Common Sense Is Uncommon

Agency Theory in Action

2011-07-26T17:09:00.000+05:30

Airtel recently announced a hike of 20% in its tariff, which was taken quite positively by the investors – Airtel’s stocks reached a 22-month high yesterday. But I am sure the customers won’t be happy by this decision. The investors are thinking that this 20% increase in tariff would translate into better profits, and hence increase the valuation of the company. This in turn would lead to stock price appreciation, and would be kind of an inversion point in the attractiveness of the Telecom sector as a whole, which had taken a beating earlier.

What the analysts and investors have failed to factor in is how this move would be taken by the customers. Their theory is based on the fact that other players would follow suit and increase their respective tariffs. They believe that after all the bloodshed in this sector due to price wars, the players are finally back to their senses - their priority has changed from increasing the customer base to increasing the profit margins.

But why would a customer want to shell out the extra money in the present scenario is one question that the leaders at Airtel have forgotten to factor in. With the inflation never seeming to bow down – and the RBI and the inflationary pressure having resorted to going at war with each other in order to soothe their egos – why would an existing customer of Airtel want to shell out even a paisa more for the existing service? I don’t see any marked improvement in their services – now that they have even started charging for calling the famous customer toll free number -121. , as a customer, don’t see the value proposition of paying 20% more, with the MNP (Mobile Number Portability) in place. Thinking on tangential lines, I see this price rise as a measure to serve the enormous loans that Airtel has taken for acquiring the 3G license. The financial planners at Airtel would have been asked how to break even early - and the outcome is the rise in the tariff rates. It would have been more justified if Airtel would have passed on these costs to the 3G customers.

Well, what I see from my side is that this is a temporary rise in stock price witnessed by Airtel. As the customers start switching to other players - those who can’t afford to raise their tariff rates and still have their focus on acquiring customer base- this strategy of Airtel is not going to work. Also, one must remember that Vodafone was the biggest beneficiary of the MNP. This makes me conclude that customers see more value proposition in Vodafone than Airtel. Vodafone will take over Airtel as the No 1 player. Just because Airtel is the No 1 player as of now doesn’t mean that the whole industry is going to follow suit. Remember, Tata Docomo was the first player to introduce 1 paise per minute, which compelled the other players, large or small, to follow suit. . I believe Airtel should start counting its days now, as it has dug up its own grave. Is this an example of one of the cases of classical Agency Theory? Only time can tell….

India's White Elephant

2011-07-19T16:19:00.000+05:30

Air India has been enjoying the limelight almost on a daily basis with all the leading newspapers in India. But it is getting popularity for all the wrong reasons. According to sources, Air India has a cumulative loss and a massive debt burden collectively totaling upto 67000 crores!! Well, seriously, I don't even want to know how many zeroes are there in this figure. But one thing that I know is that it is roughly 1% of India's 1.3 trillion USD GDP. People do joke that the airline makes less losses on a day it is not functioning (due to strikes etc) than when it is operational!!

Jokes apart, I believe that the culture at Air India is still similar to that of the bygone days babus regime where the employees did not pay any heed to what is going on around them - the typical mentality of a PSU back in those days. There seems to be no accountability at Air India, and absence of skilled employees and/or presence of red tapism could be the reasons why the losses of Air India are always headed North. I believe Lalu Prasad Yadav should be made the Aviation minister, based on the fact that he was the only Railways minister under whose regime Indian Railways posted profits ever.

Why does the Government always have to infuse equity capital into Air India, when it knows that the equity gets eroded as soon as it is infused!! Why not declare Air India a sick company, like it has been doing with many others and divest its stakes. Let the Government hold the majority stake and invite the private players to take a minority stake - which could possibly lead to Air India's turn around. Imagine where would have the Air India been had it not been taken over from J.R.D Tata in 1940s. It would probably have been the most profitable air line by now!!

I strongly believe that the Government should manage the various ministries just like a corporate, with the payout of the minister dependent on the performance of the ministry. It is the only sustainable way going forward to get in more accountability into these portfolios.

Air India should set a target for itself to make it comparable to the Navratnas, where people from all walks of life want to go and be a part of. It should try hiring good people from the corporate world and from good B schools and devise a turn around strategy. Hoping to see Air India in green soon.

Rendezvous with PM's Cabinet

2011-07-13T13:32:00.000+05:30

July 12,2011 would be marked as a red letter day in the history of PM Cabinet reshuffle in India. The Govt and our respected PM wanted to undertake this reshuffle to counter the tarred image of the Govt due to numerous scams that have been unearthed recently by the likes of CAG as well as other respected Govt agencies(at least they still have an ethical piece alive in their soul). It was also a day for our PM to prove that he is not a puppet in the hand of the ruling party chief.

After the reshuffle, the only thing that comes to my mind is "What a Waste"! The purpose of this reshuffle was lost perhaps in the various meetings that the NDA Govt had with its allies, threatening to withdraw their support if they weren't given representation in the Cabinet. Well, thankfully the DMK didn't have much muscle power this time to ask the Congress to include some of its highly corrupt party members to be included in the Cabinet, after Karunanidhi suffered from a triple whammy - A. Raja, Dayanidhi Maran and Kanimozhi. The Cabinet seems to be greatly inspired from Einstein's Mass Energy equivalence (E = mc^2) and has adapted it in a different context. The portfolio of a minster can get changed from one form to another, making the total number of ministers almost a constant.

