Don`t put all your eggs in one basket!

Don`t put your eggs in a single basket, cause a single rotten egg spoils the entire basket!

The world of investing also replicates a similar phenomenon. Guru`s in the investment world have always advised to invest in various asset classes to reduce the risk of eroding the portfolio value. This article explains the types of risks in a portfolio with an example of how you can reduce your portfolio risk to certain extent by diversifying your investment portfolio.

Components of risks in a portfolio...The total portfolio always comprises of two types of risks, which comprises of mainly two components:

The first one is the market risk comprising of interest rates, recessions and wars. Though classic guru`s have strongly propagated that this cannot be eliminated, experts in the investment world can apply special hedging strategies to reduce the currency, inflation, tax and regulatory risks. However, you cannot eliminate the risks associated with natural disasters.

The second is the unsystematic risk which is also called stock specific risk. To explain in simpler words, if a company launches a new product in the market and it is successful, the revenues of the company will increase leading to an increase in the share price; however, if the product fails, it is likely to be called back and the news is more likely to have negative impact on the company`s share price.

While systematic risk is cannot be reduced, unsystematic risk is the one which is reduced by diversifying your investments. We shall explain how.

To understand the disastrous effect of parking your investments in one basket, let`s take an example:

I have with me Rs 10,000 to invest in equities and I buy 200 shares of a speculative stock trading at a price of Rs 50. If the price of this stock falls by 50%, say to Rs 25, the value of the portfolio (suppose it contains only two stocks) will fall to Rs 5,000 (an equal proportion).

Let`s take another case, where I have the same amount that is Rs 10,000 which is partly parked in a speculative stock (200 shares @ Rs 25) while the remaining amount (50 shares @ Rs 100) is parked in a defensive company. Now suppose, the price of the speculative company falls 50% to Rs 12.50 and the price of the defensive company stays at Rs 100, the total fall in the portfolio value will be Rs 7,500 (12.50*200 + 50*100). You minimize your loss by Rs 2,500 by investing in two companies rather than 1.

Diversification, which simply means parking your investments in various investment instruments, surely helps in reducing portfolio risk!

However, the English idiom - No pain no gain applies to the world of investing as well. The higher the risks, the more are the returns. But the question is goes you want take?

Each person has a different risk bearing appetite. A young investor who still has long yours to live and earn surely is able to bear a lot of risk than a near retirement employee whose earning capacity is less than his predecessor. Thus, a there is always a trade-off which occurs between expected returns and the amount of risk you want to take.

If you are a high risk taker, you will definitely have greater proportion of your investments in equities. In such cases, your risks can be reduced by adding more stocks in your portfolio. How many stocks should you add? Academic studies have shown that as the number of stocks in a portfolio increases, the portfolio`s risk falls towards the level of market risk.

Conversely, a low risk taker will invest less proportion in equities and greater proportion in low risk bearing instruments like bonds, commodities and real estate’s investments (which is also called diversification of asset classes). Again, the proportion of each asset class in the portfolio will depend on the investor`s goal and his risk bearing appetite.

Ultimately, the decision lies in the hands of the investor on how he wants to choose his portfolio prudently in order to earn maximum returns with minimum amount of risk!

Tax planning - Avoid last minute investment

We are into last quarter of financial year 2010-2011 and most of the taxpayers will be looking for tax saving instrument. It is a long history that most of the people plan at the end of the year and end up buying instrument, which may not be in line of their financial need. Nearly 70% of the life insurance business happens in the last quarter of the year and this quarter is like a season for insurance professionals. We all know very well that every year we have to save 1 lakh for tax benefits u/s 80-C of the income tax act, but still we wait till end and end up buying wrong product. It is not at all advisable to wait till end for getting tax benefit. But, still if you are looking for tax saving instrument than here are some tips for tax planning.

> Calculate what the exact amount is still pending for investment to get the benefit u/s 80-C. If you are not sure than consult your CA or tax consultant.

> Buy term insurance, which is very much important and has to be given top priority. Calculate exact cover you require and buy risk cover for the protection & security of your family.

> Avoid other insurance products, as you will be not having time to assess and compare the products for the long-term benefit of yourself and your family. Insurance products are loaded with irrecoverable charges, which need to be assessed & analyzed. Do not commit yourself for long-term premium payments unless you very well understand the features of products you are buying.

> Finalize your asset allocation and be sure where your investment has to go. Whether you would like to go for risky products for higher returns or want capital protection fund.

> Business man and professional must consider P.P.F. investment for tax saving, as it gives 8% tax free returns which are the best in debt category. You can deposit up to Rs. 70,000 per annum in one financial year.

> Principal payment of your home loan EMI is also eligible for tax benefit.

> N.S.C. interest is also eligible for tax benefit but the interest is also chargeable to tax as income from other source. 

> Tuition fees for two children`s are also eligible for tax benefit.

> Mutual fund ELSS schemes are best for those who would like to invest in equity and want to participate in growth story of India. ELSS schemes have lowest lock in period of 3 years.

> Do not buy any fixed income instruments with lock in period of 5 years. Rather invest in ELSS schemes of mutual fund, as the 5-year time horizon is very good for equity investment.

