Evaluating Management

Talk to any investment expert, growth or value or the ones that use blended approach, all would recommend that investors should look at the quality of the management. But how should one check the quality of management?

There are multiple ways of evaluating company management. Be it quantitatively or qualitative judgement. Experts tend to use a combination of these criteria to form their opinion on company management.

Qualitative aspect

Ravi Gopalakrishnan, Head Equities, Canara Robeco Mutual Fund looks at how well the capital was used by the management. He says, “The ability of the management to deploy capital efficiently based on past track record needs to be evaluated. For example periodic raising of capital from the market or unrelated capital expenditure for new ventures should raise red flags.” He doesn’t stop here, other variables he looks at are the quality of board, background of key management personnel, transparency and communication.

“Management quality is about evaluating intension of management. One way to check is whether management is overpromising and under delivering,” says Vinay Khattar, Head of Research at Edelweiss.

Parag Parikh, Director of Parag Parikh Financial Advisory Services (PPFAS) says, “We can observe a few things that can help gauge the quality of the management like the treatment of minority shareholders. If management also owns controlling stake in the company it is vital to see how the management is using the shareholder’s funds.” He also advises to check how the management has dealt with acquisitions in the past & try to understand the rationale behind them. 

“We can monitor management during lean times when the industry is under performing. That’s a good time to separate smart managements from the rest who will take advantage of the lean times to invest in new capacity for the expected upturn,” says Parikh.

So there is no one standard on the quality side either. But a number of items that investors should look at based on availability of information.

Quantitative aspect

“Consistent dividend track record of the company helps us evaluate the ability of the management to reward shareholders,” points Gopalakrishnan. Among the financial parameters which can be used to evaluate management quality are growth rates of the company and its margin compared to industry average across various business cycles. “Further, consistency of returns ratios such as ROE, ROA, and ROCE compared to Industry average across different business cycles also helps us in understanding the efficiency of use of capital by the management”, he says.

Meanwhile, Parikh adds to it by mentioning, that he also looks at working capital related metrics over a period of time, as it shows how the management constantly endeavours to avoid cash drain through good working capital management. He further adds that ratios that measure credit risk over a period of time tells, how comfortable the management is about borrowing money to fund growth. “All these metrics tracked over a period of time along with understanding the business operations can give us a fair idea about the management’s ability to run their business well,” he says.

Vivek Mahajan, Head fundamental Research, Aditya Birla Money believes that one can easily get the historical record of all the key parameters of the company performance (both financial and operational) during good as well as bad times. On top of that if the management is willing to share fair view on the company as well as industry and most important, is sharing key operational parameters of the company with investors then it is acceptable. “In case management is not able to disclose some data points, in view of competition, it is acceptable,” says Mahajan. 

Differentiating the management intention.

One of the most difficult part is to figure out when the management has unintentionally made a mistake, and when they were involved in poor decision making or they are making decisions with malicious intent. Since, the ability of management to identify the needs of the business in terms of capital requirements for new business opportunities or for expansion of existing capacity is an important criteria for evaluation.

Gopalkrishnan says, “If the intent of the management is to create a long term profitable organisation, management is likely to be more conservative / realistic in setting targets or goals for itself while red flags should be raised when the targeted goals are way beyond the industry norms.”

“Reporting false revenues, excessive related party transactions where the management owned entities benefit the most, issuing increase in salary despite underperforming business, issuing warrants to key management that allows them to purchase shares at below quoted market rate, making unnecessary purchases of trophy objects like helicopters / private jets with the company’s funds, using listed entity’s funds to create assets benefiting unlisted group companies, etc. These are ways that intentionally harm minority shareholders,” says Parikh.

He further adds that there may be instances where the management has taken to risk to back a particular business that did not turn out the way they anticipated for reasons beyond their control. “The distinguishing factor between wrong intent and bad luck is the amount of the business that was at stake,” he says.

Sharing his views, Mahajan adds, “Investors should get cautious, usually, when the top management gives indication of venturing into non-related business from the core business, without proper justification.” Key example can be the case of Satyam Computers. Satyam Computers, which was into the business of software development, was planning to venture into the infrastructure business. He adds, software and infrastructure business are totally unrelated businesses and has pole apart style of doing business. Later on, it was revealed, cash on book with Satyam Computers were fictitious and the company was trying to hide the same, by the way of acquisition of infrastructure company.

Giving another example, Mahajan says, “Crompton too was punished some four years back once they announced intention of acquiring a plane. They subsequently got rid of the same in within a year.”

Another important point to watch out for management intention is the changes in dividend policy, changes in accounting policy, etc. says Khattar of Edelweiss.

Is meeting management important?   

It is not possible for small investors to meet the management, even though many experts always point that one should meet the management to understand their intention. Gopalkrishnan believes that if management is not approachable for small investors, the management evaluation can be done through the process of channels through which they would normally communicate. For e.g. Attending Annual General Meetings would give perspective about the future course of management’s plans or alternatively through Annual Reports where management gives colour on the business environment.

Further, an analysis of the annual report might give some aspects of the management quality in terms of capital allocation, debt position, related party disclosures, etc.

Parikh further adds that, “If an investor cannot meet the management at all & yet wants to understand the business & the management quality then he/she should interact with customers of that business, suppliers to that business, dealers / distributors, competitors, etc. This can give a good idea about how the management treats these entities. It’s not fool-proof but adds another layer to our understanding about the management.” 

Arpinder Singh, Partner and National Leader, Fraud Investigation & Dispute Services, EY says, "Being sceptical is very important. For example if the accounts receivables is equal to a full year’s sales then it’s a clear red flag. Or growth has been nearly 100% in the last one year whereas for the last 10 years the company has been reporting only 15%. So the management will give a rosy picture so I would actually advice that go meet the customers and vendors."

