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portfolio management

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									                                                          PORTFOLIO MANAGEMENT


                                           INDEX


Sr No          Topic                                           Page No
               Section 1
1)      Introduction to Portfolio Theory
2)      Basic Principles of Portfolio Management
3)      Objectives of Portfolio Management
4)      Factors affecting decisions in Portfolio management
5)      Activities in Portfolio Management
6)      Portfolio Manager (Functions Involved)
7)      Portfolio Construction, Revision & Evaluation
        a) Objectives of Investor
        b) Motives for Investment
        c) Tax Provision
        d) Capital Gains
        Section 2    Asset Allocation
        Section 3    Shares (Options, Futures)
        Section 4      Markowitz theory
        Section 5    Mutual Funds
        Section 6    Insurance
        Section 7 Fixed Deposits
                                                             PORTFOLIO MANAGEMENT


Section 1

1) Introduction to Portfolio Theory


Two basic principles of Finance form the basis of Portfolio theory, namely, Time value of
Money and Safety of Money.


Rupee today is worth more than rupee of tomorrow or a year hence and as parting with
money involves the loss of present consumption, it has to be rewarded by a return
commensurate with time of waiting. Secondly, a safe rupee is preferred to an unsafe
rupee at any point of time. Due to risk aversion of investor, they feel risk is inconvenient
and has to be rewarded by a return. The larger the risk taken, the higher should be the
return.


Present values and future values are related by a discount factor comprising of firstly the
interest rate component and secondly the time factor. The future flows are to be
discounted to the present by a required rate of discount to make them comparable and
equal in value.


As regards the risk factor, there is a direct relationship between the expected return and
unavoidable risk. Avoidable risk can be reduced or even eliminated by measures like
diversification.




2) BASIC PRINCIPLES OF PORTFOLIO MANAGEMENT


 There are two basic principles for effective portfolio management.


Effective investment planning for the investment in securities by considering the
following factors:
Fiscal, financial and monetary policies of the Government of India and the Reserve Bank
of India.
                                                            PORTFOLIO MANAGEMENT


Industries and economic environment and its impact on industry prospects in terms of
prospective technological changes, competition in the market, capacity utilization with
industry and demand prospects.


Constant review of investment: Portfolio managers are required to review their
investment         in securities and continue selling and purchasing their investment in
more profitable avenues. For this purpose they will have to carry the following analysis.


Assessment of quality of management of the companies in which investment has been
already made or is proposed to be made.


Financial and trend analysis of companies‟ balance sheets/profit and loss accounts to
identify sound companies with optimum capital structure and better performance and to
disinvest the holding of those companies whose performance is found to be slackening.


The analysis of securities market and its trend is to be done on a continuous basis


The above analysis will help the portfolio manager to arrive at a conclusion as to
whether the securities already in possession should be disinvested and new securities
be purchased. If, so the timing for investment or dis-investment is also revealed.




3) OBJECTIVES OF PORTFOLIO MANAGEMENT


Various Objectives of Portfolio Management are mentioned below:


Security / Safety of principal: Security not only involves keeping the principal sum intact
but also keeping its purchasing power.


Stability of income so as to facilitate planning more accurately and systematically the
reinvestment or consumption of income.


Capital growth, which can be attained by reinvesting in growth securities or through
purchase of growth securities.
                                                               PORTFOLIO MANAGEMENT



Marketability i.e. the case with which a security can be bought or sold. This is essentially
for providing flexibility to investment portfolio.


Liquidity i.e. nearness to money. It is desirable for the investor so as to take advantage
of attractive opportunities upcoming in the market.


Diversification: The basic objective of building a portfolio is to reduce the risk of loss of
capital and/or income by investing in various types of securities and over a wide range of
securities.


Favourable tax status: The effective yield an investor gets from his investment depends
on tax to which he is subject. By minimizing the tax burden, yield can be effectively
improved.


4) FACTORS AFFECTING INVESTMENT DECISIONS IN PORTFOLIO
MANAGEMENT


Objectives of Investment Portfolio:


This is the crucial point, which a finance manager must consider. There can be many
objectives of making an investment. The manager of a provident fund portfolio has to
look for security (low risk) and may be satisfied with none too high a return. As
aggressive investment company may, however, be willing to take higher risk in order to
have capital appreciation. How the objectives can affect in investment decision can be
seen from the fact that the Unit Trust of India has two major schemes : Its capital units
are meant for those who wish to have a good capital appreciation and a moderate
return. The ordinary units are meant to provide a steady return only. The investment
managers under both the schemes will invest the money of the Trust in different kinds of
shares and securities.


It is obvious; therefore, that the objectives must be clearly defined before an investment
decision is taken. It is on this basis of the objectives that a finance manager decides
upon the type of investment to be purchased.
                                                             PORTFOLIO MANAGEMENT



The objectives of an investment portfolio are normally expressed in terms of risk and
return. Risk and return have direct relationship. Higher the return that one wishes to
have from the investment portfolio, higher could be the risk that one has to take. Thus, if
one wishes to double his investment in one year, he can attempt the same by
purchasing high-risk shares, in which there is a great amount of risk that he may be even
lose his initial investment itself.


5) ACTIVITIES IN PORTFOLIO MANAGEMENT


The following three major activities are involved in an efficient Portfolio Management:


Identification of assets or securities, allocation of investment and identifying asset
classes.


Deciding about major weights/proportion of different assets/securities in the portfolio.


Security selection within the asset classes as identified earlier.


The above activities are directed to achieve the sole purpose to maximize return and
minimize risk in the investments. This will however be depending upon the class of
assets chosen for investment.




The foregoing table gives a bird‟s view of various parameters attached with different
classes of assets/securities return wise


Class_Type of Security_Period of Maturity_Return Shape_Certainty of Return_Tax
Structure_Risk__1. Fixed income class _(a) Bonds/ Debentures ________-Govt.
Bonds_Long _Interest Coupon
_Definite_Tax Relief _No___-Local Authority Bonds _Long_ -Do-


_ -Do-_ -Do- _No
___-Public Sector Bonds_Long _ -Do-
                                                                PORTFOLIO MANAGEMENT


_ -Do-_ -Do- _No_____
______(b) Corporate debentures


_Long_ -Do-_ High_Taxable_Medium___Preference Stock __
______- Redeemable _Long_Dividend
_High_Taxable_Medium___-Non Redeemable_Perpetual_ -Do-_Moderately
high_Taxable_Medium____
______2) Non Specific Income_-Equity_Perpetual_Dividends
And Capital Gains_Least _Tax Relief _High__3) Cash equivalent_-Treasury Bills
-Commercial Papers _Short_Discount_High_Taxable_Low__




Thus, from the Table we can notice that the degree of risk varies according to the class
of assets/securities etc. It is also well known that the portfolio manager envisages
balancing the risk and return in a portfolio investment. With higher risk, higher returns
may be expected and vice-versa.




Various types of risks involved in an investment are as follows:
Interest rate risk: This arises due to variability in the interest rates from time to time. A
change in the interest rates establishes an inverse relationship in the price of security i.e.
price of securities tends to move inversely with change in rate of interest, long term
securities show greater variability in the price with respect to interest rate changes than
short term securities. Interest rate risk vulnerability for different securities is as under:


Types_Risk Extent__Cash Equivalent_Less vulnerable to interest rate risk__Long Term
Bonds_More vulnerable to interest rate risk.__
Purchasing power risk: It is also known as inflation risk. It arises because inflation affects
the purchasing power adversely. Nominal return contains both the real return component
and an inflation premium in a transaction involving risk of the above type to compensate
for inflation over an investment-holding period. Inflation rates vary over time and
investors are caught unaware when rate of inflation changes unexpectedly causing
erosion in the value of realized rate of return and expected return. Purchasing power risk
is more in inflationary conditions especially in respect of bonds and fixed income
                                                               PORTFOLIO MANAGEMENT


securities. It is not desirable to invest in such securities during inflationary periods.
Purchasing power risk is however, less in flexible income securities like equity shares or
common stock where rise in dividend income offsets increase in the rate of inflation and
provides advantage of capital gains.


Business risk: Business risk emanates from sale and purchase of securities affected by
business cycles, technological changes etc. Business cycles affect all types of securities
viz; there is cheerful movement in boom due to bullish trend in stock prices whereas
bearish trends in depression brings down fall in the prices of all types of securities.
Flexible income securities are more affected than fixed rate securities during depression
due to decline in their market price.


Financial risk: It arises due to changes in the capital structure of the company. It is also
known as leveraged risk and expressed in terms of debt-equity ratio. Excess of debt vis-
à-vis equity in the capital structure indicates that the company is highly geared. Although
a leveraged company‟s earnings per share are more but dependence on borrowings
exposes it to the winding-up for its inability to honour its commitment towards
lenders/creditors. This risk is known as leveraged or financial risk of which investors
should be aware and portfolio manager should be very careful.




6) Portfolio Manager


Portfolio management in common parlance refers to selection of securities and their
continuous shifting in the portfolio to optimize returns to suit the objectives of an investor.
This, however requires financial expertise in selecting the right mix of securities in
changing market conditions to get the best out of the stock market. In India, as well as in
a number of western countries, portfolio management service has assumed the role of a
specialized service now a days and a number of professional merchant bankers
compete aggressively to provide the best of high net-worth clients, who have little time to
manage their investments. The idea is catching on with the boom in the capital market
and an increasing number of people are inclined to make profits out
of their hard-earned savings.
                                                             PORTFOLIO MANAGEMENT


Portfolio management service is one of the merchant banking activities recognized by
Securities and Exchange Board of India (SEBI). The portfolio management service can
rendered either by the SEBI authorized categories I & II merchant bankers or portfolio
managers or discretionary portfolio manager as defined in clauses (e) & (f) of Rule 2 of
Securities and Exchange Board of India (Portfolio Managers) Rule, 1993.


According to the definitions as contained in the above clauses,




 Diversification : The basic objective of building a portfolio is to reduce the risk of loss
     of capital and/or income by investing in various types of securities and over a wide
     range of securities.


 Favourable tax status:       The effective yield an investor gets from his investment
     depends on tax to which he is subject. By minimizing the tax burden, yield can be
     effectively improved.


4)      FACTORS              AFFECTING        INVESTMENT             DECISIONS            IN
PORTFOLIO MANAGEMENT
Objective of Investment Portfolio:


This is the crucial point, which a finance manager must consider. There can be many
objectives of making an investment. The manager of a provident fund portfolio has to
look for security (low risk) and may be satisfied with non too high a return.             As
aggressive investment company may, however, be willing to take higher risk in order to
have capital appreciation. How the objectives can affect in investment decision can be
seen from the fact that the Unit Trust of India has two major schemes : Its capital units
are meant for those who wish to have a good capital appreciation and a moderate
return. The ordinary units are meant to provide a steady return only. The investment
managers under both schemes will invest the money of the Trust in different kinds of
shares and securities.
                                                             PORTFOLIO MANAGEMENT


It is obvious; therefore, that the objectives must be clearly defined before an investment
decision is taken. It is on this basis of the objectives that a finance manager decides
upon the type of investment to be purchased.


The objectives of an investment portfolio are normally expressed in terms of risk and
return. Risk and return have direct relationship. Higher the return that one wishes to
have from the investment portfolio, higher could be the risk that one has to take. Thus, if
one wishes to double his investment in one year, he can attempt the same by
purchasing high-risk shares, in which there is a great amount of risk that he may be even
lose his initial investment itself.
5)      ACTIVITIES IN PORTFOLIO MANAGEMENT
The following three major activities are involved in an efficient Portfolio Management:
a)      Identification of assets or securities, allocation of investment and identifying asset
        classes.
b)      Deciding about major weights / proportion of different assets / securities in the
        portfolio.
c)      Security selection within the asset classes as identified earlier.


The above activities are directed to achieve the sole purpose to maximise return and
minimise risk in the investments. This will however be depending upon the class of
assets chosen for investment.


The foregoing table gives a bird‟s view of various parameters attached with different
classes of assets / securities return wise.

Class         Type            of Period of Return          Certainty    Tax           Risk
              Security           Maturity  Shape           of Return    Structure


1. Fixed (a) Bonds /
income   Debentures
class
         - Govt. Bonds Long                   Interest     Definite     Tax Relief    No
                                              Coupon
              -Local Authority Long           -Do-         -Do-         -Do-          No
              Bonds
              - Public Sector Long            -Do-         -Do-         -Do-          No
              Bonds
                                                               PORTFOLIO MANAGEMENT




            (b) Corporate Long                -Do-            High       Taxable       Medium
            Debentures
            Preference
            Stock
            -Redeemable   Long                Dividend        High       Taxable       Medium

            - Non               Long          Dividend        High       Taxable       Medium
            Redeemable


2)    Non - Equity              Perpetual     Dividends       Least      Tax Relief    High
Specific                                      and
Income                                        Capital
                                              Gains
3) Cash - Treasury Bills        Short         Discount        High       Taxable       Low
equivalent -Commercial
           Papers



Thus, from the Table we can notice that the degree of risk varies according to the class
of assets / securities etc. It is also well known that the portfolio manager envisages
balancing the risk and return in a portfolio investment. With higher risk, higher returns
may be expected and vice-versa.


Various types of risks involved in an investment are as follows:-


1)     Interest rate risk: This arises due to variability in the interest rates from time to
       time. A change in the interest rates establishes in an inverse relationship in the
       price of security i.e. price of securities tends to move inversely with change in
       rate of interest, long term securities show greater variability in the price with
       respect to interest rate changes than short term securities. Interest rate risk
       vulnerability for different securities is as under:-


       Types                                         Risk Extent
       Cash Equivalent                               Less vulnerable to interest rate risk
       Long Term Bonds                               More vulnerable to interest rate risk
                                                              PORTFOLIO MANAGEMENT


2)     Purchasing power risk:      It is also known as inflation risk.     It arises because
       inflation affects the purchasing power adversely. Nominal return contains both
       the real return component and an inflation premium in a transaction involving risk
       of the above type to compensate for inflation over an investment-holding period.
       Inflation rates vary over time and investors are caught unaware when rate of
       inflation changes unexpectedly causing erosion in the value of realised rate of
       return and expected return.        Purchasing power risk is more in inflationary
       conditions especially in respect of bonds and fixed income securities. It is not
       desirable to invest in such securities during inflationary periods.        Purchasing
       power risk is however, less in flexible income securities like equity shares or
       common stock where rise in dividend income offsets increase in the rare of
       inflation and provides advantage of capital gains.


