The doomed Senior Citizen

(published in Moneylife magazine on September 2, 2020)

This is a letter to all the netas and babus who pay lip service to senior citizens (SCs). An SC is usually a retired person, usually someone who has no regular earnings except from his savings and investments. We work, earn and save till we are 58 or 60. Sometimes, in the private sector, we can work till we are physically able to. Even post-retirement, some take up some part-time job, in order to keep our hearths warm. All of us live in different circumstances.

Those of us who have saved and invested all our lives are now at a stage where we cannot take risks with our capital. Preservation of capital becomes important. (Of course, everything depends on how much one has and our lifestyles). Not many will be in a position to still ride the vagaries of the financial markets. 

At this stage of life, where no more capital is forthcoming, one can be paralysed by fear. Opportunities do not seem tempting enough and risks seem magnified. We are seeing the return on our money diminishing rapidly. At the same time, the risks are increasing. In our early days, we had learnt that higher the risk, the higher the reward. However, the government seems to think that higher risk is offset by lower interest rates.

Some frequented cooperative banks to get that extra return. Now, we are afraid to go to any private bank. The Reserve Bank of India (RBI) gives banking licences and is supposed to supervise them. It approves the appointment of managing director and directors. It does regular inspections. And, still, depositors’ money is at risk. Something is clearly wrong with the role that RBI is playing. 

One thing policy-makers must understand. All our savings are from ‘tax-paid’ money. Now, if you ask us to pay taxes, once again, on the fixed deposit interest that this money earns, it is very unfair. If the same finances were recorded on a business account, the business would get tax deductions. Here, we buy our car with post-tax money. We do not get ‘depreciation’ or ‘repairs’ or ‘fuel’ or ‘driver salary’ as deduction from what we earn. A businessman will simply charge all of this and his household expenses to his business and pare his personal taxes. 

Some of us were able to invest money in stocks. As far as I remember, taxation on dividends and capital gains has been ‘capricious’, at best. For most years, dividend was taxed in the hands of the shareholders; for some years, this was removed. It has come back. Then came ‘securities transaction tax’ (STT) on every trade. So, whether the investor makes money or not, the government keeps making money. This is clearly not government ‘for’ or ‘by’ the people. And when STT was introduced, the government told us that there would be no more capital gains on investments sold after one year of purchase. And STT would take care of everything. Alas, this promise was broken. Not only STT, on every component there is also a GST (goods and services tax)! The brokerage I pay my broker goes up by nearly half, thanks to all these levies. I would say that the government has cheated me and is robbing me only because it has the powers to make the law.

Those of us, who had ‘salary’ income through our working career, have paid our taxes. Now, giving me a certificate through an email is of no use. It cannot even be used as toilet paper. It hurts because you, in government, get benefits that are unheard of in the rest of the world. You keep your jobs irrespective of how well you do the job. You get pensions. Some of you get pensions that are linked to inflation. And some of you, who may be in your chairs for just five years, get pension for life. 

Of course, you guys are doing yeomen service for the nation and I do not grudge the goodies that you get. All I am saying is that all these goodies come to you from taxpayers like us. And you guys have the unique distinction of voting yourself your salaries and the hikes therein. So your treating the minority—us (if we were a significant vote bank, you would not have neglected us)—is a reflection of your character. 

I was very happy when you introduced discounts on railway tickets for SCs. Of course, you guys do not need any, since you never pay for anything from your own pockets. Everything was fine. Then, some bright chap in the ministry decided that we could ‘give up’ our concessions if we are ‘shamed’ for using it. This is brutal. 

As a politician, you have nothing to gain by giving us some financial support in the form of tax exemptions. You give tax breaks to businessmen because they contribute to your election funds and party money. You give concessions to this group called ‘farmers’ with four hands, no matter how rich some ‘farmers’ are—two from the Centre and two from the state. When I see that crowd standing in a queue at the neighbouring liquor shop every day, I realise it is a bigger game. They are buying liquor at the government shop which stocks liquor made by families and friends of the politicians. 

You do not even care about our health. Health insurance premiums are very expensive for us. And if we switch to a cheaper option, the new fellow will say ‘pre-existing’ conditions not covered till four years. And on the medical insurance premiums we pay, you have no qualms in applying GST at usurious rates. We are truly an ignored lot. Many of us are not financially ‘aware’. We go to someone who tells us that we can get a higher return on our savings. Yes, it’s our fault. But when the cheat is caught, you could at least help us with a better redress system. 

We are not asking for too much. We do not want certificates and hollow words of gratitude. We spend less on food and more on health. So, if you have to do anything, help us in a way where you spare us further taxes in life. Some of us have paid taxes for 40 years (more than most politicians will ever pay) and have done our bit for ‘nation-building’. The tax collection to GDP (gross domestic product) ratio is so low that we are only a small fraction of who you can target. 

One day, we will be a large part of the vote bank. At that time, we hope we can get some justice and fairness from the ruling elite. I suggest that you take a paper and pencil and find out what will you give up if you exempt us from taxes. It is not going to break the nation. You can easily make up for it by taking back some exemption that you have given to your friends who do business. You give yourselves a goal. Instead of saying ‘thank you’ to the taxpayers and others, do something that will make us say ‘thank you’.

