Commentary | Portfolio Yoga

Trusting financial Intermediaries

In response to a tweet of mine, Anupam Gupta (b50) tweeted this

@Moneylifers @Prashanth_Krish such huge distrust in the entire financial distribution chain, including MFs? any reason?

— Anupam Gupta (@b50) May 22, 2015

They key question is, should we trust those who claim to work on our behalf while having a business model that goes against that very logic.

Lets start of with the much hated Stock Broker. A stock broker was one who in earlier days allowed persons to buy & sell securities for a small commission. The commissions which were huge in those days steadily has crept downwards with advent of technology and more competitors.

Its general knowledge that its very tough (will not say impossible since there will always be guys who claim to make a living out of it) to make money trading the markets, especially on the intra-day time frame. Yet, almost all big brokers send daily flush of SMS calls asking their clients to Buy ABC, Short ZYX and so on and so forth.

How many brokers have you come across who shall say, well, the way to wealth generation is not by trading but by buying and holding shares of good companies over a long period of time (I kind of disagree with my own statement out here, but I hope you get the point). How many brokers advise you to just do a SIP on Nifty Bees since the probability is high that the returns you generate by doing that is way bigger than what you can achieve on your own.

On the other hand, I come across statements such as, Invest only that money in the markets that you can afford to lose. Its no wonder that people invest a Lakh in stocks and goes out and invests a Crore in Real Estate. Worst case, he knows that the land is his no matter what happens.

For the not so sophisticated investors, there is another way to get into markets – Mutual Funds. But just like most financial products, even this needs to be Sold. So, the mutual fund distributor also becomes a kind of Financial Advisor.

A financial advisor generally makes his money by charging a X% of fees on the total assets he manages. But since most of us would not want to pay from our pocket, the advisor instead advises on funds where he gets the biggest commission. And since tail commissions are low, lets churn the portfolio every time there is a new fund offering. After all, buying at 10 is cheaper than buying a fund with a NAV of 100, Right?

In India, Insurance is not seen as a hedge but as a way to save (Invest). Its no wonder then that most Insurance Advisors (agents really) advise one against buying Term life policies and instead go for Endowment / ULIP plans where the commission paid is much higher. Even after accounting for the risk coverage, the return is so low that is makes zero sense, but hey, I get back my money here seems to be the logic.

And finally we have the Financial Advisors who claim to help you trade / invest in markets for a small monthly / quaterly fee. What I find amazing about these guys is that all of them want you to pay up in advance regardless of the results. Not a single guy says, Here is the way I do business. I advise you on what to Buy / Sell for X months. If you feel the advise is worth it, pay me XX so that I continue for the next Y months, else, no worry.

Nope, every one of them wants you to trust them with your money while not trusting you for one second. Do you really think they work for your benefit?

And finally, Portfolio Management Schemes. I have tweeted on it quite a number of times and every time i look at those numbers, I wonder who would want to invest in a product that under performs all the time. Most PMS model is build upon generating brokerage. If, and that is a big IF, they do end up making some money, they want a cut of it as well.

Almost all models in the financial sphere is out there to get a cut of your savings. There are of course, many honorable guys out there who do business which is worth for both the client and himself. But they are so far and so tiny, that you rarely hear about them, let alone learn more about them.

As the saying goes, “There ain’t no such thing as a free lunch”

We spend our lives trying to save every rupee we can, but what use is it, if we allow ourselves to stumble upon when the it comes to making the money earn for us.

Perils of following Advisors

For nearly a month now, a website that sells Intra-da / Positional tips has been sending at the end of the day, a SMS showcasing that their 1 trade yielded XX, XXX amounts (Always in 5 figures, never less). After sending nearly 20 SMS, the guy changed track and today morning informed me that I was selected for a free 1 day trial (how generous of him).

So, promptly after markets opened I got the SMS for the trade of the day – A buy on PNB at market price. For added affect, I was also informed since their source had confirmed the news (whatever it was), one could take a big position (Bigger the better 🙂 )

A second SMS promptly followed the first – in case I was not interested in buying PNB in cash or futures, I could also buy the 160 CE. While the price he recommended was 7, by the time I looked it up, it was already available at 6.

Before I go further, lets look at the PNB chart (hourly) as was seen at close of yesterday

Chart-wise, it is nowhere bullish, but at the same time was not extremely bearish either. To go long would need some guts since there is no indication of any major move coming.

