Look at these MF schemes for great risk adjusted returns

We are passing through rather interesting times in the Indian economy and markets. The rise in the indices have had investors thinking as to whether it will be a good idea to keep buying as of now. By all conceivable logic, there is a correction round the corner. Is it likely to be momentary or very deep? We can only speculate in an intelligent manner.

In my opinion, it does not really matter much if there is a correction soon. Nifty will probably find support at 10800 plus levels and that is something none of us expected a couple of months back. In the scenario I see unfolding, we are very much in a structural bull run and corrections are going to be price based rather than time based. To that extent you need not really change your investment plans a great deal.

What about people who are starting off building a MF portfolio or ones who want to realign their portfolio to better funds, taking advantage of the current highs? Which funds should we bet on for the next 15 years or more? I gathered some inputs from experts managing HNI money and this is what they had to say:-

  • A good fund manager has generated 4-5 % alpha over the indices in the past 2 decades. For this reason avoid Index ETF in our markets right now.
  • There may well be a structural bull run in our markets over the next 10-15 years.
  • Multi cap funds will be the best suited for this time frame but look at other categories like large cap and mid/small caps too.

So which are the funds to bet on? Here are a few for you to consider:-

  • ICICI Focused Blue chip
  • Kotak Select Focus
  • Reliance Vision
  • SBI Pharma
  • Kotak 50
  • Franklin High growth
  • MOST 25
  • MOST 35
  • ICICI Value Discovery

You will not find many of your known funds here, but then these are futuristic in their likely performance. Go with them if you are willing to take some risks for potential higher returns.

However, if your existing funds are doing well, do not change for the sake of change.

PPF investments – what should your strategy be now?

Readers who have been with the blog since it’s inception will know that PPF is one of my favorite debt instruments. New readers may want to read the post on Why you must invest in PPF. As this post attracted a lot of feedback and comments, I had to do A follow-up post on PPF. Finally as readers wanted to know how I had used PPF for my own financial planning, I did the final post on PPF – A personal perspective. Apart from these there are several other posts in my blog which will give you an idea about how you can use PPF in retirement etc. Read through them and you will realize the power of this simple but powerful investment. Now several people have asked me what is likely to happen to the PPF rates in the current interest rate regime and whether investing in it is still a good idea or not.

Before we get to the strategies of how to deal with PPF, let us first look at the historical rates of PPF over the last 30 years. It will be interesting to see that, in general, PPF rates have tended to be sticky and except for a brief period when the NDA government tried to link it to prevailing interest rates in the market, changes have been fairly rare. Look at the data:-

  • Between 1986 and 2000 the rate was fixed at 12 %
  • Between 2000 and 2003 it went down every year and dropped from 11 % to 8 %
  • Between 2003 and 2011 the rate remained at 8 %
  • Since 2011 the rates have not changed for long and stayed at 8.7 %
  • With the market linking, the rates were really outside government control and dropped to 8.1 %, 7.8 % and 7.6 % in a few quarters

It is important to note that with the RBI signalling a turnaround in the interest rates of late and recommending that the small savings rate be bought in line with the bank FD rates, a change in the PPF rates is imminent. Politically the NDA formation believes in aligning rates of such instruments to the market rates, as they demonstrated the previous time, on the downward route. I fully expect the rates to go up to 8 % by end of year and maybe even higher around the next budget.

So what should a new investor do now? I believe that despite the rate cuts that will definitely happen from time to time, PPF remains the best debt instrument that you can invest in due to the EEE tax treatment that it gives you. Remember that you are getting less than 7.5 % from Bank FD and and after taxes it will only be a little more than 5 %, if you are in the highest tax bracket. You can invest in debt funds where the returns will improve with falling rates, but remember that with lowered inflation the cost inflation index will also increase less and the effective taxation of LTCG in debt funds may increase. Also, PPF is a long term instrument that builds investment discipline. But most importantly, over a period of time it builds you a suitable corpus that you can tap into at the time of your goals. should the time not be a right one for redemption of equities due to the markets doing badly. This is really the biggest risk in equity investment and PPF gives you a cover for it. My suggestion to all new investors will therefore still be to open a PPF account as early as they can and maximize their contribution there.

