Market-linked retirement options to look at

NPS works best for conservative investors, risk takers can look at equity-diversified MFs

Aquery that we often receive at Mint Money is how to build a retirement corpus—while some plan early retirement, some plan to follow the course. Regardless of when you decide to hang up your boots, the one need you will have to service is periodic income. In order to maintain your lifestyle after retirement, one thing that you need to do is to start saving as early as possible. Another factor you must consider is to get a return kicker by not just remaining invested in debt instruments, but also looking at some market-linked investments.

In fact, some retirement products are designed in a way to accommodate debt as well as market-linked elements. Here are the options you can look at.

Mutual fund products

Mutual funds (MFs) offer two kinds of retirement products—ones that offer tax deduction and other than don’t. Let’s call schemes that offer tax deduction type I and those which do not type II schemes.

Besides the difference in tax treatment, type I and type II schemes’ investment pattern differs significantly. While type I schemes primarily invest in debt, irrespective of the age of investor, type II schemes mainly invest in equities until the time the investor nears the age of retirement. Typically, after the investor crosses 60 years of age, the fund begins to invest primarily in debt in order to secure your capital. You can make systematic or lump sum withdrawal during this stage.

There are two type I schemes in the market: Templeton India Pension Plan and UTI Retirement Benefit Fund. Both the schemes invest 40% of the corpus into equity and the balance into debt. These funds are relatively safe as a major part of the corpus is invested in debt, but they do not guarantee your capital.

On the other hand, type II schemes are being offered by several MF companies, including Birla Sun Life Asset Management Co. Ltd and ICICI Prudential Asset Management Co. Ltd. The newly launched Tata Retirement Savings Fund by Tata Asset Management Ltd also falls in the same category. Since type II schemes mainly invest in equities, the long-term returns may be higher as compared with type I scheme. “In the long run, equities are likely to yield higher returns compared with any other investment class and since our scheme investments in equities are higher compared with some other MF schemes, insurance plan or even National Pension System (NPS), it suits investors looking for higher appreciation,” says Bhupinder Sethi, fund manager, Tata Retirement Savings Funds.

Assuming the same rate of return, type 1 schemes are better because of the tax deduction factor. Sample this: you invest Rs. 25,000 every year for 20 years and the scheme charges an expense ratio of 2%. At 10% per annum your corpus would be Rs. 12.06 lakh. In a type 1 scheme, if you factor in the tax deduction, you will save Rs. 7,725 every year assuming you are in the highest tax bracket of 30.9%. Over 20 years, this would add up to Rs. 1.55 lakh.

Type 1 schemes tend to lose their edge only if the returns from equity are very high. For instance, equity funds’ yield would be higher if they return 15% as compared with type 1 funds that yield 10%. Hence, the choice between the two depends on your risk profile.

The problem: Both type I and type II schemes discussed above suffer a problem—they have an easy exit option. By paying an exit load, you can redeem your investments and this can dent your retirement savings. Says Sethi, “Ideally, only a partial withdrawal should be allowed but the Indian market would take more time to mature to that level.”

Insurance products

Pension products from insurance companies have a better cost structure, but owing to a mandatory guarantee on the capital, pension policies invest heavily in debt products.

Let’s sample a policy from the Life Insurance Corp. of India (LIC). LIC’s Pension Plus is a regular premium policy that offers two options—one invests up to 100% in debt, while the other limits debt exposure to 65-85%. It has a premium allocation charge of 6.75% in the first year, 4.5% from the second to fifth years and 2.5% thereafter. The fund management charge is 0.7% for the debt fund and 0.8% for the mixed fund.

Assuming a return of 10% over 20 years on an investment of Rs. 25,000 every year, the policy will return Rs. 13.16 lakh. Throw in the additional Rs. 1.55 lakh—the premiums of pension policies qualify for a tax deduction under section 80C—and the total corpus at the end of 20 years stands at Rs. 14.71 lakh.

