THE ILLUSIONS OF HIGH RETURNS

 

THE other day we got a query from a client of ours who was disappointed with five-year SIP returns of equity funds that are published in a personal finance magazine. This client of ours had pulled up the table that listed SIP returns of all equity funds and had observed that there were some which had 5 year returns as low as 12% per annum and some others had returns in the range of 14-15% per annum.

The “safe” returns that one gets nowadays means one’s money becomes approx.one-and-a-half times in 5 years. In contrast 15% a year corresponds to doubling one’s money in 5 years. Is it possible to be disappointed by 15% a year over five years? Well, it is possible to be disappointed by almost anything in this world, as you will no doubt recall from those childhood occasions when your parents would see your exam marks. It all depends on where you set your expectations.

However, we’re not blaming anyone who has unrealistic expectations from equity returns. The fault actually lies with the History of high inflation and high nominal returns that India has, coupled with the general difficulty in doing mental math involving compounding returns. How do inflation and past high rates affect how we think about investment rates? For one almost everyone remembers a time when it was possible to get 10% a year from a bank fixed deposit. Older people may even remember getting 12% or more in PPF.  Now a days, the highest interest rates between 7 and 8% are the norm, with the upper end of that range already being quite rare.

What is the difference between 10% a year and 7% a year? With the routine number sense that most people have the difference is 3%. And yet it is actually much more. The number 10 is 43% more than 7. The amount you earn at 10% in a year is 43% more than what you earn at 7%. Then comes the compounding. Over 5 years 10% a year earns you roughly 52% more (one and a half times) than what 7% would

To people who are familiar with the basic arithmetic of saving and investing all this is trivial stuff, self-evident and hardly worth mentioning. And yet it’s far from self-evident to the vast majority of savers. They feel that an equity mutual fund’s SIP return of 15% is roughly speaking in the same range as bank FD’s because they feel that FD rates are around 8 and used to be 10 at some point. These illusions are in a direct way a byproduct of high inflation and high interest rates. If you adjust for 6% inflation, then the bank FD got you 1% and as SIP in a middling equity fund 9%. You should try the above calculations now.

This demonetization how high inflation and nominally high interest rates create the illusion that fixed-income assets like bank and other deposits are investments. In reality they are not. They can barely preserve the value of your money There are many who have lakhs lying in savings accounts. This money is nothing but a donation to the bank. Savings’ accounts are the most misnamed financial products in INDIA as there has never been a time when they had interest rates even remotely near the inflation rate. Again, people let money in accounts because a 4 or 5% number looks like something. There is no solution to this except to be aware of it and not let big numbers trick you. The first step towards real and useful financial literacy is to be aware of inflation and compounding and always look at investments after mentally adjusting for these. It is not difficult and there are few things that are useful.

How to stay calm in a nervous-cum-volatile market?

Investors are right to feel jittery. The situation in Ukraine, unusually high inflation in certain parts of the globe, and the lingering impact of the pandemic all pose significant risks to future economic growth.  However, the markets ignored such negatives for far too long. It is therefore unsurprising that asset prices have increased in volatility, gyrating between the full spectrum of “buy the dip” optimists to “seek shelter” pessimists.

So, we’re in an all-too-common situation where investors (and speculators) attempt to discern the correct price of these risks, creating heightened loss aversion for as long as the uncertainty exists.

As is often the case at these inflection points, many will ask: is it different this time? In today’s case, it is different in the details from what we’ve experienced till now, but the way investors are responding is more or less the same as what we’ve seen in other periods of volatility.

First, let’s start with the unique aspects of the current situation. Primarily, investors are being asked to weigh downside risks against strong profitability, low unemployment, and plentiful support from governments and central banks — with the unwinding of unprecedented stimulus a challenge we’ve never faced.

Emotional Responses: Flight, Fright, Freeze

Europe is closer to war than at any point in decades, which is sure to give people goosebumps.

Now let’s turn to what is similar to the past. Periods of sharp price movements tend to trigger an emotional response from investors as we perceive such movements as a threat to us. When faced with the perception of such a threat, we tend to display a "flight, fright, or freeze" response. These various responses result in particular behaviours in investors, which are consistent with what we saw in past bouts of uncertainty— including in 2000, 2008, and 2020.