3)     Business risk : Business risk emanates from sale and purchase of securities
       affected by business cycles technological changes etc. Business cycles affect all
       types of securities viz; there is cheerful movement in boom due to bullish trend in
       stock prices whereas bearish trends in depression brings down fall in the prices
       of types of securities. Flexible income securities are more affected than fixed rate
       securities during depression due to decline in their market price.


4)     Financial risk: It arises due to changes in the capital structure of the company. It
       is also known as leveraged risk and expressed in terms of debt-equity ratio.
       Excess of debt vis-à-vis equity in the capital structure indicates that the company
       is highly geared. Although a leveraged company‟s earning per share are more
       but dependence on borrowings exposes it to the winding-up for its inability to
       honour its commitment towards lenders / creditors.            The risk is known as
       leveraged or financial risk of which investors should be aware and portfolio
       manager should be very careful.


6)     Portfolio Manager


Portfolio management in common parlance refers to selection of securities and their
continuous shifting in the portfolio to optimise returns to suit the objectives of an investor.
                                                             PORTFOLIO MANAGEMENT


This, however requires financial expertise in selecting the right mix of securities in
changing market conditions to get the best out of the stock market. In India, as well as
in a number of western countries, portfolio management service has assumed the role of
a specialised service now a days and a number of professional merchant bankers
compete aggressively to provide the best of high net-worth clients, who have little time to
manager their investments. The idea is catching on with the boom in the capital market
and an increasing number of people are inclined to make profits out of their hard earned
savings.   Portfolio management service is one of the merchant banking activities
recognised by Securities and Exchange Board of India (SEBI).                   The portfolio
management service can be rendered either by the SEBI authorised categories I&II
merchant bankers or portfolio managers or discretionary portfolio manager as defined in
clauses (e) & (f) of Rule 2 of Securities & Exchange Board of India (Portfolio Managers)
Rule, 1993.


According to the definitions as contained in the above clauses, a portfoilio manager
means any person who pursuant to a contract or arrangement with a client, advises or
directs or undertakes on behalf of client (whether as a discretionary portfolio manager or
otherwise) the management or administration of a portfolio of securities or the funds of
the client, as the case may be. A merchant banker acting as a portfolio manager shall
also be bound by the rules and regulations as applicable to a portfolio manager.


a)      FUNTIONS OF PORTFOLIO MANAGERS


Merchant bankers and portfolio managers rendering the service of portfolio management
to their clients in different categories, viz. individuals, residents Indians and Non-resident
Indians, firms , association of persons like Joint Hindu Family, trust, society, corporate
enterprises, provident fund trustees etc. have to enquire of their respective individual
objectives, need pattern for funds, perspective towards growth and attitude towards risk
before counselling them on the subject and acceptance of the assignment.
Nevertheless, portfolio managers in the wake of rendering their services perform
following set of functions:-


      They study economic environment affecting the capital market and clients
        investment.
                                                                PORTFOLIO MANAGEMENT



    They study securities market and evaluate price trend of shares and securities in
       which investment is to be made.


    They maintain complete and updated financial performance date of blue chip and
       other companies.


    They keep a tract on the latest policies and guidelines of Government of India,
       RBI and stock exchanges.


    They study problems of industry affecting securities market and the attitude of
       investors.


    They study the financial behaviours of development financial institutions and
       other players in the capital markets to find out sentiments in the capital market.


    They counsel the prospective investors on share market and suggest
       investments in certain assured securities.


    They carry out investment in securities or sale or purchase of securities on behalf
       of the client to attain maximum return at lesser risk.


The services of portfolio managers may be discretionary or non-discretionary, depending
on whether the investor decides to leave all investment decisions in professional hands
or whether he takes the final decision himself.


The advantage offered by discretionary service is that the manager can react quickly to
market changes without consulting the investor. To this end in view, portfolio managers
should therefore have good infrastructure and broker services to buy and sell promptly.
However, in a non-discretionary service the final decision is to be taken by the investor
himself. This can be viewed as a milestone towards discretionary portfolio management
services as the investor gains confidence in the ability of the portfolio manager.
                                                            PORTFOLIO MANAGEMENT


SEBI guidelines states that a lock period of one year for investment made through
portfolio managers as this service may be abused for short-term speculation purposes.
Moreover, reasonable returns can be achieved only in such a time frame. Importantly,
the fee charged by the portfolio manager is to be on a non profit sharing basis.


Portfolio management services also varies in terms of minimum investment, lock-in-
period, risk return factors and management fee.         Based on the investment policy
statement from the investor containing the specifications and quantifications of his
objectives, the portfolio manager allocates assets, determines the appropriate portfolio
strategy for each asset class and selects the securities. The performance of the portfolio
is evaluated constantly to ensure attainment of the investor objectives.


The portfolio is rebalanced when necessary by repeating the asset allocation portfolio
strategy and security selection.    Portfolio Management Services (PMS) needs to be
supported by a good research base to determine and quantify capital market
expectations for the economy, industries and individual securities.


Portfolio Management Services (PMS) is an ideal investment vehicle for high net worth
investors and much more flexible investment instrument than a mutual fund. Under
portfolio management service the investor knows the exact nature of his investments as
the shares are held in his name. He has a regular interaction with the fund manager
which allows him more control over his investments. This is, however, meant for high
net worth investors as reasonable corpus is needed to allow a balanced mix of 8-10
securities which is beyond the reach of a small investor and therefore professional
services of portfolio managers are desirable.


A portfolio manager acts as a personal financial consultant on investment decisions. He
also offers other value added services such as Tax planning, benefit collection, safe
custody of securities, registration and transfers, etc. Professional portfolio management
services are expected to flourish gigantically in the years ahead. However, they will
have to equip themselves to fulfil the expectations of investors.




7)     PORTFOLIO, CONSTRUCTION, REVISION & EVALUATION
                                                                 PORTFOLIO MANAGEMENT



The portfolio theory is the basis of portfolio management and relates to the efficient
portfolio investment in financial assets, including shares and debentures of companies.
A portfolio of an individual or a corporate unit is the holding of securities and investment
in financial assets. These holdings are the result of individual preferences and decision
of the holders regarding risk & return and a host of other considerations.


Fact Sheet ------ Client Data Base


The following preferences of the investor are to be noted first in investment decisions.
These will constitute the database of the investor or client.


1)     Income and savings decisions: how much income can be saved for
       contingencies and the present position of wealth, income and savings of the
       investor.


2)     Asset preferences profile: preferences for riskless asset like bank deposits or for
       risky stock market investment:


       a)           The degree of risk the investor is capable of taking and willing to take;
       b)           The risk aversion and preference for safety and certainty;
       c)           Requirement of regular income;
       d)           Objective of capital appreciation;
       e)           Objective of speculative gains, etc.


3)     Investor‟s objectives, constraints and financial commitments;


4)     Tax bracket into which the investor falls and his preferences for planning the tax
       liability;


5)     Time horizon in which investment should fructify or results expected.


These and other factors constitute the “Fact Sheet” of the investor on the basis of which
the individual portfolio is to be constructed, structured and managed.
                                                          PORTFOLIO MANAGEMENT



The motives for savings are varied depending on the individual. For example, provision
for insurance, contingencies, contribution for PF, pension funds, etc, which are mostly
contractual obligations, provision for future income, etc; are some of the motives. Some
of the savers are influenced by interest return or stable income while others are by
speculative gains or get-rich quick motive.


a)     Objectives of Investors


The investor‟s objectives are to be specified in the first place. The objective may be
income, capital appreciation or a future provision for contingencies such as marriage,
death, birth, etc. Provision for retirement and accident could be covered by contractual
obligations like insurance and contributions to PF and pension funds. A certain amount
of savings has to be kept as cash with themselves or in deposits with banks or post
offices to facilitate daily transactions for purchase and sale.   While cash earns no
interest, savings deposit with bank, co-operative and PO‟s would earn 4.5 – 6% on
accounts. But when inflation is prevalent in the economy at the rate of 8 – 10%, this
return of 4-5% will provide only a negative real return to the savers. So the amount kept
in the form of cash and deposits with banks, etc should normally be bare minimum. The
rest of the amount has to be spread in various investment avenues, earning higher
returns than the normal inflation rate of 8-10%.




b)     Motives for investment


The investor has to set out his priorities keeping the following motives in mind. All
investors would like to have:


       1.      Capital appreciation
       2.      Income
       3.      Liquidity or marketability
       4.      Safety or Security
       5.      Hedge against inflation
                                                           PORTFOLIO MANAGEMENT


The investor gets his income from the dividend or yield or interest. There will be no
capital appreciation also in the case of enquiries.      The liquidity and safety of an
investment will depend upon the marketability and credit rating of the borrower, namely
the company or the issuer of securities. These characteristics vary between assets and
securities. These characteristics vary between assets and securities. An investor is
also concerned in having a tax plan to reduce his tax commitments so as to maximise
the take home income. For this purpose, investor should specify his income bracket, his
liabilities and his preference, tax planning, etc. The investment avenues have certain
characteristics of risk and return and also of some tax concessions attached to them.
These tax provisions as such can influence the investor in a big way as these provisions
will alter the risk return scenario of investment alternatives. It is therefore, necessary
that all these avenues should be assessed in terms of yields, capital appreciation,
liquidity, safety and tax implications. The investment strategy should be based on the
above objective after a thorough study of the goals of the investor, in the background of
characteristics of the investment avenues.




c)     Tax Provisions


It is apt to start with the tax-exempt incomes of the securities in which investment can be
made. The income by way of interest on PSU bonds, N.S. certificates, securities of the
central government and those deposits specified by the Central Government are
exempted from income tax subject to certain limits or conditions. The P.O. deposits,
certificates and other claims operated by the P.O.‟s are exempted up to a limit of
Rs.13,000/- This exemption is, however, not applicable to Indira Vikas Patra, Kisan
Vikas Patra and NSC VIII Issue, Deposits in PPF and NSS are exempted from taxes in
the year of deposit and subject to some limit in the year of withdrawal except in the case
of NSS, which is, however, taxable in the year of withdrawal.


Under the category of insurance, in addition to LIC policies, the ULIP (of UTI) enjoys
popularly due to the tax shelters:


Wealth tax exemption for all investments in share and debentures along with other
eligible investments.
                                                           PORTFOLIO MANAGEMENT



Income-tax exemption up to Rs.13,000/- aggregate income from bank deposits, shares,
UTI units, P.O. deposits, Mutual Funds and other specified categories of investment.




d)     Capital Gains


Capital gains refer to profit earned on the transfer of capital assets, sale or exchange,
etc. These gains are long-term gains, if they are held for more than 36 months for all
those assets except shares of a company for which this period is 12 months. Long term
capital gains are taxable at a lower rate of 20%. Under this section 54E and 54F of
Income Tax Act, the long term capital gains are exempt, if these funds are invested in
Central Government Securities, UTIs.




Section 2 Asset Allocation


What is Asset Allocation?


Analyst and other “experts” invariably spout jargon. Terms like valuation, diversification,
asset allocation are thrown at us from every angle. Little wonder that investors are
invariably confused. But not all these things are as incredibly complex as they sound.
One such term we often hear is asset allocation. Though it appears intimidating, in
actual fact, the meaning is quite straightforward. Asset allocation is all about putting
your eggs in different baskets. It‟s a kind of insurance or protection, should one of your
investments go bad. If the stock market crashes, your non-stock holdings can help bail
you out. Or if real estate plunges, you will thank God for your PPF account. In actual
fact, whether you realise it or not, you are already allocating your assets – as most of us
have our wealth divided into different assets – gold, real estate, stocks, bank account,
etc. The question is whether you are doing so consciously and strategically, or simply in
a random or haphazard manner.              The two phrases, “asset allocation” and
“diversification” are often used interchangeably.    But not many know that there is a
                                                             PORTFOLIO MANAGEMENT


subtle difference between the two terms. This is because they have similar objectives:
To minimise risk and provide exposure to differing growth opportunities within an
investment portfolio. Diversification is often likened to the old adage; “Don‟t put all your
eggs in one basket.” By doing this, you can help prevent losing it all on one poor choice-
just as all your eggs would break if your dropped the basket. A diversified portfolio help
protect against large losses because, typically, if some securities crash, other may
perform well.


Asset allocation is similar to diversification, but involves some amount of strategy. The
cornerstone of this is allocation of assets over different asset classes. In a diversified
stock portfolio, we not only have a stock portfolio, but a bond portfolio, a cash equivalent
portfolio, and maybe some other types of assets as well. The combination of multiple
asset classes offers the growth potential of stocks, combined with regular income and
relative stability of bonds and the liquidity and security of cash.      Most of us spend
sleepless nights trying to figure out which stocks to buy or sell, or whether to own mutual
funds or derivatives. These are no doubt real concerns, but much of the tension could
be minimized by some prior planning.         And it is this planning that is called asset
allocaton.


Asset allocation is actually a relatively new concept. Till about twenty or thirty years ago,
it was believed that specific stock selection, or market timing, or timing the decision to
move from stocks to bonds were the most important determinants of investment
success. But today, though most of us still try to live on timing and selection of individual
securities, he investment professionals have come to recognize the importance of asset
allocation.


Several studies in the recent past have shown that asset allocation is the single greatest
determinant of investment performance. Depending on whose research you look at, you
will find that the distribution of our money amongst types of asset.




Why Asset Allocation?
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If stocks are the best long-term investments, then why don’t I just stock to
stocks?


Though the first article of this primer (What is asset allocation?) lays down the basic
reasons for asset allocation, many assume that this is only theoretical. The common
belief is that asset allocation is meant only retired or conservative investors. After all,
market-savvy punters like us don‟t need all these bonds and other such boring
investments. We know how to play the stock markets so well and make so much money
from our capital, that we don‟t need all this asset allocation stuff. If this is what you
believe, then you could‟nt be more wrong. If actual fact, the reasons for the recent
disillusionment with asset allocation has been the incredible, decade long bull market in
the US.   In India, too, the unabated (and phenomenal) rise in ICE stocks has led
investors to shun all other options. Obviously, investors believe they can achieve better
returns by concentrating their investments rather than diversifying them. Through this
strategy may have proved very successful in the late nineties, the year 2000 should
have woken you up to the reality. Ultimately, over-dependence on one asset class
ignores the risks that are being taken, while considering only the Returns.           Asset
allocation may or may not help increase your overall returns, but it will definitely help
lower the risks.    One should realise that the recent extra-ordinary stock-market
performances are just the extra-ordinary! No one knows what the future holds in store,
and asset allocation is one simply one measure that tries to insulate on from various
possibilities. The first thing to remember is that “The future may really be different!”
Despite the fact the we keep saying that past performance is no guarantee of future
returns, do we really believe it – and base our investments on that? When we are
making money had over fist on high-flying stocks like Infosys and Zee, we tend to
believe that our stock-picking skills will provide good returns forever. But in our heart of
hearts we all know it is impossible to be certain of any future market performance, and
the recent crash should have brought around even the most die-hard punters. The
selection of any investment is preceded, either implicitly or explicitly, by an asset
allocation decision. Asset allocation is therefore said to be the most fundamental of
investment decisions. As we saw in the first article of this primer, the asset allocation
decision accounts for around 90% of the variation in returns over time. Despite this, until
recently, asset allocation was an ad hoc exercise. Investors were advised to allocate
anywhere from 100% in bonds based on a cursory classification by age or income.
                                                             PORTFOLIO MANAGEMENT


However, in recent times, much research has gone into the subject and the concept has
become much more scientific than in the past. The principles underlying asset allocation
are actually quite simple. Firstly, history shows that not all classes of assets move in the
same direction at the same time. In one year, large-cap stocks may rise, while bonds
fall. In another year small-caps may surge along with real estate. History also tells us
that some asset classes are far more volatile than others. For instance, the yearly
variance in the stock markets can be quite drastic, while your bank account does not
change regardless of what happens in the outside world.


