Every time people who have defined benefit retirement plans make rules for the market, their lack of understanding comes across clearly. Take people in the Ministry of Finance for instance, and then look at what subsequent Budgets have put in place. Not only is there arbitrage between asset classes on the definition of long term, there is arbitrage within an asset class too on the basis of which product you choose to buy. If tax policy is used to nudge behaviour, there is some serious malfunction in the Indian policy that is nudging in all the wrong directions and all the wrong products.
In India we answer the question, ‘How many years does it take for an asset to become long-term?’ in different ways depending on the asset. You have to hold equity for 1 year, real estate for 2 years and debt for 3 years for the profit made to become ‘long term’. This classification of assets is against Finance 101, since both equity and real estate are asset classes that cook slowly over time. They give their best performance over a long period of time. How long is long? Data analysis done by my colleague Kayezad E. Adajania (read it here) shows that it takes about a 7-year holding period to iron out volatility in equity. The thumb rule for real estate puts the cycle at about 10 years. Market-linked debt (as opposed to relatively fixed-return debt products such as bank deposits) as an asset class for retail investors is mostly used for short-term purposes for emergency funds, for near-term cash needs and for income generation. It would be more logical to make debt go long term at 1 year and keep a 5-year threshold for long term for both equity and real estate. At the very least, policymakers need to equalize the definition of long term across asset classes.
Are Indian stocks in bubble territory? An interview given by Uday Kotak to The Indian Express (you can read it here) asks this question. Kotak is making valid points when he says that there is a wall of money coming at the market which does not have enough stocks to absorb the cash. A strong institutional flow is bringing Indian household money to the stock market through mutual funds, unit-linked insurance plans (Ulips), National Pension System (NPS) and the Employees’ Provident Fund Organisation (EPFO). This money is going into a few hundred stocks because the Indian market lacks depth. The market cap of the top stock is Rs6 trillion and that of the 100th stock is just Rs32,000 crore. The market looks overvalued on metrics of the current price-to-earnings (PE) ratio, which is much higher than the 10-year average. Valuations can go back down in two ways—markets can crash, bringing prices down or the earnings can grow; both bring the PE down. The wait for earnings has kept the market buoyant in the past few years and the wait is still on. Which will come first, the market crash or the earnings bump? As retail investors, we have no option but to give our money an equity exposure; see Table 1. But we will never have the relevant insight to time the market. We also know that markets go up and down, get overvalued, crash and then recover. See Table 2. So, is there a way in which we can ride out the bubble, if indeed there is one?
Regulations in the financial sector need to keep evolving as the market grows in depth, breadth and complexity. Think of this as the need for road rules and a traffic management system in a large metro—what worked 30 years ago cannot work today. It was possible to travel 5 km in Delhi without running into traffic lights or traffic cops 30 years ago as road traffic was thin. A malfunctioning traffic light today causes hours of traffic jams. As the traffic volume rises, cities resort to one-way traffic rules, higher parking fees and other measures to curb traffic in the city centre. Financial markets are similar; regulations need to keep moving to keep pace with the changing face of the market. Has the market changed? Yes, the size of the assets under management by the three large parts of the retail financial market—mutual funds (only retail), life insurance and the National Pension System (NPS)—crossed Rs34 trillion in FY 2017, up from Rs22 trillion just 3 years ago. Both the volume of money and the number of people on-boarding these products has risen sharply over the past few years. The share of household savings in financial products has been rising and now more than one-third of household savings find their way into financial products. In addition to the urban users of these products, a new category of investors are getting added through the Jan Dhan accounts. These are people who will be first-time users of many financial products as they move from cash, gold and real estate.
ICICI Prudential Mutual Fund’s new fund offer (NFO) of Bharat 22 exchange traded fund (ETF) is in the market this week seeking investor money for the government’s disinvestment programme. Looking through the document, I was struck with the expense ratio of this fund. At 0.0095% per year, this is the cheapest ETF in the market today. Understand what this cost means first. The expense ratio describes the price you pay for the facility of handing your money over to a fund manager and it is charged on your funds under management. For example, a Rs10 lakh corpus, with an expense ratio of 1%, will cost you Rs10,000 a year. You don’t have to cut a cheque for this cost since it is taken by the fund house out of your corpus—that’s why it is called net asset value, it is ‘net’ of costs. Expense ratios have a big impact on investor returns over a lifetime of investing. At 0.0095%, Bharat 22 will cost you Rs95 a year. Reliance AMC’s CPSE ETF (the first government disinvestment fund) costs 0.07% or Rs700 a year. A 2% managed fund expense ratio costs you Rs20,000 a year.
At the 4th edition of the annual Mint Mutual Fund Conclave last week, the overarching theme was the question: should FY 2018 be called the year of the mutual fund? For an industry that just two years back was still calling itself ‘nascent’ 24 years after privatisation, it is a giant leap forward to have assets under management that have tripled in the last five years. Mutual fund assets are now one-fifth of bank deposits and almost two-thirds of the assets under management by the life insurance industry. G. Mahalingam, whole-time member of the Securities and Exchange Board of India (Sebi), in his keynote address, said that possibly the external factors that helped this growth, such as easy money policy overseas for the last few years and more recently, demonetisation, are coming to an end, and now the real mettle of the industry will be tested. He said that several regulatory measures that are coming in the days ahead will ensure that the industry is investor-friendly. One, the scheme merger announcement will be made soon by Sebi. Two, the work on the total expense ratio (TER) going down must begin. Third, investor-friendly disclosure measures such as using the total return index should be taken. “Good times are the best times to swallow bitter medicine,” he said.
I don’t think there will be many people in urban India who do not have a bank mis-selling story to share. The systemic use of bank branches to mis-sell life insurance products and to churn mutual fund portfolios is now part of the urban Indian discourse. The problem is not new. I remember first raising the issue of banks mis-selling insurance and mutual fund products in 2007 with one deputy governor of the Reserve Bank of India (RBI). I was treated to lunch and anecdotes from those in the room of how people close to them were ripped off by banks. In fact, subsequently, in every committee I served on—Swarup Committee 2009 (bit.ly/2tLat6F) and Bose Committee 2015 (bit.ly/2rS3xmK)—the offline conversations included stories of bank branches turning into dens of tricks and traps. I’ve raised the issue of mis-selling with RBI, and with the ministry of finance, and so have others who work in this space, most notably Moneylife magazine (bit.ly/2t7r5HJ and bit.ly/2sHtN6b), which has raised it on multiple occasions. But the messaging that came down from the towers of oblivion on Mint Street was always the same: not our problem; let the sector regulators deal with this.
As a kid I remember getting irritated whenever the old people would get together. Now they’ll start talking about how expensive everything is, I used to mutter. Back in those days, kids couldn’t utter aloud all the insidious little comments that were swimming around in their heads when adults were around. “Arrey, on a salary of twenty rupees you could run the house and then have something left over? That shawl mamijee wears, no? That cost a full five rupees. Now toh, you can’t buy it for five thousand only.” Everybody shakes their heads. “Tch tch. Zamana hi kharab hai (these are bad times).” As a kid I remember buying sweets for 5 paise and bus tickets cost 25 paise (and I’m on my way to irritating the life out of kids in the family). My daughter has never seen coins below one rupee. Her daughter will probably say the same for fifty bucks. The fall in purchasing power is the reason that we worry about meeting our expenses when we retire.