“Today there is a major aspirational class in India that wants to invest for growth….According to the Association of Mutual Funds, the assets under management of the mutual fund industry in India in 2014 were around 10 lakh crores. In these eight years, by June 2022, it has increased by 250 percent to 35 lakh crore. That is, people want to invest. They are ready for it”. This is Prime Minister Narendra Modi speaking at the inauguration of the International Bullion Exchange in GIFT City, Gandhinagar on July 29, 2022. These are not words that India has ever seen coming from the political leadership. To the contrary there has been a deep-seated suspicion of markets in general and stock markets in particular. This discomfort with markets has led to decades of sub-optimal investment options for Indians wanting to keep savings ahead of inflation.
In March 2020 we understood risk a little better in both equity and debt mutual funds. Better returns have been one of the reasons that investors released the safety belt of the fixed deposit to ride market-linked returns in both equity and debt. But higher returns and liquidity come with a greater risk. Investors need to be able to evaluate risk better before they fully let go of the low post-tax return FDs or traditional bundled life insurance policies.
There are two ways to take risk into consideration when investing – one through a fee-only financial planner who does the risk analysis for you and chooses the products to build a portfolio that suits your ability to handle the risk. The other way is for you to evaluate the risk and return parameters and build your own portfolio.
Having an easy way to understand risk became reality on 1 January, 2021 when Sebi’s new rules on marking and updating risk in mutual funds became live through a new version of the old risk-o-meter. This risk-o-meter is an upgrade over the previous one in three ways.
One, there are now six categories of risk instead of five. Risk metrics go from low to very high. The last one is a new category to indicate schemes where investors money is exposed to what is extreme risk for a retail investor.
Two, the way that risk itself is calculated now has a proper methodology. Debt funds will be judged on three metrics of liquidity, credit risk and interest rate risk. You can watch this video to understand these risks better. Or read this. And this. The final score will be a mix of the risk of these three attributes.
Equity risk will be mapped on volatility, market cap and impact cost. For example, the risk of a sharp fall in value is higher for a small cap stock than a large cap stock. The new risk-o-meter will take the holdings of such stocks in the portfolio into account.
Three, the risk score will be disclosed by the 10th of each month on the individual fund and AMFI website. Then every year on 31 March, the fund will disclose how many times the risk metric changed over the year. If you find your fund’s risk rating changing often, it will be a red flag to see why this is happening.
I’ll tell you how I will use the risk-o-meter. I want my debt funds to be fully safe – that’s why I moved out of FDs to debt – for higher returns, flexibility along with low risk. I do not want to expose my debt funds to needless risk and will choose the very low and low risk funds only. The risk-o-meter will mark risk clearly in debt funds that take very high risk on buying lower quality bonds or those that have a large liquidity risk (these two are related since bond markets for non-triple A bonds are not very deep in India).
In equity, the risk metrics will be mostly high and very high for most schemes and I will need to do further work to see that the portfolio has slices of large, mid and small cap and foreign funds. I will look at the overall portfolio risk that I carry to see if this is in tune with how I see my own ability to suffer a capital loss.
Just looking at the risk-o-meter will not be enough to judge whether or not you should invest in a scheme, but gives you one more tool to evaluate risk. If you work with a planner, ask her to indicate the portfolio risk basis the risk-o-meter to understand whether the overall portfolio risk metric is in line with what you think it should be.
Sebi has been the most proactive regulator in making disclosures meaningful for investors. Do engage with the risk-o-meter to understand your own schemes and portfolio. The markets are on an happy upward sprint today, but always remember that March 2020 week when your equity lost 30% of its value and six debt funds got frozen. That is the risk that you need to remember when you are investing in a bull market.
Monika Halan writes on household finance, policy and regulation. She tweets at @monikahalan.
The year 2020 was one of fear for our health, jobs and net worth. A small section of the Indian investors – those with the right exposure to equity and with a good blend of bonds and stocks – did well. The rest just looked on from the sidelines and wished they had the mindset to step away from the purchasing-power-depleting fixed deposits and other fixed-return financial products towards equity. Minus another global pandemic or something similar that we cannot blend into our predictions for the year, 2021 is being seen as the year that we recover our lives. But along with this recovery comes big change. We are told that the world has changed forever. That the dollar will lose its crown. That gold and Bitcoin will rule. That the stock market will collapse. It is frightening to hear these doomsday predictions and continue to think about our own financial futures with any confidence. As you hear these aggressive predictions, just do a quick search online to see that almost every year there has been a new reason for the financial world to end. The pandemic is just a larger and all-pervasive global event, but this too will pass.
