Wednesday 16 October 2013

Why you don’t make money from Income Funds

The last few weeks have been extremely turbulent and volatile for the financial markets - stock markets have been moving up and down in crazy frenzy moves, bond yields have been galloping upwards resulting in falling bond prices, precious metals (gold and silver) hitting new multi-year lows while the Indian rupee hitting all time life time lows. The striking of them all is the realization to many a fund investors that they have lost money in Income / Debt / Bond Funds. Yes, it’s very difficult for a fixed income investor to digest the fact of losing his capital.

You don’t make money from Income Funds because of:

Interest Rate Risks
Although the name is Fixed Income securities, there are different types of risks while investing in them like credit risks, interest rate risks, yield curve risks, liquidity risks and basis risks. A very misunderstood, formidable, unquantifiable and underrated risk is “interest rate risk”. This risk is directly related with the maturity of a security – the longer the maturity the higher the risk (and return). For long dated fixed income securities, when interest rates increase the price of the bond decreases and vice versa. Therefore, if you invest in Income Funds during an increasing interest rate environment then the value of the fund is likely to depreciate.

Absurd outdated advise from Fund Advisors
Investments in income funds should ideally be done when the interest rates are high because of dual factors – firstly, the inherent yield of the income fund would be elevated which will ensure high accrual income and secondly, if interest rates are currently high then other things remaining constant, there is more likelihood of it going down in the future. However, unfortunately income funds are generally not marketed when interest rates are high but are actually promoted when interest rates have already moved down because when interest rates have already softened in the near past, the return from Income Funds would be unsustainably super normal which would look further bloated when it is incorrectly annualized.   

Fund Manager Bias
Any fund manager hates when his fund underperforms. And the fund manager would certainly not like when there is negative return on a debt product like an Income Fund. Hence, during an increasing interest rate environment, the fund manager would unjustifiably reduce the maturity of the fund and start managing an income fund like a short term plan going against the very mandate of the fund itself.

Poor Performance does not come cheap
Income Funds are nothing but interest yielding debt products. But, when someone deducts high fees from the interest rate then what would happen – substantial fall in the income yields. That is what happens with Income Funds which are loaded with high fund management expenses. After all, poor performance does not come cheap!

Conclusion

There are some distinct advantages of investing in Income Funds like tax arbitrage since return on growth funds is treated as capital gains as compared to interest income in the case of bank fixed deposits and hence subject to lower tax rates along with indexation benefits, a chance to ride the interest rate cycle, invest in GSecs etc. However, your success with Income Funds, like any other investment would depend on dual factors. Firstly, the entry point of your investment – timing is very important while investing in Income Funds, if you invest just before an increasing interest rate cycle then unfortunately it would take many months or even couple of years to regain by way of interest accrual the capital which you might have lost. Secondly the exit point, Income Fund like any other product is not an investment for the long term, once you ride the downward shift in the yield curve, it is time to pack your bags, book your profits and get out of it.


To conclude, learn to ride the interest rate curve earning above normal profits from your Income Fund investments and not allow the fund manager or advisor to have a ride with your money.  

Thursday 15 August 2013

How to make money during bad times

The last few weeks have been extremely turbulent and volatile for the Indian financial markets. Stock markets have been moving up and down in crazy frenzy moves, bond yields have been galloping upwards resulting in falling bond prices, precious metals (gold and silver) hitting new multi-year lows and the striking of them all – the Indian rupee hitting all time life time lows. Keeping up with the current mood, lot of investors would be contemplating as to where to put their hard earned money with an eye on return “of” and return “on” their money. This article attempts to dissect the different opportunities available so as to bring to the fore the best investment option for you in the current turbulent times.

The investments options can be dividend based on liquidity, risk, time horizon as well as the category of the asset itself - debt, equity, commodity or real estate. Without making an attempt to confuse the reader, the table below provides an overview of the various asset classes, the time horizon, type of risk, what kind of return to expect, suitability as well as the timing of the investment in a clear logical manner so as to aid the decision making process.


