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    • Archive for the 'Investments' Category


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    Before investing in Mutual Funds

    Posted by sushil on 1st July 2008

     

    MOST of us have an inner rebel. That’s why often fall for the guy mother warned us against. Or continue smoking even when told not to.

    So, it’s no wonder that when mutual fund advertisements worth millions of dollars, tell us to ‘Please read the offer document (OD) carefully before investing’, we still don’t! This is understandable; after all it’s a 100-page document filled with jargon. But in the long run, you will be the loser, if you don’t.

    The Securities and Exchange Board of India (SEBI) have even come out with an abridged version called the Key Information Memorandum, which stipulates standard sections and disclosures in all ODs.

    An OD is critical because it tells you whether your money is in the right hands, at the right place and at the right time. Your financial advisor will have a copy, and the company web site should have it online, too.

    If you still don’t want to read the whole document, take the easy way out. wealth scopes out 10 must-reads in the OD.

    1. Date of issue

    Verify that you have the latest edition of the OD (an OD must be updated once a year, at least).

    2. The minimum investment

    Mutual funds differ both in the minimum initial investment required, and the minimum for subsequent investments.

    For example, equity funds may stipulate Rs 5,000, while institutional premium liquid plans may stipulate Rs 10,000,000 (Rs 10 crore) as the minimum amount.

    3. Why invest

    The goal of each fund must be clearly defined, from income to long-term capital appreciation. You, the investor, must be sure that the fund’s objective matches with your’s.

    4. Investment policy

    An OD will outline general strategies implemented by the fund managers. You will learn what types of investments will be included, such as government bonds (with ratings) or stocks, considered appropriate. Be sure to check if it offers adequate diversification.

    5    . Risk factors

    Every investment involves some level of risk. Look for descriptions of the risks associated with investments in the fund (like credit risk, market risk or interest-rate risk) and decide if it matches your risk appetite.

    For example, a mutual fund Monthly Income Plan (MIP) invests mainly in bonds and gilts (up to 90 per cent) with a sprinkling of equity(10 per cent) to generate capital appreciation. This is passed on to customers as monthly income.

    But remember: it is subject to availability of distributable surplus. In 2004, many mutual fund customers underestimated this market risk and were caught by surprise when the MIPs gave low/negative returns.

    They may have been better off with a a Post Office MIP that assures an 8 per cent monthly income payment for its six-year tenure.

    6. Past record

    ODs contain selected per-share data, which includes the net asset value and total return for different time periods, since the fund’s inception.

    Performance data listed in an OD are based on standard formulae established by the SEBI and enable investors to make comparisons with other funds. So investors should check track records over a period of time that matches their own investment horizon but always remember that ‘past performance is not an indication of future performance’.

    Additionally, investors must check that the benchmark chosen by the fund to compare its relative performance is appropriate. In addition, investors should keep in mind that many of the returns presented in historical data don’t account for tax. They must look at any fine print in these sections, as they should say whether or not taxes have been taken into account.

     

    Posted in Investments, Mutual Funds | 1 Comment »

    How to manage,withdraw,transfer money from Provident Fund

    Posted by sushil on 24th June 2008

    By transferring your PF account and eschewing withdrawals every time you shift jobs, you can add more to your retirement funds.

    You are about to take up an exciting new job. Even as you say warm goodbyes to your present colleagues, attend farewell parties and take away your personal belongings from your office drawers, are you leaving behind a lifelong friend? The Employees’ Provident Fund (EPF) account often gets left behind in the old workplace and gets ignored in the euphoria of new jobs. Often our attention it drawn to it only when the gentleman from the accounts department in the new workplace calls up for details to route the fresh provident fund deductions.

    Unlike tax deductions that get influenced by, among other things, tax saving investments or expenses, and, therefore, remain within your sight, contribution to the provident fund (PF) account gets deducted before you get your paycheque. As a result, it often gets ignored even as it silently builds up a corpus for your retirement thanks to contributions by you and your employer that can be up to 12 per cent of your salary (constituting of basic, dearness allowance and retaining allowance, if any).

    In many cases, when people change jobs, they end up ignoring money lying in existing PF accounts and open fresh ones without transferring money from the older one. Eventually, after some more job switches, the older accounts fall off people’s mental radars.

    Your PF account is portable and can be continued with during your whole career despite any number of job changes (see A Number To Give You Company). You can turn it into a lifelong friend, much like the pug in a popular mobile phone service provider’s advertisement.

    Let the PF account be an uninterrupted effort to have a large corpus. However, if the need is great, you can also partially or fully withdraw money. This can happen in instances when you expect to be under a spell of prolonged unemployment, a transition to self-employment where you would want to continue with your retirement accumulation efforts or have no other option but to tap a part of this money to meet requirements such as those for kids’ higher education, health expenses or building a house.

    Here is a guidemap on how to transfer your provident fund account or withdraw money from it either partially or in full.

    TRANSFERRING THE ACCOUNT

    When you move to a new job, your EPF account does not get transferred with you automatically. You have to ask your previous PF office, which maintained your account, to transfer it. You need to fill up Form 13 (available at www.epfindia.com) and give it your present employer along with your EPF account number with the previous employer.

    You can get your account number from the HR or administration of your previous organisation. The number is a function of your employee code, the PF regional office with which the account is maintained and your employer’s PF code.

    After your present organisation gets these details, it adds your current account number and submits the form to the regional office with which your previous employer maintains the account.

    Pension. Your EPF not only offers you a lump sum during retirement, but also pension for life. Of the 12 per cent of your salary that your employer contributes to the account, 8.33 per cent gets diverted to the Employees Pension Scheme, which offers a defined benefit at the age of 58 years. This 8.33 per cent contribution, however, is made till your basic salary is Rs 6,500 per month. Therefore, when you diligently transfer your PF account after every job switch, you secure a source of regular retirement income.