What exactly do we mean by that? In financial markets asset prices are set by transactions. Volatility in prices, therefore, indicates that transactions are occurring across a wide range of prices. This suggests that investors are unsure about the intrinsic value of an asset given the current confluence of risks.

Those who display the fight response are most likely to increase their trading activity during this period, confidently buying assets that have fallen in the expectation that they will recover, with little thought to the intrinsic value of those positions.

Those more vulnerable to the flight response will likely sell their entire portfolio and subsequently tend to remain under-invested for far too long.

Those who freeze will do nothing even when the intrinsic value of their asset is changing.

Each of these responses places too much emphasis on near-term price movements leading to potentially devastating consequences for the long-term financial health of the investor.

The key to staying a step ahead is to focus on the intrinsic value of the asset, as over the long-term prices converge with that value. This was something Benjamin Graham famously called Mr Market, which was notably supported by Warren Buffett. Sometimes the prevailing price offered by Mr Market (the current price available) will be above that intrinsic value and sometimes below. Herein lies opportunity

Watch where your focus is!!

FIIs Vs. DIIs Their actions and Inference

 

Consider this-- an investor who had invested Rs. 10,000 in Nippon India Growth Fund (erstwhile Reliance Growth Fund) during its NFO (08/10/1995) has grown to Rs. 15,57,118  (as on 28/02/2021) logging an eye popping CAGR of 21.98%.

We Indian retail investors -- always suffered from FII phobia (fear of “heavy selling' by FIIs) one day” before exiting India lock, stock and barrel.

The FIIs seems to have played on to this fear of retail investors and have come to hold nearly 25% of the floating stock of Sensex—confident of the companies’ performance over long term and its impact on the stock prices.

Every new high made by the stock prices or indices are looked upon as “peak” by retail investors worthy of converting their equity holdings into say gold  or fixed deposit.

A majority of equity investors have gradually evolved as investment traders over the years rather than long term investors in true sense of the word.

Does the buying and selling by FIIs have any underlying message?

The answer is probably yes.

When the pandemic first struck India in March 2020, FIIs sold (net) Rs. 5,200 worth of equities, while Domestic Institutional Investors (MF, Insurance companies etc.) sold Rs. 825 crores (net) of equities to meet redemption pressure. Thereafter, FIIs went on a buying spree (because of attractive valuations) and bought (net) equities worth Rs. 36,910 crores over the next 4 months. Domestic Institutional Investors sold equities worth Rs. 7,263 during the said period. The Nifty went up from 9,553 (closing level of April 2020) to 11,387(closing of August 2020)

The buying spree started again from October 2020 (net buy Rs. 14,537 crores) when Nifty closed at 11642 and till March 2021, FIIs bought stocks worth Rs. 1,75,381 crores. Nifty closed at 14690. While DIIs sold (net) stocks worth Rs. 1,26,000 crores.

Consider the following table:-

	FII	DII	Nifty	Sensex
April 2020	-5209	-825	9553	32720
May 2020	13178	11356	9580	32420
June 2020	5493	2434	10302	34915
July 2020	2490	-10007	11073	37606
August 2020	15749	-11046	11387	38628
Sept 2020	-11410	110	11247	38067
October 2020	14537	-17318	11642	39614
November 2020	66307	-48339	12968	44150
December 2020	49992	-37293	13981	47751
January 2021	14775	-11970	13634	46285
February 2021	18023	-16358	14529	49099
March 2021	11747	5204	14507	49008

 

One thing that is evident from the table above is that Indians investors do not have the confidence in their own equity markets and therefore are not willing to hold on to their equity investments for long term and reap the benefit of not only compounding but also the positive effects of growth in our Indian economy.

We, Indian investors—are more willing to convert an asset returning 12-15% CAGR to an asset returning 8-9% and without any intermittent payouts.

It is because of our unfounded fear of FIIs exiting en masse’ that they have been able to gain control of roughly 25% of the free float of BSE.

The above numbers reinforces our belief that FIIs have more confidence in the potential of our equity markets than we have in our own market. It will be prudent to follow FIIs while investing—buy right, sit tight.

 

 

Green Shoots in Indian Economy --what lies ahead!!

Stock market, it is said always discounts the future much ahead of the investors. Indications of turn-around--either for good or for bad--do appear in business papers, but they don't make headlines-- and hence skips attention of the investor.

