Why higher equity allocation is optimal for long-term investors?
Many investors have carried their exposure to stocks through 2008 in the hope that these stocks would generate positive returns if they hold on longer.
If their hopes have indeed come true, there is a lesson for long-term investors: construct portfolios with higher equity allocation.
But are stocks less risky over the long term?
This article explains time diversification — the notion that the risk of stocks declines as time horizon increases.
It discusses why experts are still divided on the subject. It then suggests why it is optimal for investors to carry higher equity allocation without engaging in time diversification.
Long-term investment is typically an after-thought. Or to be precise, it is usually a short-term investment that has turned wrong!
But does extending the time horizon help? Jeremy Siegel in his book “Stocks for the long run” states that stocks produced positive real returns in excess of both bonds and Treasury bills over longer time horizons.
Intuitively then, extending time horizon makes sense. Suppose a portfolio was set-up in October 2003 with the objective of doubling capital in five years. The portfolio would have fallen short by seven percentage points in October 2008. Extending the investment horizon by a year would have served the objective.
Suppose the portfolio was instead set-up with a strict five-year time horizon. Some experts argue that the terminal wealth then becomes important. That is, an investor should not be bothered about yearly volatility in asset prices as much as the holding-period volatility.
But that may not be true. Suppose the average yearly volatility over five years is 20 per cent while the five-year holding-period volatility is only 7.5 per cent. An investor has to first endure five one-year periods to realise the five-year holding period.
And that could be painful for many. This is one of the reasons critics argue that extending time horizon does not reduce risk.
So, the question remains:
Should investors with longer time horizon have higher equity allocations?
Behavioural investing
Suppose an investor wanting to buy a house in five years time constructs a portfolio today with a higher equity allocation.
The investor will regret the decision if equity prices decline at the horizon. Importantly, the investor has to then settle for a smaller house if the portfolio does not generate enough to buy the desired real estate. Extending time horizon in this case moderates the regret.
If equity prices, however, climb up sharply within five years, the investor experiences pride of making gainful allocation, not to mention the joy of buying a larger real estate.
A discerning investor, therefore, wants to balance pride and regret. Making higher equity allocation, hence, assumes importance.
But can investors take higher equity exposure without engaging in time diversification?
The answer lies in constructing the portfolio within a core-satellite framework. It is clear that a strict buy-and-hold strategy will not be optimal in a volatile world.
The investor, therefore, needs to construct a passive core at various price points using the concept of rupee cost averaging. This portfolio will be held for five years, subject to periodic risk rebalancing.
The pain of regret associated with this portfolio could be high, if equity returns trail bond returns.
This pain could be offset with the satellite portfolio, which will be actively traded to take advantage of the high intermediate volatility.
Note that the actual asset allocation policy would be drawn up based on the time horizon and the risk appetite of the investor, a factor dependent on a person’s human capital.
Conclusion
Extending time horizon may not always make stocks less risky. It is true that a portfolio can generate higher returns in 10 years compared with five years.
But risk may also increase with horizon due to high intermediate volatility. Nevertheless, higher equity allocation may be optimal for long-term investors based on pride-regret behaviour
Sunday, June 28, 2009
Saturday, June 27, 2009
WHICH MUTUAL FUND SIP IS BEST
LOTS OF MF ADVISORS , WEBSITES AND SELF PROCLIAMED ANALYSTS CLAIM THAT SO AND SO MF IS BEST TO INVEST IN. THE SENSEX HAS SEEN A SEE SAW DURING THE LAST 1 YEAR 8 MONTHS .
WE AT INVESTMENT DUNIYA DECIDED TO CHECK OUT THE CLAIMS BY ALL THESE LEADING ANALYSTS.
WE CHOOSE NOV 5, 2007 AS OUT START DATE OF SIP OF RS 2000 AND RECORDED THE GAINS MADE DURING THE LAST 21 MONTHS . TOTAL INVESTMENT IS RS 42000.
WE CHOOSE HDFC TOP 200 , HDFC EQUITY G , FROM THE HDFC MF STABLE
KOTAK 30 FROM KOTAK MF , SUNDARAM SELECT FOCUS FROM THE SUNDARAM MF STABLE, ICICI PRU INFRASTRUCTURE FROM THE ICICI MF , JM BASIC FROM THE JM MF STABLE ,
REL DIVERSIFIED AND RELIANCE GROWTH FUND FROM THE RELIANCE MF STABLE.
WITHOUT ANY BIAS AND WITHOUT ANY CLAIMS THE FOLLOWING ANALYSIS IS THE ANALYSIS TABLE
THE HDFC MF SCHEMES TOP 200 WAS THE BEST WITH AN OVERALL GAIN OF 22.1% FOLLOWED BY HDFC EQUITY 19.77 % AND THEN BY RELIANCE DIVERSIFIED 19.17 %.
WE EVEN TOOK INTO ACCOUNT JM BASIC WHICH DELEIVED A POOR 4.5 % RETURN AND ALSO KOTAK 30 WHICH SCORED A POOR 4.33% AND SUNDARAM SELECT FOCUS RETURNED A VERY POOR 2.83 % RETURN DURING THE SAME PERIOD.
NOW IT IS FOR THE WISE INVESTOR TO DECIDE WHICH MF SCHEME TO INVEST IN.
IN THE ANALYSIS ABOVE, WE HAVE ASSUMED ALL GROWTH SCHEMES WITH NO ENTRY LOAD AND ALSO RETAIL SCHEMES.
WE AT INVESTMENT DUNIYA DECIDED TO CHECK OUT THE CLAIMS BY ALL THESE LEADING ANALYSTS.
WE CHOOSE NOV 5, 2007 AS OUT START DATE OF SIP OF RS 2000 AND RECORDED THE GAINS MADE DURING THE LAST 21 MONTHS . TOTAL INVESTMENT IS RS 42000.
WE CHOOSE HDFC TOP 200 , HDFC EQUITY G , FROM THE HDFC MF STABLE
KOTAK 30 FROM KOTAK MF , SUNDARAM SELECT FOCUS FROM THE SUNDARAM MF STABLE, ICICI PRU INFRASTRUCTURE FROM THE ICICI MF , JM BASIC FROM THE JM MF STABLE ,
REL DIVERSIFIED AND RELIANCE GROWTH FUND FROM THE RELIANCE MF STABLE.
WITHOUT ANY BIAS AND WITHOUT ANY CLAIMS THE FOLLOWING ANALYSIS IS THE ANALYSIS TABLE
THE HDFC MF SCHEMES TOP 200 WAS THE BEST WITH AN OVERALL GAIN OF 22.1% FOLLOWED BY HDFC EQUITY 19.77 % AND THEN BY RELIANCE DIVERSIFIED 19.17 %.
WE EVEN TOOK INTO ACCOUNT JM BASIC WHICH DELEIVED A POOR 4.5 % RETURN AND ALSO KOTAK 30 WHICH SCORED A POOR 4.33% AND SUNDARAM SELECT FOCUS RETURNED A VERY POOR 2.83 % RETURN DURING THE SAME PERIOD.
NOW IT IS FOR THE WISE INVESTOR TO DECIDE WHICH MF SCHEME TO INVEST IN.
IN THE ANALYSIS ABOVE, WE HAVE ASSUMED ALL GROWTH SCHEMES WITH NO ENTRY LOAD AND ALSO RETAIL SCHEMES.
FIXED DEPOSIT RATES IN THE CURRENT SCENERIO
The interest rates on Term FDs are climbing down. Given below are the list of FDs rates of Nationlised banks and also of Cooperative banks around the country for your reference.