Investment Option
Asset Class
Investment Time Horizon
Type of Risk
Intensity of Risk
Return Expectation
Suitability
Comments
Liquid / Ultra Short Term MF
Fixed Income – Mutual Fund
Very Short Term
Credit Risk
Very Low
Low
For parking surplus funds
For temporary parking of funds – a superior alternative to Bank Savings Account
Short Term Plans
Fixed Income – Mutual Funds
Short Term
Credit Risk & Moderate Interest Rate Risk
Low
Comparatively Low
Opportunistic Superior returns for short term funds
For short term better investment in an inverted yield curve scenario
Income / Gilt Funds
Fixed Income
Medium to Long Term
Credit Risk & High Interest Rate Risk
High
Medium to High
Opportunistic Superior returns for medium to long term funds
For medium to long term opportunistic investment in a steep yield curve scenario
MF Fixed Maturity Plan /
Fixed Income – Mutual Funds
Medium to Long Term
Credit & Yield Curve Risk
Low
Medium
Fixed Return for Fixed Duration
As a superior tax saving alternative to Bank Fixed Deposits. Ideally done at the peak of policy interest rate hike cycle.
Bank Fixed Deposit
Fixed Income – Banks
Medium to Long Term
Yield Curve Risk
Very Low
Medium
Fixed Return for Fixed Duration
Less tax efficient as compared to MF FMPs. Ideally done at the peak of policy interest rate hike cycle.
Balanced Fund - MF
Hybrid - Equity + Fixed Income
Medium to Long Term
Credit, Interest Rate & Stock Market Risk
Medium
Medium to High
Ideal for Asset Allocation
Balance of risk, return, asset allocation with maximum tax advantages
Direct Equity or Mutual Fund
Equity
Long Term
Stock Market Risk
High
High
For long term wealth creation
Moderate Risk for superior return – higher risk and tax adjusted return
Physical Gold or Gold Fund
Commodity
Long Term
Commodity & Currency Risk
High
Medium to High
High risk for higher inflation adjusted returns
For betting on the movement of a commodity and currency
Physical Real Estate or Real Estate Fund
Real Estate
Long Term
High
Moderate to High
Medium to High
Undefined Risk in expectation of return
At the peak of the interest rate cycle when property prices have just started rising
International Fund
Primarily Equity but can also be commodities, bonds or real estate
Medium to Long Term
Global Market and Currency Risk
High
High
For diversifying into difficult asset classes along with assuming currency risk

High unknown and un-measurable risk in expectation of better returns


Conclusion

To conclude, there are many simple and avoidable mistakes which investors mutually commit at the time of investing. Simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc. Returns from investment come only because of two numbers – cost and selling price. This article makes an attempt to bring out the cost price factor by letting you know which is the best investment option for you. There is no other place to test your virtues than the market. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses. Investing is not about beating the market or anybody else, it’s simply beating your own self, your own negative traits and once you are able to master your own self and become a complete human being, then only you would also become a successful investor. Articulate your investment goals, know your time horizon, recognize your risk appetite, understand your need for income and growth, invest regularly although it may be in small lots, do your thinking and research and after doing it don’t panic just because the market went against you, accept your mistakes and flaws and follow the above mentioned simple rules and principles to select the best investment option for you.



Thursday 6 June 2013

In Search of the Bull’s Birth

The global equity markets have been overly volatile over the past few months. This has left many an investors gasping for breath. Now, if somebody studies the great bear market bottoms of the last century – 1907, 1921, 1932, 1949, 1974 and 1982 from where equities multiplied in the coming years along with the study of human behavior, mass psychology, behavior finance and the “madness of crowds” spanning back by around last 500 years including the minor financial revolution of the 1550s, troubles of Henry VIII, Francois I, the Fuggers, the Genose and eighteenth century “madness of crowds” like the South Sea Bubble, Tulip Bulb craze and the Mississippi bubbles, then certain conclusions can be drawn from history.

What do we learn from financial history? How do we identify a great bear market bottom? There are lots of factors which are common to the great bear market bottoms. However, it’s very difficult to anticipate it. Some of the common factors which we find at bear market bottoms are as under. Also, the current positioning of the Indian markets in regards to them are given alongside: 

