One of our readers who had a windfall from his employer to the tune of Rs 6 lakh informed us that that he was planning to invest this sum for long term in a combination of equity funds, hybrid debt-oriented schemes and monthly income schemes (MIP) for diversification. Would this be an optimal strategy?
Maybe not. If one has the risk appetite for equity investment and if the time horizon is long, an ideal strategy would be to invest in a pure equity fund and just stagger the investment over a long period.
Hybrid funds or monthly income plans are not good options to route the equity part of your investment. The expenses ratio and capital gain taxes are two major hindrances for the investors investing in them. Here is why.
Tax factor
Hybrid debt schemes have expense ratios varying from 0.75% to 2.5% a year and MIPs, by and large, have expense ratios of about 2%.
Consider this: An investor is willing to invest in a hybrid debt scheme a sum of Rs 2 lakh for a ten-year period. Assuming his investment is generating hybrid debt return (11.7% over the past five years) for next 10 years, an investment of Rs 2 lakh will become Rs 6 lakh at the end of the maturity period.
Since these are debt schemes, long-term capital gains in respect of units held more than 12 months are chargeable to tax at 20%, after factoring in the cost of inflation index. Alternatively, they are taxed at 10% without indexation. This means the investor would end up paying capital gains tax for the entire returns, including the equity portion.
For an appreciation of Rs 4 lakh, if the long-term capital gains are taxed at a flat 10%, the total tax out go will be Rs 40,000. Had the investor, instead, split his investment between equity and a debt fund, his tax outgo would be much lower because equity funds enjoy a more favorable tax structure.
If the investor had instead spread out the Rs 2 lakh as Rs 1.2 lakh in a debt fund and Rs 80,000 in equity fund, the maturity value could be Rs 5.8 lakh assuming that he generate similar returns. Under the second option, LTCG will be just Rs 24,000 and his overall return could have increased by Rs 16,000.
Similar to hybrid debt schemes, investors in MIPs too suffer higher tax incidence. Hence, investors will be better off separating the debt and equity investments to save a higher tax outgo and to generate higher return if their time horizon is for longer period.
However, debt would be a better option if your investments are for less than three years and you would like to stay away from the vagaries of the equity market.
Investors can separate their debt and equity investments to reduce tax outgo and generate higher returns over a longer period.
Saturday, June 26, 2010
Investing in tough times: Some tips
Are we in a slowdown or in a recession? Well, nobody has an answer to this question. When we see the media hysteria we keep wondering how `shriller` can the voices become?
If you are in the middle portion of your life and surrounded by EMIs for your house, children`s education, car payments the situation will of course be scary. And we in the media business love to write about `negative things` rather than positive things. The current state of the economy could be a worry. What should you do in such a slow down? Here is some generic advice that might help.
Your goals still standIf you are a scientific investor, most of your investments will be towards a specific goal. So unless you are sure that a particular goal is not important (and your spouse also feels the same way) do not touch the amounts set aside for a specific important goal. Early withdrawals from insurance and life insurance plans can be very expensive in terms of costs and taxes. Perhaps more importantly if the equity market looks up even a little your investments could recoup very well. Howsoever tempting, do not touch moneys to which you have given direction and momentum.
Many eggs in 3-4 baskets
All types of financial assets - life insurance, mutual funds, savings bank accounts, bank fixed deposits, provident fund schemes, government securities, equities, etc. all of them have a role in life. Each asset class (real estate, debt and equity) - perform differently in different economic climates. Stop chasing media headlines. This is a time when you will hear statements like `Cash is King`, `Stay away from equities` - just ignore them. There is no permanently correct investment advice. Today there are people who can manipulate data for long periods of time and come up with `newsletters` - ignoring most of it has its advantages too!
Track changes in your lifeIf you did your risk profiling 5 years back, do it again. Do not take on too much risk when the markets are rising and cut equity exposure when markets are down. Realise that `risk` is largely counter intuitive. If you feel there was no risk, risk may be at its maximum and vice-versa! However if you are closer to some event for which you are saving, then you may still find it worthwhile to sell. In the last 5 years you have built some assets, you son has started working, your EMIs are over, your car loan is paid off… if all this has happened you may need less insurance. But if the goals are valid, the savings and investments are not enough to fill the gaps, keep your term life insurance valid and in force. If you are dependent on your company`s group insurance - life and medical - take an individual policy and keep it live. In case of a job loss it will be vital.
Think Long Term, not next quarter
Markets are cyclical! It is only the media which should be worried about quarterly results. You should not be so short term `ish` in your thinking. So it should call for long periods of inaction. Warren Buffet says at Berkshire Hathway we think of this as a good habit. Markets fall, and then they go up - the broad index is wavy, ALWAYS over the long term. Rather than react to the market, it makes sense to create a carefully considered long-term strategy, especially when it comes to your long-term needs. Frankly if you are saving money for your daughters post graduate education, and she is 3 years of age - how does it matter that the markets will take 6 months to recover? You should be worried about the corpus size only when your daughter is 3-4 years away from graduation.
Use the Knowledge of Your Advisor / Relationship Manager, if any!
If any - was meant for the advisor, not his knowledge! Unfortunately most life insurance companies and mutual funds chase only the `potential` new customer with all kind of freebies. The existing advisors and investors are not helped at all - either in the form of guides or teaching aids. It is imperative that you learn and understand on your own - and know the art of wealth creation and for most of my clients` - wealth preservation!
If you are in the middle portion of your life and surrounded by EMIs for your house, children`s education, car payments the situation will of course be scary. And we in the media business love to write about `negative things` rather than positive things. The current state of the economy could be a worry. What should you do in such a slow down? Here is some generic advice that might help.
Your goals still standIf you are a scientific investor, most of your investments will be towards a specific goal. So unless you are sure that a particular goal is not important (and your spouse also feels the same way) do not touch the amounts set aside for a specific important goal. Early withdrawals from insurance and life insurance plans can be very expensive in terms of costs and taxes. Perhaps more importantly if the equity market looks up even a little your investments could recoup very well. Howsoever tempting, do not touch moneys to which you have given direction and momentum.
Many eggs in 3-4 baskets
All types of financial assets - life insurance, mutual funds, savings bank accounts, bank fixed deposits, provident fund schemes, government securities, equities, etc. all of them have a role in life. Each asset class (real estate, debt and equity) - perform differently in different economic climates. Stop chasing media headlines. This is a time when you will hear statements like `Cash is King`, `Stay away from equities` - just ignore them. There is no permanently correct investment advice. Today there are people who can manipulate data for long periods of time and come up with `newsletters` - ignoring most of it has its advantages too!
