Personal FN had the privilege to interview Mr. Ajit Dayal, Co-founder and Director of Quantum Information Services Pvt. Ltd. Mr. Dayal shared his views on a range of subjects such as equity markets and other asset classes and, of course, on the importance of financial planning.

 

Mr. Ajit Dayal is also a Director at Quantum Advisors Pvt. Ltd. and Quantum Asset Management Company Pvt. Ltd.

Views on Financial Planning

Views on Equity Markets

Views on Gold

Views on Global Investments

Views on Real Estate

Views on Financial Market Regulation

 

Views on Financial Planning

Personal FN:Can you demystify the word “Financial Planning” for our audience?

Mr. Dayal: Financial Planning is actually pretty simple. All that it really means is that: you earn money, you will be spending some of it and you will be saving some of it. And how you save the money and where you save it is a planning process which helps you get a future income. So that the day when you retire or the day when you need the money for your children’s education or marriage is when you can use the money that you save today. So, financial planning is just looking after the portion of the income which you save every month, and how to put it to work in the best use to suit your needs, based on the risk you are willing to take over time.

 

 Personal FN:Most people believe that they don’t have enough money to start planning for their financial goals. So is there a “time trigger” or “enough money trigger” when people should start planning?

Mr. Dayal: I think people should start planning from Day 1 - the minute you earn your first salary. There will of course be a certain level of consumption, and then there will be savings. I don’t think you have to be rich to plan. Planning is not only for poor people or middle class, or rich people, it’s for everyone. Of course your needs will vary over time and will be a function of your salary income, but your needs need to be realistic. If you have some wild ambition to own 3 Mercedes cars and 5 Rolls Royce cars and your salary is Rs 10,000 a month, then that is financial dreaming, not financial planning. So there is no “time trigger” as such. It’s really a more prudent way of trying to get to a future goal, and in many ways it’s never too early to start, but it can always be too late. You must not wait till you’re 45 years old to start planning; you should start doing it from your first job onwards.

 

Personal FN: In the entire planning process, risk is often misunderstood, underemphasized or completely ignored. How important is risk and its various nuances in the planning process?

Mr. Dayal: I think risk is the most important thing to understand when you make an investment. If you are planning to buy a house 5-10 years from now, people try to invest in sometimes silly and risky places for the next 5 or 10 years. And if you take the case of stock markets, if you invest a lot of your money in stock markets and are about to buy a house in 3 years time or 5 years time, you don’t really know where the markets are going to be in 3 years or 5 years. They could be half of where they are, they could be double from where they are. So I think it’s important to understand the riskiness of the asset class in which you are investing, and again there are various definitions of risk. One kind of risk is a “time risk”, that while equity shares are wonderful things to own on a 5, 10, 15 or 20 year period, it may be bad luck or it may be bad risk in some sense, that the day when you want the cash back from the stock market, when you wish to exit your mutual fund to buy your house, the stock markets have lost 50%. What do you do then? So I think it is very important to understand the risk of the various asset classes in which you invest, when you make your financial plan as an individual. Just as we have an SIP on the way in when we agree to invest a minimum amount every month, individuals must be disciplined to have an SIP on the “exit”.So, if you need money 3 year from now and your money is in equity mutual funds, start selling 1/36^th of what you own every month for the next 36 months. In that way you remove some of the “time risk” of where the markets will be the specific day – 3 years from now – when you are ready to pay for your house. Or your child’s education or marriage.

 

Views on Equity Markets

 Personal FN: As you know, Stock markets have moved up from 8,100 levels to 17,000. Do you think fundamentals have improved to justify this move or is it more driven by liquidity?

Mr. Dayal: " Well, I think we need to rewind a bit and recognize that in January 2008, stock markets were at a 20,500 level and then they fell to 8,100, as you correctly said, 15 months later in March 2009. I think the first question to ask is, were the markets justified in falling from 20,500 to 8,100 in March 2009? And my view on that has been “No, the markets were totally unjustified in falling to that 8,000 level”. Our analysis showed that India’s economy and Indian companies, were doing far better than what the stock market levels indicated at that time. Again, India is not that closely connected to the global economy, and just because Lehman brothers went bust in the US in September 2008, we saw the Indian stock market fall by 50% in 5 weeks between September 2008 and October 2008, and we saw the Indian currency fall by about 20% between September 2008 and December 2008. And I think that was totally unjustified. There was the emotion of panic and the fact that foreign investors were selling everything they owned to send money back to their home countries.