PNB declared its results during market time and not surprisingly it came in weak (Results). Again, markets reacted to the same slamming down the stock by 6% at close. The call option which was trading at around 6 when he issued the call, closed at 1.75 (a loss of 70%+ of invested capital)

The entire episode could have turned out the other way if instead of a Buy call, he had given a Sell call. But with markets opening very strong, that would have went against the general logic. If the call was a Sell, it would have succeeded beyond his imagination & if I were to be a novice, I would have been attracted to it.

At the same time, I wonder if he sent a Buy call to half the numbers he had and a Sell call to the other half. If he had followed that strategy, his evening today would be busy showcasing the win and pushing the reader to pay for the next tip.

Market Advisory firms are now dime a dozen since the investment to start one is fairly low. But do the people behind it really have the skill-sets to advise is a question that rarely gets answered. Add to that, unlike in say the US, we just do not have ways to independently measure the performance of a analyst using a fixed capital.

As in any other field, there is no Free money out in the markets that allow one to take it out repeatedly without sweating it out. The biggest attraction for trading is that the capital requirement is very low but just as in Forex markets, the consistent winners tend to be negligible in number.

Its no wonder that most advisors ask you to first pay them their monthly fee before they start the services. Why not ask for the payment after the month is over. If the quality of advise is so good, at the very least serious minded traders / investors would love to pay and continue to get their services. The only reason you cannot see such a offer is because the failure rate (both due to wrong calls by the Analyst as well as missing of trades / bad execution by clients) is so high, that barely a few want to continue further.

A fool and his money are soon parted goes the age-old idiom. What is worse than paying for such services is to actually deploy real hard earned money in an attempt to recover one’s cost. Sunk cost fallacy becomes obvious out here.

Timing Mutual Fund Investments

In today’s edition of DNA, Ritesh Jain, CIO of TATA Asset Management Ltd makes a case for investing in Mutual funds since returns from Real Estate going forward are going to be impacted owing to both a excess of supply and changes in government rules with regard to black money (Link). In a way, we agree with his view that forward returns from Real Estate may not be as interesting as it had been in the years gone by (specifically between 2005 – 2010).

But that does mean that investing in Mutual funds at any point of time is the best way forward. While we strongly believe that for most investors who cannot afford time and investment to analyze the markets on their own, the best path is by way of Mutual funds, there still lies the fact that even Mutual funds have big risks.

To buttress my case, lets look at one of the top Equity funds of Tata Mutual Funds – Tata Pure Equity Fund – Growth.

The scheme has been a steady compounder with CAGR returns sinec inception coming in at 20.19%. But that return has not come without some significant volatility. The fund has twice in the last 15 years seen a draw-down that exceeded 50%.

To give you a better picture, assume you invested into the fund in early March 2000 based on the exuberant markets you had heard about and how rather than risk in direct equity, Mutual funds were a better tool. Well, the next time you saw the fund NAV return back to your purchase price was in December 2003.

While I may have chosen the most extreme example, my point is that while Mutual funds are good investments, even there timing matters a lot. Invest in a wrong time (such as the early 2000 or late 2007), and no fund manager can provide you the cushion you so desperately wish.

As I wrote in an earlier post, some of the best performing funds saw big draw-downs in 2008 / 09 and in a way unless one really slept off during the period, the pain of the losses (even though they would be Notional) is too hard to ignore.

The thing called #NetNeutrality

By now I am sure you would have heard and read a lot about the term Net Neutrality and hence I shall not seek to reinvent the wheel so as to say. I myself have been reading voices both in favor and against Net Neutrality as its being understood but rarely have I seen a voice so uniform that the government regulate what kind of services a business can offer for free and offer for a fee.

Net Neutrality in the US pertained to telecom companies offering a higher speed for a few firms that paid them off and the normal or even throttled speed for others. In other words, they said that only if you pay me (the toll booth operator?), I shall allow you this road that has no signals so that you can reach your customers faster. The rest would have to use the normal road and since everyone else shall use the road, this would be slower. This has been seen as wrong and telecom companies out in the US now have to offer the same speed to everyone.

