Near-perfect strategy

Name: N Krishna Anand Age: 40 Years Monthly Income: Rs 69,500 (Post Tax) Financial Dependents: Three (Wife And Children)

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The doctor is impressed. After many weeks we have a patient who gets a thumbs-up from us. N. Krishna Anand belongs to the rare breed of investors who stick to classic rules of financial planning while keeping themselves updated about new products and investing theories. Not that the 40-year-old businessman has not made mistakes. An unwieldy equity portfolio and inadequate insurance cover are two of the most important ones. But he is a conscientious investor which has considerably neutralised the effect of the flaws in his strategy.

The first indication of Anand’s meticulousness was the structured manner in which he sent us his investment details. We don’t recall any patient who has specified unrealised gains, asset allocation of Ulips, maturity dates of debt investments and the rate of returns on moneyback policies without our having asked for these details. Some have been unable to give us this information even after repeated requests.

In terms of strategy too, Anand has many firsts to his credit. None of our patients parked his/her monthly surplus in liquid funds to earn more than a savings bank account. No one took the initiative to buy personal accident policies for every member of the family. Very few case studies favoured fixed maturity plans (FMPs) for debt investments.

Anand must be applauded for these decisions. But the question is, where did such a careful investor slip up? Was it a conceptual error or an oversight? Let’s find out.

As Anand runs a business, he does not have a fixed income. He has assigned himself a monthly salary of Rs 30,000. On an average, he earns an additional Rs 35,000 a month from his business. Another Rs 4,500 comes in as rent from one of his apartments.

Tips from Anand’s plan Dos • Maintain detailed records of all your investments • Park surplus in a liquid fund to earn more than a savings bank account • Diversify investments across all investment categories • Buy personal accident insurance policies for all members of the family Don’ts • Don’t invest in too many funds • Don’t invest a large amount in stocks if you do not understand equities fully

Routine expenses skim off about Rs 9,000 a month. The EMIs for two home loans and a car loan use up nearly Rs 23,400. After subtracting the investment of Rs 7,500 in systematic investment plans (SIPs) and average insurance premiums of Rs 7,200, Anand’s monthly surplus is Rs 22,376—32% of his income.

In another four months, when the tenure for the car loan is complete, Anand’s surplus will increase to 39% of his monthly income. Considering that Anand is at that point in life when expenses peak, this surplus is not low.

Diversification is a key feature in Anand’s strategy. His investments are spread across all asset classes. In 2003, Anand bought two houses in Kochi for Rs 29 lakh. It was a well-timed purchase. The collective value of the properties has jumped to about Rs 83 lakh—almost seven times the cost.

To fund the purchase, Anand took two home loans at 7.75% fixed rate of interest. Given the rise in interest rates over the past few months, opting for a fixed interest when the rate was low was a good decision. Now, the outstanding loan amount is close to Rs 18 lakh. We suggest that Anand withdraw investments from his debt portfolio to prepay the loan partially. He has invested about Rs 5.5 lakh in the Public Provident Fund, an FMP and infrastructure bonds. These investments give a higher rate of return than the loan rate, but the difference is insignificant— only 0.25%. In the long run, it is better to reduce either the EMIs or the loan tenure to loosen up the cash flow. The increase in surplus can be invested in instruments that give significantly higher returns.

As it should be, the thrust of Anand’s investments is equities. In a bid to diversify within this asset class, Anand has binged on mutual funds, adding 23 to his portfolio. The choice of funds is not bad—he has picked consistent performers over the past four-five years. Also, the investments are spread across different economies, sectors and company sizes.

Trimming the flab Anand has too many funds in his portfolio. Iris makes the following suggestions to get it in shape:
Mutual Funds	Advice
ABN Amro Equity Fund-G	SELL
Birla India GenNext-G	SELL
DSPML Opportunities-G	KEEP
DSPML Small and Mid Cap Reg-G	KEEP*
DSPML T.I.G.E.R. Reg-G	KEEP
Fidelity Equity-G	SELL
Fidelity India Special Situations-G	SELL
Fidelity International Opportunities-G	KEEP
Franklin India Bluechip-G	KEEP
Franklin India Prima-G	KEEP
Franklin Pharma-G	SELL
HDFC Long Term Advantage Fund-G	KEEP*
HSBC Equity-G	SELL
Magnum Contra-G	SELL
Magnum Global-G	SELL
Reliance Tax Saver-G	KEEP
Sundaram BNP Paribas S.M.I.L.E. Reg-G	SELL
Sundaram BNP Paribas Select Midcap Reg-G	SELL
Templeton India Growth-Div Reinvest	KEEP*
Templeton India Growth-G	KEEP
ING Global Real Estate-G	KEEP
Lotus India Liquid Plus Fund	KEEP
*Invest through SIPs

