Jaitley Removes Retrospectivity in Debt Mutual Funds, But FMPs Will Still See Tears

8 comments Written on July 25th, 2014 by
Categories: Budget2014, MutualFunds

NDTV reports that the higher tax on debt mutual funds will apply only from July 10 onwards, and not “retrospectively”, from a statement given by Arun Jailtley (Finance Minister) to Parliament.

Which needs a change in the finance bill, to state that units of non-equity mutual funds that have been sold between April 1 2014 and July 10, 2014 and held for more than one year from purchase will be attract long term capital gains. This means a “proviso” needs to be added stating this intention.

However for investors in FMPs who bought for a year’s holding for the tax exemption, their exit will be classified as a short-term gain, and it’ll be added to their income. For them it’s retrospective by implication, since they had no idea about this when they invested.

Read: The Murder of the Debt Mutual Fund in this budget.

But the concept of retrospective taxation is only that a rule should apply on after the rule has been announced. In this case, the only reason that the rule was retrospective was that the budget came in July (usually in February). The difference? A Feb announcement allows a month to be able to do things since the tax changes apply from April onwards. A July announcement - because the budget was postponed due to the elections - is applicable, from the same April, so technically, it will apply to transactions made from April to July as well. This aspect has been addressed by Jaitley’s statement.

Lesson: Don’t invest in things because of tax benefits alone. The fact remains that short term funds, even today, give way better returns than fixed deposits, and even if the two were equally taxed (as they are now) I would choose the short term mutual fund.

Mutual Fund Commissions Go Up in FY14, But The Future Is Scary (Freemium)

Comments Off Written on July 18th, 2014 by
Categories: MutualFunds, Premium

Each year AMFI releases data on all commissions paid to agents by all mutual funds, to distributors that meet any of:

  • Manage more than 100 cr. Of assets
  • Commissions of Rs. 1 cr. In total (all MFs) or Rs. 50 lakh from a single fund house
  • Presence in 20 locations or more

What we have found after a multi-year analysis of this data is:

  • Commissions go up marginally, AUMs too, but share of total mutual fund assets decline.
  • Banks and financials continue to dominate commissions by a huge margin
  • Many large agents including banks have lower assets under management (AUM) than the previous year
  • Outliers: Axis Bank saw a whopping 698% increase in its AUM this year, while HSBC saw its ranking plummet from #3 to #10.

Commissions Aren’t Very Negatively Impacted By “Direct” Plans, but Commission Growth Slows

AMFI introduced “Direct” plans in January 2013, where investors could invest in the same plans and no commissions would be paid to agents. This has, however much the unhappiness of the agents, not impacted their commissions in a large way. Commissions haven’t gone down, but they haven’t gone up at the same pace.

As per data released by AMFI, the total commissions earned by MF distributors has gone up 8.1% to Rs. 2,582 cr in FY 2013-2014 from Rs. 2,389 cr in FY 2012-2013. This increase was markedly lower than the 26.76% jump that was seen last year.

This was despite a 3.7% jump in agent-managed AUM from Rs. 4.76 lakh cr last year to Rs. 4.94 lakh cr this year.

Since the disclosures are only provided for distributors qualifying above a certain limit, but the system is “top heavy” so these will form a bulk of total commissions paid.

Part of this can be attributed to the reduced number of large active MF distributors in the market. This number stood at 373 in FY 2011-2012, to 432 in FY 2012-2013 and then finally at 329 this year.

We will come back to a detailed breakdown of AUM later on.

Top Earners:

The top 2 earners remain the same as last year:

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No Easy Choices for AMCs as They Stop Issuing FMPs

4 comments Written on July 14th, 2014 by
Categories: Budget2014, MutualFunds

There are no easy choices for Mutual Fund Asset Management Companies. After Budget 2014 raised the tax on debt mutual funds, they have pulled out Fixed Maturity Plans from the market, even returning money collected to investors (before the fund would have actually launched).

FMPs have more than 160,000 cr. invested - most of which will mature in a year. That money will not come back to new FMPs - and assuming a 9% return and an average of 20% tax, the tax collections will be more than Rs. 2800 cr. That’s the stake on the table now.

Some AMCs want SEBI to fight for them. Yet others want SEBI to let them make the FMPs open-ended so that investors get to stick around for 36 months.

FMPs can be moved to open-ended, but there are high operational costs. They’ll have to change the mandate, get investor approval (90% must approve) and then, offer automatic exits to those that didn’t want it.

These costs will have to be born by the AMC. SEBI will probably tell them that, and might not easily approve the large changes in mandate. (FMPs lock in the yield in an early transaction. An open ended fund will need a more flexible mandate)

Will the Finance Ministry Help?

No. They’ve decided that the loophole has to be closed, and FMPs of less than three years must involve paying short term capital gains tax.

In effect they’re telling us “long term is three years or more”. If this is the signal to debt markets this time, it is likely they do this to equity markets next year.

I don’t disagree entirely. One year is too short a term perhaps. And we can expect this three-year rule to hit equity markets soon.

In that context, no one should refuse the FMP investors a choice to stick around for two more years. If three years is what’s needed to get your gains tax free, then a stretch to three years isn’t a bad idea.

Lesson Learnt: Don’t Depend on Tax Arb

While I have been guilty of recommending this tax arbitrage, it was legal and visible. It’s taught me this again: don’t rely on tax rules for your longer term investments. (Or, apparently, even your shorter term investments)

To me, an FMP was an anomaly. You buy a bank deposit for one year, you pay tax on the interest. But you buy a mutual fund that buys the same bank deposit, it pays no tax, and then,by virtue of the magic tax arb, you also pay no tax. I suppose the taxman thought of it that way as well.

What I would like, though, is for them to think of real estate in the same way. If I own five houses, why should I pay no tax on selling one at a profit, if all I did was to buy another house? That’s blatantly unfair, and deserves to be removed as well. In terms of relatively unfair laws, the mutual fund one was benign compared to the massive arb in real estate. They need to remove that as well, and I wouldn’t be half as sad.

(And if you’ve bought a house for the tax arb, please note: the tax freedom is likely to go away)

If you asked me, I would recommend one thing:

  • Let this new tax rule apply only to investments made after the Budget day. This is the spirit of non-retrospective taxation. I hope FinMin listens.

The Murder of the Debt Mutual Fund By Closing a Tax Loophole

51 comments Written on July 10th, 2014 by
Categories: Budget2014, MutualFunds


Invested in an FMP?

Bought a Liquid Fund And Stuck around for a Year?

Bought Debt Funds for the “Inflation Indexation”?

You’re going to hate Arun Jaitley.


Let’s start with the basics. You can invest in a fixed deposit with banks. Which pays you interest. The interest is added to your income, and taxed at the highest rate you qualify in. So a 9% fixed deposit falls down to 6.3% if you are in the 30% bracket.

For companies, it was always going to be 30%.

But there was the Great Indian Debt Fund Tax arbitrage. If instead of buying a fixed deposit, you bought a debt mutual fund which bought bank wholesale deposits, a massive tax arbitrage worked in your favour.

If you held units for a year, then the gains were “Long Term Capital Gains”. These gains are taxed at lower rates of 10% of absolute gains, or 20% of “indexed” gains. When you index, you basically adjust your gains for inflation, and tax only what’s beyond the inflation impact.

The Example

So, if you put in Rs. 100,000 in a debt fund that returned 12% and you sold after a year, you got Rs. 112,000. Your tax used to be like this:

  • My 100,000 is adjusted up for (say) 9% inflation, so it’s now equivalent to 109,000.
  • The gain I made is only 112,000 minus 109,000 = Rs. 3,000.
  • The tax I pay is 20% of that = Rs. 600.

So for a gain of Rs. 12,000 I pay a tax of only Rs. 600 - effectively, a 5% tax!

The equivalent in a fixed deposit would have cost me, at the highest tax bracket, 30% of the interest of Rs. 12,000, or Rs. 3,600.

I pay 6x more tax with a fixed deposit!

The Result

High networth investors and corporates flocked to debt funds. There were liquid funds, income funds, gilt funds and other “debt oriented” funds. These, as of June 2014, manage over Rs. 700,000 crores.



That’s a lot of money.

What’s Changed?

Finance Minister Arun Jaitley, in Budget 2014, has removed this tax arbitrage. Now, you must hold a debt fund for three years in order to claim long term capital gains taxes, otherwise the gains are “short term” in nature, don’t get the lower tax rates, are added to your income and don’t allow indexation.

Further, and thanks to Madhu for noticing this, the tax rate on long term gains used to be the lower of 20% (with indexation) or 10% (without indexation). The second part - of a lower 10% - is now gone.

From one year to three years, is a big change - a large amount of funds sit with mutual funds so that they get much lower taxes, but don’t have the visibility of staying for three years.

Remember, debt funds can’t guarantee you an interest rate. Fixed deposits from banks can. You can lose money in debt funds - in fixed deposits your principal is guaranteed. Without the lower tax, debt funds are not quite as attractive.

FMPs Might Be Dead

Fixed maturity plans that didn’t let you exit before a year, and took advantage of this tax arb are now effectively toast. Most of them are a year or so in horizon, and very few have a three year range.

When they are redeemed, and they have to be redeemed, they will incur short term capital gains tax.

New FMPs will have to be at least three years long.

This is a huge part of the industry, and if the industry loses even 100,000 cr. to bank FDs, that’s between 100 cr. and 1000 cr. (assuming 0.1% to 1% management fees) that the industry loses.

It Impacts You Now, Even For Exits After April 2014!

The change impacts you from “Assessment Year 2015-16”. In tax parlance that means it applies for Financial Year 2014-15, as assessment years are the year ahead.

If you thought you exited before the budget and are safe, you are not!

It applies retrospectively, in a way, because stuff you invested in the past will hurt you when you exit in the future. And then, if you’ve already exited earlier, you’ll pay more tax.

By the way this applies to:

  • Debt funds
  • Gold funds
  • Infrastructure non-equity funds
  • Monthly Income plans where equity is < 65%
  • Fund of Funds
  • (Don’t kill me I’m just the messenger)

Are Dividend Options Better?

Jaitley’s hurt you there as well. Earlier the dividend tax was 25% of the amount distributed, for debt funds. If a fund had Rs. 100 to distribute, it would pay out Rs. 80, and 25% of that (or Rs. 20) was paid to the government as tax.

Now with the new rules, they’ve changed that. They introduce a calculation in which you will only get Rs. 75 and Rs. 25 is paid out as tax.  (They apply the tax on what they calculate to be the distributable surplus).

