Welcome to the Machine: America and Money

I wrote a while ago of my first brush with America's financial system as a fresh-off-the-boat expat applying for a credit card. Thanks to a career mostly pivoted on financial services, however, my experiences with the world's largest economy run broader. These have only deepened in the last couple of years building a life in the country, but continue to leave me perplexed on more than one count.

Of my subsequent wanderings, I find the average American's attitude vis-à-vis the stock market the most peculiar. One might verily imagine investors lining up outside the door given its extraordinary breadth (in offerings), depth (of liquidity) and information access (implying transparency). Yet, in reality, retail participation in the NYSE-Nasdaq is unlikely to make India's NSE jealous. Broader still, it appears linked to the outlook around Money.

Some facts for starters. Wealth-accumulation is, in many ways, an inveterate part of the 'American dream'. Next, unlike the land of my birth, inflation has mostly been in check since the Supply Shocks of the 70s. Finally, median incomes have almost doubled in the period. Statistics, therefore, point to significant investible surpluses. Yet, reams can rightly be written about burgeoning US household debt as much as the general disaffection of its populace in matters financial. It takes us back squarely to saving discipline.

To unravel this, consider an analogy from another bane of modern human existence, namely lack of fitness. Be it a shudh desi tond or American overweight, we know that exercise is key. Indeed, that rush of endorphins at the end of a workout is the glow of champions. Watch what happens next, as the hungry, proud-as-Punch body heads out to eat. How often do we overestimate calories burned; gorge on 2X the amount we typically need; and feel no qualms therefrom? And then we bemoan fitness levels, go jumping from one fancy exercise plan or fad diet to another, and hurtle towards the eventuality of a large medical bill.

Just as the gap between calories burned and replenished drives success in a weight-loss regimen, so a saving habit determines financial well-being. So why the proclivity for conspicuous consumption that fells the average American? Answers are at hand. Akin to the rush post a rigorous workout, income growth also stokes an increased propensity to spend. Cast under its 'have-earned-this' spell, Americans splurge guiltlessly on indulgences. Luxuries of today turn into necessities of tomorrow, and wallets continuously seek new extravagances to feed the sense of entitlement. A social-media-centric existence plays no small part in this frenzy, with lifestyle expectations driven by peer benchmarks, resulting in a vicious dance of debt.

Culturally overindexed on wealth, America can only be happy when the cycle of overcompensating rising income with indiscriminate consumption breaks. The solution is obvious, but fundamental. From chasing the tangible and easy (spending), the Average Joe or Jane needs to be inspired towards the intangible and difficult (saving, directed towards goal-focused investment). Apps that demystify wealth by making its creation and tracking ubiquitous shall pave the way. Celebrate, therefore, the tingle of income more than the whoosh of the credit card, virgin or otherwise, as the real money machine. Godspeed.

Teesri Kasam

Investing as a theme pops up periodically here, a testament to my abiding interest therein. Success here can have a fairly direct correlation with material well-being. That said, in matters financial, it matters more what not to do than otherwise. In this, I am reminded of Teesri Kasam and its quintessential Bihari ethos.

Flashback 1966. Mare Gaye Gulfam, penned by the indomitable Phanishwarnath Renu, was turned to a film by some of Indian cinema's tallest. On camera were Raj Kapoor and Waheeda Rehman, but also Iftekhar, Keshto Mukherjee, AK Hangal and Asit Sen: names that veritably lit up the silver screen much as they did the faces of cinemagoers for generations. Rest of the crew was no less luminous: Renu himself, Basu Bhattacharya, Shankar-Jaikishan, Lata Mangeshkar, Manna Dey, Asha Bhosle, Mukesh etc. Perhaps above all was Shailendra, this being the only movie the lyricist extraordinaire ever produced. Thus, we got Teesri Kasam.

So how does Teesri Kasam connect to my investing experience, personal or observed? Simply that Hiraman, its bullock-cart-driving protagonist — idealist yet unafraid to try the new — makes mistakes in his pursuit of life's affairs, swearing each time never to repeat them. And in a fashion, his three blunders, which lead to the eponymous three vows, mirror my view of the most common slips in financial matters.

Perhaps unsurprisingly, Hiraman stumbles first in ignoring the risk-reward equation. His simpleton character tries to make a fast buck ferrying smuggled goods, managing only to land a brush with the police, and promising himself a long-term focus thereafter. Many of us, myself included, start life at the other end, content with managing money near-term and confusing a bank balance for financial security. We fret about market risk but assume inflation immunity. Consequently, savings go to FDs, PF contributions stay at a minimum, and equity action is confined to a rushed, year-end Sec 80 investment at most. Thus, the power of compounding is missed for years.