The problem: Though pension policies have a friendlier cost structure, they may not turn out to be an effective investment vehicle over the long term. According to the guidelines of the Insurance Regulatory and Development Authority, insurance companies need to provide a minimum guaranteed return of 3-6% on the total premiums paid. To fulfil the requirement, insurance companies invest predominantly in debt and hence the returns are conservative. “Under the present structure, retirement products offered by insurance companies would not be able to provide high return. The cost structure of insurance products too is higher as compared with other products such as the NPS. Hence, even conservative investors should not invest in these products and would be better off investing in products like NPS,” says Satkam Divya, business head, Rupeetalk.com, a Net Ambit Venture.

National Pension System

Like MF and insurance products, NPS also invests in a mix of equity and debt. The scheme allows for three investment options: equity (E) in which a maximum of 50% can be invested, fixed income instruments other than government securities (c) and government securities (G).

What compensates for lower equity investment by NPS (up to 50%) is its low cost structure. Among all retirement product, NPS charges the least. The costs in NPS are a mix of fixed and variable costs. While the fixed costs fail to make any visible dent on the return, especially if the investment corpus is large, even variable costs are minimal. The fund management charge is as low as 0.0009%. Hence, your investment of Rs. 25,000 per year for 20 years at an annual return of 10% per annum would give you Rs. 15.45 lakh.

Also, since NPS provides tax deduction, indirect savings can yield another Rs. 1.55 lakh. And it is not the cost alone that pleases you; the structure of NPS is such that it allows for no leakages. The scheme has a strict lock-in till 60 years of age. If you wish to withdraw before you turn 60, the system discourages you by annuitizing at least 80% of your corpus: it buys an annuity product that gives periodic income.

What should you do?

If you are a conservative or balanced investor, NPS is best suited for you. Type 1 MF schemes and debt-oriented pension plans are best avoided. For risk takers or equity investors, we recommend equity diversified mutual funds for wealth accumulation.

Source: http://www.livemint.com/2011/10/17213335/Marketlinked-retirement-optio.html?h=B

Tata Mutual may seek tie-ups to tap QFI

Tata Mutual Fund may go in for strategic tie-ups that will offer opportunity to qualified foreign investors (QFIs) to tap the Indian market.

In order to promote the portfolio investment route, the Government last month allowed QFIs -- individual, group or association -- to invest up to USD 13 billion in equity and debt schemes of mutual funds in the infrastructure sector.

Besides, with an aim to further liberalise the capital market, the Government is contemplating to allow foreign individuals to buy equities directly in stock markets.

"We are looking at strategic partnership and at ways to have access to newer markets," Tata Asset Management president and chief executive officer Sanjay Sachdev said.

"It will happen ... it is a matter of time. We are working on that," Sachdev said on the sidelines of launch of 'Tata Retirement Savings Fund' -- an open-ended scheme.

Sebi had recently said that efforts were being made to sort out a few concerns including KYC issues to make QFI entry into Indian mutual funds a reality.

Asset under management of the Tata Mutual house was Rs 23,000 crore as on September, and offshore AUM Rs 2,800 crore.

Speaking about the mutual fund industry, Sachdev said it was expected to grow 20 per cent in next five years and welcomed combined Know Your Customer (KYC) norms planned by the capital market regulator Sebi.

On the new Retirement Saving Fund, Sachdev said the number of senior citizens had gone up from 71 million in 2007 to 100 million in 2011 and there was need for a fund to meet retirement goals.

The NFO of the fund was open and would remain so till October 21.

Source: http://www.moneycontrol.com/news/mf-news/tata-mutual-may-seek-tie-ups-to-tap-qfi_600721.html

SEBI aids structured product investors.

In a bid to make the popular but unregulated and complicated structured products more lucid for investors, the capital market regulator, the Securities and Exchange Board of India (Sebi), last month issued guidelines on additional disclosures for the issue and listing of these. Structured products or market-linked debentures are products where majority of the money is invested in fixed-income securities and the smaller portion in derivatives linked to a assets such as equities.

