SEBI to eye e-commerce companies for selling mutual fund - way forward?

SEBI to eye e-commerce companies for selling mutual funds reminded me of what happened with Motorola.

The fortunes of Motorola revived due to e-commerce portal Flipkart when it started selling moto phone models in 2014. Always a user of motorola products in the previous decade, I was an early adopter of a Moto-G phone. So, when any one around me asked me about a phone for purchase, Moto E/G, due to the “value for money” proposition was the obvious suggestion. However, the biggest concern (with 100 percent strike rate) was “post purchase service”. Does Motorola have service centers around the city/country? was the popular enquiry. I had to literally coax them to buying Moto stating that the servicing may not be required at the first place and  even if it is required our “around-the-corner” mobile service centres will be equipped. Moto was a big success for both Motorola and for Flipkart.

I am glad that SEBI is thinking creatively to increase penetration and dismiss the theory that they are just following the herd mentatlity of every thing going digital. However, I am intrigued about the modus operandi.

Firstly, there is a talk of new plans for each online player. Like in other countries, there could be different share classes for each fund. Depending on the commission paid to e-commerce companies, there could be multiple plans – one for flipkart, one for snap deal, one for paytm etc. This will take mutual funds back to pre-2009 era where SEBI in all its wisdom (and rightfully so) thought that there should be only one saleable plan – the regular plan – no institutional, no super institutional, no retail et al. Again in 2012, came the advent of direct plans. That doubled the number of plans available to deal with. Now comes FK plans, SD plans, PTM plans among others and not to forget their daily/weekly/monthly/quarterly/yearly dividend options.

 

Alternatively, there could be only one plan for e-commerce players. Defining a seperate TER (Total Expense Ratio) may do the trick. The draw back in this is that this channel can mobilize larger assets but still get paid lower than the traditional channels. To ennumerate, a fund charging TER of 2.5% for regular plan may pay 1% to distributor. E-commerce plan may charge 2% and pay 0.8% to the ecommerce company. Why should the online company agree? I hope predatory pricing is not allowed in one form or the other. Else, it would tantamount to “paying back” the investor to acquire him.

One more element which needs to be focussed on is that investment unlike consumption does not involve instant gratification. In whatever way the information about a fund for purchase (after research and through use of analytics) is presented, there will be other funds which would better. There comes the element of dissappointment to the investor and I am not sure how ecommerce companies will be equipped to deal with this. The new model may remove any human interaction. The investors usually need human intervention during periods of market crashes – Yes! There will be bad times in markets as well.

Post the spending binge, the e-commerce companies will return to normal pricing. In this steady state, the gross margins on goods sold would be in double digits (20-50%). Compared to this, the best margin in a mutual fund is 1% and that too as trail (thanks to recent guidelines by AMFI). Will ecommerce companies be excited to participate in this opportunity? Or should SEBI focus on getting MF Utility equipped to deal with this opportunity. Sadly, in over two years of wait, all I have seen is an issuance of a number (yet another in ones life called CAN) and no online facility. Already exisisting  online portals need to be assisted – especially on the long winding-never ending KYC process.

While one may not turn a blind eye to the growing digitization era, the traditional channel should also be supported and expanded. There are harldy 20,000 active mutual fund distributors (and sadly most of them distribute insurance, amway products, tupperware etc as well) for a population of 1.25 crores people. They are hit by the constantly changing regulations and market dynamics. There are lakhs of insurance agents who work in a silo of their when the end customer needs are mostly the same – achieving the goals set out by him/her. My fear is that more country men than not may end up living poorer if these solders on the ground are not guided / taken care of. There is nothing like a perfect solution!. However, I feel that a combination and association of the online and offline models is the way forward.

Disclosure: Views are personal. Numbers quoted may have margin of error.  

