There are some things that can confuse even seasoned equity investors. One of these things is the link between debt funds and the interest rate cycle. Let's start at the beginning.
First, what is a debt fund?
A debt fund is nothing but a pool of investments (also known as a mutual fund) in which the core portfolio comprises fixed income investments. These would be a mix of short, medium or long term bonds, money market instruments, securitized products and floating rate debt.
Bonds (also called fixed income securities) are used by a variety of entities such as corporate, municipalities and even the Government, to finance activities. When you buy a bond, you are effectively lending money to this entity that borrows your funds for a fixed time period and pays you a pre-decided rate of interest at regular intervals, also pre-decided. This interest is called a Coupon. Bonds are also traded in the secondary market before they reach maturity, and each bond has a price that fluctuates depending on market factors.
Given that bond prices fluctuate, it is unlikely that you would ever buy a bond on the secondary market "at par," or at its exact face value. You would either buy below par i.e. at a discount, or above par i.e. at a premium.
Now that we know what coupon, price, and discount and premium are, what is yield (to maturity)?
Yield to Maturity (YTM) represents the total return you can expect to earn if you buy a bond at a certain price and hold it till it matures, earning all the coupons (or regular interest payouts) on the way too.
A simpler version of this is just Current Yield. If you buy a bond "at par", the yield is simply the Coupon. But if you by a bond where the price is fluctuating, your yield will also fluctuate depending on how expensive (or not) your bond is. This Yield is equal to nothing but Coupon divided by Price.
So current yield = Coupon / Price
Now that you've understood the relation between yields and prices, in which situation would you want high yields and in which situation would you want high prices?
You would want high yields (i.e. low prices) when you are looking to buy a bond. The adage Buy Low, Sell High applies here too. Once you have already bought the bond and become a bondholder, you want high prices so that you can sell at maximum gain.
So knowing this, when is a good time to become a bondholder?
When you know that yields are going to go down, going forward and therefore prices of existing bonds are going to go up which will enable you, the bondholder, to make maximum gain when your bond matures, or when you sell. This is what's happening in our economy at the moment…
We are currently in a falling interest rate cycle.
When interest rates in the economy (the repo and reverse repo rate) begin to fall, new bonds will offer interest (coupon, to the bondholder) in line with the new, lower rates of interest. This means that their coupon will be lower, so their yield will be lower than the coupon and yield of existing bonds. Older bonds that were issued in times of higher interest rates, would be offering higher coupons and therefore comparatively higher yields. So these existing bonds therefore become comparatively more attractive than newer bonds. People are therefore willing to pay a premium to own these bonds. So when yields fall, prices of existing bonds go up. It's simply a question of demand and supply.
And that's when debt funds make money, when the bonds in their portfolios start to command higher prices, in times of falling interest rates.
How does this affect your finances? Should you be adding to your debt portfolio currently?
To answer the second question first, yes you should be adding to your debt exposure if you have a lower risk appetite, a shorter time horizon (up to 3 years) and want to increase your debt portfolio exposure, to balance your equity portfolio you should invest in short and medium income funds. Keep your liquidity requirements in mind and also have an estimate of what post-tax return you can expect (debt funds long term gains are taxed at 10% without indexation or 20% with indexation).
Coming to the first question, remember, debt funds are great investment avenues to help you meet your short term life goals and also to contribute towards a corpus for your longer term life goals. So if you are looking to build a debt portfolio, now is a great time to do it.
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Things to keep in mind before selling a mutual fund
If your mutual fund is yielding a lower return than you anticipated and is consistently performing badly than you may be tempted to cash in your fund units and invest your money elsewhere. The rate of return on other funds may look enticing but you should be careful as there are both pros and cons to the redemption of your mutual fund units.
The first thing you need to understand is that mutual funds are not same as stocks. So, a decline in the stock market does not necessarily mean that it is time to sell the fund. Stocks are single entities with rates of return associated with the market. Stocks are driven by the "buy low, sell high" rationale, which explains why, in a falling stock market, many investors panic and quickly dump all of their stock-oriented assets.
Mutual funds on the other hand are not single entities; they are portfolios of financial instruments, such as stocks and bonds, chosen by a portfolio or fund manager in accordance with the fund's strategy. An advantage of this portfolio of assets is diversification. There are many types of mutual funds, and their degrees of diversification vary with each of them. Sector funds, for instance, will have the least diversification, while balanced funds will have the most. Within all mutual funds, however, the decline of one or a few of the stocks can be offset by other assets within the portfolio that are either holding steady or increasing in value.
