(This appeared in the recent issue of Moneylife)
Investors are facing a dilemma. The capital markets are perhaps going through a kind of ennui. Perhaps Rip Van Winkle will go to sleep, wake up, find the markets at the same level and carry on without even realising that a couple of decades have gone missing.
Investment in equities, according to all experts, would give an annualised fifteen percent return over the long term. This is on the premise that our economy would sustain a growth rate of eight to ten percent year on year and inflation would be under around five to six percent per annum. The unfortunate aspect of this is that timing matters. For each investor, what matters is the time he puts his money and the time he cashes in his chips. This can take your returns from zero to fifty, depending on your luck, and the timing of your investments. Of course, one can theoretically smoothen it out with regular investments etc., The fact of the matter is that each one of us wakes up at different times in our lives and money for investment gets ear marked, at different stages in each one’s lives. Someone may start at thirty and someone at fifty. And many never start.
Inflation continues to be a bugbear and will likely stay at near double digits in the foreseeable future. Much as our RBI tries, its policies make no dent in inflation. Perhaps RBI actions are adding to inflation. Whatever be the case, the fact is that inflation with economic growth is better than no inflation and no growth.
These monetary policy measures have thrown up an investment opportunity. We are bombarded with SMS and mails about bank FD’s that are offering ten to eleven percent annual interest. Most offer these for a year or two. The hope is that interest rates at some point would start cooling off. If they don’t then we are headed towards very interesting times (also called as ‘stagflation’ or stagnating growth with rising prices). I would like to believe the former.
In these times, we are seeing some companies raise money through long term bonds (five to ten years or more duration) and some very aggressive instruments. For instance, Tata Steel raised nearly Rs.1500 cr by way of ‘perpetual’ bonds. In essence, it means no repayment ever, unless the company is wound up. The bonds carry a ‘coupon’ interest rate of 11.80% p.a, payable every six months. Tata Steel has also put in a clause ( a ‘call’ option) which enables them to repay (at their instance alone) at the end of ten years the principal in full. In case they choose not to repay at the end of ten years, the interest rate gets automatically revised to 14.80% p.a!!
Alas, the company did not make a retail issue. It placed all the bonds with insurance companies, funds, banks and other wholesale merchants. The bond is listed on the exchanges and is ‘traded’ on the exchanges (BSE, I think). So, now one has to pay a price of anything between Rs.107 or thereabouts (a premium of Rs.7/-) to buy it. Even after paying this premium, it works out to a yield of 11% p.a. if one assumes a ten year repayment. If there is no repayment, the simple yield would be 11.80 on every 107 (or whatever price one pays) .
This compares very well with FD’s or FMP’s. In fact, if I am bullish on India, surely interest rates would come off. So, I am getting a great opportunity to lock in to a high yield for ten years! And I would sincerely pray that at the end of the tenth year, the company gets in to some problems which would make repayment impossible and the bond gets in to the 14.80% percent interest. Today, when I put money in FD or FMP, the duration is short (one to three years) and after that the returns may not be so attractive. Currently, the FMP enjoys a tax arbitrage, which would vanish post end June 2011.
I have give the example of Tata Steel bonds due to its attractive features. There are other instruments with varying yields available. The sad thing about these bonds are its lack of pricing transparency. Stocks have abandoned the concept of ‘market lots’, but bonds continue to have ‘minimum’ trade sizes. The Tata Steel bonds are traded in single deal sizes of five lakh rupee face value of bonds.
It is imperative that the regulators remove these stupid ‘ticket’ size considerations for the debt instruments. Only then will the debt markets expand. So would awareness. Today, the entire debt market is like a ‘black’ box.
The other interesting thing is that there is no TDS on the interest that would come to the investor in bonds. These are in demat form, so easier to manage also.
Once interest rates start to move up, the prices of these bonds would go up. So, after a year, if the interest rates go down by half a percent, the price of the bond would go up by nearly three rupees (in the Tata Steel example). So over a one year period, you would have got a return of nearly fourteen to fifteen percent! Of course, the risk is that the prices can go down further if the interest rates keep rising. In which case, one continues to enjoy the interest rate on the instrument.
The instrument like that of a Tata Steel would be a bad one if at the end of ten year (at the tenth anniversary of the bonds) the economy is in such a bad shape that interest rates go up to 18 or 20 percent per annum. So, best not to put everything in these kind of instruments, but a fair part of one’s portfolio that is earmarked for low risk, predictable return portfolio.
Saturday, June 11, 2011
GENTLEMEN PREFER BONDS
(A piece I had written for an investor magazine)
The economic outlook seems cloudy. Not so cloudy that we are in the dumps, but just the fact that double digit growth in GDP now looks like a tough ask. Everyone seems to be now on a seven to eight percent band for the immediate couple of years. What this means is that our equity markets are likely to remain range-bound for longer than we think. Whilst we could see some extreme volatility in the near term based on funds flows from the FII universe, the upside seems to be kind of capped.
Of the many worries, interest rate worry seems to be one that is dampening corporate profit growth. We are seeing a large number of companies offering rates in excess of eleven percent per annum for long dated borrowings. To me, this is perhaps a good opportunity. I look at it this way. The corporate is raising money at over eleven percent for ten years. In essence, it gives me a great opportunity to lock in some money at this kind of a rate. Of course, I will go wrong if inflation and interest rates keep rising significantly. Is that likely? Perhaps there would be one more round of misguided interest rate hike by the Reserve Bank of India. After that there has to be a lull and hopefully a decline in interest rates. This lowering or falling in interest rates will not happen only if we see economic growth of India slipping dramatically over the next few years. I think that India will grow at over seven percent, irrespective of politics. About double digits, I am not sure. If this has to happen, we need lower interest rates.
So, coming back to these bonds and other long dated debt instruments, it is great to put in some money at this juncture. There is a twofold gain here:
i) If interest rates remain high, equity is going to be in the dumps. We lock in a sure and reasonably attractive yield on the debt instrument (above 11% p.a. for ten years or so, without any re-investment risk);
ii) If interest rates fall, then the values of the papers we buy now increase. For instance, in a ten year bond, a quarter percent decline in interest rates would mean a capital appreciation of over one rupee in the debt paper that we buy today. (When interest rates fall, the price of bonds go up and vice versa)
I think debt may be the best place over the next six months to a year, for investors.