Track changes in your lifeIf you did your risk profiling 5 years back, do it again. Do not take on too much risk when the markets are rising and cut equity exposure when markets are down. Realise that `risk` is largely counter intuitive. If you feel there was no risk, risk may be at its maximum and vice-versa! However if you are closer to some event for which you are saving, then you may still find it worthwhile to sell. In the last 5 years you have built some assets, you son has started working, your EMIs are over, your car loan is paid off… if all this has happened you may need less insurance. But if the goals are valid, the savings and investments are not enough to fill the gaps, keep your term life insurance valid and in force. If you are dependent on your company`s group insurance - life and medical - take an individual policy and keep it live. In case of a job loss it will be vital.
Think Long Term, not next quarter
Markets are cyclical! It is only the media which should be worried about quarterly results. You should not be so short term `ish` in your thinking. So it should call for long periods of inaction. Warren Buffet says at Berkshire Hathway we think of this as a good habit. Markets fall, and then they go up - the broad index is wavy, ALWAYS over the long term. Rather than react to the market, it makes sense to create a carefully considered long-term strategy, especially when it comes to your long-term needs. Frankly if you are saving money for your daughters post graduate education, and she is 3 years of age - how does it matter that the markets will take 6 months to recover? You should be worried about the corpus size only when your daughter is 3-4 years away from graduation.
Use the Knowledge of Your Advisor / Relationship Manager, if any!
If any - was meant for the advisor, not his knowledge! Unfortunately most life insurance companies and mutual funds chase only the `potential` new customer with all kind of freebies. The existing advisors and investors are not helped at all - either in the form of guides or teaching aids. It is imperative that you learn and understand on your own - and know the art of wealth creation and for most of my clients` - wealth preservation!
Why managing your portfolio is exciting?
In India, more than 10 million people invest in the stock market and that number is growing fast. You might say that 10 million people couldn`t be wrong but that argument doesn`t always hold true.
Keeping up with the news, studying broker reports and punching in your own trades all takes time and effort and these days there are hundreds of low-cost, low-effort investment schemes you could choose from.
So, if managing your own portfolio means putting in more time and effort, shouldn`t you get more money back in return?
However, that isn`t really why we do it anyway. The reason why so many of us invest in the stock market is that `Do-it-yourself` (DIY) investing has an appeal that mutual funds will never have.
Excitement
Short-term investing or speculating has often been likened to gambling, not only because of the high risks involved but also because of the way it makes people feel.
Although few people would admit to being stock market thrill seekers, the excitement of the markets is clearly a factor in their popularity and the risks that put some people off are themselves a big draw for others.
The masses of eyeballs glued to ticking prices on broker screens up and down the country are testimony to that.
Enjoyment
For many of us, the appeal of investing is the research itself. Digging into a company`s background or researching a particular industry can be an extremely interesting activity and almost a reward in itself.
I say almost because like many pursuits it`s more engaging when there`s something riding on it.
Only a few die-hard hobbyists would spend hours researching an investment they had no intention of making so the prospect of doing it `just for fun` doesn`t have the same appeal.
Control
In the same way that some people prefer to keep gold at home rather than putting their money in a bank some of us prefer to know exactly where our shares are.
Although a fund manager may be more qualified than us to make investment decisions, there is a certain satisfaction that comes from doing things yourself.
Keeping up with the news, studying broker reports and punching in your own trades all takes time and effort and these days there are hundreds of low-cost, low-effort investment schemes you could choose from.
So, if managing your own portfolio means putting in more time and effort, shouldn`t you get more money back in return?
However, that isn`t really why we do it anyway. The reason why so many of us invest in the stock market is that `Do-it-yourself` (DIY) investing has an appeal that mutual funds will never have.
Excitement
Short-term investing or speculating has often been likened to gambling, not only because of the high risks involved but also because of the way it makes people feel.
Although few people would admit to being stock market thrill seekers, the excitement of the markets is clearly a factor in their popularity and the risks that put some people off are themselves a big draw for others.
The masses of eyeballs glued to ticking prices on broker screens up and down the country are testimony to that.
Enjoyment
For many of us, the appeal of investing is the research itself. Digging into a company`s background or researching a particular industry can be an extremely interesting activity and almost a reward in itself.
I say almost because like many pursuits it`s more engaging when there`s something riding on it.
Only a few die-hard hobbyists would spend hours researching an investment they had no intention of making so the prospect of doing it `just for fun` doesn`t have the same appeal.
Control
In the same way that some people prefer to keep gold at home rather than putting their money in a bank some of us prefer to know exactly where our shares are.
Although a fund manager may be more qualified than us to make investment decisions, there is a certain satisfaction that comes from doing things yourself.
This makes the business of managing your own portfolio seem less like a chore but does have the disadvantage of leaving you with no one to blame if things don`t turn out as planned.
Overconfidence
Like it or not, some of us just fancy our chances. It may be illogical to assume we can beat the market but most of us can be illogical sometimes.
Sure we know that 10 million of us can`t all be winners but that`s no reason to think one of the lucky ones won`t be me. Not only can human nature help us to mentally inflate our own abilities but also the markets themselves have an uncanny ability to reward even rank amateurs.
You would have a fairly good chance of making a profit by randomly buying any of the blue-chip stocks and yet all it takes is a couple of winning trades before we start seeing Warren Buffett in the mirror each morning.
Whatever your reasons may be there are plenty of people who say retail investors are better off staying at home and letting someone else manage their money for them. On strictly logical terms they are correct.
Many fund managers fail to consistently beat the market so there really is no reason to assume that the DIY approach will be the more profitable way to invest.
However, this argument ignores the real reasons why lots of us play the markets. It`s not only to make money (although that is very important), we also do it because we like it. Investing because you enjoy it makes perfect sense so long as you realize this is what you`re doing. If you find yourself spending more and more time shuffling a shrinking portfolio you might want to ask yourself whether this is a hobby you can really afford.
Overconfidence
Like it or not, some of us just fancy our chances. It may be illogical to assume we can beat the market but most of us can be illogical sometimes.
Sure we know that 10 million of us can`t all be winners but that`s no reason to think one of the lucky ones won`t be me. Not only can human nature help us to mentally inflate our own abilities but also the markets themselves have an uncanny ability to reward even rank amateurs.
You would have a fairly good chance of making a profit by randomly buying any of the blue-chip stocks and yet all it takes is a couple of winning trades before we start seeing Warren Buffett in the mirror each morning.
Whatever your reasons may be there are plenty of people who say retail investors are better off staying at home and letting someone else manage their money for them. On strictly logical terms they are correct.