The people of India are dying to see younger people in the cabinet, when today the average age of Cabinet is equal to almost 64 years. The cabinet needs relatively younger people who are dynamic, open to newer ideas and much more flexible. This kind of a change would surely be taken positively by the foreign investors, thereby increasing the confidence of the FII and FDI investors in the Indian economy - a much needed thing at this point of time when the foreign investors are shying away from investing in India due to the untamed inflation.

Last but not the least, Mr. Jairam Ramesh, who earlier held the Environment Ministry, has now been "promoted" to Rural Development. I really don't know how much of a good news it is for the Indian environment. He is the leader who changed the perception of the environment ministry from a rubber stamp to something more serious in nature. I believe he did so well because his heart was into the cause of saving the depleting Environment, and he didn't treat it as just another portfolio. But alas! It seems the lobbying of the MNCs and industrialists - whose projects have been stalled due to clearance issues from the Ministry - has finally worked.

Now, it is upto Jayanthi Natarajan, the new MoS for Environment, to either uphold the standards set by his predecessor Mr. Jairam Ramesh or succumb to the pressures of the big MNCs and industrialists.

Why everything seems topsy turvy?

2011-05-15T13:11:00.000+05:30

Are you one of those persons whose forehead shows creases after reading everyday’s newspaper, who start readjusting their monthly budget plans on a weekly basis or who think money is never sufficient? The root question of all the other questions that flash across your mind remains the same – “What’s wrong with the Government”.

It would be wrong to say that this Government has been the perpetrator of maximum number of scams. I look at it the other way. The Indian Media community has greatly evolved through these years. The media persons seem to me like members of one of those secret societies – similar to Illuminati or any other secret society name you might come across in any novel – who behave like they are omni-present and omni-potent. They are a pain in all the possible points of the corrupt politicians and Govt officials.
The RBI is on a different freaky path. Its actions seem to have defied all common sense. It’s difficult to imagine how it would be able to control the food inflation through increase in lending rates. I think it’s trying to create a new economic theory/law of its own, and we are the subjects of experiments – our fate no less than the rats used for scientific experiments. Whether the price of essential food commodities is Rs 20 per kilo or Rs 50 per kilo, I wouldn’t stop buying it. They are totally price insensitive. The only effects that the increase in interest rates are having on our day to day life is increasing the loan EMIs, decrease in demand of house loans (the car sales have increased month-on-month – can RBI solve this anomaly) and giving more incentives to the common man to invest in fixed income securities.
The petrol prices- another pain point for the common man. The petrol prices are also highly price insensitive. The people would wine about the increased petrol prices and the opposition would take out rallies to show their disapproval for these unfavourable measures against the aam aadmi . After the end of 2 days or less, life moves on. People won’t start walking to their offices just because of the fact that petrol prices have increased! On second thought, this could be a good way to protest against the rising fuel prices.
The fuel prices have been deregulated just on papers. The crude oil had risen like anything in the past few months, but the fuel prices were not increased. This is because GOI is the major stakeholder in all these Oil Marketing Companies, and without its consent nothing can happen! It actually seems to be a part of the political gimmicks wherein the State didn’t allowed the increase in fuel prices just as a goodwill measure until the elections got over. But even this didn’t fool the common people, who turned out in huge, unimaginable numbers in the State elections to show their disapproval against the Govt.
The considerable huge BPL people of the world’s largest democracy are dying out of starvation and are malnutritioned, while the food grains keep on rotting in the food warehouses of the Central Govt. Well, the blame game is already on, with the Supreme Court blaming the Central Govt, which in turn is blaming the State Govts for picking up only 40% quantity of food grain approved for releasing. Needless to say, the State Govts as well as the Central Govt need to build State of the Art food warehouses in this country, so that any living person in this country is not deprived of the basic needs.

These inefficiencies of the Govt are very evidently visible:

The rising cost expenses are putting pressure on the corporate performance, as the cost of funds keep on rising.
The FIIs are pulling out of the Indian stock market on concerns of uncontrolled inflation.
The honourable PM seems to be just a puppet in the hands of the ruling party, who even doesn’t have the power to properly choose the Cabinet himself.
We, the people, have to bear with the chosen Govt for a period of 5 years, before being able to change the Govt.

The only ray of hope that I see at this point of time is Anna Hazare who has started the movement to make the Govt accountable. Also, I am eagerly waiting for the UID to be implemented throughout the country. Both these initiatives should be able to plug off the paths through which the hard earned money of the public is leaking, bring transparency and accountability on part of the Govt and empower the people of India.

Money - A Friend in Need is a Friend Indeed (Part 2)

2010-12-22T22:25:00.002+05:30

Okay.. It’s that time of the year when all salaried people rush to invest the money in order to save them from the Axe of Tax. In my earlier post, I tried to provide some pointers regarding investing in stock markets indirectly through Mutual Fund. One thing that I forgot to mention over there was that a person should ideally go with SIP as far as possible, so as to reap maximum benefits. Many people keep on waiting and analyzing as to when the NAV of any fund would reach low levels, so that they could invest the entire amount at that time in order to reap maximum benefits. However, they forget that if the market would have been that predictable, then there wouldn't have been any tension in life.. right.

Why do I need Insurance?

Let's now turn our attention to the second most sought after investment instrument - Insurance. First of all, let me clarify that insurance should not be treated as an investment instrument, as it defeats the very purpose of its existence. One needs insurance in order to protect his/her family in case the bread-earner dies, so that the regular family expenses are met, and the liabilities in form of loans etc could be easily taken care of.