Lessons to be learnt in the recent credit event in two JP Morgan debt funds

What happened?:

JP Morgan India Short Term Fund and Treasury Fund have fallen 3.38% and 1.73% respectively on  27 Aug 2015. Investors were set back by 3-6 months in their returns

Why this happened?:

The above two funds hold Amtek Auto security to the tune of 15.37% and 5.29% of the portfolio respectively as of end of previous month. The stocks of the group in the equity market have been under pressure the entire month -  some falling more than 85% in value. The rating agency, CARE has suspended rating on the company’s debt paper three weeks back. Another rating agency, Brickwork has downgraded to C rating from A+. This necessitated the fund house to take a hit on the Rs 200 crore exposure to the tune of 25% – a loss of Rs 50 crores to the investors. Incase of a default in the next coupon or principal payment, the hit taken by the funds could be more. This development could preempt the existing investors from redeeming and even if they redeem, it ensures that they will take the hit. 

Lessons to be learnt:

1.     There is no free lunch! The rationale for investing in a fixed income product is for its very definition – “I want fixed  income”. It is for the safety of the principal and consistent stream of cash flows through interest payments all through the time of investment.

2.     In the chase for returns, what might get forgotten is that there is trade off between risk and return. The reason why a company may pay a higher coupon / interest compared to the other is because of the additional risk it carries – There is no free lunch in markets.

3.     Liquid funds may give negative returns and so do debt funds, frequently! Through higher accrual (higher coupon payments), the credit funds / part credit funds attract huge investor participation. Due to higher payouts, the distributors also push them through. In 2008, a couple of liquid funds has given negative return for the first time in the history of Indian mutual fund industry. This was due to a liquidity event – the funds were unable to sell the paper as the market was frozen. Other funds managed dip into resources that bailed them out. The second instance was in 2013, on the fateful day when RBI increased the short term rates by 300 bps, due to the interest rate risk, the liquid funds across the industry gave negative returns. This was a rude wake up call again that fixed income funds including liquid funds can give negative returns. Infact for the next six months, funds across categories gave negative returns. This episode was another occasion where investors and distributors learnt the fixed income funds are also subject to volatility of returns.

4.     Is there enough lunch on table? In India, the exposure to credit funds does not offer the return which is commensurate with the risk investors are taking – not much lunch left on the table. For instance, 10 year Gsec yields 8% today compared to about 10.5-11% by AA security. Post the expense ratio, the realized yield is about 9-9.5% vs 7.5% in Gsec funds, extra return of 1.5-2% for significant additional risk(funds hold varies buckets of papers but just simplifying the explanation to make a point).

5.     The above does not indicate that one should not enter credit funds. Investors should hope to get a kicker in the portfolio. However, having a cap of 30-40% is a good idea. In a situation like today when a fund takes a hit, one should be able to sail through the period for 6 months to 1 year (and more probably) by tapping into other funds for liquidity and income. Also, one should be aware that negative returns to the quantum quoted above may be seen more frequently than in the past.

6.     Show what you are made of? It is very easy to be on television and print media when things are easy. It is very difficult when calls misfire. It is only during these times that the CEO and Fund Manager have to be everywhere stating what steps are being taken. Investing is all about predicting the future and taking calculated risks. In moments like these can stakeholders understand better and become more mature for future. The CEO and fund manager not being reachable to the people who recommended or invested in their funds is a shame. These are the moments when it shows what you are made of.

I am hoping that this is just a one off during these tough times for various sectors before economy picks up steam. Being discipline and diversified is the best formula to have sound sleep at night and make money work

   

Disclosure: Views are personal. No exposure to above mentioned funds.

   

Somebody’s pain is Somebody’s gain

Five seconds of Finance Minister’s budget speech has changed the landscape of mutual fund for ever.  It was like a bolt from the blue which has far reaching implications and complications all stake holders - fund houses, investors, companies and distributors.