> You can also buy health insurance products or increase your family cover for mediclaim and get additional tax benefit of Rs. 15,000 u/s 80-D of the income tax act. 
You also get additional Rs. 15,000 benefit for covering your parents (Rs. 20,000 if they are senior citizens).

> You can also avail the benefit of investing in infrastructure bond for onetime benefit for F.Y. 2010-2011 u/s 80-CCF up to Rs. 20,000.

Investment resolutions for 2011

Author: PV Subramanyam

However is a good list of resolutions that you can make - it is really useful if you made it already, just reiterate it, and follow it! So here it goes:

1. I will write down my financial goals - NOW, IMMEDIATELY.

2. I will convert a big portion of my savings into investments - especially because I am young!

3. I will live a simple, frugal life by choice - but choose my dream career.

4. I will start saving / investing for my retirement - NOW IMMEDIATELY.

5. I will have regular conversations about money, saving and investing with my colleagues, friends, spouse, kids and parents - all people for whom I feel financially responsible.

6. I will not deal in direct equity with my current level of knowledge of equities.

7. I will increase my financial knowledge - inter-alia by visiting www.subramoney.com , www.myiris.com and such other sites.

8. I will maintain my income and expenditure details diligently and keep reviewing them.

9. I will maintain proper records of my assets and liabilities, understand the risk of each asset class, and do proper asset allocation.

10. I will protect all those people dependent on me. Will review my term insurance, medical insurance and retirement and make sure it is up to date and adequate, and the nominees are current.

Here are some more resolutions - on the will not do side!

1. I will not buy anything on a credit card unless I can pay it off in full on the due date.

2. I will not buy any product before I understand the why, when, how of the product.

3. I will not buy things or services to show off to friends who are also doing the same!

4. I will not buy a `branded` product unless I can see the Value in what I am buying.

5. I will not change jobs just to get a higher salary.

6. I will not invest in any financial instrument without increasing my knowledge.

7. I will not buy any asset beyond my means hoping to pay a higher EMI from an increased income.

8. I will not mix my investments with my insurance IMMATERIAL of how attractive the transaction looks!

9. I will not marry a person who is financially incompatible with me.

10. I will not assume anything in the financial world- will check using present value and future value before taking a decision.

11. I will not buy a house `because it is conventional to do so`. Will buy a house when I am convinced that I am planning to stay in it for more than 10 years at least!

Most important: Properly stick to all the resolutions!

Take the easier path to wealth creation Source: BUSINESS LINE (10-JAN-11)

Most salary-earners believe that wealth-building is only for the ultra high-net-worth individuals. After all, doesn`t money beget money? However, wealth creation is really not just for an exclusive club of ultra-rich individuals. Anyone can build wealth through planned investments over a long period of time.

However, unless you have strategies in place you are leaving wealth creation to chance. The fact that ultra HNIs achieve higher returns than middle-income individuals owes a lot to their asset allocation pattern. There may be several strategies to build wealth. However, we draw on real-life examples to arrive at four basic tenets that will guide you in your pursuit of wealth, even as you avoid the cardinal mistakes some people commit.

Invest based on life cycle
Most people tailor their investment and savings habits to the experiences of others. Take Rajesh Mariappan, an IT professional in his late twenties, who reveals that since his father lost quite a lot of money during the stock market correction in 2000, he himself never invested in equities!

The fear factor made Rajesh opt for an ultra safe portfolio, with all his savings in debt investments earning an average interest rate of about 7% per annum. Inflation and taxes have since whittled down these returns to nothing, with the result that Rajesh has been saving diligently, but has built no wealth in the past six years.

Individuals should base their investment preferences on their own life stage. Investors in the age group of 20 plus can take higher exposures to risky asset classes such as equity compared to those in their late 50s, because they have the ability to wait out any market corrections. Those having a long working life ahead of them with financial goals 10-15 years ahead should include equity in their portfolio. Due to the compounding effect and lower taxes compared to pure debt investments, equity can help one build wealth at a faster pace.

So this is Rule 1: Investment strategies should be tailored to one`s needs.

Know thy risk
Risk-profiling is the first step towards asset allocation. Each asset has a different risk profile and the investor needs to understand and choose from among options based on his own risk appetite. Having chosen a particular option after understanding the risks, one should avoid changing the allocation unduly because those risks actually materialized!

Many individual investors, for instance, booked profits in stocks after the initial run up in this bull market and have not been able to re-enter market at prevailing prices due to a dilemma about whether the market is too risky to enter. Now, investors with a 10-year horizon and keen on building wealth should not drastically reduce their equity exposure on small market blips.

Take the case of Bangarappa, who holds a business administration degree. On the advice of his broker he promised his father that he could double his retirement money in the short term by investing in derivative instruments. He invested the entire Rs 16 lakh of his father`s retirement proceeds in late 2007 in stock futures. When the market crashed, his portfolio was worth just Rs 3 lakh, effectively decimating his father`s savings and jeopardizing his sister`s marriage. While equity investments or derivative exposures may be suitable for people with a high-risk appetite and a big surplus to spare, they certainly aren`t a parking ground for retirement savings.