PS: the Finance Minister is kind to those who buy gold and diamonds. Low GST, cash tolerated and treated like the favourite child. The Senior Citizen is clearly an unwanted specie by the Ministers.

And now, the government has unleashed the KYC monster on all of us. It is all part of a conspiracy to steal whatever wealth we have left on death.

You give free ration to 80 crore people! I am sure that it is all stolen from our pockets. And then you put your photo and say that you are the generous donor!

Which mutual fund?

The choice of which mutual fund you choose makes a phenomenal difference to the result. For example, your 10,000-rupee SIP could have either become Rs.50 lakh or Rs.22 lakh at the end of ten years!

I must confess that I never gave very serious attention to performance by various mutual funds.  Just assumed that some will do better than the index and some will do worse. And as each fund grows in size, they start looking like each other and will start mirroring the index. Given the fluid definitions of large, mid and small cap, the MF industry has had a great run till almost 2021-22. There were enough small caps that became large and smaller corpus helped deliver a great show. It might still happen in smaller corpus owning funds given the lack of depth and the play on free float.

I like Value Research, the mutual fund magazine that has been around since the early days of the mutual fund industry.  They let the data speak.

The April issue had a very interesting table towards the end of the issue. It shows what an SIP of Rs.10,000 would have done in various funds across five- and ten-year periods.

This is mind boggling.  Here are some extracts from the magazine.  

	5YR	5YR VAL	10YR	10YR VAL
QUANT SMALL CAP	CAGR %              47.47	RS LAKH             27.19	CAGR  %          18.74	RS LAKH       50.80
QUANT ELSS	36.98		26.57
NIPPON INDIA SMALL CAP	37.01		25.65
QUANT MID CAP	39.33		25.02
QUANT FLEXI CAP	36.47		24.79

These are the TOP five. Four of these are from one fund house. And it over a five and ten year period. Maybe the corpus was small or whatever, but clearly, it demonstrates a process that has worked very well.

How far away are these from the index?  So, here are three index funds

	5YR		10YR
	CAGR %		CAGR %
SBI NIFTY INDEX	18.13		14.37
HDFC NIFTY INDEX	18.17		14.49
LIC NIFTY INDEX	18.00		14.34

Perhaps I should have looked at mid cap and small cap index performance. I do not have the data readily available with me, so I will assume that the last ten years have been great for investing in small and mid cap companies. BSE Mid cap index delivered around  20 percent CAGR over five years. The BSE Small cap index delivered around 25 percent CAGR over five years (the last year it delivered sixty percent). I am not able to pull out data for ten years.

So now I will just pick up a few well-known names and see what they did

	5YR		10YR
	CAGR %		CAGR %
PARAG PARIKH FLEXICAP	25.93		20.57
ICICI PRU VALUE DISCOVERY	28.81		19.35
SBI LONG TERM EQUITY	29.03		18.70
CAN ROBECO BLUECHIP	20.28		16.83
HDFC TOP 100	22.85		16.23
HDFC CHILDRENS’	20.48		16.10
FRANKLIN INDIA BLUECHIP	18.40		13.65

Barring one of the oldest funds, others seem to have done better than the index.

And a look at the names that make up the tail

	5YR		10YR
	CAGR		CAGR
TAURUS FLEXI CAP	18.30		12.04
LIC FLEXI CAP	16.77		12.23
ABSL ELSS	14.12		12.25
TAURUS LARGE CAP	18.60		12.68
LIC LARGE CAP	15.99		13.28
DSP TOP 100	18.45		13.49

Out of the list given in the magazine, about one fourth of the funds have done worse than the index. I have ignored including the names of ‘hybrid’ funds due to my lack of understanding on their composition and dynamics.

MY KEY TAKEAWAYS FROM THIS DATA

1. Diversification in mutual funds is important.
2. Big names do not mean anything.
3. It is difficult to predict the winner.
4. As an investor, it is useful to diversify in to funds based on their investment universe (Mid cap, small cap, large cap etc)

I will be happy to see my fund performance in the first quartile, consistently. It is a matter of luck to be the best performer. Chasing the best is not ideal. Yes the best of the past could be a choice but that is not my criteria. I want a fund house that has a clean reputation, good fund managers and a track record that meets my requirements.

As an investor, if you think that direct equity investing is tough, it is also a tough job choosing a mutual fund.  I find it useful to rely on Value Research ( https://www.valueresearchonline.com ) or Prime Investor (https://primeinvestor.in/prime-funds/ ) or Moneylife (https://advisor.moneylife.in/ ).  While some things may be free, it is better to be a paid subscriber so that you can get the whole picture. Free advice is often very expensive. 

PRICE DISCOVERY OF INVESTMENT /HOLDING CO SHARES

SEBI has put up a paper inviting comments with respect to ‘price’ discovery of listed Investment / Investment Holding Companies (IHC). These companies exist solely to hold shares in companies belonging to the promoter, generally. Sometimes they may hold shares in some other companies since there is no bar. These companies have no operations and the only inflow is from dividends / buybacks. There are virtually no operating costs barring compliance and statutory costs. Of course it may be convenient to load some other promoter group expenses.