So to some extent, the market coming back from the low of 8,100 in March 2009, and as you know, has more than doubled to 17,000, is not surprising. This is a function of 2 things. One is, it’s a recognition that India’s fundamentals, Indian companies’ profitability, is far superior than to of the profitability of many companies in many parts of the world, and secondly, money flows from foreign investors has resumed at a feverish pace. Stock markets move on fundamentals, what you call the profits of the companies, but they also move on the ability of someone to sign a cheque and actually buy the shares. So there was no ability of people to buy shares at the time when Lehman brothers declared bankruptcy in September 2008. People were risk-averse; they were scared of buying stocks. With green shoots appearing in many parts of the global economy in March 2009, people’s ability to go back to risky assets like stock markets and the ability to sign cheques has increased dramatically. So it’s a combination of two things; One is the fact that the markets fell, in my humble opinion, to very unjustified levels. And what we’ve seen is just a clawback to where the markets were in May of 2008.

 

PersonalFN: So, what are the risks an investor should look out for in 2010?

Mr. Dayal: "Well, in my opinion, the risks are in terms of the sustainability of the global economy and the continued foreign money flows.

Are the green shoots going to sort of disappear, and be replaced by brown shoots and yellow shoots, or just lots of weeds? I think the global economy is still in deep trouble. The US and European economies have a fundamental problem. Even China, which has been branded as the economy that will lead the world out of recession, has got its own problems. China was built on an export-led market model, and the problems in the US and Europe are that there is too much consumption and too much debt, particularly in the US and UK. So if the consumers in the US and UK actually begin to spend less and save more, then it is a problem for China.

So there are many things to worry about in 2009, 2010, 2011 and 2012. And the main things are - ‘Where are the global economies going? What’s happening to money flows?’ While these are things that will upset and will determine share prices in India in the near term, but if you ask me from a 5, 10 or 20 year perspective, I think the Indian stock markets are the best place to put your money. Because, in my view, in the long run, ultimately share prices are a reflection of the earnings power of companies. Liquidity flows follow earnings, and if you see earnings in India, then cheques from around the world will be signed with a nice line which says ‘Pay to Indian company: I want to buy their shares’ and this will be very good for Indian stock markets in the long haul.

But there will be bumpy rides. Again, like I said, if there are weeds in the world, you could find the stock markets down to 10,000 levels or down to 8,000 levels again. Because if the foreigners sell, there are not enough Indians willing to buy. For every 4 rupees of foreign buying, there is only 1 rupee of Indian buying. So foreigners are buying or selling 4 times that of what we buy and sell within India through mutual funds.

FN:Mr. Dayal, several investors have missed the opportunity to invest.Do you think they should wait for the markets to correct? What do you think should be their strategy going forward?

Mr. Dayal: "I think the one lesson for retail investors who have missed an opportunity to invest is that you really don’t know how wide these windows of opportunity are, and we always recommend to our clients that they should continue to invest in stock markets on a continuous and regular basis irrespective of what the Index level is. If you have a 5, 10, 15, 20 year time horizon, worrying about index levels on a weekly, monthly, quarterly basis is a complete waste of time.

Again in 1980, that’s the year when the BSE 30 Index was created, the BSE 30 Index base was 100. Today the same index is now 17,000! That’s a 170 times increase in 29 years, which works out roughly to a rate of return of about 20-22% every year, on an average. Of course there are years when the markets are plus 70%, and there are years like we had in 2008 when the markets are down -65%. So you can have these wild swings in markets, but if you had kept on buying or if you just bought in 1980 and you hung around with the stocks that you had, you would have probably made 170 times your money. And we believe that over the next 2 decades, over the next 20 years, investing in Indian stock markets will still give you that opportunity. You should be able to make at least 15%, 18%, 20% rates of return in the stock markets over the next 20 years. This is a far better rate of return than what you can expect from bank deposits or Fixed Deposits.