This can further be supplemented by management interviews and quarterly conference call transcripts. By doing this an investor can a have good sense on the quality of the management, vision and the way management plans to execute.

It is not an easy work to assess the management of the company but nonetheless there are ways to assess them.

ELEMENT - 1

Quick guide: Qualitative Evaluation Management

1. Capital Efficiency –The ability of the management to deploy capital efficiently based on past track record needs to be evaluated.

1. Quality of Board – The composition of the board of directors in terms of independence, quality and experience of persons in the board determines the broad outlook for the company. 

1. Background of key management personnel – Further, the experience and track record of key management personnel in running the business also is a key determinant of management quality.

1. Ability to move up the value chain  - It is important to determine if the company has invested in backward and forward integration and thereby improved its operating efficiencies over time.

1. Ability to de-risk the business at all levels– The ability of the management to de-risk the business is also an important criteria. It is important to evaluate whether the company has been able to perform consistently compared to peers & industry during both, upturn as well as during the down turn in business cycles. Ability of the management to protect the business from uncertainties and global events also needs to be evaluated.

1. Transparency and communication – Finally, the extent of how transparent the company is in terms of sharing / communicating the information with the investors as well as to the public at large also helps in evaluating management quality.

1. Treatment of minority shareholders & upholding their rights:  – Check out the related party transactions within the promoter group. They inform which promoter group entity has benefited from transactions with the company.

ELEMENT - 2

Arpinder Singh, Partner and National Leader, Fraud Investigation & Dispute Services, EY, shares his views on what investors should look at in a private company. The same principles can also be employed in a public listed company.

Round tripping is where you create fictitious customers and vendors. To take an example, there is a company which shows 1,000 crore of sales to customers and also shows that supplies came from vendors which is also an exact amount of 1,000 crore. So the company management will show it was a no-profit and no-loss situation but it’s the red flag. In this the money just flows between customers and vendors who are all related parties and the balance sheet is inflated. If you look at most of the financial statement fraud that are reported in the newspaper is around this. So what we suggest is that rather than talking to management investors should always go and meet the top five customers and vendors.

Background check is very important. While investors have been doing it in India pre-investment, I believe investors should also do a background check post-investment in a company. By background check I mean see if the promoter has other businesses as well, not listed or having any connections with the current business? If there has been tax raid on this business or any other business? Is there any police case against him? Is the promoter black listed in the CIBIL or globally on something called world check?

I think post investment investors should also track the cash flow and not limit it to P/L and financial statement. How much money was put in and how is it being used every month. Usually many investors just invest and then they do not bother much for a year, till the next financial statement.

Being sceptical is very important. For example if the accounts receivables is equal to a full year’s sales then it’s a clear red flag. Or growth has been nearly 100% in the last one year whereas for the last 10 years the company has been reporting only 15%. So the management will give a rosy picture so I would actually advice that go meet the customers and vendors.

Also another important factor that investors should always ask, though the new companies act gives direction on whistle blowing policy, but investors should always also check this aspect of a company. The employees always get to know when something is wrong and they will also report it and making sure the mechanism is such that you as investor also gets to know about it.

One of the trends that we witness is that while major investors are hiring us for assessing the financial statement, they also request someone from the forensic team to look into key risk area to avoid major embarrassment in the future. For example in terms of excessive cash - are the bank statement correct or forged? Are the sales what the company is telling us? Is there any money being syphoned out to related parties?

With foreign investors we are noticing an interesting point, perhaps because of the UK Bribery Act of the Foreign Corrupt Practices Act, they are all checking if the company has been paying bribes to get the business, etc. They are making sure they do the bribery and corruption due diligence before investing. So they want to know if you have the right policies, are they heavily dependent on government businesses?

This is the submission draft. The actual story had appeared in August issue of Money Today. You can read the final version. Click here or copy paste the given below link - http://businesstoday.intoday.in/story/return-value-yearly-systematic-investment-plans-sip/1/209784.html

Upgrading or learning a new skill

How many times you have felt that there is perhaps a need to upgrade your knowledge of the latest things in your field of choosing? Or how many times have you felt, that ‘it would be nice to know more about a subject that you had perhaps enjoyed during college days’ but the call of duty, from both personal and professional life, didn’t allow you the opportunity? Well now there is a chance to learn all of that for free through MOOCs. And there is also an option to pay and be certified.

MOOC

Massive open online courses (or MOOCs) are online courses trying to share college-level knowledge. All lectures and course materials are accessed online, and to check the knowledge given by the course there is a process whereby online tests would be available. In some cases there is a provision for peer review, where in other students will check your copy while you will check the other students’ copy.

“There are two aspects to MOOCs: a technology platform that can enable new pedagogy and mode of delivery that increases the reach to a much larger audiences,” says Sundar S Balasubramaniam, Dean, Academic and Resource Planning BITS Pilani. He further adds, “We believe that the technology is still evolving and there are many aspects of MOOCs which will complement conventional learning but also open up new modes of learning.” Balasubramaniam believes that MOOCs are likely to prove beneficial for mature learners and varied groups where learners will be able to learn at their own pace and way.

Isaac Chuang, a professor at Massachusetts Institute of Technology (MIT) for electrical engineering and computer science and of physics, and also co-lead of a research team from MIT and Harvard shares the vision and thought behind MOOC. He says, “MIT sees that MOOCs may lead to the spread of knowledge worldwide, and improvements in on-campus education, such as in residential universities like MIT and Harvard.”

Stanford, another world renowned university, runs its own instance of an open-source online learning platform (Stanford OpenEdX) that supports research and experimentation in instructional design. In a report on MOOC 2013, John Mitchell Vice Provost Stanford was quoted as “Stanford's vision is much broader than MOOCs. We're thinking about how we will best educate students for generations to come.”

