Bank FDs score over Debt funds

Interest rates are all set to rise. Central banks across globe are facing pressure of high inflation. US have inflation of 7% which is at 40 years high and Europe on the hand has 5% inflation which is at 30 years high. As crude is near 90$ a barrel we also have to face the higher inflation. Federal Reserve signalled a rate hike in coming March. Government borrowings will go up after high capex is announced in the budget 2022.

Debt funds of mutual fund gave better returns till last 6-8 months but as the rates are likely to go up the debt will not give better returns. The duration play is over. 10 year gilt is trading above 0.80 paise than coupon rate. Long duration and medium term bonds may give negative or very low returns. Investors must know that the bond prices drops when rates go up.  

Now it’s time to evaluate the debt investment in the current scenario. Last one year’s returns of debt mutual fund investment has fallen below the fixed deposit rates. The average 1 year return of regular plans in liquid and money market fund is below 3.50%. The average 1 year return of low duration and short term fund is below 4%. The average 1 year return of corporate bond and gilt fund is below 4%  The charges are also high which reduces overall return. In MF debt funds net returns are gained after you minus expenses from YTM (Yield till maturity). The returns are also subject to credit and duration risk which most investors fail to understand.

On the other hand the fixed deposits rates are around 5/5.50% in bigger banks. Safe corporate deposits of AAA rated co. offers around 6/6.50% p.a. return. The senior citizens also get 0.25% or 0.50% higher in fixed deposits which are not available in debt fund investments. Recently government increased the limit of insurance for bank deposits from Rs. 2 lakhs to Rs. 5 lakhs also gives advantage to banks fixed deposits.

Mutual funds must relook high expense in debt products given current unfavourable conditions and make debt products more competitive. Debt funds are unlikely to beat fixed deposits rates going forward. The tax treatment is same both in FD and MF if you invest for less than 3 years time horizon.

Infected by Bullishness (Article published in ET Wealth on 15.11.2021)

 

Rebalance Portfolio (ET Wealth - 19/04/2021)

 

Govt borrowing plan roils debt market, here’s what you should do

“Looking at the current scenario of fiscal deficit and amidst rising crude prices, investors should stay away from a long duration debt investment,” said Pankaaj Maalde, certified financial planner.

Corporate India has hailed Budget 2021 as bold and growth-oriented while the bourses have also given it a thumbs-up.  However, investors of debt category have a lot to worry with fiscal deficit pegged at 9.5% and 6.8% of the GDP for FY21 and FY22 respectively.

Moreover, government has planned a Rs 12-lakh crore borrowing for FY22 in the budget. This has fuelled negative sentiments in the debt market with yields rising.

“If you have a long duration investment in a commercial paper, the rise in interest rates will bring huge losses. The bond market has turned negative and there is a sell-off in long duration funds. Looking at the current scenario of fiscal deficit and amidst rising crude prices, investors should stay away from a long duration debt investment,” said Pankaaj Maalde, certified financial planner.

Equity funds are riskier for the short-term and investors with goals planned for the next three to four years are usually inclined to debt for diversification. Should one make a change in asset allocation with the recent dent to the debt market? Maalde doesn’t suggest a change.

“Asset allocation is more dependent on time horizon and the risk profile. If the investment is for long duration, then one can opt for 90 percent allocation in equities. One should avoid debt market for two reason – the yield may go up further and there is little room with RBI to cut the rates further due to fiscal rates. Also, when the loan moratorium period is over, there will be clarity on credit risk,” he said.

Experts say they recommend liquid funds or ultra short-term funds, beyond which the risk of rising interest rates are higher.

https://www.money9.com/news/debt/want-to-invest-in-debt-funds-heres-what-you-should-do-5318.html

BT Buzz: Gilt funds witness 237% higher inflows in April; should you invest?

Debt mutual funds may have been in the news for all the wrong reasons over the last one and half years, there is one category that is sitting on high double-digit returns at a time when even equity returns are dismal. Gilt and Gilt with 10-year Constant Duration categories have returned 15 per cent and 17 per cent, respectively in last one year. Returns for three and five years horizon are also in the range of 8-10 per cent.

In fact, the gilt category received inflows of Rs 2,515.61 crore in April compared to just Rs 746.71 crore in March. Now this is where the trouble begins. After the closure of six debt fund schemes by Franklin Templeton, investors have virtually abandoned the credit risk category. It witnessed outflows of Rs 19,238.98 crore in April. On the other hand, inflows in gilt funds, that carry negligible credit risk, more than doubled in a month. If you are keen to invest in gilt funds, you must know while gilt funds do carry very little credit risk due to sovereign backing, they are prone to interest rate risks. Experts believe new investor are unlikely to fetch double digit returns as we are witnessing today. Let's understand gilt funds in detail:

What are gilt funds?