Effectively, with the surcharges, your dividends are taxed at 28.2%. (It used to be 22%).

What to do?

Nothing. Just pay the darn tax. Mutual funds, even debt, continue to have their advantages. They don’t accrue tax if you don’t exit - so if you don’t need the money, you won’t pay the tax. (FDs make you pay taxes even if the money continues to compound). Second, there is no TDS on debt fund exits, which makes cash management a little bit easier.

Dividend investments make sense if you need to exit earlier than three years, if you are in a 30% bracket. But it may just be better to put the money in a fixed deposit instead.

I would continue to keep my money in the debt funds - why pay tax unless I need it? But of course if you own an FMP you don’t have a choice about the exit. FDs will probably have to be evaluated alongside a debt fund, and might win, considering the tax advantage is gone.

This is a rough part of the budget and affects the whole Mutual Fund industry. Let’s hope they can have it pushed out by another year (but don’t hold your breath).

How Much Are You Paying Mutual Funds in Commissions?

18 comments Written on November 6th, 2013 by
Categories: MutualFunds
Check out Capital Mind Premium! Take a 30-day Free Trial.

A question on Ask Capital Mind goes like this:

Is there any link from which I can get to know the Trailing commission which the AMC pays to the distributor?

The one simple way to find out what it costs you in commissions is to check the mutual funds’ direct plan versus the regular plan. Check only the growth options because dividends distort the NAVs since the payouts could happen at different times.

Here's a quick comparison of a few funds mentioned in that question:




  • Since Direct plans were introduced on Jan 1, we don’t have a full year to compare. I have taken the values on Jan 15 (some funds took a few days to create such their direct plans) and compared them to the November 5 value. (Approximately 10 days short of 10 months)
  • The first two funds are ultra-short term plans, which is why the difference as a percentage is small. But you would typically invest a lot more in a debt fund than an equity fund, unless you were a trader. An ultra short term plan could be used to hold emergency funds, be an alternative to longer term fixed deposits, and so on.

Think of the last column as : what am I paying my agent?

Ultra short term debt funds in general pay lesser commissions. However, you might find larger differences in longer term bond funds, dynamic funds, and hybrid funds.

Equity funds have around 0.5% difference in 10 months, which is quite a big difference. For a Rs. 10 lakh portfolio (Rs. 1 million) you are paying Rs. 5,000 in commissions!

Completely tangential: Noticed how the mid-cap funds have delivered negative returns, even though the Nifty has had a positive year till date? That’s how tough this market is.

Big investors, says LiveMint, have figured this out and have moved most of their money to direct funds. It makes complete sense to do this for corporate treasuries, for who the difference could be in crores (for JM Money Manager super, for instance, a Rs. 100 cr. maintained over 10 months sees a difference of Rs. 1.61 crores!)

The other thing is that a financial controller or board member could easily use a commission agent and get kickbacks for investing large amounts. It would make more sense for corporates, especially listed ones, to move their money into direct plans.

Typically the industry has had an implicit subsidy. Rich investors used to have to pay commissions (trailing fees) on their investments, and those commissions would feed agents who could then afford to lose money on the smaller investors (through more detailed hand-holding, education, running around to fill forms etc.). Now that subsidy is gone, because the rich investors are closing down their accounts and going direct.

Mutual fund distributors are either going to have to stop doing business, or attempt to charge investors directly; and I believe investors have to learn to pay, or learn to do things by themselves. Without the implicit subsidy, we don’t have easy choices anymore.

Video: Liquid and Ultra Short Term funds, and Fixed Deposits

1 Comment » Written on October 18th, 2013 by
Categories: FixedIncome, MutualFunds, Video

Some of you have talked about Liquid and Ultra Short Term funds, versus fixed deposits, and how to compare all of them:

Here’s a video that I’d made at MarketVision a long time back which might be relevant:

Certain minor things might have changed - like the Dividend taxes on ultra-short term funds have now been upped to 25% as well, so that advantage over liquid funds has gone away. But the concepts remain useful to investors today.

Liquid Funds Recover From the July 15 Damage

2 comments Written on August 5th, 2013 by
Categories: Gilts, MutualFunds

Liquid Funds have recovered substantially from their fall on July 16. Remember, on July 15, the RBI took extraordinary measures to cut liquidity and that raised short term interest rates by 300 bps (3%). This caused liquid funds to fall in their NAV, as short term funds were impacted by rising yields (yields move inversely with prices).

At the time there was a fear that these funds have a major problem. However, my view has been that if you don’t need the liquidity, stick around. The NAV will recover, and it has. Here’s the NAVs of all liquid funds since then, and the return from July 15.

Fund Aug-04 Jul-15 From Jul-15 Jul-16 Jul-16 Move
Pramerica Liquid Fund  1001.472 1001.4746 0.00% 999.6694 -0.18%
ING Liquid Fund 24.7574 24.7486 0.04% 24.6638 -0.34%
DWS Insta Cash Plus Fund 19.8389 19.8131 0.13% 19.7611 -0.26%
Kotak Liquid 2269.528 2266.0098 0.16% 2260.2502 -0.25%
IDBI Liquid Fund 1291.702 1289.6532 0.16% 1287.0052 -0.21%
Quantum Liquid Fund 17.0102 16.9781 0.19% 16.9308 -0.28%
L&T Liquid Fund  1652.147 1649.0143 0.19% 1644.7143 -0.26%
UTI-  Liquid Fund-Cash Plan 1910.616 1906.8792 0.20% 1903.0043 -0.20%
Taurus Liquid Fund 1564.906 1561.726 0.20% 1558.4587 -0.21%
HDFC Cash Management Fund  25.1652 25.1135 0.21% 25.0565 -0.23%
Baroda Pioneer Liquid Fund 1380.499 1377.6247 0.21% 1374.7201 -0.21%
Reliance Liquid Fund-Treasury Plan 2934.297 2928.1634 0.21% 2921.1051 -0.24%
Principal Cash Management Fund  1170.899 1168.4451 0.21% 1165.4774 -0.25%
Religare Invesco Liquid Fund 1656.409 1652.6882 0.23% 1648.9476 -0.23%
Birla Sun Life Cash Plus  193.0481 192.6104 0.23% 192.1657 -0.23%
Sundaram Money Fund  25.4083 25.3473 0.24% 25.2935 -0.21%
Peerless Liquid Fund 12.6068 12.5759 0.25% 12.5597 -0.13%
JPMorgan India Liquid Fund 14.2731 14.2363 0.26% 14.2036 -0.23%
DSP BlackRock Liquidity Fund 28.4375 28.3608 0.27% 28.3021 -0.21%
Edelweiss Liquid  1188.91 1185.6322 0.28% 1183.8301 -0.15%
Tata Liquid Fund Plan A 2225.315 2219.1199 0.28% 2215.0341 -0.18%
ICICI Prudential Liquid  178.2966 177.7998 0.28% 177.5085 -0.16%
IDFC  Cash Fund  1465.352 1461.2355 0.28% 1458.8483 -0.16%
Escorts Liquid Plan 18.6281 18.575 0.29% 18.5786 0.02%
Axis Liquid Fund  1335.661 1331.8348 0.29% 1329.2837 -0.19%
Templeton India Cash Management Account 19.4942 19.4379 0.29% 19.4132 -0.13%
Canara Robeco Liquid-Regular Plan 1465.268 1460.997 0.29% 1458.4159 -0.18%
SBI Premier Liquid Fund 1894.858 1889.2991 0.29% 1886.0524 -0.17%
HDFC Liquid Fund 23.7783 23.7067 0.30% 23.6685 -0.16%
JM High Liquidity Fund 32.8678 32.7679 0.30% 32.7098 -0.18%
LIC NOMURA MF Liquid Fund 2185.199 2178.4663 0.31% 2174.9464 -0.16%
Birla Sun Life Floating Rate 160.2393 159.7396 0.31% 159.4547 -0.18%
BOI AXA Liquid Fund- Regular Plan 1386.982 1382.5764 0.32% 1380.3935 -0.16%
MS Liquid Fund  1184.616 1180.6085 0.34% 1178.8718 -0.15%
BNP Paribas Overnight Fund 18.552 18.4872 0.35% 18.4607 -0.14%
ICICI Prudential Money Market Fund 167.0005 166.3933 0.36% 166.1902 -0.12%
Daiwa Liquid Fund  1346.148 1340.9971 0.38% 1340.0904 -0.07%


(Note: Mirae Asset Liquid Fund is missing, which has reported a positive return till 30 July but the NAV is not available after that)

See carefully that yields on July 15 were just 7.5% for a short term security (CP, CD or govt debt of less than 1 year to maturity). Today these yields are at 10% or whereabouts, and yet, liquid funds have kicked into profit. The funda: for short term assets, the interest accrual on a bond will quickly overshadow the price drop (which is very short due to the small duration).

Yields won’t rise forever – they will find a top at which there will be enough buyers to keep the price steady. The question was – and I suppose, will be going forward – is the 10% the top, or will we see a higher number? This will tell you if you should buy bond funds.

Liquid funds on the other hand should only hurt if there is a potential of default, the risk of which, given the situation wit NSEL, I will not write off.

Mutual Funds that Owned Shares of Financial Technologies

5 comments Written on August 2nd, 2013 by
Categories: FinanTech, MutualFunds

Mutual funds owning FT stock are largely from the Reliance and Birla stable, it seems. Going purely from the shareholding on Jun 30 (the last we have) the shares they own are as follows, aggregated by AMC.

FT Shares held by Mutual Funds

Note that all of these are shares held on behalf of mutual fund holders.

In Bulk trades yesterday a few of the top shareholders exited their stake. Remember, anyone trading more than 0.5% of the days volume will get reported as bulk trades. Looking at the NSE and BSE together it seems that Birla and Reliance have exited part of their portfolio. (If the others were to exit, they would be too small to be reported in bulk trades, so it’s likely that they’ve exited as well)

Bulk Sellers of FT

Amal Parikh is probably related to the guys at Pivotal Securities, a firm that owns a large stake in FT.

Note that Birla sold at Rs. 271, which Reliance sold (in both BSE and NSE) at about 212. (Current prices are around Rs. 150)

Every single mutual fund scheme has a different account, and many funds have very tiny holdings, so their sales will also be invisible right now.