SBI
CANARA BANK
TAMIL NAD MERCANTILE BANK
COOPERATIVE BANKS
NEW INDIA COOPERATIVE BANK
KAPOL BANK
PUNJAB MAHARASHTRA COOPERATIVE BANK
JANKALYAN SAHKARI COOPERATIVE BANK
SBI
CANARA BANK
TAMIL NAD MERCANTILE BANK
COOPERATIVE BANKS
NEW INDIA COOPERATIVE BANK
KAPOL BANK
PUNJAB MAHARASHTRA COOPERATIVE BANK
JANKALYAN SAHKARI COOPERATIVE BANK
Monday, June 22, 2009
‘Markets can fall by 10-20% from peak’
Usually a diehard optimist, Mr Sandip Sabharwal, CEO - PMS, Prabhudas Lilladher Markets, sounds a note of caution about the stock markets after their breathless rally over the past three months. Markets have not been so overbought technically for a very long time and such a state will not last too long, he says. Even while expecting a 10-20 per cent correction from the peak, he feels that India’s valuations will continue to remain at elevated levels, given the improved growth prospects for the economy.
Excerpts from the interview:
Have the Indian markets run up way ahead of companies’ fundamentals, especially in sectors such as realty, cement and infrastructure? The pace and ferocity of the recent rally in the stock markets is unprecedented. If one looks at a market like India, the key indices have all nearly doubled in a period of just around 13 weeks.
This run-up has come on the back of beaten down valuations, extreme pessimism and short positions in the markets, huge cash on the sidelines, improving liquidity, reducing interest rates and a bottoming of economic performance globally. The weakness in the US Dollar combined with low short-term interest rates has made the “Dollar Carry Trade” gain momentum.
If we go back to the year 2003 when the last rally started, it took the markets nearly one year to double from the bottom. The same thing has happened in just three months this time. However as a counterpoint, markets also never sold off the way they did in the year 2008. Since the fall was so sudden and sharp, the initial rally had to be sudden and sharp.
The key is that the speed of the rally has made everyone too complacent and has led to a phenomenon of panic buying in the markets.
Lot of the stocks in the above mentioned sectors have clearly run ahead of fundamentals although the prospects for cement still look positive. Valuations have moved up due to improving growth prospects and growth in the economy is likely to be strong at least for the next five years. Under the circumstances valuations will continue to remain at elevated levels over the next few quarters.
Should investors wait for a correction now to start buying?
Markets look overbought in the short run and should see some correction. I believe it is important today to stick to fundamentals and not to be carried away with the market momentum.
As we sit to evaluate what should be the course of action going forward it is important to recollect a number of data points that have come out over the last few days:
- Global trade continues to be in doldrums and both exports and imports of most countries are still in a severe downturn.
- Most large economies continue to contract and there are no signs of economic revival anywhere in the West. It is just that the pace of fall has slowed down.
- The valuations of most markets have clearly run ahead of fundamentals with most emerging markets now trading in the range of 15-17 times 2010 earnings, up from 7-10 times in the beginning of March 2009.
- The fiscal deficit projections of most governments worldwide are continuously moving up with slowing tax collections and higher spending.
- Cash on the sidelines has come down very sharply over the last two to three weeks as most institutions, especially mutual funds and FIIs whose portfolios are declared at the end of every month rushed to deploy a large part of their cash holdings so that their month end portfolio does not show huge cash throughout the rally .
- Inflows into emerging market funds which were running at over a billion dollars a week have now slowed down drastically over the last two weeks. As such a combination of low cash and low inflows should be a near-term negative.
- Markets have not been so overbought technically for a very long time and such overbought conditions will not last too long and will ultimately lead to a big sell off. The overbought nature of the markets at this point in time is similar to the markets prior to the fall in May 2006 when the markets fell off sharply before recovering in the latter part of the year. It is also similar to February 2008 when emerging markets were most oversold than ever in history.
- Government bond yields have firmed up globally over the last few weeks, driven by fears of huge borrowings and high fiscal deficits. The rise in these bond yields will make interest rate declines more difficult and may lead to interest rates stabilising at levels higher than what they should have given the global economic outlook and low inflation prevailing currently. Reducing Libor and corporate bond spreads have hidden this phenomenon in the near term, however this is something that need to be watched out
- If one includes the QIP issuances announced till date combined with the IPO pipeline, nearly $10 billion is proposed to be raised from the markets over the next one year. This is a huge supply of paper which can not only reduce the pace of market up move but also stop it at its heel.
Markets, as they start their correction, can fall by 10-20 per cent from the peak.
Mid-caps have once again caught the fancy of investors. Have the concerns about the companies abated?
The fear of insolvency or defaults in mid-cap companies has significantly reduced today. Moreover prior to the elections, most investors were unwilling to invest into mid-caps as they were not sure whether they could move out if things turned adverse. Subsequently, as investors became convinced over the long term direction of the markets, mid-caps have come back into the investment radar. Improved liquidity and reducing interest rates will now benefit mid-caps more than large caps. A vast majority of mid-caps fell by nearly 70-80 per cent in the bear market and have now bounced back to 30-50 per cent of their peak values on a broad basis. I believe that given the growth prospects of the Indian economy there are lot of quality mid-cap companies which will not only go back to their earlier highs but also move higher up. As such, any corrective moves in the market will provide a good opportunity to build up positions in high quality mid-cap companies.
Growth-oriented stocks will continue to get a greater premium over the next few weeks and months as investors become more convinced that the economy is clearly on the path of recovery. As such, long-term investors should prefer growth over value.
There have been contradicting signals on the commodity recovery story. What is your view on commodities?
More than 50 per cent of the global economy is unlikely to see much growth over the next five years and as such demand pressures will be low. This will result in commodity prices remaining suppressed (not withstanding the current rally backed by dollar weakness and expectations of economic recovery). Moreover the capacity expansion over the last few years have led to an overcapacity in lot of commodity industries which is unlikely to correct in the near term. Under the circumstances, I do not expect commodity prices to rally significantly over the next two to three years and would be more or less range bound.
Excerpts from the interview:
Have the Indian markets run up way ahead of companies’ fundamentals, especially in sectors such as realty, cement and infrastructure? The pace and ferocity of the recent rally in the stock markets is unprecedented. If one looks at a market like India, the key indices have all nearly doubled in a period of just around 13 weeks.
This run-up has come on the back of beaten down valuations, extreme pessimism and short positions in the markets, huge cash on the sidelines, improving liquidity, reducing interest rates and a bottoming of economic performance globally. The weakness in the US Dollar combined with low short-term interest rates has made the “Dollar Carry Trade” gain momentum.
If we go back to the year 2003 when the last rally started, it took the markets nearly one year to double from the bottom. The same thing has happened in just three months this time. However as a counterpoint, markets also never sold off the way they did in the year 2008. Since the fall was so sudden and sharp, the initial rally had to be sudden and sharp.
The key is that the speed of the rally has made everyone too complacent and has led to a phenomenon of panic buying in the markets.
Lot of the stocks in the above mentioned sectors have clearly run ahead of fundamentals although the prospects for cement still look positive. Valuations have moved up due to improving growth prospects and growth in the economy is likely to be strong at least for the next five years. Under the circumstances valuations will continue to remain at elevated levels over the next few quarters.
Should investors wait for a correction now to start buying?
Markets look overbought in the short run and should see some correction. I believe it is important today to stick to fundamentals and not to be carried away with the market momentum.
As we sit to evaluate what should be the course of action going forward it is important to recollect a number of data points that have come out over the last few days:
- Global trade continues to be in doldrums and both exports and imports of most countries are still in a severe downturn.
- Most large economies continue to contract and there are no signs of economic revival anywhere in the West. It is just that the pace of fall has slowed down.
- The valuations of most markets have clearly run ahead of fundamentals with most emerging markets now trading in the range of 15-17 times 2010 earnings, up from 7-10 times in the beginning of March 2009.
- The fiscal deficit projections of most governments worldwide are continuously moving up with slowing tax collections and higher spending.
- Cash on the sidelines has come down very sharply over the last two to three weeks as most institutions, especially mutual funds and FIIs whose portfolios are declared at the end of every month rushed to deploy a large part of their cash holdings so that their month end portfolio does not show huge cash throughout the rally .