    ENCASHMENT

    To encash your PF money, you need to fill up Form 19 and submit it to your previous employer. The PF office lets you withdraw the entire amount on medical grounds, voluntary retirement and unemployment for more than two months. The mandatory break of two months for withdrawal is often circumvented by submission for the claims once two months have passed after a change of organisation. Women employees who leave their job to get married do not need to wait for two months.

    In addition to Form 19, you also need to fill up Form 10C, which lets you withdraw the pension money that your employer contributes. However, if you do not wish to withdraw your pension money, you have the option of obtaining a scheme certificate through the same form which continues your pension account even as you encash your PF money. So, you can submit the scheme certificate in the next organisation that you join and carry forward your pension account.

    Since the system is fraught with loopholes and making a full withdrawal is just a matter of submitting an application two months after quitting a job, there are plenty of cases of people taking out their money. However, with the plan of having Social Security Numbers (SSN) in the pipeline, it may be that there will be just one account number that will move across jobs, and then withdrawals may not be that simple.

    Claim timeline. A claim is mandated to be paid within 30 days of being registered with the PF office. If this 30-day deadline is not met, your PF office is liable to pay you penal interest on the claim amount at the rate of 12 per cent per annum. This will be paid from the salary of the regional PF commissioner.

    PARTIAL WITHDRAWAL

    It is a good idea to not encash your account, but the scheme does provide for partial withdrawals in case of emergencies. You can withdraw for many purposes like housing, medical emergencies, marriage of self or children, and college education of children. However, there are certain restrictions with every kind of withdrawal. To take out money for housing, for instance, you need to be a member of the EPFO for at least five years and the maximum amount you can withdraw is the basic plus DA for 36 months, or your and your employer’s share for 36 months, or the cost of construction, whichever is the lowest.

    It is easy to spend on present consumption and forego accumulation for the future in the form of EPF money, which will give you both a lump sum and pension. It will serve you well to not take a myopic view. Stay invested in it and lug it everywhere you go as it can give you some respite in the second innings of your life.

    A NUMBER TO GIVE YOU COMPANY

    The 13-digit Social Security Number (SSN) the Employees’ Provident Fund Organisation (EPFO) is working on will be unique to every employee and make the EPF account portable. Says A. Viswanathan, chairman, EPFO: “You can show your SSN to your new employer and he will then contribute to the same account.” Transfer of account and creation of a new number will not be needed with job changes.

    This will check undue withdrawals and ensure accumulation of fund. Complete withdrawals are allowed after an unemployment period of two months. Many people withdraw their EPF money two months after leaving an organisation and do not give details of the new employer. A person can be tracked by the PF office only through his employer and different organisations assign different EPF numbers to him, so it is not possible to detect such withdrawals.

    The EPFO is planning a smart card that is likely to have details of all the EPF contributions made so that a person can easily find out how much he had contributed at any given point of time. Says Viswanathan: “We didn’t make it alphanumeric or adopt the PAN because we wanted to eventually upgrade it so that people will just have to punch in their number to get information. Besides, PAN could have been difficult to procure for people with lower incomes.”

    So, SSNs have been generated for 3.4 million of 45 million EPFO members. For now, you will have to fill up an SSN form at the time of withdrawing money and, eventually, new entrants will have to fill up the SSN form. The EPFO is still not ready to give a deadline to the operation.

    Posted in Investments, Personal Finance | No Comments »

    Benefits of ELSS investments

    Posted by sushilgirdher on 23rd June 2008

    Taxing times are here again. For most of us, this would mean parking more money in PPF or NSC to earn tepid returns, just to claim the tax break. This year, if you are looking to save tax and earn relatively higher returns, we suggest you take a look at Equity Linked Saving Schemes (ELSS). Coupled with other benefits such as shorter lock-in periods and tax-free dividends, the ELSS is definitely worth a slice of your Section 80C investments.

    WHY ELSS?

    ELSS is like any other diversified equity fund but investors can avail tax benefits, provided the investment is locked-in for a period of three years. How do these schemes stack up against other instruments permitted for tax planning?

    The best performing ELSS scheme gave a three-year return of 64.5 per cent, while the worst performer in the period gave a return of 19.88 per cent. The eight per cent return from PPF and NSC hardly compare. ELSS scores on the liquidity front too, with a lower lock-in of three years compared to the PPF’s 15 years and six years of the NSC.

    Unlike assured return schemes, ELSS does not guarantee returns, but if you are comfortable with taking a moderate risk for higher returns, ELSS is just the product for you.

    WHICH ELSS?

    Outlook Money offers you a shortlist for selecting the ELSS that is ideal for you. While the category as a whole has given impressive returns, we have selected five schemes that are definite candidates in any selection process. To remove period bias from the return, rolling returns were considered to shortlist these schemes. Other factors such as portfolio composition and risk-adjusted return (RAR) were considered to ensure that the risk is lower.

    Franklin India Taxshield. This scheme, which has given steady returns since its inception, makes the grade on consistency. It is suitable for investors who are not looking for fireworks in their returns and are uncomfortable with volatility. It has a comparatively lower exposure to mid-caps and that explains the lower returns of 34.49 per cent that the fund has generated in the three-year period as compared to its peers. There is a high degree of concentration in the portfolio with the top five holdings constituting a huge 29.76 per cent and the top three sectors constituting almost 50 per cent of the portfolio. This exposes the scheme to the risk of under-performance by these companies/sectors.

    HDFC Taxsaver. This is a star performer from the HDFC stable. In the one-year and three-year periods, its returns were 33.92 per cent and 51.70 per cent, respectively.

    The scheme has a large-cap focus with the flexibility to move to other segments. This has helped the scheme generate good returns in most scenarios. It has a new fund manager and it remains to be seen if the fund will continue its past excellence.

      Principal Tax Savings Fund. Principal tax saving scheme has rewarded investors with returns of 43.87 per cent, 41.99 per cent and 48.59 per cent, over one, three and five years, respectively.