I’m saying that because you shouldn’t rush to sell the following mutual funds, which have reported holdings of FT as of Jun 30. Just for reference:

AMC Fund Shares % of portfolio
Reliance Reliance Growth Fund - RP  19,80,807 3.41%
Birla SL Birla SL Frontline Equity  4,70,196 1.16%
Reliance Reliance Equity Fund - RP 3,13,236 2.49%
Birla SL Birla Sun Life Midcap Fund  2,46,676 1.80%
Birla SL Birla Sun Life Equity Fund  1,04,811 1.25%
Reliance Reliance RSF - Balanced  1,01,220 1.46%
Birla SL Birla Sun Life 95 Fund  86,487 1.16%
Birla SL Birla SL Special Situations 43,142 2.44%
Birla SL Birla Sun Life Top 100  41,343 1.06%
Birla SL Birla SL Intl. Equity - B  39,210 1.97%
Birla SL Birla SL Advantage Fund  34,206 0.96%
Birla SL Birla SL India GenNext  15,510 0.84%
Religare Religare Invesco Tax Plan  12,442 0.72%
Birla SL Birla SL Small and Midcap Fund  10,225 0.87%
Reliance Reliance Growth Fund - IP  8,908 3.41%
Religare Religare Invesco Contra  7,363 1.21%
Reliance Reliance Growth Fund -Direct  7,303 3.41%
ING ING Multi-Mgr Eqty -A  5,560 2.37%
Religare Religare Invesco Mid Cap  5,040 0.78%
Birla SL Birla SL Long Term Advan.  4,989 0.29%
Birla SL Birla SL Frontline Eqty-Direct  4,044 1.16%
Birla SL Birla SL New Millennium  3,202 0.56%
Birla SL Birla Sun Life MIP  2,950 0.17%
Religare Religare Invesco Mid N SmallCap  2,597 0.75%
Birla SL Birla SL Midcap Fund -Direct  1,210 1.80%
Reliance Reliance RSF - Balanced -Direct  936 1.46%
Birla SL Birla SL India GenNext-Direct  675 0.84%
Birla SL Birla SL Top 100 - Direct  665 1.06%
Birla SL Birla SL 95 Fund -Direct  658 1.16%
Goldman GS CNX 500 Fund  491 0.06%
Birla SL Birla SL Equity Fund -Direct  381 1.25%
Birla SL Birla SL Advantage Fund -DIrect  310 0.96%
Birla SL Birla SL Small & Midcap -Direct  215 0.87%
Reliance Reliance Equity Fund -Direct  156 2.49%
Religare Religare Invesco Mid N Small-DP  50 0.75%
Religare Religare Invesco Tax Plan - DP  50 0.72%
Religare Religare Invesco Contra - Dir  30 1.21%
Religare Religare Invesco Mid Cap-Direct  27 0.78%
Birla SL Birla SL Special Situat.-Direct  22 2.44%
Birla SL Birla SL Intl. Equity B -Direct  13 1.97%
Birla SL Birla SL MIP - Direct  10 0.17%
Goldman GS CNX 500 Fund - Direct  7 0.06%
Birla SL Birla SL New Millennium-Direct  6 0.56%
Birla SL Birla SL Long Term Adv. -Direct  2 0.29%
ING ING Multi-Mgr Eqty-A -Direct  2 2.37%

(Source: Moneycontrol)

Investing in bond funds : What you actually need to know, by Dheeraj Singh

13 comments Written on July 26th, 2013 by
Categories: Bonds, MutualFunds

This is a guest post by Dheeraj Singh. Dheeraj was a fund manager for many years specializing in fixed income. He used to head fixed income at IL&FS Mutual Fund (before it got taken over by UTI) and subsequently worked with Sundaram BNP Paribas Mutual Fund (now Sundaram Mutual Fund) heading the fixed income desk. He runs Finanzlab Advisors, a treasury and risk management consultancy.

(Warning : Slightly long read, but probably worth it)

For the past week and a couple of days more investors in debt funds (of any flavor) have had a tough time.

RBI’s actions to constrain money market liquidity, in it’s attempt to arrest the fall in the value of the rupee in the foreign exchange markets, has led to a blood bath in the bond and money markets with yields rising sharply (equivalent to prices falling).

(Read: RBI has had two moves to constrain liquidity: One, Two)

Price movements have been large enough to ensure that even liquid funds could not ignore market prices in their valuations. Liquid fund net asset values are generally expected to grow by small amounts every day (by ignoring actual price changes). However that is true only if actual price movements in the market are small. In case of large price movements (generally greater than 0.1% on a portfolio basis) actual price movements have to be factored in.

Hardly had the market recovered from the initial RBI move announced late into the night on July 15, that we had some follow up measures on July 23, which exacerbated an already bad situation.

Consequently even liquid funds have generated negative day on day returns at least on two occasions within the last 10 days (as on July 25, 2013).

These developments have led to apprehensions in the minds of investors, several of them unfounded.

I have come across people labeling debt fund managers as incompetent. Nothing could be farther from the truth. Debt fund managers perform a very difficult task, that of managing the portfolio which is marked to market on a daily basis, within an uncertain and volatile environment. They do manage risks but that can be done only within the parameters of what is known and what can be anticipated. Unanticipated events like the RBI action are, by definition, impossible to protect against. Of course, there will always be some managers who are more skillful than the others. This doesn’t mean that we paint the entire community of debt fund managers with the brush of incompetence.

So, given the experience of the past few days, how should investors evaluate fixed income or debt mutual fund investments. It is no easy task, but some of the pointers below may enable investors to make a more informed decision

1. Appreciate the market linked nature of returns :

Returns from debt mutual funds come from two sources

i) the regular coupon accruals; and

ii) the gain or loss that arises due to fluctuation in market prices

Unless there are credit defaults, the coupon accrues regularly every day, usually at a fixed rate – this provides the regular daily return to investors in the fund as long as market prices do not change.

The situation becomes complicated however, as market prices are rarely constant. When prices go up, the return gets enhanced, and when they go down they take away from the regular accruals. When the price fall is large, the regular coupon can be completely wiped out by the extent of the price fall.

To get a view of the relative weightages of the two components in the total return, let’s consider a single security portfolio which has a coupon rate of 10% per annum. In such a case, the daily coupon accrual per Rs. 100 of investment can be calculated as

Daily Coupon Accrual =  0.10 * 100 / 365 = 0.0274

In other words the daily coupon accruals add a little less than 3 paise per Rs. 100 of investment. This corresponds to a return of 10% per annum.

In contrast, price changes on a day can sometimes be as large as 20 to 30 paise per Rs. 100 in case of very short term securities and as much as Rs. 2.00 to Rs. 3.00 in case of medium to long term securities.

When prices rise, they add to that 3 paise of coupon accruals. When they fall they take away from those accruals.

In effect, the returns are extremely sensitive to price changes in the market place.

This is what makes the return from these products attractive at times and unattractive at other times.

In the case of liquid funds which generally invest in securities maturing in 60 days or less, prices changes of upto 10 paise (approx.) are allowed to be ignored. Without this rule, returns from liquid funds would also suffer from volatility and the whole purpose of using liquid fund as a stable short term investment would be defeated.

However, when price changes are more than 10 paise, funds have no choice but to take on record these price changes and value the underlying securities accordingly. This is done to ensure that the valuation of securities in the portfolio does not deviate too much from the true market value. This is important since, if valuations are not close to market value, the fund returns would suffer volatility if and when the manager actually sells the security in the market.

The negative returns witnessed in liquid funds on a couple of occasions in the past few days was precisely for this reason (of valuing securities at their correct market prices). Prices fell by more than 10 paise and funds were forced to take on the actual market prices to value their portfolios.

This could as well have worked the other way. Had prices risen, returns from the funds would have been abnormally high. This kind of situation too occurs from time to time in the market, but since that’s generally good news for investors it gets ignored. Bad news commands a greater audience.

The revaluing of the portfolio of securities is actually a good thing for many reasons :

1) It is fair to new investors

While existing investors suffer, the revaluation of a portfolio provides new investors with an opportunity to invest and earn a fair market related return. Without revaluation new investors would suffer and existing investors would benefit. New investors would end up subsidizing existing investors. I’m sure none of us would like to be in such a situation.

This phenomenon can already be witnessed with liquid funds. Prior to July 15 liquid fund returns averaged about 8.0-8.5% per annum. After the fall in prices on July 16, returns started averaging about 10.0-10.5% per annum. This reflected the fact that yields in the money market had gone up by about 2% per annum. For new investors this provided an entry point to earn the higher return. If funds had not revalued (to avoid that negative one day return), new investors would still earn only 8-8.5% per annum.

This is a fundamental principle of any market mechanism and we should recognize it’s utility and fairness.

2) Interest rates do not rise (bond prices do not fall) indefinitely:

Unless we really manage to screw our economy very badly, interest rates generally move in cycles, meaning if they’re on the way up, they’re more than likely to reverse and start moving down. Conversely, if they’ve been moving down, they’re more likely to start moving up in the near future.

What this means is that, unlike equities, bond investments do not, generally, suffer from the “catching a falling knife” metaphor.

(Assumption : We’re considering only credit default free bonds. Prices of bonds issued by entities which default can fall continuously and even be worth nothing.)


3) Bond price movements actually become less sensitive at higher interest rates

Bond prices are most sensitive when interest rates are low - meaning, price changes can be large for even small changes in interest rates. However once interest rates have risen, this sensitivity goes down.

Price changes are larger when interest rates are low and smaller when interest rates are high.

This is better understood visually. The chart below depicts the price behaviour of a typical bond for different levels of yield.


(This is the general shape of the price yield curve of all option free bonds. The curve is downward sloping convex to the origin. While some bonds will display a more convex shape others may show a lesser convex shape. Higher convexity is a desirable feature in bonds).

Looking at the graph one can infer that prices movements are larger (P1 to P2) even for small yield changes (Y1 to Y2) when the absolute yield levels are low. Price changes are smaller (P3 to P4) even for a larger change in yield (Y3 to Y4) at higher levels of yield.

Effectively, once you invest at higher interest rates, the price risk that you take is much lower compared to the price risk that you take when you invest at lower interest rates, even if the portfolio of bonds remain identical.

This alone should dispel any doubts about investing in bonds or bond funds when yields have risen sharply and are likely to remain high only for a relatively short period of time. Conversely, if yields have fallen and are unlikely to sustain the fall, that is the time to start getting worried about your bond or bond fund investments.

The reality is when yields fall the positive price changes inflate our return. This manifests in complacency at the very time that caution is advisable. On the other hand, when yields have risen and are likely to fall sometime in the near future, it is possibly the best time to invest in bonds and bond funds with greater enthusiasm.

Disclosure : I have been a senior professional of the fund industry in the past. To that extent, some bias may creep into my writing. Also, I may possess information of and about the industry that may not be generally known. This could have a bearing on how and what I write.