Ideally, if you or I could predict which asset classes would do best in any specific time
period, we would have no need for asset allocation. In such a situation (assuming we
were operating in Indian markets), we would have moved into stocks in late 1993, exited
in late 1994 and bough bonds, entered into IT stocks in late 1996 and then sold out
again in early 2000. But then how many of us are psychic?


Or if we were sure that we would not need money for the next thirty years, it may make
sense to buy only stocks and stick with them – given that this asset class has historically
provided the best returns. Again, how many of us can be sure that we won‟t need
money a few years down the line, and this need won‟t arise when the markets are in the
grip of bears?


Asset allocation is ideal for all us mortals who aren‟t psychic, and who will need to use
their savings at some point in their lifetime. By following a policy of balancing the types
of assets we own between stocks, bonds, and cash, we trade “the best” returns we‟d get
if we timed the markets perfectly for predictability and piece of mind. Strangely enough,
most people tend to abandon asset allocation just when they need most – like at the
peak of a bull-run or at the bottom. At the height of a “teji” we should be looking at non-
stock assets more seriously, while at the bottom, we tend to go overboard on bonds,
when we should be looking more closely at stocks. Typically a strong recent trend
makes us want to concentrate our holdings in that asset class, while logic and long term
history tell us that this is when we should actually look closer at other asset classes.


In conclusion, rather than trying to figure out when a particular asset class has peaked or
bottomed, it makes sense for investors to formulate a broad strategy for allocation that
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can be fine tuned from time to time. This is the only way to ensure that you minimize the
risks, while taking advantage of growth possibilities.




Different Asset Classes – Risk v/s Return


We know asset allocation and present a (hopefully, convincing) case for using this
technique. We also spoke loosely about “asset classes”. Essentially, the allocation
process needs to first categorise different assets into broad classes with similar
characteristics. In the investment world, there are two parameters that are of paramount
importance. The first is the return that one gets from a particular investment, and the
second is the risk that one takes to achieve that return. Also, it is known that there is a
direct relationship between the two. Typically, the greater the returns, the greater the
risk. It is very difficult to foresee the future risks or returns that a particular investment
will have, so we tend to use historical data for classification purposes.


Conservative investments, such as cash or bank accounts offer minimal risk, and
essentially seek to preserve existing capital and offer minimal risk.          Moderate-risk
investments include highly debt instruments (such as company fixed deposits or bonds
issued by corporates) as well as bonds with shorter maturities. Stocks typically offer
greater growth possibilities-as well as greater risk potential.


But it is not simple. Within each of these individual asset classes lie further segments,
such as value and growth stocks, corporate and government bonds, bank deposits and
PPF. There are also other assets like gold or real estate that may not fit into the three
commonly accepted categories. Also, certain types of assets like cyclical stocks are
often treated as separate assets classes because they have different historical
performance characteristics from other stocks.


While talking of real estate, though these investments have been very popular in the
Indian context, their lack of liquidity and high unit value makes them intrinsically
unsuitable as investments for most of us. For the purpose of this dicussion, we will
restrict ourselves to the three basic asset classes comprised of financial securities.
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Once the basic principles are understood, an investor can choose to define further
classes as per his needs and perceptions.


A Profile of the Three Basic Asset Classes each of these three-asset class offers
measurably different tradeoffs between risk and return, and each benefits your portfolio
in a different way.


   Cash Equivalents: money market funds, Treasury Bills, bank deposits, post office
    savings and the like – provide for low risk, and the preservation of principal but
    generally do not provide returns high enough to outpace inflation.


   Bonds (fixed-income investment): represent loans to a business or government,
    provide for preservation of principal and a fixed rate of return when held to maturity.
    While most bonds generate current income, they offer limited potential for increasing
    returns. Examples of these in India are company fixed deposits, ICICI bonds and the
    like.


   Stocks (equities) : represent shares (or part ownership) of a company.           While
    stocks can and do experience significant volatility, historically, they have provided
    the best record of long term growth of principal.


    We have compiled a broad comparison of the risk versus return equation for various
    investment opportunities for the Indian investor, in the table below:-

    Risk-Return Comparison of various Investment Avenues

    Type of Investment                        Historical Returns             Risk Level

    Cash equivalents
    Liquid Funds (money market mutual funds)            7-8%                 Low
    Bank Fixed Deposits                                 7-10%                Low
    Post Office, NSC (Govt.)                            10-12%               Low
    Govt. Securities                                    8.5-12%              Low
    PF/PPF/Pension                                      11-12%               Low
    Bonds
    Company FD                                          10-14%               Low
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   Bonds                                            10-15%
   Income Mutual Funds                              10-14%                 Low
   Equity
   Equity Mutual Funds                              18-22%                 High
   Equities                                         18-22%                 High


   Note 1: In India, though PPF and similar accounts appear to have higher returns for
   lower risk (because the government guarantees them), this is illusory.          These
   instruments are very illiquid, and given that liquidity is an important measure of risk
   (you should get the money when you need it) – some would argue that these
   instruments should be classified as bonds.
   Note 2: At some point of time, company FDs offered much higher returns (similar to
   equities), and as was found later, bore a huge risk as most of the issuers defaulted.
   By now, most of you have a pretty good idea of what the different asset classes are,
   and their historical risk-return profiles. Ow we can get down to the business of
   allocating your assets among these classes.


What are your investment goals?
As we know each person is different. This means that each of us is likely to have
varying objectives with regard to our investments. The first step in figuring your asset
allocation is to determine your investment goal.
For this you need to ask yourself, “Why am I investing?”
Naturally, each of us will come up with different answers.
Some of the most common answers to this question are as follows:


      To build up sufficient assets to ensure a comfortable retirement.
      To finance a child‟s college or post graduate education
      To buy a house, or a second home, or a farm house.
      To have enough money to pay for the children‟s marriages.
      To ensure a comfortable income for our dependents after your death.


While this list is by no means comprehensive, the above goals are some of the most
common, and would apply to most of us. Of course, you might have some different
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types of ambitions – like taking a trip round the world, or setting up a charitable trust or
any other. It doesn‟t matter what these goals are, or how crazy they may seem to
others. What is important is that they reflect your personal objectives regarding you
investments. Setting out your goals clearly serves several purposes. First of all this
exercise helps you focus on why you‟re investing. It also helps you figure out exactly
how much money you might need and when. Once you‟ve invested, the goals laid down
at the beginning help in charting the progress of your investment plan. In this context,
they also serve as a reminder or reference if a sudden bull-run or market volatility tempts
you to change your investment strategy – and help you stay on course.


It is relevant at this stage to avoid overly ambitious goals like doubling your money in
three years or such like. Goals must be realistic and it is better to avoid the “get-rich-
quick” approach. Highly aggressive goals will encourage you to take more risk than is
prudent for your situation.


Also, since most of us have more than one goal, it may provide for greater clarity if each
of these is treated separately. This is because they may have different time horizons
and relative importance to you. By separating out the goals, you could even allocate
assets to a separate portfolio for each. By now you‟ve worked out what your investment
goals are, and its time to move to the next step – figuring out your investment time
horizons.


What is your time horizon?
Now that you‟ve laid down your basic goals or objectives, the next question deals with
the time horizon. Again, this will vary from person to person. Essentially, your time
horizon is defined as the number of years you expect the investment to cover. This not
only includes the time taken for you to reach the goal, but also the time period, however
long or short, during which you make withdrawals from your investments.


For instance, if you are saving for your retirement years, the time horizon should the sum
of the time left of your working career and the number of years that you will live off your
savings post-retirement. Essentially, this means you have to try and estimate how long
you will live. So if you‟re 30 years old, and the average life expectancy is 70 years, this
means that the time horizon is 40 years. Of course, if your goals included a plan to
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leave a part of your retirement savings to your children or heirs, then your time horizon
could extend well beyond your life span. Though it is difficult to estimate one‟s life span,
a suitable starting point could be the average for your social class (the middle class and
rich tend to live loner). Then add a few years to be on the safe side. If your goal is to
save for your daughter‟s wedding, you could make an estimate of the age when you
think she will marry and subtract her current age. Calculating the time horizon for other
goals like college education are a lot easier. Since we know when most children start
college (usually 18), we have to deduct their current age from this. To this, we must add
the number of years during which he or she will be enrolled (usually 4 for
undergraduate).


While calculating the time horizon for your goals, and the asset allocation relevant to that
it is important to keep a couple of points in mind:


    Firstly, the longer the time horizon, the more time you have to be able to weather
     market volatility or a bad period in the markets. Consequently, the greater the time
     horizon, the asset allocation can be more aggressive with a greater percentage of
     high-risk instruments (stocks).
    Secondly, as you get closer to your goals, your portfolio will have less time to
     recover from shocks. Therefore, as time goes by, it might make sense to gradually
     shift to a more conservative asset allocation, and move some money into less risky
     investments.


Now that you‟ve figured out your investment goals and the time horizon for each, your‟re
now ready to move to the next step – evaluating your risk tolerance.


What is your risk tolerance?

This is probably the most difficult part of asset allocation, since the judgement is rather
subjective – unlike measuring your goals and time horizon, which can be relatively easily
quantified.


Essentially, risk tolerance is an individual‟s ability (or willingness) to endure declines in
the value of their investment, even as they wait for better days. While some investors
                                                               PORTFOLIO MANAGEMENT


are able to ignore market fluctuations and remain focused on their long-term investing
goals, others become anxious when their portfolio declines even by a small amount.
The emotional makeup of the individual plays a significant role in this, and ultimately
decides on how you should allocate your investment assets.              Apart from the basic
personality traits of the individual, job security, income levels, family wealth or other
circumstances also influence risk tolerance.


Since most of the high volatility or high-risk type of situations arise in relation to equities,
it is important to remember the following:


    o   I most bear markets, stocks typically lose 25% of their peak value, though this
        could be much more (even as high as 50%).
    o   Over the past four decades, bear markets in the US have occurred on average,
        once every five years. In India, over the last fifteen years, we have seen four
        bear markets.
    o   In 2000, the BSE Sensex lost more than 50% from its peak, while most IT stocks
        have lost anywhere from 60-90%.


In order to help you evaluate your own risk tolerance, you could ask yourself the
following questions:


    1. If the stock market collapses by 25% or more, would you increase your exposure
        equities?
    2. Though you have a considerable exposure to tech stocks, you have not suffered
        sleepless nights over the recent fall in NSADAQ, and IT stocks on the BSE? If
        you answered “Yes” to the two questions above, then you appear to be quite
        comfortable taking risks with your money. If not, you should choose a relatively
        conservative asset mix, with lower equity exposure. However, this means that
        you run the risk that inflation will eat away a greater portion of your returns. While
        much of the „risk‟ discussion invariably centres on equity, it is important to
        remember that other instruments also carry some risk. Company bonds (even
        AAA rated ones) have been known to default on principle and interest payments.
        Even “super-safe” choices like bank accounts can go under-remember the Bank
        of Karad?
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  It is relevant to note that your tolerance for risk, or even your need for financial
  security may change over time. For instance, somebody may leave you a large
  inheritance, which will change your perception towards risk. Also, parents have
  different responsibilities and income needs than do single people. So if you have a
  child, it will affect your tolerance for risk. Hence, the asset allocation strategy that you
  adopt at one stage of your life may not be right for a later phase. By now, you are
  pretty far into the asset allocation process, and we are ready to move to the the next
  stage.


Know thyself each person is different

  Before you jump in and start choosing your favourite stocks or bonds or whatever, it
  might be appropriate to understand a little bit about yourself ( no this is not a
  psychology lesson, but chapter 4 of the primer on asset allocation). A fundamental
  truth about portfolio management(and life for that matter) is that everybody is
  different. Essentially, each one of us has different financial needs, income and
  tolerance for risk.


  So while your neighbour may be willing to live with the risk of a heavily stock-
  weighted portfolio, this may not work for you. Some people can remain smiling even
  while their life savings are riding on the Sensex, while others may worry themselves
  sick. Though it does differ from person to person, there is a correlation between age,
  or stage of one‟s life-and the ability to bear risk as well as financial needs.


  Though it will vary with each individual, there is some kind of broad classification
  system used by portfolio mangers to determine where you are in your own wealth
  building process. Generally, individuals are placed in one of three phases. These are
  commonly called the accumulation phase, the consolidation phase and the
  spending/gifting phase.


  Typically, individuals in the accumulation phase (are not we all?) are in the early
  stages of their career. At this stage your priorities revolve around satisfying
  immediate needs like housing, acquiring physical assets like consumer durables, or
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  savings for long-term goals like your children‟s college education. Because you have
  a fairly long-term investment horizon, and can expect your income to grow
  substantially in the future – you can afford to take relatively higher risks. Even if you
  have a higher weightage in stocks and experience a couple of bad years in the
  market, there will be plenty of time to recover.


  Individuals in the consolidation phase are typically in their prime earning years.
  Earnings exceed expenses substantially, and there is the ability to invest relatively
  large amounts every year.


  Though these are the prime wealth building years, age has begun to catch up and
  some amount of aversion to risk has crept in. Looking at it another way, you now
  have something to lose. Moreover, the time horizon of your portfolio has shortened.
  The spending phase typically occurs with retirement. Ideally (if you have saved well
  during the two earlier phases), your daily living expenses are covered by income
  from investments or pensions. Hence, the investment focus tends to shift to the
  protection of your portfolio and the need for regular income. Any major losses will be
  very difficult to recoup from. Hence, there is a far lower tolerance to risk, and a
  greater leaning towards preservation of capital.


