As an investor in a multi-cap fund, you could be feeling really confused about the uproar caused by the 11 September 2020 Sebi circular on making these funds more ‘true-to-label’. What happened is this: the circular changed the earlier rule of allowing a multi-cap fund to invest across market caps as they liked and has put in minimum limits across market caps. A multi-cap fund, from February 2021, must have a minimum of 25% in large-caps (defined as the first 100 stocks by market cap), 25% in mid-caps (101st to 250th stock by market cap) and 25% in small-caps (251st stock onwards). The rest of the 25% can be invested in any of the above three categories, technically allowing a 50% large-cap exposure in a multi-cap fund. You can read the circular here.
The upset is because multi-cap funds will now be forced to invest into the small-cap market, reducing the elbow room available with the funds to manage as they liked. There are three things that you as an investor need to consider before you get caught up in the hysterical outpouring seen last week about this circular. One, financial products are invisible. It is in their description they are created in the minds of investors. Therefore, product labels are very important in an industry that manufactures and sells products that are invisible and whose moment of truth is not immediate, but far in the future. The moment of truth of another invisible service like a mobile data plan is at once. A physical product like a plate of sushi is also immediate. But an equity-linked investment will by its very nature have its moment of truth in the future. Put these two things together and you need mutual fund labels to describe correctly what the investor is buying. Calling a credit risk fund, a credit opportunity fund is a sleight of hand to make risk sound like an opportunity. It has taken a lot of internal push to get the industry to agree to call a ‘risk’ a ‘risk’ and not an ‘opportunity’.
Bundled insurance plans neither give you a good life cover nor a good return and in India these are built like traps. In this episode of the special series of Money with Monika, personal finance expert Monika Halan explains why one should stop buying bundled life insurance plans in India and how it destroys one’s savings. Watch the full video for more.
You are doing great harm to your financial well-being if you continue to fall into the trap laid down by life insurance companies, their agents and now the shareholders of these companies, under the benevolent gaze of the insurance regulator. How many of us are still buying these traps? In financial year 2018-19 (that is the latest data available), individuals bought almost 30 million new life insurance policies, pumping almost ₹1 trillion of household savings into them.
Which policies are the most harmful? Traditional plans that include with-profit money-back, whole-life, endowment policies and guaranteed plans are the worst. These make up 85% of the entire market. Ulips are not traps and are much better products but don’t do well on disclosures and flexibility as compared to mutual funds. Term cover, the best kind of life insurance that you must have, are hardly sold. They are largely self-bought as smart people figure out what to buy. They buy online, cutting out the agent.
The crucial lines between an adviser and an agent have finally been clearly drawn in the Indian capital market. This is as crucial as drawing a distinction between a doctor and a chemist. The process that the capital market regulator began in 2013 ended in July 2020 with the Securities and Exchange Board of India (Sebi) notifying the registered investment adviser (RIA) amendments that have gone through years of debate, consultation papers and introspection. Sebi began by asking a question to the mutual fund intermediary: who are you? Are you an agent of the mutual fund or are you an adviser to the investor? The answer to this will determine in whose interest you work. The agent gets his compensation from the mutual fund in the form of a trail commission (Sebi banned front commissions in 2009) and the adviser is compensated by the investor through a fee. You can read the way the debate moved over the years here.
The retail investors in India lurch from crisis to crisis, made worse by the pandemic. The reason that the same problem recurs has to do with broken market places and redress system than anything to do with investors behaving ‘wrongly’.
Indian investors periodically hit the headlines when there is a large blow-up of some product or market. We’ve seen recently a cooperative bank failure. Then a private scheduled commercial bank (those that usually are not allowed to fail) saw its operations and deposits frozen for a few days. Even as the depositors in Yes Bank got their money back, the investors in its AT1 bonds saw their money disappear. These high-risk bonds were mis-sold by Yes Bank managers as FDs to senior citizens among other low-risk investors. Debt mutual fund investors have seen money they thought safe being exposed to excessive risk as fund managers cut deals with promotors, introducing the risk of equity in debt funds. A series of bond downgrades have left retail investors booking large losses over the past year. The latest has been the Franklin Templeton story that saw a liquidity problem become the cause for shutting down six schemes. The matter is now sub-judice since one HNI got a stay. These are the stories that come into the public eye, but there are plenty others that don’t make news simply because the investor is not an HNI or does not belong to a strong group such as a broker lobby.
The success of the Bharat Bond issue where PSU bonds were sold through an exchange-traded fund (ETFs are mutual funds that mimic an index and list on the stock exchange) and the use of ETFs earlier for equity disinvestment of public sector firms has rung alarm bells in the plush offices of the life insurance industry. To see how they are connected, we will have to use a wide-angle lens and watch from 30,000 feet. The story is about who gets to be the pipe that connects savings to investments, and shaves off a few basis points to a few percentage points of costs, as it does so. Households and firms generate savings, which becomes the raw material for firms for their investments, that they use to start a new business or expand an existing one. Firms will either borrow or sell their equity to get the funds. Banks, insurance firms, mutual funds and pension funds are the pipes that connect savers to users (both borrowers and equity sellers).
Policymakers have long bemoaned the “non-optimal” Indian household that holds “unproductive” gold and land rather than financial assets. The same policymakers have sat on defined-benefit pension plans, medical treatment for life, other perks and have had very little idea about markets, how they work and how ordinary people deal with on-ground issues. They also forget to look at supply-side market failure before blaming the household. That household whose rupee finally makes the whole story hold together through taxes, consumption and savings. But very little work goes into working through why a household behaves the way it does when it makes its investing choices and even when there is work, it is ignored and not implemented.
The average drawing room conversation on the government encroaching on the independence of the RBI tut-tuts over the good guys at the Reserve Bank of India (RBI) getting stamped on by a bully government. Now, the resignation of Urjit Patel has added fuel to the views fire. But I wonder if the conversation would change if the same groups realized what this ‘independence’ or its obverse, the lack of accountability, means to their money. Last week, the RBI announced that new floating rate home loans from banks would be benchmarked to a rate not controlled by banks from April 1 2019. Anybody who has taken a floating rate loan in India knows that as the interest rate cycle goes up, loan rates mostly go up very quickly, but the opposite does not happen. This is not a new problem. I remember flagging the issue more than 15 years ago. It is not as if the RBI has not been aware of the problem of benchmark fixing by banks to cheat retail home loan borrowers. RBI has changed the way the rate is calculated four times in the past 24 years to make it difficult for banks to fix the rate—starting with the Prime Lending Rate (PLR) in 1994 to the Marginal Cost of Funds lending Rate (MCLR) in 2016. But in each case the power to calculate and fix the rate remained with the banks. A power they have mis-used freely at your expense. An internal RBI committee found that banks fixed rates at will.
If in the 1950s somebody wrote a future finance story about India, they may not have predicted the market that faces a retail consumer today. Till the 1990s, your savings and investing decisions were dependent on the government. No wonder Indian households chose gold and real estate as saving sumps. The financial sector was a reflection of the overall direction of the economy. Costs were high, service poor in state-owned and run finance. But post 1991, change came suddenly to finance and this column maps some of those changes as India celebrates 70 years of political and 26 years of economic freedom.