So the strategy should be, if you have money to invest and you have money to save, and you don’t need that money for 5, 10, 20 years; through an SIP, continuously buy into mutual funds, and you’ll be rewarded for your patience and for your discipline".

 

Views on Gold

PersonalFN:Mr. Dayal you have been advocating investing in gold. Now, do you think an investor should invest in gold to achieve his financial goals or just to hedge against inflation?

Mr. Dayal: "Having a 10%-15% allocation of your total savings pool to gold is very, very important in my view. During the last few months and the last year, we’ve been told by the press about how the US dollar is going to weaken.Well, the fact of the matter is that US dollar has weakened tremendously since 1971, right through even the year 2007, forget what has happened in the last 2 years. And for this I’ll use the proxy of gold prices when measured in US dollars. In 1971, when President Nixon de-linked the US dollar from gold, the price of gold was 33 dollars for 1 troy ounce of gold. Now, that same troy ounce of gold today is priced at 1,050 dollars. If you look at the numbers in another way, it’s like saying that the dollar is worth only 3% of what it was worth in the year 1971. So over the last 38 years, the US dollar has lost 97% of its value. Now the mainstream press has told us over the last one year that the US dollar is weakening. Well, the mainstream press has missed the main point! Between the year 1971 and 2007 the dollar had already lost approx 70% - 80% of its value already when measured in gold. And that loss in the value of the US dollar was accelerated over the last year. So my humble opinion is that people must have gold in their portfolios. It is a store of value, as it has been for centuries.

The other reason why you should have gold and why even the US dollar or the UK pound or the Chinese renminbi or the Indian rupee will weaken is because of this systemic problem that we have across the world. And this problem would continue as long as you have politicians, and as long as politicians stand up on a podium at the time of elections and promise us hospitals, bridges, schools, free food, free power, and free everything else. Again this is a global problem and it’s not an India specific problem.

So you have politicians making promises. They win elections and try to make good their promises, which is very nice of them. But the problem is that to make good their promises, they don’t have enough money, because the tax collection may only be 50% or 70% of the cost of the promises that they made. A disciplined government should spend money from the taxes that they collect just as a household has to spend from the incomes that are earned. But of course governments have created this wonderful thing called the printing press, and they have the currency notes. Governments have a monopoly on the ink which they can use to print the currency note, the paper, the template, the water mark, and the printing press itself! They don’t need anyone’s approval to print as much, or as little as they wish to. So - to fill in the gap between the promises made and the tax collected - they use this wonderful monopoly of the printing machine. They’ve been doing that successfully ever since the US Dollar was taken off the gold standard in 1971, which is why the US Dollar has lost 97% of its value over the last 38 years.

So as long as you have politicians making promises, as long as you have voters like us who fall for these promises and vote for those politicians, you should buy gold, because all paper currencies will eventually get debased, as they have over the last 38 years. As they have over centuries.

Please keep in mind that there is not a single paper currency, not even one currency in the world which has appreciated vis-à-vis gold in the last 38 years, when the world went-off the gold standard.

The day when we vote for a politician who stands up on a dias and says “I cannot promise you free water, I can’t give you free clothes, I can’t give you free hospitals, I can’t give you free roads.” The day we have that politician, and the day we all decide to elect him, that’s the day you should sell gold. Until then, please keep on buying it".

 

Personal FN:Don’t you think that gold prices have touched a historical high and investors should wait for a correction?

Mr. Dayal: "That again goes to the same thing I said about stocks. I don’t think you need to buy all the equity stocks or mutual funds in one day, I don’t think you need to buy all your gold in one day. So you’re right, gold has hit a historical high, there’s no doubt about it. The question is no one knows where gold’s is likely to be tomorrow, or next week, or at the end of the year. But I just gave the example of the dollar and of all paper currencies on a 15, 20, 30 year view; gold will strengthen and gain value against all paper currencies, as long as we live in a world where politicians make promises and where we as voters elect those kind of politicians, anywhere in the world. So you should keep on buying gold regularly, you may buy it every week or every month; you may buy it once a quarter, you may buy it once in 6 months. But keep on buying it, till 10%-15% of your total savings is lying in gold.