Many fund managers fail to consistently beat the market so there really is no reason to assume that the DIY approach will be the more profitable way to invest.
However, this argument ignores the real reasons why lots of us play the markets. It`s not only to make money (although that is very important), we also do it because we like it. Investing because you enjoy it makes perfect sense so long as you realize this is what you`re doing. If you find yourself spending more and more time shuffling a shrinking portfolio you might want to ask yourself whether this is a hobby you can really afford.
How the revised tax code impacts you?
Pressure from many sections of taxpayers has led the government to effect revisions in its Direct Taxes Code (DTC) proposals.
The revised code has several beneficial aspects of which the most beneficial is that it has toned down its stance on tax concessions granted to home loan repayments.
Going by the plea that without social security the proposed EET (Exempt-Exempt-Taxed) structure was harsh on individuals, the revised code has proposed to bring some relief to long-term savings investment such as PF, PPF, New Pension Scheme, approved pure life insurance, annuity schemes and GPF. These will now be subject to the Exempt-Exempt-Exempt (EEE) method of taxation rather the EET model proposed last year.
The revised code has several beneficial aspects of which the most beneficial is that it has toned down its stance on tax concessions granted to home loan repayments.
Going by the plea that without social security the proposed EET (Exempt-Exempt-Taxed) structure was harsh on individuals, the revised code has proposed to bring some relief to long-term savings investment such as PF, PPF, New Pension Scheme, approved pure life insurance, annuity schemes and GPF. These will now be subject to the Exempt-Exempt-Exempt (EEE) method of taxation rather the EET model proposed last year.
Here`s how some of the provisions affect your personal finances:
Existing and new home loan borrowers have a reason to cheer. The revised DTC proposes to follow the existing method of tax deduction on home loan at least for the interest paid. In case of the house being self-occupied, the individual will be eligible for deduction of interest on capital borrowed for acquisition or construction of the house, subject to a ceiling of Rs 1.5 lakh, from the gross total income.
This revised proposal is a change from the earlier stand of disallowing tax exemptions on the interest and principal paid on house property.
However, the revised code has preferred to be silent on the status of principal repayments on home loans, which are now allowed under section 80C.
While extending this benefit for self-occupied properties, borrowers need to note that the revised code suggests that interest paid towards home loan will be adjusted under the overall savings limit of Rs 3 lakh a year proposed for section 80C.
The New Pension Scheme, which was launched with fanfare as a social security measure, was struggling to find patronage owing to uncertainties relating to its tax structure. In an attempt to make this scheme more attractive and to introduce some flexibility in making withdrawals in lump sum without being subject to taxation, the revised code proposes to extend the EEE method of taxation to the pension scheme administered by the Pension Fund Regulatory and Development Authority, apart from PF, GPF and recognized provident funds.
The revised code has preferred to retain its stand on pure life insurance and annuity schemes, but has kept unit-linked plans out of the EEE method of taxation. ULIPs continue to be clubbed with savings options like the NSC, ELSS and bank deposits.
With annuity products brought under EEE it may encourage long-term savings, and help increase social security after retirement.
The earlier code proposed to remove the distinction between short-term and long-term capital gains, based on the investor`s holding period. Now that has been tweaked.
Under the revised code, capital gains arising on account of transfer of equity shares or units of an equity oriented fund held for more than one year will be computed after allowing a deduction at a specific percentage of capital gains without any indexation.
This `specific percentage` is yet to be notified.
After adjusting the capital gains thus, the balance will be included in the total income of tax payer and taxed at the applicable rate. According to the revised code, the individual in the lower bracket will pay a lower tax for capital gains compared to those in higher tax brackets.
To illustrate, if an investor has invested in an equity fund at a NAV of Rs 10 and sells his unit at Rs 110, the capital gains before deduction at the specified rate comes to Rs 100. Supposing the rate of deduction is 50%, this would stand reduced to Rs 50. The capital gain of Rs 50 would then be added to the tax payer`s income and taxed at the applicable rate. If tax payer is in a 10% slab, such gain will bear Rs 5 as tax.
Existing and new home loan borrowers have a reason to cheer. The revised DTC proposes to follow the existing method of tax deduction on home loan at least for the interest paid. In case of the house being self-occupied, the individual will be eligible for deduction of interest on capital borrowed for acquisition or construction of the house, subject to a ceiling of Rs 1.5 lakh, from the gross total income.
This revised proposal is a change from the earlier stand of disallowing tax exemptions on the interest and principal paid on house property.
However, the revised code has preferred to be silent on the status of principal repayments on home loans, which are now allowed under section 80C.
While extending this benefit for self-occupied properties, borrowers need to note that the revised code suggests that interest paid towards home loan will be adjusted under the overall savings limit of Rs 3 lakh a year proposed for section 80C.
The New Pension Scheme, which was launched with fanfare as a social security measure, was struggling to find patronage owing to uncertainties relating to its tax structure. In an attempt to make this scheme more attractive and to introduce some flexibility in making withdrawals in lump sum without being subject to taxation, the revised code proposes to extend the EEE method of taxation to the pension scheme administered by the Pension Fund Regulatory and Development Authority, apart from PF, GPF and recognized provident funds.
The revised code has preferred to retain its stand on pure life insurance and annuity schemes, but has kept unit-linked plans out of the EEE method of taxation. ULIPs continue to be clubbed with savings options like the NSC, ELSS and bank deposits.
With annuity products brought under EEE it may encourage long-term savings, and help increase social security after retirement.
The earlier code proposed to remove the distinction between short-term and long-term capital gains, based on the investor`s holding period. Now that has been tweaked.
Under the revised code, capital gains arising on account of transfer of equity shares or units of an equity oriented fund held for more than one year will be computed after allowing a deduction at a specific percentage of capital gains without any indexation.
This `specific percentage` is yet to be notified.
After adjusting the capital gains thus, the balance will be included in the total income of tax payer and taxed at the applicable rate. According to the revised code, the individual in the lower bracket will pay a lower tax for capital gains compared to those in higher tax brackets.
To illustrate, if an investor has invested in an equity fund at a NAV of Rs 10 and sells his unit at Rs 110, the capital gains before deduction at the specified rate comes to Rs 100. Supposing the rate of deduction is 50%, this would stand reduced to Rs 50. The capital gain of Rs 50 would then be added to the tax payer`s income and taxed at the applicable rate. If tax payer is in a 10% slab, such gain will bear Rs 5 as tax.
ULIP row ends; but will investor be a final winner?