      The fund has consistently outperformed the category average by a wide margin since the portfolio was recast in 2004-05 to have greater exposure to mid- and small-cap stocks. Holding in individual companies do not exceed five per cent and top five companies constitute only 22 per cent of the now diversified portfolio. The smaller size of the fund, at around Rs 176, crore makes for easier implementation of fund management strategies.

    Prudential ICICI Taxplan. This is the scheme for you if you are comfortable with higher risk for higher returns. With a portfolio that has more than 90 per cent in small- and mid-cap stocks, the fund gave excellent returns in 2004 and 2005 when these sectors outperformed the broader markets.

    The fund returned 44.95 per cent in the last three years and 51.90 per cent in the last five years. With a one-year return of 25.92 per cent, the scheme has under-performed due to the poor run that the mid- and small-caps have had in the last six months.

    The corpus of Rs 574 crore makes it one of the larger schemes. Finding avenues in the mid- and small-cap segment to deploy funds may become an issue.

    SBI Magnum Tax Gain Scheme 93. This scheme finds a place in the best tax savings schemes on the strength of its outstanding performance in the last two years. The scheme turned the corner in 2003, with a shift in focus to mid-cap stocks, and has since outperformed the benchmark as well as peers by a wide margin. It has given returns of 44.55 per cent, and 64.51 per cent in one- and three-year periods.

    The fund has now reduced mid-caps and increased large-cap stocks in the portfolio though mid-caps continue to have a dominant share. The scheme is suitable for investors comfortable with some volatility in returns.

    The growth in the corpus, which stood at Rs 1,163 crore in December 2006, makes the fund less nimble, especially when investing in mid- and small-cap stocks, and the change in the management team since last year are triggers that the investor must watch out for.

    WHEN TO BUY ELSS?

    Timing entry into these schemes to take advantage of dividend declarations or lower NAVs when markets fall is not a sustainable strategy. Ideally, use systematic investment plans (SIPs) as they work to your advantage in a volatile market and a small investment made periodically is less heavy on the pocket than a lump sum one-time investment. Most SIPs can be started with an initial investment of Rs 5,000 and periodic investment of Rs 500.

    ELSS provides the booster in returns to your tax planning. The ELSS, with its three-year lock-in, imposes a long-term investing discipline. However, the lock-in also has a flip side. If you make a wrong selection, you do not have an exit option for three years. This is where an existing scheme scores over a new fund offer as it gives you an idea of the efficiency of the fund management in good and bad markets.

    The road ahead for your tax investments is clear. Evaluate and select a scheme, start an SIP, and have a well-balanced tax-planning portfolio.

    Posted in Equity, Investments, Personal Finance | No Comments »

    IPO Glossary and Terms

    Posted by sushilgirdher on 19th June 2008

    What is the difference between public issue and private placement?

    When an issue is not made to only a select set of people but is open to the general public and any other investor at large, it is a public issue. But if the issue is made to a select set of people, it is called private placement. As perCompanies Act, 1956, an issue becomes public if it results in allotment to 50persons or more. This means an issue can be privately placed where an allotment is made to less than 50 persons.

    What is an Initial Public Offer (IPO)?

    An Initial Public Offer (IPO) is the selling of securities to the public in the primary market. It is when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public. This paves way for listing and trading of the issuer’s securities. The sale of securities can be either through book building or through normal public issue.

    Who decides the price of an issue?

    Indian primary market ushered in an era of free pricing in 1992. Following this, the guidelines have provided that the issuer in consultation with Merchant Banker shall decide the price. There is no price formula stipulated by SEBI. SEBI does not play any role in price fixation. The company and merchant banker are however required to give full disclosures of the parameters which they had considered while deciding the issue price. There are two types of issues, one where company and Lead Merchant Banker fix a price (called fixed price) and other, where the company and the Lead Manager (LM) stipulate a floor price or a price band and leave it to market forces to determi ne the final price (price discovery through book building process).

    What does ‘price discovery through Book Building Process’ mean?

    Book Building is basically a process used in IPOs for efficient price discovery. It is a mechanism where, during the period for which the IPO is open, bids are collected from investors at various prices, which are above or equal to the floor price. The offer price is determined after the bid closing date.

    What is the main difference between offer of shares through book building and offer of shares through normal public issue?

    Price at which securities will be allotted is not known in case of offer of shares through Book Building while in case of offer of shares through normal public issue, price is known in advance to investor. Under Book Building, investors bid for shares at the floor price or above and after the closure of the book building process the price is determined for allotment of shares. In case of Book Building, the demand can be known everyday as the book is being built. But in case of the public issue the demand is known at the close of the issue.

    What is Cut-Off Price?

    In a Book building issue, the issuer is required to indicate either the price band or a floor price in the prospectus. The actual discovered issue price can be any price in the price band or any price above the floor price. This issue price is called “Cut-Off Price”. The issuer and lead manager decides this after considering the book and the investors’ appetite for the stock.

    What is the floor price in case of book building?

    Floor price is the minimum price at which bids can be made.

    What is a Price Band in a book built IPO?

    The prospectus may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20%. In other words, it means that the cap should not be more than 120% of the floor price. The price band can have a revision and such a revision in the price band shall be widely disseminated by informing the stock exchanges, by issuing a press release and also indicating the change on the relevant website and the terminals of the trading members participating in the book building process. In case the price band is revised, the bidding period shall be extended for a further period of three days, subject to the total bidding period not exceeding ten days.

    Who decides the Price Band?

    It may be understood that the regulatory mechanism does not play a role in setting the price for issues. It is up to the company to decide on the price or the price band, in consultation with Merchant Bankers.

    What is minimum number of days for which a bid should remain open during book building?

    The Book should remain open for a minimum of 3 days.

    Can open outcry system be used for book building?

    No. As per SEBI, only electronically linked transparent facility is allowed to be used in case of book building.

    Can the individual investor use the book building facility to make an application?
    Yes.

    How does one know if shares are allotted in an IPO/offer for sale? What is the timeframe for getting refund if shares not allotted?