As far as existing investors are concerned, the choice is really simple. You should simply continue investing in it without worrying too much about the rates. You are doing this as part of a financial plan and need to stick with it. In the long term these changes in interest rates will keep happening and, despite the inevitable lower returns, PPF remains the most attractive instrument for the reasons mentioned earlier in the post.

The other aspect many investors have queries on is whether PPF is better than ELSS. I see this as a completely illogical comparison as the instruments below to completely different asset classes with diametrically opposite characteristics. You need to invest in BOTH equity and debt, it is never only one of them. Yes, they both qualify for 80 C deductions but that is about all. With capital gains from ELSS being taxed now, it makes more sense to choose the best equity MF possible and not be hamstrung to some ELSS fund just because you want to take the 80 C benefits. So go ahead and invest in PPF for debt and identify the best possible MF schemes for investing in equity. This combination is good and all investors must look at it.

In summary, do not get unduly excited by the coming rate changes of PPF to 8 % or greatly disheartened if rates again drop to7.5 % some quarters later. Continue with it if you are an existing investor and open a PPF account now if you do not have one yet. You will never regret it, I have not in 24 years.

PPF is a much maligned product due to investor ignorance

My post on PPF received quite an good response yesterday, in fact more than 500 visitors on a single day made it the most popular day for my blog. While many have appreciated the article and had nice things to say about it, there were several queries that were raised about it too. I thought it will be a good idea to cover these in a post for the benefit of all readers.

Maximizing PPF contribution is a stretch at the beginning of my career, should I really be attempting it?

  • How much you are able to put in PPF is a function of your income, expenses and other investments.
  • The long term compounding effect of PPF will grow your initial contributions the most.
  • Inculcating a habit of contributing to PPF is a good investment discipline that will be of use to you.
  • Maximizing the initial contributions will ensure that your PPF corpus reaches a healthy stage by the time you may need to withdraw from it for your goals.

I can withdraw money from PPF only after 6 years, what about goals that may be sooner than that?

  • Well, firstly PPF being a long term instrument withdrawal from it is not the preferred option. This is to be used as an option when it is not appropriate to redeem equity due to market conditions etc.
  • For goals that are in the next 2-3 years you need to plan other financial instruments like debt funds etc.
  • However, for an ongoing PPF account short term goals can be planned through PPF quite easily. You can just increase your contribution in an account ( maybe that of your spouse) which is not being maximized, earn tax free returns on it and withdraw the goal amount tax free when your goal arrives. Use this for goals like vacation or car purchase.
  • Finally, even though you can withdraw only after 6 years there is a possibility of taking a loan from it after 3 years. Again, I would not recommend it as it defeats the long term compounding objective but it is available in extreme cases.

When should I start a PPF account and when should I stop it?

  • I thought I had addressed it in my post but let me repeat it here. You need to start a PPF account as early as possible, even if cannot contribute a lot in it.
  • I started my PPF account when I was 29 and I consider that very late. My daughter is going to be 24 soon and she already has opened her PPF account. So has my son who is 21 and is still doing his internship !!
  • You do not need to stop a PPF account ever, just keep extending it for blocks of 5 years. When you need money out of the account simply withdraw the needed amount. You can withdraw a total of 60 % of your maturity balance prior to the extension. So if I have completed 15 years and have 30 lacs in my account, I will be able to withdraw 18 lacs over the next 5 years.
  • Unless you feel you need more money that this for your use, simply continue the account.

I already cover my 80C limits through my PF contributions, should I still try to maximize my PPF?

  • If you are in a happy situation that your PF contribution is more than 1.5 lacs a year, you can surely afford to maximize your PPF contribution too.
  • Remember that PPF and PF have different roles to play in your overall financial portfolio. I believe that PF should be kept strictly for retirement purpose and PPF used more flexibly for goals that come prior to retirement.
  • Maximizing your PPF contribution will really let your compounding work in the most effective manner.

Should I contribute to PPF or look at something like NPS as an option?