Let me address the issue a bit differently. A holding company is of no use to any investor other than the promoter who uses the legal structure to own more than he can through a direct share ownership. He has total control over what to do with the money, whether to pledge the shares, whether to declare dividends etc. It is of value only when there is a takeover. As a stock exchange, listing such a company amounts to double counting of market capitalization. The same business is valued twice over! It is like listing a mutual fund and aggregating its market capitalization! It is what is called as ‘chain’ listing.

IHC is like a closed ended mutual fund, with no redemption ever. It is the most illiquid of all equity investments because there may be no buyer or there may be huge discount or premium to the NAV.

SEBI wants to create a price discovery to enable trading in those shares which are made impossible due to operation of circuit limits. However, all shares are subject to circuit limits, and they are not complaining. So why has this been singled out for favourable consideration?

As an investor, it is a pain to buy holding company or investment company shares. Why buy these simply because they are at a ‘discount’ to NAV? We operate on the greater fool theory. Why not stick to the underlying companies that have the real business?

If I were to ask SEBI to do something, I will tell them to create separate ‘group’ where such investment / holding companies are traded. Simply put the daily NAV alongside. And do not tinker with the circuits. If liquidity must be found, it will be found sooner or later after a series of upper or lower circuits. There is absolutely no need to create any special window for this.  Also, the market capitalization of such shares should be excluded from computation of total market capitalization. 

R Balakrishnan

20-04-2024

A Thousand Rupees a month… Your easy retirement plan basics

A youngster, in to his second year of employment, met me.  As the talk veered towards money, he said he was earning a lakh a month, post taxes and wanted to put in place a savings plan.  He also wanted to ensure that he could continue to send home some money, gather some money for his sibling’s marriage etc .. And then for himself. A house in a couple of years, his own matrimony and so on.

I casually asked him if he thinks a lot before spending a thousand rupees at a meal with his friends. He said a thousand is not a big thing, but he does not eat out often. A thousand did not mean like a big sum of money.

We did some approximate numbers. We came to the conclusion that he has around Rs.40,000 left after his expenses and his contribution to the home kitty. He has two siblings (both have started working, but earn just about enough to contribute to the house) and their mother. There are no legacy savings.

After giving him a two minute summary about mutual funds, I turned to spend some time on compound arithmetic.  He was saying that he is not very good at numbers. Then I got round to telling him about the ‘rule of 72’. He was suddenly a changed man.  I then asked him, “ If you save ONE thousand rupees a month for the next thirty five years, how much do you think it would be at the end of the 35^th year?”.  His mobile phone was whipped out and he figured out that he had saved twelve thousand a year. For thirty five years, it came to around Rs.4.20 lakh.  After this the next steps were lost to him. 

Then we came back to the humble ‘thousand’ rupees. I gave him a table that showed the value of this humble sum invested every month, over long periods. And then gave the value of the saving at the end of various periods at rates from seven to twelve percent per annum.

I then showed him this table:

	Monthly SIP of Rs. 1000/-
	ANNUAL RETURN	7%	9%	10%	12%
	(R
	At end of
	10 yrs	1.77	1.99	2.10	2.35
	15 yrs	3.22	3.84	4.19	5.01
	20 yrs	5.26	6.69	7.56	9.68
	25 yrs	8.12	11.08	12.98	17.92
	30 yrs	12.12	17.83	21.71	32.43
	35 yrs	17.75	28.21	35.78	58.01
	(Rupees Lakh)

Suddenly he was excited.  A mere 1000 rupees a month!!  He said “ If I put aside 20,000 a month, it will be 20 times the final figure?” Does it mean that there would be enough to live off it?  

Then I talked to him about PPF. Told him how that would look like:

	PPF
	amount inv	Interest	yr end balance
1	1,50,000.00	10,500.00	1,60,500.00
2	1,50,000.00	21,735.00	3,32,235.00	3,10,500.00
3	1,50,000.00	33,756.45	5,15,991.45	4,82,235.00
4	1,50,000.00	46,619.40	7,12,610.85	6,65,991.45
5	1,50,000.00	60,382.76	9,22,993.61	8,62,610.85
6	1,50,000.00	75,109.55	11,48,103.16	10,72,993.61
7	1,50,000.00	90,867.22	13,88,970.39	12,98,103.16
8	1,50,000.00	1,07,727.93	16,46,698.31	15,38,970.39
9	1,50,000.00	1,25,768.88	19,22,467.19	17,96,698.31
10	1,50,000.00	1,45,072.70	22,17,539.90	20,72,467.19
11	1,50,000.00	1,65,727.79	25,33,267.69	23,67,539.90
12	1,50,000.00	1,87,828.74	28,71,096.43	26,83,267.69
13	1,50,000.00	2,11,476.75	32,32,573.18	30,21,096.43
14	1,50,000.00	2,36,780.12	36,19,353.30	33,82,573.18
15	1,50,000.00	2,63,854.73	40,33,208.03	37,69,353.30

This was at seven percent per annum! He was sold. I then told him that as you progress in life, you will get more and more money. So let us plan out. And the PPF account can be continued for 35 or 40 years.  This is what it would look like:

                  (Balance at the end in Rupees Lakh)

15 yrs	37.69
20 yrs	61.49
25 yrs	94.87
30 yrs	141.69
35 yrs	207.36

This is tax free. As of now. Hopefully the government of that day will not levy a tax on the PPF.