- Inflows into emerging market funds which were running at over a billion dollars a week have now slowed down drastically over the last two weeks. As such a combination of low cash and low inflows should be a near-term negative.
- Markets have not been so overbought technically for a very long time and such overbought conditions will not last too long and will ultimately lead to a big sell off. The overbought nature of the markets at this point in time is similar to the markets prior to the fall in May 2006 when the markets fell off sharply before recovering in the latter part of the year. It is also similar to February 2008 when emerging markets were most oversold than ever in history.
- Government bond yields have firmed up globally over the last few weeks, driven by fears of huge borrowings and high fiscal deficits. The rise in these bond yields will make interest rate declines more difficult and may lead to interest rates stabilising at levels higher than what they should have given the global economic outlook and low inflation prevailing currently. Reducing Libor and corporate bond spreads have hidden this phenomenon in the near term, however this is something that need to be watched out
- If one includes the QIP issuances announced till date combined with the IPO pipeline, nearly $10 billion is proposed to be raised from the markets over the next one year. This is a huge supply of paper which can not only reduce the pace of market up move but also stop it at its heel.
Markets, as they start their correction, can fall by 10-20 per cent from the peak.
Mid-caps have once again caught the fancy of investors. Have the concerns about the companies abated?
The fear of insolvency or defaults in mid-cap companies has significantly reduced today. Moreover prior to the elections, most investors were unwilling to invest into mid-caps as they were not sure whether they could move out if things turned adverse. Subsequently, as investors became convinced over the long term direction of the markets, mid-caps have come back into the investment radar. Improved liquidity and reducing interest rates will now benefit mid-caps more than large caps. A vast majority of mid-caps fell by nearly 70-80 per cent in the bear market and have now bounced back to 30-50 per cent of their peak values on a broad basis. I believe that given the growth prospects of the Indian economy there are lot of quality mid-cap companies which will not only go back to their earlier highs but also move higher up. As such, any corrective moves in the market will provide a good opportunity to build up positions in high quality mid-cap companies.
Growth-oriented stocks will continue to get a greater premium over the next few weeks and months as investors become more convinced that the economy is clearly on the path of recovery. As such, long-term investors should prefer growth over value.
There have been contradicting signals on the commodity recovery story. What is your view on commodities?
More than 50 per cent of the global economy is unlikely to see much growth over the next five years and as such demand pressures will be low. This will result in commodity prices remaining suppressed (not withstanding the current rally backed by dollar weakness and expectations of economic recovery). Moreover the capacity expansion over the last few years have led to an overcapacity in lot of commodity industries which is unlikely to correct in the near term. Under the circumstances, I do not expect commodity prices to rally significantly over the next two to three years and would be more or less range bound.
Value or growth
Watching business channels during a bull market is quite a scintillating experience. The investment community quickly put on their smiley faces and go about explaining the rationale for the current market run. Words that get thrown about include contrarian, growth, value among others. Value investing, a style pioneered by Benjamin Graham in the 1930s, involves picking up shares when they are trading below what they are supposed to be worth.
Graham also popularised the idea of stock being represented by a company. What a company is worth can be estimated by parameters such as its book value, replacement cost, and cash per share and so on. Growth investing, the diametrically opposite, involved paying a premium price for a business, perceived as having great growth potential.
Blending styles
Value investing involves buying assets worth a rupee at 50 paisa and selling them when the market acknowledges the underlying asset value. The possibility for such arbitrage exists only for active and informed investors who scour through balance-sheets looking for such stocks, which Warren Buffett referred to as the cigar butt approach to investing — stocks which akin to a used cigar which have a puff or two left in them (indicative that a stock may yet have value left in it).
Such an approach does pay off in a dull market; such opportunities diminish in a bull market or in a market where a large number of investors actively seek such opportunities. With too many people chasing these opportunities, it gets more difficult to find them.
Value investing in its modern avatar has been associated with picking up businesses at low price-earnings (P/E) multiples, price-to-sales (P/S), price-to-book (P/B) or other such ratios. Value investors have traditionally taken a strongly quantitative view of a company. Metrics such as P/E, P/S, P/B values are indicative of cash flows and financial information at a specific point. These values, ‘high’ or ‘low’, are merely a starting point to investigate a prospective investment.
Growth investing has been taken to the illogical extreme of disregard for the price paid, if the prospect for growth looks promising. But if you want to invest effectively, blending these two ‘styles’ may be the right thing to do.
If you pay a ridiculously high price for growth, even stellar growth may not recoup the price you paid. Conversely a low price is no guarantee for success, if the business you invested in goes bust or does not have enough puff left.
In growth investing, success would entail buying part of business which is capable of growing at a minimum cost to investors. The latter is an oft-ignored component. Buffett in his 2007 annual letter highlighted three types of companies:
The company which grows its earnings with minimum capital expenditure;
The company which grows its earnings with capital expenditure, but the pace of earnings growth outpaces capital expenditure;
The company whose earnings growth lags the pace of its capital expenditure.
No prizes for guessing which one of the above makes for the most desirable investment.
Cost of growth
Investors should not confuse increased earnings from increased capital expenditure, with increased earnings from increased efficiency.
The cost of growth is the vital figure. If a company spends a rupee generating a rupee of growth, growth may have no impact on the stock price!
Growth and value may, therefore, have to be put together for effective investing. The environment, economics and management of the business are other components. None of these are independent of the others.
Investing is essentially an act of buying a share of a business and its future cash flows. It involves taking a view of the future cash flows, their sustainability and the cost of generating those flows.
Your call on the sustainability of a business comes from understanding ‘intangible’ aspects such as brand, demand elasticity and institutional culture. The only way to derive value from investing is in understanding how growth happens; this is the point where growth and value cease to be standalone elements.
Graham also popularised the idea of stock being represented by a company. What a company is worth can be estimated by parameters such as its book value, replacement cost, and cash per share and so on. Growth investing, the diametrically opposite, involved paying a premium price for a business, perceived as having great growth potential.
Blending styles
Value investing involves buying assets worth a rupee at 50 paisa and selling them when the market acknowledges the underlying asset value. The possibility for such arbitrage exists only for active and informed investors who scour through balance-sheets looking for such stocks, which Warren Buffett referred to as the cigar butt approach to investing — stocks which akin to a used cigar which have a puff or two left in them (indicative that a stock may yet have value left in it).
Such an approach does pay off in a dull market; such opportunities diminish in a bull market or in a market where a large number of investors actively seek such opportunities. With too many people chasing these opportunities, it gets more difficult to find them.
Value investing in its modern avatar has been associated with picking up businesses at low price-earnings (P/E) multiples, price-to-sales (P/S), price-to-book (P/B) or other such ratios. Value investors have traditionally taken a strongly quantitative view of a company. Metrics such as P/E, P/S, P/B values are indicative of cash flows and financial information at a specific point. These values, ‘high’ or ‘low’, are merely a starting point to investigate a prospective investment.
Growth investing has been taken to the illogical extreme of disregard for the price paid, if the prospect for growth looks promising. But if you want to invest effectively, blending these two ‘styles’ may be the right thing to do.
If you pay a ridiculously high price for growth, even stellar growth may not recoup the price you paid. Conversely a low price is no guarantee for success, if the business you invested in goes bust or does not have enough puff left.
In growth investing, success would entail buying part of business which is capable of growing at a minimum cost to investors. The latter is an oft-ignored component. Buffett in his 2007 annual letter highlighted three types of companies:
The company which grows its earnings with minimum capital expenditure;
The company which grows its earnings with capital expenditure, but the pace of earnings growth outpaces capital expenditure;
The company whose earnings growth lags the pace of its capital expenditure.
No prizes for guessing which one of the above makes for the most desirable investment.
Cost of growth
Investors should not confuse increased earnings from increased capital expenditure, with increased earnings from increased efficiency.
The cost of growth is the vital figure. If a company spends a rupee generating a rupee of growth, growth may have no impact on the stock price!