Because mutual funds are diverse portfolios rather than single entities, relying only on market timing to sell your fund may be a useless strategy since a fund's portfolio may represent different kinds of markets. Also, because mutual funds are geared toward long-term returns, a rate of return that is lower than anticipated during the first year is not necessarily a sign to sell.
The following are the situations when you should consider selling a fund, though it is always not necessary but these are situations in which you should at least raise a red flag:
Change in a Fund's Manager
When you put your money into a fund, you are putting a certain amount of trust into the fund manager's expertise and knowledge, which you hope will lead to an outstanding return on an investment that suits your investment goals. If your quarterly or annual report indicates that your fund has a new manager, pay attention. The prospectus should indicate the reason for the change in manager. If the prospectus states that the fund's goal will remain the same, it may be a good idea to watch the fund's returns over the next year. For further peace of mind, you could also research the new manager's previous experience and performance.
Change in Strategy
If you researched your fund before investing in it, you most likely invested in a fund that accurately reflects your financial goals. If your fund manager suddenly starts to invest in financial instruments that do not reflect the mutual fund's original goals, you may want to re-evaluate the fund you are holding.
Consistent Underperformance
This can be tricky since the definition of "underperformance" differs from investor to investor. If the mutual fund returns have been poor over a period of less than a year, liquidating your holdings in the portfolio may not be the best idea since the mutual fund may simply be experiencing some short-term fluctuations. However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.
When Your Personal Investment Portfolio Changes
Besides changes in the mutual fund itself, other changes in your personal portfolio may require you to redeem your mutual fund units and transfer your money into a more suitable portfolio. For example you may have need to rebalance your portfolio or you may need a tax break to offset realized capital gains of your other investments and for that you may want to redeem your mutual fund units in order to apply the capital loss to your capital gains.
When Selling Your Fund following are the factors you should take care of:
When you are cashing-in your mutual fund units, there are a couple of factors to consider that may affect your return:
Exit loads - If you are an investor who holds a fund that charges a back-end load, the total you receive when redeeming your units will be affected. If your fund has a back-end load, charges will be deducted from your total redemption value. For many funds, back-end loads tend to be higher when you liquidate your units earlier rather than later, so you need to determine if liquidating your units now is optimal.
Tax consequences - If your mutual fund has realized significant capital gains in the past, you may be subject to capital gains taxes if the fund is held within a taxable account. When you redeem units of a fund that has a value greater than the total cost, you will have a taxable gain. So you should check before redeeming your units whether it makes sense after taking taxes into consideration.
Do keep in mind that even if your fund is geared to yielding long-term rates of returns, that does not mean you have to hold onto the fund through thick and thin. The purpose of a mutual fund is to increase your investment over time, not to demonstrate your loyalty to a particular sector or group of assets or a specific fund manager. So if your fund is performing badly consistently than you can consider selling it.
Mutual funds on the other hand are not single entities; they are portfolios of financial instruments, such as stocks and bonds, chosen by a portfolio or fund manager in accordance with the fund's strategy. An advantage of this portfolio of assets is diversification. There are many types of mutual funds, and their degrees of diversification vary with each of them. Sector funds, for instance, will have the least diversification, while balanced funds will have the most. Within all mutual funds, however, the decline of one or a few of the stocks can be offset by other assets within the portfolio that are either holding steady or increasing in value.
Because mutual funds are diverse portfolios rather than single entities, relying only on market timing to sell your fund may be a useless strategy since a fund's portfolio may represent different kinds of markets. Also, because mutual funds are geared toward long-term returns, a rate of return that is lower than anticipated during the first year is not necessarily a sign to sell.
The following are the situations when you should consider selling a fund, though it is always not necessary but these are situations in which you should at least raise a red flag:
Change in a Fund's Manager
When you put your money into a fund, you are putting a certain amount of trust into the fund manager's expertise and knowledge, which you hope will lead to an outstanding return on an investment that suits your investment goals. If your quarterly or annual report indicates that your fund has a new manager, pay attention. The prospectus should indicate the reason for the change in manager. If the prospectus states that the fund's goal will remain the same, it may be a good idea to watch the fund's returns over the next year. For further peace of mind, you could also research the new manager's previous experience and performance.
Change in Strategy
If you researched your fund before investing in it, you most likely invested in a fund that accurately reflects your financial goals. If your fund manager suddenly starts to invest in financial instruments that do not reflect the mutual fund's original goals, you may want to re-evaluate the fund you are holding.
