Mutual Fund Archives - Page 25 of 26

What’s the difference between arbitrage and equity savings funds?

As you might know, arbitrage funds make profits or hedge risks from buy-and-sell opportunities in the cash and the derivatives market. Whereas equity savings funds invest in equity, arbitrage and debt. They are allowed to invest a minimum of 65 per cent in equities. This will include arbitrage positions. They have a minimum of 10 per cent in debt too.

So, arbitrage funds and equity savings funds have only one thing in common. Both of them aim at reducing the volatility in returns using arbitrage. Now, what is arbitrage? Arbitrage is taking advantage of price differentials of the same stock in different markets. So, the stock will be bought in one market at a lower price and sold in another market at a higher price. Which markets are they? These are the cash and the derivatives markets.

Funds take opposite positions in each of the market. For instance, they may take a buy position in the spot market and sell position in the derivatives market to make profits or hedge or counter the equity risk. Essentially, the equity exposure of the fund’s portfolio is covered by the derivatives position. How does this help? Let’s say the stock the fund has purchased falls. The fund has already taken a sell position at a higher price in the derivatives market. This will prevent the fund’s portfolio returns from dipping.

Arbitrage opportunities are abundant only in volatile markets. If funds do not find arbitrage opportunities, they invest in short-term debt securities to lower equity risks. So, there ends the similarity between arbitrage and equity savings funds. Let’s look at the differences.

The differences

Portfolio

Arbitrage funds take offsetting positions on their entire equity portfolio in the derivatives markets. They leave a very small portion of their portfolio unhedged or open. As a result, the volatility of returns is neutralised in arbitrage funds and they will not see steep and frequent falls or rises.

Equity savings funds are an amalgamation of balanced funds and arbitrage funds. They have a portion of their portfolio in debt and the remaining in equity and some part of their equity will have arbitrage. Note that the equity portion will not be hedged completely. These funds leave a portion of their portfolio unhedged. This can be more or less based on their market research. If they feel that markets can move higher, they could decide to have a higher open position to maximise the gains.

There are equity savings funds that hold direct equity. They can actually hold significant amounts of direct equity. This means that they can have a net long equity exposure. In simple words, the extent to which they can buy stocks can be more than the extent to which they short the stocks. There are funds that are allowed to invest in foreign stocks. So, the risks are higher for equity savings funds.

Returns

Arbitrage funds will not deliver returns that match equity funds. This is because any price gain in stocks they hold will be limited by the opposite position they take using derivatives. Arbitrage funds usually provide returns that are slightly higher than short-term debt funds. In times of low arbitrage opportunities, their returns might get hit and they could fall to be on par with liquid or ultrashort-term funds.

Equity savings funds tend to provide higher returns in the short term because of their equity holdings. These returns tend to get averaged out in the long run. For instance, the one year return of ICICI Prudential Savings Fund is about 12% while the five year return is 7%.

Taxation

As per the present tax laws, fund houses are allowed to count derivative exposure as equity. So, arbitrage funds and equity savings funds are considered as equity funds. So, any gains on holdings of more than one year are tax-free up to Rs. 1 lakh. Gains of over Rs. 1 lakh will be taxed at 10%. Short-term capital gains, when the fund is held for less than a year, are taxed at 15%.

Suitability

Arbitrage funds can be considered by those in the higher tax brackets to park their short-term money. Note that arbitrage funds are not a substitute for liquid funds and might have higher risks than the latter. So, remember that arbitrage funds are low risk equity funds and not debt funds.

If you have a time horizon of one to three years and don’t want to look at balanced funds, you can consider equity savings funds. Note that it is best to remain invested in these funds for lesser number of years rather than for the long haul as the hedged portion of the equity will lower returns. Balanced funds capitalise on equity markets adequately and are suitable for long-term portfolios.

Note that under the equity funds umbrella, the standard mutual fund categories are many. This includes large-cap, diversified, mid-cap funds, small-cap funds, multi-cap funds, balanced funds among others. These funds are suited for all investors, depending on their risk appetite and are good long-term investments. However, arbitrage and equity savings funds are not for everyone and some research is needed if you want to invest in these funds.

How to invest in mutual funds for financial goals

You might have heard financial experts tell you that you can invest in mutual funds for goals such as your retirement or your kid’s education. This is because over long periods, equities have the potential to outperform every other asset class. However, you can use mutual funds for short term goals like saving up for your dream vacation or that SUV you always wanted to buy. Here’s how to invest.

The basics

While drawing up a mutual fund portfolio, keep these basic rules in mind: know the broad categories of schemes in the market, their purpose and how they work. For instance, knowing the difference between income funds and gilt funds—where they invest, their portfolio and what kind of returns they are likely to generate- will help you choose the right fund.

Ensure that the mutual fund you choose matches your risk profile and investment objective. Let’s say you know that you need to invest in equity mutual funds for your retirement. However, you have a low risk appetite. In that case, you will be better off investing in index funds rather than actively managed mutual funds. So, respect your risk-taking capacity. Do not go overboard on equities if you are not comfortable taking on the risk.

Earmark funds for each of the goals. Let’s say you are investing in ELSS mutual funds for your kid’s education that is 15 years away. ELSS funds have a lock-in period of 3 years. Once the lock-in is done, ensure you reinvest the money in another investment. Linking your investments to your goals will help ensure that you don’t use the money for other purposes before you achieve the goal.