Growth and value may, therefore, have to be put together for effective investing. The environment, economics and management of the business are other components. None of these are independent of the others.
Investing is essentially an act of buying a share of a business and its future cash flows. It involves taking a view of the future cash flows, their sustainability and the cost of generating those flows.
Your call on the sustainability of a business comes from understanding ‘intangible’ aspects such as brand, demand elasticity and institutional culture. The only way to derive value from investing is in understanding how growth happens; this is the point where growth and value cease to be standalone elements.
Performance evaluation: Why style benchmarks are important
Investors need to evaluate the performance of a mutual fund.
The problem, however, is that performance evaluation is not always easy.
Most investors simply compare the returns on their fund with that of the S&P CNX Nifty or the BSE Sensex to validate if the fund has fared well. Is such evaluation optimal?
This article discusses why comparing with the Nifty/Sensex may be useful but not enough.
It provides an optimal framework for evaluating fund managers and also explains why diversified managers have to be benchmarked against the broad-based index such as S&P CNX 500. Logically, all portfolio managers ought to be benchmarked to the S&P CNX Nifty or the BSE Sensex. The reason is not far to seek.
An investor who is taking exposure to the market would typically choose large caps. This is because large caps are actively traded, well researched and represent the largest companies among the industries that drive the economy.
Buying index funds benchmarked to the Nifty/Sensex provides the investor low-cost (beta) exposure to the market.
Suppose an investor instead chooses to take exposure to a diversified fund.
The opportunity cost principle suggests that this active fund ought to deliver more than what the Nifty/Sensex can generate. Otherwise, the investor would have been better off with the index fund.
Perhaps, this is the reason why most asset management firms benchmark their diversified funds against the Nifty/Sensex. But this argument may not always hold good.
Style mandates
Consider a mid-cap style fund. Suppose this fund is benchmarked to the Nifty/Sensex on the opportunity cost principle.
Assume the Nifty returns 20 per cent while the fund generates only 14 per cent.
An investor cannot conclude that the fund manager has underperformed.
The reason is because the fund manager could have still delivered excess returns against her style benchmark.
What if the CNX Mid-cap index, the style benchmark for mid-cap funds, returned 10 per cent during this period?
This means that the mid-cap manager has generated alpha returns of four percentage points (excess returns over the style benchmark assuming a portfolio beta is one).
Yet, the fund lagged the Nifty/Sensex because mid-cap style underperformed the large-cap style.
The investor’s (style) decision to choose a mid-cap fund was wrong; the choice of the fund was, however, right, as the manager delivered excess returns.
Benchmarking against the Nifty/Sensex would needlessly penalise the portfolio manager.
Style rotation
What about funds that do not carry any particular style mandates?
Such funds would carry exposure to large-caps, mid-caps and to value and growth stocks with some style tilts.
How can such a fund be evaluated?
One argument is that the fund can still be benchmarked to the Nifty/Sensex. Why? Suppose the fund has mid-cap tilt and, therefore, outperformed the Nifty/Sensex, the portfolio manager can be said to have delivered alpha returns.
After all, moving from large-cap to mid-cap bias requires skill.
While such a benchmark would be useful during market turns, they become counterproductive in a trending market when mid-caps continually outperform large-caps.
A portfolio manager can continue a near-passive exposure to mid-caps and claim to have beaten the Nifty/Sensex!
An investor would rather take a low-cost exposure to mid-caps in such cases.
An appropriate benchmark index would, hence, be the S&P CNX 500, as the fund manager has unconstrained style exposure.
Only a fund beating this benchmark can be said to deliver alpha returns.
Conclusion
A two-tier approach to performance evaluation appears optimal.
Tier one would compare the fund with the relevant style benchmark or the broad-based S&P CNX 500 to assess the manager’s alpha-generating skills.
Tier two would compare the fund with Nifty/Sensex to validate if the fund has delivered value on opportunity cost principle.
The tier-one evaluation would also tell the investor if the fund manager has delivered returns commensurate with the management fees.
The problem, however, is that performance evaluation is not always easy.
Most investors simply compare the returns on their fund with that of the S&P CNX Nifty or the BSE Sensex to validate if the fund has fared well. Is such evaluation optimal?
This article discusses why comparing with the Nifty/Sensex may be useful but not enough.
It provides an optimal framework for evaluating fund managers and also explains why diversified managers have to be benchmarked against the broad-based index such as S&P CNX 500. Logically, all portfolio managers ought to be benchmarked to the S&P CNX Nifty or the BSE Sensex. The reason is not far to seek.
An investor who is taking exposure to the market would typically choose large caps. This is because large caps are actively traded, well researched and represent the largest companies among the industries that drive the economy.
Buying index funds benchmarked to the Nifty/Sensex provides the investor low-cost (beta) exposure to the market.
Suppose an investor instead chooses to take exposure to a diversified fund.
The opportunity cost principle suggests that this active fund ought to deliver more than what the Nifty/Sensex can generate. Otherwise, the investor would have been better off with the index fund.
Perhaps, this is the reason why most asset management firms benchmark their diversified funds against the Nifty/Sensex. But this argument may not always hold good.
Style mandates
Consider a mid-cap style fund. Suppose this fund is benchmarked to the Nifty/Sensex on the opportunity cost principle.
Assume the Nifty returns 20 per cent while the fund generates only 14 per cent.
An investor cannot conclude that the fund manager has underperformed.
The reason is because the fund manager could have still delivered excess returns against her style benchmark.
What if the CNX Mid-cap index, the style benchmark for mid-cap funds, returned 10 per cent during this period?
This means that the mid-cap manager has generated alpha returns of four percentage points (excess returns over the style benchmark assuming a portfolio beta is one).
Yet, the fund lagged the Nifty/Sensex because mid-cap style underperformed the large-cap style.
The investor’s (style) decision to choose a mid-cap fund was wrong; the choice of the fund was, however, right, as the manager delivered excess returns.
Benchmarking against the Nifty/Sensex would needlessly penalise the portfolio manager.
Style rotation
What about funds that do not carry any particular style mandates?
Such funds would carry exposure to large-caps, mid-caps and to value and growth stocks with some style tilts.
How can such a fund be evaluated?
One argument is that the fund can still be benchmarked to the Nifty/Sensex. Why? Suppose the fund has mid-cap tilt and, therefore, outperformed the Nifty/Sensex, the portfolio manager can be said to have delivered alpha returns.
After all, moving from large-cap to mid-cap bias requires skill.
While such a benchmark would be useful during market turns, they become counterproductive in a trending market when mid-caps continually outperform large-caps.
A portfolio manager can continue a near-passive exposure to mid-caps and claim to have beaten the Nifty/Sensex!
An investor would rather take a low-cost exposure to mid-caps in such cases.
An appropriate benchmark index would, hence, be the S&P CNX 500, as the fund manager has unconstrained style exposure.
Only a fund beating this benchmark can be said to deliver alpha returns.
Conclusion
A two-tier approach to performance evaluation appears optimal.
Tier one would compare the fund with the relevant style benchmark or the broad-based S&P CNX 500 to assess the manager’s alpha-generating skills.
Tier two would compare the fund with Nifty/Sensex to validate if the fund has delivered value on opportunity cost principle.
The tier-one evaluation would also tell the investor if the fund manager has delivered returns commensurate with the management fees.
A load off investors
Investments in mutual funds may not suffer deduction of ‘entry load’ for too long. In a move that will empower investors to determine the price they will pay for service received from a distributor, thereby reducing their cost of investing in mutual funds, the Securities and Exchange Board of India (SEBI) has asked fund houses to do away with entry load on all their schemes.
Entry load is the typical 2.25 per cent (maximum of 2.5 per cent) charge levied at the time of investing in mutual funds, mostly equity funds. While this may not seem like a conspicuous charge on paper, the levy goes to reduce the final number of units allotted to you. Such levy is almost entirely utilised by the fund house for paying the commission to the distributors for marketing their fund. In other words, a small portion of the money earmarked for investment — in the name of entry load — is paid to the distributor.