  The life cycle is only representative of an average person. But no one is average!
  Different people may spend differing periods in various stages of the life cycle. Also,
  each one has different incomes and expenses. Family circumstances, short term and
  long term needs are different. Some people inherit a lot of wealth: others first need to
  acquire housing before they can think of other financial assets. Others may have to
  look after dependents, while still others may have to deal with expensive problems.




Asset allocation is never complete – Rebalancing

  Now that you have allocated your money to different assets, you might think its time
  to forget all about them. However, nothing could be further from the truth.
  Unfortunately for us, the only constant is change. Not only will the external
  environment keep changing but your individual situation will change too.
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Hence, asset allocation is a process that you re-visit again and again. Constant
review is required and depending on the circumstances your will have to re-allocate
or rebalance your assets. There are various events that could trigger the need for
rebalancing. Broadly, the kind of changes you could fall into four categories. These
are:


Changes in time frame: As you approach your goal – for example, retirement or
your child‟s college going age, it is usually a good idea to shift to a more
conservative strategy. After all, with less time left, it should be more difficult to
recover from a market crash. Hence, it may make sense to take your capital gains on
stocks and reinvest this in bonds or cash equivalents.


Changes in life circumstances: This could be of various types. You may fall ill or
may retire or you may have children. On the other hand you might inherit a large sum
unexpectedly. Any change in your circumstances might force a review and
rebalancing of your portfolio.


Changes in Portfolio Performance: You might find that the stock market enjoys
several years of phenomenal performance. This will ensure that they may represent
far more than your original target allocation, exposing you to more risk. Also, good
recent performance might suggest that stocks as a class are overvalued. At this
point, selling stocks and reinvesting in bonds or cash can bring your portfolio back
into balance. Conversely, poor market performance might lead to a lower weightage
for sticks-suggesting that you increase weightage to equity during a bull market.


Changes to goal: For some other reason, you might find that your investment goals
change. For instance, you may suddenly start dreaming of a larger house or plan to
move to a more expensive city. After all, we cannot predict our future desires, and
our asset allocation strategy must adapt to our changing goals.


All the above factors essentially serve to change your goals, time horizon, financial
resources or risk profile. Any other situation that affects these factors will also call for
a review of your allocations and you may find that these needs to be rebalanced.
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At the same time, it does not make sense to check your portfolio and re-balance it
every month. Not only this cause more tension and take up time, it will also lead to
unnecessary transaction costs. Hence, it is a good idea to check your portfolio at a
specific interval, may be six months or once a year. See where you are as compared
with your target asset mix. And if you are off target, you could make the necessary
corrections by transferring some assets into others.


It is also good idea to decide how much variance you will allow in your portfolio,
before you take corrective action. For instance, if you planned a 50% holding in
stocks and this goes up to 51 % - is it worth chopping and changing?


Start planning now?


Input
A.
When do you expect to liquidate the assets for this particular goal?
     a) Within 3 years
     b) In 2 to 5 years
     c) In 5 to 10 years
     d) More than 10 years


     B.
     Do you have an emergency fund?(savings of six months‟ living expenses)
     a) Yes
     b) No


C.
What is your current asset allocation?(in %age)
a) Cash and cash equivalents(saving deposits, MMMF etc)
b) Debt
c) Equity


 1.       Your age
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 a)        Less than 35
 b)        35 to 45
 c)        45 to 55
 d)        More than 55


2. Is your spouse earning?
a) Yes
b) No


3. Are your parents financially dependent o you?


a) Yes
b) No


4. How many children do you have?
a) None
b) 1
c) 2
d) 2 or more


5. Approximately what %age of your monthly income goes towards paying off debt
   instalments(auto, home, other)?
   a) Less than 10%
   b) Between 10 to 25%
   c) Between 26 to 50%
   d) More than 50%


6. What is your resident status?
a) Don‟t own a home
b) Own a house but paying mortgage
c) Own a house
d) Live with parents


7. How does this investments fit into your Total Fnancial Picture?
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Approximately what %age of your total investible assets-the rupee amount of
investments –will this investment represent? (Do not include your main residence)


Less than 25%
Between 25% and 50%
Between 51% and 75%
More than 75%


 8. Your current and expected future earnings and expenses?
     Your current job/business is
       a) Highly secure
       b) Somewhat secure
       c) Highly insecure


   9. If you are offered a new hob which compensation package would you choose?
       a) A 3 year job guarantee
       b) A 25% rise in your current package but with higher uncertainty
       c) A mostly ESOP loaded compensation with just enough Cash Flow for survival


   10. Which one of the following best describes your expected future earnings over the
       next five years(Assume 6% inflation)


       a) I expect my earnings to far outpace inflation(Promotions, new job foreign
          postings…)
       b) I expect my earnings increased to stay somewhat ahead of inflation
       c) I expect my earnings to keep up with inflation
       d) I expect my earnings to decrease (retirement, part time job etc.)


   11. What %age of your salary are you saving?
       a) Less than 20%
       b) Between 20 to 30 %
       c) More than 30%
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12. What %age of your monthly expenses is non-discretionary? (include monthly
     household expense, education, medical etc.).
     a) More than 70%
     b) Between 50-70%
     c) Less than 30%


Your Personal Risk Tolerance


13. have you ever invested in individual stocks or equity Mutual Funds?


     No, and I would be uncomfortable with the risk if I did
     No, and I would be comfortable with the risk if I did
     Yes, but I was uncomfortable with the risk
     Yes & I felt comfortable with the risk


14. You invest in a particular company‟s stock after lot of research and the price falls
     30% within a month. You would:


a) Not bother because you are confident about the company‟s future
b) Cut your costs by selling the stock
c) Buy some more to average out your cost
d) Wait for it to rise and sell it when it reached your purchase cost


15. Which ONE of the following statements best describes your feelings about
     investment risk?
a) “I would only select investments that have a low degree of risk associated with
     them (i., e it is unlikely I will lose my original)”.
b) “ I prefer to select a mix of investments with emphasis on those with a low
     degree of risk and a small portion in others that have a higher degree of risk that
     may yield greater returns.”
c) “ I prefer to select a balanced mix of investments-some of that have a low degree
     of risk, others have a higher degree of risk”
d)   “ I prefer to select an aggressive mix of investments-some of that have a low
     degree of risk but an emphasis on others that returns”.
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   e) “ I prefer to select an investment that has only a higher degree of risk and a
       greater potential for higher returns”.


   16. If you could increase your chances of improving your returns by taking more risk,
       would you:


   a) Be willing to take a lot more risk with all your money
   b) Be willing to take a lot more risk with some of your money
   c) Be willing to take a little more risk with all your money
   d) Be willing to take a little more risk with some of your money
   e) Be unlikely to take much more risk




Section 3 Portfolio Management for Shares

Option & Futures

Traditionally, the role of a Finance Manager was to procure funds, i.e. to obtain funds at
a cheaper rate in terms of procurement as well as payment of interest. The funds were
needed by any organisation for daily operations, for short term as well as long-term
purpose.


The term efficient capital market has been used in several contexts to describe the
operating characteristics of a capital market.       However, there is a basic difference
between an Operationally efficient capital market and a Pricing efficient capital market.


In an operationally efficient market, investors can obtain transaction services as cheaply
as possible given the cost associated with furnishing those services. Transaction cost
includes commissions and market maker spreads.


Pricing efficiency refers to a market in which prices at all times fully reflect all available
information that is relevant to the valuation of securities.       When a market is price
efficient, active strategies will not consistently produce superior returns after adjusting for
       1)      Risk
       2)      Transaction costs
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        3)      Management advisory fees
There are 3 forms of market efficiency –
a.      weak
b.      semi strong
c.      and strong


The distinction between these forms is the relevant set of information that is believed to
be impounded into the price of the securities at all the times . Weak efficiency means
that the price of the security reflects price and trading history of the security. Semi
strong efficiency means that the price of the security fully reflects all public information
(which, of couse, includes historical price and trading patterns). Strong efficiency exists
in a market in which the price of a security reflects all information regardless of whether
or not it is publicly available.
For the equity markets, the preponderance of empirical evidence is that the market is
efficient in the weak form, although there have been recent studies challenging this
position. While most of the empirical studies suggest that the market is efficient in the
semi strong form, anomalies such as the small firm effect, January effect, week end
effect and neglected firm effect, suggest that there may be pockets of inefficiency. In
these empirical tests, the measure of risk used to determine risk-adjusted returns is
beta. Studies of the strong form of market efficiency have looked at the performance of
professional money managers. These studies do not suggest that professional money
manager can consistently earn superior returns.


Studies investigating the efficiency of the bond market have examined one of the
following questions:
1)      Are there market participants who have superior interest rate forecasting ability?
2)      Do active money managers consistently outperform popular indexes?
3)      Are bonds priced such that there are arbitrage-trading opportunities?
4)      Does the market use all publicly available information to value an issue?


Studies examining the first question are tests of the weak form of the evidence of the
efficiency of the bond market. The overwhelming evidence suggests that interest rate
movement cannot be predicted with a degree of consistency and accuracy sufficient to
generate superior investment performance. As for the second question, several studies
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suggest that on average money managers have not done better they do not properly
reflect the risk accepted by the money managers surveyed in the studies.


There are a few studies that have focused on the third question. These studies have
been limited to the government bond market for three reasons;


(1)    Price data are more readily available than other sectors of the bond market.
(2)    The price data are more reliable than for other sectors of the bond market.
&
(3)    Tests can be conducted without being concerning with the impact of credit risk.


Studies of the government bond market suggest that it is efficient, yet there are
instances where trading opportunities to enhance returns occur. As for the corporate,
municipal & mortgage – backed securities market. There is insufficient evidence to draw
any conclusion about market efficiency.


This brief review of the efficiency of the equity and bond markets does not do justice to
the extensive research on the topic. There are no perfect studies. All empirical studies
are flawed due to either methodological limitations (or errors) or lack of good data.
Suppose that after evaluating empirical evidence an investment manager or fund
sponsor believes that inefficiencies exist in a particular market sector. Active portfolio
strategies can be employed to exploit that inefficiency. What strategy should be pursued
by an investor who believes that a market sector is sufficiently efficient so that superior
risk-adjusted returns cannot be consistently realized after accounting for transaction
costs and management advisory fees?


Role of options and futures in Investment Management
With the advent of options and futures on financial instruments, active and offensive
minded portfolio risk management strategies, in the broadest sense, assumed a new
dimension. The investment manager can achieve new degrees of freedom. It is now
possible to alter the market profile of an equity or fixed income patterns that were either
previously unavailable or too costly to obtain.
                                                             PORTFOLIO MANAGEMENT


Options and Future Defined
An option is a contract in which the writer of the option grants the buyer of the option the
right to purchase from or sell to the writer an underlying instrument as a specified price
(called the exercise or strike price) within a specified period of time. The underlying
instrument may be a security such as a common stock or a bond, a foreign currency, a
commodity such as a precious metal, a future contract, or a financial index such as the
Standard & Poor‟s 500. When the underlying instrument is something that cannot be
delivered, such as a financial index, the contract is settled cash.


In exchange for the option, the buyer pays the writer (seller) of the option a certain sum
of money called the option premium or option price. When an option grants the buyer
the right to purchase the underlying instrument, it is called a call option. When the
option buyer has the right to sell the underlying instrument to the writer, the option is
called a put option.


A future contract is an agreement between a buyer and a seller in which the buyer
agrees to take delivery and the seller agrees to make delivery of something at a
specified price at the end of a designated period of time (called the settlement date).
There are future contracts on agricultural products, precious metals, foreign currencies,
fixed income securities and stock indexes.


Both options and futures are highly leveraged investment vehicles. Viewed in isolation,
an option or a futures contract is a highly speculative instrument. The prudent use of
derivative instruments can reduce the overall risk of a portfolio or control the risk of a
portfolio.


There are differences between option and future contracts that determine their risk-
reward characteristics and thereby their use in investment management. In a futures
contract, both the buyer and the seller are obligated to perform at the settlement date.
For options, the buyer has the right, but not the obligation to perform. It is the option
seller (writer) who has the obligation to perform. In addition, in a futures contract the
buyer does not pay the seller to accept the obligation as in the case of an option where
the buyer pays the seller the option price. How these differences impact the risk and
return characteristics is discussed below.
                                                              PORTFOLIO MANAGEMENT




Risk and Return Characteristics of Options and Futures
The maximum amount that an option buyer can lose is the option price. The maximum
profit that the option writer (seller) can realise is the option price. The option buyer has
substantial upside return potential while the option writer has substantial downside risk.
At the expiration date, the profit or loss of an option position depends on the price of the
underlying instrument.


To see how the risk-return pattern of an option on an underlying instrument differs from
that of a cash market position in the same underlying instrument, let‟s compare the
purchase of a call option (long call option position) with the purchase of the underlying
instrument (long cash position) at the expiration date. Suppose that the price of the
underlying instrument is $100, the price of the call option is $3 and the strike price is
$100.


Both prices will increase in value as the price of the underlying instrument increases.
The long cash position alizes a dollar for dollar gain when the price rises. In contrast,
the gain on the long call position will be equal to the dollar gain on the cash market
instrument minus the cost of the option (i.e. the option price). So for, example, if at the
expiration date the price of the underlying instrument increases by $12, the gain on the
long call options is only $9. Thus, the long call position reduces the upside potential by
an amount equal to the option price. In exchange for the option price, the investor is
purchasing downside protection. If the underlying instrument decreases, the long cash
position realises a dollar loss. The long call position, however, loses at most the option
price regardless of how much the underlying instrument decreases by.


To see how an option combined with a cash market position can change a portfolio‟s
risk-return pattern, consider a portfolio that includes a long position in some cash market
instrument. This position will gain dollar for dollar for every dollar increase in the price of
the cash market instrument. However, it will also lose dollar for dollar for every dollar
decrease in the price of the cash market instrument. Suppose that a put option with a
strike price equal to the current market price equal to the current market price of the
cash market instrument is purchased. At the expiration date of the option, if the price of
the cash market instrument has increased, the gain in the position will be equal to the
                                                               PORTFOLIO MANAGEMENT


gain in the cash market instrument less the option price. Thus, once again, the upside
potential is reduced by the option price.


The benefit of the put option is that if the price of the cash market instrument falls, the
lowest price that the investor will receive is the strike price. This is because the investor
can exercise the option and sell the cash market instrument at the strike price. This is
because the investor can exercise the option and sell the cash market instrument at the
strike price which we assumed in this example is equal to the price of the cash market
instrument at the time the put option was purchased. Thus, the minimum price that the
investor will realise for the cash market is the strike price minus the put option price.
This strategy is commonly referred to as a protective put strategy.