1. The word Fixed Maturity Plan (FMP) will be found only in the web pages in the next few months. The current lot of investors will tell the future lot the sweet (and effort less) success they has with these plans.
2. While numbers vary but close to a lakh crores will be taken off from the FMPs and a similar amount from the short term funds. The mutual fund (MF) industry which recently touched an AUM size of 10 lakh crores will be offset by more than 20%.  Even assuming a worst case margin of 10 bps, the fund houses cumulatively loose over Rs. 200 crores in profit. Hopefully, the increase in equity book should compensate for this loss.
3. On the positive side, the fund houses will now increase their focus on selling long term solutions diverting the disproportionate efforts spent on liquid, FMP and short term products.
4. Since it is difficult for investors to choose a fund category for three years, the immediately implication could be a rush to Credit opportunity funds. Since the optimal size of such funds is limited, the worry could be that the mutual funds could go deep down the credit risk which could entail greater risk at a later date. They could also lap up any corporate deposit that may hit the market with a pre-tax double digit return.
5. The investors may also move towards Dynamic debt funds with a three year horizon as they are best positioned to maneuver the view on the market. Atleast now, the dynamic funds will be compared with post tax returns from competing products and not the currently existing practice of comparing with income funds when market is good and liquid funds when the market is bad.
6. The interest could increase in Financial planning products. This is because the cost of rebalancing has increased for an investor and there is no cost incurred by these products in rebalancing.
7. Since Arbitrage funds enjoy equity taxation, the dividend plans of these funds will increase in size. Companies and individuals will target these funds for their short term investments. However, the market size for arbitrage is small and hence the scalability of these funds is limited.
8. Due to the reduced participation (or even absence) from the corporate, the expense ratios of short term funds might increase. Until now, the companies were keeping them in check and it will be nearly impossible for the fragmented retail participation to influence them.
9. The distribution fraternity has been massively hit. It started with the global financial crisis in 2008 which put a spanner in their dream run of garnering assets and earning high commissions. In 2009, it was followed by the ban of entry load in MFs and reduced commission in insurance products. In 2013, the direct plans were introduced which took corporate away from distributors. In the mid of 2013 was the event of 15/07 when the RBI increased overnight rates sharply. Just when things were stabilizing 10/07 happened. The finance minister administered a new dose of medicine. The institutional side of the business may have to be restructured further.
10. Mutual Funds’ pain is banks’ gain. The lazy banking will benefit at the cost of FMPs and short term funds. This could result in banks cutting deposit rates and inturn improving their NIMs. Assuming NIM of 2.7% on the two lakh crore that would move out of mutual funds into the banking system, the net interest earned will go up by 4,000 crores adjusted for statutory requirements.
11. The biggest gain is for the government. Assuming an average of 20% tax rate on the two lakh crore that would move out of mutual funds which could yield about 9%, the tax coffers will increase by over 3,600 crores. If we include the tax paid by the banks on additional income, the tax coffers would bloat by over 4,000 crores.

Mr. FM - You just threw out the baby with the bath water

On budget day, Mr.FM has denied the nation the chance to fully utilize (and not exploit) the chance of being prudent debt market investors. The pain point is that he has increased the period considered for long term taxation to three years from one year. Any redemption from debt funds before three years will attract marginal taxation (30% for most investors). There is an increase in tax post indexation which investors can live with.

The reason given is that CBDT showed him the data that supports the view that it is the corporates who benefit from the tax arbitrage present between debt mutual funds and bank fixed deposits. He added that CBDT mentioned that very few individual investors benefit from it. Only a FM who does not have a single rupee in debt funds cannot realize the value of these.

I do not doubt the data analysis of CBDT but wonder why we have such a conclusion. Investors (I am not talking of HNIs living in Mumbai) have never understood debt funds. They have never been properly educated about debt instruments by their financial advisors and wealth managers. So much so that they get immensely confused if they are told that bond yields and bond prices move in opposite direction. Slowly but surely they were getting educated just when Mr. Subba Rao administered the bitter medicine of sharply increasing rates overnight last July. This shock had erased all the learning of the investors instantaneously. Compounding this, there was only a small percentage of people who invested in debt  market as the real rate of return was negative. The savings were channelled into Gold and Real estate.

Just when real interest rates were turning positive (on a consistent basis), did our FM threw out the baby with the bath water - in order to prevent profiting by corporates from tax arbitrage. He has destroyed an important tool available for individual investors to save with lesser risk. He has forced investors to take on vehicles of sub-optimal returns adjusted for risk. Individuals will invest in fixed deposits which give post tax returns of 6.3% if one is lucky, earning less than inflation. The enterprising advisors will convince them to invest (or punt) in equities as the sentiment is up and volatility is low. We will have yet another market where participation from FIIs will be to the brim and the individual investors will be completely absent. In any case, Mr. FM has made sure that the individual investors will never get a chance to learn how to invest in debt markets. Just when the mutual fund and wealth industries were coming out of woods, the blow has been dealt. Since significant chunk of asset size is in debt, the two industries will have to find new ways to plug the hole in their earnings. They have to work even harder to create investor interest in non-equity-non-debt funds like Gold funds (FoFs), Fund of Funds and International funds. Mr.FM! did you have to do it? Do you have to break it before fixing it, Yet again?

