20 Feb Sahi Hai, PAR IFA Zaroori Hai”.
Mutual Funds Sahi Hai has become perhaps the most successful financial campaign in recent times: a great example of the right campaign for the right product at the right time. At Vista, we always complete this pitch line as follows: , “Mutual Funds Sahi Hai, PAR IFA Zaroori Hai”. People say that the true value of an IFA is seen in a bear market – our belief however is that good IFAs add huge value in a bull market – by helping investors avoid the perils of a bull market. But in all honesty, we can complete this slogan only when we earn the right to do this. And we earn the right when we go that extra mile to help clients stay on track and avoid irrational exuberance that marks almost all bull markets. We at Vista have been very focused on earning the right to the slogan extension. We discuss these strategies within DFDA as well as with other IFAs who keep consulting us from time to time. We thought of putting this article together on Next Level Education for the benefit of all our IFA friends across the country, as we strongly believe that it is only good quality IFAs who can guide investors in a rational and prudent manner in this raging bull market.
All the 3 bull markets we predicted have come true!
Talking about the bull market, I have always maintained since June 2014 that we should “Get ready for 3 bull runs, not 1”. I am really happy that almost everything we said then has come good in the last 3 years. We are indeed witnessing 3 bull runs and reaping their benefits.
The first bull run is clearly the stock market – which is the most visible one. Second is the business bull run we predicted on the basis of the TINA factor – and that is exactly what we are seeing in terms of flows into mutual funds, as savers move their attention away from real estate, from FDs and from gold – and into capital markets in general and mutual funds in particular.
And the 3rd bull run is the structural growth path that this Government has put the country on, which is being recognized the world over.
I said back then in 2014 that those who persevered through the lean phase during 2009-2013, will reap the benefits of the 3 big bull runs which we predicted in 2014. That is indeed happening and business volumes for IFAs who stayed focused have seen big jumps in recent years.
While we as entrepreneurs will want to make the most of this business bull market, we have to nevertheless be aware of the perils of this bull market. And we owe a responsibility to our clients to steer them away from these perils and keep them firmly on track towards long term financial success.
How are the 3 market constituents behaving in this bull market?
There are 3 constituents who form our industry – investors, distributors and manufacturers. I am not talking in this article about the regulator – the 4th constituent. Lets take investors first – many of them are acting as if there is no tomorrow in the markets. There is some sort of a panic buying into equity market that we are seeing. To all such investors, our message is what James Bond proved in his hit movie – “Tomorrow Never Dies”. There will always be a tomorrow, this is not the last bus to catch the market – lets not get carried away and go overboard on our equity allocations out of fear that we will never be able to invest in equity again because it will keep running up in a one way street. This is more so in the case of Do-It-Yourself investors who are not getting the benefit of sensible asset allocation advice from good quality IFAs.
I will, by the way, keep using the term IFA – as I truly believe good IFAs are Independent Financial Angels – good IFAs make a big difference in helping savers become successful investors. You can take IFA to mean Independent Financial Angels or Independent Financial Architects – we can still call ourselves IFAs so long as we don’t mean the “A” to be advisors!
Talking of the second constituent – distributors and IFAs – many are finding it difficult to effectively counsel investors who are exhibiting this buying panic. They are finding it difficult to wean away investors from the magnetic draw of media that is feeding this buying panic. Consequently, many of them are bending their business models and compromising their own beliefs to align with the mood of the moment – which is neither in their own best interests nor in their clients’.
The third constituent is manufacturers – who are coming up with exotic closed ended funds to lock in equity allocations despite worries around market valuations. There is also this questionable push around monthly dividends on balanced funds – especially when we all know how it is being positioned as an alternative to FDs – which it clearly is not.
So, that’s the context in which I am writing this article – a context where every constituent is in their own way, creating perils in this bull market – which will create many problems for us down the road unless we curb them now.
When is the right time for high-risk bets?
The simple question every IFA must ask investors and AMCs is this: when is the right time to take high risk bets? When market valuations are high or when they are low? I am not trying to suggest that the market is at a top or anything like that – just a simple acknowledgement of the fact that market valuations are clearly high and the higher the valuations go, the higher is the risk in the market.
