Sensex, Music & Headphones

Dr Sanjiv Mehta June 27, 2008

Sensex@ 13922 With Indian inflation at more that 11%, oil at $135 a barrel, weak global cues, political uncertainty, rising interest rates and emerging signs of a slowdown in the economy, Sensex has taken a major nose dive to levels around 14000 and is expected to be under pressure for more time. Investors justifiably are worried about future prospects.

What should an investor do about Indian equity component of his portfolio? Should he just remain there, increase or flee? What should be the percentage allocated? In the earlier articles I emphasized appropriate asset allocation as the most important factor for impressive portfolio returns and harnessing the power of passive income.

Jeremy Seigel, one of the most renowned American professors and who was also my teacher at the Wharton School, wrote a highly acclaimed and deeply researched book ‘Stocks for the Long Run’. He analyzed in detail more than 200-year history of USA stock market and markets of numerous other countries. The conclusion was unmistakable that stocks held for a reasonable time horizon produce much higher returns as compared to other asset classes. It is true that stocks move with lots of fluctuations and volatility but in the long run reflect economic fundamentals.

This is borne out by my own experience. In my column exactly 5 years back, in the Deccan Chronicle on June 27, 2003, I wrote an article titled ‘Now you can invest in India’ –Sensex was then at 3583, accompanied by poor investor sentiment. Good economic fundamentals were just emerging at that time. We have come a long way marked by usual volatility of a stock market- the index reached heady levels of almost 21000 before dropping to current levels. In between there were many moments of uncertainty and amidst all these fluctuations, investors who heeded the advice of following good economic fundamentals and stayed put are the ones who gained the most, with original investment multiplying six times.

The crux, the central issue with market under intense pressure, at this juncture is that whether economic fundamentals are still intact and their impact over the next 5 years. Where would Indian economy be in the year 2013? Factors in BRIC Report by Goldman Sachs that predicted India to be the 3rd largest economy in the world in the year 2050 are still valid. These include favourable demographics, economy driven by local consumption, less dependent on global factors and stability of macro economic environment.

Moreover, Indian economic growth on a comparative basis should continue to do well. Looking at different components of GDP, Services accounting for 60% is growing at 10% and therefore should contribute 5-6% to GDP. Industry, which is 25% of GDP and growing at 10%, will contribute 2.5%. Agriculture growing at 2-3% should also contribute 0.5%. Capital expenditure to the tune of Rs. 34000 crores is expected to be commissioned during FY 2008-09 and it will have a huge multiplier effect. Overall, GDP growth rate is expected to grow at 7.5-8%. This is the most likely consensus view emerging from multiple forecasts including RBI and Economic Advisory Council to the Prime Minister. Indian banking system is also sound with limited exposure to real estate lending or share financing.

With this kind of growth establishing at least a degree of economic decoupling with USA and other developed markets, a strategic shift in global asset allocation may gradually gain momentum. Presently we are in a transitional stage of this global shift of multiple dimensions and transitions could be slow and painful. There has been a lot of debate about economic decoupling and while it will be fallacious to expect a complete decoupling, Indian growth at 7.5-8% in the face of USA sub par growth will be noticed. George Soros, one of the greatest hedge fund managers, in his latest book states that he protected his fund returns by recognizing such an impending shift and investing more in India and China. Combine this with a greater percentage of Indian savings coming into equities, and a scenario of at least partial market decoupling is highly probable.

Recommendation – With a 5 year time horizon, Indian equities should continue to be a significant part of total asset allocation. Existing investors should continue to stay invested. Since short-term pressures are likely to remain for some time, for new investors, a sensible strategy will be to invest systematically in various tranches rather than in one lump sum. Investing should be smart with selection of good funds excelling in picking fundamentally sound stocks at good valuation. Indian rupee again is on a long-term appreciation trend albeit with corrections like the present one that has taken it to Rs. 43 and therefore NRIs should gain from this factor too. Three principles of appropriate time horizon, valuation and diversification remain sacrosanct.

Conclusion - I listen intently to music while being driven in Hyderabad but gradually the joy was decreasing. Noise levels in the city were picking up with rapid growth inevitably accompanied by increasing traffic. Utilizing ‘Acoustic Noise Cancelling High Quality Headphones’ has restored that happiness. Original music is as melodious as ever though the noise is also real and almost led to the false perception as if music itself was distorted. As Shakespeare would say, play on.

