Operating Cash Flow and its importance

  by Dwaipayan Bose 

We have mentioned a number of times in our blog that, fundamental analysis is the best method to estimate the true or intrinsic value of a stock. Fundamental analysis can help investors determine whether a stock is over-valued, under-valued or fairly valued and help them make long term investment decisions. Fundamental analysts study both macro-economic factors like growth of the overall economy (GDP growth), growth of the industry sector etc and micro-economic factors like the financial condition of the company, market share of the company and quality of the management.

The stock market regulator in India, SEBI, requires all publicly traded companies to submit quarterly and year-to-date standalone financial results to the stock exchange within forty-five days of end of each quarter, along with Limited Review Report or Audit Report as applicable. In addition to quarterly filings, all publicly listed companies are required to submit Annual Audited standalone financial results for the financial year, within sixty days from the end of the financial year along with the audit report. Fund managers and analysts study the quarterly and annual financial results released by the companies to make investment decisions and recommendations.
Fixation with EPS and Net Profit
Financial results submitted by companies as part of their quarterly and annual filings include three important financial statements, Income statement (popularly known as the Profit and Loss account), Balance Sheet and the Cash Flow Statement. You will see that the coverage of quarterly or annual results by the media (television, digital media / internet and print) are primarily focused on the top-line (revenue growth), bottom-line (net profit or PAT growth) and the earnings per share numbers. Out of the three numbers maximum important is usually given to net profit and EPS.

The fixation with net profit is understandable because at the end of the day the investors are interested in share price appreciation. It is believed the EPS growth is the fundamental driver of the share price and EPS is nothing but the net profit divided by the number of shares outstanding. However, expert fund managers believe that, operating cash-flow is the most important metric in reviewing the financial performance of a company.
What is operating cash-flow?
Operating cash-flow is the net cash generated by the business operations. It does not include capital expenditures, investments, acquisitions, sale of assets, funds raised from investors as debt or equity, debt repayment etc.
Why is Operating Cash-Flow more important than Net Profit
Profit or loss is an accounting concept, but ultimately a company requires cash to run its business. A company which generates free cash-flows has a sustainable business. A company which struggles to generate free cash-flows can find it difficult to survive without raising additional capital either as debt or equity, which in the longer run is detrimental to interest of the shareholders of the company.
Income statements may not reveal the true financial health of the company. Income statement has both cash and non cash items. A company can make an accounting profit and still lose cash at the same time. Similarly a company can show a loss in its books, but still have positive cash-flows. A cash-flow statement gives a true picture of a company’s financial condition.
You may sometimes see that, the share price of a company jumping when results are just released and then they come down again after a few minutes. This can happen if investors just look at the reported (net profit or EPS) numbers. Once more financial details are available and investors realize that the EPS was boosted by a one-time item, they will sell the shares and the share price will come down again. Cash-flow statement will tell us if a company is generating profits through normal / sustainable business operations and not through one time activities like sale of assets etc.
Income statements can be subject to accounting manipulations by the management but cash-flows are harder to manipulate under our accounting standards. Hence cash-flows can reveal the true financial picture of the company.
Operating Cash-flow is not EBITDA
I have seen many market commentators and even experts use the terms operating cash-flows and Earnings before Interest, Tax, Depreciation and Amortization (popularly known as EBITDA) interchangeably. It is important for investors to understand that, operating cash-flow and EBITDA are not the same. EBITDA is calculated using the accrual concept in accounting.
Let me explain with the help of an example. Suppose a company manufactures products and sells it to different customers for Rs 1 Crore. The accounting rules allow the company to record Rs 1 Crore as legitimate revenue and will consequently get reflected in the EBITDA. However, in most business to business sales, payment terms allow customers to pay within a certain period (e.g. 30 days) after the receipt of the invoice. Just because the company has recorded revenue of Rs 1 Crore in its books, it does not mean that, it has received Rs 1 Crore in cash. Operating cash-flow, on the other hand, show how much cash was actually received by the company.
How to calculate Operating Cash-Flows?
There are two methods of calculating Operating Cash-Flows. One method uses the Income Statement (P&L account) and Balance Sheet. The other method uses the Cash Flow Statements. Let us discuss the first method using P&L account and Balance Sheet, because these two financial statements are more commonly used by investors.
Find Net Profit from the Income Statement (P&L account)

Add back non-cash items, e.g. depreciation, amortization, deferred taxes etc.

Subtract profit from sales of assets like land, property etc.