Bonds are better in one another way. Many of us are used to the Fixed Maturity Plans (FMP) of the mutual funds. Post June 30th, the change in the tax regime will rob the tax attractiveness of FMP. Bonds would be better. The other thing is that in most of the bonds, there is no tax deducted at source (TDS), which helps with a better cash flow.
Bank deposits are also attractive, but give a lower return than bonds. Another thing is that we cannot get to lock in the rate of interest for ten years in bank deposits.
Whilst talking about bonds, many people will tell you that it is ‘secured’. This means absolutely nothing so far as timely repayment is concerned. We have hardly seen a company having any assets left, when it comes to a stage of default. Rather, let us remain focused on the quality of paper we buy. Good names and a high credit rating are important whilst buying bonds, unless one is comfortable with a higher risk. The key is to be focused on risk, since a bond could be for ten years, and in ten years, a lot can happen.
The bonds can be held in demat form, which makes it easier to handle. Interest is generally payable at half yearly intervals.
Bonds are generally listed and tradable. There is a secondary market for this. In an emergency, one can always sell it through the secondary market. And unlike equity, the price changes in the bonds are not extreme. A full one percentage change in interest rate would equate to a change of around five rupees, on a ten year bond with a coupon of eleven percent. So, the risk to capital is modest, should one have to exit before maturity.
There will be many papers available and it would be good to pick up some in the next two to three months. For, when the interest rates start moving down, the yields on these bonds will start to fall, correspondingly.
The economic outlook seems cloudy. Not so cloudy that we are in the dumps, but just the fact that double digit growth in GDP now looks like a tough ask. Everyone seems to be now on a seven to eight percent band for the immediate couple of years. What this means is that our equity markets are likely to remain range-bound for longer than we think. Whilst we could see some extreme volatility in the near term based on funds flows from the FII universe, the upside seems to be kind of capped.
Of the many worries, interest rate worry seems to be one that is dampening corporate profit growth. We are seeing a large number of companies offering rates in excess of eleven percent per annum for long dated borrowings. To me, this is perhaps a good opportunity. I look at it this way. The corporate is raising money at over eleven percent for ten years. In essence, it gives me a great opportunity to lock in some money at this kind of a rate. Of course, I will go wrong if inflation and interest rates keep rising significantly. Is that likely? Perhaps there would be one more round of misguided interest rate hike by the Reserve Bank of India. After that there has to be a lull and hopefully a decline in interest rates. This lowering or falling in interest rates will not happen only if we see economic growth of India slipping dramatically over the next few years. I think that India will grow at over seven percent, irrespective of politics. About double digits, I am not sure. If this has to happen, we need lower interest rates.
So, coming back to these bonds and other long dated debt instruments, it is great to put in some money at this juncture. There is a twofold gain here:
i) If interest rates remain high, equity is going to be in the dumps. We lock in a sure and reasonably attractive yield on the debt instrument (above 11% p.a. for ten years or so, without any re-investment risk);
ii) If interest rates fall, then the values of the papers we buy now increase. For instance, in a ten year bond, a quarter percent decline in interest rates would mean a capital appreciation of over one rupee in the debt paper that we buy today. (When interest rates fall, the price of bonds go up and vice versa)
I think debt may be the best place over the next six months to a year, for investors.
Bonds are better in one another way. Many of us are used to the Fixed Maturity Plans (FMP) of the mutual funds. Post June 30th, the change in the tax regime will rob the tax attractiveness of FMP. Bonds would be better. The other thing is that in most of the bonds, there is no tax deducted at source (TDS), which helps with a better cash flow.
Bank deposits are also attractive, but give a lower return than bonds. Another thing is that we cannot get to lock in the rate of interest for ten years in bank deposits.
Whilst talking about bonds, many people will tell you that it is ‘secured’. This means absolutely nothing so far as timely repayment is concerned. We have hardly seen a company having any assets left, when it comes to a stage of default. Rather, let us remain focused on the quality of paper we buy. Good names and a high credit rating are important whilst buying bonds, unless one is comfortable with a higher risk. The key is to be focused on risk, since a bond could be for ten years, and in ten years, a lot can happen.
The bonds can be held in demat form, which makes it easier to handle. Interest is generally payable at half yearly intervals.
Bonds are generally listed and tradable. There is a secondary market for this. In an emergency, one can always sell it through the secondary market. And unlike equity, the price changes in the bonds are not extreme. A full one percentage change in interest rate would equate to a change of around five rupees, on a ten year bond with a coupon of eleven percent. So, the risk to capital is modest, should one have to exit before maturity.
There will be many papers available and it would be good to pick up some in the next two to three months. For, when the interest rates start moving down, the yields on these bonds will start to fall, correspondingly.
Thursday, May 19, 2011
Mis Selling- Screwing the Rich and Useless
(Standard Chtd bank - In Chennai edition of ET, the news of a 200 cr mis selling and the corporate ad on ethical selling appeared on the same day!!)
From Standard Chtd website:
Principles & Values
Our Principles
Leading by example to be the right partner for its stakeholders, the Group is committed to building a sustainable business over the long term that is trusted worldwide for upholding high standards of corporate governance, social responsibility, environmental protection and employee diversity. It employs over 75,000 people, nearly half of whom are women, The Group's employees are of 125 nationalities, of which about 70 are represented among senior management.
What we stand for
Strategic intent
• To be the world's best international bank
• Leading the way in Asia, Africa and the Middle East
Brand promise
• Here for good
Values
• Courageous
• Responsive
• International
• Creative
• Trustworthy
Approach
• Participation
Focusing on attractive, growing markets where we can leverage our relationships and expertise
• Competitive positioning
Combining global capability, deep local knowledge and creativity to outperform our competitors
• Management Discipline
Continuously improving the way we work, balancing the pursuit of growth with firm control of costs and risks
Commitment to stakeholders
• Customers
Passionate about our customers' success, delighting them with the quality of our service
• Our People
Helping our people to grow, enabling individuals to make a difference and teams to win
• Communities
Trusted and caring, dedicated to making a difference
• Investors
A distinctive investment delivering outstanding performance and superior returns
• Regulators
Exemplary governance and ethics wherever we are
Stanchart officers dupe 200 cr from clients
Agencies
Posted: Saturday, Apr 30, 2011 at 2028 hrs IST
Tags: StanChart | Standard Chartered Bank | Oldest Foreign Bank
Mumbai: In yet another banking fraud at the hands of greedy relationship managers of the foreign banks, some employees of StanChart are believed to have duped a few wealthy clients.