How much Insurance do I need?

The next obvious question that comes to our mind is how much insurance is enough for us. This is a kind of grey area that doesn't has any specific answer to it, because of the involvement of time factor. All the agents try to give you various perspectives on the insurance cover, and boom.. there comes the terms coined by the industry:

1. Human Life Value (HLV)

2. Underwriter's Thumb Rule

3. Income Rule

4. Income plus Expenses Rule

5. Capital Fund Rule

6. Family Needs Approach

Okay, please don't ask me about what all these things mean. If you want to get confused, please bug your agents and ask them to explain these concepts. All of them are quite fancy in nature. The purpose of my listing down so many approaches, to find out your insurance cover, is just to point out how much ambiguity is there for finding out the Sum Assured.

My Way

I believe that it's a very simple task. Just add on the transaction values for following Life Events:

1. Car Loan

2. Education Loan for Higher Education for self

3. Home Loan

4. Any other Personal Loans/Liabilities

5. Amount for Healthcare

6. Child's Education

7. Child's Marriage

8. Inflation adjusted monthly household expenses of your dependents

Which Type of Insurance Policy Should I Buy?

There is a lot of debate on this issue. I would like to dwell on two basic kinds of traditional policies available with the life insurers:

1. Term Insurance: You need to pay a yearly premium for specified number of years, and upon your death the nominees would be given the Sum Assured. In case you are hale and hearty after the policy expires, you won't get anything in the end.

2. Endowment Policy: You need to pay a yearly premium for specified number of years, and either upon your death or the expiration of the policy (whichever is earlier), a lump sum amount is paid to the nominees or the insured person respectively.

For the same value of Sum Assured, you need to pay significantly more amount of installment for Endowment Policy compared to Term Insurance. Hence, there is a classical debate on which type of policy is good.

My Verdict

It is generally advised by Financial Planners to go for a combination of PPF and Term Insurance, instead of going for Endowment Policy, as the returns offered in the former case is much more than the later. I believe that in order to fully secure the future of our family, we should go for a combination of PPF, Term Insurance and Equity Linked Financial Instrument (let's say, Mutual Fund). I have taken help of the following assumptions/ facts for my analysis:

1. The Sum Assured in the case of Term policy as well as Endowment Plan is 50 lacs.

2. The premium has been calculated for 20 years policy period; I have chosen Amulya Jeevan and Jeevan Anand policies of LIC for term and endowment policies respectively.

3. The rate of interest on PPF is taken as 9% p.a

4. The rate of interest on the Mutual Fund is taken as 10% p.a, considering the fact that the annualized rate of return of Benchmark Indices has been 15% for the last 5 years.

5. The max amount that can be invested in PPF is 70,000 p.a

The premium for Jeevan Anand (267,133) is almost 12 times that of Amulya Jeevan (12,350).

In Scenario 1, suppose a person invests Rs 70,000 p.a in PPF and pays the premium for term insurance on yearly basis. In case the person dies after 20 years, the amount that nominee receives is 5.4 times the total investment. In case the person is alive, the person gets 2.4 times the total investment.

In Scenario 2, suppose a person invests into an endowment plan which offers the same insurance cover. Assuming that the person receives Rs 57 per thousand of sum insured, the total amount payable upon maturity after 20 years is only 2 times the total investment.

In Scenario 3, an assumption is made that a person has the capability to invest Rs 267,133 p.a (similar to the premium of the endowment plan). Here, the person invests Rs70, 000 in PPF, Rs12, 350 in term insurance and the rest in a Mutual Fund giving modest annualized returns of 10% p.a. In this case, if a person dies after 20 years, the nominees get an amount equal to 3.85 times the investment; else, in case the person is alive, the person gets 2.91 times the investment amount.

For more detailed calculations, please refer to the Insurance WorkSheet .

Conclusion

The major investments of an individual should be done in the following 3 instruments (in no particular order of preference):

1. Term Insurance

2. PPF

3. Mutual Fund

In case a person is alive, the last 2 instruments would take care of the person and his/her family. In case of a misfortune that results in the death of the person, the 1st and 3rd instrument would take care of the person's family. In my next article, I would throw light on the remaining instruments – Health Insurance, Infrastructure Bonds and ~~ULIPs~~. Happy Investing J

Can Money Buy Everything !!

2010-12-08T16:42:00.000+05:30

There was a famous Mastercard Campaign that had been running for quite a few years. The punch line of their ads said –

“Money can't buy everything; for everything else there is Mastercard".

The series of ads that ran during this campaign were very touching, and people used to emotionally connect with those ads. The ads usually focused on the emotional aspects of people that can't be bought. Now, to the list of things that one can buy using money, Mastercard can add - Environment Pollution. Oh yes, now one can pollute the environment at their own will and use money to buy CER (Certified Emission Reduction) certificates; which in turn helps in reducing their Carbon Footprint - notionally. Mastercard’s new punch line can be:

“Money can't buy everything; for everything else (even environment pollution) there is Mastercard”

Carbon Foot print

The concept around reducing the global carbon footprint goes like this:

1. A company, X, uses fossil fuels/coal/natural gas for its production process, as it is cheaper compared to other "cleaner fuels" and other sources of "Renewable Energy" (e.g. - hydel power, solar power etc)

2. Hence, X emits a lot of GHG (Green House Gases) such as CO2 in the atmosphere.

3. These gases are harmful for the environment, especially the Ozone layer that protects our planet from the harmful effects of the UV rays.