Subtract increase in inventory / add decrease in inventory

Subtract increase in accounts receivables / add decrease in accounts receivables

Add increase in accounts payable / subtract decrease in accounts payable

The net result is the operating cash flow.
The method which uses Cash flow statements is the far easier method. I have seen that, many investors ignore the cash-flow statement when reading annual reports. However, expert fundamental analysts and fund managers rely on cash-flow statements to make important investment decisions. A Cash Flow Statement is an account of sources (inflows) and uses (outflows) of cash. From an accounting perspective the cash flow statement is a reconciliation of the Income Statement and Balance Sheet. A cash-flow statement segregates cash-flows into three distinct categories.
Cash Flow from Operating Activities (cash flows from normal business operations)

Cash Flow from Investing Activities (e.g. capex, sale of assets, acquisitions, interest and dividends received etc)

Cash Flow from Financing Activities (e.g. fund raising through debt or equity, debt repayment etc).

The net cash-flow from Operating Activities in the cash-flow statement is the Operating Cash Flow. This is the much simpler method of calculating Operating Cash-Flows.

Conclusion
We are in the middle of the Q1 results / earnings release season. As usual you will see that, most of discussion related to quarterly results on TV or newspapers are centred on earnings (EPS) growth or net profit growth. However, as a smart investor, you should not be led to make investment decisions based on earnings growth alone. You may have heard some investment experts and fund managers talk about the quality of earnings being more important than earnings growth itself. You should use operating cash-flows to get a sense of the quality of earnings and make better investment decisions.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

Importance of Equity in Asset Allocation

  by Dwaipayan Bose


What is Asset Allocation?
Asset allocation is simply your investment strategy where you balance the risk and return by investing in the appropriate mix of assets (like fixed income, equity, gold, real estate etc.) according to your investment objectives, investment horizon and risk tolerance.
Why is it important?
Risk and reward are interrelated. Lower the risk, lower is the return and vice versa. It is not possible to get high returns without taking risks. At the same time, your investment risk should be aligned with your investment goals. If you have a short term investment goal, then you cannot take risk with the money you have been saving for that goal. On the other hand, if you want to create wealth then you have to take some risks.

Asset allocation protects you from the vagaries of the market. All asset markets, equity, bond, commodities, real estate etc have their ups and downs. If you are invested too much in an asset class, you may be unfavourably impacted by the movement in prices of that particular asset class.

Situations in life can be unpredictable and therefore, liquidity is extremely important in asset allocation. Liquidity is the ability to convert your asset into cash, whenever you need to. While it is perfect to have some illiquid assets, having a major portion of your assets in illiquid assets can be risky, in case you have to meet an exigency.

There are no fixed asset allocation percentages applying to different asset classes (fixed income, equity, gold, real estate etc.). Your asset allocation will depend on your own financial goals, investment horizon and risk tolerance and sub-optimal asset allocation, may adversely impact both your short term and long term financial goals.
Equity is a vastly under-invested asset class in India
Each of the different asset classes, have their own risk return characteristics and play important roles in asset allocations. Unfortunately, in India, despite the increasing popularity of equity mutual funds, equity as an asset class still forms a very small portion of our average household savings. As per Bloomberg, only around 2% of India’s household savings are exposed to equities compared to 45% in the US. This is in direct contrast to the demographic profiles of the two countries. 65% of India’s population is below the age of 35, whereas around 47% of the US population is below the age of 35. Usually, equity is the preferred asset class for young investors. Investors across most age groups need to have exposure to equities, to meet their longer term financial goals. Studies have proven that asset allocation has the biggest impact on our overall investment returns. In this blog post, we will discuss the five key reasons, why equity investment is important in your asset allocation.
Why is Equity important in Asset Allocation?

Equity as an asset class can beat inflation in the long term:
Inflation is inevitable, more so, in a country like India. The most basic commodity we consume is food. Over the last 5 years, food price inflation has been around 8.5%. For the sake of simplicity, if we assume that our entire consumption basket is just made up of food, then we will lose money in real terms (on an inflation adjusted basis) if the return on investment is lower than food inflation.. The chart below shows the Consumer Price Index (CPI) inflation rate, fixed deposit interest rates (based on historical State Bank of India 1 to 2 year term deposit rates) and Sensex annualized returns over the last 10 years.

Source: BSE, Inflation.eu and SBI
You can see in the chart above that, the 1 year term fixed deposit interest rate struggled to keep up with CPI inflation, even on a pre-tax basis. On a post tax basis, the fixed deposit interest rate would have been definitely lower than the CPI inflation rate in most years, especially for investors in the highest tax bracket. On the other hand, the Sensex was able to beat the CPI inflation rates by a wide margin in most years.
Equity provides the highest return among all other asset classes in the long term:
Over a long term investment horizon, equity investments in India have given the highest returns compared to all other asset classes. From the year 2007 to 2015, diversified equity mutual funds gave on an average 12% annualized returns (as per Morningstar, 15.04.2016). Some of the top performing diversified equity funds have given over 15% returns. As far as fixed income returns are concerned, the average 10 year Government bond yield from 2007 to 2015 was around 8.3%. Retail investors who prefer fixed deposits would have got an average 8 to 8.5% interest rates over this period. This is much lower than the returns which you could have got, on an average, from equity mutual funds.