SEBI’s new proposals allow investors to directly make payments to the distributors for their services, instead of mutual fund houses deducting the same from the investment amount.
To provide an example: Had you invested Rs 10,000 in a fund which had an entry load of about 2.25 per cent and an NAV of, say, Rs 10 per unit, then, only 977.9 (10000/10.225) units would have been allotted to you, as the entry load of 2.25 per cent would have increased your cost per unit to Rs.10.225.
Under the new proposal, investors would be able to receive units for the entire amount of Rs 10,000 invested; they may have to draw a separate cheque in favour of the distributor towards a mutually agreed service fee.
This essentially means that an investor may have a choice of paying nil/small commission to an ‘no frills’ agent or go for a distributor who charges slightly higher fee, perhaps for other superior advisory service offered in addition. Viewed differently, investor will now be ‘aware’ of the commission they pay; there would be no hidden marketing charges.
Reason behind the move
While this proposal is clearly aimed at allowing the investor to decide what to pay for the service received by him/her, the move may also eliminate gratuitous churning of the portfolio by investors. In an entry load regime, distributors typically benefit more every time a fresh investment is made. Hence, it was not uncommon for distributors to recommend a switch between funds, causing churning.
Now, under the new proposal, the commission to be received by a distributor may be uncertain; the only other key source of the agent’s income would be the ‘trail commission’ received from the fund house for retaining a customer’s investments. So the motive for recommending fresh transactions may be less.
Act with discretion
Once this proposal comes into force, investors may be prompted to immediately scout for a no/low commission distributor. Beware! For one, you may be sold a fund with a poor track record or one on which the agent receives a higher ‘trail’ commission. That may not be the best fund for your portfolio. Please bear in mind that a consistent long term track record and a risk profile that suits your appetite should be the key factors that determine your investment choice.
As we have always maintained, in the Indian market context, an entry load of 2.5 per cent or a commission paid to the distributor is a small sum, compared to the 12-15 per cent annualised return that a good equity fund can easily yield.
Two, if commissions on MFs go down, products such as ULIPs may look attractive from a distributor’s point of view given their lucrative commission. Ensure that you are not sold an ULIP when you do not want one. ULIPs are long term insurance-cum-investment products. They generally build in expenses upwards of 10 per cent, in the initial years. This sum would be deducted from your investment amount.
So as an investor, what should be your response to this change?
As always, ensure that you choose a fund based on its track record. Expenses or commissions come next.
Do not be diverted into buying ‘other’ products if your objective is to buy a mutual fund
If you are a less-informed investor and need advice, do not hesitate to pay a decent sum to a good financial advisor/distributor. There are no free lunches.
If you are a well-informed investor, making your own investment decisions, you can apply for funds directly through their portals or approach any of the local offices of the fund house you want to invest in. This way there would be no commission. If you wish to make such an investment through your online broking account, you may do so; this would however entail paying a fee.
As a distributor has to now reveal the commission that he receives from the fund house for the product, ask him for the same. That way, you will know whether you are paying too high a commission or otherwise.
Note that there has been no indication so far as to the implementation date of this proposal. There are also other grey areas in implementation of the same, especially on the distribution side, which too may have to be addressed.
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Entry load is the typical 2.25 per cent (maximum of 2.5 per cent) charge levied at the time of investing in mutual funds, mostly equity funds. While this may not seem like a conspicuous charge on paper, the levy goes to reduce the final number of units allotted to you. Such levy is almost entirely utilised by the fund house for paying the commission to the distributors for marketing their fund. In other words, a small portion of the money earmarked for investment — in the name of entry load — is paid to the distributor.
SEBI’s new proposals allow investors to directly make payments to the distributors for their services, instead of mutual fund houses deducting the same from the investment amount.
To provide an example: Had you invested Rs 10,000 in a fund which had an entry load of about 2.25 per cent and an NAV of, say, Rs 10 per unit, then, only 977.9 (10000/10.225) units would have been allotted to you, as the entry load of 2.25 per cent would have increased your cost per unit to Rs.10.225.
Under the new proposal, investors would be able to receive units for the entire amount of Rs 10,000 invested; they may have to draw a separate cheque in favour of the distributor towards a mutually agreed service fee.
This essentially means that an investor may have a choice of paying nil/small commission to an ‘no frills’ agent or go for a distributor who charges slightly higher fee, perhaps for other superior advisory service offered in addition. Viewed differently, investor will now be ‘aware’ of the commission they pay; there would be no hidden marketing charges.
Reason behind the move
While this proposal is clearly aimed at allowing the investor to decide what to pay for the service received by him/her, the move may also eliminate gratuitous churning of the portfolio by investors. In an entry load regime, distributors typically benefit more every time a fresh investment is made. Hence, it was not uncommon for distributors to recommend a switch between funds, causing churning.
Now, under the new proposal, the commission to be received by a distributor may be uncertain; the only other key source of the agent’s income would be the ‘trail commission’ received from the fund house for retaining a customer’s investments. So the motive for recommending fresh transactions may be less.
Act with discretion
Once this proposal comes into force, investors may be prompted to immediately scout for a no/low commission distributor. Beware! For one, you may be sold a fund with a poor track record or one on which the agent receives a higher ‘trail’ commission. That may not be the best fund for your portfolio. Please bear in mind that a consistent long term track record and a risk profile that suits your appetite should be the key factors that determine your investment choice.
As we have always maintained, in the Indian market context, an entry load of 2.5 per cent or a commission paid to the distributor is a small sum, compared to the 12-15 per cent annualised return that a good equity fund can easily yield.
Two, if commissions on MFs go down, products such as ULIPs may look attractive from a distributor’s point of view given their lucrative commission. Ensure that you are not sold an ULIP when you do not want one. ULIPs are long term insurance-cum-investment products. They generally build in expenses upwards of 10 per cent, in the initial years. This sum would be deducted from your investment amount.
So as an investor, what should be your response to this change?
As always, ensure that you choose a fund based on its track record. Expenses or commissions come next.
Do not be diverted into buying ‘other’ products if your objective is to buy a mutual fund
If you are a less-informed investor and need advice, do not hesitate to pay a decent sum to a good financial advisor/distributor. There are no free lunches.
If you are a well-informed investor, making your own investment decisions, you can apply for funds directly through their portals or approach any of the local offices of the fund house you want to invest in. This way there would be no commission. If you wish to make such an investment through your online broking account, you may do so; this would however entail paying a fee.
As a distributor has to now reveal the commission that he receives from the fund house for the product, ask him for the same. That way, you will know whether you are paying too high a commission or otherwise.
Note that there has been no indication so far as to the implementation date of this proposal. There are also other grey areas in implementation of the same, especially on the distribution side, which too may have to be addressed.
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Friday, June 19, 2009
WHAT TO INVEST IN A BOOM AND IN DECLINES
I have been watching the NAV movements of open ended equity schemes, balanced schemes and monthly income schemes for the past two years. During the period from 17.01.2008 to 7.03.2009, popular equity schemes fell by 48 – 66 per cent and balanced funds by 39 – 45 per cent. Monthly Income Plans have hardly seen a 6 – 10 per cent fall. So, am I correct in concluding that in a booming market, you should go for equity or balanced funds and in difficult times, switch to MIPs to protect capital? Is such an inference / strategy warranted by analysis for longer periods?
Your observations are right. There has been a wide divergence in performance between equity funds, balanced funds and monthly income plans over this period, mainly due to their differing allocation to stocks. While equity funds typically have over 85 per cent of the portfolio invested in stocks, balanced funds have 60-75 per cent and monthly income plans less than 15 per cent, with the balance in debt instruments.
But you should also note that while a lower exposure to stocks helped balanced funds and MIPs in the falling markets of last year, you will find the situation exactly reversed in 2009. Over the last six months, equity funds have gained 53 per cent, while balanced funds have gained 38 per cent. MIPs are far behind with a 9.5 per cent return.