Dr Sanjiv Mehta is the MD, Finance Doctor, a wealth management company and author of Winning The Wealth Game: Cricket Strategies For Financial Freedom.

The Millionaire Next Door and impact of a Good Wealth Manager

Dr Sanjiv Mehta June 4, 2008

The Millionaire Next Door is an outstanding book on identifying factors which make an individual wealthy based on his own efforts during his lifetime. The book was actually the culmination of a 20-year research effort by 2 American business school professors Dr. Thomas Stanley and Dr. William Danko. The book was on the bestseller lists of The New York Times (for more than 3 years), The Wall Street Journal, Business Week, USA Today and Los Angeles Times.
The authors discovered three main factors, which make people wealthy, as a result of their intensive research that involved following a large diverse group of people for 20 years. Effective planning of their finances was one of these factors. The authors state that the people who become wealthy are either good themselves at managing their finances or fortunate to come across an effective wealth manager.

This finding does not come as a surprise since active income if invested well can be leveraged many times over. Suppose an individual makes an average of Rs. 1 lakh per month in a 40-year work span giving him a sum of Rs 4.8 crores from his active employment. If he were to save just 10% of his earnings every month and generate easily achievable return of 9%, in the same 40 years he will be making a passive income of Rs. 4.7 crores. If he manages to earn 10%, the resulting sum will be Rs. 6.32 crores and an astounding Rs. 11.76 crores at 12 % return. What is earned over a span of 40 years can be easily multiplied 3-4 times over by just saving and investing a small percentage.

Power of passive income can be far greater than active income and can be a great facilitator in leading a life of great freedom and security. It can help in cutting the reliance on active employment and giving the freedom to do what an individual really likes to do later on. Therefore I define wealthy as somebody whose passive income is sufficient to sustain a desirable life style.

How does one realize the power of passive income? The answer is Asset Allocation - it is the single most important tool for maximizing wealth. Multiple research studies show that appropriate asset allocation determines more than 90% of a portfolio return while individual security selection only a miniscule part. It is simply the art of determining that if you have Rs. 100 to invest, depending on business cycle and life cycle stages, asset allocation might be 10 Rs. in fixed income securities, 20 Rs. in domestic real estate, 5 Rs. in global real estate fund, 35 Rs. in Indian equity funds, 10 Rs. in a structured derivative fund, 10 Rs. in world gold fund and 10 Rs in Latin American fund. Moreover, the process is dynamic, as the business cycle moves and the life cycle and personal conditions change, allocation to Indian equity funds might increase to Rs.70 or for that matter go down to Rs.10. These dynamic portfolio-balancing decisions harness the true power of passive income.

Clearly, the core competence of a good wealth manager is the ability to generate wealth by maximizing risk-adjusted returns. He should be able to discern the macro business cycle patterns and your life cycle requirements and then select the most optimal asset allocation. The first question I ask the bankers and practicing wealth managers in my 2-day wealth management course is about the core competence of a wealth manager. In India the field is nascent and many still answer that it is relationship management. Drawing an analogy to my previous profession of a medical doctor, while a good bedside manner is important, there is no substitute for core medical competence. There is no point in dying in the arms of a medical doctor with good relationship knack but inadequate life saving skills.

But how should one go about finding such a wealth manager? The investor should focus on evidence of investment ability . Either the wealth manager should be able to demonstrate a track record of wealth generation for his own portfolio or his existing investors over a significant period of time. He should also substantiate his competence in actively following and discerning shifts in business cycle patterns.

Wealth manager’s role is holistic- he is looking at the portfolio in totality. He optimizes based on business cycle and what your personal stage and requirements are. It is at a macro level distinct from a fund manager’s narrow focus. In reality, he selects good fund managers who might be managing distinct asset classes like equities, fixed income, real estate, art and commodities.

Consequently, selecting a good wealth manager is an important decision-it is a decision that can have a significant and far reaching impact on the quality of your life. Evidence of investment ability is the key important factor in selecting an effective wealth manager. However, wealth manager adds value in many other ways and we will be discussing those in part 2 of this article next week.