With the government bringing the curtain down on the tussle, insurance companies are now free to issue fresh ULIPs and their regulator IRDA can continue to guide them.
The finance minister has kept his word. A fortnight ago he had assured life insurance companies that the dispute between IRDA and SEBI over the regulation of unit linked insurance policies or ULIPs will be resolved soon.
Now the government has ended the row by promulgating an ordinance on Friday stating that unit linked insurance policies with investment component are insurance products which will come under the regulatory jurisdiction of IRDA and not SEBI.
It amended four Acts to make it clear that ULIPs are not securities and they did not form part of collective investment schemes or mutual funds.
These amendments nullify SEBI`s April 9 ban on 14 insurance companies from issuing ULIPs because they are made effective retrospectively from that date. While making it amply clear that SEBI has no regulatory jurisdiction over ULIPs, the government has also ensured that SEBI or any other regulator will not step into the jurisdiction of other hybrid products.
Joint Mechanism
To avoid any similar regulatory turf war in the future, the government has also set up a high-level panel, called a joint mechanism - with representations from RBI, SEBI, IRDA, PFRDA and the government.
It is made mandatory for the regulators to refer to the panel any dispute or difference of opinion over the regulation of a hybrid product. The panel will have to give its decision to the government within three months and it will be binding on all regulators.
The panel appears to be similar to that of the existing High Level Co-ordination Committee (HLCC) of the capital market under the chairmanship of the RBI governor.
The difference is that at HLCC decisions are based on consensus and they are not binding on the members.
The finance minister has kept his word. A fortnight ago he had assured life insurance companies that the dispute between IRDA and SEBI over the regulation of unit linked insurance policies or ULIPs will be resolved soon.
Now the government has ended the row by promulgating an ordinance on Friday stating that unit linked insurance policies with investment component are insurance products which will come under the regulatory jurisdiction of IRDA and not SEBI.
It amended four Acts to make it clear that ULIPs are not securities and they did not form part of collective investment schemes or mutual funds.
These amendments nullify SEBI`s April 9 ban on 14 insurance companies from issuing ULIPs because they are made effective retrospectively from that date. While making it amply clear that SEBI has no regulatory jurisdiction over ULIPs, the government has also ensured that SEBI or any other regulator will not step into the jurisdiction of other hybrid products.
Joint Mechanism
To avoid any similar regulatory turf war in the future, the government has also set up a high-level panel, called a joint mechanism - with representations from RBI, SEBI, IRDA, PFRDA and the government.
It is made mandatory for the regulators to refer to the panel any dispute or difference of opinion over the regulation of a hybrid product. The panel will have to give its decision to the government within three months and it will be binding on all regulators.
The panel appears to be similar to that of the existing High Level Co-ordination Committee (HLCC) of the capital market under the chairmanship of the RBI governor.
The difference is that at HLCC decisions are based on consensus and they are not binding on the members.
With the government bringing the curtain down on the tussle, insurance companies are now free to issue fresh ULIPs and their regulator IRDA can continue to guide them.
Significantly, the ordinance has not only lifted the uncertainty that affected sale of ULIPs, but has also brought relief to thousands of unit holders who were worried about their investments ever since the turf war broke out between the regulators two months ago.
As an insurance company official pointed out, the government could have done this before the issue came to a head and the finance minister directing the regulators to approach the court to get a mandate on who has the right to regulate ULIPs. This would have avoided the two-month uncertainty and the public interest litigations filed by investors.
The IRDA, which emerged as the winner in the battle, is reportedly working on new guidelines for ULIPs. This could probably take care of the interest of investors in unit linked policies.
Investors Interest
The question now is whether the basic issues such as mis-selling and high agent`s commission over which SEBI took up the cudgels on behalf of investors get resolved. Its main contention was that ULIPs are essentially investment products and therefore insurance companies issuing them should take prior permission from the capital market regulator. But the underlying issue was the high commission (up to 30%-40% in the first year) paid to agents by investors in ULIPs.
SEBI was said to be under pressure from the mutual fund lobby as after it banned entry load on MF, their sales came down sharply as agents preferred selling ULIPs.
Though it was an investor protection move by SEBI, it came under flak for its unilateral action.
SEBI`s Achievement
Thought it is perceived that the ordinance has come as a slap in the face of capital market regulator SEBI, it has a score of things to its credit.
It was SEBI`s action that forced IRDA to take up reform of unit linked policies. After the tussle broke out, IRDA has initiated a slew of measures to make ULIPs more investor friendly. From July 1, agents selling ULIP will have to disclose to the customer the exact amount of commission they will get. IRDA has also fixed the minimum term of ULIPs to five years, made life cover compulsory for pension funds, and proposed capping surrender charges.
Now that IRDA has emerged as the winner, it is the regulator`s interest to ensure that policy holders` interests are taken care of - so that the investor becomes the final winner.
Significantly, the ordinance has not only lifted the uncertainty that affected sale of ULIPs, but has also brought relief to thousands of unit holders who were worried about their investments ever since the turf war broke out between the regulators two months ago.
As an insurance company official pointed out, the government could have done this before the issue came to a head and the finance minister directing the regulators to approach the court to get a mandate on who has the right to regulate ULIPs. This would have avoided the two-month uncertainty and the public interest litigations filed by investors.
The IRDA, which emerged as the winner in the battle, is reportedly working on new guidelines for ULIPs. This could probably take care of the interest of investors in unit linked policies.
Investors Interest
The question now is whether the basic issues such as mis-selling and high agent`s commission over which SEBI took up the cudgels on behalf of investors get resolved. Its main contention was that ULIPs are essentially investment products and therefore insurance companies issuing them should take prior permission from the capital market regulator. But the underlying issue was the high commission (up to 30%-40% in the first year) paid to agents by investors in ULIPs.
SEBI was said to be under pressure from the mutual fund lobby as after it banned entry load on MF, their sales came down sharply as agents preferred selling ULIPs.
Though it was an investor protection move by SEBI, it came under flak for its unilateral action.
SEBI`s Achievement
Thought it is perceived that the ordinance has come as a slap in the face of capital market regulator SEBI, it has a score of things to its credit.
It was SEBI`s action that forced IRDA to take up reform of unit linked policies. After the tussle broke out, IRDA has initiated a slew of measures to make ULIPs more investor friendly. From July 1, agents selling ULIP will have to disclose to the customer the exact amount of commission they will get. IRDA has also fixed the minimum term of ULIPs to five years, made life cover compulsory for pension funds, and proposed capping surrender charges.
Now that IRDA has emerged as the winner, it is the regulator`s interest to ensure that policy holders` interests are taken care of - so that the investor becomes the final winner.