According to reports, a few relationship managers at Standard Chartered Bank's private banking business here have mis-sold debt securities to some of its private banking clients with a promise to buy them back at higher returns something which is not possible under the existing regulations.
This comes close on the heels of nearly Rs 460-crore Citi fraud wherein a duplicitous offer of higher returns by one of its relationship manager came to light in December last year at the American bank's Gurgaon branch.
When contacted an official spokesperson of StanChart said the media report had sensationalised the issue and the amount reported was grossly incorrect.
"This is a small matter involving just four clients and we working with them on a quick resolution," he said but declined to give further details.
However, sources in the bank said the issue involves three relationship managers, one of whom has already been shown the door while an internal probe is underway on the other two.
The sources further said that in fact there is no investor who has lost money as they are publicly traded bonds and investors can recover their money by selling them.
On the question of the impact of this incident on the bank's reputation and possible regulatory clamp down on private wealth management banking, the sources said, "this involves only four people and not three employees and a systemic issue."
According to a report, Rs 150-200 crore of such debentures were sold by StanChart's relationship managers to their private banking and wealth management clients, which quoted two people in the wealth management industry.
The multinational Standard Chartered is the largest and oldest foreign bank in the country, and India is the largest profit centre for the bank, according to its latest audited reports.
The report also said that the bank itself funded some of the duped investors of the fake debentures.
From Standard Chtd website:
Principles & Values
Our Principles
Leading by example to be the right partner for its stakeholders, the Group is committed to building a sustainable business over the long term that is trusted worldwide for upholding high standards of corporate governance, social responsibility, environmental protection and employee diversity. It employs over 75,000 people, nearly half of whom are women, The Group's employees are of 125 nationalities, of which about 70 are represented among senior management.
What we stand for
Strategic intent
• To be the world's best international bank
• Leading the way in Asia, Africa and the Middle East
Brand promise
• Here for good
Values
• Courageous
• Responsive
• International
• Creative
• Trustworthy
Approach
• Participation
Focusing on attractive, growing markets where we can leverage our relationships and expertise
• Competitive positioning
Combining global capability, deep local knowledge and creativity to outperform our competitors
• Management Discipline
Continuously improving the way we work, balancing the pursuit of growth with firm control of costs and risks
Commitment to stakeholders
• Customers
Passionate about our customers' success, delighting them with the quality of our service
• Our People
Helping our people to grow, enabling individuals to make a difference and teams to win
• Communities
Trusted and caring, dedicated to making a difference
• Investors
A distinctive investment delivering outstanding performance and superior returns
• Regulators
Exemplary governance and ethics wherever we are
Stanchart officers dupe 200 cr from clients
Agencies
Posted: Saturday, Apr 30, 2011 at 2028 hrs IST
Tags: StanChart | Standard Chartered Bank | Oldest Foreign Bank
Mumbai: In yet another banking fraud at the hands of greedy relationship managers of the foreign banks, some employees of StanChart are believed to have duped a few wealthy clients.
According to reports, a few relationship managers at Standard Chartered Bank's private banking business here have mis-sold debt securities to some of its private banking clients with a promise to buy them back at higher returns something which is not possible under the existing regulations.
This comes close on the heels of nearly Rs 460-crore Citi fraud wherein a duplicitous offer of higher returns by one of its relationship manager came to light in December last year at the American bank's Gurgaon branch.
When contacted an official spokesperson of StanChart said the media report had sensationalised the issue and the amount reported was grossly incorrect.
"This is a small matter involving just four clients and we working with them on a quick resolution," he said but declined to give further details.
However, sources in the bank said the issue involves three relationship managers, one of whom has already been shown the door while an internal probe is underway on the other two.
The sources further said that in fact there is no investor who has lost money as they are publicly traded bonds and investors can recover their money by selling them.
On the question of the impact of this incident on the bank's reputation and possible regulatory clamp down on private wealth management banking, the sources said, "this involves only four people and not three employees and a systemic issue."
According to a report, Rs 150-200 crore of such debentures were sold by StanChart's relationship managers to their private banking and wealth management clients, which quoted two people in the wealth management industry.
The multinational Standard Chartered is the largest and oldest foreign bank in the country, and India is the largest profit centre for the bank, according to its latest audited reports.
The report also said that the bank itself funded some of the duped investors of the fake debentures.
Wednesday, May 18, 2011
(UN)Cleartrip.com - Picking your pockets with a smile
Cleartrip- On the way down, it is clear
Even though I had a not very good experience once with Cleartrip, I still try and use their airline ticket booking facilities.
Today, an interesting thing happened. I was trying to book four return tickets Chennai Kolkata. It is a tedious process and after filling in the names of passengers etc I was on the way to make the payment through the internet gateway through net banking.
Just at that moment, my mobile phone rang. It was someone from Cleartrip. He asked me if I was ok and whether there are any hitches in the payment mechanism or the site etc.. I asked him if he expected me to have one, since he butted in before I could complete the process. Then he said that instead of paying through debit to my account, I should try and use the HDFC bank credit card. And he said that it would give me a 50% discount on the ‘base’ fare.
I got angry, because in the space of talking to me, he had already delayed my payment and the site said that I would have to enter all over again. And secondly, I knew from past that the base fares were as close to zero as possible.
I asked the person to quantify the discount. He put me on hold and came back saying that if I had not used the card for a Cleartrip discount in the month, I would be entitled to a grand discount of eight rupees! It was one rupee per ticket!! This got me really pissed off and I asked him about why he did this to me, without even bothering to check the fact that whilst 50% sounds great, the real amount is small. And he virtually stopped me half way and screwed up my efforts.
Eventually, I used the details from Cleartrip and went direct to the airlines web site and completed my bookings. In the bargain, I got a total lower fare of around Rs.800/- as opposed to the total fare I was on the way to pay Cleartrip.
And another piss off that these guys (including some airlines) is that they load on a travel insurance option by default. You have to be careful to exclude it. Otherwise they add it as a default and pick your pockets almost without consent! This is unethical and unlawful, though they will get away with the fine print.
Take care whilst dealing with these kind of internet brokers and make sure that you do your homework. Whilst one is willing to pay them for a service, these kind of experiences leave a bad taste in the mouth.
R. Balakrishnan
May 18th, 2011-05-18
Even though I had a not very good experience once with Cleartrip, I still try and use their airline ticket booking facilities.
