Are FMPs risky?

Its been the hottest selling fund category of 2008. FMP AuMs are now well over Rs. 100,000 crores and growing rapidly. In recent times however, some questions have been raised about the risk associated with FMPs. What started off as stray concerns has rapidly escalated with a number of articles appearing in the media about FMP risks – prompting anxious clients to call advisors and find out whether they should be worried about this “safe” investment that they had made.

The key concern

Until recently, lending to NBFCs, brokerage firms and real estate companies looked like smart bets on the back of a booming stock market and a vibrant real estate market. As these underlying markets turned, at least some of the small / fringe players in these segments started to feel the heat – and some of that heat is now being felt in portfolios of FMPs that lent aggressively to these players.

To get a perspective on the risks associated with FMPs, Wealth Forum conducted a panel discussion where two distinguished CIOs interacted with members of the Wealth Forum Advisors Club – which comprises leading independent financial advisors from across India. 

We bring you key takeaways from the panel discussion to help you address your and your clients’ concerns on this critical issue.

(1) Duration mismatch : does happen typically in the short term (1-3 month) FMPs. There is occasional sales pressure for rates to compete with deposits – sometimes leading to mismatches, where longer term paper is taken up in short duration FMPs to boost yield – on FMP maturity, these papers are parked in subsequent FMPs / other schemes. Not a desirable situation – but can be managed by the larger fund houses who have substantial AuMs in debt schemes. Fund managers are pushing back on aggressive “rate wars” at the short end. 

Takeaway : Duration mismatches can be a risk for the smaller fund houses / fund houses that have a small AuM in debt and liquid schemes. If rates offered are higher than market, best to do your homework as advisors and ask questions on duration mismatches, before recommending to clients based solely on indicative yields. 

(2) Credit downgrades : Its important to distinguish between a downgrade and a default. In a downgrade, the market price of the bond will go down and will impact NAV when the portfolio is marked-to-market. This will impact all open-ended funds. However, in an FMP which is typically held to maturity, a downgrade need not mean a loss for the investor, if the principal is paid back on time by the downgraded entity. Its only when there is a default that the FMP suffers a loss – which will impact its investors.

panic on a downgrade, but one should definitely keep tabs on the portfolio quality on a periodic basis – especially in the longer term FMPs. Advisors need to do independent homework on accessing ratings downgrade information and seeking full portfolio disclosures of longer term FMPs – especially those that offered higher-than-market indicative yields.

(3) Roll-overs : A corporate which is unable to repay principal on maturity seeks a roll-over of the paper : effectively seeks more time to pay up. Neither of the fund managers on this panel have encouraged these kind of default-related roll overs. Only roll overs in the normal course of business – where you anyway lend to sound institutions based on your credit appraisal - are executed by these fund houses. 

Takeaway : Roll-overs (other than business-as-usual ones) could spell trouble – as the fund manager may be effectively postponing recognising the problem in the hope that the company will pay up in the extended time-frame given. There are no easy ways of determining roll-overs when you look at the portfolio – the only solution is to maintain a dialogue with the fund house in cases where you see portfolios with holdings that have got downgraded.

(4) Defaults : If an FMP portfolio is made up of AAA/P1+ instruments, history suggests that the probability of a AAA rated company turning a defaulter over a 12-18 month period is less than 1%. The biggest area of concern is FMPs that have taken an exposure to second rung real estate companies in a bid to boost yields – many of these companies are overleveraged and may find it difficult to go through a prolonged downturn in real estate markets. Both fund managers in this panel are comfortable with their own real estate exposure – but acknowledge that this is one area which needs to be very carefully tracked. One cannot rule out problems down the road in this sector. Another segment that needs to be tracked closely is companies that had mega IPO plans – which have now got derailed due to poor market conditions : some of them have made commitments based on assumptions of cash flow from their IPOs – and may struggle as a result.

Takeaway : Advisors need to look closely at the ratings profile and quality of the FMPs they’ve previously sold as well as the ones they are currently selling. Identify which of the FMPs you’ve sold previously are the ones you need to monitor closely and commit yourself to taking out the time to do so periodically. 

If we are indeed likely to see some slowdown in economic activity as some analysts suggest, these are clearly not times when one should be aspiring for aggressive yields – rather, these are times when one should focus on safety first.

Conclusion
The old saying “don’t throw the baby out along with the bath water” seems apt for FMPs. It’s easy to get carried away either way – to sell aggressively in good times without doing your homework or completely shun this asset category due to credit quality concerns in some FMPs. A sensible approach is to recognise that the category continues to have all the merits of tax efficiency, reasonable predictability of returns and low risk – provided you stick to selling FMPs that do not compromise on portfolio quality in the quest of superior returns.