Consistent Underperformance
This can be tricky since the definition of "underperformance" differs from investor to investor. If the mutual fund returns have been poor over a period of less than a year, liquidating your holdings in the portfolio may not be the best idea since the mutual fund may simply be experiencing some short-term fluctuations. However, if you have noticed significantly poor performance over the last two or more years, it may be time to cut your losses and move on. To help your decision, compare the fund's performance to a suitable benchmark or to similar funds. Exceptionally poor comparative performance should be a signal to sell the fund.
When Your Personal Investment Portfolio Changes
Besides changes in the mutual fund itself, other changes in your personal portfolio may require you to redeem your mutual fund units and transfer your money into a more suitable portfolio. For example you may have need to rebalance your portfolio or you may need a tax break to offset realized capital gains of your other investments and for that you may want to redeem your mutual fund units in order to apply the capital loss to your capital gains.
When Selling Your Fund following are the factors you should take care of:
When you are cashing-in your mutual fund units, there are a couple of factors to consider that may affect your return:
Exit loads - If you are an investor who holds a fund that charges a back-end load, the total you receive when redeeming your units will be affected. If your fund has a back-end load, charges will be deducted from your total redemption value. For many funds, back-end loads tend to be higher when you liquidate your units earlier rather than later, so you need to determine if liquidating your units now is optimal.
Tax consequences - If your mutual fund has realized significant capital gains in the past, you may be subject to capital gains taxes if the fund is held within a taxable account. When you redeem units of a fund that has a value greater than the total cost, you will have a taxable gain. So you should check before redeeming your units whether it makes sense after taking taxes into consideration.
Do keep in mind that even if your fund is geared to yielding long-term rates of returns, that does not mean you have to hold onto the fund through thick and thin. The purpose of a mutual fund is to increase your investment over time, not to demonstrate your loyalty to a particular sector or group of assets or a specific fund manager. So if your fund is performing badly consistently than you can consider selling it.
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SIP works on the principle of regular investments. It is like your recurring deposit where you put in a small amount every month. It allows you to invest in a Mutual Fund by making smaller periodic investments (monthly or quarterly) in place of a heavy one-time investment i.e. SIP allows you to pay 10 periodic investments of Rs 500 each in place of a one-time investment of Rs 5,000 in an Mutual Fund. Thus, you can invest in an Mutual Fund without altering your other financial liabilities. It is imperative to understand the concept of rupee cost averaging and the power of compounding to better appreciate the working of SIP's.
SIP has brought mutual funds within the reach of an average person as it enables even those with tight budgets to invest Rs 500 or Rs 1,000 on a regular basis in place of making a heavy, one-time investment.
While making small investments through SIP may not seem appealing at first, it enables investors to get into the habit of saving. And over the years, it can really add up and give you handsome returns. A monthly SIP of Rs 1000 at the rate of 9% would grow to Rs 6.69 lakh in 10 years, Rs 17.83 lakh in 30 years and Rs 44.20 lakh in 40 years.
Even for the cash-rich, SIPs reduces the chance of investing at the wrong time and losing their sleep over a wrong investment decision. However, the true benefit of an SIP is derived by investing at lower levels. Other benefits include:
1. Discipline
The cardinal rule of building your corpus is to stay focused, invest regularly and maintain discipline in your investing pattern. A few hundreds set aside every month will not affect your monthly disposable income. You will also find it easier to part with a few hundreds every month, rather than set aside a large sum for investing in one shot.
2. Power of compounding
Investment gurus always recommend that one must start investing early in life. One of the main reasons for doing that is the benefit of compounding. Let's explain this with an example. Person A started investing Rs 10,000 per year at the age of 30. Person B started investing the same amount every year at the age of 35. When they attained the age of 60 respectively, A had built a corpus of Rs 12.23 lakh while person B's corpus was only Rs 7.89 lakh. For this example, a rate of return of 8% compounded has been assumed. So the difference of Rs 50,000 in amount invested made a difference of more than Rs 4 lakh to their end-corpus. That difference is due to the effect of compounding. The longer the (compounding) period, the higher the returns.
Now, instead of investing Rs 10,000 each year, suppose A invested Rs 50,000 after every five years, starting at the age of 35. The total amount invested, thus remains the same -- Rs 3 lakh. However, when he is 60, his corpus will be Rs 10.43 lakh. Again, he loses the advantage of compounding in the early years.