Today, an interesting thing happened. I was trying to book four return tickets Chennai Kolkata. It is a tedious process and after filling in the names of passengers etc I was on the way to make the payment through the internet gateway through net banking.
Just at that moment, my mobile phone rang. It was someone from Cleartrip. He asked me if I was ok and whether there are any hitches in the payment mechanism or the site etc.. I asked him if he expected me to have one, since he butted in before I could complete the process. Then he said that instead of paying through debit to my account, I should try and use the HDFC bank credit card. And he said that it would give me a 50% discount on the ‘base’ fare.
I got angry, because in the space of talking to me, he had already delayed my payment and the site said that I would have to enter all over again. And secondly, I knew from past that the base fares were as close to zero as possible.
I asked the person to quantify the discount. He put me on hold and came back saying that if I had not used the card for a Cleartrip discount in the month, I would be entitled to a grand discount of eight rupees! It was one rupee per ticket!! This got me really pissed off and I asked him about why he did this to me, without even bothering to check the fact that whilst 50% sounds great, the real amount is small. And he virtually stopped me half way and screwed up my efforts.
Eventually, I used the details from Cleartrip and went direct to the airlines web site and completed my bookings. In the bargain, I got a total lower fare of around Rs.800/- as opposed to the total fare I was on the way to pay Cleartrip.
And another piss off that these guys (including some airlines) is that they load on a travel insurance option by default. You have to be careful to exclude it. Otherwise they add it as a default and pick your pockets almost without consent! This is unethical and unlawful, though they will get away with the fine print.
Take care whilst dealing with these kind of internet brokers and make sure that you do your homework. Whilst one is willing to pay them for a service, these kind of experiences leave a bad taste in the mouth.
R. Balakrishnan
May 18th, 2011-05-18
Financial care of your kids
(This appears in a recent edition of Moneylife titled "No Child's play")
It bothers me when I see so many “children’s“ plans being floated by insurance companies. They lure you with sentimental but irrational and illogical advertisements. There are no real life examples and all of them promise you that if you enrol in their schemes, your children’s education is fully provided for.
In essence, each of them are ULIP’s, packaged with sentiment to lure you to a false sense of comfort. This play to your sentiments and the efficiency of the product is poor. The returns are not very high either and you would be better off with a mutual fund. I also see financial planners invariably include a dollop of ULIP’s in developing a financial plan for a child.
To me, ULIP is a product that should not exist. It is a very expensive way to save. The insurance cover that a ULIP provides is chickenfeed and not worth it at all. Ask yourself. Does a child need to be covered by insurance? Assuming something happens to the child, does it leave behind anyone who is financially dependent on it? So, get it in to your head that THE LAST THING A CHILD NEEDS IS TO BE COVERED BY INSURANCE. Yes, maybe the parent needs to be covered with ample life insurance, if he/she does not have enough money saved to provide for the child.
A simple invest of Rs.5,000 per month, will grow to around Rs.17 lakh at the end of 25 years, assuming a return of 8% p.a. This return is available, with zero risk, from a PPF account. Look at the power of compound interest. If the return were to be 15% p.a., the same investment would amount to a little over Rs.71 lakh! Now, if you get rid of the thought of insurance / ULIP out of your mind, we can look at where to park the money, where what returns can be got and what would be the tax implications. The first two things you have to firmly get in to your head is NOT TO PUT MONEY IN TO ANY INSURANCE OR ULIP for a child.
Why no ULIPs? Let me explain. The periodic amount you pay under ULIP’s is NOT fully invested. Of that, some part is deducted towards insurance (if insurance is provided), some towards ‘policy administration’ expenses, some towards ‘Fund Management Charge’. In addition, there COULD be charges such as “Surrender charges”, “Rider premium charges” etc., In effect, the minimum amount that will NOT be invested, out of your cheque, will be far in excess of 2.25%. Why 2.25%? Well, that is the typical maximum a mutual fund scheme can charge under ALL heads out of your investments. In effect, what you give to a mutual fund, you can be sure that at least 97.75% (for schemes that have a minimum corpus of Rs.400 crore) is invested. So, more of your money earns something.
Now, the key question is as to whether the fund management skills of the insurance companies are so fabulous that they earn a return that is so high (as compared to a mutual fund investment manager) that the net result is more money. To me, it is a no-brainer. I think both the persons are inter-changeable in terms of skills. And returns in the market place bear it out. So, I do not see any compelling reason for choosing an insurance company fund manager over a mutual fund industry person.
You have to provide for a child till he/she is at least 25 years of age. This is today’s minimum. Unfortunately, we do not let our children work after graduation and take care of their own post graduate studies.
The child will need money for regular schooling and the first lumpsum would perhaps come when the child enrols for graduation (I always wonder why the Americans call this as ‘undergraduate studies’?) and for post graduation. I assume that you will have sufficient money to enrol the child in a school of your preference and affordability and pay the tuition and related fees up to completion of the schooling.
Of course, the other expense Indian parents would like to provide for is for the marriage. With the Indian families still equating a marriage with frivolous pomp and giving, it is an expensive affair. And human nature being what it is, there is a compulsive tendency to show off. Alas, even the children get caught in to the spending trap and put pressure on their parents to spend more and more. So, saving for a marriage of a child (esp a girl child, since parents want to provide for jewellery also) is an open-ended thing. Whatever you save will be short. Given the poor state of the Indian education system and the intense level of competition, most children have to opt for ‘paid’ seats in private colleges. This number is unpredictable. Rather, we have to take in to what money we have and try to find an institution that would fit the bill.
In effect, the numbers are open-ended. Of course one can reasonably estimate present education costs. If we assume an annual increase of ten percent, it would mean a doubling of the requirement every ten years. At best, we can get a number which can be a goal, which has to be continuously re-set, depending on the costs of education, the likelihood of educational loans availability, the talent of the child etc.,
Instead of giving you concrete plans, let me give you a choice of two or three instruments that will help you to save for your children’s tomorrow. But keep one thing in mind. First, save for your retirement. Only after that, provide for the children (however cruel it sounds, it is more logical and ensures that you do not depend on your child by becoming a guest with them, in today’s world). Of course, you may have to sacrifice some of your own needs, but do not lose sight of it. Often, it may mean skipping some eating out or a holiday, to ensure that you can do so when you do not earn.
