The Client's investment objective is important, not the client's fancy!

 Question: I need Rs. 60,000/- exactly after 3 years. So I would like to invest Rs. 1,700/- (Rs. 60,000/36 months = Rs. 1,667/- pm rounded off to next hundred). My assumption is that, even if my monthly investment of Rs. 1700/- did not even grow at all for the next 3 years, still I will be having Rs. 60,000/- intact.

So I also would like to have equity exposure to my investments. Hence, I would like to invest either in HDFC Prudence Fund or HDFC Balance Fund?

Mr. Gerard Colaco: As investment advisers, we must focus primarily on the need of the client. Choosing mutual fund avenues comes only thereafter. The most important thing I see from the briefing is that the client requires Rs 60,000/- after 3 years, and is prepared to make a monthly commitment to achieve that objective.

I would advise registering two SIPs of Rs 1,000/- each for 24 months into the following two funds:

1.     Templeton India Short Term Income Plan, Growth Plan
2.     FT India Dynamic PE Ratio Fund of Funds, Growth Plan

Review the investment values at the end of 24 months. If the values are above say Rs 54,000/-, the SIPs may be stopped and the existing investments may be allowed to continue until the end of the third year, after which both funds can be cashed. The chance of capital depreciation after 24 months of systematic investment in such a strategy is remote.

The client may want anything, but the client is not the expert here. We are the experts. Our advice should not pander to the fancies of the client. Our advice should zero in on the best choice to meet the client's investment objective, not the client's fancy.

This is very important. Understand that where investment advising is concerned, we set the agenda, not the client.

Question: As the short terms interest rates are nearly peaked out and inflation being easing can we park the money invested in Floating rate fund to Bond fund (Ex; Birla Sun Life Dynamic Bond Fund)?

Mr. Gerard Colaco: The client may be right. Interest rates do not remain permanently high. In fact, but for inflation, the Government of India would like a low to moderate interest rate regime, because this spurs economic growth. I do not know for how long interest rates will remain high in India. When they start declining, intermediate to long-term bond funds will undoubtedly do well.

However, in such a situation, the stock market will also generally do well and so it would be difficult to say where he would get the better returns. Where bond funds are concerned, I generally do not advise long-term bond funds or long-term G-Sect funds but today we have an extraordinary situation. Inflation is continuing to rise despite many interest rate hikes. We could see one or two further interest rate hikes.

My advice on this issue would be that if there is one more hike of 25 basis points or more, your client can go in for one diversified long-term debt fund, one diversified long-term government securities fund and also an investment in the Templeton India Short – Term Income Plan (TISTIP), which will serve to moderate risk. Amounts may be split equally between the three.

Understand that this is not my advice on investment. This is my advice to a client who is determined to invest only in bond funds, in view of the present high-interest situation. If the time horizon is three years, an MIP can be chosen instead of the diversified debt fund. Or even the FT India Dynamic PE Ratio Fund of Funds – Growth (FTDPEF).

The client should be clearly told that such investments have a minimum time horizon of 2 years, and they are not risk-free in the short term, even though the risk is of course far lower than an equity portfolio.

Mr. Harish Rao: I am no fan of long duration income funds either. A few drawbacks (none severe):

1. High Expense Ratios. Anything above 1% in a Fixed Income fund is criminal (in my opinion).

2. Fund Manager Risk. Many fund managers are rookies, not having seen a cycle like this. What if their call is wrong?

3. Exit issue: We may enter after the next big hike, convinced that it would be the last. When do we exit?

Having said that, I did get around 18% CAGR in Templeton G-Sec Fund during the period 2000-2003. But in hindsight, I would view it as a risky market timing strategy. Not recommended.

However, if advisor and his client are in the same page, timing entry and exit from long duration bond funds can give tax efficient returns.

Belief System.

Question: Your email tied in to a set of discussions I’ve been having recently on the importance of people in our business to have, what I call a “professional belief system”, a set of beliefs that define our professional conduct and our business decisions. In fact I’ve put together a small presentation which I call “Building a Belief System” (see attached). In these discussions, and in this presentation, one of the points I make is that the quality of beliefs depends upon the quality of what we read, hear and experience, and above all, the quality of our analysis of what we have read, heard and experienced. Your response to Mr. XYZ showcases the very high quality of your beliefs and I am contemplating sharing this with participants in my program (subject to your consent, and after removing the addressee’s name, of course).