As you move closer to your goals, start moving your money from equity mutual funds to debt oriented mutual funds. Say your kid is in class 10 and will go for engineering course after he completes schooling. Since you have only two years in hand, you should choose debt-oriented funds such as bond or short-term funds that will be available at any time. You also preserve your capital gains from equities if you move to debt mutual funds.

The ideal way to build an adequate corpus for your goals is to go step by step. Earlier you start, the better money you will be saving. Of course, you also need to stop along the way occasionally to make sure things are happening as planned. The closer you get to your destination, the more careful you need to be.

Choosing the fund

Have a mix of large- medium- and small-cap equity schemes if you are investing for long term goals. If you will need the funds in about 8-9 years from now, opt for mid and small cap funds. However, if the goal is five years away, you may want to stick to large-cap funds as they invest in well-established, top-rung companies and are, therefore, less volatile. They give reasonable gains when equity markets rise and are also comparatively less volatile when equity markets fall.

High risk funds like thematic funds can be considered to get the kicker in returns only if you have a higher risk profile. The idea is to take the equity advantage and yet control the risks you take. Choose well-performing equity schemes with established track record.

If you are investing for the short term which is more than one year, choose from a range of income funds, credit risk, dynamic bond funds, duration funds and bond funds. If you can take higher risks, you can invest in thematic debt funds such as Sundaram Banking & PSU Debt Fund. If you need to invest for less than a year, you could invest in liquid funds and short-term debt funds.

Diversification across funds

Diversify across and within mutual funds. Don’t diversify for the sake of diversification or over-diversify within asset classes. You can invest in up to three schemes in a category at most. Remember, one of the reasons you have opted for mutual funds is because you do not want to spend a lot of time on your investments. But you might spend more time on your mutual funds if you scatter your money across too many schemes. The rule holds true whether you are investing in the equity or the debt market. If you invest in too many schemes with the same or similar style, you could end up investing in same stocks through multiple funds. Even though there is no fixed number as to how much one should hold in one’s portfolio, it can be at the most 7-10 schemes. This makes it easy to manage your portfolio.

Portfolio review

If you think that your job is done once you have put your money in mutual funds, think again. Your portfolio may contain star performers, but just a couple of oversights could affect their performance. So, track your scheme’s Net Asset Value (NAV) on a monthly/quarterly basis. Look for changes in the scheme’s portfolio. Compare the scheme’s performance with that of the benchmark, or similar schemes of other mutual funds. Ensure that the fund is adhering to the fund objectives stated in the offer document. Read all those various periodic statements such as newsletters, and half-yearly and annual reports. Make sure you track your fund at least every 18-24 months.

Choosing the right mutual funds for each of your goals will help you achieve them without hassles and in right time.

PMS Vs Mutual Funds: Here is what you want to know

Portfolio Management Services or PMS are similar to mutual funds. However, they are offered only to High Networth Individuals or people having a large amount of surplus money. Most financial institutions promise customisation for your investments and say you will get higher returns when compared to other investments. This may not always be true. Here’s why PMS is not for all.

The difference between PMS and mutual funds

PMS are investment services that are based on your return expectations, financial requirements and risk profile. The services are provided for a fee. PMS are presently offered by independent brokerages, banks, mutual fund houses and other financial institutions.

Mutual funds are investments offered by Asset Management Companies (AMC). You need to choose the mutual fund based on your financial requirements and risk profile. There might or might not be a cost for investing in mutual funds.

Minimum investment

The Securities Exchange Board of India (SEBI) has increased the minimum investment for PMS from Rs 25 lakhs to Rs 50 lakhs. It’s just Rs 500 for most mutual funds and in some cases Rs 100 only.

Customisation

Mutual funds cannot be customised as per the needs of the investors. Even though PMS offers customisation, typically firms will offer this only to those who have a very large investible corpus of Rs 1 crore or more.

Most of the PMS firms including banks offer discretionary PMS services. Here, you will be given a few model portfolios. You need to choose a particular portfolio. The portfolio models will be different in terms of their style of investing. You need to take a look at the past performance of the portfolios.

Terms of investment

Note that PMS is an agreement between you and the service provider. So, the onus is on you to ensure that the terms are in your best interest. If you are investing in mutual funds, the terms are the same for all funds as it will be according to guidelines given by SEBI.

Charges

PMS charges are much higher than that of mutual funds as it provides more customised offering compared to a mutual fund. SEBI hasn’t set any limits for charges for PMS so far. According to SEBI, “a portfolio manager shall charge a fee as per the agreement with the client for rendering portfolio management services. The fee so charged may be a fixed amount or a return-based fee or a combination of both.” So, the cost structure might be ambiguous.

You will find that the charges are usually in two formats. One is the fixed fee model while the other is the profit-sharing model. Some could offer a combination of both. PMS firms will also charge you fund management fees. This will be apart from the depository charges, and GST. For instance, ASK Investment Managers Ltd. charges a fixed fee of 2.5% per year or you can pay 1.5% and opt for a profit-sharing model where ASK will get 20% of the gains if the returns are over 10%.

So, PMS charges can be as high as 3-5% of your investment. You can invest in a mutual fund with under 1% if you choose direct plans. Even if you use an advisor, there are mutual funds with the expense ratio as low as 0.5% of your investment.