We, Indians, have a preference for physical assets like property (real estate) and gold. About three years back, physical assets comprised nearly two thirds of our total assets, which have declined somewhat since then, but still they comprise a much bigger proportion of our total assets. Let us now see how physical assets have done from 2007 to 2015. Over this period, residential real estate prices in Mumbai rose 11% on an annualized basis, while those in Delhi rose by 8% on an annualized basis, as per National Housing Board data. Equity has outperformed real estate across the majority of real estate markets in India. Let us now see the Gold price appreciation from 2007 to 2015. Gold price in Rupee terms have risen 10% on an annualized basis from 2007 to 2015. We can see that, equity has outperformed both real estate and gold over the 2007 to 2015 time period.

Different asset classes outperform / underperform others in different market conditions:
The asset markets are dynamic. Even if you are a purely fixed income investor, your investment returns will change with market conditions. If you invest in traditional fixed income products like, bank fixed deposits, government small savings schemes etc, your income will be higher, when interest rates are high and it will be lower, when interest rates are low. On the other hand, interest rates and stock market returns, have a negative correlation (please see the chart below).

Source: BSE and Investing.in
Therefore, when interest rates are lower, equities tends to perform better. Therefore, if you have both debt and equity mutual funds in your portfolio you can get good returns in different interest rate scenarios and therefore de-risk your overall portfolio to an extent from market movements. How about Gold? The chart below shows the returns of Gold (in India) versus the Sensex from 2005 to 2015.

Source: Goldpriceindia.com, BSE
You can see from the chart above that Sensex has risen when gold prices have fallen and gold prices have risen when the Sensex has fallen. Having multiple asset classes provides stability to your portfolio in different market conditions.
Most equity investments provide higher liquidity than many other assets:
We had discussed earlier that, liquidity should be an important investment consideration in your asset allocation. Liquidity is not just the ability to convert your assets into cash, but also imply that you make minimal losses when you make such conversion. Cash obviously is the most liquid asset class, but provides low returns. On the other hand, assets like real estate can be very illiquid. It can take you from three months to even three years or even more to sell a property. In case of delayed possession of your property, the liquidity is severely hampered. There are many long maturity fixed income investments, which have very limited liquidity before maturity. Tax free bonds, Capital Gains bonds, small savings schemes like PPF, NSC etc are very illiquid before their maturities. Equity shares in publicly traded companies, for retail investors, are very liquid across most categories of shares, except some very small cap or micro cap companies. Open ended equity mutual funds can be redeemed at any time, though you may have to pay exit load, if redeemed during the exit load period.
Equity is the most tax efficient asset class in India:
Equity is undoubtedly the most tax efficient among all asset classes. Short term capital gains (investment period of less than 12 months) in equity investments are taxed at 15%, while long term capitals (investment period of more than 12 months) are entirely tax free. Dividends up to a limit of र 10 lacs received by equity investors are tax free in the hands of the investors and that in excess of र 10 lacs will be taxed at 10% in the hands of the investor. Dividends paid by equity mutual funds are entirely tax free in the hands of the investor. Interest income from most fixed income investments, on the other hand, are taxed as per the income tax rate of the investor. The table below shows the short term and long term capital gains tax of different asset types.

Conclusion
Studies have proven that asset allocation is the most important contributing factor in a portfolio’s total return. In this post we have discussed the importance of equity in asset allocation. You can get some high level asset allocation guidance by going to our Asset Allocation Calculator. However, to get a more refined and informed guidance, you should consult with a financial planner and take investment decisions accordingly.

Robo advisors in India: Should you use for mutual fund investments

Jul 28, 2017 by Dwaipayan Bose

 Some of our readers may have heard about and even used robo-advisors for making mutual fund investments. Robo-advisors are now very popular in developed countries like the United States and though robo-advisory is still a relatively new concept in India it is gradually gaining popularity. If you follow discussion threads related to robo-advisors in the social media and other online discussion forums, you will see that there are conflicting opinions both in favour and against robo-advisors.

I have seen that, views expressed in online discussion forums (including social media) are usually based on individual preferences, experiences or vested interests. For example in discussion you will notice two very divergent assumptions with regards to mutual funds investors. One assumption is that, all investors barring HNIs are naive and need hand-holding in making investment decisions. The other extreme assumption is that, all investors are mature enough to make investment decisions and execute them. The reality is that there are investors with varying degree of maturities, experience and knowledge. In Advisorkhoj we recognize the diversity (in terms of maturity and knowledge) in our investor population and try to critically analyze different perspectives keeping the diversity in mind. In this post, we will discuss about robo-advisors and there suitability for different investors.
What is a robo-advisor?