I recently came across a copy of The Four Pillars of Investing and discovered that it has been re-released with a 2010 Postscript: “What have we learned from the Meltdown?”

I also watched with great interest, the video of you presenting at an Investors Meet in Bangalore. Confession: I was riveted. I truly believe Deepak K Rao has done a great service to people in this business by posting these videos online.

Talking of videos, with the easy availability of videos online, on anything and everything, I spend a lot of my time scouring for good videos. In the process, I now have an excellent repository of videos. Foremost amongst the videos that I have seen over the past few months are a couple that offer an excellent perspective on the 2008 crisis, and if you haven’t see these, I strongly recommend doing so. The first is a movie, Inside Job. The DVD was released in India last month and can be ordered on Flipkart and similar sites. This movie, incidentally, won the Oscar, this year, for the Best Documentary Film. The second is a BBC series, The Love of Money.

One interesting advantage of videos is that there are some knowledgeable people out there, who may not be able to make a strong enough impression through their writing but who are very watchable on videos, relatively at least. A couple of examples come to mind. Mr. Daniel Kahneman, for one, who is regarded as the father of behavioral finance, is not the best of writers. He makes valid points, but his choice of words and expressions don’t easily stimulate the reader. On the other hand, he is a delight to watch in conversations, and addressing audiences, on video. Check out these as examples:

http://www.youtube.com/watch?v=uUYQrLsmNMM

http://www.youtube.com/watch?v=rZUylXXJbhE

http://www.uctv.tv/search-details.aspx?showID=12295

http://www.youtube.com/watch?v=LjGl6bZF6zs

http://www.youtube.com/watch?v=XgRlrBl-7Yg

Another example is Mr. Nassim Nicholas Taleb, (he features in one of the videos above). Though his books, Fooled by Randomness, and The Black Swan, are bestsellers, I couldn’t read either, because I found his style of writing very irritating. In his videos he gives the impression of being blunt, bordering on brusque, but that’s a lot better than having to suffer his reading.

Mr. Gerard Colaco: You may freely share extracts of my mails with any of the participants in your programmes. It is one of my life's goals to raise the standards of at least a few investment advisers, and make them true advisers, not salespeople masquerading themselves advisers.

The belief system of our firm is quite simple. It is no different from the belief system I feel that all professionals must have. It is built on a four-pronged foundation:

1. A professional must have an unswerving commitment to the highest level of ethics. Compared to this, everything else pales into insignificance.

2. A professional must attempt to acquire the highest level of expertise in her field of endeavor. A high level of ethics would of course demand that a professional will be a seeker, gatherer and implementer of the best knowledge, insight and wisdom in her field of specialization, in the interests of the individuals she serves. That is why I consider myself to be a mere student of personal finance and investment, not an expert. I wish to leave this world as nothing more than a student, and an eager one at that. I depend on no one for my education, save the best authors in the world. On an average' I read for two hours a day, and at least twice that long on weekends.

3. A professional must have a long-term commitment to quality practice.

4. A professional must practice what she preaches.

I read your presentation on building a belief system, with interest. I agree with the Mr. Nick Murray quote that one who believes is believed, subject to one or two important qualifications. Blind belief does not in turn engender further belief. The blind belief of religious zealots for example while genuine from their point-of-view, would be dismissed outright by persons capable of rational and critical thought. On the other hand, when I as a financial planner have my own financial plan which is based on the same principles that I employ to construct the financial plans of my clients, I am certainly believed, because I bring to the table unimpeachable credibility. When the investments I recommend to my clients are investments in which I have placed my own money and the money of my immediate family, I do not merely have credibility, but virtually command it. I acquire stature. I do not merely acquire credibility, I OWN the damned thing!