So, a combination of PPF plus a modest SIP of around 15,000 p.m. should give a decent corpus. However, inflation is something you do not know, so start off with a SIP of 20 K and then we will take it from there.

Then, I wanted him to take a health insurance policy. His mother is 51 and has no cover. He is covered by his employer. I told him to take a decent cover.  His earnings are important for his family. So I asked him to take a pure term policy for Rs. 1.50 to 2 cr.

The other important thing.  I asked him to put aside around 10K per month in to his bank as FD etc so that it could accumulate to about 5 to 6 lakhs as a corpus for some emergencies. Ideally, when he is 35, I would like to see an accessible emergency fund of around Rs.10 lakh or so.

He did his numbers. And then came back.  For a Rs.50 lakh housing loan, his EMI would be around 45K for a twenty year housing loan. He then said that once he gets married, that would be taken care of as there would be two salaries. On his own, it would be tough. He can continue to stay on the rented place as per present, with his siblings, till he decides on his marriage. And then, if he were to continue to live with his siblings and his mother, there would be two more earners. Yes, at some stage, the budgeting would get very tight, once family commitments rise.  Thus, it is important to keep the savings and investment plans at a manageable level.

He also gets his annual bonuses and increments. Told him to save around half of what he gets and spend the rest on his holiday or other spends. Do not plan an investment out of that. If there is surplus, we will drop it in to a mutual fund. This 20K per month should hold good till the take home rises by at least fifty percent. Savings should not be a stress or a compromise on basic living.

He called me after a few weeks to tell me that he has started with SIPs of around 20K, opened his PPF account and also persuaded his siblings to start of with SIPs and PPF on a small scale. They were also excited by the numeracy that was on display by our young man.

He had one big question.  At the end of the 30 or 35 years, what do you do with the money? Do you sell everything and keep it in the bank? I was so happy that he asked this question. We have set up a separate session on this, the next time we meet.

We then agreed to talk after a year on other investment choices.

ps. I do hope there are no big errors in the numbers.

Personal Income Taxes

(It is an unfortunate part of democracy that a few elected representatives have the legal right to impose taxes on the others. And they are given the right to decide where to spend. In such an environment, the politician will always favour the person who helps him to stay in power with money and favours. Of course, the salaried individual ( a small part of our population) has no one to speak for him. Here is an old piece that I wrote for Moneylife, in 2017)

WHY PERSONAL INCOME TAXES?

BJP had promised, before they came to power, to abolish personal income tax. However, thus far, it remains like any politicians’ promise (Did we say it? Oh, we were misquoted). While everyone probably admits to the immorality of a tax on an individual based on his earning power, no one really does anything about it. The governing system, where power is given to a few, to extract revenue and spend it as they choose, will always lead to inequity. Right wing will become middle of the road by the time the stay in office comes up for renewal. As Somerset Maugham’s unforgettable Sadie Thomson says “”You men! You filthy dirty pigs! You’re all the same, all of you. Pigs! Pigs!”

Let us examine the troubles a salaried person goes through. Or a ‘honest’ tax-payer, if there is one, goes through.

As a salaried person, everything we spend on is with ‘after-tax’ money. Do you understand the implications? Let us assume you earn a lakh of rupees a month. And for the sake of simplicity I assume that you are paying a monthly income tax of twenty thousand rupees. Thus, in effect, twenty percent of all your money is confiscated and your wage is now only eight thousand rupees. Thus if you buy something at, say, Rs.1000/- it has actually cost you Rs.1,250 of your salary. You go to a restaurant for a meal. Your bill, let us say, comes to Rs.500 for the food. And you will pay another Rs.60 to the government and say Rs.40 as tips. You have paid Rs.600. From your gross salary, you have paid Rs.750 for food worth Rs.500!

As a businessman, he pays a far lower price than what the list price is. He has this wonderful business, where all personal expenses (car, driver, repairs, home airconditioners, rent, utilities, servant, food, entertainment, birthday bashes, family weddings) are passed off as ‘business’ expenses. And they are tax deductible. What he gets as a salary or commission or dividend goes largely to his ‘savings and investment’ pool of money. And on everything he spends, the government sacrifices thirty percent in tax!. Thus, he loses only seventy percent in profits of what he spends on himself.

The businessman can buy a car in the company name. He will also get depreciation on it, that is deductible from the income. You have to buy your car from the ‘after tax’ money, which means you end up paying a twenty five percent extra from your gross salary.  The businessman thus parks every expenditure in the business account, with the government contributing thirty percent to it.  Thus, in effect, the businessman is nearly twice as well off you are, with the same level of earning.

