The watchdog can also bite

Many a times, one becomes cynical about the ways of justice and rule of law in India. Instances like the delayed process of law in the Bhopal Gas Tragedy lead one to question whether the rules and regulations really matter.

In such an environment it is heartening to see the painstaking investigation and action by SEBI in the matter of front running by a Mutual Fund dealer. Victims in fraud cases and in ponzi schemes are easy to identify and they are the ones who demand justice. On the other hand front running and insider trading are seen as what is called “victim less crimes”. It is difficult to precisely identify the victims of such crimes. The victims in such cases may not even be aware that they have been defrauded.

The current case was especially difficult to investigate as the front entities indulging in the trades had no apparent connection with the Mutual Fund in question. It must have been a difficult task indeed to have identified the connections and then to have confronted the individuals with the evidence. Cases of insider trading and front running have been difficult to prosecute in other countries as well. In the face of such odds SEBI seems to have done well in getting sworn admission of guilt from the accused in this matter.

Suspension of such individuals from the market and recovery of the ill gotten gains is only the start. One would want to see criminal prosecutions in such matters.

The is a warning to all those who indulge in insider trading, front running and market manipulation. The watchdog can also bite.

What is worse than earning negative (real) interest rates on your investments?

Investors are agitated. A lot of them have missed out on the equity rally. Many sold out shares at lower market levels. Fear made them put their money in bank fixed deposits.

Today deposits have matured, money is in savings bank account earning 3.5% nominal and a huge negative real rate of return on their money. What could be worse than this? Come to think of it, there could be many things worse than this.

1. Locking into negative real rates for a long time. Many investors in the desire to ‘improve’ returns would go in for longer maturity fixed income investments. This could be a mistake. Interest rates have to move up sooner or later. Bear with the negative returns for a while. Don’t lock into smaller negative rates for a very long time.

2. Taking foolish credit risk. Anyone in the market for Greek bonds at 14% per annum? (2 year Greek bonds had briefly touched 38% yield in trading). Well you could get 14% but there is apparently a 50% chance that Greece could default on its borrowings. In such a case you could even lose a substantial portion of your principal. In a low interest rate environment debt offerings at somewhat attractive interest rates will seem very seductive. I would be best to avoid the siren song and work on preservation of capital.

3. Buying foolish “alternative” investments. It is precisely when interest rates are low for a long time that ideas like investing in wine, art, commodities, watches etc. start floating around. There is ample time to regret these investments later when markets become somewhat normal.

4. Buying overvalued equity. Just because you missed a bus is no reason to try and board a running bus. It is always better to wait for individual opportunities to arise rather than work with a plan to forcibly deploy cash.

As someone said “Buying something and holding on is by far easier than staying liquid waiting for the right opportunity to come your way”.  

Where the package is the value, ULIPs vs. Mutual Funds

There are many products in the world where the label or the packaging is what imparts value. The product in itself constitutes a fraction of the overall value derived by the consumer.

Take for example a Rolex watch, a Louis Vitton bag or an expensive bottle of wine. It is what the consumer percieves that is important as opposed to what is rational. If consumers were rational, they would probably be willing to pay only a fraction of the current price.

The case of Unit Linked Insurance Plans (ULIPs) vs. Mutual Funds is similar. While the former is an expensive vehicle to invest through, the latter is the best value rationally. However ironically it may be the case that investors derive more “satisfaction” in ULIPs as compared to Mutual Funds. The Mutual Funds do not promise a child’s education or a comfortable retirement or the highest NAV. Also due to the fact that most funds are open ended and periodically ranked according to short term performance, it encourages short term behaviour in distributors and investors. Hence the entire focus of investors is diverted from long term investment returns from Mutual Funds to short term volatility of the markets.

What is probably needed in Mutual Funds is a move towards interval schemes with Systematic Investment Plans and a defined investment horizon. These schemes would have an asset allocation which would be determined based on the target retirement date or the target education goals (the defined investment horizon). The investor would be assured that a systematic asset allocation will take away undue volatility and help in meeting life stage financial goals and at the same time benefit from the low cost structure of Mutual Funds.