Hiraman's second folly is not planning for oversized loads. He picks up a consignment of bamboo, and — being inexperienced — rams it into a horse-cart, earning a royal thrashing. His kasam: avoid 'long poles'. Of such cargo, real estate is the most ubiquitous in our lives and the cause of much financial misery. I didn't buy my first until 12 years into my career (missing two Gurgaon booms); yet others buy too early, or too much, and some simply a 2BHK that they outgrow in no time. A similar case could be made for Insurance. The point is to tackle the big rocks as soon as one is able, which requires a financial plan.

Twice singed, Hiraman is then felled by the most confounding folly of 'em all. Tasked to transport Hirabai, a performer in the Great Bharat Nautanki Company, to the village fair, he is smitten by her beauty and (in his eyes) apparent virtue, during the course of their day-long journey. His consequent conflict with zaalim zamana and zamindar is typical filmi (the denouement is anything but), culminating in his third and final vow: say no to nautanki-walis. Cut to our financial lives; and how often have we similarly lost when appearances and emotions outbid logic and facts?

A tad more on that last-named. Its typical setting, interestingly, involves folks who spend a lifetime mistaking investing to be a spectator sport. They watch the market ceaselessly, debate it tirelessly, and wait for the 'right level' endlessly. Then suddenly one day, armed with an ostensibly hot tip (delivered over sips of 'Glen' perhaps), they rush in to bet the ranch. They may get lucky, but mostly they don't, only to slink back into the corner, cursing their luck, the market, or both.

Be it rooted in any of these mistakes, it is the dud that we carry too long that has the biggest bite (I have never lost as much money as I have selling late). Through pigheadedness, optimism, or sloth, we only invite peril home when the basic principle of stop-loss goes amiss.

These experiences aside, like most walks of life, success in investing must rest on the bedrock of hard-won lessons. "The four most dangerous words in investing are — this time it’s different", as one of the greats so adroitly put it. It remains a game where discipline and math plainly trump creativity and chance. Ignore this, and one is left to rue mare gaye gulfam.

Investor as a Split Personality

"Be ye of reasonable means, with intent to secure thy future, thou canst afford nought to be in stocks." There, I quote myself (Shakespearean merely for effect)! Truly, the merits of equity investing are beyond doubt. Even more certain is that they are ill-understood. "The real key to making money in stocks is not to get scared out of them" is how Peter Lynch, one of the gurus of the craft, put it admirably.

So why this reticence that, in the face of voluminous data on the benefits of stock-picking, makes even the well-heeled go weak in the knees? Market evidence shows that the issue is not opportunity. Nor is it barriers to entry, lack of visibility, or absence of ambition. And very rarely, contrary to popular belief, is it ability. For today, let us dwell on that last-named, for it is the one I find most difficult to fathom.

In context, ability could be thought of in two ways: the capacity to invest; and skill therein. Not that I choose my company specially, but enough investible surpluses (after emergency cash or fixed income commitments) exist around me. However, they find their way into real estate, almost without exception. I don't discount residential or commercial realty being part of a well-designed financial plan (though my personal experience of returns isn't much to write home about). However, I do take issue with overexposure to this asset class, notably when at the expense of equity.

Nothing brings this better to light (to the mythical point on ability) than the dramatically different approaches folks follow while investing in stocks versus real estate. Most realty shopping, perhaps on account of packet size, is backed by effort, discipline and rules. However, the same individuals behave in a diametrically opposite manner when picking stocks. For instance:

• Look before you leap?: You buy an apartment in DLF after arduous research, talking to the world and their mother before you commit. Stocks you buy because you got a hot tip with a shot of Jack Daniels last night!
  
• Shylock or Great Gatsby?: You bargain down to the last thousand, even hundred, in buying property: negotiating terms, comparing freebies and so on. Stocks you buy in a bull market, when the local barber is dispensing investment advice, with nary a care about valuation!
  
• Till Debt do us part?: You negotiate mortgage rates down to the last bp, manage monthly EMIs with an appropriate down payment, and pre-pay whenever you can through the tenure — all to keep debt under control. Stocks you rush headlong into F&O or complex margin positions with little regard for complexity or leverage?
  
• Ain't it a team sport, baby?: You are happy to employ and pay for real estate expertise with agents, lawyers, architects, interior designers etc — anything to ensure asset acquisition and management are optimal. Stocks you trash financial planners and avoid research advice, preferring hunches and going solo?
  