Smaller industry

Consider this: The PMS industry is said to be worth Rs. 48,000 crores while the mutual fund industry is worth more than Rs. 27 lakh crores. The PMS industry is minuscule when compared to the mutual fund industry. So, the number of PMS products are also much lesser than the mutual funds that are available for you to invest.

Transparency

PMS firms need to tell you which securities were bought, which were sold and what profits were made. You can also know exactly at what price these investments were made. However, this is at the discretion of the firm. Some firms provide these statements every month while other give quarterly statements. Also updating your investment portfolio will differ from firm to firm. Some firms may update your latest portfolio statements on a daily basis while others might update only once in 15 days. With mutual funds, the NAV will be declared every day and you can get it from any of the financial institutions’ websites.

The returns

As you know, PMS is a high-risk product. The returns will become visible only in the long run. Historical data shows that genuine PMS products can only give you only slightly higher returns than mutual funds. You must understand that it’s not guaranteed you will get phenomenal returns using PMS. Note that according to SEBI guidelines, PMS firms cannot promise even indicative returns, let alone guaranteed returns.

There are a number of things that PMS firms will tell you but you should be proactive and ask them questions instead of blindly believing everything they say.

Lock-in period

PMS products usually have no lock in period. However, most of them have an exit load if you decide to close the account within a year. The average charge could be anywhere between 1.5% and 3%. Most PMS firms will not allow you withdraw partially. With open-ended funds, you can withdraw your money any time. There are funds with no exit loads.

Taxation

Most PMS companies hold stocks in your own demat or account only. So the taxation is like any other equity investment – short term capital gains tax of 15% and long term capital gains tax of 10% for returns exceeding Rs 1 lakh a year.

For equity mutual funds too, the taxation is similar with long term capital gains only 10% if the gains are over Rs. 1 lakh, and short term capital gains tax of 15%.

Ideally, you should opt for PMS only if you have a corpus of at least more than Rs 1 crore, and you can keep it away for five years or more. It is substantially different from the standard mutual funds. For any other investors with lower corpus, mutual funds are more convenient and easier to invest in.

Should you look at investing in pharma funds?

What if we say that a pharma fund has given 65% in the past one year? Don’t believe us? Mirae Asset Healthcare Fund has given a return of 65.05% in the past year. This is not a one fund wonder. ICICI Prudential Pharma Healthcare and Diagnostics Fund has provided its investors with 63.4% in the past year while Nippon India Pharma Fund has given 57% in the same time. So, what has been driving these funds?

Indian pharma industry least affected

As an investor, you must know that the covid-19 has led to decline in business for most industries in India. However, for pharma things have been looking up. For the industry, there has been improvement in business outlook for Indian markets and the US markets.

You must understand that the industry exports most of its products and this contributes to two thirds of the companies’ revenues. There have been increasing approvals for Indian companies and the currency upswings have been favorable. The pharma companies have been changing their products to suit the US markets. Data suggest that quarterly sales of pharma products in the US has been more than $ 1.7 billion. All this has added to earnings visibility for the pharma industry. So, brokerages have upgraded the price earnings (PE) multiples for most stocks in the sector. That’s the reason for most of the upswing in the stocks.

When it comes to Indian markets, manufacturing had declined to 50% in the April-May months. Now, things are back to normal and capacity utilization is good enough for the companies to serve the Indian markets. A report by Credit rating agency, India Ratings and Research (Ind-Ra) suggests that the Indian pharma industry is set for an upswing of 3%-5% this financial year regardless of the pandemic. Ind-Ra states that the increasing number of covid-19 cases will help improve revenues for the pharma companies. New product launches that had been deferred will be considered by pharma companies now that the economy is opening up.

May be this is the reason why domestic mutual funds have increased their investments in the pharma sector. According to Motilal Oswal, institutional investment in the industry has hit a 40-month high. The weightage of pharma stocks in the portfolio of the domestic mutual funds has increased by 2%.

Another point is that Glenmark Pharmaceuticals is the first Indian company to get the approval for a drug that can be used to treat coronavirus. Favipiravir is the drug that will be manufactured and marketed by the company for the treatment of moderate symptoms of covid-19. If the drug proves to be effective, Glenmark will enjoy first mover advantage. The company has started manufacturing the drug. It is expected to be in stores by next week and will likely be available pan-India. Favipiravir is moderately priced at Rs. 103 a tablet. The complete course of medication will cost Rs 3,500.

All these factors are in favor of the Indian pharma sector. Also, going forward, the industry will do well given the higher number of population aged 50+ in India and the need for drugs for the diseases that affect this society. So, the pharma industry seems to be a reasonable long-term investment.

If you are looking to invest in the industry, you can consider pharma funds.

Pharma funds

Pharma funds such as the Nippon India Pharma Fund, Tata India Pharma & Healthcare Fund, UTI Healthcare Fund and SBI Healthcare Opportunities Fund, have given more than 15% in the last three years.