 

We at AIMS do believe that "achhe din" may not be too far. Following are the reasons why we are bullish on equities:-

•  More than 42.70 million e-way bills were generated in June 2020 with a total value of Rs. 12.40 lac crores. The corresponding figures for March 2020 were 40 million and Rs. 11.43 lac crores. The figures indicate movement of goods was getting close     to pre-covid days.

• GST collections in June clocked Rs. 90,917 crores. The figure for April 2020 was Rs. 49,500 crores.

• During Lock-down Phase 1 (from 25/03/2020 to 14/04/2020) roughly 1,72,000 e-bills were generated. While during Lock-down phase 2 (from 15/04/2020 to 03/05/2020) approx.3,51,000 e-bills had been generated.

•  Average daily passenger vehicle registrations rose to 44,273 in June 2020 as compared to 9,014 in the previous month. (ICICI Securities)

 

Based on above encouraging statistics-- as it is said numbers do not lie-- we at AIMS believe that good times may not be too far.

 

We're willing to stick our neck out to say Nifty at 13,000 -- by??? (take a guess)

 

Remember, equity investments are more a function of patience rather than intelligence!

 

Moreover, risk of losing money by investing in equities NOW is far less than risk of losing money by not investing.

 

Get your cheque books ready!!

Happy Investing!!

 

 

 

Dividend Payout or SWP--which is better?

The dividend season has arrived. Fund houses announce big payouts not only to mop up funds and increase their AUM, but also to project their investor friendly policies as they help investors generate cash flows periodically.

But the question is

•  Are dividends really helpful to the investors looking for extra income?
• Are there no other options for the investor to generate steady cash flows preferably during their retirement without impacting their investment?

The answer is YES.

It’s known as SYSTEMATIC WITHDRAWAL PLAN (or SWP as it is commonly known).

The purpose of both the option is to generate cash flows for the investor(s).

The differences between the two are listed as under:

• Dividends are paid out of booked profits only, (earlier they (fund houses) were allowed to pay dividends out of reserves also). On the other hand, SWP once registered, continues as long as the investments are alive.

• Payment of dividend is a prerogative of the fund houses. They are not bound to pay dividends if the distributable surplus is insufficient or to conserve resources when markets are in corrective mode.  SWP payout on the other hand, continues irrespective of market condition, or level of distributable surplus.

•  MF dividends, unlike corporate dividends, are not income in the hands of the investor. The dividends (MF) paid out are deducted from the NAV of the scheme the next working day. In other words, it’s your own money coming back to you in the form of dividends. In SWP, requisite number of units are redeemed and remitted to the investor on a pre-set date chosen by the investor.

• NAV of units held gets reduced in dividend payout option, while unit holdings are reduced in case of SWP.

• Dividends are taxed at source irrespective of the tax slab in which the investor falls, while the SWP which consists of capital + profits may not attract any taxation depending on the tax slab in which the investor falls. Hence, SWP is a tax-friendly manner of withdrawing money from your MF holdings.

• A fund house may cancel dividend though announced. Monthly payouts under SWP are set in auto mode and can be cancelled only by the investor.

• Dividends are useful in generating cash flows during the working life of the investor. SWP, on the other hand SWP is better in generating regular cash flows during post retirement.

• SWP is better option to fund your retirement, provided you plan well in advance.

IDFC EQUITY OPPORTUNITY FUND SERIES 6

Should you invest in IDFC Equity Opportunity Series 6?

Consider this:-

• India was the 10^th. Largest economy (in terms of US dollar) in 2014. By 2018, India was the 6^th largest economy (in terms of US dollars) 

• The Indian economy which was in a slow motion between 2004 to 2014, seems to be turning around in 2018.

• With the imprints of DeMo fading and with GST gradually gaining traction, consumption is back with vigor, leading to recovery in gross utilization numbers across sectors.

• We are seeing some green shoots --- manufacturing activity has hit its highest level in 5 years and commercial vehicle sales, which is a proxy for growth, surged by 60 to 80 percent in December. 

• Indian growth story is predominantly dependent upon domestic demand, unlike export based economies like China, or commodity driven economies like Brazil, Russia etc.

• GST collection in April’2018 crossed Rs. 1 lakh crore.

So, what’s driving the Indian economy?

Demand in the economy is driven by 3As—Awareness, Affordability, Availability.