When should investors change their risk profile and go more aggressively into equity oriented investments: when markets are cheap or when they are expensive? Is it prudent to take on a higher risk profile when the risk in the market is higher? If the logical answer is no, why then are we doing this in reality? Why are investors wanting to break FDs and come into balanced funds which have 70% in equity – at a time when valuations are not supportive? Why are fund houses marketing propositions that induce this behaviour – especially at a time when risks for such investors are a lot higher?
When we would normally recommend a debt fund as an alternative to FDs for a client with a conservative risk profile, but now we change that recommendation to equity savings schemes, with a carrot that a 1 year holding will make the returns tax efficient vs 3 year holding for debt funds – that’s another example of taking on higher risk than warranted by the profile. In general, a prudent IFA would want his client to go more aggressively into higher risk assets when the risk in that asset is low – which means when market valuations are low. Doing the opposite sets you up for unpleasant investor experiences down the road – which you will have to then tackle.
10 kmph vs 100 kmph
We must always remember one thing: a bump in the road will cause no harm or damage if your car is travelling at 10 km/hour. The same bump can cause tremendous damage – sometimes even fatal if you are travelling at 100 km/hour.
What therefore follows is that as market valuations go from reasonable to expensive, IFAs must consciously move towards the lower end of the risk spectrum within the equity category. So, if the agreed asset allocation for a client is 60 equity : 40 debt and the allocation has now gone to 70:30, you must of course rebalance back to 60:40. In addition, when you find market valuations in expensive zone or certain pockets in very expensive zone (like small and mid caps now are), you must consciously move from small and mid caps to large caps or diversified funds. Ramping up risk in the portfolio when market risk is high, is certainly not a prudent step.
High risk – high return is a big myth
There is this popular notion that higher the risk, higher is the reward. I don’t agree with this notion at all. In every bull market of the past, we saw enough of these “high risk – high return” strategies being sold and bought – whether the tech mania or the infra mania – and the fact is that rewards for investors even after a decade of holding has not at all justified the very high risk that they took. Today, the highly inflated small and mid caps zone looks like a similar danger signal.
We must understand for retail investors, there is clearly upto a point where higher risk delivers higher rewards, beyond which we are going clearly into an unnecessary risk zone that delivers no incremental gains. Perhaps in the case of savvy and nimble investors who think they can master the timing of their entry and exit, such high risk sectoral and thematic bets may actually deliver higher returns. But that’s clearly not the case for retail investors.
Who owns the risk?
Whenever you allocate client money into higher risk investments, you need to ask yourself this tough question: who owns the risk? Lets say you put an FD investor’s money into equity savings funds or balanced funds 6-9 months ago. Your client is very happy today with the returns. You and I know that these returns will not last forever, but your client may not have internalised this reality. When returns fall, especially when they go to sub FD level returns, many of these clients will come and tell you, “I never asked for this. I only asked you for better-than-FD-returns. Why did you give me this?” The risk manifests itself in the client’s portfolio, but in his mind, you own the risk. You made him take that risk. And that feeling may result in loss of that client forever.
The reality is that better-than-FD-returns would have been possible with accrual funds. So the issue to be clear about when you go into higher risk products than what are strictly required, is whether you have had a clear conversation around the risk and whether your client “owns the risk”. If you have explained the pros and cons clearly and your client chooses a higher risk product, that’s fine – you are clear that he owns the risk. But if you haven’t had a detailed conversation on different returns scenarios, well, you own the risk.
So today, even if your clients are very comfortable with say equity savings funds that you sold them 6 months ago, and you know you haven’t sat down with them and discussed pros and cons clearly, I would encourage you to show them something like this, which we at Vista are sharing with our investors in equity savings funds:
It is very important for your clients to understand how the returns from Equity Savings Funds actually come – in terms of asset classes and their return expectations – which then gives us a return expectation range over a 1 year period. So, while we may stress that we would like clients to stay invested in these funds for 5 years or more and that a double digit return expectation in reasonable over a 5 year holding period, it is also important for them to understand that an expected 10% CAGR over 5 years can be made up of some years of +14% and some years with 0% to -1% return.
If we only talk about a double digit return expectation over 5 years and stay silent about the journey over these 5 years, your clients are unprepared for a bad year. You own that risk, not your clients.