Liquid Funds Move To Break-Even from July 16 Crash Within a Week

2 comments Written on July 23rd, 2013 by
Categories: Debt, MutualFunds

Liquid Funds have been getting bashed up recently with strange things happening in the liquidity bazaar. After their NAV fell for the first time in many years, many investors were spooked that these funds have too much risk on them.

However I had written:

As you can see, things have fallen only a little bit – we’re back to about the levels of about 10 days ago. Put another way, it might be prudent to stick around a few days longer and not panic-redeem the fund.

Tracking this, I have a new update on all the bond values as of yesterday. 18 out of the 38 funds have already recovered to their NAV levels of July 15. (the day prior to the big RBI announcement that caused the crash).

Fund Jul-22 Jul-15 From Jul-15 Jul-16 Jul16 Drop
ING Liquid Fund 24.7174 24.7486 -0.13% 24.6638 -0.34%
Quantum Liquid Fund 16.9711 16.9781 -0.04% 16.9308 -0.28%
DWS Insta Cash Plus Fund 19.7996 19.8131 -0.07% 19.7611 -0.26%
L&T Liquid Fund  1647.958 1649.0143 -0.06% 1644.7143 -0.26%
Kotak Liquid 2264.639 2266.0098 -0.06% 2260.2502 -0.25%
Principal Cash Management Fund  1167.788 1168.4451 -0.06% 1165.4774 -0.25%
Reliance Liquid Fund-Treasury Plan 2927.658 2928.1634 -0.02% 2921.1051 -0.24%
Birla Sun Life Cash Plus  192.5734 192.6104 -0.02% 192.1657 -0.23%
JPMorgan India Liquid Fund 14.2287 14.2363 -0.05% 14.2036 -0.23%
HDFC Cash Management Fund  25.1065 25.1135 -0.03% 25.0565 -0.23%
Religare Invesco Liquid Fund 1652.389 1652.6882 -0.02% 1648.9476 -0.23%
Sundaram Money Fund  25.337 25.3473 -0.04% 25.2935 -0.21%
Baroda Pioneer Liquid Fund 1377.384 1377.6247 -0.02% 1374.7201 -0.21%
Taurus Liquid Fund 1561.402 1561.726 -0.02% 1558.4587 -0.21%
DSP BlackRock Liquidity Fund 28.358 28.3608 -0.01% 28.3021 -0.21%
IDBI Liquid Fund 1289.337 1289.6532 -0.02% 1287.0052 -0.21%
UTI-  Liquid Fund-Cash Plan 1906.262 1906.8792 -0.03% 1903.0043 -0.20%
Axis Liquid Fund  1331.843 1331.8348 0.00% 1329.2837 -0.19%
Tata Liquid Fund Plan A 2218.965 2219.1199 -0.01% 2215.0341 -0.18%
Pramerica Liquid Fund  1001.432 1001.4746 0.00% 999.6694 -0.18%
Birla Sun Life Floating Rate 159.7611 159.7396 0.01% 159.4547 -0.18%
JM High Liquidity Fund 32.7717 32.7679 0.01% 32.7098 -0.18%
Canara Robeco Liquid-Regular Plan 1461.207 1460.997 0.01% 1458.4159 -0.18%
SBI Premier Liquid Fund 1889.596 1889.2991 0.02% 1886.0524 -0.17%
ICICI Prudential Liquid  177.8279 177.7998 0.02% 177.5085 -0.16%
IDFC  Cash Fund  1461.3 1461.2355 0.00% 1458.8483 -0.16%
LIC NOMURA MF Liquid Fund 2178.899 2178.4663 0.02% 2174.9464 -0.16%
HDFC Liquid Fund 23.7116 23.7067 0.02% 23.6685 -0.16%
BOI AXA Liquid Fund- Regular Plan 1383.122 1382.5764 0.04% 1380.3935 -0.16%
Edelweiss Liquid  1185.676 1185.6322 0.00% 1183.8301 -0.15%
MS Liquid Fund  1180.922 1180.6085 0.03% 1178.8718 -0.15%
BNP Paribas Overnight Fund 18.4919 18.4872 0.03% 18.4607 -0.14%
Peerless Liquid Fund 12.5804 12.5759 0.04% 12.5597 -0.13%
Templeton India Cash Management 19.4488 19.4379 0.06% 19.4132 -0.13%
ICICI Prudential Money Market Fund 166.4918 166.3933 0.06% 166.1902 -0.12%
Daiwa Liquid Fund  1342.385 1340.9971 0.10% 1340.0904 -0.07%
Escorts Liquid Plan 18.6029 18.575 0.15% 18.5786 0.02%
Mirae Asset Liquid Fund 1225.228 1223.5215 0.14% 1223.7909 0.02%

Strange Things are Happening in the Liquidity Bazaar

1 Comment » Written on July 19th, 2013 by
Categories: Banks, MutualFunds, RBI

In the days following the RBI hike in rates, we are seeing interesting movements in the fixed income markets.

Repo Bids Rise Substantially, But No MSF

Repo is what banks borrow overnight from RBI at 7.25%. MSF is the same thing, at 10.25%. Ever since the repo limit was introduced at 75,000 cr. (Previously: no limit) Repo bids have gone up like crazy, but only 75,000 cr. was allocated. However, the higher bids don’t mean that banks are desperate for funds – there was little or no borrowing in the MSF window for these days.

Date Repo Bids (Cr.) Repo Given MSF
16-Jul                   2,16,350               2,16,350 5
17-Jul                   1,41,970                   75,000 0
18-Jul                       97,265                   75,000 0
19-Jul                       56,860                   56,860 ?

Note that the restrictions on Repo were from 17 July.

From Game Theory, banks will attempt to bid more (since the repo allocation is pro-rata to the bid size every day), but even that impact has subsided with 19 July seeing less than the 75K cr. bid.

T-Bill auctions rejected

RBI conducts weekly auctions of about Rs. 12,000 for Treasury bills. This week, on wednesday, all bids were rejected for the two auctions scheduled, the 91-day and the 182-day T-Bills.

At the time of auction on Wednesday, T-Bill yields were about 9% to 9.5% in the market. If all bids were rejected, RBI really didn’t want to show that it was okay with these rates.

Rates in the market are now down to 8.50% for T-Bills.

OMO Sale Fails To Go Through

The RBI also intended to remove 12,000 cr. of money from the system by selling securities in an OMO auction. (How this works: RBI Sells Securities it has on its books. Banks pay money. That money goes out of circulation since it’s now with the RBI. So money supply actually reduces.)

The auction saw only 2,500 cr. of sales by RBI, and those too of the 2026 and 2030 bonds. None of the bids in the 2017 and 2022 were accepted.

I think that’s because the 2022 bond (8.13% today) is trading too close to the 2026 bond in terms of yields, and the 2017 bond (8.26% today) is trading EVEN higher. The RBI lives in a world where it believes inverted yield curves are not acceptable, I guess; so they rejected bids for the shorter term bonds. Just my opinion.

Post the OMO auction failure, yields fell substantially. The 2023 bond went down below 8%.

Mutual Fund Special Repo Sees No Desire

There was a special repo to meet redemption needs of mutual funds, where MFs would make a request to banks, who could borrow in a special 10.25% rate auction. Although some funds have reportedly borrowed from banks, these banks have chosen to not participate in the auction at all. and there was ZERO borrowing.

This could be a violation of rules where an MF request HAS to be run through the special repo window. But banks are flush with cash; they probably decided to lend it from their own surplus and face the consequences.

(Note: There aren’t any consequences to banks, or to anyone doing any sort of illegal activity, I know. Please stop laughing.)

The Impact

You might complain about the RBI move, that it was premature, that it was not required, that it will stymie growth, it will hurt liquid funds and credit growth etc.

Yet, it’s apparent that the move hasn’t yet hurt liquidity in any serious manner and after a few days, the markets seem to have taken it in stride. Sure, interest rates are higher – yields are up about 1% to 2% on everything – but that’s bound to be the case when the goal of the RBI is to cut liquidity (money does become more expensive).

Are these measures short-term? Some bankers would like to think so. The challenge will be evident when the September crunch arrives as corporates head to pay taxes and take money out of the system.

The Rupee is at 59.79 and while it has come off from the Rs. 60 highs, it is still under pressure.

FIIs have continued to sell debt, with over $240 million worth of rupee debt being sold in the last three days (full July: $1.9 billion). 

Growth will (and should) be hit; the stability in inflation provided by liquidity measures will take at least six months to a year to come through. A lot will happen by then, so it’s way too early to call.

Liquid Funds Rebound, Normalcy Begins To Return

3 comments Written on July 18th, 2013 by
Categories: MutualFunds

For those of you who fear having to exit liquid funds due to their unusual fall in one day, note that yesterday bond markets were more stable, and therefore liquid funds made money.

Here’s a list of the same funds that crashed in value on Tuesday, to how they closed on wednesday. They’ve recovered between  0.02% and 0.09%.