Gilt funds are medium to long duration funds, which invest in government securities maturing between 3 and 20 years. The gilts could be of central and state governments both. Since we don't expect governments to go broke, these are considered the safest form of debt fund investments with negligible credit risk. However, interest rate cycle has a major role to play in how a gilt fund performs. It is called a duration risk. The longer the maturity profiles of the instruments, the higher the duration risk. If interest rates increase, the prices of the underlying debt securities will fall to match the higher return. As a result, your gilt fund will show negative returns. And when you enter a low interest rate regime, the returns go higher - as has happened in the current scenario with the RBI decreasing the interest rates for over a year now. The repo rate currently stands at 4.4 per cent, the lowest ever.

"Gilt funds are different from other bond funds because they are not exposed to credit risk. However they are exposed to interest rate movements and as such, are advised only for those who are aware of these risks and are prepared to accept them. These risks shouldn't be taken lightly and retail investors would be well served to be cautious when investing in them," says debt market expert Rajiv Shastri.

Should you invest in gilts now?

The answer lies in capturing the future movement of interest rates. With the government having raised its gross market borrowing target for the current financial year to Rs 12 lakh crore from the budgeted Rs 7.8 lakh crore, yields on government securities are expected to come under pressure. However, marketmen believe there could be another round of at least 100 bps reduction in repo rate in FY21 as the economic growth will take a hit due to coronavirus lockdown.

"If the GDP falls, the RBI will have to cut rates to fund the growth. Keeping that in mind, gilt funds stand out among other debt investments if you have a six-nine months time horizon," says certified financial planner Pankaaj Maalde. However, he cautions that other factors such as currency movement, crude oil prices and interest rate in global economies also influence RBI's move on policy rates. "With uncertainties around how crude and currency will play out in the short-term, you need to be careful about investing in gilt funds."

That said, if you invest in gilt funds on expectations of receiving similar returns as today, you could be in for a disappointment. "While gilt funds have delivered good returns over the last year or so, this cannot be the only reason for either investing in, or remaining invested in them. And while it is expected that long-term yields will continue to moderate, one needs to bear in mind that there are considerable uncertainties associated with this view. In addition, gilt funds are quite volatile and this needs to be kept in mind when investing in them," says Shastri.

How to choose a gilt fund

There are 29 gilt funds in the market, as per Valueresearch data. All of them returned in the range of 10-19 per cent in last one year. Since all gilt funds invest in government securities, how to select in which fund to invest? Experts say take into account the maturity of papers a fund has invested in and the average yield on the same along with the cost structure, that is, AMC charges. "You need to check the yield-to-maturity, modified duration and expense ratio," suggests Maalde.

Factor in taxation as well. If you hold it for more than three years, at 20 per cent with indexation, the tax rate is still fine, but if you withdraw the amount within three years, you pay taxes as per your slab rate.

"Gilt funds are not a product to be held for more than three years only to save taxes if you have already fetched returns of a falling interest rate cycle. Once you achieve the target, you need to exit. If you are in 30 per cent tax slab and exit with 8 per cent yield, the net return that you will get will be around 5.5 per cent. So, keep that in mind," says Maalde.

Thus, if you are a new investor, invest in gilt funds with the outlook that your principal will stay protected and you will fetch average returns. Don't expect spectacular returns of the past. In fact, debt funds with target maturity structures could be a better choice over gilt funds. Such funds invest in longer maturity papers initially and switch to shorter maturity papers as the maturity period of the fund comes closer.

"Their duration starts at three, five, and 10, etc, and keeps falling over the life.  That way if you hold to maturity you don't have duration risk. These funds exist - and with high quality credit. Bharat Bond, some corporate bond funds, and some banking and PSU funds have target maturity structures. They are called roll-downs also. You can just check the duration of them and match it to your investment goal tenure," explains Radhika Gupta, CEO, Edelweiss Mutual Fund.

https://www.businesstoday.in/bt-buzz/news/bt-buzz-gilt-funds-witness-237-percent-higher-inflows-in-april-should-you-invest/story/403976.html

Franklin Templeton crisis: SEBI needs to take investors' interest seriously

Sudden and unexpected winding up of 6 high risks debt funds by Franklin India AMC not only weakened the confidence of investors but also raised many questions about investment decision of mutual fund industry. When we advise our clients to invest in mutual fund the major point we highlight is the professional management and process driven investment decisions. But now the question is where the professional management and process?