Personal income tax is extremely unjust.  A very few percentage of the population actually pay it. And if people tell me that businessmen are very honest and do not park personal expenditure in to business expense accounts, I will add it to the many tall tales I know. The businessmen will build ‘holiday homes’ for ‘staff’ welfare. And some rooms will be locked and reserved for the owner and family. Of course, nothing beats the joy of having a private aircraft that is used mainly for parking at the hangars. In today’s age of instant communication, where is the need to travel?

As a salaried individual, you are paying through your nose for the house you bought. Just work out what your EMI  and factor in the tax you paid on that. Every asset you buy comes out of ‘after tax’ money. You cannot even claim deduction for the four mobile phones that the family members use! Businessmen even charge their cable television and newspaper bills to the expense account.

Thus, when you hear the term ‘income tax’ it is different for each class of individuals, depending on their station in life. And it goes against the grain of the government’s public stand of ‘taxing the rich’. In effect income tax penalises the salaried class and rewards the rich who are like ‘legally incorporated tax entities’ for business!

The pampered businessmen are now being promised a lower corporate rate of taxation as opposed to sweet nothings for the salaried slaves.

The government already takes a huge cut by way of GST on everything we buy , consume etc. And the government pays lip service to inequality, when they exempt gem and jewellery from GST! The government is FOR the rich, by the rich. The politician points out to other countries with similar rates of income tax and says that India has a moderate tax regime. Absolute rubbish. Look at both taxes together. GST, Cess and other imposts on expenditure in conjunction with Income tax will be far higher in India. Singapore, for instance used to have a 3 or 4 percent GST.

As a start, the government can start ‘disallowing’ a lot of business expenditure. For instance, deprecation on cars, fuel, driver on cars, guest houses, holiday homes, jet aircrafts, entertainment expenses etc. That will probably go a long way to equalise the impact of income tax across different class of earners. In the alternative, allow individuals to become a one man incorporated entity, with the same tax treatment as a business entity. Even in cash flow terms, the salaried individual pays his taxes monthly as opposed to quarterly by the businesses. A businessman will ‘employ’ his entire family as salaried individuals in his various corporate entities and build his wealth.  The businessman even charges his insurance premium to the business as a tax-deductible expenditure!

All of this abuse can go if income taxes are totally scrapped. If you want, let it be tax free, say, up to a crore or two a year. And the government will also be saved of all the efforts it puts to harassing the salaried individuals who have to file returns, answer queries and be treated like suspicious elements by tax officials. Even when it comes to personal income tax, if a salaried individual goes to a consultant, the fees come out of the ‘after tax’ money whereas, the businessman charges it off as an expenditure.

Redistribution of wealth and reduction of inequalities is a pipe dream that all politicians and liberals mouth. Whenever there is progress, there will be inequality. And with such a huge population, India has a bigger problem than other countries. Giving away a slice of a salaried individual’s income is not going to solve this problem. As Warren Buffett says, the rich pay lower taxes. All the exemption schemes that are dreamt up by their lobbyists cost more than the personal income taxes collected.

Dear Prime Minister & Finance Minister, it is time you made history by doing away with personal income taxes. That will also be another weapon to channelize more white money. More disposable income will also encourage savings and spending, giving a much needed boost to the economy.

R Balakrishnan

October 2017

Of KYC and other entertainments .. SEBI rocks

A day or two ago, I get a Whatsapp message from my broker, HDFC securities.  Here goes

“Dear Mr

Trading A/c xxxxxxxxx

It has been notice that the same mobile number and or email id has been utilized in multiple trading accounts registered with HDFC Securities Ltd.

Request you to update correct details latest by 6th March 2024, if failing to do the accounts will be suspended.

Click here: https://m.gs.im/e/uTwlOiT0Yef to login to your Trading Account go to Account details select option for Change Contact Details.”

Obviously, I have linked my phone number to my wife’s broking account and have disclosed that fact .  With multiple OTPs needed each time, it is more convenient and it is known that in most cases, a single person decides for all the family members. I do the investments for my family. So, it makes sense for me to link my mobile number. Similarly, they want separate email ids for each account. How absurd. Now I will have to create more email ids. How is it they assume that everyone is a qualified investor? If family members are able to trust one of their own, what is their problem?

On being asked why, the standard response “Sir, a SEBI requirement”.  We all know SEBI has its reasons and they do not owe any explanations since they do not understand how things work in the industry or with investors. Application of mind is not one of their strong points.

Now, I know it is futile to argue with authority in India unless you are big enough to care two hoots for them. So, like a good compliant and obedient citizen, I tried to change the numbers.  However, the HDFC securities site would not let me change it. It says . “Enter a NEW mobile number’. All I am trying to do was to make her phone number the first and mine the second.  But HDFC is known for its IT capabilities. It cannot be user friendly and has you knocking your head.

Now, how do you reach out? You respond to the whatsapp and out pops a drop down menu. Email? No sir. There is one blanket Customer care id. RMs keep changing over time. How does one even communicate with them?

Of late, compliance to legal requirements, KYC etc have become my full time occupation. Aadhaar was supposed be a link all. I still have multiple ID documents and struggle to remember so many passwords and security questions. Truly, the beneficiaries is the government.