The first thing would be to start a PPF account in the name of the child, preferably in age one itself. Put in the maximum of Rs.70,000/- each year. This will start at the bottom of the returns table (hopefully) giving an annualised tax free return of 8%. The account is for 15 years and can be extended five years at a time thereafter. Initially, one of the parent can be a guardian and once the child attains majority, the account would be in his/her name.
Now, it is best to look at some equity mutual fund SIP’s. These should be reasonably expected to give a return of around 15% p.a. This has the highest risk on paper, but a SIP over 25 years minimises the risk of cycles in a very big way. I would recommend a mix of Index ETF and a couple of large diversified equity funds.
If you desire to have a stock of gold at the end of 20 years or so, without breaking in to a sweat, I would urge you to buy the Gold ETF’s. No physical storage, no making charges loss (surely fashions change), no wastage losses etc., You are locking in to actual gold at various prices over 20 years. At the time you want to buy jewellery, just sell of the ETF (long term capital gains, no taxes) and use the money to buy jewellery. The way inflation and nations are headed, gold may turn out be a great investment.
The third investment I would suggest, if you can, is to buy a plot of land for your child. Maybe in a tier two or three city, in a gated community. This will be a great gift to give your child. The house you live in can be used by you for doing a reverse mortgage and enjoy you sunset years.
If you still have money left over, then maybe you can look at direct equities through the SIP route. You can make a list of two to five bluechip stocks and keep buying them regularly. Choose companies that will be in business for long. Avoid second generation companies because they will be very likely to split in the next couple of decades. Perhaps, you could buy global shares also. Each year, you are allowed to use up to US $ 200,000 for investments overseas.
The basic thing is to realise that money is fungible. Many people advocate earmarking each saving for a particular expenditure or commitment. That is not realistic, because at the maturity point, one does not know the market cycles.
It bothers me when I see so many “children’s“ plans being floated by insurance companies. They lure you with sentimental but irrational and illogical advertisements. There are no real life examples and all of them promise you that if you enrol in their schemes, your children’s education is fully provided for.
In essence, each of them are ULIP’s, packaged with sentiment to lure you to a false sense of comfort. This play to your sentiments and the efficiency of the product is poor. The returns are not very high either and you would be better off with a mutual fund. I also see financial planners invariably include a dollop of ULIP’s in developing a financial plan for a child.
To me, ULIP is a product that should not exist. It is a very expensive way to save. The insurance cover that a ULIP provides is chickenfeed and not worth it at all. Ask yourself. Does a child need to be covered by insurance? Assuming something happens to the child, does it leave behind anyone who is financially dependent on it? So, get it in to your head that THE LAST THING A CHILD NEEDS IS TO BE COVERED BY INSURANCE. Yes, maybe the parent needs to be covered with ample life insurance, if he/she does not have enough money saved to provide for the child.
A simple invest of Rs.5,000 per month, will grow to around Rs.17 lakh at the end of 25 years, assuming a return of 8% p.a. This return is available, with zero risk, from a PPF account. Look at the power of compound interest. If the return were to be 15% p.a., the same investment would amount to a little over Rs.71 lakh! Now, if you get rid of the thought of insurance / ULIP out of your mind, we can look at where to park the money, where what returns can be got and what would be the tax implications. The first two things you have to firmly get in to your head is NOT TO PUT MONEY IN TO ANY INSURANCE OR ULIP for a child.
Why no ULIPs? Let me explain. The periodic amount you pay under ULIP’s is NOT fully invested. Of that, some part is deducted towards insurance (if insurance is provided), some towards ‘policy administration’ expenses, some towards ‘Fund Management Charge’. In addition, there COULD be charges such as “Surrender charges”, “Rider premium charges” etc., In effect, the minimum amount that will NOT be invested, out of your cheque, will be far in excess of 2.25%. Why 2.25%? Well, that is the typical maximum a mutual fund scheme can charge under ALL heads out of your investments. In effect, what you give to a mutual fund, you can be sure that at least 97.75% (for schemes that have a minimum corpus of Rs.400 crore) is invested. So, more of your money earns something.
Now, the key question is as to whether the fund management skills of the insurance companies are so fabulous that they earn a return that is so high (as compared to a mutual fund investment manager) that the net result is more money. To me, it is a no-brainer. I think both the persons are inter-changeable in terms of skills. And returns in the market place bear it out. So, I do not see any compelling reason for choosing an insurance company fund manager over a mutual fund industry person.
You have to provide for a child till he/she is at least 25 years of age. This is today’s minimum. Unfortunately, we do not let our children work after graduation and take care of their own post graduate studies.
The child will need money for regular schooling and the first lumpsum would perhaps come when the child enrols for graduation (I always wonder why the Americans call this as ‘undergraduate studies’?) and for post graduation. I assume that you will have sufficient money to enrol the child in a school of your preference and affordability and pay the tuition and related fees up to completion of the schooling.
Of course, the other expense Indian parents would like to provide for is for the marriage. With the Indian families still equating a marriage with frivolous pomp and giving, it is an expensive affair. And human nature being what it is, there is a compulsive tendency to show off. Alas, even the children get caught in to the spending trap and put pressure on their parents to spend more and more. So, saving for a marriage of a child (esp a girl child, since parents want to provide for jewellery also) is an open-ended thing. Whatever you save will be short. Given the poor state of the Indian education system and the intense level of competition, most children have to opt for ‘paid’ seats in private colleges. This number is unpredictable. Rather, we have to take in to what money we have and try to find an institution that would fit the bill.
In effect, the numbers are open-ended. Of course one can reasonably estimate present education costs. If we assume an annual increase of ten percent, it would mean a doubling of the requirement every ten years. At best, we can get a number which can be a goal, which has to be continuously re-set, depending on the costs of education, the likelihood of educational loans availability, the talent of the child etc.,
Instead of giving you concrete plans, let me give you a choice of two or three instruments that will help you to save for your children’s tomorrow. But keep one thing in mind. First, save for your retirement. Only after that, provide for the children (however cruel it sounds, it is more logical and ensures that you do not depend on your child by becoming a guest with them, in today’s world). Of course, you may have to sacrifice some of your own needs, but do not lose sight of it. Often, it may mean skipping some eating out or a holiday, to ensure that you can do so when you do not earn.
The first thing would be to start a PPF account in the name of the child, preferably in age one itself. Put in the maximum of Rs.70,000/- each year. This will start at the bottom of the returns table (hopefully) giving an annualised tax free return of 8%. The account is for 15 years and can be extended five years at a time thereafter. Initially, one of the parent can be a guardian and once the child attains majority, the account would be in his/her name.