Being over-cautious can have its pitfalls too. Mutual funds are meant mainly as long-term investment options. But in 2010 retail investors have continuously withdrawn money from such funds on every rally. Having withdrawn Rs 170 billion from MF equity schemes while market was rising, they may have lost out on an opportunity to make the best of the rally. Ultra HNIs and foreign institutional investors, on the other hand, continued to pump in fresh money and made big gains in the rally. This explicitly shows that if investors don`t understand the risk implied in their investments, they may move in the opposite direction of the trend and fail to build wealth.

Rule 2, therefore, is: Be comfortable with the risks before investing in an asset class

Know where to use leverage
In an easing inflation scenario, leverage can help build wealth quickly. However, investors should be cautious in knowing where to use debt and how much leverage to take. Salary earners often fail to make a distinction between using leverage to buy `lifestyle` assets and appreciating assets.

Lifestyle assets such as an owned home, car, a plasma television or other electronics gizmos may improve your quality of life, but they do not help build your long term wealth. Wealthy people may create lifestyle assets by liquidating other investments, but salaried individuals borrowing to fund these buys may be saddled with large EMI repayments for several years at a time. That precludes investment in other appreciating investments such as shares, debt or even rental property. A decade ago the average age of the individual taking a home loan was 40-plus, whereas this has dropped to 30-plus today. That suggests that investors commit a large part of their earnings to a home loan repayment very early in their career. Investors paying 50-60% of their gross salary as EMI may, due to limited surplus failed to invest sufficiently in stocks, mutual funds or other appreciating assets.

Take the case of Chennai-based young couple Sathish and Priya, in their mid-thirties, who bought who their first house five years back and then added on a Rs 20-lakh plot of land five years later. While the home is self-occupied and the land may yield appreciation over the long term, their investment plan suffers from a key defect. Both their investments are leveraged and take away a good portion of their monthly earnings. More important, both their investments are in a single asset class - property. If property prices were to grow very slowly over the next 10 years that would certainly impact their wealth. Over-exposure to one asset class can be a hindrance to their wealth building exercise if equities or debt outperform over the next 20 years.

Thus, Rule 3: Unplanned debt will eat away growth

Diversification
No asset class is guaranteed to deliver uniform returns from year to year. The key benefits of diversification are that even if one asset class underperforms in a specific year, the others will make up for it. So, the secret to building wealth with reducing risk is diversification. For instance, in the last five years, equity, debt, real estate and even crude oil all witnessed a bumpy ride; gold is the only asset class that has delivered a consistent return from year to year.

A bit of gold in your portfolio may have helped even out the bumps while the stock market crashed or interest rates fell. However, what percentage of the portfolio should be allocated to each of these assets is based on the individual`s risk appetite. One common mistake individuals make is, however, in diversifying too much within the same asset class.

Raghavendar, a businessman, has an equity portfolio of Rs 15 lakh. With mid-cap stocks rising last year, he took a further Rs 5 lakh loan by pledging his shares and invested this sum in mid-caps too. In November, his mid-cap portfolio had lost 30%. He now faces a double whammy where he needs to pay interest on his loan and also suffer portfolio losses. Many investors own more than a dozen equity funds in their portfolio. Now that leads to duplication of stocks and may not materially lower the risk, even as it increases your hassles in tracking your portfolio.

Rule 4 says: Don`t put all your savings in one asset class. Always keep room for a surplus to diversify

Zeroing in on an advisor
Do you ever wonder why individuals and corporate investors are duped time and again when they set out to mint money? Two major reasons for financial scams are: lack of prudence and financial literacy. The Organization of Economic Co-operation and Development (OECD) discovered, in a research exercise, that financial literacy is very poor, even in developed nations. For instance, only 18 per cent of investors surveyed in the US were able to calculate a compounded return on their investment!

This makes it imperative for individuals to acquire a basic level of financial literacy before setting out to build wealth. Assuming that a good number of investors will need the help of advisors to build wealth, how should they go about selecting one? An individual needs to evaluate the advisor with some hard-hitting questions.

1. Gauge his intentions: Try and gauge the advisor`s intentions in your first meeting. Is he paying attention to your needs and goals? Or is he simply keen to sell products that may suit his purse?

2. Check the credentials of the advisor: He should have financial qualification such as Certified Financial Planner, MBA with statutory certifications such as AMFI and IRDA. Do check whether your advisor is able to respond to your clarifications on the spot or takes a long time to get back. If he seeks time repeatedly, he is a generalist and may find very difficult to construct right portfolio. Whereas a specialist will be in a position to suggest modifications to your plan based on your risk appetite. If your advisor asks you to sign on blank application forms or asks for signature on white papers, be careful and do spend time to evaluate him.

3. Know how the advisor is paid for the service: In a scenario where most financial products are broker-driven, most of the advisors are paid by the financial product vendors. Ask for disclosures on how the agent is getting his commission and whether it is from the product manufacturer. Check whether he is ready to put everything in black and white.

4. Risk management: Ask your advisor what risk management systems are in place in the event of a crisis. When a plan is given, ask for more options and check whether these are suited to your risk appetite.

5. Decide between institutional and independent financial advisors: Institutions score on technology platforms, upgrading their skills with help of internal training and some of the products that are exclusively available to the institutions from the financial product manufacturers.