Many experts believe that this is Franklin’s problem only but I don't think it is limited to Franklin India only.  It is possible that Franklin India might have taken very high risk compared to others but we should also not forget that even liquid funds have given negative returns in past. The mutual fund investors have lost more than one lakh crore in debt schemes in last 2-3 years. Right from the IL&FS to Yes Bank, Vodafone the problem is not showing sign of any relief. RBI’s move to give liquidity of Rs. 50,000 crore to meet the redemption pressure is not the solution but a temporary relief.

When investor puts his hard earned money in liquid or short term funds, he wants more of safety and little bit over savings bank and fixed deposits interest. But if such schemes give negative returns then it is difficult to hold the investors. I am really shocked when show that Franklin India Ultra Short Term Bond Fund invested in 5 and 10 year maturity paper. My understanding was ultra short term funds can invest only in 3 to 6 months maturity papers. As per SEBI scheme characteristic “ Ultra Short Duration fund can invest in debt and money market instruments such that Macaulay duration of the portfolio is 3 -6 months. Then how come a scheme can invest in Pvt. Ltd. Cos. and for duration of 5 to 10 years. This needs to be investigated and justice should be done to lakhs of investors who have suffered loss in so called safe schemes.  

I urge SEBI that Liquid, Ultra Short, Money Market, Floating Rate, Low Duration and Short term funds should be allowed to invest in quality papers only. Same criteria to be set for hybrid funds such as MIP and Equity Savings Fund. The investors in this category are low risk takers and lower quality paper in debt should not to be allowed in this category as well.

In debt funds the role of research organisation like ICRA and CRISIL is of utmost important as everything starts from there only. SEBI should review their role and assess the quality of research report they are giving. I don't know but have a feeling that is research reports are managed by the corporate? Is this also possible that some debt deals happen under the table? SEBI should go deep into this otherwise investors will shift their hard earned money to insurance and banks.

AMC and Fund Managers role also needs to be investigated. The process of investment decisions should be made public. They should also be answerable for every default. Quarterly review of the default needs to be done by expert panel of SEBI. AMC and fund managers to be penalized and the loss needs to be recovered from them if they are found guilty.

Most of investors and distributors look at the ratings given by Value research, Money Control and Morning star etc. and take the investment decision. I agree that distributors should also look at the portfolio before advising but ratings of this sites influence the decision of recommending and investing. They should be brought under the scrutiny of law so that they also give star ratings after due diligence. 

I firmly believe that loss in debt is permanent but in equity you can recover the loss if you have bought good stock or fund. The debt investment according to me is more risky than equity investment. SEBI needs to take this seriously and come out with strict guidelines to protect the investor’s interest. Damage due to lock down is not known, better SEBI awake early.

https://www.businesstoday.in/opinion/columns/franklin-templeton-crisis-sebi-investors-interest-mutual-funds-investors-debt-funds-equities/story/403508.html

Rebalance Your Portfolio - Businesstoday.in

Equity markets were trading near all-time highs when all hell broke loose and a black swan - novel coronavirus - bit the world. Its spread and fears of a looming global recession sent world markets, including India's, into a tailspin. The fast-spreading virus has triggered unconventional market trends - not just in equities, but also the debt market, and even gold. Debt funds witnessed heavy redemptions in March after bond yields spiked, though the repo rate cut by the Reserve Bank of India (RBI) has now boosted bond prices. Gold, which was at a high in the first week of March, tanked as much as 10 per cent in the following weeks. It has recouped some losses since.

With wild swings in asset classes, if your portfolio has taken a disproportionate shape not just in returns but also asset allocation, this is the occasion to rebalance it as per your life goals. However, extraordinary times require extraordinary measures.

Your equity allocation may have shrunk below your targets. Conventional wisdom says buy more. But should you really dip into equities when longevity of the Covid-19 crisis and its impact on the stock market is not clear? Wouldn't it be better to take a do-nothing approach?

A person with a key financial goal just a year or two away may prefer the safety of debt instruments compared to someone who can wait at least five years. Similarly, recent investments, for example, a three-year-old mutual fund portfolio, would have incurred losses post the market crash while returns in long-term portfolios are positive (see table). Both portfolios will require a different strategy.

"Your asset allocation should be defined not by how asset classes are performing, but by your own life situation. If your goals are near (one-two years), you cant afford to take the risk of investing in volatile assets. If your goal is more than seven-eight years away, a larger chunk of your investments should be in equities because they have the potential of giving higher returns. Under no circumstances should you overlook your overall asset mix," says Raj Khosla, Founder and MD, MyMoneyMantra.com.