In slide 36 of your presentation, you pose the question about whether one should go for active or passive investing. And the belief question to address this dilemma is whether one thinks that good security selection is possible. The answer to this question would be simple, going at least by the US experience. The best security selection over a ten year period has been by a total stock market index fund, because it has beaten 75% of actively managed funds in that period. So, my belief questions would be one, do I believe that over the next one or two or three decades over which I will be investing, the Indian equity markets will get more and more efficient? If so, will passive investing merit a serious look, especially when there are quite ominous signs already that it should? Two, can there be a diversified strategy that combines active investing, passive investing and asset allocation, thereby relieving both the adviser and advised from the stress of participating in the active-passive debate, and instead profiting from it? Let me illustrate by an example I follow in my own advising.

When I advise a client aged say 25, working and earning well, I would handle his retirement needs by recommending SIPs of equal amounts into the following three funds:

1. Goldman Sachs S&P CNX 500 Index Fund - Growth
2. HDFC Top 200 Fund - Growth
3. FT India Dynamic PE Ratio Fund of Funds (FTIDPERF) - Growth.

The first is passive, the second is active and the third is an asset allocation strategy. Three or four decades later, the investor will retire and may need to start withdrawing from his funds. If the stock market is relatively high at the time of retirement, he can choose to withdraw from any of his equity funds. But if the stock market is low, and the investor is reluctant to withdraw from his equity funds, despite fabulous returns from three decades of systematic investing, the smoothening effect rendered by the FTIDPERF will offer the psychological crutch required to take care of this need. I believe that an investment strategy such as this embraces the best of active and passive investing and asset allocation, harnessing all three to the engine of long-term, uninterrupted systematic investing and addresses the most important issue of preventing the investor from running out of money during her lifetime and the lifetime of her spouse.

Thus, if our focus does not shift from the issues that really matter, all fringe debates are meaningless and a waste of time. Which brings me to my central point. In the ultimate analysis, we need only one belief - to always use simplicity and common sense. I do not see these words appearing in any presentations these days. But these are the only tools I use in my practice. That's why I love Mr. John Bogle so much. His magnum opus "Common Sense on Mutual Funds" starts with the two words that are central to, and in fact constitute, the most part of my own belief system - COMMON SENSE, the enemy of which is the hype that is pervasive in today's financial services industry and the financial media.

Similarly, when essentially useless stuff like the Sharpe Ratio or the Treynor Ratio distracts us, I would use this "belief answer" from Mr. Warren E Buffett to trample upon it: "To invest successfully, you need not understand beta, efficient markets, modern portfolio theory, option pricing or emerging markets. You may in fact, be better off knowing nothing of these. That of course, is not the prevailing view at most business schools whose finance curriculum tends to be dominated by such subjects. In our view though, investment students need only two well taught courses - how to value a business and how to think about market prices."

Similarly, I would approach the whole debate about SIP versus STP versus lump sum investments with another "belief answer," this time from Mr. J K Galbraith: "All of the great leaders have had one characteristic in common - it was the willingness to confront unequivocally the major anxiety of their people in their time. This, and not much else, is the essence of leadership." Without understanding the import of this statement, all talk about SIP, STP and lump sum investing is futile. SIP, STP and lump sum are only means to an end. The end should be to confront unequivocally, the major anxiety of an investor during the time she is running her investment programme. If this is not realized, the "adviser" may have her client exiting from the market in a panic at the bottom, just before the next boom, a tragedy that has been played out too many times in the past and will doubtless be replayed in the future.

Mr. Harish Rao: First of all, thank you for the idea of showcasing Mr. Gerard Colaco's reply as a case study for Investor education / service / anxiety redressal (all in one).

While on the subject of Beliefs, I have on some occasions of under-employment (of which there have been alarmingly many) dabbled with serious interest on Psychology, with an eye on Investor Behaviour.
 

One particularly interesting concept that you may examine further is 'Guiding Fiction' (GF). Coined by that most amazing and prolific of psychologists - Alfred Adler, 'GF' really determines how we behave. GF is nothing but the notions, myths and beliefs about how we are supposed to think and behave and respond to the world.

GF is developed during childhood and sticks around till we die. The real paradox lies here - GFs are developed during childhood, when our sensory perception is strong, but our intellect is weak. Therefore GF really does not help in stressful adult life. In fact GFs contribute to a weak EQ and adjustment scorecard. (The worst childhood GF is the notion that 'everyone should like you'...which leads to a lifetime of high empathy behaviour with little drive for achieving one's own goals - brilliantly called ego-drive by psychologists). Like what Mr. George Bernard Shaw has been quoted as saying in your presentation on adaptability - much of human progress depends on how we adapt.