Fund Jul-17 Jul-16 Change Prev Day Change
ING Liquid Fund 24.6738 24.6638 0.04% -0.34%
Quantum Liquid Fund 16.9457 16.9308 0.09% -0.28%
DWS Insta Cash Plus Fund 19.7696 19.7611 0.04% -0.26%
L&T Liquid Fund  1645.211 1644.7143 0.03% -0.26%
Kotak Liquid 2261.222 2260.2502 0.04% -0.25%
Principal Cash Management Fund  1165.895 1165.4774 0.04% -0.25%
Reliance Liquid Fund-Treasury Plan 2922.926 2921.1051 0.06% -0.24%
Birla Sun Life Cash Plus  192.2734 192.1657 0.06% -0.23%
JPMorgan India Liquid Fund 14.2078 14.2036 0.03% -0.23%
HDFC Cash Management Fund  25.0657 25.0565 0.04% -0.23%
Religare Invesco Liquid Fund 1649.653 1648.9476 0.04% -0.23%
Sundaram Money Fund  25.3007 25.2935 0.03% -0.21%
Baroda Pioneer Liquid Fund 1375.223 1374.7201 0.04% -0.21%
Taurus Liquid Fund 1559.093 1558.4587 0.04% -0.21%
DSP BlackRock Liquidity Fund 28.3163 28.3021 0.05% -0.21%
IDBI Liquid Fund 1287.485 1287.0052 0.04% -0.21%
UTI-  Liquid Fund-Cash Plan 1903.51 1903.0043 0.03% -0.20%
Axis Liquid Fund  1329.715 1329.2837 0.03% -0.19%
Tata Liquid Fund Plan A 2215.65 2215.0341 0.03% -0.18%
Pramerica Liquid Fund  999.9687 999.6694 0.03% -0.18%
Birla Sun Life Floating Rate 159.4973 159.4547 0.03% -0.18%
JM High Liquidity Fund 32.7202 32.7098 0.03% -0.18%
Canara Robeco Liquid-Regular Plan 1458.891 1458.4159 0.03% -0.18%
SBI Premier Liquid Fund 1886.969 1886.0524 0.05% -0.17%
ICICI Prudential Liquid  177.563 177.5085 0.03% -0.16%
IDFC  Cash Fund  1459.237 1458.8483 0.03% -0.16%
LIC NOMURA MF Liquid Fund 2175.595 2174.9464 0.03% -0.16%
HDFC Liquid Fund 23.6759 23.6685 0.03% -0.16%
BOI AXA Liquid Fund- Regular Plan 1380.926 1380.3935 0.04% -0.16%
Edelweiss Liquid  1184.117 1183.8301 0.02% -0.15%
MS Liquid Fund  1179.191 1178.8718 0.03% -0.15%
BNP Paribas Overnight Fund 18.4661 18.4607 0.03% -0.14%
Peerless Liquid Fund 12.5647 12.5597 0.04% -0.13%
Templeton India Cash Management Account 19.4173 19.4132 0.02% -0.13%
ICICI Prudential Money Market Fund 166.2499 166.1902 0.04% -0.12%
Daiwa Liquid Fund  1340.511 1340.0904 0.03% -0.07%
Escorts Liquid Plan 18.5827 18.5786 0.02% 0.02%
Mirae Asset Liquid Fund 1224.063 1223.7909 0.02% 0.02%

Today yields have softened further (Thursday) with T-Bills quoting at 8.7% (versus Tuesday’s 9.5%). We should see short term funds (liquid, ultra-short term and bond funds) rebound further.

The point is: Don’t run off in a panic. We’ll see the NAVs return to the pre-RBI announcement values within two weeks, at this rate. Unless, of course, there is more drama to come! (I’ll track this weekly)

Revisiting the "Promoter Put" in Mutual Funds: Dheeraj Singh

1 Comment » Written on July 18th, 2013 by
Categories: MutualFunds

This is a guest post by Dheeraj Singh. Dheeraj was a fund manager for many years specializing in fixed income. He used to head fixed income at IL&FS Mutual Fund (before it got taken over by UTI) and subsequently worked with Sundaram BNP Paribas Mutual Fund (now Sundaram Mutual Fund) heading the fixed income desk. He runs Finanzlab Advisors, a treasury and risk management consultancy.

Four years ago, I'd written about how the "Promoter Put" - an implicit assumption that promoters of mutual funds would protect investors from large losses in case of adversity - had led to investor complacency and eschewing of prudent risk assessment. This in turn led to an anomalous situation that investments in funds were decided based on perceived brand value of the promoter entity rather than the actual performance of the fund or skills of the fund manager.

The signalling effect of the "Promoter Put" was strong enough for large investors to invest based on the likelihood of the parent bailing out the fund house in case of adversity. The thinking was - they have a reputation to protect, so why worry - they'll take a hit to protect us.

Recent developments may have put a small dent to that belief, though, and rightly so.

When RBI clamped down on liquidity and raised some interest rates in an effort to rein in exchange rate volatility, the direct impact of the move was felt in the bond and money markets. Yields on short term securities went up sharply by about 2%. In other words, prices of those securities fell sharply. One category of funds for which this was of special import were liquid funds. Liquid funds are products where you expect the NAV to rise by a small amount every day. Also, since liquid funds hold securities which are of a short maturity, they are allowed to ignore actual price deviations (which in the normal course are generally small) and accrue income at a fixed rate.

However, when actual price changes become large, the value of the funds' securities (as reflected in it's NAV) may vary significantly from it's true market value. When the NAV becomes significantly overstated (meaning the actual prices of the securities in the portfolio are much lower), savvy investors redeem (since they are aware of this divergence in values) and the fund comes under liquidity pressure.

A situation like this was seen on July 16 when liquid funds witnessed large redemptions (largely from bank investors) at a time when prices of the underlying securities fell sharply. This was in the wake of RBI's actions on the night of July 15.

Even more morbid was the fact that these very same investors would then try and buy the securities (or invest in other alternative securities) at a much higher yield. This would place the fund under even more pressure since selling at a higher yield means locking in the true value of securities which would lead to a fall in NAV. In the past fund houses have tried to protect the fund's investors by either trying to generate liquidity through alternate means (and thus avoid selling securities) or sell the securities but absorb the losses elsewhere (possibly the asset management company).

A similar situation was witnessed in October 2008 when the fund industry faced a full blown liquidity crisis. What started as a small problem related to exposure to real estate assets in one segment of the industry (viz FMPs) turned into a full blown crisis as funds (in their own wisdom) decided to ignore the true market price of securities and protect investors from losses. The result was that savvy investors walked away and the remaining investors were left holding the baby. When the trickle of redemptions became a flood within a couple of days, there was no shelter and the industry faced a serious liquidity crisis. Even during the extremely stressful days of October 2008, liquid fund returns displayed remarkable stability. Of course, valuation guidelines in 2008 were relatively lenient as compared to what they are today and this allowed the funds to remain within the law in spite of the crisis. However, in their effort to prevent losses to investors, the asset management companies and their parents had to absorb some losses.

Cut to today, and July 16 witnessed conditions similar to October 2008. As is typical in such situations, the industry did face large redemptions once savvy investors realised that the true value of securities had fallen sharply. Most of these investors were banking on the "promoter put" - that they would be protected, and therefore it was better to scoot as early as possible before the situation got out of hand.

However, on this occasion, the industry closed ranks and decided to pass on the valuation losses to investors (in the form of reduced NAV) even in liquid funds. Mutual Funds decided to mark their securities to the true value that they would fetch in the market place. The result was that, possibly, for the first time in the history of mutual funds in India, the liquid fund category gave negative day on day returns (on July 16) across most fund houses.

(Read: Liquid Fund NAVs fall for the first time in five years)

And rightly so. Mutual Funds are pass through products and investor get to share not just the upside but also the downside. The one day loss suffered by liquid funds on July 16 wiped out about 10 days of returns. This loss will however be recovered in the next 7 days (assuming short term interest rates remain stable). So, the worst affected would be liquid fund investors who invested on or about July 5. They would not witness positive returns for about two weeks. While they may be disappointed, this is fair enough. The RBI action was something that nobody had anticipated, and somebody will eventually be affected adversely.

Had this happened in the past, fund houses which gave a negative return would have faced a backlash and be subjected to outflows to the extent that they may have to almost down shutters. Many people feared the same may happen on this occasion too. However, what actually happened surprised many. Some banks which had redeemed in large numbers decided to cancel their redemption requests, once they realised that the industry was passing on the losses to investors in the fund. Even more importantly, now that the security valuations had been marked down to market yield levels, the daily accruals from the fund also reflected the market yield levels. This meant that fresh investors were duly and fairly compensated on their investments. Liquid funds are now accruing income at close to 10% which should cheer the new investors. These funds should therefore see healthy inflows.

RBI has opened a window of liquidity support for funds. I do not, however. expect funds to use this in a big way. There will be no need to. Even if they face redemptions, fund managers can now sell securities to generate cash since the securities are now marked to their correct market values, and there will be no further loss on an actual sale of securities.

The decision to correctly mark securities to market was an easy one to take, since it was the entire industry which was affected at the same time. The notion of "Promoter Put" being consigned to the dustbin would however be tested only when fund houses face similar situations which are not industrywide. Courage would be on test then.

The events of the past few days have however reinforced one simple belief: It is always good to do the "right" thing.

Disclosure : I have been a senior professional of the fund industry in the past. To that extent, some bias may creep into my writing. Also, I may possess information of and about the industry that may not be generally known. This could have a bearing on how and what I write.

Liquid Funds NAVs Fall for the First Time in 5 Years

7 comments Written on July 17th, 2013 by
Categories: Debt, MutualFunds

Liquid Fund Investors have taken it on the chin with the fall in bond prices yesterday. Across the spectrum, for the first time since 2008, Liquid Funds have fallen around 0.2% on July 16, which is an annualized fall of….wait, let’s not get stupid and try to annualize a one day fall in bonds. Here’s the list:

Fund Jul-16 Jul-15 Change
ING Liquid Fund 24.6638 24.7486 -0.34%
Quantum Liquid Fund 16.9308 16.9781 -0.28%
DWS Insta Cash Plus Fund 19.7611 19.8131 -0.26%
L&T Liquid Fund  1644.7143 1649.0143 -0.26%
Kotak Liquid 2260.2502 2266.0098 -0.25%
Principal Cash Management Fund  1165.4774 1168.4451 -0.25%
Reliance Liquid Fund-Treasury Plan 2921.1051 2928.1634 -0.24%
Birla Sun Life Cash Plus  192.1657 192.6104 -0.23%
JPMorgan India Liquid Fund 14.2036 14.2363 -0.23%
HDFC Cash Management Fund  25.0565 25.1135 -0.23%
Religare Invesco Liquid Fund 1648.9476 1652.6882 -0.23%
Sundaram Money Fund  25.2935 25.3473 -0.21%
Baroda Pioneer Liquid Fund 1374.7201 1377.6247 -0.21%
Taurus Liquid Fund 1558.4587 1561.726 -0.21%
DSP BlackRock Liquidity Fund 28.3021 28.3608 -0.21%
IDBI Liquid Fund 1287.0052 1289.6532 -0.21%
UTI-  Liquid Fund-Cash Plan 1903.0043 1906.8792 -0.20%
Axis Liquid Fund  1329.2837 1331.8348 -0.19%
Tata Liquid Fund Plan A 2215.0341 2219.1199 -0.18%
Pramerica Liquid Fund  999.6694 1001.4746 -0.18%
Birla Sun Life Floating Rate 159.4547 159.7396 -0.18%
JM High Liquidity Fund 32.7098 32.7679 -0.18%
Canara Robeco Liquid-Regular Plan 1458.4159 1460.997 -0.18%
SBI Premier Liquid Fund 1886.0524 1889.2991 -0.17%
ICICI Prudential Liquid  177.5085 177.7998 -0.16%
IDFC  Cash Fund  1458.8483 1461.2355 -0.16%
LIC NOMURA MF Liquid Fund 2174.9464 2178.4663 -0.16%
HDFC Liquid Fund 23.6685 23.7067 -0.16%
BOI AXA Liquid Fund- Regular Plan 1380.3935 1382.5764 -0.16%
Edelweiss Liquid  1183.8301 1185.6322 -0.15%
MS Liquid Fund  1178.8718 1180.6085 -0.15%
BNP Paribas Overnight Fund 18.4607 18.4872 -0.14%
Peerless Liquid Fund 12.5597 12.5759 -0.13%
Templeton India Cash Management Account 19.4132 19.4379 -0.13%
ICICI Prudential Money Market Fund 166.1902 166.3933 -0.12%
Daiwa Liquid Fund  1340.0904 1340.9971 -0.07%
Escorts Liquid Plan 18.5786 18.575 0.02%
Mirae Asset Liquid Fund 1223.7909 1223.5215 0.02%
HSBC Cash Fund  11.4467 11.4248 0.19%