    As per SEBI guidelines, the Basis of Allotment should be completed with 15 days from the issue close date. As soon as the basis of allotment is completed, within 2 working days the details of credit to demat account / allotment advice and despatch of refund order needs to be completed. So an investor should know in about 15 days time from the closure of issue, whether shares are allotted to him or not.

    How long does it take to get the shares listed after issue?

    It would take around 3 weeks after the closure of the book built issue.

    What is the role of a ‘Registrar’ to an issue?

    The Registrar finalizes the list of eligible allottees after deleting the invalid applications and ensures that the corporate action for crediting of shares to the demat accounts of the applicants is done and the dispatch of refund orders to those applicable are sent. The Lead Manager coordinates with the Registrar to ensure follow up so that that the flow of applications from collecting bank branches, processing of the applications and other matters till the basis of allotment is finalized, dispatch security certificates and refund orders completed and securities listed.

    Does NSE provide any facility for IPO?

    Yes. NSE’s electronic trading network spans across the country providing access to investors in remote areas. NSE decided to offer this infrastructure for conducting online IPOs through the Book Building process. NSE operates a fully automated screen based bidding system called NEAT IPO that enables trading members to enter bids directly from their offices through a sophisticated telecommunication network.

    Book Building through the NSE system offers several advantages:

    ?The NSE system offers a nation wide bidding facility in securities ?It provide a fair, efficient & transparent method for collecting bids using the latest electronic trading systems Costs involved in the issue are far less than those in a normal IPO
    The system reduces the time taken for completion of the issue process
    The IPO market timings are from 10.00 a.m. to 3.00 p.m. On the last day of the IPO, the session timings can be further extended on specific request by the Book Running Lead Manager.

    What is a Prospectus?

    A large number of new companies float public issues. While a large number of these companies are genuine, quite a few may want to exploit the investors. Therefore, it is very important that an investor before applying for any issue identifies future potential of a company. A part of the guidelines issued by SEBI (Securities and Exchange Board of India) is the disclosure of information to the public. This disclosure includes information like the reason for raising the money, the way money is proposed to be spent, the return expected on the money etc. This information is in the form of ‘Prospectus’ which also includes information regarding the size of the issue, the current status of the company, its equity capital, its current and past performance, the promoters, the project, cost of the project, means of financing, product and capacity etc. It also contains lot of mandatory information regarding underwriting and statutory compliances. This helps investors to evaluate short term and long term prospects of the company.

    What does ‘Draft Offer document’ mean?

    ‘Offer document’ means Prospectus in case of a public issue or offer for sale and Letter of Offer in case of a rights issue which is filed with the Registrar of Companies (ROC) and Stock Exchanges (SEs). An offer document covers all the relevant information to help an investor to make his/her investment decision.
    ‘Draft Offer document’ means the offer document in draft stage. The draft offer documents are filed with SEBI, atleast 21 days prior to the filing of the Offer Document with ROC/SEs. SEBI may specify changes, if any, in the draft Offer Document and the issuer or the lead merchant banker shall carry out such changes in the draft offer document before filing the Offer Document with ROC/SEs. The Draft Offer Document is available on the SEBI website for public comments for a period of 21 days from the filing of the Draft Offer Document with SEBI.

    What is an ‘Abridged Prospectus’?

    ‘Abridged Prospectus’ is a shorter version of the Prospectus and contains all the salient features of a Prospectus. It accompanies the application form of public issues.

    Who prepares the ‘Prospectus’/‘Offer Documents’?

    Generally, the public issues of companies are handled by ‘Merchant Bankers’ who are responsible for getting the project appraised, finalizing the cost of the project, profitability estimates and for preparing of ‘Prospectus’. The ‘Prospectus’ is submitted to SEBI for its approval.

    What does one mean by ‘Lock-in’?

    ‘Lock-in’ indicates a freeze on the sale of shares for a certain period of time.
    SEBI guidelines have stipulated lock-in requirements on shares of promoters mainly to ensure that the promoters or main persons, who are controlling the company, shall continue to hold some minimum percentage in the company after the public issue.

    What is meant by ‘Listing of Securities’?

    Listing means admission of securities of an issuer to trading privileges (dealings) on a stock exchange through a formal agreement. The prime objective of admission to dealings on the exchange is to provide liquidity and marketability to securities, as also to provide a mechanism for effective control and supervision of trading.

    What is a ‘Listing Agreement’?

    At the time of listing securities of a company on a stock exchange, the company is required to enter into a listing agreement with the exchange. The listing agreement specifies the terms and conditions of listing and the disclosures that shall be made by a company on a continuous basis to the exchange.

    What does ‘Delisting of securities’ mean?

    The term ‘Delisting of securities’ means permanent removal of securities of a listed company from a stock exchange. As a consequence of delisting, the securities of that company would no longer be traded at that stock exchange.

    What is SEBI’s Role in an Issue?

    Any company making a public issue or a listed company making a rights issue of value of more than Rs 50 lakh is required to file a draft offer document with SEBI for its observations. The company can proceed further on the issue only after getting observations from SEBI. The validity period of SEBI’s observation letter is three months only i.e. the company has to open its issue within three months period.

    Does it mean that SEBI recommends an issue?

    SEBI does not recommend any issue nor does take any responsibility either for the financial soundness of any scheme or the project for which the issue is proposed to be made or for the correctness of the statements made or opinions expressed in the offer document. SEBI mainly scrutinizes the issue for seeing that adequate disclosures are made by the issuing company in the prospectus or offer document.

    Does SEBI tag make one’s money safe?

    The investors should make an informed decision purely by themselves based on the contents disclosed in the offer documents. SEBI does not associate itself with any issue/issuer and should in no way be construed as a guarantee for the funds that the investor proposes to invest through the issue. However, the investors are generally advised to study all the material facts pertaining to the issue including the risk factors before considering any investment. They are strongly warned against relying on any ‘tips’ or news through unofficial means.

    Foreign Capital Issuance

    Can companies in India raise foreign currency resources?