As the name suggests robo-advisor is robot giving you financial advice. However, this robot is not like a walking, talking robot we see in movies. A robo-advisor is essentially a computer algorithm where you can input your investment needs and get investment recommendations. Many robo-advisors also offer online mutual fund transaction capabilities. They are available online on the websites of wealth management firms / mutual fund distributors and registered investment advisors.
How does a robo-advisor work?

Most robo-advisors follow a standard process flow that has four broad steps. In the first step, you are required to input details like your age, investment goals (including investment horizon), risk capacity and investment amount. Most robo-advisors ask investors to fill in an online questionnaire to assess their risk capacity. Once you input all the necessary details the computer algorithm will determine your optimal asset allocation (e.g. debt and equity) and asset sub-category allocation (e.g. large cap equity, midcap equity, long term debt, short term debt, money market etc). Some robo-advisors give investors the option of fine tuning the asset allocation.

Once the asset allocation is determined, the robo-advisor then generates fund recommendations for the investors. The final step is the actual execution, which includes KYC (Know your Client) checking and e-KYC if required and then online purchase of mutual fund units. Some robo-advisors may stop at the third step (fund recommendation), but most reputed robo-advisors offer online transaction capabilities.
Misconceptions regarding robo-advisors

Some investors think that, online investment automatically implies investing in direct plans. If you are investing through robo-advisor offered by a mutual fund distributor then you will be investing in regular plans.

Some investors think that, they have to pay a fee for using robo-advisors. If you are using robo-advisor solutions offered by mutual fund distributors then you do not have to pay to use the tool because mutual fund distributors get their commissions from the Asset Management Companies (AMCs). However, if you are using a robo-advisor solution offered by a Registered Investment Advisor (RIA), then you will have to pay a fee to the RIA because using the robo-advisor solution of an RIA, you will be investing in direct plans of mutual fund schemes.

Some investors think that they are susceptible to online frauds when investing through robo-advisors. You should know that, the robo-advisor is not all involved in the financial transaction of the mutual fund purchase. Your money will be routed straight from your bank account to the asset management company (AMC) which will allot you mutual fund units.
Advantages of robo-advisors
Many people prefer to do things themselves instead of relying on another person. DIY (do it yourself) gives people a sense of control over their work and is an increasingly becoming a popular trait especially among technologically savvy and younger sections of the population.

Careers are becoming increasingly busier. Some people may not have the time to meet with a financial advisor and explain their requirements to the advisor. Mobility has also increased and people are constantly on the move. So they may not want to be tied with in an advisor in a particular location. Robo-advisors give investors the flexibility to make investments from any place, at any time (even at the middle of night).

Most of the robo-advisors are very user friendly and require only basic computer knowledge to use. However, the user interface and experience will differ from solution to solution. Some robo-advisors are very sophisticated and others are fairly basic. You can choose a robo-advisor based on the kind of interface and experience you like.

Many people value judgement which comes from experience, but judgement can be subject to understanding, personal biases and human errors. Since Robo-advisors are algo based, it takes out subjectivity from investment decision making and makes the exercise objective.

Psychologists say that humans can never be bias-free. Even if a financial advisor works in the client’s best interests, there can be biases in his or her recommendations. Robo-advisors, being algorithm based, claim to be totally unbiased.

Robo-advisors are paperless. More and more people are concerned about environmental issues and robo-advisor transactions are certainly more eco-friendly than offline mutual fund transactions.
Disadvantages of Robo-Advisors
I had mentioned earlier that, robo-advisors are essentially computer algorithms. An algorithm is essentially a set of rules working on a set of assumptions coded in the algorithm. When we are working with a set of rules, customization will always be limited to a certain extent. If your investment needs are fairly common with the investment needs of large number of investors, the robo-advisors can provide you good investment solutions. However, if you have very specialized investment needs, you may need the services of an experienced financial advisor who will better understand your specific requirements and suggest the best possible solution.

Robo-advisors are devoid of any human interaction. Some people prefer human interaction and hand-holding. Knowing a financial advisor, who can be trusted, to help him or her can give some investors more confidence in making investments.

Though theoretically machines are bias free, machines are built by humans who may have vested interests. Therefore, unless you have access to the source code of the robo-advisor algorithm you will never know if it is truly bias-free. The other approach to test the bias of a robo-advisor is to analyze a large sample of robo-advisor recommendations and see if they are biased towards particular AMCs or schemes. Unfortunately no such tests are available in the public domain and therefore, you may have to rely on the reputation of the robo-advisor.