Ultimately, you must have a well-diversified portfolio across asset classes that protects you from sudden shocks such as the one that has gripped the world now.

Well-diversified Portfolios

The recent market correction may have shaved off most equity gains, but if you had diversified a part of your portfolio in debt and gold, it would have supported your overall portfolio returns in the short to medium term. For example, gold has returned 38.48 per cent, 16.08 per cent and 11.33 per cent, respectively, in last one, three and five years. Similarly, 10-year government securities (G-sec) returned 14.65 per cent, 6.85 per cent and 8.06 per cent, respectively, during these years.

"Asset allocation as per your risk appetite becomes important during times of crises. A lot of people at the moment would be avoiding equity markets completely and investing in safe-havens like gold, gold ETFs and gold funds. Aggressive players must be taking exposure to equities to make the most of lower valuations. These times also make it important for you to seee that are you insured properly. Debt investments will help you find a mid-way between equities and gold as there is more certainty attached to them," says Jashan Arora, Director, Master Capital Services.

Here's how investors in various stages of life with different life goals could rebalance their portfolio.

• If You Are 25-35 Years Old

A young person in twenties or early thirties should have about 70 per cent portfolio in equities and the rest in debt and gold. After the market correction, your equity allocation may have reduced by 10-15 per cent and allocation to debt and gold may have increased. However, your life goals will still be the same. For your long-term goals such as buying a house or having adequate retirement funds, you should rebalance your portfolio back to 70 per cent equities. "Aggressive investors can look at overbalancing, that is, going overweight on their equity exposure, say around 10 per cent more than the initial exposure," advises Arun Kumar, Head of Research at FundsIndia.com. However, for short-term life goals, for example, a destination wedding, child's school admission or down-payment for buying a car, you may want to allocate funds in fixed deposits or debt funds.

"Your investments should always be backed up by financial goals. Your investment strategy if are looking to benefit from small blips in the market would be very different from if you are saving and investing for your child's education," says Arora.

It's also important to have some cash reserve, which not only gives you some confidence but also helps in case of, say, a medical emergency. "You can think of investing in liquid funds and overnight funds as they provide liquidity and give small returns too," says Arora.

If some part of your portfolio is invested in gold, it may have risen significantly. Should you book profits and divert the funds into other classes? "Ideally, no, because if the markets remain turbulent, then gold will remain at a high value, and possibly scale newer highs. So, remaining invested would be the best strategy," says Sousthav Chakrabarty, Co-founder and CEO of Capital Quotient.

However, gold should not form a major portion of your portfolio. "Invest only 5-10 per cent in gold. Buying Sovereign Gold Bonds is a better option (than physical gold) as it gives an added interest advantage of 2.5 per cent per annum and also saves on expenses," says certified financial planner Pankaj Malde. So if your gold investment has gone beyond 10 per cent, you may prune it by shifting proceeds towards equity.

• If You Are 35-50 Years Old

People in this age bracket may have more short-term goals, such as children's education or buying a house, as well as long-term goals such as retirement planning.

If you had invested equally in debt and equities, in the current situation, your debt exposure may have gone up significantly. Should you bring it down to divert funds into other asset classes? "This will be a tactical call. Someone with higher risk appetite could bring up the equity levels as per his strategic asset allocation needs. For debt, there are no real substitutes. Within debt, one may look at PSU bonds, tax-free bonds, small savings schemes, bank FDs, etc," suggests Suresh Sadagopan, Founder, Ladder7 Financial.

In this age group, a significant chunk of portfolio may be invested in debt. But one must remember that debt investment is not always safe. "Now that the repo rate is at 4.4 per cent, you should not expect double-digit returns from debt funds. Also, the current lockdown may result in default in payment of interest and principal (by companies). So, there is risk in investing in debt funds. Investing looking at only YTM (yield-to-maturity) is foolishness," says Malde.

Moreover, one must remember that a loss in debt funds is permanent while in equity, good stocks recover in time. "In debt, increasing your investments in VPF (voluntary provident fund) and PPF (Public Provident Fund) makes sense as returns from both are above fixed deposit rates and also tax-free," says Malde.