    Yes. Indian companies are permitted to raise foreign currency resources through two main sources: a) issue of foreign currency convertible bonds more commonly known as ‘Euro’ issues and b) issue of ordinary shares through depository receipts namely ‘Global Depository Receipts
    (GDRs)/American Depository Receipts (ADRs)’ to foreign investors i.e. to the institutional investors or individual investors.

    What is an American Depository Receipt?

    An American Depositary Receipt (”ADR”) is a physical certificate evidencing ownership of American Depositary Shares (”ADSs”). The term is often used to refer to the ADSs themselves.

    What is an ADS?

    An American Depositary Share (”ADS”) is a U.S. dollar denominated form of equity ownership in a non-U.S. company. It represents the foreign shares of the company held on deposit by a custodian bank in the company’s home country and carries the corporate and economic rights of the foreign shares, subject to the terms specified on the ADR certificate. One or several ADSs can be represented by a physical ADR certificate. The terms ADR and ADS are often used interchangeably. ADSs provide U.S. investors with a convenient way to invest in overseas securities and to trade non-U.S. securities in the U.S. ADSs are issued by a depository bank, such as JPMorgan Chase Bank. They are traded in the same manner as shares in U.S. companies, on the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX) or quoted on NASDAQ and the over-the-counter (OTC) market. Although ADSs are U.S. dollar denominated securities and pay dividends in U.S. dollars, they do not eliminate the currency risk associated with an investment in a non-U.S. company.

    What is meant by Global Depository Receipts?
    Global Depository Receipts (GDRs) may be defined as a global finance vehicle that allows an issuer to raise capital simultaneously in two or markets through a global offering. GDRs may be used in public or private markets inside or outside US. GDR, a negotiable certificate usually represents company’s traded equity/debt. The underlying shares correspond to the GDRs in a fixed ratio say 1 GDR=10 shares.

    Source:-NCFM

    Posted in Equity, Investments | No Comments »

    All about IPO (Initial Public Offering)

    Posted by sushil on 18th June 2008

    Many times we come across some blog, information or news about new IPO and urging people to go for it. A number of investors, especially, beginners do not know What is an IPO at all? what are the benefits or demerits of going for IPOs. What are the term used? They want to know about listing process, book building process etc. Here we tried to put all this information in questions and answers form. Hope it comes out to be useful for all.

    1 What is an IPO?

    An IPO is defined as an exercise when an unlisted company makes either a fresh issue of securities or an offer for sale of its existing securities or both for the first time to the public.

    The exercise refers the issue of shares to the public by the promoters of the company. The shares are made available to the investors at the face value of the share or with a premium as per the perceived market value of the share by the promoters.

    The IPO can be in the form of a fixed price portion or in the form of a book building portion. The IPO paves way for listing and trading of the issuer’s securities.

    2 What are primary/secondary market transactions?

    Primary market transaction is usually referred to the purchase of shares in an IPO. The purchases are made through applications for the shares on a prescribed form. Once the shares are allotted, the share transactions are carried out in secondary market or stock exchanges.

    Secondary market transactions refer to those transactions under which an investor purchases shares from another investor at the prevailing market price or at whatever price the buyer and seller agrees upon.

    The primary and secondary markets are governed by a regulatory authority Security and Exchange Board of India (SEBI).

    3 What are eligibility norms for making an IPO?

    SEBI has laid down eligibility norms for entities planning to enter the primary market through public issues. An unlisted company needs to satisfy following criteria to be eligible for making a public issue:

    • Net tangible assets of at least Rs 3 crore for three full years
    • Distributable profits in at least three years
    • Net worth of at least Rs 1 crore in three years
    • If change in name, at least 50 per cent of revenue for preceding one year should be from the new activity
    • The issue size should not exceed five times the pre-issue net worth

    SEBI also provides alternate routes to the companies not satisfying any of the above parameters, for accessing the primary market.

    The alternative conditions are as follows:

    • Issue shall be made through book-building route, with at least 50 per cent to be mandatory allotted to the QIBs.
    • The minimum post-issue face value capital shall be Rs 10 crore or there shall be a compulsory market-making for at least two years.

    4 How can one apply for an IPO?

    An investor needs to first obtain an IPO application form through a share broker, an investment consultant or from the collecting banks. The investors are required to fill up the form and remit the amount after calculating the number of shares applied for in the bank, which has been designated as a collecting centre for the particular IPO.

    An investor holding a demat account can either apply for the shares directly through the account or can opt for physical delivery of share certificates. There are certain IPOs, which offer only demat form of shares, while others offer both the demat and regular shares. Application forms can be rejected due to incomplete details.

    Every week SEBI issues press releases for information of the public, details of offer documents filed with SEBI and observations issued. The required details can be obtained from the ‘Primary Market’ section of the SEBI website. The draft offer document can also be purchased from the SEBI office. The draft offer document/letter of offer remains posted on SEBI website for a period of 21 days from the date of filing the same to SEBI and can also be downloaded from there.

    Application forms can also be obtained from the lead manager and brokers to the issue. The application forms are also generally available at collecting bankers. Name and addresses of the lead manager are available in the prospectus/letter of offer.

    5 What is book-building process?

    SEBI guidelines defines book building as “a process undertaken by which a demand for the securities proposed to be issued by a body corporate is elicited and built up and the price for the securities is assessed on the basis of the bids obtained for the quantum of securities offered for subscription by the issuer”.

    This process provides an opportunity to the market to discover price for the securities on offer. In common words, book building is a method for public offer of equity shares of a company. The process is named so because it refers to collection of bids from investors, which is based on a price range. The issue price is fixed after the closing date of the bid.

    A company planning an IPO appoints a merchant bank as a book runner. Then the company issues a prospectus that does not mention the price, but provides other details related to the issue size, the company’s operating area and business, the promoters and future plans among other disclosures.
    A particular time frame is also fixed as the bidding period. Then the book runner builds an order book that collates bids from various investors. Potential investors are allowed to revise their bids at any time during the bidding period.