• Time in market vs timing the market?: You invest in property for the long term, commitments that typically last years; and exit only when goals are met, or as a last resort (if faced with hardship). Stocks you look for upsides in days or weeks, often selling for small profits in a bull market, or a huge loss when bears rule.

I will not even start the argument that disciplined equity investing can bear returns superior to real estate. Or that the property market is far less transparent and much more illiquid. Least of all that smaller packet size and SIP possibilities make equity an easier option to manage risk through market cycles. All of these are true; yet they are just facts. The crux here is behaviour. And hence another homily with a touch of of Will Shak: "Stay ye considered, consistent, and committed; and abiding wealth shall be thine." Amen!

Inflation Bonds: Flatter to Deceive

Months in the making, the Reserve Bank of India has finally launched consumer inflation-linked bonds. Going under the moniker of 'Inflation Indexed National Saving Securities - Cumulative' (a mouthful, if ever), these bonds have been the subject of much anticipation. Alas, the fine print finds them coming up woefully short.

The biggest stumbling block lies in the product design and its consequent tax treatment. In most countries with such bonds, the formulation goes broadly thus: pay the investor a nominal interest rate on Face Value while letting the FV float in line with the linked inflation index. It is a simple structure that pivots on gains from the inflation-driven FV increases, which are treated as capital gains in the eyes of the taxman.

To take a line from the fabled Maggi sauce commercial, the IINSS is different. It has been structured as a bond paying interest, the rate of which is pegged to the Consumer Price Index. By implication, the entire interest earned qualifies as income, to be taxed at the marginal rate. To be fair, if only the inflation-compensating portion had been subject to capital gains, it could have benefited from indexation. Clearly, the powers-that-be at FinMin and RBI thought otherwise.

Several sticky points other than taxation come up too. The typical desi fixed-income investor, mostly given to income, may not line up in droves for the compulsorily cumulative IINSS. To boot, the lock-in period itself is rather long at 10 years. Such an extended tenor may only accentuate inflation and interest rate uncertainties that scare away investors. Early exit is possible, but only after 3 years, and with a penalty. Finally, there is an unfathomable ₹5-lakh investment cap. All told, I don't see investors being inexorably drawn to IINSS (versus, say, infrastructure bonds with a friendlier format and better post-tax returns).

Be that as it may, one could still have rooted for distribution success. We know only too well that, in the Indian context, financial products need to be actively sold (occasionally with little correlation to merit, ULIPs being a case in point). I wouldn't hold my breath for this though — these bonds are to be sold only via banks, and their low commission structure is unlikely to be incentive enough for them.

Perhaps I am being overly cynical. Maybe IINSS is a step forward, but it could have been so much more. Certainly, days into his tenure, our rockstar RBI Governor had himself talked a big game as to its market-making potential. At least on that count, if not more, this is an ahem.

Shape-shifting Monster

Being a toddler-parent means toys of assorted shapes and sizes are an inescapable part of existence. I have one of either gender, and would like to believe that neither is overly pampered. Yet, there are moments when I am at wit's end as to how so many trinkets make their way into the house — my childhood benchmarks clearly don't apply, outnumbered 1:16 or so. Equally, I cannot help but marvel at the ingenuity and imagination that power many of these. Colour-changing cars and shape-shifting beasts fall into this category.

It was such an object of fantasy that offered the perfect metaphor during a fevered discussion the other day. The conversation went somewhat like this: my friend, part of the domestic insurance industry, was trying to argue for more institutional indulgence — government, courts, banks etc — to support the fledgling sector. At some point in the evening, the conversation turned to ULIPs, one of my pet peeves, thereby prompting the monster reference. I don't know how the tête-à-tête ended (some Dalmore was involved!), but perhaps a few notes from it bear repetition.

In a nutshell, that India is under-insured is beyond doubt, but there is more to the picture. We ought to know that, second only to bank deposits, insurance is the most popular financial product in town. It has a legacy that goes back decades: LIC itself in its present avatar is over half a century old, National started in 1906, and there were companies in this business even in the 1800s. So the industry is no babe in the woods.

Cut to the present, and data shows 20% of household savings going into insurance — while all of equity inflows, including mutual funds, hover around a paltry 5%. Likewise, consider AUM: insurance is 10 times the size of equity MF, with ULIPs alone being more than double at last count. Insurance, therefore, can hardly claim not to have had enough of show-me-the-money.