4. Imagine our planet surrounded by a kind of blanket (ozone layer) with lots of holes through which the UV rays are percolating.

5. Now comes the catch. There is a UN body called UNFCCC, which says that the only parameter that it would use to gauge the Carbon Footprint of an organization is the no. of CERs it has.

6. These CERs can easily be traded in the global market, in exchange for money, just like a regular financial instrument.

China Rules..

India is the 5th largest when it comes to the emission of CO2, after US, China, Russia and Japan. Just for comparison sake, India produces CO2 as much as just 18% and 30% to that of US and China respectively. What is noticeable about China is that in the past one year, it has started a lot of renewable energy projects, thus beginning to rely more on wind and hydel power. As of today, China houses as much as 50% of world's total no of hydel projects!! That is what determination (as well as Monarchy) can do for you. China is also thinking of imposing caps on industry-wise allowable limits for CO2 emissions, as well as putting an extra tax on companies that produce more than the specified limits of CO2. Hail China for these steps.

India – Again a Laggard

India has vowed to reduce its Carbon Footprint by as much as 25% by 2020. At the same time, India has also made its stand clear that it would not impose any binding emission cuts as suggested by UNFCCC, considering that the large part of the population lives below the Poverty Line - as the additional costs incurred by the company in using cleaner fuels would directly be passed on to the consumers. According to the Planning Commission of India, 27.5% of India's population lives below the poverty line, as of 2004-05. The BPL population has shown a constant decline over the years, and continuing the same trend, it's my rough estimate that the figure would now be at somewhere around 24%. So, what about the remaining 75% population?

The Govt. would never be able to pass on a bill regarding imposing industry-wise cuts in India, if the matter is left alone to the politicians and the big business houses of this country. Given the level of corruption in India (India ranks 87 in the World Corruption Index); such a bill would never see the light of the day. What is most amazing about Govt's statement is that they never tell when such a Legislative Bill would actually be introduced in India - what is their target level of population of BPL at which they would act. The most amazing part is that the BPL population didn't play any (or may be negligent) role in India's Growth Story - yet the Govt. is using it as its scapegoat. I believe it's not the Govt but the vested interests of the business houses of India that is speaking through Govt's mouth. The Govt is not concerned about the generations that are going to come - it's only concerned about the fact that again, after 5 years, they have to come to power - for which they would require the support of business groups, as well as their money for campaigning etc. It was shocking to me when I read in the newspaper last week that Mr. Sharad Pawar openly stated that the moves of the Govt is actually making the business houses the enemy of the ruling party. The business groups were feeling that the Govt was no more "business friendly" - and that they may move their support to the opposition party if this continues. Now what was that? There seems to be no space for justice for the common people in India!!

Developing Vs Developed Nations

What is the most surprising part in this issue of reducing the carbon footprint is that the developed nations, which are the biggest consumer of power, and hence have the highest carbon footprint, are so helpless at reducing their CO2 emissions. These people have so much money (as they are supposedly the biggest consumers of services in the world as well) - why can't they shell something extra to pay for renewable energy. Instead, they go on happily emitting CO2 without any checks and regulations, and then later use MONEY to buy the CERs, which is the metric used by the UN watchdog to infer about the carbon footprint of an industry. I believe that these UN bodies form the regulations keeping in mind the best interests of the Developed Nations; and try to impose all possible rules on the developing/under-developed nations. These UN bodies don't seem independent to me anymore - similar to the case when the UN bodies didn't (or may be couldn't) do anything when US attacked Iraq just because of assumptions that Iraq had WMD (Weapons of Mass Destruction). The only good thing that President Bush did was adding one more acronym to the ever-growing English dictionary - WMD. He would surely be remembered always for coining this word.

Methodology

In my opinion, taking the following course of action would be helpful in reducing the global carbon foot print and for the future generations as well:

1. A global cap should be put on all economies so that the total emission of CO2 globally should be calculated and controlled.

2. This should be then divided between the nations, factoring various things like population, kind of economy, production capacities, infrastructure etc. Each nation should be given a score on such parameters, and then a weighted average score should be calculated for all nations. The amount of CO2 emissions of each nation should be determined by this score. Higher the score, higher the allowable emission of CO2.

3. The nations should then divide the allotted limit of CO2 emission industry-wise, and the national industry bodies should then divide this limit among the various players in that particular industry, depending on the production capacity or any such relevant metric for that industry.

4. If a business group has multiple businesses across industrial sectors, those BUs (Business Units) should not be allowed to mutually share the target CO2 emission. For eg, say there is a business group ABC that has 2 business units in different sectors. The 1st BU had a limit of 5 units of CO2 emission, while the 2nd one had 8 units. So, if the 1st BU produces only 4 units, and the 2nd one 9 units, the extra 1 unit can't be transferred from 1st BU to 2nd BU.

5. The trading of CERs should be completely banned. A company can't be allowed to reduce his carbon foot print by paying for it, though it is not taking any steps towards using clean fuels.

6. The companies that produce more CO2, than what they are supposed to, should be taxed additionally - call it as "Carbon Tax"- over and above the regular corporate tax levied on the companies.