In contrast to options, a long (short) futures position will realise a dollar for dollar gain
(loss) and realise a dollar for dollar (gain) depending on whether the futures price at the
settlement date increases (decreases). The key point is that the risk-return pattern is
symmetrical for a rise or fall in the future, as is the case for a cash market position in the
underlying instrument. So, if the futures price at the settlement date is $12 greater than
the futures price at which the futures contract was purchases, the long futures position
will gain $12. However, if the futures price at the settlement date is $ 40 lower, the long
futures position will lose $40. There is no downside protection with the futures contract.


Let‟s compare a protective put strategy, which can be used for hedging a portfolio with
the sale of a futures contract for hedging a portfolio. Since the objective of a hedge is to
protect the portfolio value, the sale of a futures contract is appropriate because a loss on
the underlying cash market position if there is a price decline can be offset by a gain
realise on a short futures position.      With an appropriately constructed short futures
position a loss in one position. With an appropriately constructed short futures position a
loss in one position (long cash market position or short futures position) will be offset by
the other. There is no upside potential for the combined position. In contrast, as we
explained earlier, for the protective put strategy, the portfolio will be protected for a cost
equal to the option price. If the cash market position increases, the portfolio will realise
the increase less the option price. If there is a decline in the cash market position, the
decline in the portfolio value will be limited to the strike price minus the option price.
                                                             PORTFOLIO MANAGEMENT


Pricing of Option and Futures


The implementation of portfolio strategies using options and futures requires that the
investment manager can be capable of identifying whether they are properly priced. The
theoretical price of both options and futures are determined using arbitrage arguments.
This means that it possible to construct a portfolio using a risk-free instrument and the
underlying instrument that will have an identical risk and return characteristics as the
option or futures contract must be equal to the value of the portfolio used to replicate its
risk and return profile.


The basic futures price relationship can be expressed as:-


Future price = Current market price
           Current market price (cost of financing – yield earned)
The futures price depends on the current market price, the cost of financing the
underlying instrument if purchased and the yield earned on the underlying instrument.
The difference between the cost of financing and the yield is called the net financing cost
because it adjusts the financing cost for the yield earned. The net financing cost is more
commonly called the cost of carry or, simply carry. Positive carry means that the yield
earned is greater than the financing cost; negative carry means that the financing cost
exceeds the yield earned. The futures price can be equal to, less than, or greater than
the current market price depending on whether there is zero carry, positive carry or
negative carry, respectively. Modification to the basic futures relationship are necessary
to take into consideration the nuances of the futures contracts.


While the price of a future contract is relatively straightforward, options are more
complicated to price. The most popular option-pricing model for common stock is the
Black-Scholes option-pricing
                                                             PORTFOLIO MANAGEMENT


Section 4 Theory of PORTFOLIO MANAGEMENT

Portfolio Management – Definition


A portfolio is a combination of financial assets. In the context of a professional investor
bank or a financial institution it connotes a basket or a carefully blended combination of
investments eg., Equity/Preference Sharees, Govt./Other bonds, Debentures etc.


The objective of holding any financial asset is to earn ensured return. But any
investment has its associated risk/probability of yielding return.


Portfolio management, therefore, means management of a combination of assets so as
to ensure maximum possible return with minimum possible risks. Since there is a
combination of assets with varying rates of returns, for this purpose return denotes the
mean-average return.


The original propagator of this theory, H.M.Markowitz, therefore, called Portfolio Theory
as two parameter theory. The parameters are “Mean Expected Return” and “Variance of
Return”. This is based on the investors‟ preference for:


    a higher mean return to a lower return and
       a lower variance of return to a higher one


Return(from one Investment)-Definition


From an investor‟s point of view expected return includes gains in terms of
dividend/Interest, Bonus, Capital appreciation etc. and such returns are always
measured for a given period of time. This is generally indicated as a %age return on the
initial amount invested. Again such returns can be realized and not realized (notional) at
the time of gain analysis. Return therefore, can be defined in the following manner:


r = (p1 – p0 + d1) / p0 x 100


Where r = Expected rate of return from the investment
                                                               PORTFOLIO MANAGEMENT



P0 = Market price at time 0
P1= Market price at time 1
D1= Cash Divedend for period 1


This return to an investor during a given period is the sum total of


    -   Cash flows by way of dividend/interest, and
    -   Change in the value of investment which may be realized or notional




Flow of return and capital appreciation from an investment cannot be forecasted with
cent percent certainty. Some quantity of risk is always associated with it. The actual flow
of return may vary both in +ve and –ve ways from what is the expectation.


Therefore, analyst assign probability with each rate of return to quantify risk and to
ascertain the most probable return in the following manner:


Possible Return(xi)                      Subjective Probability(pi)


        18 %                                     0.12
        21%                                      0.20
        24%                                      0.50
        27%                                      0.10
        30%                                      0.08




The sum of the probabilities assigned is equal to 1 because actual return is confined to
take on of the five possible values. We may calculate the most probable return using
weighted average method taking the possibilities of returns as the weights. The formula
of the is - r= pi * xi. The result of this will be 23.46%.


The above may be calculated in the following manner:
                                                              PORTFOLIO MANAGEMENT



Measurement of Risk


In a situation like the above risk refers to the variability of dispersion of expected returns.
Therefore, risk is to be analyzed and for this risk has to be measured also. Risk can be
measured in such cases in the following two ways by finding out:


   -   The range of possible returns, which is simply the highest and the lowest values
       of return. In this case the same is 18% to 30%.
   -   The degree of spread of possible returns away from expected return. In other
       words, this is the standard deviation(SD) of possible outcomes.


For the given distribution of return and probability as above, the SD is 3.10%. This
investment is having a relatively high rate of expected return and low standard deviation
and hence can be termed as less risky.


In cases the result is the reverse i., income is low and the SD is high, the investment can
be termed as a risky one.


The analysis is so far simple because only one item of investment has been considered.
In a portfolio at least more than one investment will be there. For each item there will be
one set of „r‟ and SD. Comparison becomes difficult.


The tool used in such a situation is “Coefficient of Variation(CV). This can be calculated
by dividing SD by „r‟ (SD/r). Now, there is only one variable to compare for each
investment. In this instant case CV is 0.132(3.10%/23.46%). The rule is lower the CV the
less risky is the investment and vice versa.
                                                              PORTFOLIO MANAGEMENT


Window for Risk-Return-Investment Decision


                                                                  R   I   S   K
                                                  High                     Low


                    High                          Maybe                    Definite
Return


                    Low                           No investment            Maybe




Groups of Investors
Invertors can be classified into the following three broad groups in order of their nature
and attitude to risk and return:


Group                              Risk                           Return
Risk Averse                        Nil or Lower                   Happy with offered „r‟
Risk Seeker                        Ready to take any risk         Return to be high
Neutrals*                          Do not care much               Do not care much




   * In case of Neutrals investment decisions are based on considerations other than
     risk and return. However, they are certainly not high risk takers.


   Investor’s Indifference Curve


         R

         E

         T

         U

         R

         N                                        Risk
                                                              PORTFOLIO MANAGEMENT



I1 & I2 represent Investor‟s indifference curve. As the risk increases the investor will
behave in the same way if the return also increases along the path of the curve.


Investor 1 is less risk averse than Investor 2 because he is ready to take lesser risk at
the same lever of return.


Determination of Investment Portfolio:


Whatever may be thr risk perception of any investor about any se of financial assets and
the rates of returns there from ultimate determination of a portfolio is a fiffucult taks. The
decision for investment revolves around:


        The items of investment to be considered for inclusion
        The mix of the items of investment
        Present availability of investible corpus and expected future flow of funds &
        Short & long-term objectives of
     -   Realizing returns
     -   Need for immediate cash generation for distribution of profit &/or multiplication of
         the investible corpus &
     -   Diversification of the portfolio


For this several factors are to be considered. The following are the important and major
ones:


1.       Liquidity & Marketability of the Portfolio
The portfolio must be such that it provides liquidity whenever required. All the funds
should not be blocked in long-term debt securities. Or even if invested, the security must
have marketability or buy back option.


2.       Tax Planning
Selection of investment must be made in such a manner that income tax liabilities are
minimized both on the revenue income and long terms capital gains.
                                                               PORTFOLIO MANAGEMENT


3.      Capital Appreciation vs. Quick Revenue Return
The investor must fix up their priorities between long term gain and short term return
and also their proportion. Certain investment may not generate immediate revenue
return but ultimately yield better return because of greater capital appreciation. Such
securities also provide a hedge against inflation.


4.      Minimization of Total Risk Position
An investor should first be careful about the risk position of each investment vis-à-vis
return. But for the entire portfolio his first concern should be risk position. This is required
for the safety of the corpus he is handling.


His objective is to minimize overall risk of the portfolio. Thus, if the portfolio is already
consisting of high-risk securities then further fund should not be blocked in high risk
securities, even if the expected return is high.


5.      Sector/Industry Diversification
An efficient portfolio should comprise of investments in a diversified range of securities
spread over different sectors of the economy as well as within the same sector in
different industries.


The principle, “never put all the eggs in the same basket” should be applied here. This is
to ensure that recession in one of the sectors or industries do not endanger the entire
portfolio both in terms of short-term return and long-term wealth erosion. Viability of one
set of investment can take care of the adversities of the other set.


6.      Non-diversifiable Risk Minimization
In every economy the return from all types of securities tend to vary with the overall
performance and growth of the economy itself as well as the status of the Sovereign
State. The risk emanating from such variation is known as non-diversifiable risk.


This risk can be minimized to a limited extent by investing in fixed interest bearing
securities offered by the Sovereign State, i.e, in our case its Govt. of India.
                                                             PORTFOLIO MANAGEMENT


However, one may offer the argument that an investor may have in his portfolio,
securities of some other countries, if he is permitted to so invest. In such a situation he is
in for management of his portfolio with reference to the sovereign position of more than
one economy.


Risk Analysis of a Two-Security Portfolio


If the investor has to select two securities out of a given set of three securities then the
risk perspective of the portfolio is to be analyzed considering Correlation Coefficient in
addition to Mean Expected Rate of Return, Range of Return Variation, Standard
Deviation and Coefficient of Variation. Let us take the following example of three
securities:

YEAR                    EXPECTED                    EXPECTED                EXPECTED
                        RETURN (%)                  RETURN (%)              RETURN (%)
                        SECURITY-A                  SECURITY-B              SECURITY-C
1                       15                          14                      11
2                       11                          15                      20
3                       18                          17                      12
4                       17                          16                      19
5                       19                          18                      18

AVERAGE                 16                          16                      16

The condition given to the Port Folio Manager(PFM) that he has to select two out of the
three securities and invest 50% of the fund in each of them.


So, this combination could be AB,BC or CA. The following table represents the R, SD,
Range of Variation & Coefficient of Correlation(CC):


Return & Variability of Different Portfolio:

    YEAR                     EXPECTED             EXPECTED               EXPECTED
                             RETURN (%)           RETURN (%)             RETURN (%)
                             A & B Combined       B & C Combined         C & A Combined
    1                        14.5                 12.5                   13.0
    2                        13.0                 17.5                   15.5
    3                        17.5                 14.5                   15.0
    4                        16.5                 17.5                   18.0
    5                        18.5                 18.0                   18.5
                                                            PORTFOLIO MANAGEMENT


   AVERAGE                 16.0                   16.0                  16.0
   RANGE                   5.50                   5.50                  5.50
   SD                      2.08                   2.14                  2.02
   CC                      0.75                   0.22                  -0.26


   Expected rate of return from the three possible mix is the same and the SD is also
   around the same valye. Hence, CV also will be around the same value. The deciding
   factor will, therefore, be the CC.


   CC in case of Option CA is negative. That means whenever return from A increases
   the same from C reduces and vice-versa. In other words one offsets the +ve or –ve
   impact of the other. One can conclude that if CC is –ve the portfolio of two securities
   becomes less risky. This deduction in risk is also called the “ Portfolio Effect”.
   Extending this principle one can conclude the following:


   -   The lower the CC between two securities, the lower will be the risk of the
       portfolio;
   -   Portfolio risk can be reduced by diversification into –vely correlated securities;
   -   Diversification into +vely correlated securities does not reduce the portfolio risk
       and
   -   Uncorrelated securities can reduce the risk only if there are a number of
       securities in the portfolio


   The above analysis can be done varying the proportion of investment between the
   options like 70% of A and 30% of B and so on. The return and the risk of the portfolio
   will vary with the each change in proportion. We can express this in the following
   graph:

                                              B
                                        >
   Rate of
Return %               >



                       >

                                              Risk (SD)
                                                          PORTFOLIO MANAGEMENT



   The two end points represent cent percent of A or B and in between the two
   extremes there can be different combinations of the two. The given arrows show the
   combinations of A & B with different levels of risks and returns.

   Risk of a Multi – Security Portfolio

   In a situation when the portfolio is to contain more than two securities, the
   calculations of risk and return the calculation is not conceptually very difficult but
   cumbersome. However, expansion of the portfolio is needed for reducing the risks as
   has been discussed earlier.

   Further Analysis of Risks

   Every security has a built in tendency to move with the overall performance of the
   country‟s economy and the socio-economic conditions. In other words every security,
   even if with fixed return promise, may not actually yield flow or return if the
   environment affects the issuer‟s performance seriously.

   This, however, may not be applicable to fixed interest bearing securities offered by
   the sovereign State i.e, the country‟s Govt. This is why, there are restrictions on
   Trustees of Private Provident Funds, LIC etc to invest a fixed portion of their corpus
   in Govt. securities.

   Keeping the above in view the total risks associated with a security can be bifurcated
   between:

      -    Systematic Risk or Non-diversifiable Risk &
      -    Unsystematic Risk or Diversifiable Risk


Risk (%)                              Total Risk



                                                           Unsystematic

                                                           Risk




                               Systematic Risk
                                                   Portfolio (No. of Securities)
                                                             PORTFOLIO MANAGEMENT


Section 5 Mutual Funds
The Basics
What is a Mutual Fund?
A Mutual Fund is a common pool of money into which investors place their contributions
that are to be invested in accordance with a stated objective. The fund belongs to all
investors with each investor‟s ownership depending on the proportion of his contribution
to the fund, i.e. the more the contribution the higher the ownership and vice-versa.


Origins of a Mutual Fund
The concept of a mutual fund originated in 1870s with Robert Fleming establishing the
first investment trust in Scotland in 1890. The mutual fund industry in India was started
by the Unit Trust of India (UTI) in 1963 with the introduction of the Unit Scheme‟64
(US‟64). This scheme is the largest in the country.