 

Views on Debt Markets

Personal FN: Mr. Dayal, what is your view on interest rates going forward? And what should be the strategy for investing in debt instruments like Fixed Deposits and Income and Gilt funds?

Mr. Dayal: "Interest rates came down very sharply everywhere in the world over the last year and a half, because of the global financial crisis. Governments around the world, central banks around the world, are running under fiscal deficits. Governments are printing money, central banks are printing money. Interest rates have come down because the supply of money is right now more than the demand for money, and interest rates are a function of demand and supply, like anything else. Whether it is gold, or rice, or wheat, if there are more people demanding something, and less supply of it, then the price of that product or commodity goes up.

But in a risk-averse environment, where companies are not investing in new factories, where consumers are unable to borrow money to consume because they are scared of their jobs or unsure of their future salary levels, the supply of money from the banking system around the world has been significantly more than the demand for money from companies, from investors, or from consumers. Over the next few months the central banks will reduce the supply of money, they will print less, and what they have printed they will try to take back into their vaults. Yet, at the same time, consumers are consuming more, they are getting more confident that their salary levels will remain untouched; they’re getting confident that their jobs are not at stake anymore, not at risk anymore, so they will begin to consume more - around the world. So the demand for money will increase, and the supply will go down, and therefore interest rates will increase. They won’t increase dramatically, but they will certainly be on an upward swing.

If you take India as an example, I think interest rates will increase by 1% to 1.5% right through the calendar year 2010".
 

Personal FN: Now several companies are borrowing through Non Convertible Debentures and offering attractive rates of return for tenure ranging from 3 to 5 years.Do you think investors should consider them for investing?

Mr. Dayal: "The problem with Non Convertible Debentures is that, in some sense, there is a lack of liquidity of the instrument. Earlier, the NCD’s used to be traded on the stock exchange. However, now they are no longer traded on the stock exchange.Therefore they’re not that liquid. If you want to get out of it quickly, you’re not able to. You’ll have to probably sell it at a discount, and hence you won’t get that attractive rate of interest because you’ll be paying a price to get out of the lock-up period in some sense. This would mean that you are surrendering some of that rate of interest return if you wish to get out much before 3 to 5 years. So invest only that portion of your money which you can lock up, and don’t need it for 3 to 5 years. Only that amount which will make no difference to your life if you don’t have access to this NCD money for the next 5 years, then yes you should put money in NCDs. But, if you believe that you may need the money, then you should not be putting this money in NCDs, put it into a liquid fund, which of course earns you less, in fact significantly less, but at least gives you the liquidity.

So I would, as an investor, be a bit wary about NCDs, largely because there’s no way to exit from them if you need the money quickly.Plus, with interest rates increasing, you’re probably buying them at a low interest rate now, and if interest rates are heading higher, if you wait for a year, you’ll get more money not only in the liquid fund, but also in an NCD or a fixed deposit in the next 6 or 12 months.

So, I would not lock in a lower interest rate instrument at this stage. I would wait for 6-12 months, and wait for the interest rates to increase, and when companies borrow at a higher rate of interest, then I would lock into a NCD if I do not need the money for the next 3-5 years".

 

Views on Global Investments

Personal FN:Taking this discussion globally, should investors consider investing in global markets to diversify their portfolio?

Mr. Dayal: "The whole theory of portfolio diversification has taken a big beating over the last two years. One of the stark realities that came out from what happened to the global markets, right since when two hedge funds from the Bear Sterns group went bust in the USA in August 2007 and was accelerated and hit harder in September 2008 when Lehman Brothers went bust in the USA, was that all markets moved in tandem. So if you were in Chinese stocks or US stocks or Russian stocks or Indian stocks or Brazil stocks, everything fell down. Again if you look at it from March 2009, all stock markets have gone up but of course the recovery rates have varied. The Russian stock market and the Brazilian stock market this year are up more than +100% in US dollar terms whereas the Indian stock market is up by +80% in US dollar terms and the world markets are up “only” +29%, the US market is up only +19% in US dollar terms. But the movement, in terms of the direction of all markets, has been the same.