But the drawbacks of such institutions are target-based selling of products without too much customization. Frequent churning of advisors too can be a problem; when new advisors take charge of your portfolio, it may undergo unnecessary modification or the new advisor may not understand on what parameters the portfolio is constructed.

Independent advisors too are motivated by their own revenues but have fewer `targets` to meet. If you are smart and insist on an engagement letter, mis-selling could come down to greater extent with independent advisors. Unless the advisor discontinues his business, continuity too will not be a problem. However the disadvantage with individual advisors is that they may not upgrade to the latest technology and may not have access to the kind of specialized products sold by institutional advisors.

Time to lock into high-yield fixed deposits Source: BUSINESS LINE (10-JAN-11)

The year 2011 has already brought cheer to bank depositors who had to contend with low interest rates for more than 21 months now. This New Year, State Bank of India (SBI) has come up with yet another round of rate hikes; second time in less than a month which make the rate of interest relatively attractive for a retail depositor. Around 10 banks have hiked deposit rates over the last fortnight.

ICICI Bank, IDBI Bank and State Bank of Patiala, taking cues from SBI, hiked their rates to protect deposit base. However, some private sector banks, which had pre-empted deposit rate hikes, may have to come up with another round of hikes to attract retail depositors as their rates are only marginally higher than that of SBI. All in all, this signals a good time for depositors who were grappling with negative returns (adjusted for inflation) and may now see a positive real rate of return (assuming the inflation moderates from current levels).

Here we discuss some of the deposit options investors can consider to make improved returns.

The RBI, in 2010, continued its monetary tightening in order to rein inflation and in the process the effective policy rate has gone up by around 300 basis points. This rise in policy rates hadn`t deterred banks till second half of the year, thanks to surplus deposit inflows the preceding year. However, the deposit growth waned and demand for credit started picking up subsequently.

While there have been three or four hikes in deposit rates by banks, these were only in the shorter maturities as the banks were expecting liquidity to ease by the year-end. However, with liquidity not easing sufficiently, certificate of deposit rates shot up to as high as 9.75%. Hence, the deposit rate hikes to attract retail depositors.

Special deposits attractive

This time around, hikes were between one-year and three-year maturities. Additionally, the special deposit schemes are looking attractive.

For instance, SBI has hiked rate of interest (ROI) on its 555 days special deposit scheme by 175 basis points in the last four months to 9% which gives a post-tax annualised yield of 8.1% for a retail depositor (in the 10% tax bracket). Such rates in term deposits were last seen in March 2009. Subsidiary State Bank of Patiala is offering 9.25% ROI for the 555-day deposits. There are various attractive schemes from other banks - namely the 9%, 400 day-scheme from City Union Bank; 9.5%, 500-day scheme from Karur Vysya Bank; and 9%, 500-day scheme from IDBI Bank (refer to table for other special deposit schemes).

For longer term investors, IDBI Bank has an attractive 1100-day deposit with 9.25% ROI for a normal depositor and 10% for senior citizens.

Other options

Corporate and non-banking financial companies` deposits are yet to get re-priced to reflect their rising cost of borrowings from banking sector. Sundaram Finance, after raising its deposit rates recently, has an 8.75% rate of interest compounded quarterly on its one-year deposits. This cumulative option is relatively safer among NBFCs.

For investors looking for more than five years of fixed income options, the deposits begin to look attractive. With recent round of rate hikes, the five-year tax saving deposits has become more attractive than infrastructure bonds. For instance, the tax saver schemes of IDBI Bank and City Union Bank have interest of 8.5% and 9% as compared to 8% rate of interest for a buyback option in IFCI Infrastructure Bonds. Therefore investors who haven`t exhausted their 80 C are better off using these higher rates to lock-in, before considering 80 CCF option (Infrastructure bonds). There is also another long-term SBI retail bond issue on cards. With rising interest rates, NBFCs may also come up with NCD issuances as they did in 2009.

Outlook
In the weeks ahead, more banks are expected to hike deposit rates. Smaller banks may hike rates to make deposits a little more attractive than that of SBI.

The probable easing of liquidity pressures by the end of this March quarter and traditionally lower demand for credit in the June quarter will reduce the likelihood of more hikes in deposit rates. However, any threat from inflation will warrant further monetary tightening by the central bank, forcing banks to hike deposit rates.

Investors would be better off locking in to current levels as the deposit rate hikes may not be as steep from here on.

Facts beneath the factsheet Source: BUSINESS LINE (10-JAN-11)

Investing can be a rewarding exercise, especially if done in an informed manner. Of all financial products, mutual funds tend to make high levels of disclosures, usually through the periodical `factsheets`.

As the name suggests, it contains all the facts pertaining to the various fund schemes of the asset management company. While the factsheet can have a lot of details, which may seem daunting at first sight, with some guidance, they can be understood without much difficulty.

An understanding of the factsheet would allow you to appreciate the entire workings behind the single figure called the NAV (net asset value) and make comparisons between different fund houses and schemes.

Below are some of the details you will find in a factsheet and some tips to understand them. All factsheets are available in the respective fund house`s Web site.

Fund views

All the monthly disclosures start with the views of the fund house on the fundamentals of the economy, equity and bond markets in the month gone by as well as that on its expectations, going forward.

