Friday, September 23, 2011

Assured Returns

Don't be fooled by promises of guaranteed returns. It is critical to look for risks in an investment rather than seek assurances that are easy to give.

Investors love assurances. An assured return conjures up the image of a solid investment that will deliver on its promise. It seems like the best choice one can make with one's money. The truth is that delivering an assured return is the toughest act for an financial product. If investors think that assured return means a risk-free and safe investment, they should think again. The quality of the promise matters so much more than the promise itself.

Why is it tough to assure returns? The performance of an investment is primarily driven by the assets in which the investor's money is put to work. All assets are subject to risk. It is not possible to buy assets that will only appreciate in value. The degree of risk may vary, but no one can tell how an asset will perform in the future. Whether it is land, gold, houses, stocks or art, all assets are subject to the risk of price fluctuation. Prices are influenced by cyclical factors such as the state of the economy (the US housing prices crashed in 2008 triggering an economic recession), and structural factors that impact the specific asset. Some assets, such as property or equity, may face short-term risks that even out in the long-term, but they are risky anyway. All investment products are based on an underlying asset port-folio, which is risky by definition. Asking where, not how, the money will be invested is critical to understanding any assurance of return.

So, how do banks manage to assure returns on deposits? The answer lies in the balance sheet structure. A bank borrows from its depositors. Its assets are the loans it gives out to various borrowers using these deposits. The borrowers agree to pay a fixed rate of interest and return the principal, but their ability to keep the promise is again linked to their assets and performance. A person who has taken a home loan is likely to default, despite committing to a fixed rate of interest, if he loses his job or if his house drops in value significantly. Therefore, the bank's portfolio is also subject to risk. The bank does two things to keep its promise to depositors. First, it ensures that the loan portfolio is not completely risky and holds some safe investments in government bonds as well. Second, it does not fund all the loans with deposits, but ensures that a part of it is funded through equity investors who do not seek assurance. If the risk of the asset portfolio is borne adequately by equity capital, the bank is unlikely to default on its deposits. This is why capital adequacy is a regulatory requirement for banks that seek deposits from the public. This is also the reason that a bank with a poor quality loan portfolio or inadequate capital can default on it deposits despite assurance.

How does a company pay an assured return on its bonds? It does so by further extending the balance sheet structure used by a bank. Unlike a bank that holds loans, a company holds assets that are expected to generate future income. The risk associated with these assets can vary depending on the nature of the business. Therefore, a company has to be funded by its promoters even before it seeks any lenders. The lenders will, of course, want the company to have adequate equity capital already invested in it. They will ask an external credit rating agency to test the quality of assets that they are funding. As we know, these agencies can downgrade and change the rating unfavourably if a company is more likely to default.

How safe are government securities? The central government assures returns on its bonds and saving schemes because of its unique powers that provide it with three options to return the money it borrows. It can unilaterally increase the taxes, borrow internationally, or print money. We can, therefore, assume that the government will pay its liabilities. We know from the experiences in Europe that a government which borrows recklessly can also find itself in trouble, causing serious economic consequences for its lenders and citizens. Hence, the ability to assure returns comes either from the strength of the balance sheet in the case of a bank or company, and from special powers vested with a government. It is critical to learn how to look for risks in an investment, rather than seek assurances that are easy to give but tough to deliver.

Saturday, September 3, 2011

MF Grievance

A  proper redressal system is in place to address the complaints of an MF investor.

Investing in a mutual fund (MF) today is easier than ever before. Now, you could invest not just through the distributor, but also online and without an intermediary. Servicing the MF investor, on the other hand, has always been an issue, though it's being tackled through a series of steps of late. The tardy and unfriendly attitude that characterized the MF industry in its infancy stage has given way to an efficient and personal face. Still, complaints do crop up, such as a missed dividend cheque, issues with a fund's NAV pricing, non-receipt of fact-sheet and annual reports, and so on. If caught on the wrong foot, you can follow the following redressal trail.

The Fund House
Most snags get resolved at the fund house ---- the first step of the redressal ladder --- itself. In case of any clarification or complaint regarding your investment, approach your fund house or its registrar and transfer agent (R&T). Their contact details are there in the account statements or the fact-sheets that funds send to investors. You could also get them from the website of the respective fund house and its transfer agent. The  fund house or registrar will look into the complaint and, more often than not, resolve it then and there.

The Regulator
If, for some reason, the investor is not satisfied with the fund house's response and wants further intervention, the next contact should be the regulator -- Securities and Exchange Board of India (Sebi). A written complaint has to be filled with any of the four zonal offices, detailing the circumstances of the case, along with photocopies of the relevant documents. Complaints can also be filled online on Sebi's website On receiving the complaint, Sebi will give a reference number, which will need to be quoted in all future communications with it. Sebi will follow up the case with the fund house. If the fund house does not resolve the complaint with three months of filing it with Sebi, you will have to sound out (Send reminder) the regulator again.

Investor's Association
If Sebi also fails to resolve a complaint, you will have to approach an investors' association. These are independent entities that help investors in grievance cases. You will have to write to one of the associations, attaching photocopies of relevant documents. Some of these entities provide the services for free, while others charge a nominal fee in the range of 200 - 500 INR. These associations take up individual cases too. To start with, the investors' association will do what Sebi does -- hear the investor's side of the story and follow it up with the fund house concerned. If it does not get a satisfactory  answer from the fund house, and it feels there is a case, it might advise the investor to take legal action. It could even help with the case.

Ministry of Corporate Affairs
'Investor Helpline' is a free, dedicated online portal to handle investor grievances administered by different authorities, i.e., the Ministry of Corporate Affairs, Sebi and the Reserve Bank of India, in a focused and sustained manner. It is sponsored by the Investor Education and Protection Fund under the Ministry of Corporate Affairs. Right from filing of the grievances to tracking their status and interaction with the administrator, all the steps have been made online to make it user-friendly.

The Courts
On rare occasions that your problem remains unresolved, the legal system is your last recourse.