Choosing a pension policy
If you are looking to secure a regular income on retirement, pension plans offered by insurance companies possibly offer the widest menu of choices. Market-linked investment options, various choices on the annuity and a favorable tax structure for such policies are some of the reasons why investors should consider them.
Here we tell you what options are available:
An investor has to be clear about three things before buying a pension policy - the age at which he wishes to retire (vesting age), the retirement corpus, i.e. the money needed post-retirement, and the premium he can manage to pay to build that corpus.
In a pension policy, the buyer pays a fixed premium till he reaches the vesting age. Based on one`s choice of investment (in case of a unit-linked plan, the insured is offered choices; in traditional plans the choice is not in the hands of the buyer of the policy), the insurer invests this fund to generate returns.
At the time of maturity of the policy, that is, when the buyer reaches the vesting age, he will be allowed to redeem as a lump sum (called commuting) one-third of the accumulated fund. The remaining fund balance has to be converted into an annuity or annual pension payment.
An annuity policy is a product by itself. One need not buy the annuity from the same insurer who sold the pension policy. Under an annuity contract, the insurer uses the lump sum amount paid by the buyer to pay him back a guaranteed sum at regular intervals till his death (or for a fixed period). Annuity plans guarantee a nominal return. Annuity rates (return) are reviewed every month by the insurers. But once an annuity is taken, the rate remains fixed. LIC offers annuity at 6.5%-7% per annum. ICICI Prudential Life Insurance, HDFC Standard Life and SBI Life also offer annuity (also called immediate annuity) products.
Options
Pension policies come with and without life cover. However, recent IRDA regulations require an insurance cover, to be implemented in future. Pension products that come with life cover charge additional premium.
For example, ICICI Pru Assure Pension, a unit-linked pension product, charges Rs 133 per lakh of sum assured annually as mortality charge. Kotak Retirement Income Plan Premium, a traditional pension policy, offers life cover and without life cover plans. The with-cover plan comes at a premium of Rs 9,750 per annum for a male of 35 years when the sum assured is Rs 3 lakh. The same policy without life cover will come for a premium of Rs 9,060 annually.
Pension policies also fall under-traditional and unit-linked groups. Traditional policies do not give full disclosure of their underlying investments; they predominantly invest in government bonds and very little in equities. Some of the traditional pension policy providers offer even vesting bonuses (in case of with-profit plans where the insurer shares his surplus).
Traditional policies fit a conservative investor`s portfolio well. Unit-linked pension products (ULPPs) invest in stock markets and also offer a combination of equity and debt portfolio. As regular ULIPs these products too have some charges and the investment risk, linked to the market, is borne by the policyholder.
Here we tell you what options are available:
An investor has to be clear about three things before buying a pension policy - the age at which he wishes to retire (vesting age), the retirement corpus, i.e. the money needed post-retirement, and the premium he can manage to pay to build that corpus.
In a pension policy, the buyer pays a fixed premium till he reaches the vesting age. Based on one`s choice of investment (in case of a unit-linked plan, the insured is offered choices; in traditional plans the choice is not in the hands of the buyer of the policy), the insurer invests this fund to generate returns.
At the time of maturity of the policy, that is, when the buyer reaches the vesting age, he will be allowed to redeem as a lump sum (called commuting) one-third of the accumulated fund. The remaining fund balance has to be converted into an annuity or annual pension payment.
An annuity policy is a product by itself. One need not buy the annuity from the same insurer who sold the pension policy. Under an annuity contract, the insurer uses the lump sum amount paid by the buyer to pay him back a guaranteed sum at regular intervals till his death (or for a fixed period). Annuity plans guarantee a nominal return. Annuity rates (return) are reviewed every month by the insurers. But once an annuity is taken, the rate remains fixed. LIC offers annuity at 6.5%-7% per annum. ICICI Prudential Life Insurance, HDFC Standard Life and SBI Life also offer annuity (also called immediate annuity) products.
Options
Pension policies come with and without life cover. However, recent IRDA regulations require an insurance cover, to be implemented in future. Pension products that come with life cover charge additional premium.
For example, ICICI Pru Assure Pension, a unit-linked pension product, charges Rs 133 per lakh of sum assured annually as mortality charge. Kotak Retirement Income Plan Premium, a traditional pension policy, offers life cover and without life cover plans. The with-cover plan comes at a premium of Rs 9,750 per annum for a male of 35 years when the sum assured is Rs 3 lakh. The same policy without life cover will come for a premium of Rs 9,060 annually.
Pension policies also fall under-traditional and unit-linked groups. Traditional policies do not give full disclosure of their underlying investments; they predominantly invest in government bonds and very little in equities. Some of the traditional pension policy providers offer even vesting bonuses (in case of with-profit plans where the insurer shares his surplus).
Traditional policies fit a conservative investor`s portfolio well. Unit-linked pension products (ULPPs) invest in stock markets and also offer a combination of equity and debt portfolio. As regular ULIPs these products too have some charges and the investment risk, linked to the market, is borne by the policyholder.
Insurers give a benefit illustration in the policy document stating the premium charges and fund value at maturity at an assumed rate of return.
Charges
Premium allocation, policy administration and fund management are the main heads under charges in an ULPP. Before subscribing to a unit-linked policy, do your homework to find out the charges across policies of different insurers. In some policies premium allocation charge is as high as even 100% (of the premium) in the first year. Higher the charges, lower will be your yield as lesser sum goes towards investment. The fund management charge is, however, capped at 1.35% by the IRDA.
Policies with life cover plans have mortality charge in addition to the above.
Some insurance agents have been pushing pension products to prospects on the argument that the product`s cost may rise once life cover is made mandatory. Do you need to rush in to buy a pension policy before the order comes into effect? Will the increase in premium cost be very significant?
Pension products do not offer strict comparisons to quantify the extra cost the buyer has to bear for life cover. However, it is not likely to be significant, especially for buyers of below 40 years.
In the series of regulatory changes that IRDA has been bringing on over the last few months, pension policies too have seen implications. They are: One, all unit-linked pension policies (ULPPs-pension plans that invest in equities) should compulsorily offer a life cover. Two, the unit-linked pension products will have a lock-in period of five years from the current three-year time period (traditional pension policies can continue with the current three-year lock-in). Three, partial withdrawals are not be allowed in ULPPs. The deadline for all of these was July 1. But it may be extended.
When life cover gets mandatory, one concern is that the elderly may be refused pension plans. But there are other options, says Andrew Cartwright, chief actuary, Kotak Life Insurance. ``Elderly clients will still have the option of buying an immediate annuity when they get to retirement.``
If pension is the goal then there are annuity products. If tax saving is the objective, there are products such as PPF, NSC.