Equity investment is not always a walk in the park. Stock markets are volatile and at times may cause emotional distress, when you see your hard earned money making a loss (even if the loss is temporary). Machines have no empathy and cannot help you in emotional distress. On the other hand, speaking with a financial advisor who has experience of helping their clients in bear markets can be quite helpful in such situations.
Considerations in choosing a robo-advisor
If you are a new investor and have absolutely no knowledge of investing and mutual funds, you may want to invest through a financial advisor because you are likely to have questions and doubts, which the advisor can clarify.

If you are new investor and have even basic knowledge of investing and mutual funds, you can invest through a robo-advisor because they are fairly simple to use and some of them provide good information which you may find useful. You should try different robo-advisors available online (Google and you will find content on the popular robo-advisors on the web). Choose a robo-advisor based on your user experience.

You should see the different investment features offered by different robo-advisory solutions. Some robo-advisors only offer plain vanilla lump-sum and systematic investment plans, while the more advanced robo-advisory solutions offer sophisticated features like Systematic Transfer Plans, switches and Systematic Withdrawal Plans.

The quality of robo-advisory will depend on how sophisticated and robust the algorithm is. How many scenarios of investor goals and risk profiles are coded in the algorithm? Larger the number of scenarios, better will the robo-advisor output. What is the fund selection methodology? Are funds for each recommended from a static list or a dynamic list? If it is a dynamic list, at what frequency it is refreshed?

These are some of the questions that investors need to ask in order to get a sense of how sophisticated and robust the robo-advisory algorithm is. Unfortunately, there is little or no description of methodology available on the robo-advisor web pages. It will be more helpful, if you speak with a sales representative of the robo-advisor in order to understand how the robo-advisor is making investment recommendations.

If you know a friend or colleague, who has used a robo-advisory solution, you should speak with him or her to get his or her feedback on how good the robo-advisor is.

Finally, you should always enquire about the customer service support of the robo-advisor, so that if anything goes wrong, you can get the desired support them.
Conclusion
In this post, we have discussed what robo-advisors are and how they work. We have also discussed the pros and cons of robo-advisors, and the various factors you have to consider in choosing a robo-advisor. Today more and more people are using online banking, online shopping and online bill-payments because it is more convenient. Online investment is also a part of the same evolution in technology adoption and over a period of time, will gain more popularity with investors, once they realize the benefits associated with the use of technology.

Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

Equity is the best performing asset class in long term: Myth or Truth

 by Dwaipayan Bose |

You may have often heard capital market experts and financial planners saying, Equity is the best performing asset class in the long term. They cite examples of Sensex or Nifty return versus Gold and Fixed Income returns over the last 3 or 5 years. But has Sensex beaten all other asset classes across all long term time-scales?

Firstly, let us discuss how long is long term? The definition of long term is really a matter of opinion. To some people, three years is long term and to others it is 5 to 10 years. But for most people, our readers will agree, 10 years is a long time period. Consider the period from January 1, 1999 to January 1, 2009. Was equity the best performing asset class from 1999 to 2009? During this period, the Sensex, which we will take as the benchmark for equity in India, gave a compounded annual return of 12.3%. Over the same time period, your PPF account, which is one of the best long term Fixed Income schemes, would have given you a compounded annual return of around 9.3%. So Sensex would have beaten fixed income, but what about Gold? From 1999 to 2009, Gold gave a return of 13.2%. Gold beat Sensex over this investment period.

Let us take a more recent example and look at the period from January 1, 2006 to January 1, 2016. Over this period Sensex gave a return of 10.6%, comfortably beating fixed income, but Gold gave a return of 11.7%. What does the above two examples tell us? If you thought, Sensex will always give you higher returns than other asset classes then, you need to reset your expectation. But, is Gold the best performing asset class in the long term?

The simple answer is, we cannot judge the relative performance of two or more asset classes based on one-off examples, as some investment bloggers tend to do. Equity and gold returns are driven by the market determined prices and therefore market conditions at any point of time will bias the results when we look at point to point returns.

At Advisorkhoj, we are not swayed by either rhetoric or perception, and our approach is always analytical and data driven. We have said a number of times in our blog that, rolling returns is the best measure of investment performance. In this post, we will compare the rolling returns of various asset classes, over various investment horizons and try to draw useful conclusions for long term investors.

Before we get into our analysis, let us understand what rolling return is. Rolling returns are the annualized returns of the scheme taken for a specified period (rolling returns period) on every day/week/month and taken till the last day of the duration. In our analysis, we will measure rolling returns for every day in the period in consideration.