Coupled with behavioural biases and myths, GFs offer some explanation on Investor behaviour. Why are Gold showrooms in Mangalore and Kerala filled even when Gold reaches Rs. 28,000/10 gm? Why don't investors do a due-diligence on big ticket property investments?

Now onto some of Mr. Gerard Colaco's observations on Beliefs:

Yes, Beliefs should be questioned on the basis of empirical and statistical evidence. There is no place for Myths and Blind beliefs in Investing. But Beliefs should be tuned to work as the New Guiding Fictions for an Advisor's Life. You have stated that you Walk Your Talk. You will invest in only what you advice and Vice Versa. This is an excellent example of what experts call ' Strong Prosperity Consciousness' - or in layman lingo 'Win-Win Solutions'.

I also chuckled when I read your observation on Sharpe Ratio, MPT and Efficient Frontier. In an era, when even Wealth Managers think that a 40% dividend on a fund with Rs. 40 NAV gives a dividend cheque of Rs. 1600/- and not Rs. 400/-, we have some serious misconceptions to manage at the most basic level.

Life Insurance Claim / Settlement Ratio

 

Question: I have been talking to a couple of my colleagues about Term insurance. However most of them are having a notion that the claim / settlement ratio of most of the companies is bad. I don't have the statistics though.

Also, if something happens to us and later claim doesn't reach the family, what next?

Therefore, let me have your advice on issue to understand whether we should go for a Term Life Insurance based on the claim ratio.

Mr. Gerard Colaco:  In insurance, the claim ratio is irrelevant and unimportant if the insured knows how to handle a claim. In life insurance, the only question arises is whether the insured is alive or dead. If dead, the only exclusion is suicide. The only proof  required is a proper death certificate.

Where general insurance like vehicle insurance or health insurance or household insurance is concerned, many general insurance companies are in the habit of automatically rejecting claims or a general insurance claim, I advise claimants as follow.

1. Submit a complete claim form backed by notarized photocopies of all relevant documents .

2. Lodge the claim with a proper covering letter either by post acknowledgment due or by hand delivery, obtaining a proper acknowledgement bearing the seal and signature of the staff of the insurance company accepting the claim. The acknowledgement must bear a seal showing the name and address of the branch of the branch of the insurance company to which it is hand delivered. The date of lodging the claim must also appear .

3.While the assistance of the insurance agent through whom the policy was purchased may be taken when filling out a claim form, it is the responsibility of the insured to verify and confirm that the claim form has been correctly and completely filled.

4. Retain a clear photocopy of all pages of the fully filled up claim form .

5. Once these precautions are taken, if the claim is rejected, never waste time in begging of, and pleading and 'discussing' with the insurance company. Straightaway approach a good insurance lawyer, show him the policy document and photocopy of the claim form and get his opinion about whether the rejection by the company is proper.

6. A good lawyer will advise you not to proceed with legal action  if there is some factor that renders the claim invalid. For example, I know a case where a lady took out a healthy insurance policy. She paid two premium over a period of  15 months. Then she had a hysterectomy. When she lodged a claim, the insurance company pointed out that a claim for hysterectomy could be made only after two years of the date of the original policy. We immediately advised the insured not to press the claim.

7. In many other cases, the lawyer may advise the insured to go ahead with the claim. There is no need to consult only a lawyer. A competent insurance advisor or CA may also be able to give an opinion. In case the opinion is that the rejection of the claim is improper, a legal notice must immediately be sent to the company stating that the rejection of the claim is improper and if the claim is not settled in full in say 15 days the insured will be proceeding with a consumer  forum compliant against the insurance company without further reference to the insurance company.

8. The moment a legal notice is sent, the insurance company staff will generally contact the insured for a compromise. The insured must refuse to speak to them and refer them to his/ her lawyer or ask for a response to the legal notice in writing within the time given in he notice.

9. If there is no response or there is an unsatisfactory response from the insurance company, a consumer forum complaint must be filed and actively pursued. For your information, more than 90 percent of such complaints are decided in favour of the insured. Even before the consumer forum complaint is decided, the company may once again come for a compromise.