There are two directories which track all major MOOCs available online – www.mooc-list.com and www.class-central.com. One can either look for universities followed by courses offered or they can search for specific topics like – computer science or artificial intelligence, economics, music, etc, – and then decide on the university. Among the most popular MOOCs are Coursera, edX, saylor.org, Canvas, Alison, Udemy, etc. 

How will it help?

Abhay Tandon, an employee at Scaale Capital, took a course through the platform of Coursera, from University of Maryland’s on ‘Developing Innovative Ideas for New Companies’. He says that his MBA degree gave a strong theoretical understanding, but Coursera classes gave him a firm practical basis, like realizing how investors in Spain differ from those in the U.K.

Shashi Kant, a student at IIT, is doing various courses from Coursera and edX related to computer science. He reasons, “I am doing courses related to computer science as it supplements my course and it could pay off in career too as it provides you world class knowledge at just no cost.” He further adds that in the industry, the tag of your college will get you a platform but after that an individual will survive only through knowledge. He says, “Many of my friends (mostly students) are also doing these courses to improve their knowledge.”

Ketan Kapoor, Co-Founder and CEO, Mettl, a skill based online assessment platform, says, “We have seen the industry move from knowledge based hiring to skill based hiring.” He points that on the job skills and competencies are the most important selection criteria for most organizations. “If individuals are taking up the initiative of upskilling themselves, adding new feathers to their hats - they definitely come across as self-starters and motivated individuals to the hiring teams - apart from the obvious skill adds,” says Kapoor. However adding a word of caution against high hopes, he says, “The candidate applying with a certain skill set learnt from MOOCs will have a disadvantage against an experienced professional who has used that same skill set in his projects.”

Ajit Joshi, who was previously working as National Presales Manager at Ingram Micro India, says "One of the interesting incident was when I started watching the videos of Introduction to Operations, I realized there were so many things that I can implement at my company bringing in more efficiency and better coordination between departments."

Ashutosh Telang, EVP & Global Head HR, Marico says, “At Marico, we encourage employees to continuously upgrade their knowledge. Learning by doing is core to our development philosophy and this is supplemented by training, education, perspective building and coaching.”

Kapoor’s views were resonated in Telang’s words as well. Telang says, “Education and experience play an important role in assessing an individual’s capability.” Furthermore he says, “While potential talent and talent within the organization upgrade their domain knowledge through online courses or MDPs, what really matters is the ability to apply this knowledge in their work context to make a difference.”

Futures of MOOCs

Telang opines, “Access to curriculum through MOOCs conducted by reputed institutes enhances the credibility of the education and as more people enroll in MOOCs, organizations will have to take cognizance of this and revise their hiring guidelines.”

“The average age of learners registering for MITx courses is between 26 and 35 years old.  Many of these folks are professionals seeking to learn new things.  Such lifelong learning will naturally be of interest to corporations seeking to improve their workforces,” says Chuang of MIT.  

Balasubramaniam of BITS Pilani says, “The best thing about MOOCs apart from the immediate and tangible benefits is that it is forcing educators and administrators to think about learning and education in a fundamentally new way. In India MOOCs have the potential to enable half a billion India youth to access expertise in different domains.” Companies in a few countries have only invested in MOOCs but are also leveraging MOOCs for in-house training. Acceptability may take a few years but it is bound to happen. 

The Tough Part

Scheduling is an important criteria if you are student/working professional - some MOOCs allow you to join anytime of the year and some have the semester system, some allow you to learn at your own pace and some have strict schedules for lectures and assignments. Some courses provide you with a certification and some don't.

“The main challenge I found was varying deadlines because different Universities have different time issues in accordance of IST,” says Kant.

The Easy Part

Among the benefits, the most common benefit that everyone talked about were, since it is a video lecture you can pause and rewind to as many times as you want until you understand the concept. In a traditional classroom, it is highly unlikely. Secondly, one can do it anywhere as per their convenience, whether traveling in a bus, sitting in a cyber cafe or relaxing on a Sunday at home. Third, classroom participants comes from all over the world, hence, giving a complete sense of global learning with lot of new perspectives added from different angles in the discussion forums.

In Kant’s experience, “the good thing going through this format is that you are completely free to go at your own pace. In many courses you'll get new iterations of the course in just one or two upcoming months so you can have multiple options of doing such courses.”

Additionally Tandon believes there is one additional benefit, he says, “These courses don’t cost much and thus are a major value-add for those who can’t afford to take up regular courses.”

A word of Advice

Telang of Marico suggests that one should select content that is targeted and meaningful. He says, “Choose a course with videos, scenarios, case studies, and other application- focused learning activities. Most important part is to apply MOOCs experience to solve a practical challenge in work environment.” It is important to recognise that each one of us has a distinct learning style, being aware of it and choosing the right course and media goes a long way in building the capability.

Kapoor of Mettl advises, “If your focus is employability, then it makes a lot more sense to pick courses that compliment your portfolio and help you gain skills needed for your dream job.”

“Test yourself on the problems.  Data is showing that learners in MITx on edX courses spend far more time and effort working on problems than using any other kind of resource provided by the course,” says Chuang.

This is the submission draft. The actual story had appeared in August issue of Money Today. You can read the final version (which includes experience of individuals). Click here or copy paste the given below link - http://businesstoday.intoday.in/story/free-online-courses-mooc-harvard-mit-bits-pilani/1/208508.html

Retirement funds now given same tax benefits pension funds

On SEBI's recommendation for the pension market, retirement funds floated by fund houses will now be given the same tax benefits as other pension funds with the new budget.