Now, it is best to look at some equity mutual fund SIP’s. These should be reasonably expected to give a return of around 15% p.a. This has the highest risk on paper, but a SIP over 25 years minimises the risk of cycles in a very big way. I would recommend a mix of Index ETF and a couple of large diversified equity funds.
If you desire to have a stock of gold at the end of 20 years or so, without breaking in to a sweat, I would urge you to buy the Gold ETF’s. No physical storage, no making charges loss (surely fashions change), no wastage losses etc., You are locking in to actual gold at various prices over 20 years. At the time you want to buy jewellery, just sell of the ETF (long term capital gains, no taxes) and use the money to buy jewellery. The way inflation and nations are headed, gold may turn out be a great investment.
The third investment I would suggest, if you can, is to buy a plot of land for your child. Maybe in a tier two or three city, in a gated community. This will be a great gift to give your child. The house you live in can be used by you for doing a reverse mortgage and enjoy you sunset years.
If you still have money left over, then maybe you can look at direct equities through the SIP route. You can make a list of two to five bluechip stocks and keep buying them regularly. Choose companies that will be in business for long. Avoid second generation companies because they will be very likely to split in the next couple of decades. Perhaps, you could buy global shares also. Each year, you are allowed to use up to US $ 200,000 for investments overseas.
The basic thing is to realise that money is fungible. Many people advocate earmarking each saving for a particular expenditure or commitment. That is not realistic, because at the maturity point, one does not know the market cycles.
Friday, May 6, 2011
How to cheat a banker?
Wockhardt Ltd is being pulled in to winding up (or winding down??) by the group of lenders who foolishly put money in to FCCB (Foreign Currency Convertible Bond) issued by the company. Whilst I have nothing for or against the company, the issue is a far bigger one. And our High Courts have promptly granted a ‘stay’ on the winding up order! Strange are the ways our legal system works.
The Indian banking system has long been taken for a ride by Indian businessmen who have siphoned off money from the banks. At some stage, either the banks write off the loans or there is a “one time settlement” (famously known at OTS) where the bankers sacrifice virtually all and get nothing in return. Often, I have seen that in OTS, there is a stipulation that the promoter bring in a large amount of money. Does anyone bother to find out how or where from the promoter is managing to bring this money? If he can bring it in now, why did he not do it earlier? Surely, it is the best indication that he cares a fig for the people who lend money to a company.
The Parel belt at Bombay is a stark reminder of the promoters’ chicanery and the pliant bankers. And now we have what is called as the “Asset Reconstruction Companies” (ARC) which give this a stamp of legitimacy and help the bank executive to evade scrutiny.
Let us see how the scam operates.
One basic requirement for banks to take control of a borrower is for 75 percent of the lenders (those who have lent against security only please) to sell their loans to an ARC. In turn, the ARC will try and find a buyer. That is how the system is supposed to work. In reality, what happens is different. A loan has to be sold at a low price by the bank to an ARC, for the deal to make sense. Here, grease can come in to play. Logically the banker would like to sell the loan at the best possible value to minimise his losses. However, the system is such that a single lender cannot influence anything unless 75% of the secured lenders act in concert. For this the ARC is essential. Under normal circumstances, a bank chairman would be scared to sell an asset far below book value. However, when the sale is to an ARC, it passes scrutiny! So, it is an easy matter to get a bank to sell a loan to an ARC. The borrower makes his round of the banks and makes sure that the banks sell the loans to the ARC at the lowest possible price.
Once the ARC gets hold of 75% of the loans to a company, it is virtually in control of the company. The ARC can dismember the company, strip assets or sell it off in one go to whomsoever it chooses. So, the logical expectation is that once the ARC has got hold of the assets of a company, it would make efforts to sell it to the highest bidder through a public auction. In real life, it is sold back to the promoter at a price which will give a decent return to the ARC. The ARC’s board is happy. The promoter is happy because he has just escaped a huge liability. The original lenders have lost a pile, but who cares? Now, with the loans gone, the unit can suddenly become viable and the promoter rolls in money. Alternatively, the promoter, having got back his company for a song, can now sell off the real estate or develop it and make his money. The banking system (generally the PSU sector) has lost many assets through this route and no one is wiser. Bank executives have made money, the ARC guys have made money, and the promoter has made money. The only loser is the taxpayer, who keeps bailing out the PSU banks time and again as the capital gets eroded due to regular write downs of loans which are not bad, but said to be bad. Recently, a co made a IPO. It was once a defunct co which went in to BIFR after defaulting in a big way. The original promoter bought it at a bargain price in collusion with someone else, including an ARC. The bankers lost money in a big way. The promoter had enough money to buy out the co from the ARC! No one asked him how .
No one seems to care that under typical OTS schemes, the promoter is asked to bring in substantial amounts of money as ‘his share’ in reviving the company. Does anyone bother to find out where the money comes in from? If he had this money in the first place, why did he not put it in to the company?
Why do companies that ‘come out’ through OTS not share their prosperity with the lenders who sacrificed so much? Why the bankers cannot write off the loans, but to the extent of write offs, take equity shares at par, for free? After all, they have sacrificed far more than the promoter.
Also, when it comes to ARC’s, have we seen ads in mainline papers about entire company on the block? The only thing one sees are of houses / plots of lands that are seized and auctioned. Why cannot whole companies be auctioned? Surely it would get a far higher price.
And the bankers should take the lead in this. Not the bank chairmen, but the banking system, through a fiat. After all, when a bank sells a loan to an ARC, it does not get any money. It generally ends up with a ‘participation’ in the loan, in the form of an investment paper. It is rare that an ARC buys out an industrial loan by paying full cash. It would be best if the law mandates that the selling bank cannot invest in the assets it sells off. In fact, it should be a clean sale. Otherwise, the ARC’s are merely a facilitator (for a fee) to window dress the loan books of the banks. Today, there are multiple ARC’s. It should be easy for banks to put up their ‘loans for sale’ on a single website and the various ARC’s can then bid for it. This way, the banks get the best price for the loan.
Secondly, the banks should get something out of it in case the co revives and then does well. The best way would be for the banks to automatically get ten percent or so voting shares free and at par (which itself is a huge premium) or warrants that will enable them to buy shares at par. This will help the banking system in some way. Why should a defaulter get exonerated and then live to tell the tale? Surely, the lenders’ sacrifice is far greater than the promoters, in almost all Indian companies.