This brings us back to the point on ULIPs. Just the last decade saw the industry peddle them aggressively to a gullible public, backed by disingenuous advertising and aggressive distributor incentives. The opaque nature of ULIP performance reporting and high exit costs were common knowledge — perhaps even deliberate. Certainly they did not speak to any genuine effort to serve the Great Unwashed.

The IRDA did — belatedly; and perhaps only spurred on by the SEBI turf war — attempt to rein in the monster. Fee structures and rudimentary visibility parameters were mandated. Yet, even after 2010, the messaging was around ‘new, improved’ plans accompanied by significant switching costs. Shape-shifting right there.

In truth, glancing beyond ULIPs at traditional plans too shows up the industry as pretty lazy. Despite lofty goals of serving under-insured India etc, these products (term cover is a particularly glaring need) are sold with terms mired in complicated legalese, unfriendly surrenders and claims, and overly high sales commissions. Once again, the IRDA has attempted a few fixes, but these are arguably half-hearted or too late.

Summarising, it is not difficult to posit that the insurance industry has itself to blame for much of its ills. If only the Indian investor was a tad more discerning (and not perplexingly averse to equity), the heat on insurers could, in fact, have been worse. For now though, the monster lives to see another day.

The Real State of Real Estate

I plead guilty to being less than laudatory of the Real Estate sector in recent posts. This comes partly from experience — investments where I was promised the Moon have yielded negative to negligible returns. Again, I understand the caveat emptor argument (my ventures being ill-advised, risk-reward equation etc). It could be sour grapes too — nerves made me sit out the boom years and now I am priced out. Yet, it remains true that many of us are wary of the sector and its general functioning in our country.

Logically, things ought not to be in a bind. The dictum of being in money when investing in mitti has been ancient wisdom. Further, India's long-term housing shortage story had its takers a decade ago. Little wonder then that, as friendly interest rates and rising household incomes fed core demand, realty prices pushed north. Investors attracted by a visible short-term price upswing (perhaps more than long-run potential) and overseas liquidity added to the momentum. Landowners made fortunes selling ancestral holdings in New India’s cities (NCR, Hyderabad, Bangalore, Pune etc). 'Buy pre-launch sell pre-possession' became the go-to strategy while a few risk-averse or financially constrained folks like I fretted on the boundary!

This is where it began to go crazy. Developers overleveraged themselves using all avenues under the sun to raise money domestically (banks, IPOs) or across borders (ECB, FDI, PE). In short order (unlike most parts of the world), this borrowing stopped funding construction. Instead we had a mad frenzy to build ‘land banks' driven by continuous new project launches, and realty valuations feeding off every cycle. End-users were relegated to the sidelines; investor mood swung into the high speculation zone. Fly-by-night developers sprang up dime-a-dozen in urban India, more than a few clearly headed towards a debt trap.

Enter GFC 2008. Liquidity dried up and demand, speculative or otherwise, was hit. It was mayhem. Buyers, caught unaware, were the worst off; New India was abuzz with protests against project delays or defaults. The response from even the most well-known realty names was not much to write home; dharnas and court cases became the order of the day. The government could finally not look the other way, virtually leaning on banks to go easy on real estate loans to stop the bleeding from getting worse.

Today, we have come off the crisis edge. Property prices almost regained their peaks last year (although 2011 appears flat). The fundamental issues in the sector, however, have not been fixed for good. Like much else in our beloved country, there is more to it than meets the eye:

• core demand stays strong, a good chunk unmet. It ought to rise over time for population and prosperity reasons (the good);
• scope for corruption is unabated, ranging from Money Matters borrower scam variety to land acquisition, clearances etc (the bad);
• cash preponderance makes it a money-laundering magnet. Shahid Balwa types shall fester, with vested interests from the powerful neta-naukarshah-businessman nexus (the ugly).

Clearly, the only way out of this jalebi-like mess is reform. A solution benefits all — the roti-kapda-makaan seekers; tony-neighbourhood-upgrade aspirants; and wannabe investors like I. Hope is at a premium mid-week, but I set some aside for this. And may be rethink those pesky Noida Expressway SMSs again.

U(r)LIP or Mine?

A couple of smug rookies posturing as 'Relationship Managers' at my bank, an almost equally minuscule clique that seeks me out for investment advice, and hordes of DNC-dismissive telemarketers peddling insurance — all can stand testimony to my ULIP-agnostic personal finance strategy. My stance is hardly original — most experts of any standing shun ULIPs in their shopping cart must-haves. Despite this rare unanimity and strong arguments against the product class, it has drawn investor interest consistently. Reasons behind this ostensible anomaly, or the product's long-term prognostications, have assumed centrestage with recent developments in the shape of a SEBI-IRDA jurisdictional battle. At the heart of this are changed regulations that address opacity and investor-unfriendly practices that ail ULIP sales and service, or inherent design.