Ø  Commodity price stabilization: There should be stabilization in prices of commodities which precede an equity market rally. The most important commodity which is of prime importance in determining the stabilization of commodity prices turns out to be copper. This is currently happening globally.
Ø  Price stabilization: Improving demand for certain goods at lower levels, particularly autos. This has still not happened currently in India but it seems that we are going through the worst phase for the auto industry and it is likely to improve over the coming months.
Ø  Reduction in Central Bank controlled interest rates: This has worked in all the great bear market bottoms of the last Century in the US – 1907, 1921, 1932, 1949, 1974, 1982. RBI policy is one of the most powerful tools in determining the equity market bottoms because there is no other factor as important for equity valuations as is interest rates – it affects the profitability of companies through change in the finance and interest costs, valuations through change in discount rate and competes with equities for the same investment surplus.
Ø  Rally in Government Bond prices: The rally in Government bond prices has preceded a rally in high grade corporate bonds which has preceded a rally in equities with the exception of the 1949 great bear market bottom. However, that was an abnormal period when the Fed was controlling its policy interest rates due to the extra ordinary deflationary fear prevailing at that time post World War II. Currently, in India, 10-year GSec yields at 7.15% are closer to 3 ½ year lows.
Ø  Rally in Corporate Bond Prices: Rally in high grade corporate bonds follows rally in Government bonds (except in 1949 as described above) while precedes rally in equities. This phenomenon is currently playing out in India.
Ø  Rising volumes on strong stock market and falling volumes on weak stock market – this has still to be established in the current Indian markets.
Ø  Rising Short interest and the reluctance of shorts to cover on rising equity prices.
Ø  Positive signals from Dow Theory: Of all the technical methods, Dow Theory was the only one which correctly predicted the bottom at all the major bear market bottoms of the last century in the US. Every bottom in the Indian indices is a higher one and each subsequent “corrective move” is shorter in time and value. However, the rally in the large cap indices has turned very narrow and confirmation is required from the mid cap indices.

It is not that a new bull market has begun for Indian equities but maybe we are close to some kind of a bear market bottom in the Indian equity markets. To conclude, the conditions seem to suggest that the bear might be losing stream. However, that does not mean that the new bull has taken birth. The new bull may take birth only when certain macro factors like growth, inflation, interest rates, currency, deficit, corporate earnings etc stabilize or appear to be stabilizing.   


Friday 22 February 2013

10 Secrets of Mutual Fund Investing


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What do you think – is investment a problem or solution? Who does your investment make rich – your or the middleman i.e. the mutual fund, broker, distributor, rating agency, company promoter etc? How do you select a MF scheme – on your knowledge, experience or judgment or based on some recommendation or tip by a so called fund expert or market guru? Have you ever lost money in absolute terms i.e. entire or a part of your capital? Have you ever lost money in relative terms i.e. your investments earning positive returns but much less than the other alternative investments? Have you been able to differentiate between good and bad mutual fund schemes? Do you know the true clandestine of long term wealth creation? If not, then read on to unlock the true secrets of mutual fund investing.

Avoid the herd mentality

The typical mutual fund investors buy decision is usually heavily influenced by the actions of his acquaintances, neighbours or relatives. Thus, if everybody around is investing in a particular fund, the tendency for potential investors is to do the same. But this strategy is bound to backfire in the long term. No need to say that you should always avoid having the herd mentality if you don't want to lose your hard-earned money in the markets. And this rule applies to a mutual fund investor as well as a fund manager. The world's greatest investor Warren Buffett was surely not wrong when he said, "Be fearful when others are greedy, and be greedy when others are fearful!"


Take informed decision

Proper research should always be undertaken before investing in funds. But that is rarely done. If you don't have time or temperament for studying the markets, you may even take the help of a financial advisor.


Invest in business you understand

Never invest in a fund which you don’t understand. Never buy a fund which has a low NAV but always invest in a fund which has a good underlying portfolio of stocks, bonds or whatever the case which may be. And invest in the fund which you understand – equity, fixed income, money market, commodity, hybrid etc. Don’t invest in fancy fund names, sector or thematic funds – remember they are just fads by mutual fund managers and their distributors to loot the gullible investor of his hard earned money.
Understand, for instance, what your fund buys and sells, and how they make money. Thus, the more you understand the business of the company, the better you will be able to monitor your mutual fund investment.


Don't try to time the Fund

One thing that even Warren Buffett doesn't do is to try to time the stock market, although he does have a very strong view on the price levels appropriate to individual shares. A majority of investors, however, do just the opposite, something that financial planners have always been warning them to avoid, and thus lose their hard-earned money in the process. So, you should never try to time the market. In fact, nobody has ever done this successfully and consistently over multiple business or market cycles. Catching the tops and bottoms is a myth. It is so till today and will remain so in the future. In fact, in doing so, more people have lost far more money than people who have made money. And if you can’t time the market than it is a sine qua non that you would not be able to and never try to time your mutual fund investment.