  • Again, NPS is a very different product from PPF and one should invest in it for retirement purposes.
  • NPS can be a good option to PF as it allows some exposure to equity for people who earlier did not have that exposure when contributing to PF.
  • Invest in PPF for the right reasons, most of these were covered extensively in the original post.

PPF gives only 7.6 % interest, why not invest in other products like Mutual Funds?

  • Understand that PPF is part of your debt portfolio, so you can only compare it to Debt Mutual funds. You should definitely be investing in Equity MF but that is a different story altogether.
  • Compared to Debt MF PPF has the basic benefit of being an EEE instrument as far as taxation goes.
  • PPF does not have fluctuating returns and this is a very important consideration for compounding to work effectively.
  • It creates a great habit of investing regularly. Even if I wanted to, I do not know how easy it will be to put 1.5 lacs in a Debt MF every year. I find that quite easy to do with PPF.

Why did you close your wife’s PPF account, when you are advising to continue it forever?

  • Well, this shows the reader was paying attention while reading which is great.
  • Normally, I would not advocate closing a PPF account on maturity but there can be situations where it makes sense.
  • In this particular case we needed the money for making the down payment for our Chennai apartment. Availability of this money meant we had to take a loan of 15 lacs, not something closer to 30 lacs.

Can you share the details of your personal experience of using your PPF account?

I have no problems with sharing it but will do so in my next post. In the meantime keep your comments coming.

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PPF investment is a must for every investor

I have been a supporter of PPF for a long time now and it has been a cornerstone of my financial planning since my early days of investing. It is also a topic over which I have had several debates with many of my friends. The commonly held view is that PPF is an old and stodgy product, rates are controlled by government, it is essentially having poor liquidity and is not something that you need if you are having PF.

Let me explain in this post how I have used PPF and why I think you must have it in your portfolio. I will do this by explaining some of the aspects of PPF and drawing upon my own experience in this.

The first thing to understand about PPF is that it is a long term product and needs to be viewed and used as such. The normal term of a PPF account is 15 years and this can be extended indefinitely in terms of 5 year periods. That being the case, you need to open a PPF account as quickly as possible and keep it going for as long as you can. You must also do the same for your spouse at the earliest opportunity. I had opened a PPF account in February 1994 and it is now in its’ 24th year. My wife has had her PPF account mature a few years back and we have opened another one for her 6 years back.

The second important aspect of PPF is the taxation, which is EEE mode and therefore quite unique among all investment options. This essentially means that you get tax benefits on investment, on the interest earned and also on maturity. LIC policies and PF also give you similar benefits but are nowhere near as flexible as PPF. While one can argue that the government policies can change, PPF is the saving option available to the vast number of workers in the unorganized sector and the chances of this happening are really quite slim.

The third important aspect of PPF is that it is a product that demonstrates the compounding principle like no other product does. You can keep investing in PPF over the years and the compounding logic will work its’ magic quietly. The longer you keep your account going, the more you benefit from it. When I look at my own planning, if I keep my investments going in the PPF account for another 10 years, about 50 % of my retirement expenses can be met from this avenue itself.

The fourth important aspect is PPF instills a sense of disciplined investment of a fixed amount every year. Though the amount you can invest is flexible, once you get into the habit of investing the maximum amount at a particular time you will always do it. Human beings are creatures of habit and once it is formed you will tend to follow it diligently. I invest 1.5 lacs every year by the 5th of April and have known many others who do the same.

The fifth important aspect of PPF is the stability that it provides to your portfolio. While there are other instruments that provide far greater returns on your investment, none of these are giving guaranteed steady returns like PPF does. Over a period of time this builds up to a very substantial figure and serves as a hedge for the fluctuations in the other parts of your portfolio. Investing 1.5 lacs regularly in PPF for 35 years will end up as a corpus of 3.28 crores !!