Fund	AUM	1-year return	3-year return
Nippon India Pharma Fund	Rs. 2991.57 Cr	57%	20.41%
Mirae Asset Healthcare Fund	Rs. 581.1 Cr	65.05%	NA
ICICI Prudential PHD Fund	Rs. 1460.01 Cr	63.4%	NA
DSP Healthcare Fund	Rs. 412.35 Cr	58.75%	NA
UTI Healthcare Fund	Rs. 474.52 Cr	56.41%	17.08%
SBI Healthcare Opportunities Fund	Rs. 1138.75 Cr	55.21%	15.7%

Since these are theme-based funds, it is good for investors to limit allocations to under 10% of their portfolio. The investments should be made from a 3-5-year horizon. If you have a medium risk appetite, you can invest using the Systematic Investment Route (SIP) over the next few months. This will help average out the volatility in the stocks.

For investing in pharma funds or any investments you would like to do, contact us on investment@wealthzi.com or call Pradeep Pillai on 9891441777.

How are index funds different from large-cap funds?

Over the last couple of years, there have been talks about how index funds are performing better than actively managed mutual funds. First, let us look at why some of the large cap funds are just not able to beat the benchmark index.

Index fund vs large cap fund

A few years back, the Securities Exchange Board of India (SEBI) recategorised mutual funds. Why? This was to make sure that different schemes launched by mutual fund houses are clearly distinct in terms of asset allocation, investment strategy etc. Further, this was to bring in uniformity in the characteristics of similar type of schemes launched by different fund houses. This was to help investors to evaluate the different options available before taking an informed decision to invest in a mutual fund.

After the categorisation of mutual funds, large-cap funds had to invest a minimum of 80% of their portfolio in the top 100 stocks as calculated based on the market capitalisation of the stocks. Due to this, large cap funds are struggling to beat the benchmark index that is available at a lower cost. Note that before the recategorisation, several large-cap funds could take exposure to mid- and small-cap stocks and this helped them generate higher returns.

Now, what are the differences between index funds and large cap funds?

Large cap funds are actively managed funds. Funds where the fund manager decides which companies to invest in based on their research are called actively managed funds. All large/mid/small cap funds are actively managed funds.

Index funds are passively managed funds. Funds that track or mimic the composition of an index are passively managed funds. The index could be Nifty 50, Nifty Midcap 100, BSE Small cap, etc. For example, an Index fund tracking Nifty 50 will invest in all the 50 companies on the Nifty.

So, in a large cap fund, the fund manager decides which stock or sector to invest in. An index fund just tracks the benchmark index. There is no market research or intelligence involved here.

Since market research skills are needed for large cap funds, these funds have higher expense ratio compared to index funds. The biggest advantage of an index fund over a large-cap fund is its low cost. Fund management cost of an index fund can be as low as 0.17% whereas large cap funds charge anywhere between 1.5% to 2.25% as fund management charges.

Then, come the fund performance. Note that if the large cap fund manager’s views are right, the fund will generate higher returns or will outperform the benchmark. However, if the views don’t turn out to be right, it can lead to lower returns or under performance. For index funds, the returns will mimic that of the index.

The volatility of the index funds is generally comparatively lower than that of large-cap funds.

Who should invest in large cap funds?

Investors with a low level of risk tolerance can consider large cap funds. Investors who belong to the elderly age group or those who are nearing retirement should consider adding large cap funds to their portfolio. Even those who are looking at income can consider large cap funds with a good dividend history. The steady flow of dividend acts as a stable source of income. Investors with a long investment horizon and looking to invest for long term goals could channel their investments towards large cap funds. When compared to mid-cap funds and small cap funds, large cap funds are less risky.

Who should choose index funds?

First time mutual fund investors can consider index funds. It is a good way of getting introduced to the market at lower costs and lower risks. Those investors who are nearing their age of retirement could consider Index funds. Investors with low risk profile and limited capital can try index funds.

What’s the buzz in the marketplace?

With several large cap fund managers mimicking the benchmark index, wealth managers and other financial experts feel investors can make large cap allocation using low cost index funds. In these, fund managers don’t hold on to cash and there is no fund manager bias.

There are others who are saying that if you are going for an actively managed fund it is best to choose multi cap funds rather than large cap funds. Why? This is because these funds have the flexibility to choose stocks across the large cap, mid cap and small cap categories. So, while risk-averse investors can choose index funds, those with a medium or high-risk appetite could consider focused funds as part of their large cap allocation. If you are not sure about which fund suits your risk profile, financial situation and life goals, get in touch with your consultant at wealthzi.com.

How NRIs can invest using the FPI route

Non-Resident Indians (NRI) will soon be counted as Foreign Portfolio Investors (FPI) for putting resources into the Indian markets. The Securities and Exchange Board of India (SEBI) is wanting to make a different class of investors under the present FPI for NRIs. This move was reported in the Financial Year 2020 budget. Despite the fact that this was in September 2018, it couldn’t be executed because of the reluctance by the Reserve Bank of India (RBI).

This move, however, will make sure that NRIs take part in the Indian markets in more noteworthy numbers. Why? This is because investment restrictions in listed organizations will increase steeply for NRIs once they go under FPI. Another significant point is that NRIs can use the Indian markets without hardly lifting a finger since they can put resources into the Indian markets with the help of custodian banks.

Who are FPIs?

India is one of the developing economies and is one of the biggest as far as Gross Domestic Product (GDP) is concerned. That is the reason behind why India has developed as a significant place for investment flows from across the globe. Investments in India are made by global investors in Indian investments. These include stocks, government securities, convertible debentures, corporate securities, infrastructure securities, and so forth. These investors who make these investments are known as Foreign Portfolio Investors (FPIs).