To read the full version Click Here or copy paste the given below link--  

http://businesstoday.intoday.in/story/new-pension-system-mutual-funds-pension-funds-tax-benefits/1/208596.html

"Please Don't Share About Your Pay with Coworkers"

Surfing across the plethora of reading materials available online, I came across this article When the Boss Says, 'Don't Tell Your Coworkers How Much You Get Paid' on The Atlantic. 

This article talks about the gag rule at companies and how the employees are discouraged to talk about their salaries or perks/tips with their colleagues. According to the article, though it is illegal in USA to tell your employees that they can't share about their salaries with co-workers but it is a prevalent practice. 

There were two interesting observations in it. The first was: 

"Even the most confident among us can melt into awkward, self-conscious messes when we have to negotiate our salaries, and asking a coworker about pay seems akin to asking about their sex life." 

Don't think the above  requires any further explanation. The second observation was: 

"Private companies are showing that opening up the books completely can work, while the public sector has done that for decades, yet many still fear that talking about pay would destroy our workplace collegiality."

This was quite correct, in public sector the pay scale is very transparent, even in India. Therefore the question is why such secrecy? How does it make a difference? 

While the usual argument that I managed to read is that employees may not put in the same amount of effort if they are not motivated. But let's face it, every work can be quantified and  some amount of quality check can also be introduced. I think the simple solution would be to give performance based bonus with some component of quantification, and some amount in terms of quality. Its also not necessary that all of this has to be paid in full. I agree setting up that process would take some time and cross-disciplinary understanding but its definitely possible! 

Well since I have managed to retain your attention so far, let's turn talk a bit on the focus area of this blog. When you are planning to invest in any company, always look into the amount of payment made to a CEO and boar of directors (given in the annual report). Also read any note on this subject and compare this over the years. It is most of the time a vital clue if you can trust the company on transparency level or not. A company which is giving undue among of money to its CEO, just because they are also founders, then it is definitely a red flag.

Similarly when you see the list of the members of the board of directors, check how people are related to the business or the founders or the CEO, and also how much are they paid and how often are the meetings held and their views sought after. If the members of the board of directors can bring industry or cross-disciplinary insight to the business and their fees is in line with the industry (check companies of similar size and in similar domain) then it is acceptable or keep an eye on the company with periodic review.

p.s. if you are reading this and can point out to some company which has implemented some unique and perhaps open structure of salary and also makes sure that performing employees are given due encouragement then do share with me. 

Circle Rate & Market Rate, what’s the difference?

Has your broker or the person from whom you were buying the land, flat, residential complex complained about the increase in circle rates? Have you read about the increase of circle rate in your city in the media? Did it raise the queries: What is a circle rate? And what is a market rate?

What is a circle rate?

Circle rate is the minimum value at which the sale or transfer of a plot, built-up house, apartment or a commercial property can take place. This rate is set by the state government’s revenue departments or the local development authorities. Rohan Sharma, Senior Manager Research & REIS, JLL India, says, “The circle rate is in line with what the state government officials’ perceive as the prices at which property sale or transfer should be undertaken.” Within a city, there are different circle rates for different localities.

Since the real estate market is opaque and there is no accurate price index, the purpose for setting in the circle rates is to put a check on speculation of property prices.

Sharma points that across all property markets in India, the circle rates are lower than the actual market rates because circle rate are not revised often enough to keep them in tandem with the market price.

Therefore, circle rates do not represent the actual barometer of ground realities.

Box 1:  Circle rates is the least price at which the transaction can take place. The associated stamp duty and registration charges for the sale of the property is always decided on the basis of the transaction amount. And this transaction price can be higher than the circle rate, hence the stamp duty and registration will be higher. For example, circle rate in Worli area of Mumbai is in the range of Rs 32,293 per sq. ft, where as the market rate is approximately around Rs 62,000 per sq. ft; hence the market rate is at a premium of 92 per cent as over the circle rate. Whereas in another part of the city, Bandra (West)the circle rate is Rs 30,398 per sq. ft as against the market rate of Rs 42,000 per sq ft. Thereby, the premium over the market rate is of 38 per cent (Rates shared by Capri Global Capital Limited). Hence in the above example, if the transaction is done at the market price then the stamp duty and registration charges will also be set according to the market price, that is the transaction price.

What is a market rate?

Market rates are the price that one pays to buy a property, it is determined based on the agreement between buyers and sellers. Sunil Kapoor, Executive Director, Capri Global Capital, says, “Market rates are determined by the seller's expectation of price and the buyer's inclination to pay.”

It is a price range arrived at by looking at actual transaction prices in a location, and is a better indicator of what sellers demand and what buyers are willing to pay. As these prices are determined by demand and supply, an area with lower supply but higher demand will inevitably command higher prices when compared to another.

The difference

Even though circle rates and market rates are connected, they have a limited impact on each other. In reality the market rates are never below the circle rate. A significantly higher difference between the two is an indication of lag between market perception of the value and the authority’s view of it.

This difference has also been stated as the key reason for black money transactions in the Indian real estate market.

In most cases when a property is sold or transactions, stamp duties and registration charges are usually paid by the buyer. “It has been argued that the increase in circle rates causes the rate of transactions to drop. Be that as it may, the gap between the circle rate and the market rate reduces and the proportion of genuine buyers with clear, accounted money entering into transactions increases. Though this may reduce transaction velocity, it also reduces the incidence of black money being parked into real estate assets”, says Sharma.

Revising the circle rates every quarter or once in six months will keep the market rate and circle rate more in tandem. At the same time, state governments' treasuries would generate higher tax collection from real estate transactions, as stamp duty is paid on a circle rate which is in sync with the market rates, or close to them. Also it will significantly help in curbing the incidence of black money and money laundering through real estate.

However, this will impact the property buyers’ with additional burden as they would have to shell out higher stamp duties, resulting in marginally higher transaction costs and overall cost of ownership.