However, while I like PPF for all of the other things, the real importance of it to me lies in the way I can use it in my overall financial planning. There are really 3 definitive uses that I have of PPF in my financial planning and they are as follows:-

  1. In my current state of financial independence it provides me with a buffer that I can use should other things go wrong. For example, I earn a fair amount of dividend income from my stock portfolio. While this is good, there can be years where the dividend is less due to market conditions. In such a case, I can withdraw some amount from my PPF to meet the shortfall. Note that this is tax free.
  2. I have explained several times that the greatest danger of wealth destruction lies in selling equity at the wrong time. Yet many of us are forced to do it in order to meet a goal. Having a PPF account for a long time ensures that I have enough in it to meet any of my goals save retirement. This means I am free from the vagaries of the stock market. If my goal arrives at a time when the markets have crashed, I simply use money from my PPF.
  3. Once I retire I may or may not keep putting the full amount in PPF depending on funds availability. However, I will continue both of our accounts as it gives me tax free interest at a good rate. In this respect, it is similar to the tax free bonds that some of you may have invested in. I will withdraw money from it as needed and in the end it can be a pretty neat sum for my grandchildren.

Let me now suggest an innovative way of using PPF for short term goals. You may have PPF accounts which you are not funding fully today. Let us say you want to take a vacation abroad in 5 years time. The normal way will be to invest in debt funds or RD / FD etc. However, these involve fairly complex transactions in terms of purchase mechanics and taxation. A far simpler way will be to fund your PPF account with the required amount every year. You earn tax free interest and can simply withdraw the money when the goal is at hand.

My recommendation is that anyone should open a PPF account as early as possible, contribute to it as much as they can, keep it going forever and withdraw from it based on their financial plan. It may not be glamorous or exciting but this is one solid investment that you can depend on and will always stand you in good stead.

I will be happy to answer any specific query that readers may have on investing in PPF.

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Nifty at life time highs – should you cash out your large cap MF’s ?

For some time now Nifty is going great guns and is at a  life time high. Whenever such an occurrence takes place , there is a chance of some correction in the immediate future. This is probably the reason why I have got a lot of messages asking me as to whether it will be a good idea to sell the entire MF portfolio, be in cash and again buy the MFs once the markets seem to have finished the correction.

First things first – your MF portfolio will probably have large cap, mid cap, multi cap and small cap funds in it. Note that Nifty is the benchmark index only for large cap funds and therefore, it makes little sense to be thinking of selling the other types of funds that you hold. As you will see the NAV’s of several of these funds are well below what they were in January and the SIP’s you made in those are probably running at a loss for 2017 investments. So the issue really is this – now that Nifty has crossed 11500, is it a good time to sell your large cap funds and make money, maybe invest in a lump sum when the market inevitably goes down at some point?

Is it possible that you will make money in the short run through this approach? The answer to that is “yes”. Is it therefore a good idea? The answer to this is clearly a “no”. in order to understand why this is so, you need to understand how MF works in the first place. The fund manager has a certain amount of money available and he is buying stocks with it. These set of stocks for a particular scheme will keep changing. The fund manager is doing these changes and you pay him for that very reason. Now if the markets are going down the fund manager may selectively sell some stocks and buy others. As such the scheme you sell and the one you buy are fundamentally different. If you are in the scheme as part of your long term goals then it makes absolutely no sense to sell off the schemes when the markets are at highs. For all you know your fund manager is taking the appropriate decisions by selling some stocks at their highs and buying others which still have a lot of value in them. Do not try to second guess a person who is professionally trained and does this for a living. Just because you can play around with spreadsheets and calculators does not make you competent to take such decisions.

Now what if these funds are not part of your long term portfolio? Well, if you are to sell them anyway then you might as well sell when they are at their highest or near it. In that case my recommendation would be to sell NOW. Yes Nifty can still go to 11700 plus this year and maybe even 12000, but those are fraught with uncertainties. You might as well sell off now and wait for a 5 % drop or more to buy funds that you want to be in for the long term. As I said before with the same fund it does not make sense to change but if you are changing your fund you might as well look at a better entry point.

What if your investments are in Regular schemes and you want to shift to Direct schemes? The same logic will hold – sell NOW and buy after a while.

Over the years I have invested in several schemes and have now reduced it to 5 only. The current market gives me a great chance to clean up my portfolio, in terms of the large cap funds which I am presently not investing in. How do I intend to do it? Read the future posts or the earlier ones in the blog to find out.