In general, these articles talk about the major events that occurred over the month, which affected the markets and the inflows. In addition, some fund houses also give an account of the sectors that they are bullish on and the ones they are not so convinced. For example, one fund house may not believe in too much cash position being taken, another may take a conservative stance during market corrections and may move significantly into cash. Also, some fund houses, for example, may be cautious in infrastructure and realty stocks, despite their being beaten down, while others may suggest that there is scope for stock-specific selection. These articles make interesting reading, especially when markets fall or gain heavily (say 20%), as fund managers dwell on what helped or went against their funds.

Portfolio and returns

Moving on to subsequent pages, we get to individual schemes and their investments in various stocks and bonds. This is the most-followed part in a factsheet as the fund discloses the stocks and bonds that it has invested in. Some funds give their entire portfolio of stocks while others give out their top 10 holdings. In a similar fashion, funds also give details of sectors they are invested in.

It is important for investors to note if the fund takes concentrated exposure to stocks or sectors as it can then peg up the fund`s risk element. Gauging the fund`s investment style, therefore, can help investors put a finger to the fund`s risk profile and match it with their own. Exposure to individual stocks to the tune of, say, 10% of the portfolio makes it concentrated. In some cases, there may not be heavy exposure to individual stocks, but greater tendency to take increased positions on individual sectors when they are `hot` in the markets.

The fund also gives the returns it generated over a period of six months, one-, three- and five-years from the date of the factsheet. For comparison, the returns of the benchmark are also given. Note that most funds also give the returns that are generated through the SIP (Systematic Investment Plan) route. This may differ from the absolute returns that a lump-sum may have generated as SIPs are spread across market cycles and enable rupee-cost averaging.

Investors can use the data so provided to check whether the fund`s NAV change over a period of time has been more than the change in its corpus size over the same period. If yes, it suggests that the fund may have suffered higher outflows/redemptions, unless there was a dividend paid out. Checking on this trend will helps assess other investors` interest in the fund too.

The ratios

Standard deviation tells us how volatile the fund`s returns have been in relation to its average. The higher the number, the more volatile is the fund`s returns.

Sharpe ratio, another important performance metric, measures the risk-adjusted returns that the fund generates. In other words, it is the returns generated by the fund over risk-free returns, for a given unit of risk measured by the standard deviation.

Beta is the third important ratio that captures how much a fund`s returns move in relation to a change in its benchmark`s returns. A beta of 1 indicates that the fund moves in tandem with its benchmark, while a beta greater than one indicates that it rises and falls more than the benchmark. A beta of less than one suggests that the fund is less volatile than its benchmark.

Expense ratio is one of the most important measurement tools. It is the percentage of total assets that is paid as management fees and also covers the everyday costs of running a mutual fund. Actively-managed funds typically have higher expense ratio than those that are passively managed, such as index funds or ETFs as in this case it merely involves replicating the index.

All the above ratios must be used for comparing funds with similar mandates across fund houses. For example, if you own two funds that invest in large-cap stocks, it would enable you to see which is riskier and more expensive.

If it is not possible for you to examine factsheets every month, consider doing it at least on a quarterly basis. It would not only help you make sound buying or selling decisions; it is also a lot of fun!

Why investment solutions are good Source: BUSINESS LINE (10-JAN-11)

B. Venkatesh

Asset management firms continue to offer standard investment products such as fixed maturity plans, equity funds and, now, passive products on foreign indices. Investors do not always understand how to effectively utilize these products to create an optimal portfolio. Most do not seek professional investment advice either. The question is: Can asset management firms bridge the knowledge gap and channel investor resources optimally?

This article explains why asset management firms should offer investment solutions and not just products. It also explains how such solutions can be structured to improve investment experience for the end-users.

Asset management firms typically look to improving customer base through product offerings. This has resulted in most firms offering similar repertoire - equity funds, bond funds and gold ETFs. The value differentiator is generally the fund performance, though the statutory warning suggests that `past is not an indicator for the future.`

Yet, investors use past performance to choose a mutual fund. In the process, they do not actively choose alpha-generating funds and the alpha managers do not necessarily attract more investors.

Offering investment solutions could, perhaps, prove useful in several ways. For one, the differentiator would be the solutions offered, not the product. Though investment solutions can also be replicated, the offering need not be same.

Suppose an asset management firm were to offer a closed-end education fund that will enable investors pay for their child`s education at 18. The firm may decide to have 70% equity exposure, 20% bond exposure and 10% gold exposure with tactical range of 10%.

Another asset management firm may have a different asset allocation strategy for the same investment solution. An investor`s choice would depend on her preferred asset allocation, not just the fund performance.

For another, asset management firms may be able to attract even self-directed investors who may find such solutions useful. And for the investors who do not wish to pay for advisory services, such investment solutions could come cheap.

The question is: How should firms offer such investment solutions?

Portfolio structure
Consider the education portfolio. An asset management firm can offer such a solution either through direct asset exposure or through a fund-of-funds structure.

Direct exposure may be deviating from the traditional two asset-class (balanced) portfolio, as the fund will have to carry equity, bonds and, perhaps, gold. A fund-of-funds structure would be less complicated and more flexible- the fund will invest in equity funds, bond funds and Gold ETFs.