7. The CERs should be mandatory criteria for credit rating agencies when they are rating a company. That is the additional incentive the companies should get for using clean fuel, and hence for getting the CERs.

Modify the Metrics Please!!

I guess it's high time to turn more attention to this issue, and give it more attention that it actually deserves. I believe putting a global cap on CO2 emissions is a mandatory step, so that all nations get aligned to a common goal. Also, instead of the nations claiming that they would reduce the CO2 emissions by x% by a certain period of time, they should state that they would make sure that y% of their total energy production would be done through use of clean fuel / renewable energy. This approach would be more effective because each country claims to reduce the current level of their CO2 emission by x%; but this is x% of the current level.

Let us take an example. Say, a nation is producing 100 units of CO2 today, and they claim to reduce their emissions by 20% in 10 years. Hence, what they it is effectively saying is that it would reduce CO2 emissions by just 20 units in 10 years.

But, let's say, its energy demand is increasing at a rate of 5% every year. So, the total no of CO2 units it would be producing after 10 years is 162 units approx. Even if one reduces 20 units from this (Say these units come from renewable energy sources), the total units of CO2 emitted would be 142 units.

Hence, we see that over 10 years, the CO2 emission has actually increased by 42 units.

If we take the other approach, and say that by 10 years, 20% of the nation's energy consumption would come from clean fuel. This simplifies to:

Total units produced after 10 years - 162 units

Power from clean fuel/renewable energy - 32 units

Power from regular sources - 130 units.

The increase happens in this case as well, but it is much less compared to the 1^st case. There is rather a higher increase in the use of renewable energy in the latter case.

Hence, we find that the second metric would be more suitable than the 1st one. Any one from the Govt listening?

Money - A Friend in Need is a Friend Indeed (Part 1)

2010-12-06T19:39:00.000+05:30

Oh No, Not Again

I know you would have read a lot of information about how to invest wisely - both offline and online; and that this topic might sound clichéd to many readers (I am feeling it while writing, so I am sure you would also harbour the same feelings as you read on). But trust me,a lot of information is available these days, and the trick lies in correct perception, understanding and application of relevant things which impact you. Having done my MBA in Finance, I have been tempted a lot of times to write something related to financial advisory. So, today goes my first post in this series. A lot from this article is derived from my own personal experiences. I have taken uninformed decisions in the past; I want others reading this blog to take better decisions than I did.

Needs Vary with Time

I believe that as we grow, get older and pass through different phases of life, our needs change with respect to the phase of life we are in. After passing out from college, having got the first job and experiencing financial independence for the first time in life, one hardly thinks about how much one is spending, where one is spending, how much should one save, how much and where should money be invested and the likes. This generally involves youngsters in age group of 21-26 years old, and this is the target segment for most of the businesses dealing with financial investments- be it mutual fund, insurance, ULIPS etc etc. The rationale for these companies is simple - youngsters generally don't have much experience with finance and have lots of money with them (especially during the months of November to February,w.r.t India especially, when we suddenly get a jolt from our fairy-tale lifestyle and think of our 1 lac of investment for tax saving purpose.)Hence, my article is especially dedicated to this segment.

Investopedia

One can have the following Investment Options (The list is not exhaustive):

Mutual Fund
Life Insurance
Health Insurance
Public Provident Fund (PPF)
~~ULIPS~~ (I'll tell later why this is a bad option)
Infrastructure Bonds

Now, there is an obvious question: what amount should I be investing in which instrument? Many people are quite puzzled and confused with this question. I have seen people, after retirement, investing > 90% of their savings in Equity Linked Mutual Funds; while some stock broking houses target such people and invest their money directly into stock markets. I fail to understand the logic behind this, as retired people don’t even have a regular source of income. Hence, it would be difficult for them to absorb any losses that arise due to this decision.

The answer to the above question is very simple -> If your age is X, and your total investment amount is Y, then

Investment in Equity = (100 - X)*Y/100
Investment in Debt = X*100/Y

Hence, suppose if one is 25 years old and has 1 lac to invest, that person should be investing 75,000 into Equity Instruments and 25,000 into Debt Instruments. The above equation helps you to decrease your exposure in Equity instruments, which have high risk and high return, as your age increases. Thus, as the risk bearing capacity of a person decreases with age (and hence, due to the different phases of life - marriage, kids, kids' education etc), his exposure to Debt instruments, also known as Fixed Income instruments, increases.

In this article, my focus would be on the Mutual Funds. In my subsequent articles, I'd throw more light on the other investment instruments listed above.

What’s in Here for Me??

Do these questions sound familiar?

Should I invest directly in Stock Market or in Mutual Funds?

In my opinion, and as suggested by the great Mr. Jhunjhunwalla, it is best to invest in Mutual Funds than in direct stock market, because of the following reasons:

The Mutual Fund houses have dedicated and qualified people who do the research about various companies, and then churn the portfolio accordingly, in order to keep in line with the investment focus of a particular mutual fund scheme, and give you the desired returns.
One doesn't have to glue himself to the stock broking websites all the time, and keep on looking for opportunities to buy/sell one's shared.
The portfolio maintained by the mutual fund houses are much more diversified than the portfolio of stocks that one holds. Many a times, due to inappropriate amount of diversification in the stock portfolio of individuals, they gain/lose more than the Sensex.

Should I invest in a New Fund Offer (NFO) or an Existing Scheme?