Observing that these products are different from regular debentures in nature and their risk-return relationship, Sebi felt the need for additional disclosures and requirements in offer documents. The guidelines broadly talk about disclosure norms for risk, return and product valuation.

Over the last few years, structured products have carved a definite niche in most high networth individuals’ (HNI) portfolios.

According to Gaurav Arora, vice-president (products), India Infoline Ltd, “In the last couple of years, on average there have been annual issuance of roughly Rs. 3,000 crore and the demand continues to remain healthy.” What makes these products a popular choice among HNIs is the combination of yield, principal protection and participation in returns. Says Rajesh Saluja, chief executive officer, ASK Wealth Advisors Pvt. Ltd, “Participation in equity returns without risk of capital erosion, make these products attractive.”

Structured products are rightly positioned for the sophisticated investor as the nuances involved are many and you need to give it adequate thought and analyse the details before investing. Here’s how the recently issued guidelines will help the investors understand the products better.

What’s under regulation

Though a majority of the structures offer capital or principal protection, there are some that do not protect the principal and therefore assume the risk of investing in equity. The recent Sebi guidelines apply only to capital-protected structures.

However, this does not mean that capital protection structures do not invest in equities: the larger chunk of funds collected in these is invested in fixed-income instruments and the rest in derivatives where the underlying asset is the main return generator. Usually, these derivatives are equity, but some structures also use gold derivatives.

Given that the main payout for structures is a coupon or interest rate, they are classified as non-convertible debentures (NCDs).

Subscription size

Among other things, Sebi has mandated the minimum ticket size for subscription at Rs. 10 lakh for any issue. This will act as a deterrent for small investors, which is good, since these are complicated products best positioned for investors who can take on all the underlying risks.

Says Saluja, “We assess the net worth and existing allocation to structures before recommending these products to HNIs. The minimum ticket size is Rs. 50 lakh, which is compromised only if there are liquidity constraints that the client faces, but the client profile has to be right.”

Additionally, Sebi has prescribed a number of disclosure requirements pertaining to valuation, risks, returns and distributor commissions with the intent to ensure that the investor is better informed.

The risks

Let’s understand some of the main underlying risks that come with investing in structured products and the guidelines around them.

Credit risk: The primary and most critical risk linked to structured products is credit risk or the risk that the issuer may default. The product, basically an NCD, is issued by non-banking financial companies (NBFCs) and the adviser is simply a distributor. It is, thus, rated as a debt instrument from that NBFC and carries the same risk of default and non-payment of coupon as would other debt instruments issued by the NBFC. This essentially means you take the risk, irrespective of it being a capital-protected structure, that the issuer may not be able to pay you back.

Sebi has mandated that credit risk of the issuer should be explicitly mentioned in the offer document of the product. This is already being followed in practice by large advisers.

While such default hasn’t yet been witnessed in India, during the 2008 global financial crisis, there were large overseas issuers which did default. Says Rajesh Iyer, executive vice-president and head (products and research), Kotak Mahindra Bank Ltd, “For structured products, credit rating is a guideline to assess the ability of the NBFC. But risks remain, as a second check, the adviser and investor should assess the stability of the underlying asset exposure for the NBFC issuing the debenture.”

Market risk: The asset risk mainly comes from the derivative part of the product. Here it’s important to understand that each structure is designed to cater to a specific view on the price movement of the underlying asset. For example, if the underlying asset is the Nifty, a 36-month structure may be designed to cater to the analysis that the Nifty most likely will return up to 5% during the tenor, another structure may be designed to cater to the view that the Nifty will double the returns over the same period. Participation rate, coupon, knock out and other relevant features (see box) vary according to the view taken.

Before you subscribe to a particular structure, you need to have a rough idea of where you think the Nifty level will reach at the end of the tenor. This will determine the final payout you are willing to accept from the adviser. This is very unlike investing in mutual funds, debt or equity, or even fundamental stock picking. If your view is wrong, you risk not making any returns from this product even after being invested for two-three years or more.