Diversification really means when something goes down, my other asset the other thing that I own - goes up. So you have only seen the benefits of diversification in gold. Gold has been the only truly diversified asset since the day when Bear Sterns funds went bust. From July 31, 2007 gold was up by +52% right through September, 2009 whereas the world stock markets have been down about -22%. The world stock markets went down and gold went up.

I think from an India sense there are enough opportunities within India. I don’t think you need to invest your money in US markets because those companies operate in an economy which is very uncertain for the next few years whereas in India for the next 20 years you will have a 6.0%-6.5% p.a. average rate of growth in your GDP. When we have such a wonderful 6.5% growth rate, Indian companies have what we call local tailwinds with them because they have the potential to grow in a growing economy. Whereas, in USA you will have to find those companies that will survive and do well in an economy that’s in trouble and is slowing down. Therefore, diversification outside India in equities as an asset class does not really make sense.

The way to diversify really is to have fixed income instruments whether liquid funds or fixed deposits or NCDs, to have equity mutual funds, to have gold and to have real estate.

 

Views on Real Estate

Personal FN:There is a belief that the Real Estate Market has not felt the same pain as did other asset classes? What is your take on this?

Mr. Dayal: "I just wrote a piece which basically said that if you’re wondering why real estate prices are still high you need to talk to your branch manager.

Left to free markets, the real estate prices in India should have collapsed. We saw the Indian stock market fall from a level of 20,500 all the way down to 8,000 by October 2008. So in ten months time you saw the Indian markets lose about 70% of their value. Yet, the real estate markets fell by 20%-25% from the peak. This is mainly because they have been helped and they have been cushioned by the banking loans. Many real estate companies were in trouble, they had borrowed too much money mostly from foreign institutions. Either they took loans from foreign investors or took loans from foreign banks. After Lehman Brother’s bankruptcy in September 2008, all the foreign banks were asked to bring their capital back home to their parent company. They stopped giving loans, in fact they asked for repayment of all the loans outstanding.

The Indian real estate developer that had taken loans and bought illiquid assets and built land banks and all that rubbish were in deep trouble. But the data from the RBI which I have analysed and referred to in the article indicates that it was the PSU banks which have really bailed them out. There were only 35,000 units of property sold in the five big city-areas between the second quarter of 2008 and the second quarter of 2009. If you do some calculations and make some assumptions, then one can conclude that the loans given by the PSU banks to the real estate developers (whether listed developers or privately held developers) basically prevented about 160,000 units of property that would otherwise have come to the market to get that same cashflows.

So what you saw was an illiquid market like real estate in a controlled decline. This is unlike stock markets which are very liquid, as every foreign investor who wanted to sell was able to sell. About US 13 bn dollars of foreign equity money went out of the door in India in the calendar year 2008 and that’s why you saw the stock markets collapsing. But in the case of real estate, the real estate developers were rescued. They didn’t have to come to the market to sell property to raise money. They went to their friendly neighborhood PSU bank and they got a loan. That prevented the real estate prices from coming down because they were not enforced to bring all the stock that was lying surplus with them.

So left to free markets, real estate prices can fall easily by 40%-50% from where they are. But left to the system as we have it today in India, chances are they may not fall too much."

 

Personal FN:Where do you see urban India in 2020 in terms of infrastructure, sanitation, healthcare etc?

Mr. Dayal: "Urban India and India in general has huge challenges. We have too many people moving from rural India to urban India. They come to an already-crowded urban India because of the fact that there are no jobs within rural India. So it’s a lot of tough work. I am not an infrastructure expert but I do go back to a lot of things Mahatma Gandhi said and one of the things Gandhi said was that India lives in its villages. I think the solution in some sense may be to create jobs in rural India so that people don’t leave rural India, they don’t leave the villages and they don’t come to cities in search of jobs where they end up really sleeping on streets and living in misery.