High inflation

An interesting blog by Ajay Shah inflation. http://ajayshahblog.blogspot.com/2011/10/reining-in-inflationary-dragon.html

He says that the supply side constraints have been present earlier also and hence we should not critic supply side constraints alone. However, the scenario from 2004 is different from now as we have more people consuming better quality products. Also, there should be political will to keep these constraints checked. I doubt if some of our ministers have such a commitment.

As the central bankers across the globe target tradeables for lower prices, we should also experience lower prices. Only catch is that the global central bankers should be able to contain inflation for us to experience the same.
Macro data points that are given in this link could be useful

http://www.mayin.org/cycle.in/tracking.html

RBI rate hike: Too dangerous to pause now - Jahangir Aziz

The RBI rate hike last week set the cat among the pigeons. Activity in India is undeniably slowing. Add to that the global slowdown. And it is easy to see why business is imploring for a pause in the tightening. I don't think that there is much more tightening left to come, but a pause needs to be timed well. Now is not that time. It may have been if the RBI had moved more aggressively last week.
True the economy is slowing, but is it slowing sufficiently for inflation to decline on its own? Take away the volatile capital goods component and non-capital IP grew 6.7% in July, the fastest in 4 months. Indirect tax for the first five months of this fiscal year is up 24% despite the duty cuts on petroleum products. Exports grew 44% in August and imports 41%.

On the other hand, August headline inflation accelerated to 9.8 %, domestic input prices rose sharply and core inflation jumped to 7.7%, twice the historical average.

Critics claim that these are yesterday's news. One needs to look forward as monetary policy affects the future. True, but core inflation can decline if capacity eases. Our best guess is that trend GDP growth has fallen to 7-7.5%. After last quarter's 7.7% GDP growth, the output gap (actual GDP less trend GDP) has risen to 1%. For core inflation to fall, growth needs to slow below trend turning the output gap to negative. This happened in 2009 when growth fell below 6%. But nothing today suggests that growth will fall to such levels.

Capacity can also ease if investment raises trend growth. A key factor holding back investment is macroeconomic uncertainty, both global and domestic. There is little the RBI can do about the first, but it can reduce domestic uncertainty by inducing inflation to peak and growth to trough early. The quicker the domestic uncertainty is resolved, the sooner investment will resume. This requires the RBI to act more aggressively to bring the cycle to an early end not less aggressively to prolong the cycle.
We know since 1972 (Bob Lucas) that the growth-inflation trade-off exists only when expectations are stable not when they are rising as in India now or falling as in Japan in the 1990s. Empirically, we know since the late 1980s (Stan Fisher) that the trade-off exists only when inflation is low not when the core inflation is twice its historical average. Instead curbing inflation by sacrificing near-term growth is essential to anchor inflationary expectations and safeguard medium-term growth.

Separately it is also argued that inflation is structurally high as non-farm growth has outstripped agricultural growth. Therefore, policy needs to tolerate a higher "normal" inflation. Nothing can be more dangerous. Many economies have tried controlling inflation at a higher "normal" only to find that it quickly goes out of hand (Latin America in the 1980s and 1990s).

We are not there yet but expectations are coming unhinged. The year-ahead inflation expectations of household have been rising since 2009, but till September last year they were below actual inflation. Since then inflation expectations have not only risen relentlessly but are markedly above realized inflation. Households till late last year believed that the authorities' could bring down inflation, today they are losing faith. Tolerating a higher normal inflation will further erode the authorities' credibility.