For our analysis, we have taken daily Sensex and Gold prices from January 1, 1996 onwards till July 1, 2016. We will also compare the rolling returns of Sensex and Gold with Fixed Deposit. Let us see 10 year rolling returns of Sensex versus Gold versus Fixed Depost from 1996 till date. In other words, we will see how much returns an investor has got over a 10 year investment horizon, by investing in Sensex, Gold or FD on any day from January 1, 2016 to July 1, 2016.


Source: BSE (Sensex), RBI (Gold and FD)
You can see that, both Sensex and Gold beat FD comfortably over a 10 year investment horizon. Between Sensex and Gold, as you can see in the chart above, there were times when Sensex beat Gold, there were times when Gold beat Sensex and for long periods of time Sensex and Gold returns were closely matched over a 10 year investment horizon. However, you can see that, when Sensex beat Gold, it outperformed by a bigger margin than when Gold beat Sensex. One important conclusion we can draw from the above chart is that, asset allocation is important, if you are looking for long term investment returns.

We have discussed earlier that, the definition of long term is really a matter of opinion. Let us look at the 5 year rolling returns of these three asset classes; in other words, how much returns an investor has got over a 5 year investment horizon, by investing in Sensex, Gold or FD on any day from January 1, 2016 to July 1, 2016.
If you compare 5 year rolling returns chart with the 10 year rolling returns, you can see that Sensex is the more volatile asset class as the investment horizon shortens. You can also see that, the performance gap between the Sensex and gold widens (either Sensex beating Gold or vice versa), when we shorten the investment horizon. But look at the minimum and maximum rolling returns of Sensex versus Gold. The minimum rolling returns of Sensex and Gold are -8% and -5% respectively, whereas the maximum rolling returns of Sensex and Gold are 47% and 29% respectively. Therefore, while the worst case scenarios of Sensex and Gold were separated by only 3%, in the best case scenario, Sensex outperformed Gold by a huge margin (18%). In other words, the possibility of getting high returns from equity is much more than other asset classes. The risk return trade-off of equity versus other asset classes over a long investment horizon makes it a more attractive investment option for investors with high risk appetite.

Let us spend some more time on risk return profile of these asset classes. If you thought Gold is a safe asset, look at the chart above again. Gold gave lower returns than Fixed Deposit, even over a 5 year investment horizon, a number of times over the last 20 years. In fact in the late nineties and early twenties Gold even gave negative returns over a 5 year investment horizon, as you can see in the chart above. Many of us have the perception that in times of global financial crisis, investors shift to gold. Precious metals price response to financial crisis does not always support this perception. For example, during the Asian currency crisis, investors shifted their assets to US Treasury Bonds instead of gold. However, in the financial recession of 2008, gold price did rise. When equity markets fell in 2015 due to China and Eurozone concerns, gold also fell about 8%, as investors shifted to US Treasuries.

As far equity is concerned, we have discussed a number of times in our blog that, it is the most volatile asset class. Retail investors, who think that, equities will always give higher returns than Fixed Deposits over a three to five year horizon, need to correct their perception. You can see that, while Sensex beat Fixed Deposits most of time in terms of 5 year rolling returns, there were times when Sensex return was lower than FD even over a five year investment horizon. However, if you have a longer term investment horizon, the probability of Sensex beating risk free returns increases substantially.

As discussed earlier, over a 10 year investment horizon, Sensex always beat Fixed Deposits. In fact, in our blog post, How Investing in Equities for the long term reduces risk, we looked at Sensex data over the past 25 years and analyzed rolling returns over various investment tenures. We saw that, volatility or risk goes down as the investment tenure gets longer.

Let us now discuss the relevance of Sensex for retail equity investors. Though we often use Sensex or Nifty as a proxy for the equity market in India, as a retail investor you should understand the practical relevance of Sensex or Nifty as far as your equity portfolio is concerned. While your portfolio movement can be directionally aligned with Sensex movement, your portfolio returns can be very different from Sensex returns. Sensex is made up of the 30 largest market capitalizations of stocks in the market. Do you own all the 30 Sensex stocks, in the proportion of their weights in the Sensex? If not, your portfolio returns will be different from Sensex returns. In fact, diversified equity mutual funds have historically beaten Sensex returns over different time-scales. The chart below shows the average trailing returns of diversified equity funds and the Sensex over different time scales.