This is a very common misconception amongst the investors that they would be gaining more by investing in NFOs. This is because one thinks that one would be able to buy more units of the NFO, and more units translate to more profit, which is absolutely wrong.

For eg, let's say one has 10,000 for investment. There is an NFO in which 1 unit is priced at 10/-. There is another scheme, say MF, that has been in market for 5 years now, and its 1 unit costs 100/-

No of units bought if invested in NFO - 1000

No of units if invested in MF - 100

Now, suppose after a year, the MF gives 15% returns, whereas the NFO gives 12% returns. Hence, a unit of NFO would now be valued at roughly 11.2/-, and that of MF would be valued at roughly 115. Hence, after a year

Value of Investment in NFO = 1000 * 11.2 = 11,200

Value of investment in MF = 100 * 115 = 11,500

Hence, the same amount of money (10,000/-) amounts more when invested in MF than in NFO. Of course, if you have reasons to believe that the portfolio of NFO is much stronger than that of MF, and has potential to generate more returns than NFO, one should go for the NFO. But, for taking this decision, one should have a good know how of finance.

Which Scheme should I invest in?

There are a plethora of schemes available in the market. The scheme in which you want to invest depends on your financial goal. If your goal is to save tax, then go for tax-saving schemes; if your objective is to generate wealth, then go for other schemes available in the market. In the tax saving ELSS schemes, there is a lock-in period of 3 years, whereas there is no such lock-in period in other schemes. Hence, once you have invested in a tax saving scheme and it’s not performing well, you can't do much about it for 3 years; the same is not true for other schemes though. Moreover, many of the non tax saving schemes in the market are giving much more returns as compared to the tax saving schemes. Hence, it's totally a call of an individual as to what one wants to do.

While selecting a scheme, keep in mind the following 2 points:

The scheme that you select should be giving a consistent performance in the past 3-5 years. If a scheme is in top 5 schemes based on 5-yearly, 3-yearly and 2-yearly returns, short list that scheme.
This is one of the most important thing that people generally ignore. The returns of the scheme that you have shortlisted should also be greater than the returns of the Benchmark index that the scheme refers to, or at least the Nifty/Sensex. If you apply this criterion, you would be surprised that the short list that you arrived at in the first step would further get shortened. :)

The rationale behind the last point is that if the portfolio of shares maintained by the mutual fund scheme is not able to give more returns compared to the portfolio of shares used in calculation of Nifty/Sensex, then you are not gaining anything. You can easily get as much returns as the Nifty/Sensex, because their portfolio of shares is easily available to the general public. Hence, the logic.

The mutual funds that invest in large cap stocks are most secure, followed by mid-cap stocks, small cap stocks and sectoral stocks. Hence, the returns provided by these follows a reverse order,i.e, max in sectoral/small cap funds and min in large cap funds. This is because the small cap stocks are the most volatile and large cap stocks are least volatile. Thus, gains/losses in case of small cap stocks are much more than the large-cap stocks, when compared to the gains/losses in Sensex.

Conclusion

Watch out for the continuation of this series, for information on the other investment products. I hope the information in this article would help you in taking more informed decisions when it comes to choosing your Mutual Fund. All the Best!!

India's (UN)True Growth Story

2010-12-03T17:59:00.003+05:30

What's This Blog About?

I recently conducted a poll on my blog, asking whether the Indian Govt. should start focusing on improving its UN Human Development Index rather than bettering its GDP year on year. I got a staggering response, with a total of 6 people stating their opinion!! I am really thankful to those 6 people from the bottom of my bottomless heart, really. Although the population size is not statistically significant to infer any results, yet I would say that 83% of the respondents were in favour of UN HDI over GDP. Well, I'd like to concur with the majority, and that is what this blog is all about!!

UN HDwhat??

Well, I wouldn't like to delve into the intricacies of how HDI is calculated. As they say, a picture speaks as much as 100 pages of writing (don’t scratch your heads; I just made it up!!). So I hope that by looking at the above graphics, one would be able to understand the basics of how HDI is calculated. For more details, (as if one needs to be told :)), please Google UN HDI or have a look at UN HDI

India’s ~~Growth~~ True Story

Coming to India's stats: India - hailed as one of the most promising economies in times to come, the Great Investment Destination, blah blah blah (you can think of as many such accolades as you can, that keep coming in the business papers and business news). In 2010, India stands at a position of 119 out of 169 countries that were a part of the survey conducted by UN for their Human Development Report!! Can you beat that? One is forced to think how that could be possible. All the economies of the world go gaga over the "India Growth Story". At this time when even the IMF has made an upward revision of estimated growth of India's GDP YoY, does the common man also stand to gain from this growth? At this time when India is poised to grow at such enormous rates which even other economies of the world can only dream of, is this the "Inclusive Growth" that the politicians keep on talking about?

Consider this -

% of Population without electricity (as of 2008) - 34.2
Employment to population ratio - 55.6
Employed people living on less than $ 1.25 a day - 51.4
Overall Life satisfaction (on a scale of 0 to 10; 0 being the lowest) - 5.5

For more statistics, I have compiled a ppt taking excerpts from the UN HDR 2010 annual report. You can access the file here.

Do we need more Indices??