To appreciate the context of the proposed changes, one must recognize that ULIPs have been sold in a manner completely antithetical to the fundamentals of the family to which they ostensibly belong. (Most people one knows, when buying a ULIP, actually believe they are taking 'smart' life cover.) The lure of entering an asset class where 'your money is not idle' but 'deployed to maximize returns' and offer 'better term cover', has been irresistible for the typical gullible investor, fed on years of stodgy state-run insurance firms’ (often unfairly so dubbed) unimaginative offerings and dull salesfolk. A general expectation of market efficiency over public sector sloth thus plays into the aggressively positioned ULIP schemes promising lay investors the moon.

Again, an investment offering of this kind, with significant dependence on market performance, usually comes into its own in the long run (and this is not 3 or 5 years that qualify as 'lifetime' to 25-year-olds nowadays). Think 10-15 years, or 20 if not more, and cyclical noise is factored out of markets and sensible stockpicking yields results fully. Admittedly, this is market investment spiel (for, say, equity MF) but unfortunately not what many newbie investors readily bite, obsessed as they are with 'timing' the market. The same investor, when thinking term cover, expects longer tenors in line with life expectancy. The resultant surge of patience, sweetened with promise of exceptional returns, draws savings to ULIP schemes by the boatloads.

Of course, it is obvious that such troths of exponential growth do not sit well with life cover. Yet, spurred by extraordinary incentives that can only come from heavily front-loaded cost structures (45% of Y1 premium, no less!), a bevy of insurance salesmen position ULIP as a best-of-both-worlds insurance product generating assured returns over months and years. The post-sale dissonance that naturally results (it is difficult to think a worse period of investor sentiment and market return than the last two years) leads to massive exits. Yet, unlike market instruments where such attrition is visible (and actionable), ULIP truancy figures are hardly the most advertised. Hence the ecosystem of under-informed investors, malintentioned agents, and lazy insurance firms continues to flourish unashamedly.

At another level, ULIPs represent a large (if invisible) problem for private sector insurance companies. There is a highly credible school of thought that unravels what drives this disproportionate focus on the win-today-worry-tomorrow rat race for the investable rupee. The motivation seemingly comes from higher capital adequacy norms for guaranteed (term insurance) vs market-linked (investment) assets. This makes minimization of life cover (per rupee vested) a lucrative short-term strategy. Unfortunately, this evanescence creates not merely an economic but a potentially significant social issue that can wreck us in the long run. In an under-insured nation like India, with rising healthcare demand (and costs) yet inadequate social security structures, such mis-selling of investment in the garb of insurance can lead to consequences far more dramatic than most of us care to think. (Term cover, after all, is for those eventualities of life that leave us at our most frail and disturbed.)

All this has been known for a while. Yet, aside from individual decisions like mine (big picture-inconsequential, likely), not much was attempted to correct this systemically (or if something was in the works, it was certainly not PDQ pace!). To this extent, the very public spat between our hyperactive market regulator and their largely somnolent insurance cousin was most welcome. In characteristic Bhave fashion, SEBI initiated measures to clear the mess under an investor friendly bias. In the ensuing turf battle, however, the IRDA came up trumps (SEBI's knock on the Supreme Court’s doors was in vain: GOI nipped it in the bud with an IRDA-primacy ordinance before milords could weigh in — all while CBB was away on business in Canada!).

Cynics in our midst ought to be unsurprised - the venerable J Hari Narayan has impeccable credentials to win any back-room battle. Years spent in the government have admirably equipped the ex-IAS officer to work the Establishment. (Interestingly, despite similar pedigree, Bhave does not have the same reputation.) Equally, while missing the visible zeal of his no-nonsense SEBI counterpart, the charitable can point to JHN’s record of not shirking from a tough stand in the face of controversy. In any case, he has Pranab-da’s mandate.

Regardless, the verdict in the territorial fracas is hardly the key issue. Of essence is whether and how the Govt and its now unequivocally empowered regulator finally set the house in order. Even if one were to ignore my arguably over-pessimistic predilections on the social impact of messing with the small saver, there can be little doubt that Shri Hari Narayan presides over a window of opportunity — to serve the lay investor well, while providing an overdue lifeline to ULIPs. Else, the victory, so to speak, may remain Pyrrhic.