That said, in the current scenario, if you can take risk, you may consider tactically increasing exposure in equities - at least for discretionary goals three-five years away. "Historically, markets have always recovered from corrections and the initial phase of recovery has been extremely sharp. Given the significant fall of around 35-40 per cent, going by pure math, we are looking at a 50-70 per cent upside return just to get back to earlier levels," says Kumar of FundsIndia. For example, during the global financial crisis of 2008-09, the market (Nifty 500 TRI) had gone up 85 per cent in the first three months of recovery, he adds.

• If You Are in 50-65 Age Group

For this age group, usually, major life goals have been met and retirement fund is of utmost importance. Since retirement is not far away, ideally you should have started shifting your retirement fund invested in equities to debt at points when equities were trading at a high. If you weren't already shifting away from equities, the market crash would have put your portfolio in a soup. But don't panic. Selling equities at such steep losses will be a wrong move. "Stocks, though pulverised at this point, will bounce back with time. If you have sufficient liquidity and contingency funds to tide over this crisis as well as meet short-term needs, you need not worry. In time, all these will recover. If these are long-term funds, then it should not be a matter for concern," says Sadagopan.

Ideally, people in this age bracket should have little equity exposure. However, for the purpose of wealth creation or bequeathing, you may invest in equities. Consider this thumb rule: ideal equity allocation is 100 minus your age. For example, a 60-year-old should not keep more than 40 per cent portfolio in equities.

"In the debt market, we recommend investors to stay invested in traditional instruments like FDs. If they want to further secure their investments, they could venture into AAA-category corporate bonds or PSU and banking bonds," says Tarun Birani, Founder and Director of TBNG Capital Advisors.

If you are 65 years and above, keep all investments in debt instruments, especially those that offer regular income. With the available cash, you may also buy pension plans such as an immediate life annuity with return of purchase price.

What About Real Estate?

Being an illiquid asset, financial planners do not advise purchase of real estate for investment. Pan-India data for last 10 years shows that real estate has appreciated only 2 per cent in the period, according to Crisil. In fact, it has depreciated by 2 per cent in the medium term. "Investment in real estate is not advisable at this juncture. Buying a property for self makes sense, particularly if you are paying high rentals. Buy a ready-to-move in home if you are in a position to service the EMIs. Not only does this help you save rentals, home loan interest (up to Rs 2 lakh) and principal (up to Rs 1.5 lakh) are tax deductible," says Malde.

Cost Involved in Rebalancing

While you rebalance your portfolio, keep in mind the various costs involved such as exit loads, brokerage charges and even taxation. "If an investor considers a portfolio rebalance, he needs to analyse his earnings versus cost and net profitability," says Birani.

For example, selling a stock attracts brokerage charges, equity and debt mutual funds have expense ratios and, in some cases, exit loads. In case of fixed income options, Khosla says, the costs can be in the form of lower interest rates on fixed deposits or a penalty for foreclosing a bond.

Gains on debt instruments are taxed as regular income if the holding period is less than three years and at 20 per cent with inflation indexation if you hold it for more than three years. Equities attract short-term (less than a year) capital gains tax of 15 per cent and long-term capital gains tax of 10 per cent without indexation. Note that long-term profits up to Rs 1 lakh are tax-exempt.

What Should a New Investor Do?

If you are a new investor looking to build your portfolio, start with fixing allocation across asset classes as per your age. Build the equity portfolio over a period of 12 months via systematic investment plans (SIPs) or systematic transfer plans (STPs) on a weekly basis, advises Himanshu Kohli, Co-founder, Client Associates. "For fixed income, park money in high quality short-term or corporate bond funds," he adds.

In equities, pick blue chip stocks and large-cap and multi-cap funds. Besides, if you are a new investor, you should always be ready for 20-30 per cent correction in equities over a six month period. "This should be considered a normal stock market behavior. Once in 8-10 years, investors should also be mentally prepared for a 50 per cent correction," says Kumar of FundsIndia.

In debt, always keep some investments in fixed deposits apart from investing in AAA-category corporate bonds, banking bonds and PSU bond funds. "Exposing your portfolio by investing in anything below AAA-rated securities, credit risk funds and/or in sectors like infrastructure, metal, etc, must be strictly avoided," cautions Birani.

If picking quality investments is a crucial first step towards building of your portfolio, reviewing it periodically is even more crucial. Always keep an eye on your financial goals and balance your asset allocation accordingly to avoid painful shocks when you need money.

https://www.businesstoday.in/magazine/money-today/cover-story/rebalance-your-portfolio/story/401048.html

Don’t jump in to debt funds without knowing risk and charges

The correction in Equity market and interest rate yields going up shifted the focus of investors to debt instruments. Government also raised the interest rates for small savings instruments by 0.40% from Oct’2018 to December’2018 quarter. The debt funds of mutual funds are also in lime light. Debt funds obviously scores over traditional instruments if you hold for more than 3 years because of indexation benefit. Yields in mutual funds particularly in credit funds and corporate bond funds are higher compared to traditional investments. The returns of 3 years FMPs are also attractive if you don’t want daily volatility. But is debt risk free? The answer is no.