Recently, I read somewhere that a few countries want to create and adopt a new index- "Happiness Index"- and India wants to follow suit. My question is what would happen if the Govt goes ahead and adopts it. Isn't it shameful enough for us to be placed at 119 out of 169 countries? The actual image of India wouldn't change, no matter whether it’s UN HDI or any other index, unless it takes some drastic steps to improve on the other indicators included in calculating the HDI. Concentrating on just GDP is not going to help India in the long run. To me, this increase in GDP year on year just seems to be a kind of bubble that is bound to explode one day, shattering the hopes of millions of India's inhabitants as well as the foreign players/FDIs/FIIs. The Govt needs to focus on growing internally, and not just focus on making the face of India as a place where only businesses make profit. There is a need to strengthen India internally, and I am sure that the only way ahead is Public Private Partnerships. After all, whatever expenditure the Govt would make in improving the quality of life of fellow Indians will add to economic activities and increase the GDP finally.

To Sum it All…

The end goal remains the same (increase of GDP YoY); only the approach needs to change a bit. It's high time to introduce the new concept of GSR (Govt. Social Responsibility), and take a further leap from CSR (Corporate Social Responsibility). After all, People are the Real WEALTH of a Nation.

India is doing a good job by improving upon its HDI year on year, but it’s not a great job. The people here are hungry to see a phenomenal growth in its HDI, just like they are seeing in the GDP. After all, it’s a matter of our well being rather than that of self respect and pride. I believe the Govt should also incorporate seeing India in the top 80 nations out of the 169 nations, in the UN HDR, in its 5 Years plan. To add on, this objective should actually materialize in coming 5 years, unlike the status of previous 5 year plans. The Govt can do wonders if it improves on its efficiency and effectiveness of execution of its strategies that would help in the timely achievements of its goals. Let’s hope for the best. Amen!!

Let the Aviation Sector Live in PEACE!!

2010-11-28T22:58:00.000+05:30

Blast from the Past

I believe most of our first flying experiences would date back to the times when the Indian Aviation sector was revolutionized with the introduction of Air Deccan - India's First Low Cost Carrier. That was one such time in the Indian History which threatened the normal functioning of Indian Railways - people going by First Class in Railways started taking flights, maybe by paying a little extra, but with the added advantage of reaching their destination much much earlier. The value that they derived from paying just a little extra than the First Class railway fare outweighed the marginal difference of the same from the flight fare. It was also perhaps the First time when the Railway officials would have heard about the word Strategy - how to retain their customers. This is a classic example of cross - elasticity of demand - wherein an increase in demand of a service caused a decrease in demand of the other and vice versa. This is also an important landmark where we saw the aviation sector changing from a Duopoly to Oligopoly. Before the advent of Air Deccan, there were only 2 players in the Aviation Sector - the erstwhile Air India and Jet Airways.

Present Times..

Recently, we have been hearing and reading a lot about the so called "Predatory Pricing" of the Aviation sector. The Govt. is accusing the players of the Aviation sector of forming a kind of cartel wherein they are charging exorbitant rates to the consumers during the peak season of Christmas/New Year. They have even asked all the players to fix their price bands so that the consumer knows at the time of purchasing the ticket whether he is buying the cheapest or the costliest ticket. One would say that Govt. is doing this in the interest of common people. Agreed. This would bring in more visibility for the customers, and would help them in turn to take more informed decisions. That's the kind of perfect world that we dream of living in, and that’s what the Govt. is trying to provide. Bravo!!

Airline Industry Woes.. Hear Them Out

Now, let us understand this from the point of view of the airline players. The Govt, indirectly, is trying to fix the profit margins of the players. Which kind of business would like to operate in this scenario? The Govt. doesn't come to the rescue of the airline players during the lean season and want to compensate any loss that the airline players incur at those points of time. This move of the Govt. is only trying to rationalize the profits of the players, not their losses. One needs to keep in mind that this business is seasonal in nature, and not like that of an industry where demand doesn't fluctuate much throughout the year - like FMCG. At the same time, airline players are unable to increase their flying capacity as and when they want, because the lead time between placing an order and getting a new plane delivered runs into years, and it also requires a lot of CAPEX. Hence, the players have to do a financial analysis of whether they should actually buy a plane or lease it. Having recently witnessed the financial meltdown, the players would have preferred to go with conservative forecasts and hence, would have ramped up their capacity accordingly. But the response of the consumers has been spectacular (thanks to the confidence the customers have shown in the economy). A few players had also given a statement saying that some of their aircrafts were not operational and under maintenance. Hence, due to the supply-demand mismatch, prices are bound to rise.

It’s Time to Take a Stand..

I would have loved to support this move of the Govt, but am unable to do so, because of the following couple of examples that I could think of:

It's a known fact that during the time of Diwali, every year, year-on-year, gold and silver prices touch the peaks, and have always followed an upward trend.
The prices of Real Estate have always been a concern of the common man (except during financial meltdown)

Everyone knows that gold is precious. If one asks why that is, there is only one answer - it is a scarce resource. I believe that it’s only a perception that has been created in the minds of the consumers that it is scarce. Same is the case with diamonds. As there is uncertainty over the fact whether additional sources of the same would be found in future, hence the high value associated with it. Without further arguing on the topic whether gold/diamond is scarce or not, let’s focus on the consumers now. At the time of Dhanteras, there are people who believe that they have to buy gold on that day, as it’s considered auspicious. Whether the price was 20K this year or whether it would be 25K next year, it’s a known fact that people would buy gold - come what may. This is because people believe that they are/would be deriving more value from the ownership compared to the price they have to pay.

In the case of Real Estate, the same theory applies. People believe that the value of their property would always appreciate - as in the case of gold.