What’s happening now?

At present, NRIs by and large put resources into India using the Portfolio Investment Scheme (PIS) route. PIS funds are regulated by the RBI and SEBI information shows that these investments are worth just Rs. 3,000 crores. However, once NRIs go under FPI, their funds will be adequately administered by SEBI and we will see more participants.

What is PIS?

PIS is an RBI scheme that empowers NRIs and Overseas Corporate Bodies (OCB) to buy and sell stocks and convertible debentures of Indian organizations on any recognised stock exchange in India. Such security buys are done utilising their NRI Savings Account with an assigned bank branch. One can decide to put resources on a repatriation or non-repatriation basis.

There are a few prerequisites for utilising the PIS course. One is that for any transactions in the secondary market that is done on a repatriable basis, NRIs will need a NRE Savings Account with a bank. For any transaction done on a non-repatriable premise, NRIs will need a Non-Resident Ordinary (NRO) Savings Account with the bank. NRIs should present the PIS application structure in the recommended format for assigning the referenced account as a PIS Account on a repatriation/non-repatriation basis.

What are the changes suggested?

It has been suggested that FPIs ought to get further access to the Indian markets and SEBI will increase FPI limits in listed organizations. By and large, there is a restriction of 24% on FPI interests in an organization. SEBI is hoping to increase this up to as far as possible utilising its board’s resolutions.

Also, NRIs can put just 5% in a listed organization. In the wake of putting the NRIs under the FPI, they can invest up to the maximum limit in an organization, which could be up to 100%. How? After the overall limit is raised, the limit for a company will be automatically set to the maximum limit for the sector. Nonetheless, note that if the organization wants lower FPI support, it can pass resolution to cut off the limit.

SEBI is hoping to give adaptability to NRIs as far as compliance and expenses are concerned. What are these? SEBI will defer the licensing charges for NRIs for enlisting as FPIs. The licensing expenses as a rule cost $2,000-5,000.

Another significant favourable point is the participation of NRI funds in the Indian market. NRIs can’t hold over 49% in an FPI. In any case, if NRIs are allowed to be FPIs, these limitations won’t have any significant bearing. Also, by and large NRI investments are liable to Tax Deducted at Source (TDS). On the off chance that NRIs are permitted to get through the FPI course, there will be no TDS. Note that SBEI has suggested that the Know Your Customer (KYC) standards for FPIs should be simplified.

Note that under the PIS framework, NRIs are can just contribute utilising the banks where they have opened Non-Resident Rupee External (NRE) accounts. In any case, when they go under FPI, they can utilise administrations of worldwide custodian banks, for example, Citi or HSBC to put resources into India.

Presently, several banks in India have NRE clients. As per information of RBI, NRE accounts had deposits of more than $90 billion toward the end of December 2019. However, the banks are not enrolled as custodians with SEBI. SEBI will presently take a look at permitting similar banks to give trading licenses to NRIs. On the off chance that this occurs here, it would guarantee a consistent progress.

NRIs can keep on contributing utilising the PIS route to make non-market investments including fixed deposits and recurring deposits.If you are an NRI looking to invest in India using the PIS or FPI route and need help investing, get in touch with advisors with wealthzi.com. They can help you choose the right investments.

How changes in interest rates affect your portfolio

Consistently, the Reserve Bank of India (RBI) changes the interest rates in the nation utilising its fiscal strategy. This influences various loans and deposits. You realise that loan rates change. Nonetheless, do you realise that your investments get influenced as well? Interest rate dynamics affect your investments too. In the recent years, RBI has been cutting interest rates. s

Why the rate cut

Lower loan costs encourage consumer spending in the economy. This gives the country a lift when it is in the midst of slower economic growth. Lower interest rates mean lower loan rates and this urges enterprises to obtain and put the cash in maintaining their business. When organisations progress well, the economy does well too.

In this way, the RBI utilises the fiscal strategy to keep the economy fit as a fiddle. At the point when the economy is developing and in great condition, RBI takes measures to increase loan costs to keep inflation under control. RBI controls the repo rate, which impacts long term loan fees in the nation. Repo rate is the rate at which RBI lends cash to banks in case of any deficit. By setting the repo rate, the RBI in a roundabout way changes long term interest rates, which boosts spending and in the long run encourages industrial and economic prosperity.

Now, how does this affect your investments?

Stock investors

Interest rate changes do not have any direct impact on your stocks. However, RBI’s actions can have a trickle-down effect. For instance, when RBI increases interest rates, banks increase their loan rates and increased rates for business loans can cause companies to halt expansions and reduce employment. Reduced business spending will lower the value of a company’s stock. The reverse will be true when RBI cuts interest rates.

However, note that there is no guarantee that a rate cut will positively impact stocks or a rate hike will reduce stock prices. For instance, falling interest rates happen during periods of economic slowdown coinciding with a bear market. So, stock prices might fall. The impact of the interest rate changes will depend on the stock you chose to invest in.

Debt investors

There is a direct correlation between interest rates and fixed income investments. For these investors, change in interest rates can have significant portfolio implications. How? Bonds and interest rates have an inverse relationship. When interest rates fall, bond prices will rise. When interest rates rise for an extended period, bond prices will decrease. Why does this happen? Newly issued bonds will have higher yields after interest rates rise, making bonds with low coupon rates worth much lesser.