There is no doubt that debt also plays an important role in the portfolio and you can’t avoid it. But it is also important to note that if you aim for higher returns, higher risk is inbuilt in it. Therefore it is important to know the risk, charges and tax implications before investing in debt funds. You may have to suffer loss if you jump into the debt funds only looking at YTM (Yield till Maturity) which most of the investors do. Knowing Modified duration, tax implications and charges levied are also important aspect before investing in debt funds. Very few know that in hand return is not YTM but YTM minus fund management charges. If you are in a credit funds or corporate bond funds then interest rate movement can also impact funds day to day performance.

SEBI recently lowered the TER both in debt and equity funds and which will bring down overall charges. It is surely going to benefit the investors but it is important to note that final date of implementation is still awaited. More importantly lower charges will not take away the risk of default and risk of interest rate volatility which is likely to continue for some more time. Surprisingly, even charges are regularised there is still difference in charges levied in the schemes within the same category. The difference is too high that if you ignore your return can go down drastically. I think SEBI is also not ware about the disproportion charges levied in the same category. Just to clarify that lower charges does not mean higher returns but the fund management also plays important role. 

The US Federal reserve hiked the interest rate by 0.25% third time in this year. The RBI may also hike the interest rate or change the stance which most of the experts believe in its review meeting to be held on 5^th October’2018. Yields may go up again if RBI raises repo rate. Surely It’s not the time to chase the returns.

Let us evaluate the three major categories of debts which attracts majority of the debt money. Liquid funds are not considered as risk and charges are low compared to other categories. It is true that categorisation will help investors in identifying the nature of risk inbuilt in the product but there are other things also to be looked into. I am sure that this will help you deciding the debt funds very well. The source of information is from Aditya Birla Capital

1) Credit Funds: 

As per SEBI definition given under categorisation these funds have to invest minimum 65% of the corpus below highest rated corporate bonds. Means papers like AA or below rated papers which are too risky. The recent ILFS downgrade has put a question mark on the process of the mutual fund houses while investing people’s money in debt markets. Now its known fact that fund houses depend largely on the rating agencies for ratings and do not have in house mechanism to support it. In credit funds the yields are very high but also the risk is. One mistake and your corpus will be at risk, forget the interest part. We have seen negative returns in liquid funds as well in recent past which tells us that debt funds are also not risk free.

Another important thing I would like to highlight is the charges. There are around 20 schemes in the credit risk category and the average YTM is 9.76% and the average charges is 1.71%. This means your net in hand return will be around 8.05% only post expenses. Most of the investors invest in these funds looking at YTM only and ignore the charges levied or mostly not aware about the same. Even more surprising is the lowest charge in the category is 1.14% and highest is 1.89%. The difference is more than 50%. How this can be allowed and is SEBI ignorant about this?

2) Corporate Bond Funds:

As per SEBI definition given under categorisation these funds have to invest minimum 80% of the corpus in highest rated corporate bonds. These funds are much safer than the credit risk funds but the YTM is also lower. There are around 20 schemes in this category and the average YTM in these funds is 8.59% and the average charges is 0.86%. This means your net in hand return will be around 7.73% only post expenses. Again the lowest charge in the category is 0.44% and highest is 1.55%. The difference is more than 150% which nobody is talking about.

3) Ultra Short Term Fund:

As per SEBI definition given under categorisation these funds have to invest in instruments with duration of 3 to 6 months. Surprisingly there is no mention about credit quality of the papers. That means fund houses can take higher risk at the cost of investors money. Please note that fund giving higher return in the category is taking higher risk by putting money in below rated papers which can backfire. These funds are relatively safer compared to above two funds as the maturity is lower but again low paper can hit your investment badly.  

There are around 20 schemes in this category and the average YTM is 7.84% and the average charges is 0.73%. This means your net in hand return will be around 7.11% only post expenses. Again the lowest charge in the category is 0.20% and highest is 1.15%. The difference is 600% which nobody has noticed till date.