But there is reason for us to believe that the profit margins in both the above businesses are very high. Why doesn't the Govt try to regulate the profit margins in these cases as well? I believe it would provide greater respite to a larger population, rather than just concentrating on the aviation sector. Whether a person would like to fly or not, he/she would always want to have a house of his/her own. Any person's yearly expenditure on flight travels would surely be much less compared to his yearly outgo towards home loans. Also, Real Estate as well as Gold gives you tangible products, whose value is supposed to increase over time, unlike travelling by flight - which is a service, intangible in nature that one consumes in a very short span of time.

In the case of the peak time of aviation sector around New Year, although the prices have supposedly risen "sky-high", still there is a demand from the customers. This is because the customer believes that they would be deriving value greater than or equal to the price that they are paying for. If such is the perception, then why unnecessarily interfere with the system?

Change is NOT Always for the Better..

I know all this sounds illogical, isn't it? How can the Govt keep tracking all the sectors and fix their profit margins. It isn’t right and it isn’t feasible for the Govt. as well. After all, businesses are running for providing good returns to the shareholders. If the shareholders come to know about the profitability of each and every sector in an industry, there would be a crowding out effect wherein the all investments would rationally flow to the sector giving the highest returns to the shareholders, while other sectors would remain under-financed. To cut short the imagination, it would result in utter chaos. So, let’s not try fixing the price bands of any sector in an industry - be it a goods or a services industry. Let things take their natural path, and all would be well in the end. Amen. :)

Can THIS Cause Inflation ??

2010-11-26T17:01:00.000+05:30

I guess inflation is the word which is equally understood by the rich and the poor, the educated and the uneducated, and whatever other combinations you can think of. As most of us know, it’s a man-made phenomenon, and generally works to the disadvantage of the commoners, or better, the consumers. Who would like to get smitten by the prices of the daily use items that burn BIG holes into your pockets? Although the inflationary pressures have been brought down a bit and is currently hovering around 10.15% (as of 25/11/2010), still one can't forget that it reached to as high as 16% in the current fiscal year itself.

What Government Says..

The Government of India has smartly given its opinion that the food inflation is not because of supply - demand factors, the Classical Supply-Demand theory of Economics known to one and all. I would like to agree with that, and I am sure (as well as hopeful) that it would be lowered further on account of good monsoons (Now even that is under scrutiny - more than expected rains is being attributed to Climate change!!)

Why are you Reading This!!

I have a different take on this topic, and a weird one too. I believe that the food inflation is because of the Supply-Demand Factors, not relating to the food supply directly, but to that related to Labour- again one of the favourite topics of Classical Economics. I think most of us must be aware of the Government Scheme called NREGA. All the Indians are gaga over this scheme, and believe that it would be one of the prominent pillars for the upliftment of the poor. I completely agree with this, but somehow I feel that it’s doing some bad as well - like two sides of the same coin.

Some GYAN

Consider this - A farmer in the village needs some helping hand on his fields, as he can't do all work by himself. Yes.. Even the Indian farmer is implementing the world famous "Outsourcing Model" - does what is his core competency, and outsources the remaining activities. Kudos!! The labourers that work in the fields consider themselves to be very lucky if they are able to earn as much as Rs 20-40 a day, depending on the type of work.

Next day, to the dismay of the farmer and the happiness of the unskilled/semi-skilled labourers, NREGA scheme gets launched in the same village. It promises Rs 100 per day to a worker. Now, it’s a human tendency to get attracted to higher income (all the employees would vouch for that). Hence, now the same labourers would want to leave the farmer, and go for NREGA, as it would give him at least 2.5 times his daily income. He has common sense, after all. Therefore, here we see the classic case of supply-demand factors acting on the labourers, wherein the demand has increased, but the supply would not get increased in the same proportion (or even remain constant, who knows).

Now, the farmer is facing the issue of labour crunch. He either has to increase the pay of the labourers or else look for new helping hands which is a huge task of its own (considering the rate at which young people from villages are leaving their villages for finding greener pastures in the cities). Even the labourer understands that NREGA would be there in the village only for a limited period; after that, he would again have to fall back on the same farmer. So, here come some Management concepts as well!! In order to maintain his Long Term Relationship with the farmer, he would ask the farmer for some hike in his pay. Let’s assume that under pressure, the farmer has to increase the pay of the labourers by 10%. Now comes a Supply Chain Concept :)

We all know that the price which the consumer pays for a commodity is much more than the price at which the supplier sells it. So, taking a conservative approach, let’s say the farmer simply increase his selling price by only 10%, which gets magnified as it changes hands (all the players in the distribution channel), and finally, the end consumer, that is us, have to pay 20-25% more for the same quantity of the commodity.

Government's Two-Pronged Strategy

This is quite interesting. On one hand we are paying more for our daily use products, and as we saw, the reason why this all started was the NREGA scheme - that is, the Government. On the other hand, the RBI has been increasing the base rates every now and then (a total of 5 times this year), thus making the loans costlier as well. So, the Government is impacting both our long term goals (say, a house loan) as well as short term necessities (our day to day consumption of food items).

Conclusion

To conclude, I'd like to say that this is just my perspective, and I am not sure how much impact my deductions can have on the inflation. It might be tiny or a mighty part of the pie. The purpose of this article is just to point out that NREGA scheme can be having negatives (apart from the negatives pointed out by the politicians). What Say??