Sunday, December 23, 2012

Why investors do not make Good Returns?

It is an accepted fact that equity as an asset class is an excellent vehicle to create wealth over long term. Pink papers sing paeans about how the Rs. 10,000 invested in Wipro in 1990 would be worth Rs.455 odd crores. The list goes on for other shares. The same holds true for mutual funds.
Consider the figures set out in the table below:-

Inception date
Value of Rs. 10,000(as on 30/11/2012)invested

at  inception
on 03/01/2000
DSP BR Top 100Equity Fund
1, 14,630 (28.49%)
DSPBR Equity Fund(*)
2, 24,153 (22.06%)
68,577    (16.07%)
HDFC Equity Fund
2, 76,571 (20.56%)
1, 11,655 (21.00%)
HDFC Top 200 Fund
2, 61,295 (22.66%)
80,913     (18.00%)
Reliance Growth Fund
4, 92,000 (25.75%)
1, 12,005 (21.00%)
(*) Dividend Reinvestment option

However, the question is: - If equity is so rewarding, then why do ordinary investors do not make the kind of money as referred to above? You will hardly come across anybody who has realized/generated this kind of wealth by just being a passive investor! Rather it is an irony that we have come across far more people who have managed to either lose money or gain very little while investing in equity. Why is this so? If equity investing is such a wonderful thing, why aren't the streets full of ordinary investors singing virtues of the stock market?

We believe all or a combination of below mentioned facts that could be responsible for investors missing the wealth creation bus:-
  • Investments are supposed to be liquidated at a point in time

Investors believe or are made to believe by their advisers/agents that since equities are volatile, they need to be liquidated to protect the value of investments. Intermittent crashes only tend to prove the point. However, the fact that markets will and recover after the crash is overlooked by the investors. The fact that in equity markets you make money not despite the crashes but because of the crashes—is usually missed by the investors. That an existing investment is liquidated only in under following circumstances:-
1. Your life’s goal has matured for payment.
2.Availability of an alternative investment which can yield more than the present one.
3.  In an emergency.
  •  Failure to see the big picture

Investors simply fail to realize that if the economy is growing, equity—being slaves of performance, prices will ultimately catch up with the underlying fundamentals.
Over the last 30 years or so the Indian economy grew by 6.20% per year. This is the real growth rate. If we add inflation to this (averaging 7% over this period), the nominal growth rate was about 13%. This growth has come in spite of the famines, wars, assassinations, bankruptcy of our economy ET all. Is there anything to suggest that the next 30 years will be different from the last 30 years?(Click to read "Fear, Greed & Panic)
  • Too much news flow/daily nav

Do we track the price of the property we have invested in on a daily basis? Or for that matter, do we follow the interest rates for the FD we made? “Yeh to long term ke liye hai” is our normal reply for other investments. However, when it comes to equities, we follow day to day price/nav movement? Thanks to the regular bombardment of price sensitive information on business channels or pink papers (whose primary objective ironically is creating informed investors).
  •  Lack of faith

Our market it is said is driven by FII money. We Indians have less faith in our own economy than FIIs. There’s been positive funds flow since FIIs have been allowed to invest in India since early nineties. We have had net outflows of FIIs money only on 2 occasions (2008 and 2011). Moreover, is it not strange that FIIs shareholding in India’s top 75 companies touched an all-time high of 21.60% as of 31/10/2012? Would this have been possible if we had not performed as a promising economy? All these years, anything that could have gone wrong with the economy has occurred viz; droughts, floods, wars, scam ET all. Despite these negative events, we have grown by roughly 15% p.a. over last 30 odd years. Sadly, FIIs have realized this but not us.
  •  Absence of goals

Investors usually make investments without any specific goals. It’s more like starting on a journey without a specific destination. We at AIMS have always advocated goal based investing. This gives a sense of purpose and hence longevity of investments. 

Sunday, December 16, 2012

Right Way

Recently we got a mandate to express a second opinion about the Mutual Fund portfolio of a prospective client which had been constructed by a “big” distribution house.

We were amazed at the logic (or the absence of it) that went behind the process of portfolio creation. There were investments in short term funds, bond funds, and gilt funds. Equity exposure was restricted to small sectoral funds and only average diversified equity funds. It was evident that the portfolio was not a client-centric one but distributor-centric. To add to the unprofessionalism  the distributor was also charging fees. We had every reason to believe that the funds recommended had been shortlisted on payout model. Fund houses that do not support extra payouts were missing from the portfolio.

We are sure this is a common story with thousands of fellow investors who are not able to get the right person for advising them on their financial present and future and end up buying or investing in products which they do not want. Today we all are hard pressed for time but it’s high time that we realize that to earn money it takes time, then why don’t we give time to select the right person to deal with our financial lives. If the above story has got you thinking then read further for a few guidelines that you can follow in your pursuit to find the right financial advisor or planner

1.    Diversify across fund managers and not across funds

Today every investor has realized that diversification is good for a portfolio. Most people have a vague idea that it means that one should invest in a large variety of stocks and funds. Can diversification be defined as being proportional to the number of stocks or schemes and nothing else? If a portfolio with 5 stocks is better diversified than one with two, then one with 50 stocks must be much better diversified than either, right? As it turns out, it isn't as simple as that. Investors who wish to keep their life simple can do fine with just three or four funds. To sum up, diversification is not a goal in itself. It has its downside and is part of your workload as an investor. One should do the minimum required and no more.

2.    Be clear about reason for  investment

The portfolio should not be based on either or basis.  The advisor cannot and should not suggest mutually exclusive recommendation. For example, short term funds and bond funds cannot co-exist. This implies that the advisor has not done his due diligence about the client’s profile. Mere “parking” funds cannot be termed investment. The portfolio or proposal should reflect the thought process of the advisor/distributor. In absence of such clarity it will be imprudent on part of the agent/advisor to charge fees—if he is charging any.
3.    Do your own homework

A little homework about the fund selection would be beneficial for the investor himself. Factors like consistency of the returns, expense ratio vis-a-vis peer schemes would give a fair idea about the intention or capability of the advisor. It has been observed that a fund with not so good financial performance usually offers higher payout to the distributor as compared to the better performing ones within the fund house. Quality is non-negotiable while price is.

4.    Do you work with an advisor or an agent

This is very important for the safety & future performance of your investments.  An advisor will always place the client’s interest before him whereas an agent/distributor will place his own interest before that of his client’s. You do not need to be an Einstein to discover this trait of your consultant. A peer group comparison of suggested schemes would in all likelihood bring out this distinction.  Moreover, it is important to note that every meeting with your advisor need not result in new investments or churning of the existing ones.

5.    Get a Second opinion

Very often an investor wants to evaluate his existing portfolio or is approached by a bank or a big distribution house with an investment proposal which he cannot refuse. It is preferable in such cases to obtain a second opinion about the proposal/existing portfolio or We at AIMS offer “Second Opinion Service” (SOS) without any obligation on part of the investor (however the only obligation is towards our fees for this service). The portfolio/proposal is evaluated based on certain parameters and opinion expressed thereon. 

The above guidelines need to be followed if you are serious and concerned about your money. The time invested initially in finding the right person for your wealth management needs will hold you in good stead as such relationships lasts a lifetime. Also remember to be realistic in your expectations from your advisor. Don’t expect results overnight as you would have to be equally cooperative and serious about the recommendations provided.