Source: http://economictimes.indiatimes.com/news/economy/finance/rbi-rate-hike-too-dangerous-to-pause-now/articleshow/10047086.cms

How to Tame Hunger

Arun Firodia, Chairman of Kinetic Group

Food inflation in August accelerated to 9.78% year on year, the fastest it has been in 13 months. This is over and above the high inflation of last year. As it has been doing all along, an alarmed RBI has tried yet again to combat this by hiking interest rates by 25 basis points — its 12th hike in the last 18 months. But obviously, this is not going to reduce demand for food nor food inflation.

What is the cause of food inflation? Some say that increased urban demand is the culprit. But production of food products has been increasing in step with the rise in urban population. And export of food products is too insignificant to have any impact on prices. What, then, is the real reason for the runaway rise in food prices?

In 1951-52, 89% of what the consumer spent on food reached the farmer. Now, only 34% reaches him while 66% goes to middlemen. This amounts to a whopping Rs 20 lakh crore. And why is it so? Because as per the Agricultural Produce Market Committee Act (APMC Act), a farmer must take his produce to a `market yard` and sell it through middlemen. The chain of middlemen consists of eight to 10 links, each adding his profit margin of 30% or so. No wonder, then, that a farmer gets only Rs 5 per kg for onions while the consumer pays over Rs 30 per kg!

The APMC Act, passed in 1954, needs to be scrapped or substantially amended. The central government prepared a Model APMC Act in 2003. But agriculture being a state subject, many states have yet to adopt this Model Act — which provides for direct selling by farmers, contract farming and aims to remove interstate barriers for movement of food products — or implement it faithfully due to vested interests.

There are some honour-able exceptions. For instance, Andhra Pradesh has started `Raythu Bazar` (farmer`s market) where farmers can sell their produce directly to consumers at select locations in the city. ITC, meanwhile, has started an `e-chaupal` scheme to provide internet connectivity to farmers so that they can decide to sell their produce directly to supermarkets or through market yards. The scheme covers four million farmers in nine states.

However, neither these exceptions nor modifying the APMC Act will be enough. Presently, 30-35% of food products perish during sto-rage and transportation. If this proportion is reduced, supply would substantially increase and prices would come down. For this, we need to develop cold chains for storage and transportation all over the country on a massive scale.

Barc scientists have proved that gamma rays increase the storage life of food pro-ducts like onions. And scientists at CSIO in Chandigarh have developed a high voltage process to disinfect milk in seconds. This will replace the current method of pasteurisation and save a huge amount of energy. But, needless to say, farmers just cannot afford cold storage or gamma ray equipment. Nationalised banks should step in and create a network of food banks to make storage facilities available to farmers on a rental basis. Farmers could then safely store their produce in these food banks and sell only when the market rate was remunerative. They could also get loans for buying seeds, fertilisers and pesticides from the banks.

Contract farming is another idea whose time has come. The Model APMC Act provides for this. Some companies have already made forays, sourcing produce from farmers under contract and selling them under their own brand names. More such initiatives are required by corporate retailers for a variety of farm produce. This would improve farm productivity and total food production.

Unseasonal rains, famine or pests hit farmers every three to four years. In order to prevent such calamities from devastating them, insurance companies should come forward with different schemes to give insurance cover to farmers so that they can protect their incomes. In fact, given how essential this is to our food security, the government should make it compulsory for insurance companies to do so. It should also bear fully or partly the cost of insurance for small farmers so that they are not unduly burdened. That, again, would make farming a safe and remunerative vocation.

Presently, agricultural produce does not freely move across state boundaries. The time has come to remove such restrictions. In fact, why not go for free trade in food crops among all Saarc countries? If food prices start going up in some area, supplies could be rushed from other states or neighbouring countries. Also, there is an urgent need to exempt all food products from import duties and sales tax to bring food prices under control.

No country in the world has as much fertile irrigated land as we have. But our food productivity is quite low; China`s food productivity is double that of India`s. Contract farming or precision farming technology developed by our agricultural universities can help double our food productivity too.

In short, the government must take these urgent steps if both farmers and consumers are to benefit. Merely increasing interest rates will not do.

Source:
http://articles.timesofindia.indiatimes.com/2011-09-19/edit-page/30172315_1_food-inflation-food-products-farmers/2