Some people will forget. All will die at some stage. And successors / heirs wont be able to retrieve anything. And then it will all go to the government via the Investor Education and Protection Fund which then does the needful.

Byju’s – value 25 million?

The recent ‘rights’ issue announcement by Byju’s seems to put a pre money value of 25 mn dollars and a post rights value of 225 mn dollars. What is happening?

It is a clever move. It is like a shotgun fund raise of 200 mn dollars. No existing shareholder can say no. If anyone says no, the promoter will put in the additional money and thereby raise his shareholding. Let us say, that the capital is 25 dollars and there are 25 shares. Rights shares of one dollar each numbering 200 are on offer. If everyone takes up their rights, then there is no change in the stakes in the company. However, if one or more of the shareholders say no to the rights, the promoter could take up the rights and increase his shareholding. And it could be significant enough to make a difference in the voting powers.

So, either you give up on the company or subscribe and hope that there is a higher residual value at the end.

Interesting possibiities.

Fractional Ownership in Real Estate

Fractional Ownership in Real Estate

(This article was published in Moneylife Magazine on 02 June 2023)

The year was 1993; I was working at CRISIL Ltd. That year, we saw quite a few interesting ‘structured’ obligations that had come to us for rating. One, that was my favourite, was this:

Lokhandwala Construction Industries Ltd (LCIL), a reputed builder, announced a large housing project in Kandivali East, a suburb of Mumbai. It is now known as the Lokhandwala Township.

I do not remember the exact numbers; but approximately 600+ apartments were planned. The project was priced at Rs750/sqft (square foot), at the initial launch. The project had a very interesting funding structure. Since it was an innovative idea, the builder was particular about being compliant with Reserve Bank of India (RBI) regulations—the Securities & Exchange Board of India (SEBI) had just got its statutory teeth and was yet to make its presence felt in this area. 

The structure was simple and elegant. LCIL would create ‘units’ for Rs750 each. Each unit represented 1sqft of space in the designated project. Say, there are 600 flats, with an average area of 1,500sqft each. It meant a total saleable area of 1,500X 600 sqft or 900,000sqft. Thus, 900,000 ‘units’ would be created. The units would be sold at par to applicants through a ‘trust’. LCIL would not leverage itself. The money collected would then be given to LCIL to execute the project. There were enough bells & whistles to ensure that the cash-flow was controlled and an audit mechanism was in place. The project completion time was a window of 30 to 36 months from the launch day.

The units were planned to be tradable in the secondary market. One could trade in multiples of 10 units. At any point of time, one could buy enough units and ‘buy’ a flat. Once a flat was bought, the units were extinguished. There was a separate Registrar & Transfer (R&T) mechanism, a financial audit, a designated ‘market-maker’ who would offer a 2-way quote, until the project was completed. Once that project was completed, the units that were not yet converted into flats would be surrendered to the trust, which would get money from LCIL to pay off the unit-holders. 

As a unit-holder, one had a direct representation in the market price of the apartment. As the project neared completion, the price of the flat would start rising. The unit prices would rise correspondingly. An investor would ‘participate’ in the movement of the real estate prices. It was a wonderful structure that would have allowed someone with just a few thousand rupees to participate in real estate as an asset. The unit prices would be a proxy for the real estate price of that project. The mechanism was well-honed and we could see that, except market prices, every factor that was subject to execution was well-covered.

The risk assumed by the investor was two-fold. One, timely execution; and, two, price. In the event, the price fell below Rs750/sqft, LCIL would have to find ways to either buy out the units (those not yet converted into flats) or give a discount on the units trading between Rs750 and the prevailing (lower) market price. I recall that the going rate for apartments in nearby localities was around Rs650/sqft. The LCIL project was quite grand in scale and had enough amenities and facilities to justify a premium to market rates (at that time). In other words, the financial risk that we were evaluating was around Rs100/sqft and whether the builder could raise that money, assuming every unit eventually had to be funded. He would also need resources to fund unsold flats.

We were convinced about the feasibility of the project. The discussion centred on real estate market outlook, builder integrity, etc. What if there was zero demand for the project? What if there was a recession and prices crashed to below construction costs? Remember, this was 1993 and most minds were fresh with the fallout of the Harshad Mehta scam and stock market crash. 

The instrument was aptly called ‘REAL ESTATE PARTICIPATION SCHEME’ or REPS. As an analyst, I had assessed the capabilities of LCIL to execute the project and the team was convinced about the builder’s capabilities. The team at LCIL was excellent. Legal checks about land titles, building permissions, etc, were all verified and we were satisfied. 

From a rating perspective, we had enough financial comfort to provide for a price drop to, say, Rs500/sqft or so. 

The only worry was whether it would amount to ‘fixed deposits’ and, if yes, the amount could not be raised. While we were debating about whether or not we should assign the rating, the company wrote to RBI, seeking its approval to launch such a financial instrument. No two guesses about the outcome. The plan had to be abandoned.