Theoretically, it would be ideal for investors to have a high allocation to stocks and equity funds in a bull market, and cut it to near zero (holding cash or liquid funds) when the market is in a downturn, thus protecting capital.
But this strategy is quite difficult to practise, as this will require you to correctly predict both a bull market and a downturn ahead of the event. The events of last year have proved that practically no one was able to tell us in advance that the Sensex would peak in January 2008. Similarly no one was sure in early March this year that it would recover to this extent.
Investors who sold equity funds during last year’s fall will, in fact, tell you that they completely missed the rally since March, as they failed to re-invest this money when the Sensex bottomed at 8000 levels. Getting out of equity funds after a fall has started; and trying to get in after the market has gained, may lead to wrongly timed moves, which can further destroy wealth.
This is the key reason why experts advocate that maintaining a steady asset allocation: a predetermined mix between equity, debt and other avenues, is the best way to ensure that your portfolio is not too affected by the swings of the equity market. Once you try and maintain a fixed allocation between equity funds and debt options in your portfolio, you will automatically sell when markets are high and buy when they are low, to re-balance your portfolio.
In order to avoid the worst of equity market losses, it is necessary to maintain a diversified portfolio, without an unduly high equity exposure. Balanced funds are a good option for investors who are comfortable with an over 60 per cent equity exposure.
Gold ETFs can be a good diversifier, as they may perform when equity funds don’t. But we wouldn’t recommend MIPs as an option to investors looking for a “safe” component to their portfolio. Bank term deposits, the small savings schemes and liquid funds (if liquidity and not returns, are your priority) are the best places to park the “safe” portion of your portfolio. Park only that portion of your money in equity funds that you don’t require over the next five years.
Your observations are right. There has been a wide divergence in performance between equity funds, balanced funds and monthly income plans over this period, mainly due to their differing allocation to stocks. While equity funds typically have over 85 per cent of the portfolio invested in stocks, balanced funds have 60-75 per cent and monthly income plans less than 15 per cent, with the balance in debt instruments.
But you should also note that while a lower exposure to stocks helped balanced funds and MIPs in the falling markets of last year, you will find the situation exactly reversed in 2009. Over the last six months, equity funds have gained 53 per cent, while balanced funds have gained 38 per cent. MIPs are far behind with a 9.5 per cent return.
Theoretically, it would be ideal for investors to have a high allocation to stocks and equity funds in a bull market, and cut it to near zero (holding cash or liquid funds) when the market is in a downturn, thus protecting capital.
But this strategy is quite difficult to practise, as this will require you to correctly predict both a bull market and a downturn ahead of the event. The events of last year have proved that practically no one was able to tell us in advance that the Sensex would peak in January 2008. Similarly no one was sure in early March this year that it would recover to this extent.
Investors who sold equity funds during last year’s fall will, in fact, tell you that they completely missed the rally since March, as they failed to re-invest this money when the Sensex bottomed at 8000 levels. Getting out of equity funds after a fall has started; and trying to get in after the market has gained, may lead to wrongly timed moves, which can further destroy wealth.
This is the key reason why experts advocate that maintaining a steady asset allocation: a predetermined mix between equity, debt and other avenues, is the best way to ensure that your portfolio is not too affected by the swings of the equity market. Once you try and maintain a fixed allocation between equity funds and debt options in your portfolio, you will automatically sell when markets are high and buy when they are low, to re-balance your portfolio.
In order to avoid the worst of equity market losses, it is necessary to maintain a diversified portfolio, without an unduly high equity exposure. Balanced funds are a good option for investors who are comfortable with an over 60 per cent equity exposure.
Gold ETFs can be a good diversifier, as they may perform when equity funds don’t. But we wouldn’t recommend MIPs as an option to investors looking for a “safe” component to their portfolio. Bank term deposits, the small savings schemes and liquid funds (if liquidity and not returns, are your priority) are the best places to park the “safe” portion of your portfolio. Park only that portion of your money in equity funds that you don’t require over the next five years.
Thursday, June 11, 2009
How good is your exit strategy?
If you belong to the class of investors who exit mutual funds when markets fall and invest after they have risen, you are never likely to make money in the markets. Nowadays, with more and more investors investing in mutual funds via Systematic Investment Plans, the tendency to stop investing in equity mutual funds when the markets are down is on the decline. Nevertheless, having a sound set of criteria regarding when to sell your mutual fund holdings is perhaps as important as knowing which funds to invest in.
Investments in mutual funds should be made with a defined time horizon. Typically for long duration funds such as equity funds, the time horizon should not be less than three to five years. “Investors should invest with a goal — your child’s education, marriage, or retirement planning. Once the goal is attained, you may exit,” says R Raja, product head, UTI asset management company (AMC). However, under certain circumstances investors may have to take a call and exit a fund even before their goals have been attained.
Consistently poor performance. At the end of every year evaluate the performance of your fund. According to Vishal Dhawan, a Mumbai-based financial planner, “Compare the performance of the fund with its benchmark and category average returns. If the fund consistently underperforms against these benchmarks for a year, exit.” During the last one year prior to March, some funds did not do well when the markets were plunging. But the same funds did very well when the markets were on the upswing in the last couple of months. According to Gopal Agarwal, head-equity, Mirae Asset Global Investment (India), “Evaluate the performance of a fund and an AMC after at least a year, so that the cycle gets completed and you can get a clear picture.”
What investors also need to compare is the risk-adjusted returns of funds. Ratios such as Sharpe ratio and Treynor ratio allow you to do this. You may find this information on web sites such as valueresearchonline.com and mutualfundsindia.com and also in the fact sheets of funds.
To rebalance portfolio. Another reason for exiting or lowering your holding in a mutual fund could be that the markets have run up and your portfolio has become overweight in a certain asset class, such as equities. Says Dhawan: “Your asset allocation should depend on your risk appetite and investment horizon. Evaluate how much exposure you want to assets such as equities, debt, and commodities. If the asset mix gets skewed vis-à-vis a particular asset class in which you have invested through a mutual fund, you need to trim your exposure and get back to the original asset allocation.”
Change in fund mandate. Investment in mutual funds should be driven by objectives. If your objectives are not getting fulfilled, exit. Recently, a couple of mutual fund houses have proposed the merger of some of their schemes. When such an event occurs, you need to decide whether to remain invested or to exit from the merged scheme. “If there are changes in the mandate of the fund and if you find that your investment goals are not being met, opt for the exit,” says Dhawan. Adds Jaideep Lunial, a Chandigarh-based financial planner: “If the fund was invested 50 per cent in equities and after the change the exposure rises to 80 per cent, the investor should exit the fund if it does not suits his needs.”
Change of fund manager. Fund houses promote their star fund manager’s performance and launch new schemes under his name. Many investors too pursue the strategy of following the fund manager. They invest in mutual funds based on the fund manager’s reputation, and when the fund manager exits, they too exit along with him. An alternative approach could be to evaluate the qualities of the new fund manager by making inquiries about his track record. According to Lunial, follow-the-manager may no longer be a good strategy. “Of late, fund houses are no longer focusing on the fund manager. The performance of funds is becoming more system and process driven,” he says.
Burgeoning fund size. When the size of a fund becomes very large, producing market-beating returns becomes more difficult. If earlier, say, 30 investment ideas sufficed to fetch good results, now the fund manager needs a hundred or more. Or, for instance, a small-sized mid-cap fund may find it easy to pick up sufficient number of quality mid-cap stocks. But if the fund size balloons, finding so many quality mid-cap stocks might become difficult. If size is beginning to hinder performance, exit.