The key point in India is interestingly not about throttling speeds for certain websites which is not happening (supposedly) but about offering for free certain services (Applications) by charging the site operator instead of the end customer. The one making the biggest noise has been Airtel Zero since it was the first to take the initiative and the Facebook promoted internet.org

One of the key concerns among those who are against Airtel Zero and are compelling sites that have signed up with them to withdraw is that by providing certain sites for free, Airtel (and other Telecom operators who are sure to come up with similar plans) shall end up killing the small guy who is unable to pay for the said service and hence may not reach a large portion of users who would not be able to get to their site since they lack the internet connection that they need.

When mobiles were first introduced to India, the call rates were so high that the number of users were those who could afford to not just buy the expensive handset but also pay for the expensive calls (both Incoming and Outgoing). Its only as competition picked up and volumes grew that we now see more people having mobile phones than those having toilets.

While the growth of cell phone in India has been legendary so as to speak, the question here is whether we shall see similar growth in data. Right now, data is expensive (if measured as % of what a general user of telephone pays). While one can have a active phone (for incoming only) with only a Rupee as balance, the same is not possible with data. Also, while more and more people are now getting hooked to smart phones, I doubt if we are seeing the same kind of growth in 3G packages. My guess is that is not happening since 3G packages start for a month at prices close or even more than what many pay for their voice calls.

The way internet penetration (via Mobile) is calculated is by adding anyone who has even mistakenly clicked and went online. If one were to check the major apps and come up with the number of concurrent users and extrapolate them, the number we are looking would be a lot smaller. And even in that, one needs to check how many actually are using 2G / 3G data and how many are using a Wifi connection.

Coming back to the claim that products like Airtel Zero would kill the new competition which would be unable to compete with them, I wonder how many have a clue as to what it takes to survive in this eCommerce world where companies are trying to raise as much cash as possible to ensure that the competition is killed not by quality of service but by ability to burn money for longer than others.

If anyone had read the interview of Taxi for Sure founder, he can recall that the promoters were forced to sell as they were “running out of cash” even as Ola which would have been incurring a similar if not higher cash burn was able to sustain by raising more capital. Anyone today who fancies to start a taxi aggregator better have deep pockets with the ability to go deeper.

In terms of the general eCommerce companies, giving a fight to Flipkart / Snapdeal or Amazon is no child’s play. While there are nearly a dozen other sites that sell Books, how many have one even bothered to visit, forget about purchasing the same in recent times.

Good friend Deepak Shenoy had a wonderful write up on how Telecom companies were not losing money. The write was one of excellent data analysis. But then again, while he used the example of Airtel and Idea, he omitted companies like RCom, TTML and MTNL (all listed with financials available) who are literally bleeding to death. BSNL, the other biggie is also on the path of obscurity.

To me, Telecom companies are not utility companies in the sense that they get to have a fixed rate of return. The winners are ones who provide better services than the competition. The reason Airtel is able to generate a good ROE has more to do with its ability to please customers. Displease them and a competitor will be happy to have them port out to them.

Nowhere in business is there a equal field for everyone. The success of Big Bazaar / Brand Factory / Reliance Fresh was in affect more due to the deep pockets of their owners than any other advantage. For them, the biggest risk they see is not the corner grocery store owner still in business but the likes of sites which having raised Billions can undercut any other store as long as they care to.

The number of people who are online in India is a very minuscule part and unless one thinks that the government should provide internet for free, things like Airtel Zero are the only way to bring them to the super highway. Once exposed, the addiction will have them move to other sites rather than just stick with what is offered.

Yes, Airtel Zero has its faults, especially when it comes to things like Hike, but that said does it make sense to deprive a large part of population from the ability to traverse even the little bit for free?

The War in my opinion has to be against telecom companies offering a fast lane and a slow lane. All lanes should have equal speed regardless of whether there is a conflict of interest or not. But if they want to provide a service road for free, who am I to say that they should not offer the same.

In the world of stock broking where I have been for the last 18 years, the brokerage has been on a steady fall not due to government intervention but due to competition. We have witnessed the same in Telecom as well and the way forward is to ensure that the government enables this to remain a competitive field rather than have it restricted to the benefit of the few.

Building for Rent

Recently I was at a housewarming ceremony of a friend of mine. The said friend of mine had been holding the plot for sometime now and decided that the best way forward was to build a few houses and let it out for rent. This he said gave him the best possible return for his money compared to investing in a fixed deposit or stocks with his assets providing him a regular income which keeps raising year on year.

While in theory, that sounded perfectly fine, I wondered (as I do when people make statements with too many assumptions and without any data to back them up) as to whether that is really true.