But this act will help to remove the black money in real estate, and hence it would behave in a rational manner as far as pricing of projects is concerned. Rather than considering this as a wasted expenditure, it will be helpful in increasing the investment value, and therefore potential resale value, of the property. Finally, higher revenue for the government means more funds available for support infrastructure development.

As an individual should you look at the circle rate or market rate more often? Sachin Sandhir, Managing Director, RICS South Asia says, “Buyers should look at the market rate, as that determines their buying capacity. Market rate also indicate the extent of appreciation in an area.”

Ideally one should look out for the difference between the circle rate and market rate earlier and at current levels.  For genuine buyers a less difference between circle rate and market rate will be beneficial, since loans are given on the basis of the sales deed, which is often closer to the circle rates.

(This is the submission draft. The story had appeared in July issue of Money Today. To read the final version click here or copy paste the given below link--  

http://businesstoday.intoday.in/story/buying-property-circle-market-rates-comparison/1/207690.html)

Who has got it wrong -- SEBI or the Journalist?

Business Standard published a news article where it informs that SEBI has sent notice to 20 AMCs, for parking undeployed funds in short term debt instruments.

"By Sebi norms, an AMC cannot park funds in short-term deposits of banks in excess of 15 per cent of net assets of the scheme. The investment could be raised up to 20 per cent but only after the approval of trustees." -- Business Standard 

Now I think there is a serious problem with this news. Perhaps it is correct or maybe SEBI needs to do a bit of homework. Each fund has a strategy. Anyone who has been reading market history or has had the chance to see it will know that no strategy works all the time.

At one point in time, the fund manager will not able to find good ideas to invest in because of the strategy or the philosophy is not suitable for that market condition. In such times the choice for the fund manager would be limited. Either they can keep the money in some safe, liquid deposit or take risk beyond their comfort level. Therefore, this notice from SEBI’s does question their wisdom or the reporting standard?

I don’t know what to think! Perhaps the SEBI.

ETFs in India - Where they are and what to expect?

Why equity exchange-traded funds attract few investors in India.

Despite the potential to grow, ETF in India are slowly losing its relevance as active fund management still outperforms ETF in returns as well as on risk parameters

Mukesh Chothani, president at Investment Consultant Association in Nashik, some 170 km away from Mumbai doesn’t market, exchange traded fund (ETFs) to investors. The reason: Simple it doesn’t pay. Says Chothani, “Unlike equity mutual fund we do not get anything in an ETF. In Nashik the total investment market is about Rs 2,000 crore and ETFs investment is about Rs 50 crore. Among the clients whom I advise, about 1 per cent of the AUM is in the ETF segment.”

Cut to Aashish Somaiyaa, CEO and MD of Motilal Oswal Mutual Fund himself believes in parking his money in active funds than passive funds. Somaiyaa says, “I would personally prefer to invest in an active fund driven by a philosophy I understand, and agree to.” It’s interesting because it comes from a fund house that started from selling ETF funds to investors and today has changed their marketing strategy by selling active mutual funds. The reason being lack of interest in ETF’s in India.

Players like Chothani sells ETF to clients where he is sure that they would pay him an advisory fee. It’s not just Chothani but the trend is similar across Nashik and in the country and the number says it all.

The ETF space in the Indian mutual fund industry has a meagre share of 0.5 per cent of the equity asset under management (AUM) till the launch of GS CPSE Exchange Traded Scheme. After the GS CPSE ETS had garnered Rs 3395 crore, the share of the ETF/ETS in the equity space has risen to 2.45 per cent. Compared globally the ETF industry continues to grow, as investors and traders around the world become more familiar with the unique features of ETFs. According to E&Y, at the end of October 2013, from 215 providers on 58 exchanges.

Why is the ETF market small in India?

Awareness about ETFs is currently very limited. Maximum awareness is about the gold ETFs due to the popularity. Vishal Dhawan, Chief Financial Planner at Plan Ahead, an investment advisory firm, says, “Since a large number of ETFs are based on equity indices, and equities as an asset class has seen very limited participation from investors in the last few years, ETFs have naturally not got much attention.” He expects that as equity markets start to get enhanced participation, ETFs would become more popular as well.

Adds Rohit Shah, a SEBI registered Investment Adviser based out of Mumbai, “Indian savers love fixed deposits and real estate, they don't yet understand how ETFs can be leveraged in one's portfolio. Another reason is internationally ETFs are low cost products. In India, with AMC expenses, brokerage, securities transaction tax (STT), Demat charges, the ETFs aren’t attractive and the cost structure are very much similar with actively managed funds.”

Everyone accepts that the ETF market is not deep in India because there are less institutional investors in India who are using it as an investment vehicle. Vineet Arora, Head – Product Distribution at ICICI Securities says, “ETFs are not on the approved list of many institutional investors, even the IRDA has recently allowed insurance companies to invest in ETFs.” Meanwhile Vinod Jain, Founder of Jain Investment points that the institutional market is not deep in India as pension funds hardly invest in the Indian stock market.

“With the latest effort of the market regulator to bring in more transparency and shift the business model towards fee or advisory based structure rather than the commission based model, the ETFs will witness new demand from the retail investors as financial advisors would be recommending the product more often, considering ETFs are cheaper in cost and the advisor will look into the asset allocation for the investors,” says Aashish Somaiyaa, CEO and MD of Motilal Oswal Mutual Fund.  Adds Chothani, “In India we need to decide if ETFs will be promoted as an investment product or as a trading product.”

On the performance front, ETFs lag the active funds anywhere between 200 to 500 basis points. Interestingly, active funds have delivered higher returns on back of low risk. On an average the active funds enjoyed a beta (it measures volatility compared to the index) of 0.8 compared to a one of ETFs. (See: The performance differential --Active V/s Passive)

So should investors in India consider ETFs?