When you need money. This is one of the most important reasons for selling your mutual-fund holdings. However, before selling, decide which asset you should sell so that the returns from your portfolio get affected the least. “In a falling interest rate environment, where fixed deposits (FDs) lose their sheen and equities become attractive, selling the former could be a better exit option,” suggests Agarwal
Different categories, different motives
Investors invest in different categories of mutual funds for different reasons, hence their reasons for exiting these funds also vary. According to Krishnan Sitaraman, director, CRISIL Fund Services, “Typically, in case of liquid funds, investors, generally corporates, invest for a short time horizon and the decision to exit could be driven by their liquidity needs.” Moreover, Dhawan says, in a debt fund the quality of the portfolio, and not just returns, is critical. Investors invest in these funds as a substitute for deposits and don’t like to risk the principal. So they look not only at the risk associated with the portfolio, but also at the risk associated with the various components of the portfolio, he says.
Bottomline
According to Sitaraman, “Investments in mutual funds should be made for the long term unless one’s objective is to trade or to profit from short-term movements. You should ideally not exit investments in such categories prior to this time horizon unless there is an urgent requirement.”
Adds Lunial: “Bear in mind the exit load (if any) and the higher tax burden you may have to pay if you make an early exit.” For equity funds, the tax on short-term capital gains (if you sell within one year) is 16.99 per cent (inclusive of surcharge and education cess), while on long-term capital gains (if you sell after a year) it is zero. In the debt category, the short-term capital gains tax is charged at your marginal income tax rate. Long-term capital gains tax is the lower of the two rates: 10 per cent without indexation or 20 per cent with indexation. For an investor in the higher tax bracket, exiting after a year would be a less costly affair.
Investors who enter a mutual fund without a clear exit strategy are likely to meet the same fate as befell Abhimanyu who managed to enter the chakravyuh but then could not fight his way out of it.
Investments in mutual funds should be made with a defined time horizon. Typically for long duration funds such as equity funds, the time horizon should not be less than three to five years. “Investors should invest with a goal — your child’s education, marriage, or retirement planning. Once the goal is attained, you may exit,” says R Raja, product head, UTI asset management company (AMC). However, under certain circumstances investors may have to take a call and exit a fund even before their goals have been attained.
Consistently poor performance. At the end of every year evaluate the performance of your fund. According to Vishal Dhawan, a Mumbai-based financial planner, “Compare the performance of the fund with its benchmark and category average returns. If the fund consistently underperforms against these benchmarks for a year, exit.” During the last one year prior to March, some funds did not do well when the markets were plunging. But the same funds did very well when the markets were on the upswing in the last couple of months. According to Gopal Agarwal, head-equity, Mirae Asset Global Investment (India), “Evaluate the performance of a fund and an AMC after at least a year, so that the cycle gets completed and you can get a clear picture.”
What investors also need to compare is the risk-adjusted returns of funds. Ratios such as Sharpe ratio and Treynor ratio allow you to do this. You may find this information on web sites such as valueresearchonline.com and mutualfundsindia.com and also in the fact sheets of funds.
To rebalance portfolio. Another reason for exiting or lowering your holding in a mutual fund could be that the markets have run up and your portfolio has become overweight in a certain asset class, such as equities. Says Dhawan: “Your asset allocation should depend on your risk appetite and investment horizon. Evaluate how much exposure you want to assets such as equities, debt, and commodities. If the asset mix gets skewed vis-à-vis a particular asset class in which you have invested through a mutual fund, you need to trim your exposure and get back to the original asset allocation.”
Change in fund mandate. Investment in mutual funds should be driven by objectives. If your objectives are not getting fulfilled, exit. Recently, a couple of mutual fund houses have proposed the merger of some of their schemes. When such an event occurs, you need to decide whether to remain invested or to exit from the merged scheme. “If there are changes in the mandate of the fund and if you find that your investment goals are not being met, opt for the exit,” says Dhawan. Adds Jaideep Lunial, a Chandigarh-based financial planner: “If the fund was invested 50 per cent in equities and after the change the exposure rises to 80 per cent, the investor should exit the fund if it does not suits his needs.”
Change of fund manager. Fund houses promote their star fund manager’s performance and launch new schemes under his name. Many investors too pursue the strategy of following the fund manager. They invest in mutual funds based on the fund manager’s reputation, and when the fund manager exits, they too exit along with him. An alternative approach could be to evaluate the qualities of the new fund manager by making inquiries about his track record. According to Lunial, follow-the-manager may no longer be a good strategy. “Of late, fund houses are no longer focusing on the fund manager. The performance of funds is becoming more system and process driven,” he says.
Burgeoning fund size. When the size of a fund becomes very large, producing market-beating returns becomes more difficult. If earlier, say, 30 investment ideas sufficed to fetch good results, now the fund manager needs a hundred or more. Or, for instance, a small-sized mid-cap fund may find it easy to pick up sufficient number of quality mid-cap stocks. But if the fund size balloons, finding so many quality mid-cap stocks might become difficult. If size is beginning to hinder performance, exit.
When you need money. This is one of the most important reasons for selling your mutual-fund holdings. However, before selling, decide which asset you should sell so that the returns from your portfolio get affected the least. “In a falling interest rate environment, where fixed deposits (FDs) lose their sheen and equities become attractive, selling the former could be a better exit option,” suggests Agarwal
Different categories, different motives
Investors invest in different categories of mutual funds for different reasons, hence their reasons for exiting these funds also vary. According to Krishnan Sitaraman, director, CRISIL Fund Services, “Typically, in case of liquid funds, investors, generally corporates, invest for a short time horizon and the decision to exit could be driven by their liquidity needs.” Moreover, Dhawan says, in a debt fund the quality of the portfolio, and not just returns, is critical. Investors invest in these funds as a substitute for deposits and don’t like to risk the principal. So they look not only at the risk associated with the portfolio, but also at the risk associated with the various components of the portfolio, he says.
Bottomline
According to Sitaraman, “Investments in mutual funds should be made for the long term unless one’s objective is to trade or to profit from short-term movements. You should ideally not exit investments in such categories prior to this time horizon unless there is an urgent requirement.”
Adds Lunial: “Bear in mind the exit load (if any) and the higher tax burden you may have to pay if you make an early exit.” For equity funds, the tax on short-term capital gains (if you sell within one year) is 16.99 per cent (inclusive of surcharge and education cess), while on long-term capital gains (if you sell after a year) it is zero. In the debt category, the short-term capital gains tax is charged at your marginal income tax rate. Long-term capital gains tax is the lower of the two rates: 10 per cent without indexation or 20 per cent with indexation. For an investor in the higher tax bracket, exiting after a year would be a less costly affair.
Investors who enter a mutual fund without a clear exit strategy are likely to meet the same fate as befell Abhimanyu who managed to enter the chakravyuh but then could not fight his way out of it.
REAL ESTATE - PUNE
In November 2007, the Government of Maharashtra gave the nod for 100-metre buildings in Pune. The official notification issued on November 15 of that year gave vertical growth a robust push. With the bar raised substantially from the prevailing height restriction of 36 m (12-floors) that had came into force a decade earlier, 30-floor buildings (above the ground) are poised to become a reality.
The move has set the ball rolling for a transformation of the Pune skyline, and the city is slowly, but surely, evolving from one dominated by low-rise residential and commercial structures to one where buildings, a dozen ones to begin with, will, literally speaking, soon tower above the landscape. Clearly, penthouses are set to get a new, more evocative meaning.
Flying off the shelves
Part of the evolution process is the gradual ebbing away of the claustrophobia associated with lifts and fear of dizzying heights amongst the buying clientele. Pune-based developer Kumar Builders was the first to announce the launch of its first 100 m high residential tower of 80 apartments about two weeks ago. Kruti Jain, Executive Director, said that houses located on floors 15-23 (currently permission up to 70 m height has been procured, and the rest is under process) are flying off the shelves. “In the first week, we received bookings for 50 per cent of the houses. In fact, there is a wait list for those who want a house on a particular floor,” she says, adding the second tower in the four-tower 45 Nirvana Hills project in Erandwane will open for bookings in a month’s time. The going rate for bare flats (minus fittings and paint) is Rs 4,500 per sq.ft, with Rs 25 per sq.ft for floor raise. One of the notable features in this scheme will be a one-acre garden on the 30th floor.