Change in interest rates can directly impact bond yields. Long-term bonds having maturity ranging from 10 to 30 years will have substantial effects. Short-term bonds are less affected by interest rate changes.

If you have bond holdings in your portfolio, such as bond funds, liquid funds or money market funds, falling rates mean a lower return on your investment. If there is an increase in interest rates, deposit rates and debt fund returns will go up. However, understand that interest rate changes impact you, as an investor, only if you are going to redeem your bond holdings.

Let’s consider an example. You purchased a bond for Rs. 3,000. The RBI increases the interest rate and our bond’s market value drops to Rs. 2,900. So, the loss is Rs. 100. However, this loss is only on paper and if you hold the bond to maturity, you will still receive Rs. 3,000. Understand that most times bond price decreases will be offset by bond price increases at a later date if you stay invested.

Other investments

If you have invested in commodities, their prices will increase when interest rates fall and prices may fall when interest rates rise. For instance, gold prices touched an all-time high in India after RBI cut interest rates. If you have property holdings, an interest rate cut can be beneficial. Real estate prices are directly related to interest rates due to the cost of financing. Real estate becomes more attractive as interest rates fall.

What to do?

As interest rate changes can affect investments in different ways, there is no single action you can take. Knowing how to manage your portfolio can help mitigate any potential negative effects. Assess your portfolio and look at how individual asset classes are likely to be impacted by the interest rates. Based on how your portfolio is structured, you can decide whether you should take any action.

You should analyse each investment. For instance, in case of stock investments, try and analyse the industries that might get impacted by interest rate changes. Cyclical industries such as financial institutions, industrial companies, and energy providers tend to perform better when rates rise. Real estate, utilities, and telecommunication, might perform well when interest rates fall.

If you don’t want to do all this, just build a diversified portfolio made up of quality stocks and bonds. Diversifying can help preserve your overall investment portfolio from the negative effects of changing interest rates in the long run. With a balance of stocks and bonds, your portfolio will be better positioned to maintain stability.

Work with wealth consultants at Wealthzi.com to understand how you can minimise the risks arising from interest rate changes to your portfolio.

How to rebalance your portfolio

When you set up a portfolio, you will have an asset allocation for your portfolio. Asset allocation is an investment strategy that helps balance the risks and rewards associated with investing by apportioning the portfolio’s assets as per your goals, risk tolerance, and investment horizon. In simple terms, you will set the percentages for investments in debt and equity and the cash that you will maintain. However, these percentages don’t remain the same throughout your investing horizon. They change based on the equity and debt market movements. Let’s understand how this happens.

Let’s say given your risk tolerance, financial goals and their time horizon, you have decided that your portfolio should look like this:

Asset	%	Rs.
Equity	60	6,00,000
Bond	35	3,50,000
Cash	5	50,000

Over the years, the markets seem to be doing really well and a couple of your shares zoom ahead and before you know it, your portfolio changes to:

Asset	%	Rs.
Equity	71.0	11,00,000
Bond	25.8	4,00,000
Cash	3.2	50,000

You might want to ask, ‘What’s the problem? I gained Rs. 5,00,000 – isn’t that a good thing?’ Of course, it is. However, the problem is that, you have moved away from your original asset allocation and possibly exposed yourself to more risk than is not in line with your risk profile.

This is where you, as a sensible investor, should take some action to bring the portfolio back to the original asset allocation. This is rebalancing.

What is rebalancing?

Rebalancing is the process of buying and selling parts of your portfolio in a bid to rearrange the weight of each asset class back to its initial proportions. In simple terms, it is returning your portfolio to the proper mix of equities, debt and cash when they no longer conform to your financial plan.

Portfolio rebalancing will help you keep your portfolio in line with your financial plan. Understand that rebalancing is not an endeavor to time the market. You need to consider it as a timely reassessment and modification of your investments that will help you reach your goals while ensuring that your risk profile isn’t ignored.

How to re-balance your portfolio

There are different methods for rebalancing your portfolio.

Calendar rebalancing

Calendar rebalancing is the most basic approach. This involves analysing your investments in the portfolio at scheduled time intervals and then adjusting them to the original allocation at a preferred frequency.

Quarterly assessments might be preferred for equity investments because monthly or weekly rebalancing could be overly expensive. A yearly approach could also be considered if you have a higher risk appetite. You should determine the ideal frequency of rebalancing based on time constraints, transaction costs and your risk profile. A major advantage of calendar rebalancing over other methods is that it is less time consuming and least expensive for you as it involves less trades and the assessments are made at pre-determined dates. The downside to calendar rebalancing is that it does not allow for rebalancing on a more dynamic basis even if the markets change significantly.

Here’s how to rebalance using calendar rebalancing.

First you need to record your investments. If you have decided on an asset-allocation strategy and have purchased the right securities in each asset class, keep a record of the cost of each investment at that time, as well as the total cost of your portfolio along with the percentages for each of the asset classes. This historical data will help you compare them with present values in the future.
On a chosen date, review the value of your portfolio and of each asset class. Calculate the percentages for each asset class in your portfolio by dividing the value of each asset class by the total portfolio value. Compare this to the original percentages. Note if there are any significant changes. If not, it may be better to remain passive.