10. There is one additional measure that can be used along with the legal notice and threat of a consumer forum complaint and that is a compliant before the insurance ombudsman. I think some more years may have to pass before the insurance ombudsman start functioning efficiently. The same thing was observed where the banking ombudsmen deal with dispose of customers grievances quite efficiently and fairly.

 The original insurance policies must be kept in a safe or a bank locker together with all other important documents of the insured such as property documents and jewellery. This will ensure that the legal heirs and /or executors of the will of a deceased insured will happen upon the insurance policies when sorting out other important papers of the deceased.

If the nominee too is no more, then the policy proceeds have to g to the legal heir by operation of the inheritance law under which the legal heir are governed. This may require the probate of a will in case of testate succession .

The only in way in which a life insurance policy can remain unclaimed despite of the death of the insured is if the legal heir are totally unaware of the existence of the policy itself and original policy documents is not found with the other possessions of the insured after the death of the insured.

It is therefore a good practice to keep all important papers together in a bank locker. Photocopies of all important papers must be kept in a separate file in a totally different place, perhaps in a safe in the home of the individual. Additional copies can also be deposited with the lawyer or CA of the insured.

An elderly spinster who is our client has considerable financial physical assets. All her original documents on our advise were placed in a bank locker after taking two  sets of notarised photocopies thereof. One set is at  her residence in a file. The other set is in another file in her name deposited with our firm.

To conclude, the claimants under an insurance policy can improve the claim ratio by adopting an efficient, correctly documented, no-nonsense process with the insurance company against whom they are making the claim.

Secondly, all of us can improve and ensure the smooth transmission of our assets in favour of our legal heirs, by making a will and arranging for the proper safekeeping and placing of all our important papers as well as attested copies thereof.

Mutual Fund Scheme for Children

Question: The XYZ AMC has come out with a fund for children; 'The XYZ Children's Plan'. Do you think this is good fund to invest?

Mr. Gerard Colaco: 'The XYZ Children's Plan' is a good fund NOT to invest in. This is a classic case of how an otherwise good Asset Management Company (AMC)/Mutual Fund can come out with a lousy investment product just to appeal to parental emotions to increase its Assets Under Management (AUM).

First of all, there is no such thing as a "children's plan". If someone chooses to do proper financial planning, that individual needs to have funds in just 3 investment accounts - an emergency fund, a retirement fund and a general investment fund.

An emergency fund should be generally be equal to one year's normal living expenses and can be liquidated only in case of emergency. The purpose of an emergency fund is to take care of emergencies, as the name suggests.

A retirement fund should be built up with at least 10 percent of your net take home pay going into it each month. In the Indian context, a retirement fund should be predominantly into equity avenues if you are more than 10 years away from retirement. The purpose of a retirement fund is to take care of your wife and you from the time you retire until end of both your lives.

A general investment fund should be built up with at least 15 percent of your net monthly take home income. A mix of debt and equity can be used here. The purpose of a general investment fund is to take care of all non-normal expenditure from the time the fund is set up, until retirement. A general investment fund can be used for down payment on a house, family vacations, vehicle purchases, child education, marriage expenses of children, etc.

So, in investment or financial planning there is no such thing as a "child plan".

The second foolishness of the XYZ Children's Plan is that investments can be made only in the name of a minor. In India, the law is very clear that any asset in the name of a minor cannot be liquidated, even in an emergency, unless the guardian approaches the court of minors and wards and obtains an order for sale of the minor's assets. Such an order will be granted only after the court is satisfied that such a sale is necessary to provide for the minor's genuine needs.

Right now, investments in the name of a minor in mutual funds can be liquidated even during minority of the holder thereof by the guardian signing the redemption form, because most entities appear unaware of this law. If it is discovered, the government and/or SEBI will certainly plug this loophole and liquidity in such investments will dry up.

Third, once a minor attains majority, the asset becomes the minor's property absolutely, and if the minor so chooses the asset can liquidated and used for any purpose that the minor wants, thereby defeating whatever intention the parents/ guardians had in mind at the time of making the investment originally.

For all these reasons it would be extremely unwise to have investments in the name of minor. What is more important is to build and distribute them judiciously between an emergency fund, a retirement plan and a general investment fund. Various investments and strategies can of course be chosen under each of these categories of investment.