It may be possible that a migrant from rural India gets Rs 3,000 per month as an income in Bombay city but he lives on the streets. Your GDP may have gone up as an individual because you got Rs 3,000. But your gross happiness as an individual has come down dramatically because you’re living on the streets of Bombay and living in terrible conditions. If you probably earned Rs 1,000 in your village where you have your home, no matter how small the home may be, it’s still got a roof over its head. May be that Rs 1,000 of income you have, makes you less rich in monetary terms, your GDP comes down as an individual but your chance of being a happier person and being with your family increases. Your individual Gross Happiness Product increases.

So the challenge is how do you give someone an income of Rs 2,000 (doubles his salary) in rural India that makes him rich rather than build a bridge in Bombay that cost Rs 580 crores and gave probably 5,000 people a job of Rs 3,000 a month and made them all miserable because they are now stuck within urban India. Again don’t get me wrong, I have nothing against the bridge. I have been on it a few times and it’s great. But it maybe that Rs 580 crores would have been better spent creating jobs in rural India and basically giving everyone a spade and saying go and build canals or go and help build a road as opposed to spending Rs 580 crores on building a bridge which saves me 20 minutes of my time to get to a meeting..

The definition of economics is you have limited resources and a lot of needs, it comes from the Greek "oikos” which means household or real estate and “nomos” which means rules. If you look at this definition, India as a unified household has huge needs in urban India and as I just pointed out huge needs in rural India. I think policy making over the next decade and its implementation is more important.More than just policy making, the intention and implementation has to be to create a lot more jobs in rural India so that we have a much more stable society.

In their famous BRIC report, Goldman Sachs wrote that one of the plus points for India was that India will have 150 million to 200 million young people of an employable age by the year 2025, which is about 16 years from now. I see that as a huge negative because if you have people of a young age hanging around, they will migrate to urban India if there are no jobs in rural India and, if they don’t have any jobs in urban India, that’s a recipe for social disaster. India needs to create about 14,500 jobs a day for the next 6,935 days to avoid this social time bomb from blowing up.

The government planning must be focused a lot more, in my opinion, on rural India and how you create jobs in villages and create wealth in villages that discourages people to move from rural India to urban India and, to that extent, will also solve urban India’s problem. Because then there are not many people coming to Bombay, Delhi, Chennai or Bangalore looking for jobs and putting a strain on the already-strained infrastructure, sanitation, healthcare within the cities".

 

Views on Financial Market Regulation

Personal FN:As we know, SEBI has changed the rules for Mutual Funds distribution by banning entry load and the D. Swarup Committee has made far reaching recommendations with regards to financial product distribution. Where do you see the regulatory environment for financial product distribution in the next few years?

Mr. Dayal: "We are seeing a new regulatory environment what I would call a regulator version 2.0.

In the first regulatory environment - across regulators whether it's for telecom, whether it's for SEBI looking after stock markets and mutual funds, whether it's insurance regulator or banking regulator - the regulator so far have worried about the framework. They have correctly built the framework under which companies, market participants and market intermediaries can operate. There have been enough rules and enough paper in terms of protection for the investor. So that version 1.0 focus on building a framework under which the financial companies can operate within India; whether it was banking, stock market, stock broking, mutual funds or even insurance.

The version 2.0 - and here the lead has been clearly taken by SEBI - is very much focused on what is good for the investor. So fine, we have built this framework in version 1.0. We have got all the market participants. We have got all the industrial people out there doing what they have to do in the financial industry, but are they doing things that make sense for the investors? This is version 2.0 and welcome to the real world. So I am personally delighted that SEBI has taken the lead in this role.

In fact, there used to be a time when SEBI as a regulator would look at what’s happening in the western world. What was the SEC doing in the USA, what was the SIB doing in UK. And they would look at what those regulators are doing and try to build frameworks in India based on what was happening there. Now, the international regulators are looking at SEBI and saying “Wow, this is amazing. They have come out with this rule on August 1, 2009, which bans entry loads, which bans funds from paying distributors. Maybe we in the SEC, maybe we in the SIB in Europe should follow what SEBI is doing.”