Experts believe otherwise. Investors should consider ETFs for the passive part of their portfolio, wherein they are looking for a passively managed lower cost solution. “International ETFs like the MOSL NASDAQ, GS Hang Seng Bees are other options that one can consider,” says Dhavan.

“This depends upon one's investment objectives, duration and current asset allocation. Since over a long period of time, ETFs can save on costs and therefore we normally recommend exposure of around 10 to 15 per cent exposure to ETFs subject to various factors,” says Shah.

There has been a raging debate on whether in a growing economy like India one should choose passive funds. PVK Mohan – Head Equity Principal PNB AMC believes that active fund manager is the choice to go for investors. “If I see the BSE mid-cap today, the FIIs own about 15 per cent of the index, the same thing 3 or 4 years ago was about 9 per cent. This tells you the interest. So the Alpha (measure of returns) generation potential continues in the near term. Over the next 4-5 years the alpha returns in India will be high, hence active fund management will be a better choice of funds.”

With the ETF segment being open to institutional investors like life insurance and pension funds, the segment has potential to grow and evolve. Investors, especially retail would be better-off investing in active funds than ETFs.

(This is the submission draft. The story had appeared in June issue of Money Today. You can read the final version Click here or copy paste the given below link--  

http://businesstoday.intoday.in/story/why-equity-exchange-traded-funds-unpopular-in-india/1/206320.html)

Tax Savings through Charity

Sharing is Caring and using the same for tax benefit.

To help in the hour of need is humanity and as much a part of the Indian Culture.

McKinsy & Company in its report, Designing Philanthropy for Impact, sums up the evolution of philanthropy in India, “India has a long tradition of philanthropic giving, with all religions promoting the concept of charity. Until the 1800s, giving in India was largely religious in nature and motivated by the search for individual salvation.

“Later, philanthropy also began to be directed toward social causes such as education and women’s rights. Throughout the 20th century, leading Indian industrialists established foundations and other charitable institutions of national importance (for example, the Indian Institute of Science, catalyzed by the Tata Group), some of which were partly inspired by the country’s freedom movement.”

Adding to this J.C. Sharma, Vice Chairman and Managing Director, Sobha Developers says, “We have been lucky to have had the opportunity to grow and live the lifestyle that not many people are privileged to lead. I believe it is our obligation to do our bit for the society.”

At one point or the other, most people tend to be involved in helping an unknown person through charity or philanthropy but there were some common queries among people.

The biggest concern was, ‘was the money properly utilized’ for the purpose for which they had been giving out charity.

“It was a big challenge to identify NGO's who genuinely work for the poor and needy of the society. So to best utilize our resources for a cause we created our own charity wing- The Paras Foundation,” says Pravesh Jain, Founder Paras Foundation and Managing Director, Paras Dyes and Chemicals.

Jain says, “It has been almost a three decade since my brother, Rakesh Jain, and I ventured into opening an old age home- Ghauranda.” The idea was to give home to homeless, our old age home provides comfortable accommodation, healthy food, health care, recreations etc. all free of cost.

“We do all our charity works through our own foundation as it is easy to monitor and evaluate. Hardly have we donated to others. But yes, in any special situation we do so after evaluating their track record and their ethics and dedication,” says Jain.

Prema Sagar, Founding Trustee, Genesis Foundation says, “There are various factors that go into evaluating an NGO. Some of the important parameters are background of founders, number of years in operation, impact of work, transparency, organizations associated with the NGO, reputation etc.”

Sagar further adds that donors can ask the NGO to provide details of how their funds have been utilized. And that the NGOs should also as a practice inform its donors about the impact that has been made by donations.

Rohit Shah, CEO, GettingYouRich and a Certified Financial Planner, says “While clients are donating money, they have no way to actually monitor the usage etc.” He then points out that organizations like www.giveindia.org are doing a good job by providing regular updates to donors. As an example, if someone has opted for education fees support to a girl, then they send progress reports on a regular basis.

The second aspect of the charity is that many people who are not aware that their charitable cause can also result in tax benefit. Samir Rahman, an IT consultant from Bangalore says, “I give out charity to religious and other NGOs in the space of the child support but I don’t look into the tax benefit angle of the same.”

The form 16 given to salaried individuals doesn't show any deductions on donations made under Section 80G. Therefore, any donation made that can qualify for tax deduction under Section 80G, for which you will have to furnish details of donations made while filing your return and claim a refund.

Post-retirement from Paramilitary Forces, Rati Acharya went to see NGOs and felt it was more about collecting money than serving the needy. So she started using her expertise as a doctor for serving the needy. "Being a doctor I started checking patients free of charge, started going for medical camps. And over a period of 15 years discovered an NGO who genuinely help people; they don’t take aid from anywhere and they organise their own camps and help people," says Acharya.

Acharya says, “If charity is to done with the aim of saving save taxes then it can be done by donating to an NGO, where the work of the NGO gives it the benefit of section 80G.” And then she adds, “If one really wants to help then that individual should give their time along with money, and they should see the effort people are putting before donating because it’s not about just helping; it’s about helping the one person who genuinely needs it.”

Ramesh Krishnan, a Cost & Management Accountant expert with Olive Lifesciences says, “My advice is that, people who want to give charity & donation should choose the institution approved by Income tax.” Giving an example he says that Government funds like – Prime Minister Relief Fund, Chief Minister Relief Fund, Earth-quake Relief Fund, Flood Relief Fund has 100% deduction eligibility etc. which is more beneficial. 