Dr Sanjiv Mehta is the MD, Finance Doctor, a wealth management company and author of Winning The Wealth Game: Cricket Strategies For Financial Freedom.

Rajasthan Royals and the art of creating wealth

Dr Sanjiv Mehta May 14, 2008

With IPL in full flow and providing such a visual delight, it was interesting to read an article by Graeme Smith titled ‘My Hindi lessons are going well’. He writes that it has been wonderful moving around with young Indian players. He has been gaining a different perspective and exploring a different side of India. He never expected a South African-Australian encounter to be so tame- he found Shane warm, interesting and certainly instructive for a captain.

Never before have players of so diverse skills, talent, age groups and nationalities played on the same platform. Rajasthan Royals, who are presently leading the league table, have meshed exceedingly well as a team and put in an outstanding performance. Warne has marshaled his resources optimally and each player has contributed in his well-assigned specific role. It disproved the earlier forecasts of experts that Royals lacked superstars and would not fare well.

Managing your financial portfolio is similar. Markowitz won the 1992 Economics Nobel Prize for his portfolio management theory. He states that it is possible to maximize returns while minimizing risks by diversifying your portfolio. Effective diversification is achieved by putting your money in various asset classes and not relying on one superstar. Moreover, these asset classes should have a low correlation or in other words they should not all rise together or fall together. On the other hand, some could thrive in certain conditions and some in others. They could have specific roles in the portfolio and together as a team will maximize risk adjusted returns. It disproves the misconception of many investors that high returns can only be achieved by taking high risks.

Multiple research studies over a long period of time establish that appropriate asset allocation determines more than 90% of a portfolio return while individual security selection only a miniscule part. Unfortunately time spent is totally the opposite. In my conversation with numerous investors, I am surprised by their fixation on getting hot tips on how a stock will fare rather than on economic factors driving various asset classes. Effective diversification or appropriate asset allocation is similar to cricket team selection and the single most important tool for maximizing wealth.

T20 cricket has clearly and forcefully delineated the importance of team selection. Vijay Mallya, owner of Bangalore Royal Challengers has no hesitation in agreeing totally. According to him, he had erroneously taken a back seat, mixing a heady cocktail of F1 and T20 for producing real good times, while his main drivers Rahul and Charu were selecting the team. According to some, they left no stone unturned and no avenue unexplored in selecting a full fledged test team smartly turned out in their flashy T20 clothing.

You can have multiple permutations and combinations for a portfolio. For example, if you have Rs. 100, you can put everything in cash but it will not produce any return. Alternatively you can put the full amount in one stock, but that will be highly risky. Similarly everything in real estate will be risky and illiquid. Appropriate asset allocation is achieved by optimizing an equation where personal life cycle and business cycle stages are the constraints. It is akin to targeting maximum possible runs taking into account the pitch condition (business cycle stage) and the team strengths (personal stage).

The current Indian business cycle is akin to a batsman friendly pitch where a good score is very much possible. Presently the economic growth rate is high and not likely to be affected too much by global woes. Corporate earnings growth rate is lower as compared to preceding years but still impressive. Indian equities will continue to perform well.

However some cracks are just beginning to appear. Inflation is higher with consequent impact on interest rates. Global cues are not so rosy with USA subprime crisis and housing slowdown. Oil and commodity prices have risen at a fast pace. While the pitch is still good, a hostile bowler is presently engaged in a good spell. Relying only on one kind of player could lead to loss of wickets. A mix of players with diverse skill sets is required at this stage.

With the medium and long term Indian story totally intact, India, irrespective of whether iconic or non-iconic, will remain the mainstay of the team. However, there is rationale for taking players across geography and across alternative asset classes. Insert solid Hayden and a dash of global real estate, put exotic Marsh and a bit of Latin America, add lustrous Warne and a trace of gold, attach versatile Watson and a little of multi tasking structured fund and you will be making your team lot more productive, resilient, colourful and successful like Royals.

Summarizing, appropriate asset allocation, like the right team selection in cricket, is the single most important factor determining whether somebody wins the wealth game.

Dr Sanjiv Mehta is the MD of Finance Doctor (www.financedoctor.in), a wealth management company and author of the highly acclaimed book, 'Winning the Wealth Game: Cricket Strategies for Financial Freedom'.