Thanks to this project, I got an opportunity to meet Siraj Lokhandwala. I also had the pleasure of interacting with the full-time CEO, Arvind Pahwa. Finding a high-quality professional in the real estate industry was a rarity those days. The structure was put together by the brilliant PS Jayakumar at Citibank (who went on to become the CEO of Bank of Baroda) and Shitin Desai at DSP Financial Consultants. This assignment helped me learn a lot about the construction industry, and gave me an understanding of the Lokhandwala group. I was convinced about their quality and had no doubts that the project would have been a profitable one for investors. Unfortunately, RBI was not willing to look at new possibilities (the scam had burnt all minds). 

Finally, 30 years later, our regulators are talking about ‘fractional’ ownership in real estate! Lokhandwala and their team of bankers had come up with this idea in 1993! While our regulators are still ‘talking’, this investment vehicle is already operational for the past few years. There are multiple instruments that offer you fractional ownership in rental properties. 

Just like equity shares, real estate is an asset class. Indians have always loved real estate. Given the fancy realty prices in cities like Mumbai, the only way most of us can participate in this asset class is through ‘fractional’ ownership. I am not sure how the laws will evolve. We already have a truncated form of ‘REIT’ (real estate investment trust) with fractional ownership available through buying and selling of units in listed secondary market instruments. 

From my experience with the real estate industry, I can say that all investments have an element of risk. However, the risk is not any worse than in stocks. In fact, a stock can go down to zero; but it unlikely that any real estate unit will drop to zero; unless there is a fraud. If the legal structure is immaculate, the only real risks would be execution risk and market price risk. In India, we have rarely seen serious dips in real estate prices. Most builders also seem to have holding powers, thanks to the entry foreign capital, sometimes bank loans or and real estate funds that are willing to step in, at a price. 

SEBI is now proposing to ‘regulate’ online ‘platforms’ offering ‘fractional ownership’ realty schemes. No one sought any permission to launch such schemes and SEBI, in essence, accepts that they exist and wants to get in sideways to regulate them. 

These fractional ownership schemes open up a new avenue for investors, and a new fund-raising option for the real estate industry. There will be good projects, bad projects and outright frauds. There is no escape. As investors, it is useful to understand the risk before buying into such ‘fractional ownership’. As the name suggests, put in only a fraction of your wealth in these assets. Ultimately, they cannot return more than the average real estate price appreciation. There will be pure fixed-income-oriented products as well as some that promise you a share in real estate price movements. Remember that prices can move in two directions.

Note: Personally, I was very keen to see the launch of REPS. I was tracking the price movements at the project and, if REPS were launched at Rs750, the exit would have been at close to Rs1000. One other important reason I was happy with REPS was that it was taking away the black money out of the equation. It would have been ‘all-cheque’ deals, at a time, when it was quite common for real estate deals to have a large chunk of ‘cash’.

Rumours & Price Manipulation- SEBI consultation paper.

(SEBI’s consultation paper is an important step towards reducing rumor induced price movements in shares. It would be good if all of us responded to SEBI with a view that it must be implemented soonest. Details can always evolve)

Share prices move with every trade. Sometimes, prices take an unusual leap up or crash suddenly. We can rationalize it if there is some public news about the company or the industry. Or if there is some big liquidation due to a margin call etc. Beyond these explicable causes, if price moves in an unusual range, one always suspects something is about to happen. The news is not yet published, but someone has already taken advantage of the same. In today’s age of instant communication, it is easy to spread news- both true and untrue. This gives an unfair advantage to the one who is acting based on privileged information about such an event that could unfold in the future.

There is a consultation paper from SEBI  (htdtps://www.sebi.gov.in/reports-and-statistics/reports/dec-2023/consultation-paper-on-amendments-to-sebi-regulations-with-respect-to-verification-of-market-rumours_80237.html ).  This seeks to address the important issue.

In my career, I have seen that when there are preliminary merger or acquisition talks between an investment bank and a company, somehow, there is a flutter. Often there is informed buying that happens. And then the price moves before any announcement. SEBI does try and find out if someone has taken any advantage of the news and made a trade before the news has become public. 

The objective is simple. Someone unfairly takes advantage of privileged information to make money. If the same information was available to all the participants, the trade would have been at a different price. If it is good news for the company, the seller would get a higher price and if it is negative news, the buyer would not have bought at that price.

I strongly support the view that companies must be forced to confirm or deny any rumours. SEBI has sought to create an alarm for that action from the company. That alarm or trigger is in the nature of a ‘price’ move that is beyond a certain percent and is not a normal move for such a share.  These unusual price moves also impact many things. It could take the price beyond a threshold at which the company wanted to do a deal.  SEBI proposes to address this by ignoring such movements for the purpose of any legal compliances. I think it is a fair approach.

Some might say that it could lead to a lot of ‘fishing’ expeditions. Someone says that a company may have signed a “Non Disclosure” agreement with someone. In fact, I would like to see a company coming out and saying that “ We have engaged XYZ Bank to find a suitable acquisition for us etc etc..” . Similarly a company that is offering itself as a suitor can admit that “Our promoters are looking at selling out the stakes or selling out some part of the business”.  Why does it have to be confidential?