Compounding of equity returns – the greatest fallacy in financial planning

In several of my blog posts I have written about the frequent wrong usage of Maths to create misconceptions in investing which are not factually true. One such glaring misconception is for investors to feel that there will be compounding returns on equity investments, at least over the long term. This is simply not true and I would have thought that most investors would be able to understand this. However, as I have got quite a few queries and requests for clarification, let me do so here.

To start with let us fundamentally understand what Compounding is. I have used the following definition from Investopedia:-

DEFINITION of ‘Compounding’

The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings.

Essentially compounding involves some positive return on your asset, irrespective of what the return might be. Due to this the absolute value of your investment will always be increasing. Note here that we are not talking of inflation and Real returns here. For example, if I have a FD of 1 lac Rs and it pays me an interest of 8 % today then at the end of 1 year I will have an amount of 1.08 Lacs. Now if inflation is also at 8 %, my real return ( interest rate – inflation rate) is 0 and I have not really gained anything in terms of my purchasing power through this investment. At the same time, the absolute value of my investment has definitely grown by 8000 Rs in the one year period. This 1.08 lacs becomes my principal amount in the next year and I earn interest on this new amount. So in effect, compounding entails my earning interest not only on the principal amount but also on the interest amount.

The usage of compounding logic works great with debt products where the interest rates are relatively stable. Take an FD as an example again. At 8 % interest rate your money will double in approximately 9 years, at 12 % rate it will double in approximately 6 years and so on. Your money always grows in absolute terms, ignore the real growth for this discussion.

Now let us look at equities and see if this logic can be sustained in the light of our knowledge of it. If you look at stock prices over a period of time, you will see that it is clearly not so. Let me give you some examples from well known companies and their share prices from fairly recent memory:-

  • ITC reached 400 Rs and is now down to 300 odd levels.
  • Tata Motors went to 600 and then declined to levels of 250.
  • Reliance has had negative growth over years, so has Tata Steel.
  • Some company shares like Kingfisher Airlines and Gitanjali Gems have become penny stocks today.

There are also many examples of company shares having done extremely well and generate spectacular returns. My point here is simple – equities can give great growth but the way to understand that is not through the compounding principle. The growth in equity is non-linear and carries serious risk with it. Now at this point, people may tell you that over the long term of 15-20 years the compounding logic will hold true for equities. Sorry, it does not – if you bought the shares of Deccan Aviation at 146 Rs in the IPO , you have lost this money pretty much forever, never mind how long you are going to wait.

When I think about why there is such a great misconception about something really straightforward, I could come up with the following reasoning in my mind:-

  1. Most people invest in equity through Mutual Funds. As a MF scheme maintains a portfolio of stocks, the overall NAV of the scheme would normally increase in a reasonably good market, which we have had in recent years. If you take the mid cap and small cap funds in 2018, you will see the extent of loss that your schemes have suffered.
  2. Of course, the above can change in a prolonged poor market, but not many of today’s investors have had this experience. 2008 through 2010 was such a phase but has been mostly forgotten now. That is why many investors are shocked in 2018 when the NAV’s  of their Mutual fund schemes went south in a big way.
  3. The usage of CAGR term, somehow makes one think that equity investments compound. This, of course, is complete nonsense but I have seen many sensible people believe this. CAGR is an artificial construct to understand annual returns, it in no way says that such returns are stable and not even that they are positive. In fact you can have negative CAGR and negative IRR / XIRR quite easily.

So, if it is clear by now that compounding logic is irrelevant to equities then how do we go about financial planning with equities as an investment asset class? I will answer that in a future post. For now, do understand that you cannot just hope that you will invest in stocks and it will give you an XIRR of 15-20 % because that has been the historical returns in the index. I really wish life were that simple for me and you, but it does not work like that.

Take heart though – we can make great returns from equity, by understanding the correct ways of investing in it.

Interested readers may pls follow my blog on email by clicking on the relevant button on the right hand panel. I will shortly be stopping the practice of posting the links in different Facebook groups. Following the blog will ensure you get intimated whenever there is a new post.