Constant rebalancing

A more responsive approach to rebalancing is constant rebalancing. Every asset class is given a target percentage and a corresponding tolerance range. For instance, an allocation strategy might say that the requirement is to have 30% in mid-cap equities, 30% in blue chips and 20% in bonds with a range of +/- 5% for each of these asset classes. Note that mid-cap equities and blue chips can fluctuate between 5% and 35%. When the percentage of any one asset class moves outside the allowable band, the entire portfolio needs to be rebalanced to reflect the initial asset allocation.

You can use any one of these portfolio rebalancing techniques.

When you find that changes in your asset class percentages have distorted the portfolio, take the present value of your portfolio and multiply it by each of the percentages originally assigned to each asset class. The figures you get will be the amounts that should be invested in each asset class to maintain your original asset allocation.
To achieve the original asset allocation, you could sell off some of the shares where profits have exceeded your expectations and invest those profits in debt. Another alternative will be to look at your other equity holdings and sell the underperformers. You could even introduce new shares or bonds in your portfolio to bring those percentages back to where they were.

It might seem okay to leave the portfolio alone, especially if you have made profits. However, the purpose of having an asset allocation is to achieve the best return for your risk appetite. Doing nothing will violate this. As a rule of thumb, when your allocations drift by 10% or more from your original allocation, you should re-balance. This could happen over time or following an abrupt rise or decline in one or more asset classes.

Portfolio rebalancing helps you stick to your financial plan. You should check your portfolio once a quarter and more frequently if there is significant gain/loss in an asset class.

How to invest in mutual funds during a market crash

Stock market crashes aren’t uncommon at all. For instance, in March 2020, the Indian stock market investors lost over Rs. 19,000 crores because of the Coronavirus and the slide in crude oil prices. These market crashes are usually well talked about and most investors are aware of these falls. Most of the time you might read articles about how fund houses purchased stocks in the market and that helped stabilise the market losses. Now, the question is should you follow fund houses and buy mutual funds when the markets crash? You will be investing in those funds that buy stocks at lower prices. Will this be a prudent strategy? Let’s find out.

What happens to your investments when there is a market crash?

You know that most stock prices fall when the overall market crashed. When it comes to your mutual funds, the Net Asset Values (NAV) or prices of the equity mutual funds will also fall as they invest in stocks. Typically, investors either panic because their returns are beaten down or they decide to buy the funds because the NAV becomes attractive.

What if you buy funds at lower NAVs? When you buy mutual funds during a market crash, you get more fund units as the NAVs have fallen. How? Suppose the NAV of your mutual funds was Rs 12 per unit. If you decide to to invest Rs 12,000, you could get 1,000 units of the fund. Let’s say the markets crash and the NAV falls to Rs. 8. At this price, you can get 1,500 units. This is much more than what you would have got before the crash.

Should you buy mutual funds then?

Even though getting more units looks attractive, how will you know if the NAV is good enough? Does lower NAV mean that the fund is actually undervalued? You need to do some calculations here. Let’s look at two scenarios. One, where you are putting more money in a new fund and another, where you want to put more money in an existing fund.

Investing in a new fund

You need to look at the past performance of the fund and compare it to its peers. You will need to look at various factors such as the entry load, exit load, expense ratio, among others as this will determine the cost of investing in the fund. Looking at several ratios such as alpha will help you understand if the fund is undervalued compared to peers. Since it’s not possible to compare NAVs of two peer funds, the best way to choose a mutual fund is by looking at information such as Sharpe ratio, Sortino ratio and Treynor ratio. Read this article for more information – The mutual funds ratios you need to know.

Also, if the fund you have chosen hasn’t fallen as much as its peers, don’t think it’s unattractive. In fact, it might be a better fund than its peers because it has resisted a market crash. Choosing dividend paying funds whose NAVs have fallen is a good strategy if you need income from your investments.

Investing in an existing fund

Look at all the funds in your portfolio. See how they have fallen after the market crash. Look at the NAV history of the funds. Check the average NAV of the funds. Choose a fund whose NAV is close to or below its average NAV. If the NAV of the fund is below its 3-year average, you could consider it as being undervalued if the fund’s fundamentals haven’t changed in those years. However, you need to check if this fall has happened because of the market crash or if there has been a consistent fall. If the NAV has been sliding much before the crash, avoid investing in the fund and look at whether you should exit the fund. The idea is to invest in a fund that is a performer and has slipped due to the market crash alone. You can invest in the fund using the same folio if you are investing in an existing fund.

Should you invest a lumpsum or step up your SIP?

Invest a significant lumpsum only if you have a high-risk appetite. Why? Because there is no guarantee that the markets won’t fall further. Let’s say the markets have crashed quite a bit and that you invest a lumpsum in a fund whose NAV has fallen by Rs. 5. If there is a subsequent bull run and the NAV goes up, you might feel you made a wise investment. If the NAV falls by another Rs. 5, you might have to wait longer for the market to move up. So, check with a knowledgeable financial advisor such as those with Wealthzi.com before committing a lumpsum after a market crash.

The best way will be to combine two strategies of investing a lumpsum after the markets crash and continuing to invest in funds as you always do. You can choose to step up your SIP. However, this beats the whole purpose of starting an SIP which is to remain unperturbed during market crashes.

How to invest?