Even a 0.2% fall is large enough to spook investors. Liquid funds are typically funds where you expect the NAV will go up every day, as long as the bonds that the MF has bought don’t default. And in general, rules allow mutual funds to “straight line” the NAV. Example:

  • I buy a Government Treasury-Bill with 30 days left to maturity, at Rs. 99.70.
  • Tomorrow, because of some drama in the market, the price falls to Rs. 99.60
  • I have made a “mark-to-market” loss of Rs. 0.10 – which should reflect in my portfolio
  • However, the T-Bill will give me Rs. 100 in the last 29 days, and the government backs it, so there is little risk of default
  • In such a case, I am allowed to mark the bill using the straight line method – From 99.70 to 100 in 30 days, or Rs. +0.01 every day. So I’ll say the next day the price is Rs. 99.71.

This is okay in a one-off case. But what if, when the price falls, half my investors redeem their money? I will know of redemptions only after market hours, so what should my NAV really be?

If I have to sell in the market at Rs. 99.60, but if I tell investors that the price is 99.71, the differential is a Rs. 0.11 that doesn’t exist.

Earlier, like Dheeraj writes, there was a “promoter put” in place – an implicit assumption that in such cases, the promoter of the mutual fund would take the hit and not allow investors to see losses. The promoter may buy a distressed security at the higher price and take it on his own books, like it happened when Deccan Chronicle defaulted on paying back a few mutual funds.

This is effectively the promoter underwriting your losses – a “put” option given to you for free. But obviously in a system-wide fall in prices, it will be impossible for any mutual fund promoter to take the hit.

Yesterday was one such case. Prices of nearly all securities fell. And it seems redemptions were a massive number, with many entities hoping that the “promoter put” will save them from action. However, it looks like Mutual Funds decided, all together, that they can’t have this happen – and so, all funds were marked down to the market.

Liquid fund investors will be spooked – after all you never really worry about loss of principal in what is supposed to be a safe investment, and here you’re losing 0.2%. But this spookiness is the correct thing – all investors need to understand that at the edge, there is risk. If liquid fund investors can stick around a little longer, they are likely to see a recovery (if the funds don’t have to sell the underlying investments, which will converge to par in a short while). But when patience does not exist, the hit has to be taken.

Take the largest Liquid Fund, ICICI Prudential Liquid plan (nearly 20,000 cr. in assets) and how it’s NAV has been hit.

ICICI Prudential Liquid Plan NAV: Capital Mind

As you can see, things have fallen only a little bit – we’re back to about the levels of about 10 days ago. Put another way, it might be prudent to stick around a few days longer and not panic-redeem the fund.

If yields fall further – short term yields are now at 9.5% – these funds might just be a great place to put additional money into.

To help redemptions go through smoothly, RBI has allowed banks to borrow in a special repo window (temporary) at the higher 10.25% rate to lend to mutual funds (who can give the underlying collateral as security instead of selling it). Given that funds have marked their positions to market, they might not need such a facility, but it’s useful to have it, even if the rate is 10.25%.

Two clear takeaways:

  • Don’t panic, things aren’t quite as bad as they seem, such funds will rebound.
  • If short term yields go up further, you might get a great deal if you put in additional money.

Government Bonds Fall 1% to 4% on the Liquidity Squeeze

5 comments Written on July 17th, 2013 by
Categories: Bonds, Debt, Gilts, MutualFunds, RBI

Mutual Funds are going to have it rough in the next few days. Bond prices have crashed after the liquidity squeeze introduced by RBI late evening on the 15th. Government bond prices have fallen between 1% and 4% in a single day. Here’s how the prices have fallen, plotting the difference in price (as a percentage fall) over the previous day, on a per-maturity date basis.

Fall in Govt Bond Prices: Capital Mind

Source: CCIL

(There are some items are zero loss; these are bonds which have not traded today, and probably traded in the last six days. You can ignore them – there was no trade at the “zero loss” number. There is one bond that seems to have “increased” in value, the 2041 bond, which is probably an outlier)

Yields at the 10 year level rose to an astounding 8.2% (the 2022 bond) from about 7.66% yesterday. Yields are inversely related to prices – a lower price is a higher yield (usually).

To know more about Bond Yields, see this video I created a while back: What are Bond Yields?

The situation is just as bad with corporate bonds where yields have gone beyond 10%. The Commercial Paper (CP) and Certificate of Deposit (CD) market – where corporates and banks issue short term debt  - have also seen yields go beyond 10% even for maturity terms as low as 45 days.

Given this, mutual fund portfolios will see a pretty big hit on the debt side. If you thought debt was safe, it’s not – not even ultra short term or liquid funds. Anyone that has invested in such assets, even short term assets, will see a huge price drop today.

Retail Investors Are More Interested in Debt than Equity, Investor Count Falling Since 2009

5 comments Written on July 15th, 2013 by
Categories: MutualFunds

Since 2009, retail individual investors seem to have lost interest in mutual funds. AMFI data shows the total number of folio numbers to have reduced 10% since 2009, down to 3.3 crore folios.

Note: The listed folios are under the headings of “Retail” and “High Networth Investors”. HNIs are those that have more than Rs. 500,000 in mutual funds, which is low enough to be called “Retail”.

Number of Total Mutual Fund Folios: Capital Mind

This data is revealed half-yearly, and the latest was on March 31. Many mutual funds have been trying to remove inactive folios and merge others so there is a lot of duplication here, however the impact can’t be much.

From a money perspective, mutual fund assets (retail+HNI) have grown since 2009.

Total Mutual Fund Money Managed (Retail+HNI) : Capital Mind

The growth rate seems to have tracked the stock market indexes, which have doubled since 2009, meaning that new money isn’t really coming in? Actually it’s worse – money has been leaving equity funds.

Interestingly, Individual investors now have more money in debt funds than equity funds for the first time since reporting started.

Retail Money in Types of Mutual Funds

Of course, most of the debt money in with HNIs, but this means the tide is starting to turn. It makes a lot of sense for individual investors to put money into debt funds in an interest rate+inflation cycle that guarantees nearly 9% tax free returns.

But this data tells you: even though the market is about 50% higher than September 2009, and most retail assets are in equity oriented funds, equity fund assets are lower now. Which means retail investors have pulled out money and the assets remain high purely because markets have grown.

What will it take to get investors interested in funds again? Please don’t ask for the return of high commissions.

Horrendous Performance of IDFC Infra Fund

3 comments Written on April 3rd, 2013 by
Categories: MutualFunds

I had featured a “new fund offer'” by IDFC AMC, for it’s IDFC Infra Fund on this blog two years ago and I’m honestly very embarrassed to note its terrible performance over this period. It was the worst performing fund in its category in 2012, and it has done worse than the category average, and indeed, even the CNX Infra Index. From Value Research:



If you look at the bar chart above, you can see that it has underperformed the category on the way up, and done worse on the way down. Overall returns are substandard.

From Moneycontrol:


The fund hasn’t beaten CNX Infra in any timeframe, expect the 2 year one (where the infra index went down 1% more than this fund)

It is true that infra stocks have taken a beating, but it is also true that this fund, even with a star fund manager like Kenneth Andrade, has grossly underperfomed.

In the post I made, I did take some positions on infra stocks like Elecon Engineering, which have fallen substantially – luckily, I was able to exit with a 15% stop loss (the stock has fallen over 50%).

In the comments, many people mentioned that it’s a great time to buy infra stocks (though I had maintained that the worst was yet to come). It was not a great time to buy infra stocks, apparently. Now may sound like an even better time to get in but here’s my deal: I won’t. I have to wait till prices show strength. Money can be made by betting on bottoms, but there is no “trigger” for these stocks to move up – government spending will need to be controlled, the economy has starting its down move, and infra stocks are hugely overleveraged (so every delay costs them in bank interest). If you’re going to be a vulture, at least wait for them to die.

However, what I have learnt is:

  • Sector funds, even when run by star managers, can be a sheer waste of time and money.
  • Do not review NFOs just because the fund management team did a phone call with you.

SEBI Makes Mutual Funds Show Risk in Colours

6 comments Written on March 19th, 2013 by
Categories: MutualFunds, SEBI

SEBI has gone from seeing things in black-and-white to now, colour-coded mutual funds. It has, in a circular, asked all mutual funds to colour code their funds blue, yellow or brown according to their risk levels (low, medium or high respectively).

This is a great source of revenue for all the printers that currently print their brochures, memorandums and information booklets. This is not a good day for trees.

Much as I may joke, a concept like this can actually be useful. Once, while filling tax returns, the forms were colour coded, and it made life very easy for all of us. Individuals got one colour, companies another, those with business income in a proprietorship yet another, etc. But that made a difference only since the ENTIRE form was that colour. I doubt having a little square box will make a meaningful difference.

All funds should have a single box with three attributes:

  • long term growth or short term income (or any other combination of the term/goal)
  • objective of the fund like we intend to mortgage your children to pay for our beer, or more realistically “ investment in equity and equity-related securities including equity derivatives of
    top 200 companies by market capitalisation.”
  • The “risk” with the colour box (Low risk, Medium Risk, High Risk) )

My notes:

  • The products will still be mislabelled. Is an FMP that invests in short term corporate debt low or high risk?

  • Investors understand risk in mutual funds. In fact they overestimate it. People tell me mutual funds have high risk, even those that invest in short term g-secs, the lowest risk product available) So I’m not sure who will benefit.

  • I would recommend that such labelling be carried over to all fin products. Insurance, bank deposits and even ETFs (on their web pages). What’s the point of doing this only for Mutual funds?

  • Who prints the stationery really? Are they public?