3. Rupee cost averaging
This is especially true for investments in equities. When you invest the same amount in a fund at regular intervals over time, you buy more units when the price is lower. Thus, you would reduce your average cost per share (or per unit) over time. This strategy is called 'rupee cost averaging'. With a sensible and long-term investment approach, rupee cost averaging can smooth-en out the market's ups and downs and reduce the risks of investing in volatile markets.
People who invest through SIP's capture the lows as well as the highs of the market. In an SIP, your average cost of investing comes down since you will go through all phases of the market, bull or bear.
4. Convenience
This is a very convenient way of investing. You have to just submit cheques along with the filled up enrollment form. The mutual fund will deposit the cheques on the requested date and credit the units to one's account and will send the confirmation for the same.
5. Other advantages
· The entry or exit loads on SIP investments are lesser.
· Capital gains, wherever applicable, are taxed on a first-in, first-out basis.
SIP has brought mutual funds within the reach of an average person as it enables even those with tight budgets to invest Rs 500 or Rs 1,000 on a regular basis in place of making a heavy, one-time investment.
While making small investments through SIP may not seem appealing at first, it enables investors to get into the habit of saving. And over the years, it can really add up and give you handsome returns. A monthly SIP of Rs 1000 at the rate of 9% would grow to Rs 6.69 lakh in 10 years, Rs 17.83 lakh in 30 years and Rs 44.20 lakh in 40 years.
Even for the cash-rich, SIPs reduces the chance of investing at the wrong time and losing their sleep over a wrong investment decision. However, the true benefit of an SIP is derived by investing at lower levels. Other benefits include:
1. Discipline
The cardinal rule of building your corpus is to stay focused, invest regularly and maintain discipline in your investing pattern. A few hundreds set aside every month will not affect your monthly disposable income. You will also find it easier to part with a few hundreds every month, rather than set aside a large sum for investing in one shot.
2. Power of compounding
Investment gurus always recommend that one must start investing early in life. One of the main reasons for doing that is the benefit of compounding. Let's explain this with an example. Person A started investing Rs 10,000 per year at the age of 30. Person B started investing the same amount every year at the age of 35. When they attained the age of 60 respectively, A had built a corpus of Rs 12.23 lakh while person B's corpus was only Rs 7.89 lakh. For this example, a rate of return of 8% compounded has been assumed. So the difference of Rs 50,000 in amount invested made a difference of more than Rs 4 lakh to their end-corpus. That difference is due to the effect of compounding. The longer the (compounding) period, the higher the returns.
Now, instead of investing Rs 10,000 each year, suppose A invested Rs 50,000 after every five years, starting at the age of 35. The total amount invested, thus remains the same -- Rs 3 lakh. However, when he is 60, his corpus will be Rs 10.43 lakh. Again, he loses the advantage of compounding in the early years.
3. Rupee cost averaging
This is especially true for investments in equities. When you invest the same amount in a fund at regular intervals over time, you buy more units when the price is lower. Thus, you would reduce your average cost per share (or per unit) over time. This strategy is called 'rupee cost averaging'. With a sensible and long-term investment approach, rupee cost averaging can smooth-en out the market's ups and downs and reduce the risks of investing in volatile markets.
People who invest through SIP's capture the lows as well as the highs of the market. In an SIP, your average cost of investing comes down since you will go through all phases of the market, bull or bear.
4. Convenience
This is a very convenient way of investing. You have to just submit cheques along with the filled up enrollment form. The mutual fund will deposit the cheques on the requested date and credit the units to one's account and will send the confirmation for the same.
5. Other advantages
· The entry or exit loads on SIP investments are lesser.
· Capital gains, wherever applicable, are taxed on a first-in, first-out basis.
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What is Systematic Transfer Plan (STP)?
Equity fund investment has the potential of
wealth creation through capital appreciation, whereas debt fund investment
accounts for consistent returns in the long run. Investor risk appetite plays
an important role while choosing between the two and unpredictable nature of
equity fund returns normally pulls investors away from them. What if some
investor wants best of both worlds i.e. wealth creation and consistency at the
same time? This has been made possible by the fund houses, as they have
introduced the Systematic Transfer Plan (STP) concept.
Through STP, investors
can invest lump sum amount in schemes with stable returns i.e. debt funds and
ascertain small exposure in equity schemes, so as to maximize the chances of
wealth creation in long run. STP operates via investment of a lump sum amount
in a debt scheme (100% debt or with very less equity exposure) and specifying a
predefined sum to be invested in any equity schemes of the same AMC at regular
intervals. The switching can be in reverse fashion also, depending upon the
market scenario. This is in a way similar to SIP(Systematic Investment Plan), resulting in
lower risk and higher return.