Follow a disciplined investment approach

Historically, it has been witnessed that even great bull runs have shown bouts of panic moments. The volatility witnessed in the markets has inevitably made investors lose money despite in the great bull runs. Lot of investors, although successful in the short term, actually lose over the long term simply because they don’t follow a disciplined investment approach. However, the investors who put in money systematically, in the right shares and held on to their investments patiently have been seen generating outstanding returns. Hence, it is prudent to have patience and follow a disciplined investment approach besides keeping a long-term broad picture in mind. Remember that investment is a simple mechanical boring process.

Do not let emotions cloud your judgment

Many investors have been losing money in stock markets due to their inability to control emotions, particularly fear and greed. In a bull market, the lure of quick wealth is difficult to resist. Greed augments when investors hear stories of fabulous returns being made in the stock market in a short period of time. This leads them to speculate, invest in fancy mutual fund schemes of lesser known funds without really understanding the risk involved. Instead of creating wealth, these investors thus burn their fingers very badly the moment the sentiment in the market reverses. In a bear market, on the other hand, investors panic and sell their long held good mutual fund schemes at rock-bottom prices. Thus, fear and greed are the worst emotions to feel when investing, and it is better not to be guided by them.

Create a broad portfolio of funds

Almost 90% of portfolio variability is due to asset allocation while only 10% of the variability in portfolio performance is due to market timing and stock selection. The only thing in your control is asset allocation and the good news as written in lesson number 1 is that 90% of portfolio variability is due to asset allocation. Diversification of portfolio across asset classes and instruments is the key factor to earn optimum returns on investments with minimum risk. The reason for the relatively poor performance of portfolios of individual investors even in greatest of bull runs has been lots of variation in different schemes. There have been periods running into several months or years when the entire rally has been in equities or on other occasions by fixed income securities while sometimes by inflation hedges like gold. So, it becomes imperative to diversify your portfolio across various mutual fund schemes which provide you with such a diversification.

Have realistic expectations

There's nothing wrong with hoping for the 'best' from your mutual fund investments, but you could be heading for trouble if your financial goals are based on unrealistic assumptions. For instance, lots of equity funds have generated more than 50% returns during the great bull run of recent years or even debt fund returned in excess of 25% in times of substantial fall in interest rates. However, it doesn't mean that you should always expect the same kind of return from the markets. Have realistic expectations from your mutual fund investments – this in itself will ensure that you avoid a lot of common financial mistakes.

Invest only your surplus funds in high risk funds

If you want to take risk in by investing in high risk unknown funds, then see whether you have surplus funds which you can afford to lose. It is not necessary that you will lose money in them; your investments can give you huge gains too in the months to come. But no one can be hundred percent sure. That is why you will have to take risk. No need to say that invest only if you are flush with surplus funds.

Monitor rigorously

We are living in a global village. Any important event happening in any part of the world has an impact on our financial markets. Hence we need to constantly monitor our portfolio and keep affecting the desired changes in them. If you can't review your portfolio due to time constraint or lack of knowledge, then you should take the help of a good financial planner or someone who is capable of doing that. And while selecting a good broker or distributor don’t go after some high flying big name or market guru; instead opt for a person with common sense who considers himself as a student of investing.

Conclusion

To conclude, there are many simple and avoidable mistakes which we human beings as social animals succumb to at different levels of our dealing with money, be it at the time of earning, protecting, budgeting, saving, spending, leveraging, investing and insuring. Market is a place which will test your patience and character. Many times you might have bought the right stock or Mutual Fund for all the right reasons at the right price but it simply refuses to go up for a long period of time – just hang on to it because the day you get frustrated and sell it off, there are chances it will then start rising. Hence, patience and character are key virtues which will be repeatedly tested by the market. This article made a humble attempt to explain the 10 secrets of mutual fund investing.   

Before I end this article, kindly note that simple logical things work far better in the market place rather than complex algorithms, theorems, valuations principles, DCF etc. And there is no other place to test your virtues than at the time of dealing with money – be it common sense, logical thinking, patience, perseverance, mental balance, emotional intelligence, performing under stress etc. All the qualities which make a successful human being will be tested by the market –it has its own method of finding and exploiting human weaknesses. Investing is not about beating the market or anybody else, its simply beating your own self, your own negative traits and once you are able to master your own self and become a complete human being, then only you would also become a successful investor. Articulate your investment goals, know your time horizon, recognize your risk appetite, understand your need for income and growth, invest regularly although it may be in small lots, do your thinking and research and after doing it don’t panic just because the market went against you, accept your mistakes and flaws and avoid the common mistakes which human beings commit while dealing with money and investing so as to embark on becoming your own a successful “money manager” and a complete human being.