Says Iyer, “For larger ticket sizes, there is a customization of the structure based on the client’s view of where the market is headed. Typically, though it’s a merging of the house view (portfolio manager) with the client’s view. There are mass products, which subscribe to the general trend, as well.”

Event risk: Unexpected events such as natural calamities, civil wars, terrorist attacks and technology crash can lead to a standstill in asset trading. While the probability of such events happening is very low, but they have happened and a halt in trading can impact not only the value of a derivative but also the fixed income portion of the structure. The occurrence and outcome of such events is hard to predict, thus this can’t be quantified or avoided.

To help investors understand this risk better, Sebi has mandated disclosure of model risk, which essentially says that the actual behaviour of securities may significantly differ from what the mathematical model says as it will be influenced by market events.

Is it worth the risk?

Says Iyer, “For capital protected structures, we allocate 10-15% of the client’s fixed-income money and aim not to have more than 20% of the overall portfolio in structured products.” According to Saluja, these products warrant roughly 5% allocation within the asset class—fixed income or equity—they belong to.

Despite the risks, this product has a unique proposition which allows you to make money regardless of the volatility in asset prices. Moreover, even if the underlying asset is in a rally, the participation rate of more than 100% means that you make more returns than if you invest directly in the underlying asset.

Structures which offer a fixed coupon (dependent on the level of underlying asset at the end of the tenor) are also very attractive as the payoff is certain and that makes sense in volatile markets. Moreover, structures with capital protection mean that there is no downside in the product itself. Says Rohit Bhuta, chief executive officer, Religare Macquarie Private Wealth, “It’s not a product that every client demands. It’s more like a solution for sophisticated investors and surely has a small place in their portfolios.”

Of course, you have to remember the biggest risk you undertake is that the issuer may default and in that case despite the capital protected nature of the product, you may not get back the principal.

Also, these are event-based products and the view prescribed has to be accurate for the product to deliver. Adds Saluja, “Globally, 70-80% of structured products don’t deliver, but when they do, for capital protected structures which form part of fixed income, returns are hugely enhanced and that’s a chance people are willing to take.”

How do you choose?

The confusion arises in deciding which kind of structure suits you the best. Firstly, you have to have some idea about which direction you think the underlying asset prices are headed. A product may be geared to take advantage of a 15% rise in the Nifty after three years, whereas you are actually expecting at least a 30% rise; in this case, you may not make any money if there is a knock out when the Nifty rises by 20%.

Also, small changes in one feature of the structure may make it look better than another, but that may not be the case. For example, a product that offers a participation of 200% isn’t necessarily better than a product that offers a participation of 150%. You have to consider other features such as credit rating, knock out, coupon and tenor. In all likelihood, if one feature looks more advantageous, then another may be restrictive. Moreover, as Arora says, “You have to avoid overexposure to one issuer.”

In an attempt to standardize reporting of returns, Sebi guidelines talk about indicative returns/interest rates being shown only on annualized basis. So far, portfolio managers have been disclosing absolute return/interest figures along with the compounded annual growth rate over the life of the product or the annual interest rate, as the case may be.

Other guidelines

Valuation: Some guidelines such as appointment of a third-party valuation agency will add to the issuer’s cost. The valuation is to be done by a Sebi-registered credit rating agency and published at least once a week. Expertise of credit rating agencies in analysing and valuing structures is nascent and streamlining this will take time. However, it is a step in the right direction though challenges remain.

Frequently valuing these hold-to-maturity products may not be most productive and accurate given the many variables involved. Says Iyer, “For these products, the market is illiquid, so valuations may look skewed. Also, for debt securities there is a marked-to-market value and that can make the valuation a bit hazardous.” The implementation and appropriateness of the valuation disclosures are still a grey area.

Commissions: Sebi has mandated that the broker commissions be disclosed to the client. The norm so far is to disclose fees in the information mandate. Says Bhuta, “These guidelines attempt to minimize conflict from the client’s perspective and ensure that they can question the distributor about the fees charged.” At present, in some cases, where the distributor and manufacturer are under a single umbrella, there could be hidden fees.