What is STP?
Systematic Transfer
Plan (STP) enables investors to periodically switch mutual fund investments
from one scheme to another. First scheme from which money is transferred is
called the ‘Source’ scheme and the scheme to which money is transferred is the
‘Target’ scheme. Both source and target schemes should be of the same Asset
Management Company. On the date specified by the investor, the amount chosen is
transferred from source scheme to target scheme of investor’s choice. This
automatic switching repeats itself at pre specified frequencies till the tenure
ends.
Benefits of STP
Concepts of SIP and
SWP (Systematic Withdrawal Plan) were introduced basically to minimize the risk
of timing the market and maximize the return at the same time. Systematic
transfer plan functionally is a combination of SIP and SWP, which has following
benefits:
·
Optimum balance of risk and return - STP ensures consistent return with
capital appreciation potential, which is not possible if investment in either
debt or equity scheme is done. Individually, debt funds lack capital
appreciation potential while equity funds returns are unpredictable in nature.
·
Investment Cost Averaging - As mentioned earlier, STP is
equivalent to SIP + SWP, hence you keep on buying more number of less costly
units and less number of more costly units. This ultimately lowers your cost
resulting in enhanced returns.
·
Portfolio Rebalancing – Investing through STP automatically rebalances portfolio
between debt and equity. If your portfolio is debt heavy, STP keeps on
allocating more money towards equity funds and vice versa.
Best Time to Invest
through STP
There are basically
two modes by which you invest in STP.
First case - Source
fund is a debt fund and target fund is an equity fund. In this case, investment
through STP is recommended when equity market is trading around its peak and
future uptrend doesn’t seem likely. In this way, you get to buy equity fund at
cheaper valuation in future.
Second case - Source
fund is an equity fund and the target fund is a debt fund. In this case,
investment through STP is recommended when equity market is trading around its
bottom and future downtrend doesn’t seem likely. In this way you keep on
booking profit in equity fund as the market goes up and at the same time your
money gets invested in a debt fund with more consistent returns in future.
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Know Your Customer (KYC)
Effective January 01, 2011, KYC has been made mandatory for all category of investors who wish to invest in the schemes of Mutual Fund irrespective of investment amount for all transactions.
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What is the Regulation?
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Securities and Exchange Board of India (SEBI) has issued guidelines under The Prevention of Money Laundering Act, 2002 (PMLA) which requires Mutual Funds to follow enhanced Know Your Customer (KYC) norms.
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What is the Prevention of Money Laundering Act (PMLA)?
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The Prevention of Money Laundering Act, 2002 ("PMLA") created under the aegis of Financial Action Task Force ("FATF") forms the core of the legal framework put in place by India to combat money laundering required to be followed by banking companies, financial institutions and intermediaries by administering KYC and other reporting requirements such as suspicious transactions reporting, etc.
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What is KYC?
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KYC is an acronym for "Know Your Customer", a term commonly used for Customer Identification Process. SEBI has prescribed certain requirements relating to KYC norms for Financial Institutions and Financial Intermediaries including Mutual Funds to 'know' their clients. This entails In-Person Verification (IPV), verification of identity and address, financial status, occupation and such other personal information as may be prescribed by guidelines, rules and regulation.
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TO SUMMARIZE:
Step 1 Download and Fill-up the revised KYC form (effective January 01, 2012)
Step 2 Attach the following documents:
For Individuals and Non-Individuals:
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Documents evidencing Proof of Identity and Proof of Address
(List of requisite KYC documents for individuals and non-individuals are mentioned in the revised KYC Application Form) |
Step 3 In-Person Verification (IPV):
Complete IPV from any of the following:
·
· NISM/AMFI certified distributors who are KYD compliant
Step 4 Submit the KYC form along with necessary documents At our office.
Please Note:
Please download (See attach file) and print the KYC Details Form both sides on A4 SIZE PAPER i.e front and back on same paper.
Fill in the information as mentioned above in Sections of the Form with black pen. Complete IPV by producing your original ID, Pan Card, Proof of Address ,with a copy of documents on A4 Page (Self Attested) for verification and submit the Form .
· Investor(s) must note that KYC compliance is mandatory at the time of submission of each subscription request with the designated Official Points of Acceptance.
· Applications by investors without valid KYC are liable to be rejected.
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· We strongly recommend all our Investors to be KYC Compliant by completing the KYC formalities, in accordance with applicable KYC rules in force from time to time, at the earliest so they can continue to invest with us smoothly.