So SEBI has taken a lead globally and this whole focus on the investor is phenomenal. We have to get used to it because this is the whole new template within which all regulation, maybe world wide, will start moving.

We saw the fraud happening from the Wall Street firms. Time and again every five years, they find a new way to cheat people in USA and their regulator has been blind. The SEC has forgiven them, taken money as a fine and then allowed all those firms to exist. But did they stop cheating? No way! They have gone and created bigger scandals! Every 3-5 years they do this in the USA. Our regulator SEBI is saying we are not going to follow that failed SEC model of fine and forgive. We are going to come out with a model which is focused on the investor. If the firms don’t follow these rules we will take action against them, which may be – at the extreme - of possibly shutting them down and taking away their licenses".

 

Personal FN:What are the criteria for selecting a good financial advisor?

Mr. Dayal: "I think selecting a good financial advisor is like selecting a good wife in many ways. If you are single, you have your income, your wallet and your cupboard keys with you when you go to work. But the minute you get married, you hand over that key of the “tijori” or safe in the wardrobe to your wife.

Selecting a financial advisor is a bit like that because you earn your money, you have worked hard, and you spend some of it and save some of it. The money you save, you give it to your financial advisor, distributor or fund manager who tells you what to do with your money. Basically you’re giving that person a blank cheque. So when you leave for the office, you give the keys of your safe, the keys of your cupboard and the keys of your house to your wife, because you trust your wife. When you leave your entire savings with a financial advisor, it’s basically like your wife, trusting that person and saying you have the keys to my wardrobe. Well, make sure you have chosen the financial advisor on that basis.

One very good test, to find out whether you have selected the right financial advisor or not is this evening when you go back home, take a blank cheque, sign it at the bottom and leave the “Pay To” area blank and tear it out of the cheque book, look at it for a long time in your hand and then look at the image of the financial advisor that you have or the firm you have chosen. Ask yourself the question, can I leave the signed blank cheque with this financial advisory firm for the next 10 years, for the next 3,650 nights? If the answer to that is “yes”, then you have made the right choice. If the answer to that sounds like a “maybe not”, then you better go back to that drawing board and find a financial advisor. So, that’s one level - your comfort level, your trust level.

The other level is to gauge the financial advisor based on the advice. You need to understand the basis on which the financial advisor is giving you advice. Is it based on the commission that they are getting? Is it based on research? What kind of research? What is their track record of the advice given in the past – of all their advice, not just the “good” advice? What is the depth of the team? How long have the team members on the research side been with them?

So you may trust your wife with your cupboard key, you may trust her with the savings. But you won’t necessarily trust her with the decision on what to do with the money. So while you may think you have a good financial advisor and you trust that person, the next level is, do you understand how the financial advisor is making recommendations for you? Do you trust the way they are giving you recommendations. So there are 2 levels of trusting, trust in terms of comfort and trust in terms of expertise".

 

Personal FN:After SEBI’s banning of entry load, investors have to make payment directly to the advisor based on the value they perceive. So how should an investor decide whether the fee the advisor is proposing is appropriate?

Mr. Dayal: "That’s kind of a tough one, isn’t it? We are all thrown into this new world. Earlier it was the fund house or the mutual fund you invested in, which paid some unknown amount of money to the distributors, the banks, and the financial advisors through a secret side pocket. You as an investor thought that you were getting all the service for free! Well, if you had invested in a mutual fund you were typically paying 4, 5 or 6% of the money you invested to a distributor for the advice. Now that this is gone away in this post August 1, 2009 regime, the question becomes if the same person comes to you with the same recommendation and they tell you to buy fund A or fund B or a mix of financial products, how should you decide what is the correct fee?

One way of doing this is by looking at the advice, based upon the total value of your investment. So if you have Rs 10 lacs to invest and a financial advisor says they need a Rs 10,000 cheque for that advice then, what they are really telling you, is to give them 1% i.e. Rs 10,000 out of your corpus of Rs 10 lacs for the advice. So, you need to take a call on whether 1% is a good number or not, whether you’re comfortable, giving 1% out of Rs 10 lacs for that advise.

