Transcript of my chat on www.moneycontrol.com on 17th December, 2014

Is this the right time to invest in Mutual funds?

The market crash is good news!

Look at the correction as an opportunity to engage with your clients

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Balanced funds - a good option for a first time investor

My article in Mumbai edition of Gujarati Mid-day today

http://epaper.gujaratimidday.com//epaperpdf/gmd/15122014/15122014-md-gm-11.pdf

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The English translation is as under:

“What are balanced funds? I heard an expert recommending these funds for a conservative investor.” Someone asked. “As the name suggests, such funds should be expected to maintain balance. Am I correct?”

Well, a balanced fund should be understood as a hybrid fund that invests larger portion in equity and some in fixed income securities. The word “balanced” might have been used as in the beginning one would have tried to maintain equal allocation to the two assets, viz., equity and fixed income. However, later on, the allocation changed due to changes in the Income Tax Act (the Act).

As per the Act, a fund is categorized as an equity fund if at least 65% of the fund’s assets are invested in equity shares listed in India. Equity funds enjoy better tax treatment as compared to the other categories. Due to this, the balanced funds invest more than 65% of the fund’s assets in equity shares.

Having said this, these funds are still less risky as compared to the equity funds and hence the same might be a good starting point for a new investor. Let us look at the performance of these funds, especially when the equity markets fell.

We looked at calendar year data of performance of scheme categories – these numbers are added for all schemes in a particular category.

In the last 10 years, there were two calendar years in which equity markets fell: 2008 and 2011.

BSE Sensex fell by more than 52% in 2008 and by more than 24% in 2011. In these two years, the balanced fund category lost 37.14% and 15.41%, respectively as compared to equity multicap funds category, which lost 53.90% and 24.60%, respectively.

As can be seen, the balanced funds lost much less than the pure equity funds in the falling markets. However, in rising markets, equity funds did better than balanced funds in 7 years whereas balanced funds outperformed the equity funds in 1 year.

Thus, we can see that in the rising equity markets, balanced funds do not rise as much as the equity funds, but they provide reasonable protection in falling markets.

It is this characteristic of the balanced funds that make them suitable for a beginner. The equity allocation provides potential of capital appreciation, debt provides cushion against steep fall and classification as equity funds result into better tax-efficiency.

Coming back to the numbers, it is important to note that these funds may also exhibit steep fall in value as can be seen from the performance in the year 2008. Balanced funds as a category fell by as much as 37% during the year. This is quite a steep fall by any standards. Hence, one should not expect these funds to provide complete protection when the markets fall. Even in 2011, when the Sensex fell by roughly 25%, balanced funds lost around 17% for the year.

However, there is a hidden benefit here. When the markets fall, the equity allocation loses value, but the debt allocation would not. This results into the equity allocation being lower than what one started with.

Let us say, the scheme started with Rs. 70 allocation to equity and Rs. 30 to fixed income. After a year, equity had lost 25% and fixed income had earned 9%.

This means, the year-end values of equity and fixed income allocations would be Rs. 52.50 and fixed income allocation would be Rs. 32.70. This means the equity allocation is below 65%. In order to maintain the fund’s status as an equity fund, the equity portion needs to be increased. This can be achieved by selling some part of fixed income component to buy equity. This process is also known as rebalancing.

This rebalancing results into the fund buying equity when the prices are low.

Balanced funds are good for beginners. However, as explained, one must understand the limitations of the same. Some of the biggest limitations would be:

1.     In rising markets, balanced funds may underperform equity funds

2.     In falling markets, the NAV of balanced funds may fall, though not as much as equity funds

3.     Long term returns from balanced funds could be lower than equity funds, if equity markets exhibit a long term rising trend.

Happy investing.

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions.

Santa Claus is coming along riding on his sleigh ...

This is a two year old article that I had written. Good to remind us of the lessons any time.


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SWP - part two

This article, second of the two articles on the subject, explains two important features of SWP:

1. Tax benefit, and
2. Impact of NAV fluctuations on the withdrawals

Happy reading ...

http://epaper.gujaratimidday.com//epaperpdf/gmd/01122014/01122014-md-gm-12.pdf

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English translation is as under:

Last time, we talked about a convenience offered by mutual funds for those seeking regular income. In that article, we also mentioned the following words of caution: “… please consider this discussion only in the context of liquid and short-term debt funds and no other categories. “

Why is such a caution required? To answer this question, we have to understand how mutual funds work.