Source: Advisorkhoj Research Category and Benchmark monitor
You can see that, diversified equity funds on an average beat Sensex by 3 – 8% across different time-scales. Please note that the chart above shows the average diversified equity fund returns. Top performing funds beat average diversified equity fund returns by a further 7 – 12%. If you compare the top performing diversified equity mutual fund’s returns with Sensex, the outperformance is quite huge.
Conclusion
Let us end with the question asked at the beginning of this post. Is the equity the best performing asset class in the long term? We shared with you, the results of our analysis of performance of different asset classes over a 5 and 10 year investment horizons. There were times when the Sensex outperformed gold and vice versa, and there also long periods of time, when gold and Sensex rolling returns were closely matched. In Advisorkhoj, our take on the asset class question is that, different asset classes serve different purpose. Fixed income provides safety of capital and stability of income. Gold is a good long term hedge against inflation and as an asset class is less volatile than equity. Equity investment is much more complicated than investing in fixed income or gold because there is a vast universe of stocks with different growth potentials. By relying on the expertise of good mutual fund managers, you can use equity to create wealth over a long investment horizon.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

ULIP: Insurance and investment in one

Jun 26, 2017 by Priyanka Chakrabarty

ULIP or Unit Linked Insurance Plans provides you the benefit of market-linked returns along with a life insurance cover into one product. ULIPs are a wealth-creating tool that fulfils your financial goals in the medium to long-term period. ULIP plans offers flexibility to invest both in equity and debt fund portfolios depending upon your risk profile.
The unique feature of market linked returns clubbed with protection makes ULIP a sought after choice of the new generation. With growing popularity, ULIPs have contributed around 12.77% of the total Insurance Industry premium paid in India during the FY 2015-16.
What are the benefits of ULIP

There are 5 major benefits offered by ULIPs –
It offers flexibility

It offers transparency

Helps you save for your financial goals

Saves taxes

Easy to buy

Let us now discuss all the 5 benefits offered by a ULIP plan.
ULIP offer flexibility
ULIPs offer the flexibility of choosing an investment option based on your risk profile. If you are young and want to take risk for high returns, equity fund could be suitable for you. But in case you do not want to take any risk, you may like to invest in debt fund.

Again, it offers the flexibility to switch from one fund portfolio to the other suiting your changing risk profile or the market conditions.

ULIP offer to you withdraw partially of fully any time from 6th policy year. Therefore, if you have any financial need you can draw from your accumulated corpus any time after 5 years

If offers the flexibility to change your premium amount. ULIPs offer the facility of paying top up premiums whenever you have some investible surpluses

There is a flexibility to change your life cover as well by paying additional premium. Please note that in ULIPs, the minimum life cover should be 10 times of your premium so that you can avail the income tax rebate under Section 80C.

It offers the flexibility of adding a rider. Through riders you can choose to customize your ULIPs and get additional protection. One can add riders like accidental death benefit, disability benefit and critical illness and many others.

ULIPs offer the flexibility of paying your premiums monthly. This helps you buy the units of your fund portfolio at different NAVs.
ULIP offers transparency
Good thing about ULIP is that the charges are transparent and specified. The company reveals the charges in the product brochures which you should go through very carefully. Normally the charges applicable are policy administration, fund management and the mortality charges. You should select a ULIP plan with minimum charges.

The charges so deducted are transparent as you know the percentage of each charge deducted from your premium. Moreover, the company sends you a detailed statement which shows how the charges have been deducted as well as the fund allocation and its performance. The same can be viewed online by login to the respective insurance company website.

The fund performance is totally transparent as there are no hidden charges and it reflects in the net asset value of the fund (NAV) which is declared daily. Increase and decrease in the NAV indicates how the fund is performing
ULIP helps you save for your financial goals
The unique benefit of market linked returns helps you plan your long term goals by investing in ULIPs. You can save for long term goals like, retirement, children higher education or buying a house by saving through ULIPs

You can pay your premiums through monthly instalments and save small amounts for achieving a big corpus in future.
ULIP offers tax benefit
Premiums paid upto Rs 150,000 in a Financial Year qualifies for tax deduction under Section 80C of the Income Tax Act 1961.

ULIPs being insurance plans, the gains and maturity proceeds are also tax-free under Section 10(10d) of The Income Tax Act.

The claim amount paid to your nominee in case of your sudden death is also tax free under Section 10(10d) of The Income Tax Act.
Easy to buy
You can easily buy ULIPs by visiting the company website. All you have to do is fill up your personal details, communication and nominee details, answer the health questionnaire, upload the KYC documents and pay premiums using net-banking or debit card.

ULILP bought online has lesser charges as no intermediation fee is paid to the insurance agent or the broker.

Insurance is the subject matter of the solicitation.