    At the end of bidding period the order book is closed and consequently the quantum of shares ordered and the respective prices offered are known. The calculation of final price is based on demand at various prices and also involves negotiations between those involved in the issue.

    The book runner and the company finalise the pricing and allocation to each syndicate member.

    6 What is the main difference between a book-building route and the normal public issue?

    Unlike the book-building route, the price is known in advance to investors in case of offer of shares through normal public issue. On the other hand, the demand can be known everyday as the book is built in case of book building, which demand is not known until the close of the issue in case of the normal public issue.

    7 What is the minimum number of days for which a bid should remain open in book building?

    Book should remain open for a minimum of five days.

    8 Can open outcry system be used for book building?

    No. As per SEBI, only electronically linked transparent facility is allowed to be used in case of book building.

    9 Is the issue price for placement portion and net offer to public the same?

    Yes.

    10 What is the floor price in case of book building?

    Floor price is the minimum price at which bids can be made. The issuer company in consultation with the book-running lead manager fixes the floor price.

    11 Can the individual investor use book building facility for making an application?

    Yes.

    12 Can the bidder revise his bids?
    Yes.
     
     

     

    13 What proof can a bidder request from a trading member for entering bids?

    A bidder can request for a transaction registration slip as proof of his/her having entered the bid. Whenever a bid is entered by trading members into the system, a unique transaction registration slip is automatically generated. Transaction registration slip gives details regarding number of shares bid for, price, the client name among other details.

    14 Is it possible to enter bids less than floor price?

    No. The system automatically rejects the bids if price is less than floor price.

    15 Are there any restrictions on pricing by companies?

    The companies can freely price their equity shares. However they have to give justification of the price in the offer document.

    16 Who are syndicate members?

    Syndicate members are the intermediaries registered with the board and permitted to carry on activity as underwriters. The book-running lead managers to the issue appoint the syndicate members.

    17 What is an order book?

    It is an ‘electronic book’ that shows the demand for the shares of the company at various prices.

    18 What is a red herring prospectus?

    A red herring prospectus (RHP) is a preliminary registration statement that must be filed with the regulatory authority describing the IPO and the prospects of the issuing company. There is no price or issue size stated in the red herring, and it is sometimes updated several times before being called the final prospectus.

    It is known as a red herring because it contains a passage in red that states the company is not attempting to sell their shares before the registration is approved by the regulatory authority.

    19 What is the difference between an offer document, an RHP, a prospectus and an abridged prospectus? What is a “draft offer doc”?

    “Offer document” means a prospectus in the case of a public issue or offer for sale which is filed with Registrar of Companies (RoC) and the stock exchanges. An offer document covers all the relevant information required to help an investor to make his/her investment decision.

    “Draft offer document” refers to an offer document in a draft stage. The draft offer documents are filed with SEBI at least 21 days prior to the filing of the offer document with the registrar and the exchanges. SEBI may specify necessary changes in the draft offer document and the issuer or the lead merchant banker is required to implement changes in the draft offer document before filing the offer document. The draft offer document is available on the SEBI website for public comments for a period of 21 days from the filing of the draft offer document with SEBI.

    A red herring prospectus does not have details of either price or the number of shares being offered or the amount of issue. However, this prospectus mentions the number of shares and the upper and lower price bands. An issuer can also state that the issue size and the number of shares would be determined later. In case of a book-built issues, RHP is a process of price discovery and the price cannot be determined until the bidding process is completed. Hence, such details are not shown in the RHP filed with the RoC. Only on completion of the bidding process, the details of the final price are included in the offer document.

    The offer document filed thereafter with ROC is called a prospectus. “Abridged prospectus” refers to a prospectus that contains all the salient features of a prospectus. It accompanies the application form of public issues.
    20 What does one mean by ‘lock-in’?

    Lock-in refers to a freeze on the shares. SEBI guidelines have stipulated lock-in requirements on shares of promoters primarily to ensure that the promoters, who are controlling the company, shall continue to hold some minimum percentage in the company after the public issue.

    21 Who is a promoter?

    The promoter is defined as a person (or persons, as the case may be) who is in over-all control of the company, is instrumental in the formulation of a plan or programme pursuant to which the securities are offered to the public and who is named in the prospectus as promoter. A director/officer of the issuer company or person, if they are acting as such merely in their professional capacity are not be included in the definition of a promoter.

    ‘Promoter group’ includes the promoter, an immediate relative of the promoter (i.e. spouse of that person, or any parent, brother, sister or child of the person or of the spouse).

    In case the promoter is a company, a subsidiary or holding company of that company; any company in which the promoter holds 10 per cent or more of the equity capital or which holds 10 per cent or more of the equity capital of the promoter; any company in which a group of individuals or companies or combinations thereof who holds 20 per cent or more of the equity capital in that company also holds 20 per cent or more of the equity capital of the issuer company.

    22 What are the requirements regarding promoter’s contribution and lock-in?

    In case of an IPO, the promoters have to necessarily offer at least 20 per cent of the post issue capital. In case of public issues by listed companies, the promoters shall participate either to the extent of 20 per cent of the proposed issue or ensure post-issue share holding to the extent of 20 per cent of the post-issue capital.

    In case of any issue of capital to the public the minimum contribution of promoters shall be locked in for a period of three years, both for an IPO and public issue by listed companies. In case of an IPO, if the promoters’ contribution in the proposed issue exceeds the required minimum contribution, such excess contribution shall also be locked in for a period of one year. In addition, the entire pre-issue share capital, or paid up share capital prior to IPO, and shares issued on a firm allotment basis along with issue shall be locked-in for a period of one year from the date of allotment in public issue.

    23 What is the basis of allotment?

    In case of over-subscription in a fixed price issue, the allotment is done in marketable lots and on a proportionate basis. In case of a book building issue, allotment to Qualified Institutional Buyers (QIBs) and Non-Institutional Buyers (NIBs) are done on a discretionary basis. Allotment to retail investors is done on a proportionate basis.