It is probably a time for Mutual Funds and the regulators to understand the art of packaging!

Day trading as a respectable full time vocation!

It is amazing how day trading becomes ‘respectable’ in every bull market. I am surprised to see online trading ads on mainstream television channels now. These ads were earlier restricted to business news channels like CNBC and NDTV Profit.

There is this ad where the wife gives the husband his mobile phone, lunch box and where his mother puts tilak on his forehead. Finally what the husband does is go to his ‘office’. This is a room in his house where there is a computer with online trading facility.

There have always been compulsive traders and gamblers. However the activity of being glued to the screen and continuously buying or selling something is being given a new found respectability. I wonder what these professional traders will do if the markets were to be not so kind!

How long is long term? Should one take a SIP?

I was talking recently with a couple who are our clients. The couple wanted to invest regularly for their children and were looking for alternatives. Since they were just starting off and the amounts were relatively sdirect equity investment was not very practical and hence I suggested Systematic Investment Plans in Mutual Funds. They were somewhat skeptical. They said that their experience with SIPs had not been too good.

Now there may be some subjectivity here because they (like most people) did not know the exact capital invested and the annualised returns that they had got. They only knew that the returns were “not very good”. It could be a case of wrong interpretation of returns, excessive expectations, bad choice of mutual fund schemes etc.

However it got me thinking. What if someone had invested in a SENSEX index fund on a SIP basis? What would have been the experience? I have taken SENSEX instead of NIFTY as it has a longer period for which to make calculations. I have ignored dividends as they would go towards asset management charges, entry loads etc.

The first chart indicates the terminal value if a SIP has been done for Rs. 10,000 every month starting in various months from 1979 to 1999 and ending 10 years later from 1989 to 2009. This would involve a capital investment of Rs. 1,200,000 (Twelve lacs) or 10,000 multiplied by 120 months.

The terminal values would range from Rs. 120 lacs to Rs. 10 lacs. At Rs. 10 lacs terminal value obviously there would be a loss since Rs. 12 lacs would have been invested.


The annualised yields from 10 year SIPs would range from +43% p.a. to -3.6% p.a.. Obviously a very large and unacceptable range for financial planning purposes. A long term investment horizon and a Systematic Investment Plan would not be a fail safe formula in many cases.

 I had a re-run of the investment performance assuming a time horizon of 20 years. The results here were more heartening.

The chart below indicates the terminal value if a SIP has been done for Rs. 10,000 every month starting in various months from 1979 to 1989 and ending 20 years later from 1999 to 2009. This would involve a capital investment of Rs. 2,400,000 (Twenty four lacs) or 10,000 multiplied by 240 months.

The terminal values would range from Rs. 252 lacs to Rs. 77 lacs. Even at Rs. 77 lacs terminal value obviously there is no loss since only Rs. 24 lacs have been invested.

The annualised yields from 20 year SIPs had a much more acceptable range from +20% p.a. to + 10.5% pa. A long term investment horizon of around 20 years and a Systematic Investment Plan would most likely not result in hardship for investors.

So what are the lessons from this exercise?

  1. Long term as is normally understood is an underestimate. The Government classifies an investment more than a year as long term. The investment professionals sing virtues of having a long term investing horizon defined as a 3-5 years horizon. I would propose that an investment horizon of around 20 years would be truly long term!
  2. Long term is in reality not very long. Considering the fact that a person joining employment at the age 25 and retiring at 60 spends 35 years waiting to grow a retirement corpus or the fact that a new born will go to college around 15 and join a business school at 20 or get married between 25 and 30, in our lives the goals that we want to achieve are sufficiently long for equity investments. 
  3. While market timing does not make sense, valuing the market may be very important. If one were to avoid investing at times of bubble and actually reduce equity exposure and increase equity exposure in down markets, the results would be dramatically different.
  4. Avoiding some perennial value destroying sectors would also improve the results dramatically. 

Points number 3 & 4 are subject matter for further calculations and a future post. Happy investing!