Investing in debt funds is more critical compared to investing in equity. From above comparison it is clear that you should invest in ultra short funds and be happy with 7.11% return instead taking higher risk for just 0.50 to 0.75% higher. Evfen 3 years FMP with quality paper is good option. Therefore “Advisor Jaruri Hai”. Direct plans can save on expenses but what about the credit risk and tax planning? I know the higher charges are passed to distributors but this must stop. I hope SEBI will look into charges within the same category and give relief to investors. There is no denial that charges are within the limits prescribed but high difference with in the category is not justified.

This article first published at indianotes.com

https://www.indianotes.com/en/articles/dont-jump-in-to-debt-funds-without-knowing-risk-and-charges/

Say Good Bye to Dividend Option

This year’s budget hit mutual fund investors very badly. Not only it levied Long Term Capital Gain Tax @10% on Equity Funds but also introduced 10% dividend distribution tax on dividend declared by Equity Funds. Post demonetization and stiff fall in interest rates large chunk of flow came to mutual fund. It’s really unfortunate that large chunk of fund came in balanced funds which invests minimum 65% in equity under monthly dividend option with so called assured 1% return every month. Product was largely missold to the senior citizens who were looking for the regular income every month. The dividend now is falling and new investors are realizing that something is wrong but still most of them are in confused mind. The dividend option takes away 10% in equity funds and around 29% in debt funds.

Normally dividend is declared when there is good appreciation in the NAV due to better performance by the scheme compared to bench mark. But, in practice it is largely misused to garner the new business which is what happening in recent time. Most of the people do not understand this sales pitch and are lured to invest in the fund without understanding the risk involved in the scheme. What exactly happens if dividend is declared can be understood by an example. Suppose “X” an equity fund scheme has NAV of Rs. 20 in growth option as well in dividend option. The scheme was launched at Face Value of Rs. 10 few years back. Suppose the Fund house today decides to declare Rs. 1.20 per unit i.e. 12% as dividend in the dividend option. In above case after the ex-dividend NAV of Growth option in “X” fund will remain the same at Rs. 20 but NAV under  the dividend option will come down to Rs. 18.80 as Rs. 1.20 is paid back to investor by way of dividend. By looking at attractive 12% dividend income you opt to invest Rs. 10,000 which investors have done in recent times. Most of the lay investors think that they will get same kind of dividend every year which is not true. The returns in equity are volatile and also not guaranteed. The corpus can also go negative and fund manager can’t declare dividend if there is no surplus generated. You have to remember while investing in mutual fund that past performance is not indicator of future returns and returns can vary depending on market.

According to me dividend option does not make any sense in both equity and debt. Let us understand the implications for both separately. First if you want regular income periodically than equity is not the correct asset class to invest. Opting for dividend option in debt funds is worst as there is a dividend distribution tax of around 29% compared to 10% in equity funds. Most of the investors are not aware of this because DDT is directly deducted by the AMCs before paying dividend to them. Also distributors do not tell or are not aware of this facts.

On other hand equity investment comes under high risk high return category. You should invest in equity after understanding the risk involved in it.  You must invest in equity only if your time horizon is long term say 5 years or more so that you get better inflation adjusted returns. So if you want to take the advantage of India’s growth you should stay invested in equity for longer period of time. Dividend option reduces your investment by dividend declared amount in equity so it will not give you advantage of power of compounding in longer run. So in equity also dividend option is not advisable.

Dividend Distribution Tax reduces overall return and it is right time to say Good Bye to dividend option. If you want a regular income opt for Systematic Withdrawal Plan in debt funds and avoid equity funds for regular income. Tax planning is very important part of financial planning which most investors ignore. You should know final outcome of the investment post tax and also study the hidden charges while taking financial decision.

To conclude making a new investment in mutual fund on the basis of dividend declared is not at all a good idea. You should take informed decision before investing in mutual fund schemes. You should consult a professional if you want regular flow of income every month and also know tax implications. Investing for short tern gain without understanding the long term impact may hit you badly. SEBI must also intervene and should abolish dividend reinvestment option and also stop monthly dividend option in equity funds to protect the interest of investors.

This article first appeared at indianotes.com on 20th June 2018

https://www.indianotes.com/en/articles/say-good-bye-to-dividend-option/

5 measures that Sebi should consider

The regulator must look beyond just lowering the expense ratios of mutual funds to safeguard the interest of investors, says Pankaaj Maalde.

Abolish dividend reinvestment option

The dividend distributed by equity funds will now be taxed at 10%, reducing investors’ returns. This will make the dividend reinvestment option of equity funds unviable because it will saddle the investor with a tax he can’t avoid. Even earlier, the dividend reinvestment options of equity funds had no advantage over the growth option. It is time these plans are scrapped to protect the interest of lakhs of investors.