A senior agent with LIC said that a mandatory life cover will save investors who had purchased unit-linked pension products from the risk of fall in the cover value when the market is down. ``For a ULPP buyer, there is always a risk of the fund value going down with the market. What if the death occurs in the period when the market is down? If life cover is combined, he will have some relief in the form of the sum assured.``
Currently, premium paid towards a pension policy (up to Rs 1 lakh) is allowed as deduction for tax purposes from the income. At the vesting age, one-third of the amount that is withdrawn is tax exempt; the remaining received as a pension through an annuity scheme is taxed as regular income. However, the revised Direct Taxes Code has brought annuity products under the EEE category.
If the DTC is implemented (it is proposed to be implemented from April 2011), pension policies will be treated on a par with endowment policies. Pension plans are, therefore, set to become attractive if the proposals in the Code are implemented.
Charges
Premium allocation, policy administration and fund management are the main heads under charges in an ULPP. Before subscribing to a unit-linked policy, do your homework to find out the charges across policies of different insurers. In some policies premium allocation charge is as high as even 100% (of the premium) in the first year. Higher the charges, lower will be your yield as lesser sum goes towards investment. The fund management charge is, however, capped at 1.35% by the IRDA.
Policies with life cover plans have mortality charge in addition to the above.
Some insurance agents have been pushing pension products to prospects on the argument that the product`s cost may rise once life cover is made mandatory. Do you need to rush in to buy a pension policy before the order comes into effect? Will the increase in premium cost be very significant?
Pension products do not offer strict comparisons to quantify the extra cost the buyer has to bear for life cover. However, it is not likely to be significant, especially for buyers of below 40 years.
In the series of regulatory changes that IRDA has been bringing on over the last few months, pension policies too have seen implications. They are: One, all unit-linked pension policies (ULPPs-pension plans that invest in equities) should compulsorily offer a life cover. Two, the unit-linked pension products will have a lock-in period of five years from the current three-year time period (traditional pension policies can continue with the current three-year lock-in). Three, partial withdrawals are not be allowed in ULPPs. The deadline for all of these was July 1. But it may be extended.
When life cover gets mandatory, one concern is that the elderly may be refused pension plans. But there are other options, says Andrew Cartwright, chief actuary, Kotak Life Insurance. ``Elderly clients will still have the option of buying an immediate annuity when they get to retirement.``
If pension is the goal then there are annuity products. If tax saving is the objective, there are products such as PPF, NSC.
A senior agent with LIC said that a mandatory life cover will save investors who had purchased unit-linked pension products from the risk of fall in the cover value when the market is down. ``For a ULPP buyer, there is always a risk of the fund value going down with the market. What if the death occurs in the period when the market is down? If life cover is combined, he will have some relief in the form of the sum assured.``
Currently, premium paid towards a pension policy (up to Rs 1 lakh) is allowed as deduction for tax purposes from the income. At the vesting age, one-third of the amount that is withdrawn is tax exempt; the remaining received as a pension through an annuity scheme is taxed as regular income. However, the revised Direct Taxes Code has brought annuity products under the EEE category.
If the DTC is implemented (it is proposed to be implemented from April 2011), pension policies will be treated on a par with endowment policies. Pension plans are, therefore, set to become attractive if the proposals in the Code are implemented.
We welcome resolution of ULIP-IRDA issue: Deepak Sood
With the government bringing the curtain down on the tussle, insurance companies are now free to issue fresh ULIPs and their regulator IRDA can continue to guide them.
Commenting on resolution of ULIP/IRDA issue, Deepak Sood, MD & CEO, Future Generali India Life Insurance Co said, ``The long awaited clarity in the regulatory framework is welcomed by insurers and customers alike. The uncertainty had led to insurers delaying their distribution thrust and customers delaying the decision to invest in insurance cover. Now with this ordinance and the clarity it offers, both the IRDA as the regulator and us as insurers can focus on our efforts to provide total insurance solutions to Indian customers and focus on the bigger macro-economic need (i.e.) Indians are uninsured and/or underinsured and there is a crying need to rapidly grow the real penetration (per capita) of insurance cover among our people, to help ensure the financial security and happiness that this provides.``
He further added, ``It has also been clarified that pension products need not compulsorily offer life insurance cover or health insurance cover as was required by an earlier IRDA circular. Now an insurance contract offering one out of three i.e. life insurance cover, health insurance cover or annuitisation on human life is sufficient to categories it as a life insurance product. Going forward, we are confident that customers will benefit from the awaited fresh guidelines on ULIPS from IRDA.``
Commenting on resolution of ULIP/IRDA issue, Deepak Sood, MD & CEO, Future Generali India Life Insurance Co said, ``The long awaited clarity in the regulatory framework is welcomed by insurers and customers alike. The uncertainty had led to insurers delaying their distribution thrust and customers delaying the decision to invest in insurance cover. Now with this ordinance and the clarity it offers, both the IRDA as the regulator and us as insurers can focus on our efforts to provide total insurance solutions to Indian customers and focus on the bigger macro-economic need (i.e.) Indians are uninsured and/or underinsured and there is a crying need to rapidly grow the real penetration (per capita) of insurance cover among our people, to help ensure the financial security and happiness that this provides.``
He further added, ``It has also been clarified that pension products need not compulsorily offer life insurance cover or health insurance cover as was required by an earlier IRDA circular. Now an insurance contract offering one out of three i.e. life insurance cover, health insurance cover or annuitisation on human life is sufficient to categories it as a life insurance product. Going forward, we are confident that customers will benefit from the awaited fresh guidelines on ULIPS from IRDA.``
Optimal strategy - Equities, hybrids or MIPs
One of our readers who had a windfall from his employer to the tune of Rs 6 lakh informed us that that he was planning to invest this sum for long term in a combination of equity funds, hybrid debt-oriented schemes and monthly income schemes (MIP) for diversification. Would this be an optimal strategy?
Maybe not. If one has the risk appetite for equity investment and if the time horizon is long, an ideal strategy would be to invest in a pure equity fund and just stagger the investment over a long period.
Hybrid funds or monthly income plans are not good options to route the equity part of your investment. The expenses ratio and capital gain taxes are two major hindrances for the investors investing in them. Here is why.
Tax factor
Hybrid debt schemes have expense ratios varying from 0.75% to 2.5% a year and MIPs, by and large, have expense ratios of about 2%.