The guidelines are a good move in transparency. Says Arora, “The present scenario analysis showed to clients is already ahead of what Sebi is talking about.” It is also important to remember that the very nature of structures is customization and to that extent, standardizing return and valuation disclosures may have the undesired outcome of creating more confusion than intended.

Glossary

Here are some common features of a structure. These get tweaked for customization of each structure, which may have unique nuances. Also, it is not necessary that each structure has all these features.

Coupon: While all structures may not have an in-built coupon or interest rate, some have a specific interest payout if certain events (market linked) occur. This is specified in the product brochure.

Participation: This is the amount of return you can generate from the derivative part of the product. It basically refers to the participation in returns of the underlying asset. For example, if the underlying asset is an equity market index such as the S&P Nifty, then a participation of 120% means 120% of the returns generated by the index in a specified time period.

Knock out: This is the upper price limit of the underlying asset beyond which the contract gets “knocked out” or ends at a value much before the completion of its tenor.

Rebate: The return earned if the structure gets knocked out.

Tenor: It is usually specified with two time lines. For example, the tenor for a three-year structure may be specified as 36/39— here 36 refers to the number of months in the tenor and 39 refers to the month of the closure of the product. In the three months between the end of tenor and closure, the product can be listed on an exchange and sold in the secondary market.

Initial level: This is the level of the underlying asset on the start date of the product. It is better if this is specified as an average rather than a one-day price.

Final level: This is the level of the underlying asset when the structure ends. Similar to the initial level, it is better if this is specified as an average. For example, for a Nifty-linked structure, the final level can be the three-month daily price average taken in the last three months of the tenor. By doing this, market risk is mitigated to an extent.

Strike level: This is a specific observation level of the underlying asset. For example, strike level can be 80% of the initial level or 20% below the initial level. In some structures, the final payout is linked to the strike level rather than the initial level.

Auto call level: It’s a specific level of the underlying asset. If reached, the product gets auto-called or closed. There can be a defined payout if the auto-call level is reached. For example, the auto-call level can be 105% of the initial level, which means if the Nifty gains 5% anytime during the tenor of the product, then the payout will be fixed as defined.

Source: http://www.livemint.com/2011/10/16210216/Sebi-aids-structured-product-i.html?h=B

More efficient decision making to woo investors: Reliance Mutual Fund

With global crisis affecting the Indian economy, volatility in prices is also influencing the country already hit by high rate of inflation. Sunil Singhania, head (equity) at Reliance Mutual Fund talks to NDTV about the Greece crisis and the possibilities of the Indian economy attracting more fund flows.

NDTV: Is there a sense of deep unease with what is happening globally at your end?

Sunil: Everyone would like things to be much more stable. One would like things to be more clear at this point of time. Every day is a new day. We don’t know, about problems of the countries and it is so difficult . We have all sorts of analysis available, like hunderd reports 40 of which are positive, 40 of which are negative and 20 in which they have no view.

We also rely speaking to experts, which are stationed there. So it does concern us, but what we have been analysing is that a lot of these concerns have already been factored in the pricing. For example, Greece defaulting has 95 percent been factored because there is 95 percent probability of Greece defaulting. So if it defaults, it’s only 5 per cent surprise and our view is that one of the largest country in the near term looks like in its defaulting.

If India had been more proactive in its political and economic decision making, we would have benefited out of it because global investors are actually looking at some avenues where there is stability in the domestic economy and India stands out as one of them.

NDTV: There is an attempt by the RBI to bring demand for investment to lower levels otherwise they can control inflation. So everything plays out accordingly. So would you look at RBI’s inflation compulsion to increase interest rates may be one or twice and worries about the corporate earnings and impact of all this?

Sunil: It is right now too early to say that RBI will tighten more because it all depends on the trend and commodity prices and oil prices over the next one month.