    After the closure of the issue, the bids received are aggregated under different categories, such as firm allotment, Qualified Institutional Buyers (QIBs), Non-Institutional Buyers (NIBs) and Retail Individual Investors. The oversubscription ratios are calculated for each of the categories as against the shares reserved for each of the categories in the offer document. Within each of these categories, the bids are segregated into different segments based on the number of shares applied for.

    The oversubscription ratio is then applied to the number of shares applied for and the number of shares to be allotted for applicants in each of the buckets is determined. Then, the number of successful allottees is determined. This process is followed in case of proportionate allotment. In case of allotment for QIBs, it is subject to the discretion of the post issue lead manager.

    24 Can the public give their comments/complaints on the issuer company or others connected with the issue?

    Yes, the objective of making offer document public is to invite public comments. The comments should be given within 21 days of the filing of the draft offer document with SEBI.

    25 Within how many days should an investor receive the refund order/allotment advise?

    The investor is entitled to receive a confirmatory allotment note (CAN) in case he has been allotted shares within 15 days from the date of closure of a book-built issue. The registrar has to ensure that the demat credit or refund as applicable is completed within 15 days of the closure of the book built issue.

    The refund orders/allotment advice is to be despatched within two working days of finalising the basis of allotment. Companies are required to finalise the basis of allotment within 30 days from the closure of the issue in case of a fixed price issue and within 15 days from the closure of the issue in case of a book building issue or else they are liable to pay interest at the rate of 15 per cent per annum

    26 In case of non-receipt of the refund order/share certificate/allotment advise, what is the course of action available to the investor?

    The investor should complain in writing to the lead manger/registrar/SEBI’s Investor Grievance Cell.

    27 Within how many days should the company get its securities listed after the issue?

    The post-issue lead manager ensures that all steps for completion of the necessary formalities for listing and commencement of trading at all stock exchanges where the securities are to be listed are taken within 7 working days of finalisation of basis of allotment.

    28 Is it mandatory to have a demat account for applying in public issue?

    An investor has the option to apply for and receive the shares in physical form. However, it is advisable to get the allotment in demat form as the shares in IPO shall be compulsorily tradable in demat segment in stock exchanges. In case of an IPO of any security of issue size of Rs 10 crore or more, security shall be issued only in dematerialised form.

    In book built issues, for QIBs and large investors (applying for more than 1,000 shares) allotment shall be only in demat form and hence they should have a demat account.

    29 What are greenshoe option and safety net?

    Greenshoe is an option that allows the underwriting syndicate of an IPO to sell additional shares to public if the demand is high.

    The name comes from the fact that Green Shoe Company was the first to issue this type of option.

    A safety net means investors who subscribe to the IPO of a company can sell those shares to the entity offering safety net at the IPO price. Safety net is actually a put option given to the investors, but not by the company issuing the shares. A put option gives the right but not the obligation to the investors to sell the stock to the entity offering the option at a particular price before a certain period.

    Any safety net scheme or buy-back arrangements of the shares proposed in any public issue shall be finalised by the issuer company with the lead merchant banker in advance and should be disclosed in the prospectus.

    30 What are fixed price offers?

    An issuer company is allowed to freely price the issue. The basis of issue price is disclosed in the offer document where the issuer discloses in detail about the qualitative and quantitative factors justifying the issue price. The issuer company can mention a price band of 20 per cent (cap in the price band should not be more than 20 per cent of the floor price) in the draft offer documents filed with SEBI and actual price can be determined at a later date before filing of the final offer document with SEBI/RoCs.

    31 What is a price band?

    The RHP may contain either the floor price for the securities or a price band within which the investors can bid. The spread between the floor and the cap of the price band shall not be more than 20 per cent. The price band can be revised also and any such revision is required to be widely disseminated by informing the stock exchanges, by issuing press release and also indicating the change on the relevant website and the terminals of the syndicate members.

    In case the price band is revised, the bidding period shall be extended for additional three days, subject to the total bidding period not exceeding thirteen days.

    32 Who decides the price band?

    The regulators do not play a role in setting the price for issues. The company decides the price or the price band in consultation with merchant bankers. The basis of issue price is disclosed in the offer document. The issuer is required to disclose in detail about the qualitative and quantitative factors justifying the issue price.

    33 What is firm allotment?

    A company making an issue to public is eligible to reserve some shares on ‘allotment on firm basis’ for certain categories. The shares to be allotted on ‘firm allotment category’ can be issued at a price different from the price at which the net offer to the public is made, provided that the price at which the security is being offered to the applicants in firm allotment category is higher than the price at which securities are offered to public.

    34 What is reservation on competitive basis?

    Reservation on competitive basis refers to allotment of shares made in proportion to the shares applied for by the concerned reserved categories. Reservation on competitive basis can be made in a public issue to the employees of the company, shareholders of the promoter companies in the case of a new company and shareholders of group companies in the case of an existing company, Indian mutual funds, foreign institutional investors (FIIs), Indian and multilateral development institutions and scheduled banks.

    In a book built issue allocation to Retail Individual Investors (RIIs), Non Institutional Investors (NIIs) and Qualified Institutional Buyers (QIBs) is in the ratio of 35: 15: 50 respectively.

    35 Is there any preference while doing the allotment?

    The allotment to the Qualified Institutional Buyers (QIBs) is made on a discretionary basis. The discretion is left to the merchant bankers who first disclose the parameters of judgment in the Red Herring Prospectus. The merchant bankers are free to set their criteria and mention the same in the Red Herring Prospectus.

    36 How is the Retail Investor defined as?

    Retail individual investor refers to an investor who applies or bids for securities of or for a value of not more than Rs.1,00,000.

    37 What is an e-IPO?

    A company can also issue capital to public through the online system of the stock exchange. The appointment of various intermediaries by the issuer includes a prerequisite that such members/registrars have the required facilities to accommodate such an online issue process.