Consider this: An investor is willing to invest in a hybrid debt scheme a sum of Rs 2 lakh for a ten-year period. Assuming his investment is generating hybrid debt return (11.7% over the past five years) for next 10 years, an investment of Rs 2 lakh will become Rs 6 lakh at the end of the maturity period.
Since these are debt schemes, long-term capital gains in respect of units held more than 12 months are chargeable to tax at 20%, after factoring in the cost of inflation index. Alternatively, they are taxed at 10% without indexation. This means the investor would end up paying capital gains tax for the entire returns, including the equity portion.
For an appreciation of Rs 4 lakh, if the long-term capital gains are taxed at a flat 10%, the total tax out go will be Rs 40,000. Had the investor, instead, split his investment between equity and a debt fund, his tax outgo would be much lower because equity funds enjoy a more favorable tax structure.
If the investor had instead spread out the Rs 2 lakh as Rs 1.2 lakh in a debt fund and Rs 80,000 in equity fund, the maturity value could be Rs 5.8 lakh assuming that he generate similar returns. Under the second option, LTCG will be just Rs 24,000 and his overall return could have increased by Rs 16,000.
Similar to hybrid debt schemes, investors in MIPs too suffer higher tax incidence. Hence, investors will be better off separating the debt and equity investments to save a higher tax outgo and to generate higher return if their time horizon is for longer period.
However, debt would be a better option if your investments are for less than three years and you would like to stay away from the vagaries of the equity market.
Investors can separate their debt and equity investments to reduce tax outgo and generate higher returns over a longer period.
Maybe not. If one has the risk appetite for equity investment and if the time horizon is long, an ideal strategy would be to invest in a pure equity fund and just stagger the investment over a long period.
Hybrid funds or monthly income plans are not good options to route the equity part of your investment. The expenses ratio and capital gain taxes are two major hindrances for the investors investing in them. Here is why.
Tax factor
Hybrid debt schemes have expense ratios varying from 0.75% to 2.5% a year and MIPs, by and large, have expense ratios of about 2%.
Consider this: An investor is willing to invest in a hybrid debt scheme a sum of Rs 2 lakh for a ten-year period. Assuming his investment is generating hybrid debt return (11.7% over the past five years) for next 10 years, an investment of Rs 2 lakh will become Rs 6 lakh at the end of the maturity period.
Since these are debt schemes, long-term capital gains in respect of units held more than 12 months are chargeable to tax at 20%, after factoring in the cost of inflation index. Alternatively, they are taxed at 10% without indexation. This means the investor would end up paying capital gains tax for the entire returns, including the equity portion.
For an appreciation of Rs 4 lakh, if the long-term capital gains are taxed at a flat 10%, the total tax out go will be Rs 40,000. Had the investor, instead, split his investment between equity and a debt fund, his tax outgo would be much lower because equity funds enjoy a more favorable tax structure.
If the investor had instead spread out the Rs 2 lakh as Rs 1.2 lakh in a debt fund and Rs 80,000 in equity fund, the maturity value could be Rs 5.8 lakh assuming that he generate similar returns. Under the second option, LTCG will be just Rs 24,000 and his overall return could have increased by Rs 16,000.
Similar to hybrid debt schemes, investors in MIPs too suffer higher tax incidence. Hence, investors will be better off separating the debt and equity investments to save a higher tax outgo and to generate higher return if their time horizon is for longer period.
However, debt would be a better option if your investments are for less than three years and you would like to stay away from the vagaries of the equity market.
Investors can separate their debt and equity investments to reduce tax outgo and generate higher returns over a longer period.
Thursday, June 24, 2010
Financial Technologies Ltd.
More than a year ago
Financial Technologies Ltd.was quoting at Triple digit PE.
Obviously for any matured investor this was not a price to buy.
The stock plunged to below 500 an it was a great buy at these levels.
But Today it is trading at around 1400.
If we calculate PE taking average EPS of last 5 years,
Then the PE comes around 17.
Is this valuation high or unreasonable.
Of course not for a company such as this.
It owns MCX and has tied up with several international exchanges.
The financials are very good. It is likely that next 10 year will belong to this company and the ambitious management will not deter to take steps for large MnA in years to come.
It is in our opinion still an under-covered, less followed less capitalized or midcap blue-chip company.
The listing of BSE shares and increased MnA activity in this space is likely to drag attention in this counter.
We have earlier also advocated strongly at 500 levels and at this levels also see investment opportunity in this counter.
Its drive to own and operate self-incorporated and established exchanges world over makes it a buy and a valuation of PE 17 is not excessive.
The Future's Largetst Indian Conglomerate of Financial Exchanges, or Even The WORLD'S!
Buy Financial Technologies Ltd. with Target of Rs.5000
Lessons for Investors and Traders
Remain contended with your profits.
At the same time don’t lay idle. Act with markets if you want profits. You have got to trade in companies shares that you know well about.
You have got to believe in the power of fundamentals. And then understand the game of volumes.
You also have to get the ‘right’ idea about ‘general conditions’ what is explained by jesse Livermore in his famous book ‘reminiscence of a stock operator’
Never take profits for granted. Don’t think things are easy and you got it your way. Keep your feet on ground.
Some misconceptions and misunderstandings: prevailing amongst investor class.
When a company enters into new venture it is always profitable to it.
When the company launches new product sales will increase.
When the company makes any JV, merger, amalgamation, takeover it is profitable.
When a company splits share or gives bonuses it’s profitable.
When a company makes buy back its profitable.
When a company wins some lawsuit it is profitable.
When a company announces dividend its profitable.
When a company’s share is moved in or out of index on stock exchanges.
When face value is split or increased its profitable.
And such other things.
If economy is growing, every sector and company will benefit.
New sectors and novel technology makes more money.
IPOs are for good and profit of investors.
Brokerage houses and merchant/investment bankers act in the best interest of investors.
TV and other media give un-biased reporting and views.
TV channel or News paper analysts are all genuine.
Everybody earns in a bull market.
Everybody loses in a bear market.
Why Bubbles continue to create?
Why Bubbles continue to create?
People’s memory is short term and they forget how last bubble was formed and prickled.
The sure beneficiary from a bubble like brokers, analysts, corporate wants the bubble. Because simply their profit increases in such periods and decreases when bubble busts or absence of it.
New players:
Every time there are several new players (investors, students, analysts, brokers, fund managers, mf company, foreign financial company, new FIIs, traders etc.) who enter in markets. They generally do not have any past market (bubble) experience and hence no institutional memory.
People with memory and experience have lost in earlier bubble and now out of market.