Since investing after a market crash is risky, it is best to use your income from investments such as interest from fixed deposits and dividends from stocks and mutual funds. This way, you won’t be stressed about putting in more money. If you are using cash from your savings account, you might be disappointed if the markets crash further. The point is always use only money that you won’t need immediately for such investments.

What are perpetual bonds or AT-1 bonds?

Additional Tier 1 bonds or AT-1 bonds are annual coupon bearing perpetual bonds. So, they have no fixed maturity date and bondholders get interest on the bonds. However, these bonds will have call dates, that is, they can be called back by the issuing bank. Typically, this is at the end of five years. Does this mean you will get back your money then? Not exactly.

Banks are under no legal obligation to exercise the call options. So, they can decide not to exercise the call option and not repay bondholders on the call dates. To understand these bonds better, you need to know why they were issued in the first place. So, how did these bonds come about?

The origin

After the 2008 financial crisis, the Basel-III accord introduced the AT-1 bonds. This was meant to protect depositors of a bank on a ‘going concern’ basis. The essential element of these bonds is the imposition of losses on the bondholders if the bank’s capital ratio falls below a threshold level. This could be done without having to liquidate the bank. Now, what is this capital ratio?

According to Basel-III norms, total regulatory capital for a bank consists of tier-1 capital and tier-2 capital. Tier-1 includes common equity tier-1 (CET1) and AT-1. Since 2014, minimum capital requirements have been gradually increased. Basel III norms say that the minimum tier-1 capital requirement for any bank needs to be 6% of the risk-weighted assets. This 6% will have 4.5% of CET1 and 1.5% of AT-1.

To maintain these ratios, banks started issuing AT-1 instruments. AT-1 instruments had a contractual provision that the AT-1 bonds can be written down if a bank needs to raise its capital levels or they could be converted into ordinary shares. This was to happen if CET ratio threshold is breached. It could also happen if authorities such as the Reserve Bank of India (RBI) find that the bank has reached the point of non-viability.

What does AT-1 consist of?

AT-1 capital is made up of all the subordinated and perpetual tier-1 capital instruments issued by the bank that have not been included in CET1. It also has the share premium received from the issue of AT1 capital instruments. Any instruments issued by the bank’s subsidiaries and held by third parties will be included in the AT-1 capital too.

Basel III has actually defined 14 criteria for any instrument to qualify as an A-1 instrument. The criteria are different from that of CET1 as the AT-1 capital can be called after it has been issued. The bank cannot include any step-ups or incentives to redeem when they issue AT-1 bonds.

What do the AT-1 bonds offer?

As mentioned earlier, the bonds do not have a redemption date. They are callable at the initiative of the issuing bank only after a minimum period of five years. Supervisory approval is required for calling the bonds. The bank that issues these bonds has the full discretion to cancel coupon/dividend payments any time. So, the interest on these bonds isn’t guaranteed.

Coupon/dividends for these bonds have to be paid out of distributable surplus of the bank. The bondholders have to accept the losses on the bonds if the capital ratio falls below the threshold. The bonds will either be written down or converted to common shares. So, AT-1 bonds are quasi equity instruments that seek to protect bank depositors while leaving bondholders in high risk circumstances.

Then, why did mutual funds buy these bonds?

The answer is: yield. In comparison, AT-1 bonds across the globe offer over 5% yield while Indian AT-1 bonds offered yields of up to 12%. The yield for Indian PSU banks’ rupee perpetual bonds has been ranging between 8% and 12.5%in the past years. So, the higher yields lured mutual funds to invest in these bonds.

How have these bonds done globally?

Many years back, Banco Popular of Spain faced mounting losses. The European Commission, got the Spanish bank Santander to take over Banco Popular and imposed a write-down on AT-1 bond holders for close to 2 billion Euros. For Italian bank Montei Dei Paschi, 4.5 billion Euros worth AT-1 bonds were converted into ordinary shares.

In Europe, Basel-III doesn’t allow AT-1 bonds to be sold to individuals unless such investors have substantial wealth.

What about India?

Many banks have issued AT-1 bonds. However, it caught people’s attention only when Yes Bank got into difficulties. Yes Bank actually declined to exercise call options for its AT-1 bonds. It is estimated that the bank has issued AT-1 bonds worth Rs. 10,000 crores. Most of these bonds are held by institutional investors while a small portion is also held by individuals. RBI wrote down all the AT-1 bonds issued by the bank. Read how this will affect your mutual funds.

What’s the way forward?

Indian banks, especially private lenders, will find it difficult to sell AT-1 bonds in the coming years. Already, some banks have decided not to go ahead with the issues of these bonds. For instance, IndusInd Bank recently deferred its plans to sell AT-1 bonds.

The incident might have a broader impact on the banking industry. Industry experts feel that the yields of bonds issued by banks might go up as investors have now seen the clear extent of the risks these bonds have. Even though AT-1 is a riskier instrument when compared to a Tier-II bond, the market may not differentiate between them too much. There will be an increase in the risk premium for AT-1 bonds in the following years. Even those banks where the perceived risk is lower might need to sell the bonds at higher yields.

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Index fund vs large cap fund

Now, what are the differences between index funds and large cap funds?

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Investing in a new fund

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Should you invest a lumpsum or step up your SIP?

How to invest?

The origin

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Then, why did mutual funds buy these bonds?

How have these bonds done globally?

What about India?

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