Already, we have seen a sharp pulldown in commodity prices, copper is down 30 per cent, even gold and silver have come off a bit, oil is down, to some extent. A sharp depreciation in rupee has negated some of these benefits. Possibility of global prices to remain very strong is definitely unrealistic.

So from our perspective, we did a study where we zeroed down on all the concerns that markets are facing at this point of time and what they would look like after one year and across the board whether there was inflation issue, interest rate and European issue.

Source: http://profit.ndtv.com/news/show/more-efficient-decision-making-to-woo-investors-reliance-mutual-fund-183145

AMCs turn eager lenders to companies

With banks’ lending rates hitting a high, asset management firms have raised Rs 1.2 lakh cr through FMPs in 1.5 yrs.

Indian companies have found an eager lender in asset management companies (AMCs). With interest rates rising 300 basis points in the last one-and-a-half years, AMCs have raised as much as Rs 1.2 lakh crore through fixed maturity plans (FMPs) and companies account for more than half of this. The same money is being used to fund companies by investing in their papers.

Senior AMC sources say that the process of lending to companies had gathered traction due to high lending rates of banks. “We have set up a team dedicated to analysing corporate papers like commercial papers (CPs), corporate bonds (CBs) and non-convertible debentures (NCDs),” said the CEO of one of the top five fund houses.

Companies also stand to benefit from this. For instance, an AAA rated company has to pay 9.5-10 per cent for commercial papers of up to one year. Similarly, for corporate bonds of longer tenures, they have to pay 9.6-9.75 per cent.

“In comparison, banks charge 50-200 basis points over the base rate, in the current market scenario, even for the best of companies,” said a risk management head of a bank.

That is, considering that the base rate of State Bank of India stands at 10 per cent, the cost of short-term loans would be 10.5 per cent and 11-12 per cent for loans of longer terms for top-rated companies. The rate of interest would keep rising for companies rated lower.

While the mutual fund industry lends to companies through other schemes, like liquid, liquid-plus and income schemes, FMPs have come to the focus once again because fund managers are getting money that allows them to take calls for the longer term.

Exiting these schemes after they have been listed on the stock exchanges is difficult in the absence of a robust secondary market. As a result, investors in these schemes have to be locked in for the entire tenure.

However, both retail and corporate investors have been aggressively investing in these schemes because the attractive rates are making these popular for investors too. Axis Mutual Fund CEO Rajiv Anand says: “FMPs have certainly caught the fancy of retail investors because of predictability in returns.” In fact, in the wealth management and private banking segment, vis and vis bank deposits, these products are being aggressively routed to high net-worth individuals.

The main competition for FMPs comes from banks’ fixed deposits. But the rates are quite competitive. Sample this: The country’s largest bank, State Bank of India, offers 9.25 per cent on a one-year fixed deposit, with the rate staying the same for up to 10 years. Returns from a one-year FMP, at 9.4 per cent, according to industry sources, is slightly higher. And, the portfolio consists of only bank certificate of deposits (CDs). A slightly riskier portfolio that invests in commercial papers will offer higher returns of 9.6 per cent.

Importantly, the post-tax returns make these more attractive. For an investor in the highest income-tax bracket (30 per cent), returns would be around 6.25 per cent on an FD. On the other hand, returns from FMPs would be taxed at 10.3 per cent without inflation indexation, and 20.6 per cent with indexation.

Even if one does not take the inflation indexation benefit, the return would stand at 8.43 per cent.

For someone in the lowest income-tax bracket (of 10 per cent), the returns from FDs and FMPs are comparable. Also, if someone goes for inflation indexation, the benefits will also be substantial, because of the high inflation rate of 9-10 per cent.

Importantly, fund houses make FMPs more interesting by having 13-14-month products. In such products, an investor gets double indexation benefits. That is, if an FMP is bought in April 2011 and is maturing in May 2012, the investor will get double indexation benefits — one for 2010-11 and another for 2012-13.

Source: http://www.business-standard.com/india/news/amcs-turn-eager-lenders-to-companies/452357/