The third thing that may require some attention is where individuals would want to give out charity but they are not sure who to give. Tahseen Alam, Regional Advocacy Manager-EMPHASIS at CARE says, “It is important that one identifies for what purpose they would like to contribute. India is an emerging economy but there still exists massive inequality and poverty among sections of the population. Individual contributions play a role in addressing critical issues including children's education, women's empowerment, disaster response, livelihood support, etc.”  

(This is the submission draft. The story had appeared in June issue of Money Today. You can read the final version Click here or copy paste the given below link-- 

http://businesstoday.intoday.in/story/tax-saving-tips-contribute-to-charities-and-ngos/1/206573.html) 

Small-cap Stocks: Risks and opportunities

Understanding small cap companies and how you can find opportunities in it. Also understanding the risks involved in it.

The SRK Industries stock rose 2,000% from Rs 7.78 to Rs 185.70 in 2013. SRK, with a market capitalisation of just Rs 343 crore, has been making aprons and cots since March 2012. Last year, it started making inroads into the real estate markets of Mumbai and Tamil Nadu.
Does this mean you missed a great opportunity to make money? The answer, at the end of 2013, was a big yes. But wait. The stock fell 70% in the following weeks and was at Rs 55.60 on February 28. Now, does this mean that not taking part in the stupendous growth of the SRK stock was a wise decision?

Click here to read the full story.

Or copy paste the given below link -
http://businesstoday.intoday.in/story/risks-involved-in-investing-in-small-cap-stocks/1/205531.html

Mutual Fund: Method Over Mind

There is a perpetual debate about if investors should put their money with process oriented AMCs or with AMCs who have star fund manager?

In this story we dissect the different views on the topic.

Click here to read the full story.

Or copy paste the given below link -
http://businesstoday.intoday.in/story/mutual-funds-management-now-focus-on-process-not-leader/1/206340.html

Basics of asset allocation with a portfolio consisting of MFs

Most people think that its all about stock picking, and timing that leads to money making. While it may be true for someone whose only job is to manage investment, it is certainly not the case for an individual who already has a full-time job!

The trick to getting higher returns on your savings is understanding the art and science of asset allocation and practicing it, while making sure that you don't give it too much time or too less a time.

Click here to read the full story.

Or copy paste the given below link -
http://businesstoday.intoday.in/story/tips-for-asset-allocation-in-mutual-fund-portfolio-returns/1/206625.html

It is not often that I would update an old post. But here in making an exception is perhaps necessary. Just in case if you are more interested in reading the original draft and a cruder version then it's given below.

The key to wealth is Asset Allocation

The right asset allocation model is the key to building a mutual fund portfolio that helps you achieve your goals. First let’s refresh you on the basics of asset allocation. There are broadly 5 asset classes – equities, debt, foreign funds, realty, others and index funds. And within each asset classes there are many other sub-assets. (Refer: Asset Class Chart)

“The importance of asset Allocation to investment is similar to what oxygen is to human life,” says Rohit Shah, Founder of GettingYouRich. In Determinants of Portfolio Performance II: An Update by Gary P. Brinson, Brian D. Singer and Gilbert L. Beebower published in Financial Analysts Journal, May-June 1991, “It has been observed that 91% of the portfolio performance is linked to asset allocation. One typically has 40 to 50 years of life left after one starts earning money. Over such a long period of time, we believe that one's ability to move in and out of the right asset will be a key determinant to the portfolio ROI.”

Ajit Menon, EVP DSP Black Rock also reiterates the view, says “asset allocation is the best method of determining the right outcome for your investments. Close to 93.6% of the outcome of a portfolio is determined by the asset allocation you had and not by the stocks or products that you chose.”

PART -1

Now that we have established the importance of asset allocation, the next question for anyone would be, what is this wand of Asset allocation? Simply put, it is building the right portfolio to suit your needs.

Building a portfolio is a combination of art and science. It’s an art because one has to understand the investor’s risk appetite. “To build a portfolio using mutual funds, investor should link the investments to goals and map the schemes to risk profile”, says Shah of GettingYouRich.

The second question i.e. the science of building a portfolio is how do you actually do it? Before setting in the process to build a portfolio, one must give strong foundations by way of risk profiling and writing down their investment policy.

Menon of DSP Black Rock explains this in detail, “risk profile is made up of two parts - risk tolerance and risk capacity.” He further explains that risk capacity may vary, as it is based on circumstances, while risk tolerance is a natural bent and this doesn't change dramatically over a period of time. It will change marginally in 5-7 years.

A lot of people don’t believe in risk profiling, their argument is that risk profile changes from time-to-time. This is supplemented with the anecdote that, ‘when the market is not doing well, everyone’s risk profile is low. When it is doing well, suddenly everyone’s risk profile is high’. To exemplify, Menon says that an adventurous person would like to go for trekking, scuba diving and snowboarding. But when it is raining that person will not go out for trekking, but that doesn't mean the person is not an adventurer. Therefore risk tolerance is an inherent attitude towards risk.

Whereas risk capacity is different. If you have a dependent child, etc. then your risk capacity will perhaps be at the low; whereas if a person is single in a senior position with no dependant’s and no responsibilities then risk appetite could be very high.

Typically, as retail investors we all want the maximum returns at the lowest possible risk. However, we ought to be rational and realistic about risk and need to be risk-aware instead of being risk-averse. “If we are seeking good long term returns, our risk appetite needs to be congruent to the desired returns”, says Puneet Chaddha, CEO HSBC Global Asset Management, says.

Hence it is advisable and it’s best that for risk assessment, one meets a financial advisor.

After understanding one’s risk profile, investors should write an investment policy with goals and timelines clearly stated in it along with the risk assessment.  This should also be periodically reviewed.