The year 1987 saw the entry of public sector mutual funds into the market. These were
mainly public sector banks and financial institutions, which established their own Mutual
Funds. SBI Mutual Fund, Canbank Mutual Fund, LIC Mutual Fund and Indian Bank
Mutual Fund were among the first to launched.


The private sector entered the scene in 1993.          These were mainly foreign fund
management companies entering India through joint ventures with Indian Companies.


How does a Mutual Fund work?


A Mutual Fund is set up by a sponsor who contributes a portion of the Mutual Fund‟s net
worth. The sponsor gets the Mutual Fund registered with SEBI and sets up a trust and
an Asset Management Company (AMC). The Sponsor, the Trust and the AMC form the
core entities of a Mutual Fund.


The Trust is represented by a Board of Trustees – the guardians of the investors‟ funds.
They ensure that the investors‟ interests are safeguarded.
                                                               PORTFOLIO MANAGEMENT


The AMC is the investment manager of the investors‟ funds. It invests funds on behalf of
the investors. The activities of the AMC are monitored by the Board of Trustees.


The AMC creates various schemes, which the Mutual Fund advertises, inviting the public
to deposit their faith and their money with the Mutual Fund.            These investors fill in
application forms giving their personal details and how much money they want to deposit
with the Mutual Fund and submit these forms along with their cheques with either the
Mutual Fund or its bankers.


Against this money collected, the Mutual Fund issues units, usually with a face value of
Rs.10/- each. For instance, if the investor invests Rs.5,000, he will be allotted 500 units
of the Mutual Fund.


The AMC then takes over and decides where to invest the money collected from these
investors. All these investments are made in the name of the Mutual Fund and not in the
name of the individual investors. For instance, if Kothari Pioneer Mutual Fund invests in
100 shares of Reliance Industries Ltd., the latter will issue its shares in the name of
Kothari Pioneer Mutual Fund.


The Mutual Fund then starts collecting income on the investments – like dividends and
interest, which it will either reinvest or distribute among its investors.


The Fund Managers also buy and sell the investments in the market and collect the sale
proceeds on behalf of the investors.


When the Mutual Fund distributes the income among its investors, it does so on a pro-
rata basis. For instance, an investor holding 300 units of the Mutual Fund will get more
dividend than an investor holding 100 units.


Why investing through a Mutual Funds
There are a number of good reasons for an investor to invest through the Mutual Fund
vehicle. These are enumerated below:
                                                             PORTFOLIO MANAGEMENT


Lower Risk
Each investor in the Mutual Fund owns a proportionate part of all the Mutual Fund‟s
assets. Even with a small amount of investments, he becomes a part owner of a large
asset value spread over a number of investments.          This is explained below with a
specific situation.


You have Rs.10,000 to invest. You want to invest in software stocks. With this amount,
you will be able to purchase in only one or at the most two IT shares. A fall in one or
both these shares can wipe you out! However, if you deposit your money with a Mutual
Fund specialising in investing in IT shares, your Rs.10,000 will go into the pool of money
collected from other investors like you and the Mutual Fund will buy IT shares of a larger
number of companies.


Your Rs.10,000 will now be spread over more than 2 companies reducing the chances
of you losing your money.


The downside is that if the shares were to go up, the profits to you would be higher if you
directly invest in them than if you invest through a Mutual Fund. But that is a sacrifice
worth making for the sake of safety.


Asset Allocation
Mutual Funds offer the investors a valuable tool – Asset Allocation. This is explained by
an example.


An investor investing Rs.1,00,000 in a Mutual Fund scheme, which has collected Rs.100
crores and invested the money in various investment options, will have his Rs.1,00,000
spread over a number of investment options as demonstrated below:


Investment                    Percentage             Total          Investor’s
Type                          of Allocation          Portfolio of   Portfolio
                              (% of total            the Mutual     allocation
                              portfolio)          Fund Scheme         (Rs.)
                                                  (Rs.in crores)
Equity                        57%                    57             57,000
                                                           PORTFOLIO MANAGEMENT


Hindustan Lever Ltd.          15%                   15             15,000
Indian Shaving                12%                   12             12,000
Procter & Gamble              10%                   10             10,000
Cadbury Ltd.                   9%                    9              9,000
Nestle Ltd.                    7%                    7              7,000
Kodak Ltd.                     4%                    4              4,000
Debt:                         43%                   43             43,000
Government Securities         20%                   20             20,000
Company Debentures            10%                   10             10,000
Institution Bonds              9%                    9              9,000
Money market                   4%                    4              4,000
TOTAL                         100%                  100            1,00,000


Thus “Asset Allocation” is allocating your investment into different investment options
depending on your risk profile and return expectations.


Professional Management
Very few people have the time and inclination to understand and analyze finance
markets while making their investments. Fund Managers of the Mutual Funds AMC are
professionals with experience and tract records of managing money and closely tracking
the finance markets.


Mutual Funds have a team of research professionals who are constantly providing these
Fund Managers with inputs of opportunities and changes happening in the markets. For
an individual investor, this management services comes along with his investment in the
Mutual Fund.


Easy Liquidity
This is one of the most important benefits a Mutual Fund offers its investors. Very often,
investors holding equity and debt cannot sell their investments easily and quickly.
However, by investing through a Mutual Fund, they have the option of selling their units
back to the Mutual Fund and receiving their money within 4 to 7 working days.
                                                           PORTFOLIO MANAGEMENT


Saving Taxes
Tax saving schemes of Mutual Funds offers investors a tax rebate under section 88 of
the Income Tax Act. Under this section, a person investing up to Rs.10,000 in a tax
saving scheme can avail of a tax rebate of 20% of his investment amount. However, the
rebate is capped to 20% of a maximum investment of Rs.10,000. This implies that if an
investor invests more than Rs.10,000 in a tax saving scheme, he will get a tax rebate of
only Rs.2,000 (20% of Rs.10,000). This tax rebate is available every Financial Year.


Retirement Planning
Mutual Funds offer investors „Systematic Investment Plans‟ (SIP) and „Systematic
Withdrawal Plans (SWP). These plans are very useful as a tool to provide for one‟s
retirement needs.


Systematic Investment Plans are best suited for young people who have started their
careers and need to build their wealth. SIP‟s entail an investor to invest money at
regular intervals in the Mutual Fund scheme the investor has chosen. For instance, an
investor selecting Templeton‟s SIP will need to invest a certain sum of money every
month / quarter / half-year in the scheme of his choice.


Systematic Withdrawal Plans are best suited for people nearing retirement. In these
plans, an investor invests in a Mutual Fund scheme and is allowed to withdraw money at
regular intervals to take care of his expenses.


Index Investing
Index schemes of Mutual Funds give investors the opportunity to invest in index scripts
in the same proportion of weightage these scripts have in the index. Thus the investor‟s
return on investment mirrors the index he invests in.


G-Sec Investing
Gilt and money market schemes of Mutual Funds give investors the opportunity to invest
in Government securities and money markets (including inter-bank call money market),
which, an investor, on his own would not have access to (i.e. these investment options
are normally not available to individual investors).
                                                           PORTFOLIO MANAGEMENT


Convenience and Flexibility
Mutual Funds offer investors added benefits such as switching between schemes at low
or no cost, getting regular information on the markets and the status of their investment
through the Mutual Fund‟s newsletters or their websites on the Internet.
Some of the prominent services offering convenience and ease are :
       Switching              between                MF             Schemes
       This option is very useful for an investor who can easily and without cost switch
       from one scheme of a Mutual Fund to another. The investor has to simply fill in
       the switching open in his account statement and tick mark the scheme he wants
       to switch to.


       The Mutual Fund transfers his investment to the new scheme at its prevailing
       NAV. The investor‟s exit from the old scheme happens at the time old scheme‟s
       prevailing NAV. For instance :


       Ease of communicating with the Mutual Fund to change personal details
       An investor can easily intimate the Mutual Fund regarding change in his personal
       details such as address and telephone number by filling in the change in the
       account statement and sending it to the Mutual Fund‟s registrars. The new
       personal details on being incorporated in the Mutual Fund‟s records appear in the
       account statements sent after intimation.


       Having dividend and redemption directly credited into your bank account.


       Mutual Funds now offer investors the Electronic Clearing System (ECS) whereby
       investors can intimate the Mutual Fund their bank account numbers, the MICR
       number of their cheque book and the bank‟s branch address where their account
       is maintained. The Mutual Fund directly has the investor‟s account credited with
       dividends/redemptions and intimates the investor by issuing him a letter stating
       that his account has been credited with the amount.


Types of Mutual Funds
Nature of investment
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a.   Equity schemes
     These schemes invest most of their corpuses in equities of companies in various
     industries / sectors / businesses. A very small portion of the corpus is invested in
     debt securities in order to enable the scheme to repay money to outgoing
     investors. Since there is no investment focus on a particular type of business or
     sector, these are called diversified equity schemes.


b.   Debt / Income schemes
     These schemes invest most of their corpuses in debt instruments issued by the
     Government, corporates, banks, financial institutions and entities engaged in
     infrastructure / utilities. Since these schemes don‟t focus on capital appreciation
     but on earning higher incomes, they are also called income schemes.


c.   Balanced schemes
     Portfolios of these schemes consist of debt instruments, convertible securities,
     preference shares and equities. The investment in equity and debt is more or
     less in equal proportion.     These schemes‟ objective is to earn income with
     moderate capital appreciation.


d.   Money Market schemes
     These schemes invest in securities with maturities of less than one year. These
     securities are mainly Treasury Bills issued by the Government, Certificates of
     Deposits issued by banks and Commercial Paper issued by companies. These
     scheme also invest in the inter-bank call money market.


e.   Gilt schemes
     These schemes invest in Government securities with medium to long term
     maturities i.e. more than one year. Although these securities have „zero‟ risk
     (Sovereign ratin), fluctuations in interest rates bring about changes in market
     prices of these securities resulting in gain or loss to the investor.


f.   Sector Specific schemes
     These schemes invest in only one industry or sector of the market such as
     Information Technology, Pharmaceuticals or Fast Moving Consumer Goods.
                                                         PORTFOLIO MANAGEMENT


     Being a very focused investment option, these schemes carry a high level of
     sector and company specific risk.


g.   Index schemes
     These schemes track the performance of a specific stock market index. The
     objective is to match the performance of the index by investing in shares that
     constitute the index. Not only do these schemes invest in the same shares that
     make up the index, they invest in these share in the same proportion as the
     weightage they are given in the index.       For instance, if the index tracked
     constitutes shares of Hindustan Lever Ltd. (HLL) wherein HLL‟s shares make up
     25% of the index, the scheme will also invest 25% of its corpus in HLL shares.


h.   Tax saving schemes
     These schemes are essentially diversified equity schemes with an additional
     benefit of offering a tax rebate under Section 88 to the investor. This section
     stipulates that an investor gets a tax rebate of 20% on a maximum investment
     amount of Rs.10,000 per Financial Year in a tax saving scheme. However, the
     investor has to remain invested for a minimum period of three years in order not
     to have the tax rebate cancelled.


i.   Bond schemes
     These are focused debt schemes investing primarily in corporate debentures and
     bonds or in infrastructure or municipal bonds.


Tenure
a.   Open-ended schemes
     These schemes are available for sale and repurchase at all times. An investor
     can buy units from or redeem units to the Mutual Fund itself, at a price based on
     the schemes Net Asset Value (NAV).


b.   Close-ended schemes
     These schemes offer units for sale and repurchase at all times. An investor can
     buy units from or redeem units to the Mutual Fund itself, at a price based on the
     scheme‟s Net Asset Value (NAV)
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c.     Interval schemes
       Some close-ended schemes offer repurchase facility for short periods of time
       where the investor can directly sell his units back to the Mutual Fund. These are
       called „Interval Schemes‟. Mutual Funds intimate their investors when they plan
       to open repurchase facility for a specific period of time. Also, investors can
       obtain this information from popular financial publications, which announce dates
       during which interval schemes are open for repurchase.


Dividends
a.     Payout option
       Investors have the option of collecting their dividends in cash, i.e. not reinvesting
       their dividends back into the scheme.


b.     Reinvestment option
       Investors have the option of having their individuals declared and then having it
       reinvested back into the scheme. This method of reinvestment is a tax saving
       tool (dividend income attracts no tax).


c.     Growth option
       Investors can opt for not having dividends declared at all with the appreciation in
       value of the portfolio being constantly added on to the NAV. This is another
       method of income reinvestment offered by the Mutual Fund.


Net Asset Value
When a Mutual Fund scheme is first offered to the public, the offer price is usually Rs.10
per unit. After the amount raised is invested, the total funds under the control of the
Mutual Fund increases or decreases depending upon the fluctuation in the market value
of the investments. As a result, this Rs.10 per unit becomes higher or lower. This is the
NAV or the market value of each unit of the scheme.
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Let‟s take example


Initial amount collected by Rs.100 crores
The Mutual Fund
Number of initial units 10 crores
taking Rs.10 per unit as
the initial value per unit
This initial amount is now Rs.80 crores
Invested and the market
value comes down to
Taking the initial numbers Rs.8 [Rs.80
of units [i.e. 10 crores dividend
units], the value per unit by 10 crore
[the NAV] will now be units]


Rs.8 is the NAV of each unit.
This is a simplistic example. In reality there a number of factors affecting the NAV such
as expenses charged to the scheme, fresh unit sales and repurchases, bonuses issued
and dividends declared.


Choosing a Fund
Risk capacity


Risk and return are always commensurate with each other. If you are willing to take a
higher risk with your money, go in for an equity scheme. Equity shares are the riskiest
investments since they are unsecured and are the last to receive money in case the
company winds up. However, if the company does well, they are given the highest
share of the profits.


If you are willing to take risks but would like to moderate it, go in for a balance scheme.
These schemes invest an equal portion of their funds in equity shares and debt. This
helps balance risks with debt being the cushion in case of a downfall in the equity
investments. If you are absolutely not willing to take any risks with your money, a debt
                                                            PORTFOLIO MANAGEMENT


scheme, money market scheme and gilt scheme are ideal for you. These schemes stay
away from equity shares almost completely and offer an average returns.


Liquidity
If you want your money to be available to you easily in time of need, go for an open-
ended scheme.


However, if you are okay with your money not being available to you quickly and easily
and would rather remain invested, a close-ended scheme is suitable.


Another way of looking at liquidity is the size of the money collected (corpus) by the
scheme and the type of investments of that scheme. If the corpus is very small, there is
a risk of the Fund Manager being forced to sell during a rush for redemptions. However,
if there is a large corpus, the Fund Manager can handle this situation easily.