In absence of any of one A— demand will be missing or low

Growing middle class, rising literacy rates, distribution push and brand pull is transforming India from A to 3A.

A classic case of missing of either one of the A is Bajaj Scooters & Ambassador Cars—there was Awareness and Affordability but no immediate Availability. Hero Honda (erstwhile) became world’s largest bike manufacturers.

It took India 70 years to reach $2.50 trillion economy.  It will reach $5 trillion economy in next 5-7 years—and this is not possible if economy is not growing.

  

So, where is the growth going to come from? Growth will come from factors like

• Growing consumption data base. 
• Strong technology adoption (for example:- Direct Benefit Transfer).
• Improve supply chain management(facilitated by increasing road connectivity)

IDFC Mutual Fund has come out with a NFO to benefit from a burgeoning economy.

The fund will focus on companies

• With high promoter holding..
• Capable & focused management driving the business
• Which are consistently generating above average RoE
• With low financial leverage.

To end we would just say...

“jo lega, so paayega”

Opportunity knocks more than once at AIMS.

NPS GOOD, BUT EQUITY MFs BETTER IN THE LONG RUN FOR RETIREMENT

Though National Pension System (NPS) offers good tax differing options, it is not suited to investors whose debt portion is already met through contribution to PF, PPF etc. and want to route the additional investment to equities. This is because as per existing regulations, NPS does not allow equity exposure beyond 50%. Though a new life cycle fund introduced recently, allows up to 75% equity exposure, it is only up to the age of 35 and after that equity exposure comes down by 2% every year. That means the equity exposure will be down to 55%, by the time one turns 45 and will drop further to 35% by the age of 55.

Does it mean that you can forgo the tax deferment option in such situations? Since historically equity has generated better returns in long term, it makes sense to pay tax now and then invest the remaining money in equity MFs.

We have tested this by assuming 12% return for equities 8% for debt and 10% for NPS (i.e. on the assumption that asset allocation here is 50% equity and 50% debt).In the first option tax payer routes Rs. 50,000 p.a. to NPS, the exclusive window allowed under section 80CCD(1B). In other options, he decides to pay tax and invest the remaining money into an equity MF. These annual investments will vary depending on the tax slabs. So the second, third, and fourth options are based on 30.9% tax slab (remaining investment Rs. 34,550) 20.6% tax slab (remaining investment 39,700 and 10.3% tax slab (remaining investment 44,850)

Total value of Rs. 34,550 p.a. investments into equity fund has overtaken the value of Rs. 50,000 p.a on investments into NPS in the year of 29.Similarly, break even year will be earlier for people in lower tax slabs—that is 19^th year for people in 20.6%tax slab and 10^th year for people in 10.3% tax slab. Please note that the above mentioned analysis is without considering the tax implication of NPS at maturity. If that is also considered, this break even will be much earlier.

Reasons why NPS may not be suitable for a new employee and neither for an existing one may be listed as under:-

• Very long lock in period:-

NPS has the longest lock-in period amongst the tax saving instruments. One can only withdraw at the age of 60. Even then, one can withdraw only 60% of the accumulated balance, while the rest (40%) has to be compulsorily utilized to buy an annuity. Hence, if one opts to create retirement corpus through NPS his lock in period can be as long as 30-35 years, if he starts investing from the age of 25-30.

• Taxation on maturity

NPS is a tax deferment product and not a tax saving one. Out of the 60% that is allowed to be withdrawn, 40% is tax free while the rest 20% will be taxed as income. Furthermore, the pension received is taxed under the current Income Tax provisions. The Indian annuity market is still not conducive for annuity seekers. The current annuity yield is between 5-7%--much less than fixed deposit. So, even if the savings earn a higher return during the accumulation phase, low pension rate will undo most of the gains.

In light of the above it is possible to create a retirement corpus through the MF route in a tax friendly manner, by commencing a monthly SIP solely for retirement purpose.

Calculations show that a monthly SIP of Rs. 5000 religiously continued for 30 years will yield a corpus of roughly Rs. 1.20 crores. This will in all likely hood yield a monthly cash flow of Rs. 80,000 at a conservative rate of return of 8% (called SWP or systematic Withdrawal Plan).

With some planning (preferably done by your financial advisor) you can live your twilight years with “sar utha ke jiyo”.

Happy retirement to you

Click on the link to read-- Why PPF may not be suitable for your retirement