The only reason mutual funds, portfolio managers and insurance companies come out with 'child care plans' from time to time is to appeal to the emotions of parents to provide for their children. Any trick will do, so long as they can collect money from you!

 

Gold Savings Fund - NFO

Question: In India so far one can invest in Gold in the form of ornaments, coins and bars. One can also invest in Gold Exchange Traded Funds (ETFs) in the Secondary Market through Demat and Trading Account. But in 'XYZ Gold Savings Fund' one can invest in gold, lump-sum and also go for monthly investment in gold through Systematic Investment Plan (SIP) like in any other equity mutual fund schemes.

Kindly let me have your advice on investing in Gold and XYZ Gold Savings Fund?

Mr. Gerard Colaco: From any investment parameters, gold is a lousy investment for long-term growth.

Let us first take returns. US$ 1/- invested in the gold in 1802, would have had a value of US$ 32.64/- in December 2006. The same one dollar invested in stocks, with reinvestment of dividends, would be worth US$ 12.7 million in the same period.

Rs. 100/- invested in the BSE Sensex on 1st April 1979 would have a value of Rs. 18,202/- today (14-02-2011). The Compounding Annual Growth Rate (CAGR) works out to approximately 17.7%. Standard gold was Rs. 100/- per gram in 1950. In 2011, 61 years later, it is Rs. 20,285/-. The CAGR is 9.10%.

Second is the factor of safety. Gold is less volatile than equity. But such volatility works in favour of a disciplined and systematic investor over the long-run. Gold also can under-perform for long periods, sometimes a decade or two. Where safety is concerned, no long-term investor has ever had to worry about safety in a diversified equity portfolio or a good piece of real estate in the long run. So a genuine long-term investor does not need the "non-correlated diversification benefit" that gold is supposed to offer.

Third, gold is a sterile investment, offering no cash flows like dividends or rentals that can be reinvested ever if there are no other amounts available to the investor to invest.

The right technique must be used on a good avenue of investment, to get the best out of the good investment. For example, if a parent is planning for the marriage of a daughter, some 5 or 10 years down the line, and thinks that a good amount will have to be spent on gold, an SIP in a well diversified equity fund or index fund should give considerably more returns than an SIP in the XYZ Gold Savings Fund over the said period.

The conclusion is simple. Gold may at the most equal inflation in the long-run. Equity and real estate beat inflation. If there is nothing special about the investment avenue itself, then nothing of value is achieved by debating about whether a lump-sum investment is good or a systematic investment is good.

The XYZ Gold Savings Fund - NFO is nothing but a marketing and AUM-augmentation exercise, capitalising upon the hype for gold because of its current high prices.

 

 

Stock Market & Monkeys!

Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for Rs. 10.

The villagers seeing that there were many monkeys around, went out to the forest and started catching them.

The man bought thousands of monkeys at Rs. 10 and as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy for Rs. 20. This renewed the efforts of the villagers and they started catching monkeys again.

Soon the supply diminished even further and people started going back to their farms. The offer rate increased to Rs. 25 and supply of became so little that it was an effort to even see a monkey let alone catch it!

The man now announced that he would buy monkeys at Rs. 50! However, since he had to go to the city on some business, his assistant would now buy on behalf of him.

In the absence of the man, the assistant told the villagers. Look at all these monkeys in the big cage that the man has collected. I will sell them to you at Rs. 35 and when the man returns from the city, you can sell it to him for Rs. 50.

The villagers squeezed up with all their savings and bought all the monkeys.

Then they never saw the man nor his assistant, only monkeys everywhere!!!

Welcome to the "Stock Market!!!"

The Stock Broker!

Two women were walking through the woods when a frog called out to them and said: "Help me, ladies! I am a stock broker who, through an evil witch's curse, has been transformed into a frog. If one of you will kiss me, I'll be returned to my former state!"

One woman took out her purse, grabbed the frog, and stuffed it inside her handbag. The other woman, aghast, screamed, "Didn't you hear him? If you kiss him, he'll turn into a stock broker!"

The second woman replied, "Sure, but these days a talking frog is worth more than a stock broker!"