Stop monthly dividend plans of equity funds

Demonetisation led to huge inflows into mutual funds. To attract investors, fund houses launched monthly dividend options in balanced funds. Being equity funds, they carry high risk and should not be missold. However, they have been used to lure senior citizens in the name of regular income—‘higher returns compared to fixed deposits’. But the schemes cannot deliver dividends if the market tumbles. Also, it is unethical to declare dividend from the investment amount and not from the gain. So, there is no ‘guaranteed’ income. In fact, most investors are not aware that even their principal can erode, if the market falls. Sebi needs to immediately stop such schemes.

Merge multiple liquid, ultra-short-term plans from same fund house

Most fund houses offer two liquid and two ultra-short-term debt funds. But there is hardly any difference in the portfolio of the two plans offered under these categories, except their expense ratios. Multiple products simply help fund houses garner more businessdistributors push expensive plans to earn higher commission. In fact, you can judge how sound your financial adviser is by checking which liquid fund plan he recommends. If it’s the one with the higher expense ratio, then he is only looking at earning a higher commission. Sebi needs to ask fund houses to merge multiple plans of liquid and ultra-short-term schemes.

Stop closed-ended equity funds

Fund houses try to encash the market tops by launching new fund offers (NFOs). The NFOs’ names and themes are decided according to the market conditions to attract maximum investors. On the one hand, Sebi wants standardisation of mutual fund products and, on the other, it gives permission to launch NFOs that may be very similar to the existing schemes of fund houses. The market regulator should look back to 2008-09 to find out what happened to the NFOs launched then—what returns did they generate? Fund houses too should clearly state why they are launching an NFO, if the new scheme is in no way superior to existing schemes.

Lower the expense ratios of arbitrage funds

Arbitrage funds will be among the worst hit categories on account of the just-imposed long-term capital gains tax on equities, given their already limited returns. The management charges for these funds are very high—1% in case of regular plans—and fund houses pay large commissions to distributors to push these funds. In today’s market, the maximum return these funds can generate will be around 6%. This does not justify their high charges—made worse by the LTCG tax. This category will lose its importance if the charges are not revised immediately.

ULIPs are good, but Mutual Funds are great!

With the LTCG levied on Equity MFs, we are seeing both media and the Insurance Companies saying, ULIP does not have LTCG. This is their new marketing strategy to SELL ULIPS. This clearly is another time when investors will burn their hands at ULIPs and will go away from Equity. 

How many remember the time when ULIPS were just launched and aggressive misselling had happened? It was after a few years when investors realized that this was not the apt investment for them and synonymed ULIPS to Equity.

The MF Industry has already gone through this once where they have had to educate investors, that Mutual Funds are different from ULIPS. This will be a dampener for the MF Industry and the investors at large if awareness about ULIPS and MF with LTCG is not created. This clearly is the new talking point for advisors with new investors. 

Mr. Pankaaj Maalde, CFP shares his views and an outline of his talking points on ULIPS vs. MFs with his investors. Advisors take note!

Charges of the taxes collected on capital gains shouldn’t matter for wealth creators.

From April 1, 2018, new Financial Budget will come into implementation; this can help ULIPs to promote the products where long-term capital gains are not taxed (LTCG). Whereas Capital gains on stock markets and Mutual Funds will be taxed for gains over 1 lac rupees at 10.4% (10% LTCG+4% Cess)    

ULIPs has advantages, but when compared to Mutual Funds, they can’t compound money the way Mutual Funds do. 

Insurance Products are kept out of the ambit of this tax. And maybe this can lead to misselling.  

ULIPS have three major points- 

1.    Allocation Charges every year.

2.    Policy Admin Charges.

3.    Higher Lock-in Period

Stick to mutual funds, invest for long periods to generate wealth. Power of compounding is the best provision here.

Insurance Agents will tell investors that in ULIPS, there are free switches available, without any tax liability. According to me, in practice it is not easy to do that and one should avoid timing the market.

When you look at Mutual funds, they beat the Benchmark and generate good wealth. Also, there is no lock-in period, except ELSS that too three years. Whereas, ULIPs have a minimum lock-in period of 5 years. Mutual funds give diversified portfolio and give the chance to shuffle from one scheme to another. 

I would like to suggest my clients as well as other investors and advisors to continue with Mutual funds if they want long-term benefits. 

Article first appeared at mutualfundlive.com

http://www.mutualfundlive.com/Lounge/Advisor-Viewpoint/ULIPs-are-good--but-Mutual-Funds-Equity-Investments-are-great!/37