Along with the Covid vaccine, you need to vaccinate yourself against reacting with fear or greed. While my money advice remains the old boring stuff of asset allocation, diversification and making your investing a matter of habit rather than a one-time decision, we must not bury our heads in the sand and look around for new information as it comes. 2021 will mean different things for different parts of our asset pie.
Fixed income. When central banks ease money supply by lowering the benchmark rate (the rate at which they lend to banks) or when they print money (as some of the hard currency countries are doing), there are fears of inflation and asset bubbles. Inflation is the result of too much money in the system that drives up prices – our rupee buys less and less. With low policy rates reflecting in a saving deposit rate of as low as 2.75% and FD rates of less than 6%. With inflation beginning to gather buoyancy, the post-tax return of the fixed-return investor will be negative. For the fully risk-averse investor in 2021, blending in some gold will be a good idea to build in some hedge against inflation. But do it only through the government sovereign gold bonds. Also remember, investing in corporate bonds that give a few percentage points higher return than bank FDs is actually far risker than having an equity exposure. Also, as an FD investor if you are thinking of unregulated investments including crypto currencies, you should really worry about your financial future.
Equity. Related to the easy money story are asset bubbles. Asset bubbles get formed when there is almost free money being given away by banks and these bubbles form across stock markets, real estate, alternate investments, art, wine – whatever the really wealthy funnel money into as they borrow at almost nothing and look for a quick short-term return. This makes for global headlines about rising and falling values of different asset classes making the average retail investor greedy or fearful. Equity investors in 2021 have just been through the rapids of 2020 and should be geared up for volatility. Having a good mix of broad market index, mid and small cap funds is your best path to getting an equity exposure to your long-term money. Find good funds and then stay with them till the data changes. Steady investors have done much better in 2020 than people who have tried to move in and out of the market. 2021 will be no different.
Real estate. For a decade the developers and brokers have been saying that this will be the year that real estate will revive hoping to draw investors in. But a mix of outright frauds, builder gouging and pure builder greed has taken investor interest out of real estate. An overall tightening of the system against black money too has worked to take the froth off. Real estate even today is a very long-term deal, the flip-and-double-in-a-year days are gone. Invest only if you see yields of at least 4% (annual rent divided by capital value of the property) and that too with cash down and not on a loan. Remember that Indian lending rates are nowhere near zero.
Gold. In times of global distress this metal does very well and so it has over 2020. Keep your exposure to gold between 5% and 10% of your net worth. Use the sovereign gold bonds to invest – you get an annual taxable interest (gold in other forms does not throw off rent, dividend or interest) and at maturity you get a free pass on the capital gains tax on these bonds.
Bitcoin. The case for bitcoin and other crypto currencies is being made keeping in mind the devaluation of the dollar due to the huge flood of money that the Fed has been releasing over the years. The search for a store of value and a hedge against potential inflation is for real – fixed return investors need to think about this. But the answer for such risk-averse investors is surely not an unregulated ‘asset’. Doomsday prophets like to think of a world where they are the wealthy owners of Bitcoin where the rest of the world currencies are fully debased. Such doomsday schemes only work out in movies. This is not to say that none of the Bitcoin investors will make money, but for pure retail investors who hesitate to step even into index funds, this is not where you put your money.
Each year will throw up a new winning asset class. By chasing last year’s winners, don’t wager your financial security. The era of uncertainty is here – steady money is your vaccine.
Monika writes on household finance, policy and regulation.
If you are worried about your equity portfolio, you are not alone. Whether or not to continue SIPs and whether or not to get out of the market would have been the most asked questions in almost every webinar that I have been a part of since end March 2020. The fear is not just about the market crash in March, but also about the possibility of a global recession and the ability of India’s already slowing and now negative growth to recover from this shock. It is a valid fear and unless India is able to get its growth back on track, targeting at least 8%, if not more, the fruits of demography, of a geopolitical advantage today and of servicing a large domestic market will all be frittered away.
Economist and former Reserve Bank of India (RBI) deputy governor Rakesh Mohan wrote in a superb 2019 paper, titled Moving India to a new Growth Trajectory: Need for a Comprehensive Big Push (read it here), that to get to the needed 8-9% GDP growth, other than a push to financial savings, there is a need to “revive animal spirits in the private sector…particularly in internationally competitive manufacturing sector”. He wrote that there seems to be an acceptance of the fact that India has missed the bus in manufacturing but that there are plenty of buses still to board, if we make the needed changes in regulatory structures that impede enterprise, both Indian and foreign, from making investments in manufacturing.