True, investors may have to incur additional costs for buying the investment solution - fund-of-funds fee of 50 basis points. But that would be a small price to pay for the manager selection skills of the fund-of-funds manager. This is, indeed, a valuable service for the investors who will otherwise find creating a portfolio of mutual funds a not-so-easy task.

There is a behavioral advantage too. The feeling of regret may be less when an investor buys mass investment solution from an asset management firm. Why?

A custom-tailored solution received from an investor advisor, though good, may sometimes not be enough. This is because the investor may feel that she could have done better by taking a more niche solution from another investment advisor. Choosing among several advisory service providers is not always easy. A mass investment solution helps, as the investor knows that her acquaintances also received the same solution as she did. Failing with the crowd, in the event the portfolio loses value, causes less regret.

Conclusion
There is a tremendous potential for asset management firms to offer mass investment solutions. Firms could use fund-of-funds route to offer solutions with even existing products.

Such offerings could provide cheaper solutions for retail investors and become a value differentiator for firms. Investment advisors could also use such products to custom-tailor portfolios for HNIs.

Placebo to drive away investment blues? Source: BUSINESS LINE (10-JAN-11)

B. Venkatesh

Consider this. You are running fever and your doctor recommends a medicine that is available only at select medical stores. You recover after a four-day dosage only to realize later that the pills were a mere placebo. Why do we fall for placebos and what are its linkages to investments?

Role of psychology

Placebo is Latin for ``I shall please``. Placebos have been documented to provide effective cure to patients, prompting pharma companies to research to find out why. Psychologists argue that it is our expectations that make the sugar pill work so well.

In one study, people were given light electric shocks on their wrists. They were then given a placebo. Half the people were given a brochure mentioning full cost of the pill while the other half were told that the price was marked down without providing a reason why. The researchers found that the people who were told the full price experienced less pain than the ones who were told that the price was marked down! This and similar experiments brings to the fore the role of psychology in placebo effect.

Why we diversify

How is this related to investments? Suppose we know that a particular stock is sure to move up, we would then use substantial part of our money, if not all, to buy the stock. The fact that we do not place all our money in one stock clearly shows that we are uncertain about asset price movements. We, hence, diversify.

Diversification in some ways is like a placebo. You feel good about diversifying, just like you feel better after swallowing the sugar pill. Why?

Suppose you have 15 stocks in your portfolio. Assume the market crashes and eight stocks in your portfolio fall 20 per cent and the rest fall by less than 10 per cent. You take relief from the fact that you did not lose 20 per cent in the other seven stocks as well! Diversification is the sugar pill that helps us typically drive away our investment blues!

Inflation: Go easy, big challenge ahead!

Author: Anil Rego

``Inflation is as violent as a mugger, as frightening as an armed robber and as deadly as a hit man.`` - Ronald Reagan

No better day to understand this! If there is one thing that has provided the maximum returns over the past year, then it has to be the humble onion and it`s red Indian cousin tomato. Food inflation is at 14.44%, the Y-o-Y increase in vegetable prices was 29.26%. Despite multiple attempts by the RBI to adjust the liquidity to in turn reduce inflation, they haven`t been able to tame inflation yet.

Understanding Inflation
Inflationary scenario, simply put would be when too many people chase too few goods and too few services, which automatically makes the prices of the goods and services high because of the high demand. At the same time, when inflation falls below the desired mark (in the negative territory); there are few people and abundant supply of goods and services, making the prices of the goods and services cheap. India`s vast population lives close to or below the poverty line, inflation acts as a `Poor Man`s Tax`. This effect is amplified when food prices rise, since food represents more than half of the expenditure of this population.

There are two measures for inflation, Wholesale Price Index and Consumer Price Index, the latter being more accurate in evaluating the change in value of money for the `Aam-Aadmi`. Here is a look at how inflation has fared over the past years - 

Source of data: Ministry of finance
From the above graph, it is evident that inflation is definitely off the peaks, from a whopping 16.22% in Jan `10 to the current levels hovering around 10% - 11%, however, food items continue to suffer. 

Impact of inflation on your budget
This is absolutely simple. Over the past year onion prices have risen ~35%, a kilo of onion, now costs a little higher than a liter of petrol, of course petrol itself was not spared either, the prices were revised recently and your outlay to fuel is definitely higher than what you did in the previous quarter. 

When inflation is on the rise, it is amply clear that your outlay to the core ingredients of household expenses immediately increases by a similar % as your inflation. Further, inflation affects all without any discrimination, this simply means that your servant maid will demand a higher monthly salary than earlier, for she too has to face the brunt of increasing food items. There are indeed multiple factors which affect the household pattern, the rate hike by the RBI to curtail inflation, will in turn reflect in increased EMI outlay, thereby shrinking your investment / savings portion further. 

Let`s assume that your due to the above factors, the core ingredients - food items, medical / clothing / entertainment expenses, ancillary expenses have risen by ~15%, fuel / vehicle maintenance outlay has increased by 10%, EMI outlay has increased by 8%, other expenses have moved up by a modest 8% (lesser than the inflation rate thru- the year) - here is how the pie of your net earnings / expenses / savings pattern would look at the begin of the year and at current times -

Savings / Investments have shrunk by a whopping 10%, atrocious as it may sound; this is clearly how things have panned out for the middle class over the past year. The big question is ``Can the `Aam  Aadmi` control this?`` The answer is simply `No`, however, what is within his control is to keep tab on the expense pattern. 