STT Gets Slashed, CTT Comes In

1 Comment » Written on February 28th, 2013 by
Categories: Budget2013, MutualFunds

Securities Transaction Tax (STT) is something traders seemed to expect would go away (Read my last post about why I thought it would not be taken out), and it has indeed been reduced. From the finance memorandum:


Mutual Fund STT Cut

STT for Delivery transactions – that is, where you purchase but do not sell intraday – of an equity mutual fund , bought on a stock exchange (so, an Exchange Traded Fund, effectively) – is currently 0.1% each way (buying and selling).

From June 1, you will not pay STT for purchasing Equity ETFs. And you’ll pay just 0.001% for selling them.

What about regular equity mutual funds (not sold on the exchange)? The STT has been cut from 25 basis points (0.25%) to a miniscule 0.001%.

Why even that? Because as I have argued in a detailed post, taking it to zero means that long term capital gains taxes will apply – and that is not desirable.

Futures STT cut to 1 basis point

STT for futures was 0.017%, or Rs. 1,700 per crore. For a single Nifty Lot, that worked out to Rs. 51 per lot (at Nifty of 6,000). That will now come down to Rs. 30 per lot at 0.01%. (Only on the sell side)

Commodity Derivatives Taxed

The FM has introduced a Commodities Transaction Tax (CTT) at 0.01% of the total contract value, for all non-agricultural commodities. A contract to buy 100 grams of gold (costing Rs. 2.8 lakh today) will pay Rs. 28 in taxes (paid by the seller).

This can be a bummer, since most contracts are highly levered (you pay a margin of just Rs. 8,000 or so per contract) and therefore people make trades that get them Rs. 100-200 per contract in profit. Of that, this CTT is a significant number.

Dividend Distribution Tax on Debt Mutual Funds Hiked to 25%

14 comments Written on February 28th, 2013 by
Categories: Budget2013, Debt, IncomeTax, MutualFunds

From 1 June 2013, any dividends paid out by debt mutual funds to individuals will have to deduct Dividend Distribution Tax (DDT) of 25%, regardless of the type of scheme. Equity mutual funds (>65% in equity shares) will not pay such a DDT, as earlier.

As of now, non equity mutual funds have to pay the following Dividend Distribution Tax when paying out:


Individual or HUFNon-individual

Type of Fund

Money Market /Liquid Fund



All other non-equity Funds



The 12.5% is now being changed to 25%.

This dividend is not taxed in the hands of the fundholder, but then the NAV will come down that much. For example if I hold a fund with an NAV of Rs. 11, and it decides to pay out Rs. 1 per unit as dividend, it will pay a DDT of Rs. 0.25 and the NAV will fall down to Rs. 9.75. Effectively, that tax is paid by you.

The relevant extract in the memorandum is:

Under the existing provisions of section 115R any amount of income distributed by the specified company or a Mutual Fund to its unit holders is chargeable to additional income-tax. In case of any distribution made by a fund other than equity oriented fund to a person who is not an individual and HUF, the rate of tax is 30% whereas in case of distribution to an individual or an HUF it is 12.5% or 25% depending on the nature of the fund.

In order to provide uniform taxation for all types of funds, other than equity oriented fund, it is proposed to increase the rate of tax on distributed income from 12.5% to 25% in all cases where distribution is made to an individual or a HUF.

This is a bummer for all those that have bought the dividend option of any non-equity fund, including:

  • Gilt Funds
  • Bond Funds
  • Income funds
  • Balanced funds (where equity is less than 65%)
  • Fund of Funds
  • Gold Funds

Solution: Buy the Growth option instead. You can set up a systematic withdrawal plan (SWP) that simulates dividends, and not have to pay this tax in whatever form. Since the change in DDT applies from 1 June 2013, so you have the time to now move your debt investments to the growth option.

Note: Uma notes that you may actually pay more - there's a 10% surcharge that applies, so the real tax including cess is a little above 28%. However a switch to growth option may involve an exit load (if you shift before the exit load term). Also, if there are any capital gains, you will have to pay short or long term taxes on them.

An Exception: However if you are a non-resident investor and buy a mutual fund designated as an “infrastructure debt fund” (IDF) then the applicable tax is just 5%.

Note2: The above "exception" may not be true. After Uma's note, I checked the actual finance bill, it seems to say that a 5% tax will apply BEYOND the above distribution tax. 

They told us DDT was toxic. Now we know it applies to anything that forms that acronym.

Links: Direct Plans Win, Be-Sahara, ESOP Disclosures …

5 comments Written on February 14th, 2013 by
Categories: KFA, Links, MutualFunds

Links for today:

Direct plans garner 56% of new inflows in Jan, says ET. Out of 60,000 cr., of fresh investments, nearly 33,000 cr. has come into direct plans. This should happen, as corporates shift their debt investments into direct plans. Why? Because debt plans are seeing about 0.2% to 0.5% better performance by direct plans, and on a corpus of Rs. 10 crore, that translates to Rs. 2 to 5 lakh per year, a very reasonable sum of money.

Update 19/2/2013:  Reader Neerav says  Wealth Forum post points out that ET has issued a corrigendum, saying that there was an error in their data, mixing up both direct and regular flows. However, I couldn't find the admission on the ET site, so I'm keeping both the original link and this other post as is.

SEBI has attached assets of Subroto Roy and two Sahara Group companies that were supposed to refund more than 25,000 cr. to investors. After a long supreme court battle, when the SC allowed SEBI full reign to attach assets or bank accounts to recover the money, SEBI has acted and attached everything it knows, including properties, mutual fund holdings, bank accounts and equity holdings. This is a confident sign for governance – now they have to investigate properly and find if Sahara has been involved in fraud as well.

Zee has made a disclosure about what it’s ESOP trust will do – sell off the nearly 11,000 shares it holds. Remember that SEBI has barred ESOP trusts from buying from the market, and has asked for a disclosure of what they will do with existing holdings.

Kingfisher Airlines’ assets may only fetch Rs. 1,500 cr. out of the Rs. 7,500 cr. debt it owes. Oh, well.

Damodaran says $100 bills are hard to come by. A must read, HT @CupLord.

Mutual Fund Mis-Selling is now Fraud: SEBI

11 comments Written on December 15th, 2012 by
Categories: MutualFunds, SEBI

SEBI has made misselling a fraudulent practice by adding a clause into the "Prevention of Fraudulent and Unfair Trade Practices" Regulations, via a notification:

(s)  mis-selling of units of a mutual fund scheme;
Explanation.- For the purpose of this clause, "mis-selling" means sale of units of a        
mutual fund scheme by any person, directly or indirectly, by─ 
(i) making a false or misleading statement, or 
(ii) concealing or omitting material facts of the scheme, or
(iii)concealing the associated risk factors of the scheme, or
(iv) not taking reasonable care to ensure suitability of the scheme to the buyer.

At first glance this appears to be a far reaching addition because you can hardly prove (or disprove) such an allegation when it occurs. Did the agent conceal a material aspect of a scheme? How can you prove it if he said he did reveal it?

The last bit (ensuring suitability of the buyer) seems even more subjective, but I suppose it could be on a "reasonable effort" basis where you can only get rapped in a very extreme case.

Having gone through the rest of the "fraudulent" practices, it seems we do have a framework of subjectivity. For example:

(b) dealing in a security not intended to effect transfer of beneficial ownership but
intended to operate only as a device to inflate, depress or cause fluctuations in
the price of such security for wrongful gain or avoidance of loss;

You could easily state that most intraday "strategies" of a large size will qualify. However I believe the framework is subjective because it needs to be so: given the range of appeals available (SAT, courts) it is better to have a law that is broad and subjective, rather than create a tight and restricted rule which the big and bad jokers will easily find a way around.

So overall, I don't find it such a bad deal to not have a strict definition of what misselling is. What I would like to see, however, is that SEBI investigates cases, and has HUGE penalties on extreme forms of fraud of any sort, including jail time.

Today, fraudsters get away with small fines and a small period of a ban on trading. That should not be the case. If we want to deter other people from a crime, the punishment should be huge and visible. That means when they catch the big frauds, those people need to go to prison. We need to see people banned for life from the markets. We need to see fines that are so heavy they will leave the fraudsters with nothing - I mean, for a fraud of Rs. 100 cr. we should see fines of Rs. 500 cr. as punitive damages.

In this respect, if a bank is found to be selling equity mutual funds to old women who come in looking for a deposit, I think the bank should be fined a minimum of Rs. 10 cr. as a deterrent. Banks seem to have the most serious offences of misselling agents who pose as "relationship managers".

Misselling may be provable only in an extreme case, and with respect to mutual fund selling I think it's difficult to prove either side. Online players need to be careful; they must provide all information available (risk factors etc.) and have some defence available to state that they tried to provide "suitable" products for a buyer. For others, agents have to be careful to reveal such information pro-actively.

I don't believe this regulation changes much: misselling in mutual funds has been cut down since SEBI removed entry loads and the new offer frenzy died. But I would welcome something similar in insurance and banking.

SEBI Notes: MFs, Direct Investing, Brokerage Caps

4 comments Written on August 26th, 2012 by
Categories: MutualFunds, SEBI

In the latest SEBI board meeting, a few norms have been discussed that will change the world of mutual funds and personal advise. Note that the actual circulars to implement these changes will follow. (I waited a week, then I decided this post had to be made) A few points that make the grade:

Mutual Funds To Have More Flexible Expense Ratios

Asset Management Companies (AMCs) have complained that they are restricted in how they can use their expense ratios. SEBI has now allowed "total fungibility" in such expenses; only the total number can't be greater than 2.5%. Earlier they had fees of about 1.25%, other charge

And it *can* be greater than 2.5%. Upto another 0.30% is allowed if funds flow in from beyond the top 15 cities. Note that this doesn't mean expenses will go to 2.8% - if funds have to remain competitive they must not load the expenses too much; so they will likely still stay around the 2% level which they currently are.

There is a problem - in that the top 15 cities account for over 85% of assets in the MF industry. But it's further skewed than that. Nearly 45% comes from Mumbai, and more 70% comes from Mumbai and Delhi.


Further, the top 15 cities keep changing every quarter. Gurgaon was #16 in terms of total AUMs in the Jun 2012 quarter. However, one quarter earlier, it was 14th. I wonder how these things get taken care of. In the 6-monthly disclosures, AMCs need to mention what they are doing to broaden geographical penetration.

Finally, Any service tax charged to the AMC for the scheme was borne by it. Now that can be transferred to the scheme (meaning, investors will pay).