A big class of so many people with memory and experience start taking things for granted. They either have learned that bubbles do get created and prickled or have become habituated of bull market and bear markets. That is why they do not react rationally and joins the market in way it goes.
Every time different themes are contended for bull markets, but one argument is repeated: and that is ‘it’s different this time’.
Yes, many things may be different because we live in a world of fast changes. But the reality is that greed, fear, behavioral anomalies, and mental heuristics remain the same. Excesses are the same.
The govt. helps:
The govt. always likes the stock market go up. It presents good image. No govt. like a depressed and doomed stock market as it is perceived as a barometer of nation’s economy. So govt. always supports the rising markets and hence supports bubble formation as well. Has ever govt. said ‘all right, its 20,000 index, it’s enough now!’No. you have seen govt. trying everything if markets become nervous. From giving statements, to declaring policy measures and so on.
We mentioned excesses are the same every time in bull bubble or bear depression.
Several behavioral heuristics behind such happenings are,
The herd mentality
Confirmatory bias
Representative bias
Endowment effect
Instant gratification
The greater fool theory
The winners’ curse
Availability bias
Herd mentality
Rationalization trap
Over-simplification bias
Growth investing
Fancy of new
And so on
Money flow of other markets-
When prices are rising in some markets speculative money will start flowing into that market from other markets to take benefit of rising prices/bull market. This it fuels it.
IPOs-
Floods of IPOs that too at scorching high valuation are a sure sign of bubble as well part of bubble making process. If the IPOs come at reasonable valuations why would bubble come up? Investors will never touch 20+ and triple digit PE stock in primary markets, and thus no bubble would arise. If this could happen then IPOs would continue to come at any time a company wants money or want to raise resources and not only a bull market! IPO market could become an all-season market if they used to come at good valuations and returns on table for investors. But this doesn’t happen. So thus IPOs invariable helps bubble formation and an integral part of bubble formation process and bubble phase.
In fact to repeat- Floods of IPOs that too at schorching high valuation are a sure sign of bubble.
They help bubble formation and expansion in that increasing speculative activity and shares to trade on exchanges.
IPOs/Primary markets are a important segment of trading and speculation. God know of investing! Si they invariably are part.
Sunday, June 20, 2010
European recession 'almost inevitable' next year
LONDON: Europe faces almost inevitable recession next year and years of stagnation as policymakers’ response to the Eurozone crisis causes a
downward spiral, billionaire investor George Soros said on Tuesday.
Flaws built into the euro from the start had become acute, Soros told a seminar, warning that the euro crisis could have the potential to destroy the 27-nation European Union.
The euro’s lack of a correction mechanism or of a provision for countries to leave it could be a fatal weakness, he said.
Germany had imposed its criteria on how a 750 billion euro ($1 trillion) Eurozone rescue mechanism should be used and was imposing its own standards — a trade surplus and a high savings rate — on the rest of Europe, Soros said.
“But you can’t be a creditor country, a surplus country, without somebody being in deficit,” he said.
“That’s the real danger of the present situation — that by imposing fiscal discipline at a time of insufficient demand and a weak banking system, by wanting to have a balanced budget you are actually — setting in motion a downward spiral,” he said.
Germany would do relatively well because the decline in the euro had boosted its economy, he told the seminar on the Eurozone crisis organized by two thinktanks, the European Council on Foreign Relations and the Center for European Reform.
“Germany is going to smell like roses but (the rest of) Europe is going to be pushed into a downward spiral, stagnation lasting many years and possibly worse than that,” he said.
“In other words, I think a recession next year is almost inevitable given the current policies,” Soros said, later clarifying that he meant a recession in Europe as a whole.
“If there is no exit, (it) is liable to give rise to social unrest and, if you follow the line, social unrest can give rise to demand for law and order and (sow the) seeds of what happened in the inter-war period,” he said.
Political will to forge a common fiscal policy in Europe was absent and since Europe was liable to move backwards if it did not advance, “the crisis of the euro could actually have the potential of destroying the European Union,” he said.
European banks had bought large amounts of the sovereign bonds of weaker Eurozone countries for a tiny interest rate differential, Soros said.
“That’s one of the reasons why the banks are so over-leveraged and why the German and the French banks own Spanish bonds,” he said.
“Now, they have a loss on their balance sheets which is not recognised and it reduces the credibility of those banks so the banking system is in serious trouble,” he said.
“The commercial paper market, for instance, in America is now refusing to lend to European banks so there is even a funding crisis and the ECB (European Central Bank) has to step in and the banks are unwilling to lend to each other,” he said.
Flaws built into the euro from the start had become acute, Soros told a seminar, warning that the euro crisis could have the potential to destroy the 27-nation European Union.
The euro’s lack of a correction mechanism or of a provision for countries to leave it could be a fatal weakness, he said.
Germany had imposed its criteria on how a 750 billion euro ($1 trillion) Eurozone rescue mechanism should be used and was imposing its own standards — a trade surplus and a high savings rate — on the rest of Europe, Soros said.
“But you can’t be a creditor country, a surplus country, without somebody being in deficit,” he said.
“That’s the real danger of the present situation — that by imposing fiscal discipline at a time of insufficient demand and a weak banking system, by wanting to have a balanced budget you are actually — setting in motion a downward spiral,” he said.
Germany would do relatively well because the decline in the euro had boosted its economy, he told the seminar on the Eurozone crisis organized by two thinktanks, the European Council on Foreign Relations and the Center for European Reform.
“Germany is going to smell like roses but (the rest of) Europe is going to be pushed into a downward spiral, stagnation lasting many years and possibly worse than that,” he said.
“In other words, I think a recession next year is almost inevitable given the current policies,” Soros said, later clarifying that he meant a recession in Europe as a whole.
“If there is no exit, (it) is liable to give rise to social unrest and, if you follow the line, social unrest can give rise to demand for law and order and (sow the) seeds of what happened in the inter-war period,” he said.
Political will to forge a common fiscal policy in Europe was absent and since Europe was liable to move backwards if it did not advance, “the crisis of the euro could actually have the potential of destroying the European Union,” he said.
European banks had bought large amounts of the sovereign bonds of weaker Eurozone countries for a tiny interest rate differential, Soros said.
“That’s one of the reasons why the banks are so over-leveraged and why the German and the French banks own Spanish bonds,” he said.
“Now, they have a loss on their balance sheets which is not recognised and it reduces the credibility of those banks so the banking system is in serious trouble,” he said.
“The commercial paper market, for instance, in America is now refusing to lend to European banks so there is even a funding crisis and the ECB (European Central Bank) has to step in and the banks are unwilling to lend to each other,” he said.
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