Yet, there is a considerable overlap in the companies that the funds invest in. For instance, the ABN Amro Equity fund, Templeton India Growth fund and Fidelity Equity fund give exposure to almost the same set of stocks.

Iris has pruned Anand’s cache by consolidating investments in 10 funds. He should funnel the entire monthly surplus in five of these funds via SIPs (see “Trimming the Flab”). A new fund should be added only if it gives a unique equity exposure.

Interestingly, Anand began to buy stocks 14 years ago, much before he started to invest in mutual funds. Some of those stocks, like Pioneer Embroideries, are still in his portfolio.

It is clear that Anand invests in stocks for the long term. He does not choose them on the basis of a fixed criterion. “Each for its own merit” is his mantra. For example, Anand bought the shares of Balrampur Chini Mills because he has immense faith in the company’s management. Another stock like Artson Engineering finds a place in his portfolio of 34 stocks because it has the potential to earn high returns.

The problem is that there is no strategy for his stocks portfolio as a whole. Anand is lost in the particulars and has not given adequate attention to the bigger picture. He has overlooked important questions: Do the stocks conform to his risk profile? Is he over-exposed to a particular sector? Does he understand the business of the companies he has chosen?

Moreover, Anand doesn’t evaluate the performance of his stocks regularly. Given the long holding period, the portfolio should have given him much higher returns. This is another indication that his strategy is flawed.

Managing all equity-oriented financial products requires a thorough knowledge of how the markets work. Anand is lacking in this regard. In June, he switched investments of his Ulips from 65% to 100% debt. In the same month, the stock markets recorded the worst monthly fall in 16 years.

The timing of his move was way off the mark. Anand should have switched to debt in January when the markets peaked or he should not have switched to debt at all.

We cannot advise Anand to exit direct equity completely as the invested amount is very large. Iris suggests that he build a portfolio of not more than six to seven stocks for an investment of Rs 12 lakh. The focus should be on large-cap stocks as these are the safest.

Anand’s life insurance cover is also inadequate. He has two moneyback policies, one pension plan and three Ulips, which cover him for Rs 17.8 lakh. The annual premiums amount to about Rs 82,000. The cover is less than his outstanding car and home loans. Anand has also taken a business loan of Rs 30 lakh with a personal guarantee. We suggest that Anand increase his insurance cover immediately by buying a term plan of Rs 70 lakh for 20 years.

The annual premium will be about Rs 39,000. Contrary to our usual recommendations, we shall not ask him to surrender the money-back policies as they give him 12% assured returns. He can opt out of the whole life plan though. Anand bought it because he will be unable to renew the insurance cover at a reasonable cost when the other policies expire. But he shouldn’t worry about insurance in his old age. If he follows our financial plan, Anand should be able to build a reasonably meaty nest egg.

Revisiting past patients We do a quick check-up to monitor the health of our past patients’ portfolios Appavoo Muralie, 40 Financial dependents: Two         Old asset allocation: 73% Real Estate 25% Equities 1% Debt 1% cash What we diagnosed • No investments in debt instruments • Inadequate life insurance cover • Low equity exposure What we prescribed • Invest in National savings Certificates and/or PPF • Buy term insurance plan » Invest in mutual funds which have been consistent performers over the past four-five years What he did • Pruned his direct equity portfolio from 13 to six stocks • Invested in an equity-oriented mutual fund What he didn’t • Buy a term insurance plan • Invest in debt instruments Muralie must increase his equity exposure through mutual funds as this is safer than investing directly in stocks. Also, as he is over 40 years old, he must start building a debt cushion. "The home loan EMI has reduced my current monthly surplus. So I don’t have enough money to invest in SIPs aggressively"