Of course, not everything that the ARC does is like the above. The above is just an example of how the ARC structure provides a ready conduit for the crooked promoters.
Going back to Wockhardt, it is time that the lenders taught a lesson. Let the co go in to liquidation or else, the remaining creditors who are so generous, can also first pay off the entire FCCB holders in full and then grant indulgence to the company. In many cases, the promoters are so smart that they leave nothing of value in the company. Real estate is often held in family companies and the listed company pays a fat deposit and a huge rental.
I would be glad to see the day when companies are genuinely ‘sold’ by the ARC’s. That is the best way to put back some integrity in to the banking system, which is now the handmaiden of businessmen and politicians.
The Indian banking system has long been taken for a ride by Indian businessmen who have siphoned off money from the banks. At some stage, either the banks write off the loans or there is a “one time settlement” (famously known at OTS) where the bankers sacrifice virtually all and get nothing in return. Often, I have seen that in OTS, there is a stipulation that the promoter bring in a large amount of money. Does anyone bother to find out how or where from the promoter is managing to bring this money? If he can bring it in now, why did he not do it earlier? Surely, it is the best indication that he cares a fig for the people who lend money to a company.
The Parel belt at Bombay is a stark reminder of the promoters’ chicanery and the pliant bankers. And now we have what is called as the “Asset Reconstruction Companies” (ARC) which give this a stamp of legitimacy and help the bank executive to evade scrutiny.
Let us see how the scam operates.
One basic requirement for banks to take control of a borrower is for 75 percent of the lenders (those who have lent against security only please) to sell their loans to an ARC. In turn, the ARC will try and find a buyer. That is how the system is supposed to work. In reality, what happens is different. A loan has to be sold at a low price by the bank to an ARC, for the deal to make sense. Here, grease can come in to play. Logically the banker would like to sell the loan at the best possible value to minimise his losses. However, the system is such that a single lender cannot influence anything unless 75% of the secured lenders act in concert. For this the ARC is essential. Under normal circumstances, a bank chairman would be scared to sell an asset far below book value. However, when the sale is to an ARC, it passes scrutiny! So, it is an easy matter to get a bank to sell a loan to an ARC. The borrower makes his round of the banks and makes sure that the banks sell the loans to the ARC at the lowest possible price.
Once the ARC gets hold of 75% of the loans to a company, it is virtually in control of the company. The ARC can dismember the company, strip assets or sell it off in one go to whomsoever it chooses. So, the logical expectation is that once the ARC has got hold of the assets of a company, it would make efforts to sell it to the highest bidder through a public auction. In real life, it is sold back to the promoter at a price which will give a decent return to the ARC. The ARC’s board is happy. The promoter is happy because he has just escaped a huge liability. The original lenders have lost a pile, but who cares? Now, with the loans gone, the unit can suddenly become viable and the promoter rolls in money. Alternatively, the promoter, having got back his company for a song, can now sell off the real estate or develop it and make his money. The banking system (generally the PSU sector) has lost many assets through this route and no one is wiser. Bank executives have made money, the ARC guys have made money, and the promoter has made money. The only loser is the taxpayer, who keeps bailing out the PSU banks time and again as the capital gets eroded due to regular write downs of loans which are not bad, but said to be bad. Recently, a co made a IPO. It was once a defunct co which went in to BIFR after defaulting in a big way. The original promoter bought it at a bargain price in collusion with someone else, including an ARC. The bankers lost money in a big way. The promoter had enough money to buy out the co from the ARC! No one asked him how .
No one seems to care that under typical OTS schemes, the promoter is asked to bring in substantial amounts of money as ‘his share’ in reviving the company. Does anyone bother to find out where the money comes in from? If he had this money in the first place, why did he not put it in to the company?
Why do companies that ‘come out’ through OTS not share their prosperity with the lenders who sacrificed so much? Why the bankers cannot write off the loans, but to the extent of write offs, take equity shares at par, for free? After all, they have sacrificed far more than the promoter.
Also, when it comes to ARC’s, have we seen ads in mainline papers about entire company on the block? The only thing one sees are of houses / plots of lands that are seized and auctioned. Why cannot whole companies be auctioned? Surely it would get a far higher price.
And the bankers should take the lead in this. Not the bank chairmen, but the banking system, through a fiat. After all, when a bank sells a loan to an ARC, it does not get any money. It generally ends up with a ‘participation’ in the loan, in the form of an investment paper. It is rare that an ARC buys out an industrial loan by paying full cash. It would be best if the law mandates that the selling bank cannot invest in the assets it sells off. In fact, it should be a clean sale. Otherwise, the ARC’s are merely a facilitator (for a fee) to window dress the loan books of the banks. Today, there are multiple ARC’s. It should be easy for banks to put up their ‘loans for sale’ on a single website and the various ARC’s can then bid for it. This way, the banks get the best price for the loan.
Secondly, the banks should get something out of it in case the co revives and then does well. The best way would be for the banks to automatically get ten percent or so voting shares free and at par (which itself is a huge premium) or warrants that will enable them to buy shares at par. This will help the banking system in some way. Why should a defaulter get exonerated and then live to tell the tale? Surely, the lenders’ sacrifice is far greater than the promoters, in almost all Indian companies.
Of course, not everything that the ARC does is like the above. The above is just an example of how the ARC structure provides a ready conduit for the crooked promoters.
Going back to Wockhardt, it is time that the lenders taught a lesson. Let the co go in to liquidation or else, the remaining creditors who are so generous, can also first pay off the entire FCCB holders in full and then grant indulgence to the company. In many cases, the promoters are so smart that they leave nothing of value in the company. Real estate is often held in family companies and the listed company pays a fat deposit and a huge rental.
I would be glad to see the day when companies are genuinely ‘sold’ by the ARC’s. That is the best way to put back some integrity in to the banking system, which is now the handmaiden of businessmen and politicians.
OF LIFE INSURANCE AND SUNSET YEARS
(this appears in a recent issue of Moneylife)
How much are we willing to pay as a charge, in order to provide for our family? What is it that we really want, is something fatal were to happen to us? How much of a role does money play in this? These are difficult to quantify, I guess. Of course, there are many possibilities of calculating numbers to come to some conclusion.