The cost of construction came to 7 Million and the friend of mine was anticipating a rent of around 40,000 per month which comes to a rental yield of around 6.85% (pre-tax) on his investment excluding the amount that was spent on acquiring the said site. This seems like a very good number indeed, but how would this compare to investing the same amount of money in the market.

While I come across persons who are happy to invest big money onto properties at one go (after all, you cannot acquire a plot by way of Investing Systematically month on month, can you 🙂 ), when it comes to the market, they find themselves scared enough to risk only a small amount, something even if invested in a very good stock can become meaningless over time.

While its true that risk in markets are high, the same is the case for any other investment save for investing in a fixed deposit. But then again, with fixed deposits not even beating inflation, its not exactly a wealth generator, especially for the younger generation who are and should take more risks in an attempt to build a better nest egg.

First off, here is the matrix of Capital growth using only Rent (which rises 5% year on year). Tax has been assumed to be 15% . While there will be other costs (Taxes, Repairs, Broker Fee, etc), all those have been excluded to make the assumptions simple. Also I have added Interest (on previous years Rent + Accured) at 6% p.a All in all, the end amount is the minimum (not the maximum) one will definitely be able to save / gain from the house.

Our final number comes to a impressive 12.20 Million at the end of 15 years. Definitely not a number to be scoffed at though if we were to apply a higher tax percentage, it can drop quite a bit. If tax percentage is 25%, the final number comes to just above the 10 Million mark.

Now, lets move to the other way of investing those funds – the stock market.

Theoretically there are two ways – One invest in a few bluechip stocks and hold on to them or to invest in a set of mutual funds and hope they either meet or beat the market indices. And then there is the third way, investing into a Exchange traded fund that tracks the Primary Index – in our case Nifty or the Sensex.

Direct investing in stocks can be pretty risky or a pretty awesome move with the final result being dependent on what we bought in the first place. Blue chip companies of the 1970 & 1980’s are not the blue chip companies of today (though a few do remain). Also, its generally scary to plough all the life savings into a few stocks and hope they shall click, and click big.

While its more simple in the world of Mutual funds, even there the risk remains that the fund you chose may actually turn out to be a bad choice. In 1996, you could have invested in funds like Kothari Templeton Prima / Prima Plus as also invested into funds like CRB Mutual Fund. Its only in hindsight that we know which fund delivered and which did not.

While its true that some mutual funds have delivered better results than the Sensex, I doubt if any one can tell the fund that shall BEAT market returns over the next 15 years. The easier option is to just invest into the ETF’s that track the Index and hope that the India growth story shall ensure that we garner a substantial return over time.

If I was looking at a investment period of 15 years (same as the Rent accumulation), what would be the returns provided by the ETF?

To get a answer, lets look at the historical CAGR returns that Sensex has generated over the last 15 years.

The average CAGR return over 15 years has been 14.52% with a maximum of 21.43% and a minimum of 7.31% (the 7.31% being the returns one would have got if one got in Dec 1993 and exited in Dec 2008.

If we were to assume, a CAGR growth of 12%, what would our investment today of 7 Million look like 15 years from now?

If 12 Million was awesome, how about 38 Million 🙂

But, there is a caveat you would say. While it cost 7 Million to build a house today, it would cost a lot more after 15 years and that is a true question indeed. Hence lets look at what would be the cost of construction assuming that construction prices keep moving higher. Assuming that construction costs move by around 6% per Annum, here is the table on what it may cost 15 years from now

A house that costs 7 Million to construct may cost 16 Million 15 years from now. But even accounting for that, the gap between the returns of the Sensex and Rental Income comes to around 28 Million, definitely not small change.

While one may argue that market returns are not smooth, one also needs to understand the various hassles that come with renting a property. And the above returns assume that one had the property for rent for the whole 15 years. What if one did not find a suitable tenant for a few years? How much of a impact it will have on final returns?

While FAR ratio in Indian Cities are pretty low, its bound to go up in the future. Mumbai is already working on a plan where FAR ratio may be anywhere between 0.5 to 8. The FAR ratio for properties around Metro is being increased in cities such as Bangalore and Pune and this additional supply can and would lead to softening of rental returns as we move into the suburbs.

While there can be no Apples to Apples comparison, above analysis does seem to suggest that building a house to rent it out is not exactly the best way to create wealth for ourselves and our future generation.

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