Teesri Kasam

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

Flashback 1961. Mare Gaye Gulfam, penned by the indomitable Phanishwarnath Renu, was turned to film by some of Indian cinema's tallest. On camera were Raj Kapoor and Waheeda Rehman, but also Iftekhar, Keshto Mukherji, AK Hangal and Asit Sen: names that verily lit up the silver screen much as 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 Bhosale, 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 Hiranan, 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, that 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, merely managing 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 at managing money near-term and confusing bank balance for financial security. We fret about market risk but assume inflation-immunity. Consequently, savings go to FDs, PF contributions stay minimum, and equity action is a rushed, year-end Sec 80 investment at max. 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, being new, rams it into a horse-cart, and gets a 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 till 12 years of 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 of Insurance. Point is to tackle the big rocks as soon as one is able, which means 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-plus journey. His consequent conflict with zaalim zamana and zamindar is typical filmi (the denouement is anything but), culmintating 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 fact?

A tad more on that last named. Its typical setting, interestingly, is folks who spend a lifetime confusing investing to be a armchair sport. They watch the market ceaselessly, debate it tireslessly, 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 markets, or both.

Be it rooted in any of these mistakes, but 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). 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 lessons learnt. "The four most dangerous words in investing are: this time it’s different" is how 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, thee cannot afford naught to be in stocks." There, I quote myself (Shakespeare 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 face of volumnious data on stock-picking benefits, makes even the well-heeled go weak in the knee? Market evidence shows that the issue is not opportunity. Nor is it barriers of 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 over-exposure to this asset class, and 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 diametrically opposite 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 appropriate down payment, pre-pay whenever 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 is optimal. Stocks you trash financial planners, 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 last resort (if faced with hardship). Stocks you look for upsides in days or weeks, often selling for small profits in bull market, or 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. Crux here is behaviour. And hence another homily with a touch of of Shak: "stay ye considered, consistent, and committed; and long term wealth shalt 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 had been the subject of much anticipation. Alas, the fine print finds them come up woefully short.

The biggest stumbling block is 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 the linked inflation index. It is a simple structure that pivots on gains from the inflation-driven FV increases, which are accounted as capital gains from the taxman's lens.

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 Inflation 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 been subject to capital gains, it could have benefited from indexation. Clearly Fin Min and or 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 possiblle, but only after 3 years, and with a penalty. Finally, there is an unfathomable 500K investment cap. All told, I don't see investors being inexorably drawn to IIMSS (versus, say, infrastructure bonds with friendlier format and better post-tax return.)

Be those as they may, one could still have rooted for distribution success. We know only too well that, in the Indian context, financial products need to be activey sold (occasionally with little correlation to merit, ULIP being 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 there.

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 the big game as to it's 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 inveterate part of existence. I have one of either gender, and would like to believe that neither is overly pampered. Yet, there 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). At the same time, I cannot but marvel at the ingenuity and imagination that powers many of these. Colour-changing cars and shape-shifting beasts fall in 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 instiutional indulgence (government, courts, banks etc) to support the fledgeling sector. At some point in the evening, the conversation went to ULIP, one of my pet peeves, (as I have written earlier), thereby prompting the monster reference. I don't know how the tete-a-tete ended (some Dalmore was involved!); but perhaps a few notes from it bear repitition.

In a nutshell, that India is under-insured is in no doubt, but there's more to the picture. We ought to know too that, other than bank deposits, Insurance is the most popular financial product in town. It has a legacy that goes back decades: LIC in its present avatar itself is about 60 years old; National started in 1906; and there were companies in this business in most of the 1800's. So the industry is no babe in the woods.

Cut to the present as well and data shows 20% of household savings going into insurance (all of Equity including MF is at a paltry 5%). Likewise, take AUM: Insurance is 10X of equity MF, with ULIP alone being more than double of Equity MF at last count. Insurance, therefore, can hardly claim not to have felt the love.

This brings us back to the point on ULIP. Just the last 10 years have seen the industry peddle them aggressively to a gullible public, with 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 driven by turf war) attempt to rein in the monster. Fee structures as well as rudimentary visibility levels were mandated. Yet, even after 2010, the most notable message we heard was ‘new, improved’ plans accompanied by significant switching cost. Shape-shifting right there!

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

Summarizing, 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 perplexedly averse to equity), the heat on them 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 had 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 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 high speculation zone. Fly-by-night developers sprung 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 unware, 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 for 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 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 interest from powerful neta-naukarshah-businessman nexus (the ugly)

Clearly, the only way out of this jalebi of a mess is reform. A solution benefits those looking for roti-kapda-makan; yet others desiring more upmarket addresses; and wannabe investors like I. Hope is at a premium mid-week, but I set some aside for this. And may be rethink those Noida Expressway SMSs again :)

U(r)LIP or Mine?

A couple of smug rookies posturing as 'Relationship Managers' at my banks, an almost equally miniscule minority that seek me out for speculative advice, and hordes of DNC disdainful telemarketers peddling insurance - all can stand testimony to my ULIP agnostic investment strategy. My stance is hardly original: most financial experts of any standing shun from including ULIP in their shopping cart must-haves. Despite this rare unanimity and strong arguments against the product class, it has drawn investor interest consistently. The reasons behind this ostensible paradox, or indeed the product's long term survival, have assumed centrestage with recent developments in form of the SEBI-IRDA jurisdictional battle. At the heart of this is regulatory changes that, as one understands, shall address opacity and investor-unfriendly practices that ail ULIP sale and service delivery, if not inherent in their design itself.

To fully appreciate the context of the proposed changes, one must recognize that ULIPs have been sold in a manner completely antithetical to the basic nature of the family to which they allegedly 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 return' and hence afford '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 salesforce. A general expectation of market efficiency over public sector sloth thus plays to 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 to 5 years that qualify as lifetime to today’s average 25 year old). Look out 10 years, or 15, if not 20, and cyclical noise is factored out of markets and sensible, old-fashioned stockpicking yields full results. This is clearly market-oriented investment spiel (say equity, MF) but unfortunately not one that a lot of neophyte investors readily bite, obsessed 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 return, draws savings to ULIP schemes.

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 via heavily front loaded cost structures (upto 45% of Y1 premium goes thus!), a bevy of insurance salesmen have positioned ULIP as a best-of-both-worlds insurance product generating assured return 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) 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, mal-intentioned agents and lazy insurance firms continues to flourish.

At another level, ULIPs represent a large (if invisible) problem for the last mentioned of these: private sector insurance companies. There is a highly credible school of thought that makes a case for what drives this disproportionate focus on win-today-worry-tomorrow rat race for the investable rupee. The motivation, arguably, comes from higher capital adequacy norms for guaranteed (term insurance) vs market-linked (investment) assets. This makes minimization of life cover per rupee vested an attractive strategy for quick gain. 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) but inadequate social security structures, such missell of investment in 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 these have been known for a while. Yet, aside from (big picture inconsequential) individual purchase decisions like mine, not much had been 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 action to clear the mess under an investor friendly bias. In the ensuing turf battle, the IRDA has come up trumps. (SEBI's knock on Supreme Court’s doors was in vain: GoI stepped in with its IRDA-primacy ordinance before the courtroom drama was fully played out - and while CBB was away on business in Canada!)

The cynical 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 Pranabda’s mandate.

Regardless, the verdict of 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 over-pessimistic doomsday 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.