First, if something were to happen to me, whether money is needed or not depends on whether I have financial dependants. If I do not have anyone whose day to day living is materially impacted, there is no pressing need for me to leave behind a source of income. However, if I do have someone who is dependant, then I have to make sure that I provide for the people who depend on me, as if I was around. To calculate this is a tough ask, since it involves future needs, aspirations etc of the surviving dependants. We all easily understand this as the need for a life cover or life insurance.
As we progress in life, our aspirations tend to normally go higher. Similarly, our income levels also tend to go up with time. At the same time, with each passing year, our need to provide a cushion for our dependants should decrease under normal circumstances (with more savings and commitments on children getting nearer to extinction) . So, if we do well in life, we would hopefully reach a stage, where our dependants are financially secure. For example, if one gets married at 30, has children in three to five years, by the time the person is 55, he would have provided for most of the needs of the children. He may also have had some savings / investments that take care of needs. So, with age, given normal earning cycles, the need for life insurance should decline and at some point, it should be zero. Of course, we can always argue that why not leave behind as much wealth as possible.
The issue here then boils down to two key things:
i) I need a life cover up to some stage in life; and
ii) I need to accumulate wealth and leave behind as much wealth as I can.
Often, we tend to mix up both our goals. For example, we are willing to pay a fixed amount every year to cover the loss of our vehicles or to meet any major unforeseen medical expenses (hospitalisation, surgery etc). We are even willing to pay an annual premium to insure our home and property. However, when it comes to life insurance, we think very differently. In all the cases other than life, we are willing to treat the amount spent on insurance as expenditure. We do not look at the returns etc., We look at the value covered and the lowest possible outgo.
Life insurance is no different. Why do we mix up investment in this? We get taken in when the seller of insurance tells us “ If you want a pure term policy, fine with me. However, if you want some money back, why do you not look at...?”
One interesting product to buy for life insurance is a ‘return of money’ policy. In other words, a definite sum of money is paid to the nominee/legal heirs on death of the insured. This can be a low premium product, fixed cover, no participation, riders etc., This is an interesting policy in today’s times. It is very likely that as we grow old, we will be left to fend for ourselves. By choice, we may not want to impose on our children, leave aside the fact that we may be inconvenient for them. In such a case, perhaps the best option is a genuine ‘Reverse Mortgage’ on the home we own and soon to become worthless as we near our expiry dates. A pure ‘Reverse Mortgage’ would be one where the lender or the provider of the mortgage takes a fixed call, without recourse. In other words, he takes all the risk of the market price in future. This is perfect because it makes sure that we consume our assets in our lifetime and do not leave a mess for our heirs.
In the same context, if we had a life policy with a definite payout only on death, we could perhaps sell the policy. In an article (more than a year or two ago) I had mentioned about how such a policy could be a great thing for a secondary market buyer. Imagine that I am near about 80 and have an insurance policy with a sure payout of Rs.50 lakh, on my death. I can sell it to someone for Rs.40 lakh or so. The buyer will look at two things- How long I could live and the return on his investment. The longer I live, the lower his returns. And I will get some money in my lifetime out of this policy! This should be a tradable policy.
How much are we willing to pay as a charge, in order to provide for our family? What is it that we really want, is something fatal were to happen to us? How much of a role does money play in this? These are difficult to quantify, I guess. Of course, there are many possibilities of calculating numbers to come to some conclusion.
First, if something were to happen to me, whether money is needed or not depends on whether I have financial dependants. If I do not have anyone whose day to day living is materially impacted, there is no pressing need for me to leave behind a source of income. However, if I do have someone who is dependant, then I have to make sure that I provide for the people who depend on me, as if I was around. To calculate this is a tough ask, since it involves future needs, aspirations etc of the surviving dependants. We all easily understand this as the need for a life cover or life insurance.
As we progress in life, our aspirations tend to normally go higher. Similarly, our income levels also tend to go up with time. At the same time, with each passing year, our need to provide a cushion for our dependants should decrease under normal circumstances (with more savings and commitments on children getting nearer to extinction) . So, if we do well in life, we would hopefully reach a stage, where our dependants are financially secure. For example, if one gets married at 30, has children in three to five years, by the time the person is 55, he would have provided for most of the needs of the children. He may also have had some savings / investments that take care of needs. So, with age, given normal earning cycles, the need for life insurance should decline and at some point, it should be zero. Of course, we can always argue that why not leave behind as much wealth as possible.
The issue here then boils down to two key things:
i) I need a life cover up to some stage in life; and
ii) I need to accumulate wealth and leave behind as much wealth as I can.
Often, we tend to mix up both our goals. For example, we are willing to pay a fixed amount every year to cover the loss of our vehicles or to meet any major unforeseen medical expenses (hospitalisation, surgery etc). We are even willing to pay an annual premium to insure our home and property. However, when it comes to life insurance, we think very differently. In all the cases other than life, we are willing to treat the amount spent on insurance as expenditure. We do not look at the returns etc., We look at the value covered and the lowest possible outgo.
Life insurance is no different. Why do we mix up investment in this? We get taken in when the seller of insurance tells us “ If you want a pure term policy, fine with me. However, if you want some money back, why do you not look at...?”
One interesting product to buy for life insurance is a ‘return of money’ policy. In other words, a definite sum of money is paid to the nominee/legal heirs on death of the insured. This can be a low premium product, fixed cover, no participation, riders etc., This is an interesting policy in today’s times. It is very likely that as we grow old, we will be left to fend for ourselves. By choice, we may not want to impose on our children, leave aside the fact that we may be inconvenient for them. In such a case, perhaps the best option is a genuine ‘Reverse Mortgage’ on the home we own and soon to become worthless as we near our expiry dates. A pure ‘Reverse Mortgage’ would be one where the lender or the provider of the mortgage takes a fixed call, without recourse. In other words, he takes all the risk of the market price in future. This is perfect because it makes sure that we consume our assets in our lifetime and do not leave a mess for our heirs.
In the same context, if we had a life policy with a definite payout only on death, we could perhaps sell the policy. In an article (more than a year or two ago) I had mentioned about how such a policy could be a great thing for a secondary market buyer. Imagine that I am near about 80 and have an insurance policy with a sure payout of Rs.50 lakh, on my death. I can sell it to someone for Rs.40 lakh or so. The buyer will look at two things- How long I could live and the return on his investment. The longer I live, the lower his returns. And I will get some money in my lifetime out of this policy! This should be a tradable policy.
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