Exit Loads to be Ploughed Back

If you exit a fund early, you may be charged an exit load (usually 1% in equity funds within a year, lesser in debt funds). This money was used by the AMC however they wanted; for paying distributors commissions (an upfront commission could get adjusted this way) or for extra fees.

Now, such loads must be credited back to the scheme. So as an existing investor you will benefit when other people leave early! Bad for the AMC and for agents - they will get compensated lesser.

The Lower Expense Ratio Plan - Direct

All plans of the same scheme (Institutional/Retail etc) will now have the same expense ratios. (So there's no lower expense ratio for institutional etc.) But there's one difference: DIRECT plans - where there are no distributors - can be created with lower expense ratios.

This makes sense. Where an investment is directly done by the investor - either by studying the market himself or after following advise or buying online - there is no need to compensate a distributor at all. Agents in equity funds get upto 0.5% per year as "trailing" commissions - if you consider that you make 10% a year, Rs. 500,000 today will grow to Rs. 25.93 lakhs in ten years. At a lower 0.95% per year, you will make 24.78 lakhs - a difference of about 1.15 lakh.

Distributors are crying hoarse that this will hurt their business as investors will choose to go direct. And that this does not benefit the industry. I strongly disagree. Firstly, most distributors - even those I have interacted with - provide very little value addition beyond the initial transaction. They take the cheques, fill the forms and might call you once a year. For that, you don't pay them 0.5% a year. Some say they provide advice - but they should charge separately for that advice, and this is the concept of why entry loads were removed in the first place. And if they do provide advice that is of at least some value to an investor, the investor should be happy to choose a "non-direct" scheme with slightly higher charges. Come on - if the value you provide gives no perceptible benefit to the investor, then you should not be compensated in an underhand way through higher expense ratios and trailing fees.

Second, there is an obvious benefit to the industry. Most of the corporate money into liquid and debt funds is placed directly with fund houses. Boards will likely dictate that money goes only into direct-only schemes. Of the total 6.89 trillion rupees (689,000 cr.) in mutual funds as of Jun 2012, more than 4.7 trillion (68%) is in income and debt funds; and corporates account for 43% of mutual fund assets. If you consider Rs. 2 trillion on which just 0.1% trail loads are paid which can move into a DIRECT scheme, that's a saving of Rs. 200 cr. Most of this money, today, goes into the pockets of large banks who are distributors. 

The other benefit is that you have lesser issues with direct schemes - that is, investors can't complain that distributors misled them or such.

What should happen now is that to make things easier, CAMS and Karvy should come up with a single customer login/password so they can buy any fund directly. That will make things really simple. (And then, most money seems to come from the top few cities, which can easily use the internet and migrate to direct).

Anyhow, this is a sour point for distributors (who will lose the argument since it's good for investors) and for AMCs who will now have to directly service customers.

Brokerage Capped at 12 bps and 5 bps

Brokers will be unhappy. From earlier charges of 0.20% (20 bps), mutual funds can't pay more than 12 bps (0.12%) for stock transactions and 5 bps (0.05%) for derivatives.

Regulated Advisors

People who provide financial advise for a fee will have to go through registration and provide information to SEBI. The regulations aren't yet out (there were drafts earlier) but it seems like people will have to prove they are capable of providing advice, track their customers etc. Such people cannot get paid from Mutual Funds (for trail fees etc.)

There are exemptions - people who give free advice in a broad media (so this blog author will be exempt), stock brokers, AMFI agents (who don't charge a fee for advice), insurance agents etc.

Other Changes

  • AMFI Fees for distributors will be reduced
  • Upto 20,000 investments in cash will be allowed
  • IPOs can have less than 20% owned by promoters, if the rest is contributed by VCs or PE funds.
  • A new format of disclosure like the 20F form by SEC will be created. This is great - the layer of disclosure in 20Fs is much much more than currently given.
  • Non Retail investors can't withdraw or change their bids in an IPO. Ooh.
  • ESOPs can't buy shares in the market. (See My Article)

Making Sense of Dividend Announcements

6 comments Written on July 9th, 2012 by
Categories: MutualFunds, Stocks, Yahoo

I write at Yahoo: Making Sense of Dividend Announcements:

"1860% dividend announced", goes the headline. You're excited. But the question isn't, "Where do I sign?", but "1860% is great, but a percentage of what?"

The number is a percentage of "face value" which is as relevant today as a rotary-dial telephone. When a company is created, the founders distribute the initial capital into shares. A company started with Rs. 100,000 could be split into 10,000 shares of Rs. 10 each (the "face value" per share).

This company can, over time, earn enormous profits without any further capital requirements. Or, it might borrow money from a bank to fuel expansion and as it profits from growth. The capital could remain unchanged, with the original shares changing hands in a stock market. If the company grows to earn, say, Rs. 10 crore (Rs. 100 million) in profits, and decides to distribute half of it as profit, what happens?

You have a distribution of Rs. 5 crore (50 million) divided over 10,000 shares, or a dividend of Rs. 5,000 per share. The "face value" is still Rs. 10. So this is, effectively, a 50,000% dividend.

But the face value is irrelevant if you bought a share at Rs. 100,000 per share; for you, it's a 5% dividend! The "50,000%" number has no significance.

Most companies insist — and some say there is a rule for it — on providing dividends as a percentage of face value. Mutual funds are mandated to provide both the value of dividend they offer (rupees per unit) and the percentage of face value which is usually Rs. 10.

For listed companies, a better way to represent dividend is the "yield" — or the percentage of the stock price). But there is a practical problem: the dividend is proposed (and announced) as a number per share, by the board, and approved at a general shareholder meeting a couple months later. And then, it takes another few weeks to actually pay out the money. In this time, the share price could have moved substantially away from the time when it was first announced. A Rs. 10 dividend on a stock priced at Rs. 500 is a 2% yield, but if the price moves down to Rs. 200 due to a global crisis before the dividend is paid, the yield is actually 10%.

The other problem is that face values are different. Some companies have a face value of Rs. 100, others "split" their face value down to Rs. 2 or Rs. 1. You have no idea what a "170%" dividend will mean if you don't know what the face value is.

Some companies issue bonus shares, a process of converting retained earnings into share capital. So a 1:1 bonus will effectively double the number of shares in existence (each shareholder gets to double his holding). But since it's the same company whose profit is now being distributed over a larger number of shares, the market price per share will go to half. If the company paid "100% of face value" as dividend earlier, it might only pay "50% of face value" today — yet, a shareholder will get the same amount!

The simplest way to represent a dividend is to state what percentage of profit is being paid out. A company making Rs. 10 per share as a profit could pay out Rs. 2 as dividend — the dividend distribution percentage is thus 20%. Even this has a disadvantage; since a company can pay dividend from both current and past profits, it might just turn out that some companies pay out 170% of their annual profits, which might confuse investors. (How do you pay out more than you earn?) But it is substantially better than the current "of-face-value" method.

Face value has lost relevance as companies in India have grown without the need to add more capital, and retained most of their earnings for future expansion. Paying out dividends means an extra dividend distribution tax, so companies will retain more profit back. Most times you won't even know what the face value of a stock is — for instance, Infosys, which trades at a price of Rs. 2,500, has a face value of Rs. 5, while Reliance Industries (which trades at Rs. 735) has a face value of Rs. 10.

If you'd still like to chase a high number, Hero MotoCorp has just proposed a dividend of 2,250%. What that means: It's a Rs. 45 dividend on a share that's priced at Rs. 2,000+. You just can't take dividend announcements at face value.

ULIP Underperformance: Stunted By Guarantees

7 comments Written on June 11th, 2012 by
Categories: Insurance, MutualFunds, ULIP

Unit Linked Insurance Policies tend to be very complex and highly loaded with costs. But some policies have looked good in theory, but they turn out to be dud performers anyhow.

In an email conversation I was referred to an excellent analysis of ULIP costs by RRK which talked about how ULIP costs could actually be low. He used the analysis of an IDBI Federal Dreambuilder Plan, which offers just a first year allocation cost of 3%, and fund management charges of just 1.35%.

Over a 15 year period, the return on the policy beats the return on the mutual fund+Term plan method, according to RRK; the return on the ULIP comes to 30 lakhs while the MF+Term approach gives you just 28.5 lakhs.

(35 yr old, 10 lakh sum assured, 1 lakh per year premium, 15 year policy, 10% returns assumed).

In theory, awesome policy. With low allocation charges which apply only in year 1, the difference is that mutual funds charge an average of 2% as charges every year, and the ULIP In question had only a 1.35% charge. Over the long term, the difference works out to be a gerat

Sadly, the devil is in the details. The fund outperforms because of two “guaranteed” loyalty additions of 3.15% – one at the end of the first 10 years, and the other after 15 years. Without these guaranteed additions, the ULIP would underperform, giving just 28 lakhs after 10 years.

How does the guarantee work? Does IDBI Federal give money out of the goodness of their hearts?

This guarantee is available across most of their ULIPs. Which means that they must bake in the cost somewhere. The answer is: Fund Performance.

Let’s look at the IDBI Federal Equity Fund performance since inception, compared to HDFC Taxsaver and HDFC Top 200, two funds that aren’t the best today but are something that I have used as benchmarks over the last five years. (The IDBI Fund Starts 17-Mar-2008)


In the last four years:

HDFC Top 200: 53% (Annualized: 10.60%)

HDFC TaxSaver: 45% (Annualized: 9.25%)

IDBI ULIP’s Equity Growth Fund: 26% (Annualized: 5.7%)

The IDBI fund has underperformed by over 3% per year.

We assume that a ULIP fund and a mutual fund will perform at the same level – both after all invest in the same assets. But mutual funds have no such “guarantee”; does the guarantee hurt the performance of the fund?

The cost of this guarantee seems to be hidden inside the fund management strategy. If you assume that the ULIP will do about 2% lesser every year, then the net return, after 15 years is:

Term Plan Plus MF: Rs. 28.5 lakhs.

ULIP: Rs. 23.5 lakhs. About 5 lakhs lesser.

What’s the Point?

That ULIPs are terrible investment vehicles. But you know that.

That there are two kinds of costs: a) stated and b) hidden. Hidden costs are not just shrouded in complexity, they are invisible unless you do the kind of analysis I did above. And who has the time for that?

Needless Complexity

If you’re still here, I consider myself lucky. It’s very boring, complex and unnecessary. Why bother with “guaranteed” loyalty additions? How does an investor know that this gives you a small guarantee but takes away hugely from your return? Why should anyone bother investing in such a policy unless they are excel wizards with too much time on their hands?

If you don’t have the time, invest where the proposition is simple.