Chaddha opines its best an investment policy is drawn between investor and financial advisor, where they agree to issues relating on how the investor's money will be managed and a drawdown of the financial goals and risk profile of the investor. “It is always a good practice to have it documented as both the investor as well as the financial advisor is absolutely clear on the expectations and deliverables”, adds Chaddha. Sanjay Chawla, Chief Investment Officer, Baroda Pioneer AMC adds, “Since goals and risk profile of individuals will change over time, it is important that the policy be revisited and updated at least once a year.”

Investment Policy (SAMPLE)

Goals	Time frame  (years)	Portfolio composition	SIP/Lump-sum
Sons Education	14	Equity 60%, Long term Debt 25 % , Short term debt or  cash equivalents 15%  or 5%	10,000 SIP
My retirement	30	Equity 75%, Debt  20% , Short term 5%	5,000 SIP
My European  holiday	2	Equity -0%, Fixed Debt 80%, Liquid 20%	10,000 SIP

PART - 2

The key theme that is achieved with asset allocation is portfolio diversification. Different asset classes and sub-set of asset classes do well in different periods of time, making it imperative that one invests across asset-classes depending upon their goal, time horizon and risk appetite.

Performance of different asset classes

Within asset classes, different sub sets also behave differently. Take for instance year 2013. The Large-cap fund category returned ~6% whereas mid- and small-cap funds returned ~3%. In the debt category income funds returned ~5% and liquid fund index returns were around 8.76%. On the other hand sector funds like technology fund returns were around 52%! Imagine if you were fully invested in midcaps in 2013 or if you were fully invested in liquid funds in 2005 when the liquid fund index returns were ~5%. (See: Best Performing Mutual Fund Category)

So there was a wide spread in returns from different asset classes/geographies. This is what active asset allocation seeks to address. Active asset allocation would adjust the portfolio exposure into various asset classes depending on their relative attractiveness, hence giving you the best possible outcome.

Chaddha says, asset allocation does not ensure a profit or guarantee against a loss – it can however, lead to better risk adjusted portfolio returns over time. “Hence, an active asset allocation portfolio adjusted for the investors’ respective risk profile could provide a good solution for the investors’ needs”, he adds.

Asset allocation is also the key to protect wealth. This is supported by a study, Karan Datta, National Sales Head at Axis Mutual Funds. “If we take the three base assets that is available to investors quite easily by way of mutual funds -- equities, bonds and gold, then in any single year two assets outperforms and the one asset class underperforms. Timing this is very difficult as we all know. Our study shows that if an equally weighted portfolio was managed then in the last 15 years that portfolio would have given negative returns only in one year and that wouldn’t have been 2008 but mid-1990s.” (See: Category Performance)

Part – 3

There are various asset allocation models you can consider once you have established your investment policy. Although customized asset allocation will be created by a financial advisor based on a person’s needs and risk profile.  There are three most common and talked about asset allocation model – Strategic Asset Allocation, Dynamic Asset Allocation, and Risk & Time Matrix Asset Allocation.

Strategic asset allocation: The individual composition of each asset allocation for each goal depends on your horizon and risk appetite and you must stick to this till your goal is achieved. Herein, the idea is to maintain the balance by selling over weighted assets and buying underweighting asset. The advantage is you need less monitoring and management fees; it reduced your risk too.

The idea here is that once an asset allocation like 60 equity and 40 debt is set then it should only be rebalanced once a year. Best suited for most investors.

Example, Ram is an investor who is saving Rs 10,000 a month for his retirement, which is 25 years away, and he started savings from 1^st Jan 2004. His investment policy states his risk taking capacity is moderate, that for the next 15 years he will be maintaining an asset allocation of 70% in equity and 20% in income fund and 10% in gold. And he will rebalance his portfolio on every Jan 1 of the subsequent years. (See chart on performance of Ram’s balanced portfolio vis-à-vis each individual asset class: Asset Allocation Sample).

Dynamic asset allocation: Your allocation is based on market factors, you decide the weightage based on the current market situation and the future outlook. You need to actively manage the fund, it will be more expensive and volatile, and not to mention the success depends on getting many factors right most of the time. Biju Behanan of Finwell India says, we do not recommend this strategy to investors as it is time consuming and highly volatile. While under strategic asset allocation you will have to rebalance once a year, under this philosophy it should be quarterly monitoring and one will have to take a call on the direction of the market.

Example, Shyam is also an investor, but he follows dynamic asset allocation. For this reason he reviews his portfolio every month and adjusts his asset allocation based on the economic and asset outlook that he perceives.

Risk & Time Matrix Asset Allocation: One can look at Aggressive, Balanced or Conservative asset allocation based on profile, goal requirements and available surplus.

(Given below is a sample of asset allocation matrix. It can vary depending upon the investment advisor)

Risk Profile/ Time Horizon	Upto 2 years	2 -5 year	More than 5 years
Conservative (Low Risk)	Liquid Fund 50%, Income Fund 50%	Income Fund 70%, Balanced Fund 30%	Diversified  Equity 70%, Income 20%, Gold 10%
Balanced (Medium Risk)	Liquid Fund 20%, Income Fund 80%	Income Fund 50%, Balanced Fund 50%	Diversified Equity 40%, Midcap Funds 30%, Income Fund 20%, Gold 10%
Aggressive (High Risk)	Liquid Fund 20%, Income Fund 70%, Balanced Fund 10%	Diversified Equity 30%, Midcap Funds 20%, Income Fund 40%, Gold 10%	Diversified Equity 30%, Midcap Funds 30%, Thematic Funds 10%, Income Fund 20%, Gold 10%

Rohit Shah of GettingYouRich, emphasizes that with passing of time, one is likely to have discharged responsibilities and with increasing age one typically needs to move towards less volatile investments. He further adds, “If the critical goals are discharged, then one can choose to be more flexible on asset allocation. On the other hand, if the goals are coming to maturity, then one may have to start moving the accumulations from say Equity MF to Debt MF.”