ICICI Prudential Balanced Fund: Best performing Balanced Fund in the last 5 years

Jul 26, 2017 by Dwaipayan Bose

Balanced funds have at least 65% asset allocation in equity or equity related securities and the remaining portion in fixed income securities. Fixed income (or debt) as an asset class is subject to less price volatility relative to equity and therefore, balanced funds have a moderate risk profile compared to stocks or equity mutual funds. As such these funds are ideal long term investment products for new investors and investors who do not have high risk appetites.
Launched in 1999, ICICI Prudential Balanced Fund is a very popular product in this category and is the best performing balanced fund in the last 5 years (please see Top performing Balanced Funds in our MF Research Section). Over the last 5 years, ICICI Prudential Balanced Fund gave more than 20% annualized returns. The Assets under Management of this fund has skyrocketed in the last couple of years, on the back of its strong performance and now stands at over Rs 14,200 Crores. The expense ratio of the regular plan of this scheme is 2.25%.
The asset management company, ICICI Prudential is the largest mutual fund house in India. Mutual Funds from the ICICI Prudential stable are amongst the top performers across several mutual fund categories. The fund managers of this scheme are Atul Patel, Manish Banthia and Sankaran Naren. The scheme is open for subscription for growth, yearly dividend, half yearly dividend and monthly dividend options.
ICICI Prudential Balanced Fund has given over 15% compounded annual returns since inception. The performance over the last 5 years is truly exceptional. The chart below shows the trailing returns of ICICI Prudential Balanced Fund versus the Balanced Fund category across different time-scales.

 The chart below shows the annual returns of ICICI Prudential Balanced Fund versus the product category in the last 5 years.

 You can see that ICICI Prudential Balanced Fund outperformed the category in all years except 2015. The chart below shows the NAV growth of this scheme over the last 5 years.

Rolling Returns
The 3 year rolling returns chart shows why ICICI Prudential Balanced Fund is such a strong performer. The chart below shows the 3 year rolling returns of the fund versus the balanced fund category over the last 5 years.

  With a cumulative investment of just Rs 3 lakhs you could have accumulated a corpus of almost Rs 5 lakhs in the last 5 years (a profit of nearly Rs 2 lakhs). The SIP return (XIRR) of ICICI Prudential Balanced Fund in the last 5 years was more than 19%.
Dividend Payout Track Record
ICICI Prudential Balanced Fund has an excellent dividend payout track record. For the last 10 years the fund has paid dividends every year.

he average historical dividend yield has been around 8%. From 2015 ICICI Prudential Balanced Fund started paying monthly dividends. The old Annual Dividend Option of the fund was renamed Monthly Dividend Option in December 2015. The table below shows the monthly dividends paid by the fund over the The annual dividend yield of the monthly dividend option has been 8.9%. In January 2016, Prudential Mutua  lFundD Fund re-introduced Annual Dividend frequency and paid dividends in December 2016.

Money Back Option
In December 2015 ICICI Prudential Mutual Fund announced a new option called the Money Back option for ICICI Prudential Balanced Fund. In this option investors can get a fixed monthly cash flow by withdrawing a fixed amount from the scheme depending on prevailing NAV’s of the options selected by the investor. It is the first mutual scheme to have an option like this. Investors should understand that the money back feature does not imply assured returns from the scheme. Investors should also note that all withdrawals from the scheme within 1 year of investment will be subject to short term capital gains tax. This option is also available for the other balanced fund in ICICI Prudential Mutual Fund stable, ICICI Prudential Balanced Advantage Fund.
Conclusion
While ICICI Prudential Balanced fund is a tad more aggressive relative to average balanced funds, investors may consider this product for their retirement planning and other long term financial objectives, through systematic investment plans or lump sum route with a long investment horizon. Given its good dividend pay-out track record, investors who prefer dividends can select from the various dividend options or the money back option of the ICICI Prudential Balanced Fund, depending on their cash flow requirements. Investors should consult with their financial advisors, if this scheme is suitable for their financial planning objectives.
Mutual Fund Investments are subject to market risk, read all scheme related documents carefully.

Axis Mutual Fund launches Axis Dynamic Equity Fund

Jul 17, 2017

NFO period: 11th July – 25th July, 2017

Highlights of the NFO:
Scheme type – An open-ended equity scheme

Investment objective – To generate capital appreciation by investing in a portfolio of equity or equity linked securities while secondary objective is to generate income through investments in debt and money market instruments. It also aims to manage risk through active asset allocation. However, there is no assurance or guarantee that the investment objective of the scheme will be achieved. The scheme does not assure or guarantee any returns.

Product suitability – The product is suitable for investors who are seeking capital appreciation while generating income over medium to long term by investing in equity and equity related instruments as well as debt and money market instruments while managing risk through active asset allocation.

Minimum Application Amount – First investment is Rs. 5,000/- and in multiples of Rs. 1/- thereafter

Plan/ Options available – Regular Plan and Direct Plan having Growth Option and Dividend Option (Payout Facility).

Fund Manager – Mr. Anupam Tiwari, Mr. Ashwin Patni and Mr. R.Sivakumar

Benchmark – Crisil Balanced Fund Index