There are various methods of reducing your expenses - some such examples are cutting on eat-outs, walking / jogging in open air instead of a gym subscription, car pooling, using your credit cards prudently etc.,

Your commitments
With the savings pie shrinking, it becomes increasingly tough for you to stay committed to your investments. This calls for prudently planning for contingencies, creating a buffer of 2% - 5% will help counter such adverse scenarios, this buffer can be kept in easily accessible avenues such as savings bank balance, flexi-fixed deposits or liquid plus / floating rate debt funds. 

How much EMI you intend to lay out of your net earnings can determine your lifestyle, ensure that you conduct a financial feasibility before embarking on assuming loan liabilities, remember with liabilities comes great responsibilities! As a thumb rule, not more than 30% should be laid out towards EMI.

The movement of Inflation is inevitable, managing your household budget with acumen becomes vital to counter such adverse situations, there is definitely no set rule on how to counter these fluctuations, it is up to you to find your way, being watchful of small spending patterns and digging into detail can go a long way in helping you to fend these fluctuations.

The author is the founder and CEO of Right Horizons, an investment advisory and wealth management company.

Portfolio management scheme: A unique investment opportunity

Author: Ramalingam K

What is portfolio management scheme?

Portfolio management scheme popularly known as PMS are specialized investment vehicle for lump sum investments. The portfolio manager invests the money in shares and other securities and manages the portfolio on behalf of the client.

One can invest fresh money in portfolio management scheme and the portfolio manager will construct a portfolio by deploying that money. Also one can transfer his existing share portfolio to the portfolio management scheme provider. In that case, the portfolio manager will revamp the portfolio in sync with his investment philosophy and strategy.

Once the portfolio management scheme account is opened, the client will be given with a web access to his portfolio. The client can look at where the portfolio manager is investing client`s money. Also one will be able to generate reports like investment summary, portfolio transaction list, performance analysis, portfolio statement and quarterly capital gain report.

As a result, portfolio management scheme relieves investors from all the administrative hassles of investments.

Portfolio management scheme vs. direct stock market investment:

One can directly invest in stock market. Then what is the advantage of investing in the stock market through a portfolio management scheme. Investing in share market demands knowledge, right mindset, time, and continuous monitoring. It is difficult for an individual investor to meet all these demands. But a portfolio management scheme meets these demands easily. The portfolio management scheme will be managed by an experienced professional. It saves the time and effort of the individual investors. Hence it is advisable to outsource the stock market investment to a sound portfolio management scheme operator instead of managing it on our own.

Portfolio management scheme vs. mutual funds:

Mutual fund is also a good investment vehicle. It should also form part of your total equity investment. But mutual funds are mass products. So they will be conservative by nature. As per SEBI regulation, mutual funds have some investment restrictions. There is a maximum limit on the percentage of amount invested in an individual stock. Also there is some maximum cap on the exposure in a particular sector.

Once the fund manager reaches the maximum limit prescribed by SEBI, he is forced to invest in some other stock or some other sector. That is why we see a large number of stocks in a mutual fund portfolio. Where as a Portfolio Management Scheme will invest in 15 to 20 stocks. This concentration makes it more attractive and aggressive. Managing Rs 25 lakhs portfolio management scheme portfolio will be more flexible when compared to managing Rs 20 billion mutual fund portfolio.

Portfolio management schemes relatively have more flexibility to move in and out of cash as and when required depending on the stock market outlook.

Basically the conservative portion of your equity investment can go into mutual funds. The aggressive portion can go into portfolio management scheme.

How to choose a best portfolio management scheme?

There are so many portfolio management schemes in the industry. So it is really very difficult to choose a good Portfolio Management Scheme provider. Here are some factors to be considered before choosing a portfolio management scheme.

1) Yardstick for Performance:

One should not just go by the past performance alone. Making an analysis on various Portfolio Management Schemes in the industry with their past performance along with the risk adjusted return and the consistency of performance will be useful in selecting the best Portfolio Management Scheme.

2) Minimum Investment Criteria:

Investors need to avoid Portfolio Management Schemes where the minimum investment is less than Rs 25 lacs. Even there are Portfolio Management Scheme operators who keep minimum investment for their schemes as low as Rs 5 lacs. But these kinds of Portfolio Management Scheme operators will have more number of PMS accounts. When the quantity (the number of PMS Acs) goes up the quality (the performance) may relatively come down.

 Therefore it is better to choose a Portfolio Management Scheme where the minimum investment is Rs 25 lacs or more. So that our PMS Ac will be directly handled and managed by the top level portfolio manager and not managed by the juniors and analysts. If you are planning to invest less than Rs 25 lacs, then the ideal investment product for you would be mutual funds.

3) Conflict of interest:

Portfolio management schemes have been run by some stock broking companies as well as investment management companies. There is a conflict of interest in portfolio management schemes run by share broking companies. The main business of a share broking company is to earn commission income by facilitating the share market transactions.