By the type of investments, one means that a money market scheme will be more liquid
than an equity scheme. Money market instruments are sellable easily and very quickly.
Hence money market schemes can return your money within 2 working days whereas
an equity scheme will take between 4 to 7 working days.


Specific needs
Over and above risk taking ability and liquidity needs, an investor may have specific
needs such as saving of taxes (for which he can invest in a tax saving Mutual Fund
scheme) or wanting to invest in a stock market index (for which he should invest in an
index scheme). Mutual Funds have devised a number of schemes catering to these
specific needs.


Track record
Check the scheme‟s performance since its inception and compare it with similar
schemes. By similar schemes, one means, compare an equity scheme with another
equity scheme and not with, say a debt scheme. The instrument invested in being
different in both these schemes will make a comparison have no meaning. Performance
comparison is done by comparing the annualised percentage growths in the scheme‟s
                                                           PORTFOLIO MANAGEMENT


NAV over a period of time. The higher the percentage of appreciation, the better is the
performance.


Transacting Mutual Funds
Close-ended schemes
An existing close-ended scheme invested who has purchased his units during the
scheme‟s IPO and does not want to stay invested till maturity of the scheme, can sell his
units on the stock exchange to a person wanting to buy units of that scheme.


While purchasing units during the IPO, the investor doesn‟t have to incur any costs for
purchase.


However, while purchasing units from the stock exchange, the investor has to pay his
broker a brokerage fee for purchase of his units. Similarly, while selling units on the
stock exchange, the investor has to pay his broker a brokerage fee for sale of his units.
While purchasing units, the investor has to also incur costs of stamp duty to transfer the
units in his name. However, if the investor purchases units in the dematerialized form,
no stamp duty is payable.


Brokerage rates range between 1% -2% of the transaction value. For instance, if an
investor purchases 1000 units at a price of Rs. 15 per unit, the total value of the
transaction is Rs. 15,000. Brokerage at 1% works out to Rs. 150 (!% of Rs. 15,000/-).
Stamp Duty rates in the state of Maharashtra are 0.5% of the transaction value. Taking
the above example, stamp duty payable by the purchaser will be Rs. 75 (0.5% of Rs.
15,000).


Open ended schemes


Units of open ended Mutual Fund schemes are first available during the scheme‟s IPO at
face value (i.e. Rs. 10 per unit) and then the Mutual Fund offers sale and repurchase
facilities thereafter ( at the current NAV).
While investing during the scheme‟s IPO, the investor does not incur any cost for
investment.
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However, while purchasing units from the Mutual Fund after the IPO, the investor may
be charged an entry load, which is a percentage of the NAV at the time he buys the
units. Entry loads normally range between 0.5% and 1.5%. For instance, if an investor
decides to buy 1000 units of an open-ended scheme whose NAV is Rs. 15 and the entry
load is 1% he is charged Rs. 15.15 per unit. The advantage of having the sale and
repurchase facility from the Mutual Fund is that there is no stamp duty payable on
purchase of the units.


Buying IPO units


Mutual Funds announce the IPO opening and closing dates in the daily popular
publications. Contact your broker for the application form of the IPO, or access the
website of the Mutual Fund or a personal finance site for the form.


Fill it in and make out a cheque for your investment amount. Submit the filled in
application form along with the cheque to either your broker or directly to the Mutual
Fund‟s banker for the IPO (the names of the bankers and form collection centers are
mentioned on the application form).


Your application is processed after which you receive an account statement indicating
the number of units allotted to you, the purchase ate, the cost of your investment ( which
is Rs. 10 since it is purchased during the IPO) and the current value of your investment
(i.e. the NAV).


Buying close ended units post IPO
Contact your broker to find out the market price of the Mutual Fund scheme on the stock
exchange and the availability of units. On ensuring that the buy price is acceptable and
there are sellers, place the order with your broker for purchase of the units.


The broker will execute your order and hand over the unit certificates to you (if you have
bought the units in the physical segment) or will intimate you that the units have been
credited to your dematerialization account (if you have bought the units in the
dematerialized segment).     In case of receiving units in the physical form, fill in the
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transfer deed and lodge it along with the unit certificates with the Registrar of the Mutual
Fund. In case of purchase in the dematerialized form, nothing further has to be done.


Buying open-ended units post IPO


In case of an open-ended Mutual Fund scheme, ask your broker to find out the NAV of
the scheme and entry load, if any, on the day you are submitting your application form.
The NAV and load, if any, is also available on the website of the Mutual Fund or a
personal finance site.


Submit the filled in application form along with the cheque to either your broker or
directly to the Mutual Fund‟s banker (the names of the bankers and form collection
centers are mentioned on the application form). Your application is processed after
which you receive an account statement indicating the number of units allotted to you,
the purchase date, the cost of your investment ( your entry NAV) and the current value
of your investment (i.e. the NAV on date the account statement was made).



Brokerage Payback
Mutual Funds have Direct Selling Agents (DSA) who are offered commission on
investments garnered for the Mutual Fund. Commission rates range from 0.5% to 1% of
the funds collected by the broker for the Mutual Fund.


These brokerages are paid either on a one-time flat basis or at fixed intervals of time. If
the Mutual Fund decides to pay the brokerage on a one- time basis, the time period for
which the investor remains invested in the Mutual Fund scheme becomes irrelevant i.e.
if the investor invests his money for even a few days, the brokerage rate remains the
same. This method of payment is costly for the Mutual Fund and lucrative for the broker.
In case of periodic payments of brokerage, the broker is paid brokerage only if the
investor continues to remain invested in the scheme.


All brokers offer incentives to their clients to invest in Mutual Fund schemes by sharing
their brokerage with the investor. Normally brokers offer between 75% to 90% of their
                                                            PORTFOLIO MANAGEMENT


commissions to the client. For instance, if you purchase 1,000 units x Rs. 15 per unit,
your investment cost is Rs. 15,000 (1,000 units x Rs. 15 per unit).


However, if your broker receives 0.5% flat commission from the Mutual Fund for this
investment and offers you 0.45%, you receive Rs. 67.50 (i.e. 0.45% of Rs. 15,000) as
your share of the brokerage commission.


Averaging cost of purchase


Averaging cost of purchase implies buying units of the Mutual Fund scheme at different
points of time at different costs and then finding out the average cost per unit by dividing
the total cost by the total number of units purchased. For instance, you buy units of
Reliance Income Fund at different points of time as indicated below :


Investment             Number of              Purchase price per            Total cost
Type                   units purchased               unit


15 March 2001          500                    Rs. 14.25                     Rs.7,125.00
18 April 2001 700                     Rs. 13.50                       Rs.9,450.00
21 May 2001            350                    Rs. 13.75                     Rs.4,812.50
18 June 2001           200                    Rs. 13.05                     Rs.2,610.00
14 July 2001           600                    Rs. 12.95                     Rs. 7,770.00
Total                  2350                                                Rs.31,767.50

The average cost per unit works out to Rs. 13.52 (Rs. 31,767.50/2350 units).
Systematic Investment Plans (SIPs) are one way of averaging the costs of your
investment in the Mutual Fund.


Tax angle


There are no tax implications while investing in Mutual Funds except while investing in
Tax saving schemes of Mutual Funds. These schemes are specifically designed to offer
tax rebate to investors under section 88 of the Income Tax Act. Under this section, a
                                                                 PORTFOLIO MANAGEMENT


person investing in a tax saving scheme of a Mutual Fund is given a rebate @ 20% on
an investment of up to Rs. 10,000.


However, one cannot sell, transfer or pledge his units for a period of three years from the
date of purchase of the units. If he does so, he loses his rebate and has to pay tax on
his investment. Tax saving schemes can be open-ended or close-ended. If they are
close-ended, they are listed after the initial 3 year lock in.


For instance, on 31st March 2001, X invested Rs. 10,000 in Prudential –ICICI Mutual
Fund‟s Tax Saving Scheme. X will receive a tax rebate of Rs. 2,000 for the Financial
year ended 31st March 2001 and will have to stay invested in Prudential-ICICI Mutual
Fund‟s scheme upto 31st March 2004. If he sells, transfers or pledges his units during
this time he will be taxed on his investment of Rs. 10,000 in the same year that he sells,
transfers or pledges his units.


Tracking Performance
On making investments in Mutual Fund schemes it is very important to track the
investment performance. Tracking the performance of the investment helps an investor
decide whether to hold on to his investment or switch to another Mutual Fund scheme.
There are different measures available to evaluate performance of a Mutual Fund
scheme. These are enumerated below:


Appreciation/Depreciation of the NAV
NAV is the market value of each unit of the Mutual Fund. This value is what the investor
gets back on exiting from his investment. To find out the scheme performance, work out
the annualized %age appreciation in the NAV between the periods for which
performance is to be evaluated. An example to clarify this is stated below:


You bought units of M/s Kothari Pioneer
Mutual Fund on 1st Jan 2000
Your purchase price per unit was Rs.14.00
You want to evaluate the performance of your investment on 1st Jun‟2001
Appreciation in the NAV Rs. 7.00(NAV on 1st minus your purchase price (Rs. 21.00-
Rs.14.00, on Jan 1st 2000)
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Number of days you have stayed 517 days invested in the scheme (Number of days
from 1st Jun‟01 to 1st Jan 2000)
%age Appreciation – 50%: Rs.7.00/Investment(Appreciation in Rs.14.00 x
NAV/Purchase Price x 100)


Annualized %age appreciation 35.30%(50% x in NAV (%age appreciation 365/517)


NAV X 365/Number of days you have stayed invested in the scheme




Although NAV related performance evaluation is easily understood and universally
applicable it has the shortfall of not taking into consideration the dividends declared and
paid out by the Mutual Fund leading to a technical drop in NAV. NAV is suitable if the
investor has selected the growth option(where no dividends are declared) while investing
in the Mutual Fund scheme.


                                                                  Total Return Method
In case investment in a scheme where the investor has opted for dividend payout he
should use the Total Return method of evaluating his Mutual Fund performance. The
Total Return method is elaborated with an example below:


You bought units of Kothari Pioneer 1 Jan 2000


Appreciation in the NAV( 21.00 – 14.00 = 7.00)


Total Appreciation value is 1000 x 7.00 = 7,000.00
Total Appreciation to your credit        = 8,000.00
(Appreciation in NAV + dividends, 7000 + 1000)
%age Appreciation = 57.14%


Since Investment is held for 1 year there is no question of having to annualize the return.
                                                           PORTFOLIO MANAGEMENT


Reinvesting Dividend


When an investor opts to have the dividend declared and reinvested back into the
scheme he gets additional units to the extent of the dividend declared. Reinvestment of
the dividend happens at the prevailing NAV. This changes the cost of his investment.
Return in this case has to take into account both these aspects. This is enumerated with
example below:


On 30th September 2000, the same Mutual Fund declared a dividend of 10%(1000 units
x 10%.


You have coosen to hve this 62.5 units dividend reinvested back into the scheme at the
prevailing Nav of Rs.16.00. Rs. 16.00 ( i., e NAV on 30th September 2000. You receive
additional units (Dividend due/NAV on 30th Sep‟2000). The NAV of each unit of hi was
on RS.21.00, on 31st Dec‟00.
Appreciation in the NAV (RS.7.00, Rs.21-14)
Total Appreciation value is 1000 x 7.00 = 7,000.00
Total Appreciation to your credit       = 8,000.00
(Appreciation in NAV + dividends, 7000 + 1000)
Appreciation in NAV of new Units i., e units received on reinvested (21-16).
Total Appreciation in value of new Rs.312.50 (Rs.5 x 62.5 Units)
Total Appreciation (Original Units + New Units)
Rs.7,000.00 + Rs.312.50 (Rs.5 x 62.5 Units)
Total Appreciation in value of Rs.7312.50
Total Cost of Investment Rs.15,000.00 (Rs.14,000.00 + Rs.1000.00)
Return on Investment = Rs.7,312.50/15,000.00 x 100 = 48.75%


Since investment is held of one year there is no question of having to annualize the
return.
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Analyzing Scheme Types


Besides the methods of calculating returns shown above, one needs to look at specific
aspects of performance analysis dependent on scheme type. These are enumerated
below:


For Equity Schemes


Performance of equity schemes should better the stock market index to be judged as
having a superior performance. To analyze this one must compare the appreciation in
the NAV of the Scheme with the appreciation in the index being used as the benchmark
for the same period of time. For instance, if one is using the BSE 30 share sensex as
the bench mark index, compare the performance of the NAV appreciation with the
appreciation in the sensex over the same period of time.


For Index Schemes


Index schemes invest in shares comprising an index in the same proportion as the
weightage are given in the index. Hence, index schemes performance must be equal to
the performance of the index. However, due to expenses charged to the scheme there
is a slight variation in the performance of the scheme vis-à-vis the index. This is called
„Tracking error‟. Higher the expenses higher the tracking error.


Using Public information
There are a number of sources of obtaining information on Mutual Funds. This
information is available in data form and analytical forms. The sources are:



Reports and Newsletters


Reports published by Mutual Funds include financial performance of their schemes,
portfolios of securities of each scheme with %age each security comprises of the total
portfolio, annual accounts of the Mutual Fund(Profit and Loss A/c and Balance Sheet),
happenings in the AMC in terms of recruitments and personnel leaving. Mutual Fund
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newsletters also offer investors information on the financial markets in terms of interest
rates and trends.


Popular Financial Publications

Daily newspaper provide daily NAV figures for open-ended schems and share prices of
close-ended listed schemes. Certain financial publications offer weekly supplements
which give more analytical information on fund performance.


Personal Finance Websites

Websites on the world wide web offering information on personal finance products
specific to India offer a wealth of information on Mutual Fund schemes including data,
analysis, recommendations, interviews with Fund Managers.


How to judge whether to stay invested if a close-ended scheme turns open-ended


Nowadays, Mutual Funds normally prefer creating open ended schemes since these
schemes are not forced to close down when the time is not right-for instance in case of
an equity scheme if the stock market is down when the scheme is due for redemption.


If you hold units of a close ended scheme, which is due for redemption it s most likely
that the Mutual Fund will offer you two options:


   1. Get your units redeemed at the NAV prevailing at the time of redemption
   2. Continue with the scheme which will become open-ended


   Which option do you choose?