Source: http://www.wealthforumezine.net/paneldiscussion.html?mEmail=&mVolume=20081001

PRAJ INDUSTRIES bse sensex safe bet (Bought by many AMC)

The most enticing aspect of this company is the name of some of its shareholders. JM Financial Mutual Fund bought about 5.80 lakh shares of Praj Industries, increasing its stake to 5.25%. Tata Capital holds 7.33%, Rakesh Jhunjhunwala has a 7.3% stake and Vinod Khosla holds 6.15%. Morgan Stanley holds 2.77%. Makes one wonder what is so special about the company? 


The financial performance of the company for the first quarter ended 30th June 2008 has not been as good as expected. Infact its bottomlines took a hit. YoY, its topline showed a 12% growth at Rs.154.76 crore. Though it has managed to contain its operating expenses, OPM slipped from 28.27% to 20.57% and NPM from 20.47% to 15.99%. Ethanol distillery projects contributed over 85% to the topline, whereas the brewery projects made up for the rest. But forex losses during the quarter dented its earnings. 


The ability of the company to drive down cost as a result of value engineering exercises undertaken as well as the product mix has helped boost contain the margins at these levels. Praj’s current order-book is pegged at about Rs 950 crore of which 48% is from exports and the rest domestic. Being a net exporter, the current depreciation of rupee would go in favour of the company. 


The stock price has taken a beating as there looms the likelihood of the Govt postponing the October deadline for making it mandatory for another 10% ethanol blending. The fortunes of this company are closely linked with the increasing acceptance of ethanol-blended petrol and bio-fuels. 


With fuel bills touching the sky, biofuels is the way into the future and Praj is ready to capitalize on this. It is setting up its first plant in Louisiana, based on sugarcane juice and if this biofuel gets accepted, Praj would have the whole of North America as a market. In EU, it has a JV - BioCnergy Europa B. V., with Aker Solutions. It has also got orders from European sugar majors such as British Sugar, Suedzucker and Danisco. Its JV in Brazil is expected to help tap opportunities there too but this may take a longer while as not much progress has been made on this JV. 

Currently quoted at Rs.129, Praj Industries is a safe bet in this market of turmoil.

10 Principles of Teaching Children about Money

An article published outside india.

Dear Investors,

As Indians try to come terms with the current trends in the financial markets, this provides an opportunity to teach the next generation. Here are ten principles for teaching children about money:

Talk about money. Every time money is involved, parents have a chance to teach their children the values and analysis behind their actions. Money, is one of the important topics through which we communicate our wisdom and values to our children. Every purchase, investment, or donation can be a time to teach your children something about your values.

Talk openly about money. Parent makes a mistake when they keep information from their children. The only way children learn what is a good deal and what is too expensive is by the experience of what their family earns and what items cost. Hiding this information robs children of the financial education they need.

Talk factually about money. Many parents have strong emotions about money based on their childhood experiences. These emotions are always transmitted to children. Instead of helping children, they can cripple children from growing to make sound financial decisions

Require chores; pay for optional work. Everyone in the family has to help complete the work that needs to be done. If you want to pay your children, only pay them for optional work they can choose to do or not to do.

Provide children an allowance they can make real choices with. Talk about money is important, but children need real-world lab experience to understand the consequences of their decisions. Consider giving them an allowance large enough so that they can purchase some of their own needs. Then continue to give them honest advice, and help them ask the right questions to make wise decisions based on their values.

Help children prioritize purchases. Ask them if this purchase is better than other purchases they are considering making.

Help children comparison shop. Help them consider issues such as cost, quality, and convenience.

Require children wait before making large purchases. Adults should wait at least a month whenever they are making a large purchase. Children shouldn't be expected to wait that long. Here is a good rule of thumb: Children should be required to wait as many days as they are old in years before being allowed to make a large purchase (over a week's allowance). There is always tomorrow and over half the time they won't remember what attracted them to it in the first place. Developing this habit will help make them resistant to impulse buying.

Don't use money as a punishment. Your priority should be helping to give your values to your children, not buy their outward behavior.

Don't loan your children money. If their desired purchase is something they should be saving for, let them save for it. If you want to buy it for them for the value of the experience, buy it for them. The principles are "If they want it, they have to save for it. If you want them to have it, you will buy it for them." Loaning your children money for items they want teaches them they aren't responsible and they don't have to prioritize.

India inflation in single digits soon - official

India's inflation is likely to fall to single digits within a couple of months, the deputy chief of the country's planning commission said on Wednesday.

Annual wholesale price inflation has eased in recent weeks but is still close to an annual 12 percent.

"Inflation has softened and the price graph is flat. I hope that inflation will come down to high single-digits in a couple of months," said Montek Singh Ahluwalia.

Earlier, a senior finance ministry official had told Reuters he expected inflation to be above 10 percent by the end of the calendar year.

Source: http://in.reuters.com/article/businessNews/idINIndia-35854720081008