Portfolio management scheme is an additional business for them. It is not their core business. Hence there may not be enough focus on the portfolio management scheme business. Also they may indulge in doing undue and unnecessary churning of the clients` portfolio to earn more commission income. This will cause additional expenses and short term capital gain tax to the client.

The core business of investment management companies is managing the investments of their clients to earn management fees. So, with the Portfolio Management Schemes run by investment management companies, there is no conflict of interest or vested interest. Therefore it is always advisable to choose a Portfolio Management Scheme offered by investment management companies.

4) Role of professional financial planners:

A professional financial advisor or financial planner will study and analyze the portfolio management schemes run by various stock broking companies as well as investment management companies. If we approach them, they will guide us in choosing the right portfolio management scheme depending upon our requirements and other factors.

Also a professional financial advisor will continuously monitor the performance of various portfolio management schemes and advice the client on a regular basis on the performance of the Portfolio Management Scheme where the client has invested vis a vis the other PMS schemes in the industry. After a certain period, if necessary he may advice you to move from one portfolio management scheme operator to the other.

ESOPs and portfolio management scheme:

ESOPs are provided by the companies to its employees based on their service. Most of the employees are of the opinion of keeping the ESOPs as it is forever because it is their company shares. But logically it is too riskier to invest in a company to whom you work for. Because, your employment income as well as investment income will depend on the performance of a single company.

So it is not advisable to keep your investments in a company where you actually work. So it is at all times advisable to transfer your ESOPs to a portfolio management scheme. They will revamp it to construct a well diversified portfolio.

Portfolio management scheme is an aggressive investment product and really suitable for those investors:

 > Who have a share portfolio and find it difficult to manage.

> Who have enough exposure in mutual funds and looking for a different and good investment option

> Who have sizable ESOPs.

The author is a founder and director of Holistic Investment Planners.

Decoding mutual fund in Bollywood ishtyle!

What does mutual fund mean to common man?

`Mutual fund` seems synonym of `Bollywood` to me. Let`s find out here what`s the relation between two diverse worlds one in entertainment and other in investment has?

Back to past in 1980`s - 90`s era:

This was a time in Bollywood when producers used to bet on single hero projects and invest heavily in one particular movie. Audiences were getting excited to watch this movie if a hero is popular face such as Amitabh Bachchan, Dev Anand, Dilip Kumar, etc. But, if the script and direction is weak than such caliber actors of Bollywood also can`t help to make this movie perform and it gets bombed at box office. The situation discussed here is similar to investors of that period betting heavily on equities of single company. There were investors who use to have stocks of single company for example `Reliance Industries` or `Tata Motors` in their portfolio. Investors bet on company management, future prospects, profit numbers, etc. But, if this company underperforms due to lack of experience by core management than their stock prices had shed immediately on markets. This made the investors suffer heavy losses on their portfolio. Then time came investors started understanding need for diversified asset allocation…

Present Scenario:

Now, the time has changed and audience preferences. Producers have now started betting on multiple actor projects where they showcase the talent of each actor in strong character role. Audiences are also excited to watch their favorite stars perform to their best in a single movie. Recent example of a movie which was successful due to huge start cast and showcase of decent performance onscreen is `Rajneeti`. The movie had a strong storyline and director executed this movie exceptionally well. Similar, is the story for mutual fund the asset management company invests the pool of money collected from investors in diversified star performing / emerging companies. This makes their risk diversified among many company stocks. Every company is considered as an important character in their mutual fund scheme. So, if one company is underperforming and suffer losses than it gets adjusted with other company which is outperforming and making profits in that portfolio. Here, the fund manager is a director who takes care of asset allocation / returns from the mutual fund scheme and fund offer can be said as story line which gives general clue to investors where the amount will be utilized from their investments.

Variety under mutual fund schemes:

As audiences prefer different genre of movies such as comedy, action, emotion, adventure, sci-fiction, etc. based on their interest. Similarly, asset management company has variety of schemes to offer for their investors based on their risk taking capacity and expected returns. There are index funds, sector oriented funds, global funds, balanced funds, etc.

Applicable charges:

To view movies audience has to bear the ticket charges or cost to buy DVD / VCD. Similarly, to get services of mutual fund investors have to bear annual charges for administration as well as pay exit load specified if applicable on offer document of scheme.

Advantages of investing in mutual fund:

> Professional management by Fund Manager
> Diversification of stocks
> Convenient Administration
> Return potential in schemes being offered
> Low costs to investors
> Liquidity to convert in cash
> Transparency and flexibility in operations
> Variety of schemes to select before investing
> Tax benefits products
> Well regulated by SEBI

Back to Future:

The future of mutual fund product seems bright. There are many investors who have entered into stock market thru this product because they lack the understanding of investing directly into equities and this number will keep on growing whenever there will be awareness among non-investing class of people. As, we are observing there are experimental movies such as `Phas Gaya re Obama` targeting multiplex going viewers as their audience. Similarly, asset management companies are also churning out new structured products whenever they find an opportunity to explore and target specific investors segment. This will keep on attracting investors towards their new offerings time to time and will see asset under management of mutual fund industry increasing year-on-year.