A mutual fund is a pooled investment vehicle, which means small amounts are pooled from a large number of investors to create a big corpus. This means, there could be differences between the investment horizons of various investors. Some may invest for a short period, while some may invest for a longer time.

One of the benefits of investing in open-ended mutual funds is the liquidity – any investor can enter the scheme or get out of it on any working day. However, this also means that at all times, there could be three different categories of investors: (1) those entering the scheme, (2) those exiting the scheme and (3) those old investors staying with the scheme.

It is also important to ensure that all the investors get a fair price at all times. This is why the buy and sell transactions in a mutual fund scheme happen at NAV – the Net Asset Value, which is calculated in a transparent and fair manner to be as close as possible to the realizable value.

This NAV is a function of the market value of securities in which the fund has invested. These market prices may fluctuate on a daily basis. Due to this, the mutual fund schemes witness fluctuations in the NAVs.

It is important to understand the above in order to understand why we recommended SWP of fixed amount in a liquid or ultra-short term fund. These categories of funds exhibit very low NAV volatility.

Now, let us go back to the basic objective behind setting up a SWP – it is for an investor who is seeking regular income from the investments. These regular withdrawal transactions, as we saw earlier, happen at the NAV linked prices. Let us see what happens in the below mentioned hypothetical case:

Sr	Amount withdrawn	NAV	Units redeemed
1	Rs. 10,000	Rs. 15	666.667
2	Rs. 10,000	Rs. 13	769.231
3	Rs. 10,000	Rs. 14	714.286
4	Rs. 10,000	Rs. 16	625.000

As can be seen from the above table, at the NAV of Rs. 14, the investor had to redeem 714.286 units, as compared to 625 units when the NAV was Rs. 16. Lower NAV meant withdrawal of more units. Now, if the NAV was constantly growing, such a situation may not pose any trouble. However, fluctuating NAV would mean that at lower prices, one might end up withdrawing more units. This would hurt when the NAV starts to recover after a fall.

While SWP is a good facility, one must also understand its limitations.

From a limitation, let us move onto a benefit of SWP. This might be the favourite of all – Tax efficiency.

Let us assume that an investor has Rs. 1.50 cr to invest and needs regular income of Rs. 12 lacs per year.

If one were to get such income through investment in traditional interest bearing investment option, one would get into the highest income tax slab. Interest income is added to one’s income and taxed at the marginal rate applicable at the respective income level.

On the other hand, let us consider SWP for such an investor. In case of SWP, as we saw in the table earlier, there is a redemption of units. When a unit is redeemed, the amount received consists of two components – principal invested as well as earnings thereof.

Let us say, the investment was made when the NAV was Rs. 12. As per the table above, the first withdrawal happened at NAV of Rs. 15.

Each of the units thus withdrawn was purchased at Rs. 12. The same was redeemed at Rs. 15. Hence, there would be a profit of Rs. 3 per unit. As can be seen, the amount of Rs. 15 has two components: Principal value of Rs. 12 and profit of Rs. 3. Thus, in this case, while the investor gets Rs. 15 per unit, the taxable component is only Rs. 3 – the profit. Principal withdrawal is non-taxable.

Each transaction might have a different combination of principal and profit, which one needs to carefully calculate. However, while interest income of Rs. 12 lacs a year would attract good amount of tax, SWP would result into a much lower taxation.

SWP will not help you get rid of the tax completely. However, it is a tax-deferral scheme. Each Rupee of deferred tax allows one to earn till the time the tax becomes payable. Evaluate your situation and consider the options very carefully.

(The author is not a tax-practitioner and hence one would be advised to consult a tax adviser for further details.)

Amit Trivedi

The author runs Karmayog Knowledge Academy. The views expressed are his personal opinions. 

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Price inflation is currency deflation. 

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Always buy quality stocks during a bull run

While buying any investments, make sure that you buy quality at reasonable price and not just something that is cheap

Read more at: http://www.moneycontrol.com/news/mf-experts/always-buy-quality-stocks-duringbull-run_1226193.html?utm_source=ref_article