Altering risk profile based on markets, not individual circumstances
Prudent IFAs will know that risk profile of an investor should not be contingent on market levels. Risk profile changes only due to some change in personal circumstances – job loss can reduce risk appetite while a huge bonus / stock option can legitimately increase the risk profile to some extent. What should be avoided is agreeing to change a client’s risk profile due to favourable experience with equity investments in last 1-2 years. We are seeing a lot of this happening – clients are eager to review their risk profile and change their asset allocation guided primarily by recent returns, and many IFAs are agreeing to do this and make higher equity allocations as markets go higher.
Similarly, we are seeing a lot of conversations where clients are asking their IFAs to step up the pace of STPs to ensure they have more money into the market at a faster time frame. In many cases, these are clients who were initially a little circumspect about an equity allocation in a flat market and the IFA suggested a 2-3 year STP to gently get the equity allocation up to the desired level. Some of these clients are now asking to speed up the STPs in a bull market as they feel the rest of the money is losing out. Fact is nobody can predict whether there will be a sharp correction that can make the faster STP look reckless or whether the market will continue going up in a one way manner, which will make the faster STP look like a very sensible decision. It is the job of the IFA to lay out the situation as honestly as he can, to enable the client to make a well balanced decision.
Every bubble creates two troubles
Every market bubble or product category bubble brings with it two troubles. One is when the bubble is building and second is when the bubble gets pricked and gets deflated. Both create challenges for IFAs and investors. I am no expert to give an opinion on whether we are in a stock market bubble now or not. All I am saying is that wherever we find too much irrational exuberance there is a warning signal for us that we may be in a bubble of some sort.
Today we see a lot of equity savings funds being sold with a 1 year time horizon as a replacement for a 1 year auto rollover FD, with the hook that a holding period of 1 year will make the returns tax free from these funds. As I have already mentioned, a 1 year horizon with a 9-10% return expectation is a huge risk, while the same return expectation on a 5 year basis sounds a lot more reasonable. Likewise, selling monthly dividends as the key selling proposition in balanced funds is a ticking time bomb that will explode one day. Many investors are being led to believe that they can get an 8% to 12% tax free return per annum from balanced funds, without any recognition of the fact that 70% of the corpus is linked directly to stock markets.
Let me make one thing clear – I am not against any of these product categories – I believe each one of them has a definite place in client portfolios as per risk profile and time horizon. The trouble is when they are sold with an expectation of returns based on last 2 years performance and with a time horizon of 1-2 years rather than 5 years and above.
Talking of product category bubbles, we are seeing tremendous enthusiasm among fund houses to launch more and more closed ended funds – at a time when fund managers themselves are expressing concerns about market valuations. The logic of locking up allocations into funds that do not allow periodic rebalancing – especially when you need to be lot more vigilant about rebalancing and maintaining the agreed asset allocation, frankly beats me. It certainly appears that the lessons of 2008 have been forgotten by many fund houses. It is upto prudent IFAs to remember those lessons and not repeat the same mistakes.
The pathway to justify “IFA Zaroori Hai”
I began with the statement, “Mutual Funds Sahi Hai, PAR IFA Zaroori Hai”. I also stated that for us to make this statement, we must earn the right to say it. What I have mentioned in this article are just some of the steps that we need to take in the present context of a bull market creating overexcitement among investors and unfortunately among fund houses as well. At the end of the day, it is the IFA who is best positioned to help investors guard against their own irrational impulses and against the aggressive sales pitches of manufacturers. It is upto the IFA to make mutual funds truly sahi for investors – by helping them get a good investment experience from mutual funds and avoid the perils of a bull market that will drag them into unpleasant outcomes. Mutual funds are certainly sahi – but only if IFAs are there to hold their clients’ hands through the turbulent journey that mutual funds take them, before delivering great investment outcomes. My earnest request to all my IFA friends is to take the time now to help your clients avoid the perils of this bull market. It is only then that your clients will turn around and tell everyone: , “Mutual Funds Sahi Hai, PAR IFA Zaroori Hai”.
In my next article, I will share some thoughts on how we IFAs can build robust business models that serve our clients well even as we endeavour to make the most of the fantastic tailwinds that we are seeing in our business. Watch this space for more…
Ashish Goel : Founder and CEO, Vista Wealth Consultants