Money with Monika
Season 4 Episode 10
The Corona Conversations
Indian equity and debt mutual fund investors behave differently?
On You Tube:
Many years ago, on a vacation in Singapore, I was surprised to see the number of babies all over town. It looked like a baby boom in the city state. Cute, chubby babies everywhere. You can take the journalist out of the office on a holiday but you cannot take the office out of the journalist. So I dug deeper, asked people we knew, spoke to some locals and found that the government was worried about the falling population numbers and used taxes to solve this problem. The Parenthood Tax Rebate is a tax break given to tax residents to nudge them into making babies.
India’s new finance minister is crowdsourcing ideas for the budget and I want to suggest reworking the capital gains tax structure to nudge Indians into making the right choice in their asset allocation and product choices. The current tax matrix does not follow a first principle approach and is the result of annual tinkering with the rates and rules. There are two parts to this argument. First, the definition of what asset becomes “long-term” is crucial from a financial planning point of view. India has this definition backwards where we call a one-year holding period for equity as long-term, real estate goes long-term at two years and debt profits at three years. Unfortunately, tax policy has been made by people who sat on defined benefit pensions and had no personal understanding of market-linked financial products. They relied on theoretical models and academic versions of what households do. The result is the current mess. Financial planning 101 is that you use bonds and fixed income for either generating current income, for example, for the retired or for short- and medium-term money needs like a down payment of a home in two years or a college fee fund in the next three years. Long-term on this asset class should kick in after one year and not three.
Equity went “long-term” at year one, but this is an asset that is part of the long-term holding of a household and builds wealth. Long-term should kick in on, or after, the seventh year, given the data that a seven-year holding period for a broad market index in equity reduces the risk of volatility. There is a gradual slide down to a zero long-term capital gains status at the end of year seven. Tax equity profits as short-term till the seventh year. Have the rates slide down over the short-term tenure such that rates are high in year one and go down towards zero over the seven-year period. Real estate should go long-term from two years to at least 10 years, the current two-year holding period defies logic. Again use a sliding scale of short-term rates towards a lower long-term capital gains tax. If the policy direction is towards financialization, then tax long-term capital gains from real estate at 10% at the end of 10 years to give the equity culture a boost.
Two, switches within an asset class need to have the same rules. Today the lack of logic in the free switches allowed within asset classes is driving money towards certain products. For example, profits from long-term capital gains in real estate can be invested in certain bonds to go tax-free. Or they can be invested into another property to go untaxed. There is no tax on switching in insurance products. But each time you punish a poorly performing equity fund manager to redeem and buy another better performing fund, or in a debt fund, you have to pay capital gains tax. Use a first principle approach to solve the problem of thinking about switches and then apply to the various asset classes, rather than perpetuate a flawed system.
Back-of-the-envelope calculations say that capital gains revenue is just 3% of the total income tax revenue that’s collected from individual taxpayers. The wonks in the ministry of finance should do some modelling to see what this new system will deliver and what this will do to the financialization of the economy. Just tinkering with tenure and rates will not give the deep foundation needed to take India to a tax-buoyant $5 trillion economy in the next five years.
Monika Halan is consulting editor at Mint and writes on household finance, policy and regulation
The year 2018 taught us that buying last year’s winner is not a good idea. Several years of good returns, a successful ‘mutual funds sahi hai’ campaign and the spread of the SIP culture brought plenty of first-time investors into equity mutual funds. The SIP book grew 50% over calendar year 2017 and another 20% in 2018 despite choppy markets. New investors rushed in and some of them went straight to the winners of 2017—the mid- and small-cap mutual funds. Some of these funds had given returns of over 40% in 2017 inducing investors to throw caution to the winds and rush to the risky part of the equity market. Investors made two errors. One, bought last year’s winner in 2018. Two, allocated all their equity investment to the past winner.
A short video series aimed at a better informed investor
Episode 3: We swear by real estate. But did you know that real estate has costs that we don’t count. And did you know there is a way to find out when to buy and when to sell?
Other links to the same video:
And on Facebook:
A short video series aimed at a better informed investor
Episode 2: Indians love gold. But did you know that equity gives you a better return. Gold is good for diversification but the real lift to the portfolio comes from equity.
Other links to the same video:
Or watch on Facebook:
A short video series aimed at a better informed investor
Episode 1: Stock markets scare people because of the risk of volatility, but there is a lower risk way to get the returns equity can give. Watch!
Other links to the same video:
and on Facebook