for the current financial year 201011 under section 80CCF of the income tax act, 1961.
The bonds will have a fixed rate of interest of up to 8.5 per cent and shall be payable annual or on a cumulative basis. The bonds offered will be in maturities of 10 years and 15 years with a buyback option after 5 years and 7 years respectively.

The proceeds of the issue will be utilised to finance infrastructure projects in the country, he said.

The company's loan portfolio stands at Rs 92,000 crore as on December 31, while the government expects Rs 100,000 crore investment in the power sector in the next five years, he said.

ICICI Securities and SBI Capital Markets are the lead managers to the issue.


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