   1. In case of equity schemes it the stock market is at one of its bottoms and the
       portfolio of the scheme consists of good quality stocks, remain invested.
   2. In case of debt scheme if interest rates are down and the scheme is locked in at
       high interest rates, mail invested.
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Regulators


   Main authorities regulating Mutual Funds are:


   1. SEBI


   The SEBI is to regulate all entities that either raise funds in he capital market or
   invest in capital market securities like shares and debentures. Mutual Funds come
   under purviews of SEBI. SEBI requires all Mutual Funds on where they can invest,
   investment limits and restriction there on, how thye should make disclosures of
   information to the investors keeping in mind investor‟s protection as its main goal.


   AMC‟s of Mutual Funds are formed as companies registered under the Companies
   Act, 1956 and therefore fall in the purviews of the Company Law Board(CLB) and
   Department of Company Affairs.


   The Association of Mutual Funds of India (AMFI) is an organization set up by Mutual
   Funds to promote the awareness of Mutual Funds and set ethical and professional
   standards among Mutual Funds.
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Section 6 Insurance


Since risk life is an endemic part of life, it is important to understand means by which this
risk can be mitigated. And this risk management is what life insurance is all about. In
technical terms, life insurance is a contract for the payment of a sum of money to the
person insured (or failing him/her, to the person entitle to receive the same on the
happening of the event that has been insured against. This payment, either in lump sum
or in regular installments, is paid, either on the death of the insured, or on the expiry of a
stipulated number of years.


How did insurance emerge?


The concept of insurance is believed to have first take birth in England. It came to being
due to the risk of loss of goods in transit, on account of piracy in ships. In order to protect
their goods against piracy and natural calamities like storms etc. traders started
contributing a certain percentage of the value of the goods to an agency. In turn, the
agency assured indemnification. Indemnification means that the loss will be made good.
This is how the concept of insurance emerged.


What does life insurance cover?


Usually the contact provides for the payment of an amount on


   -   the date of maturity of the contract
   -   or at specified dates at periodic intervals
   -   or at unfortunate dath, if it occurs earlier


Among other things, the contract also provides for the payment of periodic premium
periodically to the insurer by the insured.


What do the terms “Insurer” and “Insured” mean?


An Insurer is the person or agency that agrees to pay money in the event of a
contingency or which insurance had been taken. For instance, in India, LIC & GIC are
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insurers. Now several other private players like Prudential ICICI and HDFC Standard
Life are making their entrance into the life insurance business.


Insured :Insured is the party which seeks protection against a particular contingency
and is entitled to receive money from the insurer on the occurrence of that contingency.
Yhe insured is generally also the policyholder.


Beneficiary: The person to whom policy proceeds will be paid in the event of the death
of the insured is called the beneficiary.


Proposer: The person to who sends the proposal form for taking an insurance policy
and pays the premium is called a proposer of proponent.


Insured Amount: The amount for which the risk is insured is called the insured amount
policy money or face value of the policy.


Life Proposed: Prior to the acceptance of a proposal by a life insurance company, the
person on whose life insurance is sought is know as life proposed.


Life Insured/Assured: Once the insurance company accepts the proposal, the life
proposed becomes the life insured/assured.


Life Insurance Policy: The document which contains the terms and conditions of the
life insurance contract is termed as the Life Insurance Policy.


Insurable Interest: This is one of the most important terms in life insurance. The
proposer must have an Insurable Interest in the life to be insured. This means that the
proposer has such relation to the person being insured that he sufers loss by his/her
damage and is benefited by his/her safety or existence. In every life insurance contract it
is a pre-requisite to have „Insurable Interest‟ in the life that is being insured. It is take as
given that an individual has insurable interest in his or her own life.


Examples of cases where the Insurer is deemed to have Insurable Interest(i.e, where no
proof for the same is required) are that of a husband‟s interest in his wife‟s life and wife‟s
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interest in her husband‟s life. Cases where prod is required are: business and family
relationships. For example, a creditor can take a policy for the debtor, a partner can take
it for another partner, a father can take it for his son etc.


What are the different types of life insurance policies?
Broadly, the different types of life insurance policies are:


Endowment Policies: These are the most popular forms of life insurance policies. They
are more of savings schemes rather that life insurance schemes. Under these policies
the insured amount is payable to the policyholder when he reaches a desired age or in
the even of his early death to his nominee.


Anticipatory Endowment(Money Back Policies): These are variants of the
Endowment Policy. Unlike ordinary Endowment Plans, the survival benefits Money Back
policies are payable in lump sum at periodic intervals. However, in the event of death of
the insured within the term of the policy the full amount insured is payable without any
deduction of adjustment for the amount that may have been paid earlier as survival
benefit.


Whole-life Policy: A whole-life policy is one, which covers the entire life of the policy
holder. The policy money becomes payable to the policyholder when he reaches the age
of 85 or on his death to the nominee or beneficiary, whichever is earlier.


Term Assurance Policies: Term Assurane Policies are taken for a specified period of
time. The amount insured under this policy is paid by the insurer only if the insured dies
during the term of the policy. What happenes if I survive that period? It is the cheapest
form of life insurance policy.


Annuity Policies: Annuity policies provide for payment of annuity pensions, which is
usually an amount payable annually. However, it can also be paid half-yearly, quarterly
or monthly. Annuities are broadly of two types:


    1. Immediate Annuities: Are the policies where payment of money starts
        immediately.
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   2. Deffered Annuities: Are the policies where payments start after expiry of a
       specified period called deferment period.


Annuities may be payable either for the entire life of the policyholder or for a certain
specified period.


What are the benefits of life insurance?
Apart from the obvious benefit of providing a safeguard to your family agains an untimely
death life insurance is a mneans of compulsory savings, a source of income during old
age and can meet certain periodic finance needs either for a child‟s education or
marriage. In old age, it is also a means of attaining peace of mind, knowing that in case
of a prolonged illness someone will take care of the bills. Insurance also brings some tax
benefits. Under section 88 of the IT Act 20% of the contributions made towards life
insurance premiums qualify for deductions from total tax payable.


How much Insurance should I take?
A question normally encountered is „how much of life insurance do I really need? It is
essential to determine the net family income per year and then as a thumb rule to try and
work out the capital needed to maintain the standard of living of your family in case of
your death.


You would then have to purchase an insurance policy equivalent to the amount calcuted.
Usually, the amount of insurance you need works out to around 5-7 times of your current
gross annual income.


Who is an Agent, what does he do?
An agent is a person who is licensed to sell a life insurance policy to you and in turn gets
a fees from the insurance agency. The agent should be willing and able to explain
various policies and other insurance related matters. You should feel satisfied that the
agent is listening to you and looking for ways to find you the right type and amount of
insurance at an affordable price.


What should I look for in a policy?
First of all prioritise what you want from a policy. Is it
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1. tax benefit
2. ability to pay off a debt
3. consistent income at an elderly age
4. profits/higher returns from your policy at the end of the tenure
5. comfortable lifestyle for your dependents on your death
6. livelihood provision in case of disability


Once you have managed to give priority to the above in the decreasing order ask your
insurance agent if the policy he is offering encompasses all or most. Then get the
agent to calculate the premium amount.


Typically, one can add or remove certain features to increase or decrese the
premium. But check with your agent first.


Which companies offer life insurance?
In India, until now the Life Insurance Corporation was the only agency offering life
insurance. However, with the opening up of the economy the country has seen a
number of new entrants in the sector. Some of those who have received licenses
include Prudential ICICI, HDFC Standard Life, Max New York Life. Several more
are set to get licenses including Birla Sun Life, Reliance Life & TATA AIG Life etc.


What does Premium Mean?
The premium is the money paid to the life insurance company to obtain the protection
of a life insurance cover. When you uy a life insurance policy you have a choice of
how often to pay the premium: annually, semi-annually, quarterly or monthly. The
more frequently you pay the greater the cost. For example a monthly premium is
higher than 1/12 th of an annual premium. In part, this additional cost is caused by the
extra expenses for additional paperwork.
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What does Underwriting mean?


Your life insurance premium is based on the plan of the insurance and your morality
(risk and death) class. The plan of insurance is your choice. Your morality or risk
class, however, is determined by an underwriter using the underwriting process
through which an insurance company would decide whether or not to accept a risk of
if accepted in what morality class the risk should be classified.


The risk of death is determined by such factors as age, sex, habits, build, personal
and medical history, habits, residence and occupation. The company‟s decision to
insure your life is based on the application, the medical examination (if required),
inspection reports and statements from your doctor. The premium is then fixed
accordingly.


When is the money paid by the Insurance company to the insured or his/her
nominee?


Generally, the money i.,e the sum insured along with the bonuses attached (if with
profit policy) is payable to the policy holder at the end of the term of the policy. In
the case of an unfortunate death of the person insured, the money is payable to his/her
nominee. There can be some survival benefit payments during the term of the policy
in case of certain plans(These are known at the time when the Policy is bought)>
This primer is not exhaustive as there are many more concepts which will be
dealt with over a period of time when we are talking of life insurance. But it will
hopefully act as a first step towards understanding what life insurance is all
about.
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Section 7 Fixed Deposits

Today, there are hardly any options for where you should put your money. As if the
situation in the stock market was not bad enough, along came the UTI scam, to worsen
matters. Maybe, it is time to re-visit some of the safer options, one of them being the
traditional bank fixed deposit.


We have listed here the best ten banks offering the highest rates on fixed deposits from
a universe of 50 banks (including public, private and foreign banks). The best fixed
deposits have been analyzed for three different time periods : The short term (15-29
days), medium term (181 days – 1 year) and long term (2-3 years).


Most banks will offer higher rates on deposits kept for a longer period of time, as the risk
for the depositor is higher for a longer tenure of investment. However, banks do keep
varying the rates of interest offered for different maturities depending upon their own
asset-liability management requirements and their peculiar short-term requirements.


The data provided by Credence Analytics (India) Pvt. Ltd., takes the figures as on July 9,
2001 and so it is best to check back with the individual bank as well, before depositing
your money.


The Short Term (15-29 days)
In case you are looking at a shorter term maturity for a fixed deposit, check out the
foreign banks like Credit Agricole, which is offering the highest rate of 9.25 percent, and
Dresdner Bank, which is offering the next best at 8 percent. Closely followed by these
two are Bank of Nova Scotia and Deutsche Bank offering 7.5 percent and then
Centurion Bank and BNP offering 6.5 percent.


For more details and a rate-wise ranking check out the Table 1 given below :


Bank Name                                                    15-29 days (% p.a.)


Credit Agricole                                              9.25
Dresdner Bank                                                8
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Bank of Nova Scotia/Deutsche Bank                    7.5
Centurion / BNP                                              6.5
Commerz/Barclays                                             6
Bank of India                                                5.75


Dena Bank/GTB/IndusInd/Union Bank/Vijaya Bank 5.5
Punjab & Sindh Bank                                  5.3
SBI/Oriental Bank of Commerce / State Bank of
Indore/Canara Bank /Allahabad Bank                           5.25
IDBI Bank                                                    5.10


Note : Rates as on July 9, 2001
Source : Credence Analytics (India) Pvt. Ltd.,


The point to watch out for in a short-term deposit is the stability of the bank you are
trusting your money with. There have been incidents in the past of banks offering very
high rates on short-term money which means that the investment avenues they are
using for deploying your money may be riskier.


After the recent Madhavpura Bank scam, it will do you good to check the creditability of
the bank, by getting hold of the bank‟s annual report is possible. In case the report is not
available easily, try and check for the bank‟s performance through the bank‟s results,
which are usually published in the dailies as a mandatory law. The points to note are
the level of non-performing assets, the profitability and the background of the senior
officials of the banks.


The Medium Term (181 days – 1 year)


UTI Bank is offering the highest rate of 10% for a deposit of 6 months to 1 year. This is
followed closely by Development Credit Bank and Centurion Bank who are offering 9.75
percent for this period. HDFC bank, ICICI bank and HSBC are all offering 8.5 percent,
while some of the public sector banks like Bank of India and Bank of Baroda are offering
lower rates at 7.25 and 6.5 percent respectively.
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Apart from the rate, the thing to look out for is the penalty that is levied on you in case
you wish to withdraw the money before the contractual period. Most banks will levy a
prepayment penalty.      The prematurely withdrawn amount will earn between 0.5-1
percent lower rate, than the rate applicable for the period for which the deposit was
actually kept with the bank.


For greater details on the banks offering the best rates, check out the Table II below.


Bank Name                                                     181 days – 1 yr (% p.a.)


UTI Bank                                                              10
Development Credit Bank/Centurion Bank                        9.75
Bank of Punjab/Credit Llyonnais/GTB/Dresdner/                 9.5
Karnataka Bank


Credit Agricole /Commerz/IndusInd                             9.25
Amex/BNP/Karur Vysya                                                  9
Bank of Nova Scotia                                                   8.75
HDFC Bank/HSBC/ICICI Bank/IDBI Bank/Syndicate Bank 8.5
Vysya Bank /Stanchart Grindlays                                       8.25
Barclays Bank/State Bank of Hyderabad/State Bank of
Bikaner & Jaipur / Vijaya Bank/ UCO Bank/ Andhra Bank/
Allahabad Bank                                                        8.0
Notes : Rates as on July 09, 2001
Source: Credence Analytics (India) Pvt. Ltd.,


The Long Term (2-3 years)


Presuming that you wish to keep your money in a fixed deposit for a period of 2-3 years,
it will make sense to check, not only the rates but also the possibility of flexibility that a
fixed deposit can offer. Apart from the straight fixed deposit where liquidity of the money
is always an issue, some new private banks do offer flexi-deposits or sweep-in-accounts
where it is possible to get flexibility on your fixed deposit by moving money periodically
from your fixed deposit to your savings bank account.
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The most attractive rates on long term deposits are currently being offered by UTI bank
at 11 percent followed closely by Development Credit Bank at 10.75 percent. Dresdner
bank is offering 10.5 percent while GTB and Centurion are offering slightly lower at
10.25 percent. Most of the public sector banks are offering 9 percent.


To get more details on what the best rates are check the Table III given below


Bank Name                                                         2-3 yrs (%p.a.)


UTI Bank                                                                  11.00
Development Credit Bank                                                   10.75
Dresdner                                                                  10.50
GTB/Centurion                                                             10.25
Bank of Nova Scotia/State Bank of Saurasthra/State Bank of
Hyderabad/ Karur Vysya/Karnataka/ Indus Ind/Bank of Punjab                10.00
Commerz Bank/ Vysya Bank                                                   9.75
Vijaya Bank / BNP                                                          9.50
Andhra Bank/ICICI Bank/Credit Agricole/Barclays/State Bank
Of Mysore / State Bank of Bikaner and Jaipur/Syndicate Bank                9.25
Most public sector banks                                                   9.00
Citibank / HSBC                                                            8.75


Rates as on July 09, 2001
Source: Credence Analytics (India) Pvt. Ltd.,

								
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