To me, all these excuses do not hold water. Let us assume that a company is contemplating an acquisition. What is the big secrecy about it? It is an important action that impacts the shareholders in a significant manner. I always wish that a management would take PRIOR approval of non-promoter shareholders before embarking on a buyout or a sellout. There is no need to mention names.  What I find is that this absurd ‘confidentiality’ helps to hide a lot of details from the other shareholders. It could be related to price, value, non-compete fees paid to the promoter or so many things.  What is the need for secrecy on all these in a listed company?

Such transparency will stop unjust enrichment of a few at the expense of others.  

This leaves behind the nasty issue of the deliberate rumors spread by operators to move the price of a share to their advantage. Here, the best deterrent is a punishment that is so severe that no one would want to risk it. And the legal system must help by closing out such trials in fifteen to forty five days. Maybe the Supreme Court can appoint a separate bench which has experts with market knowledge and expertise.

In short, I commend SEBI for this consultation paper and hope it gets implemented soon. It will help some foolish investors from losing some money. When it comes to ethics, it is best to assume the worst, so that we do not face any disappointment. There will always be someone who is fooling all of us at any given time. It is the function of the regulator to keep reducing their population.

Of Insurance policies & Surrender Values

(an ancient piece that I had written in 2010)

If we get in to a mutual fund SIP, say, for two years, with a mutual fund and then stop it after two months, do we get penalised? We get the full NAV without any deductions except any exit loads that are pre defined. However, if we cease paying premiums on any insurance policy (other than term life with no payouts) the insurance company penalises us heavily, by charging a fat penalty, thereby unjustly enriching itself at the cost of the innocent policy holder. The same rules that apply for a mutual fund should also apply here. In the first place, the premium amount should show the amount for insurance and investment separately. Swallow the insurance amount in full. Do not touch the investment amount)

Here is the 2010 piece:

The Mint newspaper carried a story about Life Insurance policies worth over a trillion rupees getting lapsed.  Some of the interesting bits are :

1. 9.1 million policies lapsed in 2009
   1. lapse ratio for ICICI Prudential Life Insurance Co. Ltd, the life insurance arm of India’s largest private s ector lender ICICI Bank Ltd, stood at 53% in 2009, up from 40% in the previous year. About 777,000 conventional policies worth Rs25,269 crore lapsed, the highest among private insurers by value. (Obviously, ICICI does not want to miss market share any which way)
   1. In terms of lapse ratio, Aviva Life Insurance Co. India Ltd, leads the list with 32,000 policies or 59% lapsed
   1. Reliance Life Insurance Co. Ltd saw its lapse ratio almost double—40% in 2009 against 21% a year ago.
   1. Life Insurance Corp. of India (LIC) declined to 4% for 2009 from 6% in the previous year. In absolute terms, nearly 7.3 million traditional policies worth Rs52,926 crore lapsed. Almost half the conventional policies that lapsed in the industry in 2009 were sold by LIC.

If this is not rampant mis-selling I do not know what is. Most insurance companies do not repay or refund anything, if the policies are less than three years paid up. After three years, the agents commissions drop to ‘small’ levels of 2.5 to 5.0 percent, so he cares two hoots. He would rather tell the fool (Client) to take a different policy after ditching the old, since it would give him a higher commission.

The great thing is that the paper quotes the Max New York honcho as saying that it is not mis selling but “it indicates a lack of understanding on the part of policyholders”. Sir, who delivers the ‘understanding’?

Most insurance companies have a scheme or a process to ‘revive’ lapsed policies within some three years of the last premium paid. After that, they quietly pocket the money. So, for an insurance company, it actually helps if clients default on policies that have not acquired any surrender value. Probably, they must be hoping for this to happen every year and would be part of their business goals for each year. Probably, they reward agents who bring in such kind of clients in to their web of deceit.

It is time people woke up. IRDA, being run by retired guys with either LIC or RBI background, will never help the insured. They are the owners’ representatives. The ideal rule would be:

1. When policies lapse, blacklist the agent / withdraw his IRDA code, so that he can get no more commissions and sell no more policies. This is the best way to ensure that the mis-selling stops;
2. When there is a lapse, the insurance companies should refund the amounts collected less the charges they have actually incurred. For instance, if I have paid Rs.2,000 per year for two years, I should get a refund of something like 2 to 3K back. This should be made statutory and any violation should result in a heavy penalty on the insurance company.
3. A list of lapsed policies should be put online compulsorily. 
4. Surrender values should be made compulsory even for a one premium old policy. Why should the insurance company rob the payer?

The other option is to explore if third party buyers of lapsed policies can emerge legally. Maybe they can take a call on whether to revive the policy and take the assignment in their favour and continue it. All possibilities exist.

I am sure that IRDA will do zilch to resolve this issue. It is high time that the MOF stepped in and passed the supervision to another body where the insured is also taken care of. If SEBI can handle mutual funds, I am sure it can handle insurance also. After all, every product they sell (except the pure term policy which they hide) is an investment product with some optional insurance.

R. Balakrishnan

January 21st, 2010