One way is to move to a flat fee model, where you are not giving a fee based upon the AUM or the amount of money you wish to invest through a financial advisor. But this is the amount of money that you have and you are willing to pay a flat amount of money for a year irrespective of the size of your corpus. So it’s a bit like going to a doctor. You go to a doctor and say you’re not feeling well and the doctor gives you advice, and he writes down a prescription, and then he gives you a bill. The bill is not a function of whether you’re overweight or underweight or rich or you’re poor. The bill is for the doctor’s time. He says that I have spent half an hour of my time with you, my time is worth Rs 500 an hour and here is a bill for Rs 250. So, he is pricing his man-hour cost for helping you.

So that’s one flat-price model that could emerge in the industry where many financial planners like Personal FN for example, have said these are the number of man-hours we are spending on you as a client. This is the cost of a man-hour and therefore these are the slab rates for the kind of work we do for you. That, to me, seems more fair because you’re taking someone’s advice, which is man-hours of work, and then they are billing you based upon what they think the man-hours are worth.

The other model is based upon the total AUM. That model is a little suspect because to some extent you’re looking at that person’s wealth. The advisor is saying “Hey look I am doing the same amount of work but if you have Rs 10 crores, I am charging you 1% which is Rs 10 lacs. And if you have Rs 10 lacs then I am charging you 1% i.e. Rs 10,000.” But the amount of man-hours the financial advisor may have spent on the portfolio would have been about the same. You wouldn’t have spent that much more money or that much more man-hour on a person with Rs 10 crores and a person with Rs 10 lacs. Here it is a case of 100 times AUM and you’re charging 100 times more fee if you link the fee to the assets in financial planning in a bucket. But if you link it to man-hours then you’re charging like a doctor based upon doctor’s man-hours. Not based on the wealth of the person. But there is no easy answer to this. The Fund management fees paid are based on a percentage of assets under management – and it is on a declining scale. As the assets under management increase, the fund manager earns a smaller % fee. But it is still linked as a percentage to the size of the assets. Though fees earned on equity funds are more than fees earned on debt funds.

I would encourage investors to assess advisors more favorably. Personal FN is obviously adopting a new fee structure. In full disclosure as I have already said that I am a director and co-founder of the entity. But we adopted this and recommended this at board level because it seemed a more transparent and a more fair way to do it rather than link it purely to AuM since the AuM probably has debt and equity funds".

 

Personal FN:One last question, if you were Nostradamus and had a crystal ball, give us the index in the middle of 2010?

Mr. Dayal: When the index was 8,000 in October 2008, we made a forecast that the index could head towards a 21,000 level by June/July of 2010. We still stand by that. Our view is that as Indian company’s results come out every quarter for next few quarters, by March 2010, the Indian company earnings will show a robust earnings growth of 15%-20% as compared to the general view among the brokers and equity analysts that the earnings of the Index companies will grow by 3%-5%. So as those earnings come to fruition and all will be known by June/July 2010 because all the board meetings are over by then, the market will be happy. They will reward the companies with a higher share price for better than expected earnings - these are the expectations of all the brokers, the analysts who work for broking community. We are more optimistic.

Again, we are not suggesting that you put all the money in equity mutual funds in one day, if you don’t have anything. I continuously urge and repeat what I had said in the start, not to invest all your money in one month or one week in stock market or gold or anywhere. You should do it over longer periods of time. There is a wonderful thing called SIP (systematic investment plans) which allows you to make investments over longer periods of time. You should take advantage of that and also you should invest in stocks if you have a 5 or 10 or 20 year view. I don’t need a crystal ball to tell you this: having a short-term time horizon for investing in shares is very risky. If you really want to take big risks and gamble, probably it will be lot more fun to go to a casino, have a drink, get free food, look at pretty women and enjoy your time as you lose money. In the stock markets, losing money is not fun at all as compared to losing money in a casino".

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