Mayhem in Small caps – How did your MF schemes fare?

While the sheer number of investors who diligently invest in MF schemes as part of their investment goals have reached great levels and continue to rise rapidly, several of them are unaware of the details and nuances of the dynamics of investments. Many think that MF investments are a one way street, where you will pretty much have unidirectional growth. Some group of investor’s think that they should choose the MF scheme purely based on recent returns and not look at anything else. This resulted in great subscriptions to the mid cap and small cap funds over the last 2 years. In 2018 the fall has been brutal and have shocked many investors.

In the past few months I have received innumerable queries along these lines – is it a good idea to redeem these funds now, should we stop investing in these, what is the future outlook and so on. While I will take stock of the mid cap mutual fund schemes I have in my portfolio in this post and answer these questions, let us first try and get some facts straight about the more popular mid cap funds I hold.

  • DSP Blackrock Small Cap Fund
    • 52 week high NAV of 73.41 Rs was reached on Jan 9th, 2018.
    • Current NAV is 59.22 Rs, so the fall from peak has been nearly 20 %.
    • Returns of 6 months and 3 months are negative, and fairly high at that.
    • 2, 3 and 5 year XIRR stand at 9.2 %, 11.3 % and 33.3 %
    • Clearly a fund that has not been managed well and done much worse than small cap index in this year, which is down by 17 % YTD.
    • Moreover, Nifty Smallcap 100 has shown better growth in terms of XIRR in the 2 year period at 25 %
  • Franklin India Smaller Companies Fund
    • 52 week high NAV of 64.78 Rs was reached on Jan 9th, 2018.
    • Current NAV is 57.75 Rs, so the fall from peak has been nearly 11 %.
    • Returns of 6 months and 3 months are negative for the fund.
    • 2, 3 and 5 year XIRR stand at 12.2 %, 13.2 % and 30.2 %
    • Clearly a fund that has  been managed well and done better than the small cap index in this year, which is down by 17 % YTD.
    • Howver, Nifty Smallcap 100 has shown better growth in terms of XIRR in the 2 year and 3 year periods at 25 % and 31.6 %.
  • ICICI Prudential Small cap fund
    • 52 week high NAV of 31.01 Rs was reached on Jan 24, 2018.
    • Current NAV is 25.91 Rs, so the fall from peak has been nearly 16 %.
    • Returns of 6 months and 3 months are significantly negative for the fund.
    • 2, 3 and 5 year XIRR stand at 9 %, 7.5 % and 17.4 %
    • Clearly a fund that has not been managed well and done almost as bad as the small cap index in this year, which is down by 17 % YTD.
    • Moreover, Nifty Smallcap 100 has shown better growth in terms of XIRR in the 2 year and 3 year periods at 25 % and 31.6 %.

It is clear from the above that the DSP BR and Franklin  funds are relatively better  managed funds here, and the ICICI fund is struggling big time. If I want to have just one small cap fund in my current portfolio then it will be the Franklin fund.

What should I do with the other funds and what will be your best strategy? Firstly, do not act in haste, even if the figures may be telling you to get out of some fund. Secondly, understand that when the market falls as a whole, the large caps recover faster, the mid caps follow later and small caps are the last . We have to give time for this. Thirdly, due to the SEBI classification, many small cap funds have had to churn their portfolio quickly and this has resulted in some exaggerated poor returns in some of them. Based on these parameters here is what you should do:-

  • Do a similar analysis as I have done here to identify which of your small cap funds you want to keep and what will you ideally discard.
  • Keep a close eye on how the Nifty small cap 100 index is doing and what is your fund performance relative to that.
  • I expect the index to do more in the next couple of months, so there is very likely to be a recovery in the NAV values.
  • Once the index turns around, look to sell off the funds you want to discard at one go. From then on invest through targeted buying in the fund which you have decided to keep.

In the small cap fund space there are clearly laggards and  terrible laggards – you must be with the better options out of a universal set of bad ones.

Any way you look at it, your long term portfolio has taken a hit and you can only hope that in the long run you will recoup some of these losses.