As of today, there are at least two other developers in the 100 m tall building space. Panchshil Realty’s first residential project in this dimension will be YOO Pune by Phillipe Starck at Hadapsar. It will offer some 240 apartments (5 BHK condominiums) spread in six towers (totalling 1.3 million sq. ft) situated within a landscaped parkland.
Bookings are expected to open a few months on. Panchshil Tech Park at Kalyani Nagar is a commercial project in the same space.
Evaluation committee
According to an official in the Pune Municipal Corporation, sanctions to build up to 70 m have been accorded to 14 independent projects, involving both residential and commercial spaces. Most of these will apply for sanctioning of the added 30 m.
“A four-member high-rise technical committee headed by the Divisional Commissioner has been formed to evaluate these (100 m) proposals. The committee held its previous meeting last month,” he says. Sanction for the city’s first 100 m high-rise may be just a few weeks away. Also on the cards is extension of the 100 m height rule, currently applicable in the old city limits, to 23 villages brought into the PMC area in 1997.
The move has set the ball rolling for a transformation of the Pune skyline, and the city is slowly, but surely, evolving from one dominated by low-rise residential and commercial structures to one where buildings, a dozen ones to begin with, will, literally speaking, soon tower above the landscape. Clearly, penthouses are set to get a new, more evocative meaning.
Flying off the shelves
Part of the evolution process is the gradual ebbing away of the claustrophobia associated with lifts and fear of dizzying heights amongst the buying clientele. Pune-based developer Kumar Builders was the first to announce the launch of its first 100 m high residential tower of 80 apartments about two weeks ago. Kruti Jain, Executive Director, said that houses located on floors 15-23 (currently permission up to 70 m height has been procured, and the rest is under process) are flying off the shelves. “In the first week, we received bookings for 50 per cent of the houses. In fact, there is a wait list for those who want a house on a particular floor,” she says, adding the second tower in the four-tower 45 Nirvana Hills project in Erandwane will open for bookings in a month’s time. The going rate for bare flats (minus fittings and paint) is Rs 4,500 per sq.ft, with Rs 25 per sq.ft for floor raise. One of the notable features in this scheme will be a one-acre garden on the 30th floor.
As of today, there are at least two other developers in the 100 m tall building space. Panchshil Realty’s first residential project in this dimension will be YOO Pune by Phillipe Starck at Hadapsar. It will offer some 240 apartments (5 BHK condominiums) spread in six towers (totalling 1.3 million sq. ft) situated within a landscaped parkland.
Bookings are expected to open a few months on. Panchshil Tech Park at Kalyani Nagar is a commercial project in the same space.
Evaluation committee
According to an official in the Pune Municipal Corporation, sanctions to build up to 70 m have been accorded to 14 independent projects, involving both residential and commercial spaces. Most of these will apply for sanctioning of the added 30 m.
“A four-member high-rise technical committee headed by the Divisional Commissioner has been formed to evaluate these (100 m) proposals. The committee held its previous meeting last month,” he says. Sanction for the city’s first 100 m high-rise may be just a few weeks away. Also on the cards is extension of the 100 m height rule, currently applicable in the old city limits, to 23 villages brought into the PMC area in 1997.
Sunday, June 7, 2009
Don’t get carried away by forecasts
The equity market continues to surprise investors, both pleasantly and otherwise. In the last two years, the market first lulled investors into believing that what was near 21,000 would become 25,000 soon and 30,000 in no time. And then came the big blow in the form of the global turmoil, and ‘sub-prime’ became a household term.
The market surprised investors on the negative side and we saw 15,000, 10,000 and very nearly 8,000 as well. For a long time investors were again lulled into believing that the story on investing in equity markets was over and done with and what was near 7,000 would ultimately end up at well below 5,000. Throughout 2008 and early 2009 investors have remained out of equity investing, be it directly in stocks or through mutual funds. And lo and behold the market has now started surprising on the positive side.
While it is necessary for us to try and gain and understanding of market movement over every possible time horizon, investors who are looking to build their wealth to meet their life goals over a long-term horizon do not need to be disturbed or carried away by near term market movements. They need to stick to certain basics on selecting the right kind of asset class — debt, equity, etc. — and the right kind of vehicle that can help them make profitable investments in the chosen asset class.
Who talks of losses
Rather than focusing on stock market movements investors’ energies will be well spent in determining what will help them generate right returns to achieve their life goals. It is quite normal for investors to get carried away with the reporting of movements in the Sensex or Nifty and associated number of percentage growth in various stocks and mutual fund NAVs.
It’s quite common nowadays to go to a social function and hear some people talking about how they doubled their money in some mid-cap in a matter of few days. But they do not highlight how they lost 50 per cent by investing in something else.
Consistency not a fluke
Mutual funds are the best example of financial democracy, as they allow investors to implement and review with high flexibility and frequency. Investors must definitely invest with mutual funds which are like service providers for managing their money through professional approach and here too they must focus on longevity and a healthy consistent average performance.
So, rather than focusing on the last three months, six months, two days and one year numbers, investors need to focus on average performance over last 5-10 years. Consistency does not come by fluke.
Consistent long-term performance is clearly the mantra for mutual fund evaluation and a risk mitigated mutual fund portfolio. Another critical determinant in mutual fund investment is transparency and access to information.
With the market suddenly looking northwards, getting carried away by fads are easy. Focus should rather be in analysing the fundamental strength and objectivity of the investment mandate. Investments should be made in avenues that offer high transparency and information support so that investors can participate in the upside and also not worry in the eventuality of a downside. Ultimately the power of knowledge means the power to take prudent investment calls.
The market may move up or down and will continue to remain volatile in line with its character. An investor, by ensuring due diligence-based decision-making, can ensure sustainable long term wealth creation.
The market surprised investors on the negative side and we saw 15,000, 10,000 and very nearly 8,000 as well. For a long time investors were again lulled into believing that the story on investing in equity markets was over and done with and what was near 7,000 would ultimately end up at well below 5,000. Throughout 2008 and early 2009 investors have remained out of equity investing, be it directly in stocks or through mutual funds. And lo and behold the market has now started surprising on the positive side.
While it is necessary for us to try and gain and understanding of market movement over every possible time horizon, investors who are looking to build their wealth to meet their life goals over a long-term horizon do not need to be disturbed or carried away by near term market movements. They need to stick to certain basics on selecting the right kind of asset class — debt, equity, etc. — and the right kind of vehicle that can help them make profitable investments in the chosen asset class.
Who talks of losses
Rather than focusing on stock market movements investors’ energies will be well spent in determining what will help them generate right returns to achieve their life goals. It is quite normal for investors to get carried away with the reporting of movements in the Sensex or Nifty and associated number of percentage growth in various stocks and mutual fund NAVs.
It’s quite common nowadays to go to a social function and hear some people talking about how they doubled their money in some mid-cap in a matter of few days. But they do not highlight how they lost 50 per cent by investing in something else.
Consistency not a fluke
Mutual funds are the best example of financial democracy, as they allow investors to implement and review with high flexibility and frequency. Investors must definitely invest with mutual funds which are like service providers for managing their money through professional approach and here too they must focus on longevity and a healthy consistent average performance.
So, rather than focusing on the last three months, six months, two days and one year numbers, investors need to focus on average performance over last 5-10 years. Consistency does not come by fluke.
Consistent long-term performance is clearly the mantra for mutual fund evaluation and a risk mitigated mutual fund portfolio. Another critical determinant in mutual fund investment is transparency and access to information.
With the market suddenly looking northwards, getting carried away by fads are easy. Focus should rather be in analysing the fundamental strength and objectivity of the investment mandate. Investments should be made in avenues that offer high transparency and information support so that investors can participate in the upside and also not worry in the eventuality of a downside. Ultimately the power of knowledge means the power to take prudent investment calls.
The market may move up or down and will continue to remain volatile in line with its character. An investor, by ensuring due diligence-based decision-making, can ensure sustainable long term wealth creation.
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