    38 What is open book/closed book?

    In book-built issues issuers and merchant bankers are required to ensure online display of the demand and bids during the bidding period. This is known as open book system of book building. Under closed book building, the book is not made public and the bidders will have to take a call on the price at which they intend to make a bid without having any information on the bids submitted by other bidders.

    39 What is hard/soft underwriting?

    Hard underwriting refers to an exercise when an underwriter agrees to buy his commitment at its earliest stage. The underwriter guarantees a fixed amount to the issuer from the issue. If the shares are not subscribed by investors, the issue is devolved on underwriters and they have to bring in the amount by subscribing to the shares.

    Soft underwriting refers to a process when an underwriter agrees to buy the shares at later stages as soon as the pricing process is complete. Subsequently, he places those shares with institutional players. The soft underwriter also holds an option to invoke a force majeure (acts of God) clause in case there are certain factors beyond the control that can affect the underwriter’s ability to place the shares with the buyers.

    40 What is a cut-off price?

    In book-building issues, the issuer is required to indicate either the price band or a floor price in the Red Herring Prospectus. The actual issue price can be any price in the price band or any price above the floor price. This issue price is called “Cut off price”. This is decided by the issuer and lead managers after considering the book and investor demand for the stock.

    41 What is differential pricing?

    Pricing of an issue where one category is offered shares at a price different from the other category is called differential pricing. According to regulatory guidelines, differential pricing is allowed only if the securities to applicants in the firm allotment category are offered at a price higher than the price at which the net offer to the public is made.

    42 Who is qualified institutional buyer (QIBs)?

    QIBs are those institutional investors who are perceived to possess expertise and the financial strength to evaluate and invest in the capital markets. A QIB is defined as

    • Public financial institution as defined in section 4A of The Companies Act, 1956;
    • Scheduled commercial banks;
    • Mutual funds;
    • Foreign institutional investor registered with SEBI;
    • Multilateral and bilateral development financial institutions;
    • Venture capital funds registered with SEBI.
    • Foreign venture capital investors registered with SEBI.
    • State Industrial Development Corporations.
    • Insurance companies registered with the Insurance Regulatory and Development Authority (IRDA).
    • Provident Funds with minimum corpus of Rs 25 crores
    • Pension Funds with minimum corpus of Rs 25 crores

    43 Why go public?

    Usually it is not possible to buy shares in a private company. A potential investor can approach the owners, but they’re not obliged to sell any shares. However, public companies sell at least a portion of themselves to the public and they also trade on stock exchanges.

    Public companies have thousands of shareholders and are subject to strict rules and regulations. They must have a board of director and they must report financial information every quarter. Public companies are regulated by governing bodies. The stock is traded in the open market and any investor, who has got money, can invest in them. The CEO and the owner can not prevent an investor from buying stock.

    Going public provides an opportunity to raise cash for the companies, while opening many financial doors as well. Public companies can get better rates when they issue debts because of the increased scrutiny involved. A public company can always issue more stock, as long as there is market demand. Consequently, mergers and acquisitions become easier to execute as stock can be issued as part of the deal.

    (Source:-Economic Times)

    Posted in Equity, Investments | No Comments »

    A guide to Mutual Fund investment

    Posted by sushil on 14th June 2008

    Mutual funds can be broadly classified into two categories in terms of the fund management style i.e. actively managed funds and passively managed funds (popularly referred to as index funds).

    Actively managed funds are the ones wherein the fund manager uses his skills and expertise to select invest-worthy stocks from across sectors and market segments. The sole intention of actively managed funds is to identify various investment opportunities in the market in order to clock superior returns, and in the process outperform the designated benchmark index.

    On the contrary, passively managed funds/index funds are aligned to a particular benchmark index like the S&P CNX Nifty or the BSE Sensex. The endeavor of these funds is to mirror the performance of the designated benchmark index, by investing only in the stocks of the index with the corresponding allocation or weightage.

    In the Indian context, index funds have never really caught the retail investor’s fancy. This is in complete contrast to developed economies like the United States for instance wherein index funds form “staple diet” for retail investors. And the reasons for the same aren’t very difficult to guess.

    In the United States, stock markets are more efficient, so investment opportunities are at a premium and are relatively difficult to identify. Consequently, a number of actively managed funds fail to outperform the broader stock market. Also other factors like no loads and lower expenses further the cause of index funds.

    Furthermore, investing in index funds is less cumbersome as compared to investing in actively managed funds. Broadly speaking, investors need to consider two important aspects i.e. the expense ratio and the tracking error (i.e. the difference between the returns clocked by the designated index and index fund).

    Conversely, investing in actively managed funds demands a deeper review and understanding of the fund house’s investment philosophy; also the investor needs to decide on the kind of funds he wishes to invest in - a large cap/mid cap/small cap fund among others.

    In the Indian context, the mutual fund industry is dominated by actively managed funds; index funds occupy a smaller share of the market. Well-managed actively managed funds have been successful in outperforming index funds by a huge margin.

    This could be attributed to the fact that the Indian markets are still in an evolutionary phase and there exist a number of inefficiencies. These inefficiencies are in turn utilised by competent fund managers to outperform the index. This explains why many actively managed funds manage to outperform the index over the long-term (3-5 years).

    We conducted a study wherein we compared category averages of index funds (passive funds) with those of diversified equity funds (active funds), over varied time frames.

     

    The active-passive tradeoff

    Categories Average category returns
    1-Yr (%) 3-Yr (%) 5-Yr (%)
    Index funds 40.75 32.91 32.38
    Actively managed funds 29.05 38.37 41.05
    S&P CNX Nifty 39.50 30.96 30.32
    BSE Sensex 44.91 35.22 33.20

    (Source: Credence Analytics. NAV data as on February 8, 2007. Growth over 1-Yr is compounded annualised)

    The results are quite interesting. Over the 1-Yr time frame, index funds (40.75 per cent) aligned to the BSE Sensex have comfortably outscored diversified equity funds (29.05 per cent). However over longer time frames (3-Yr and 5-Yr), diversified equity funds have stolen the march over index funds powered by a strong showing. Over 3-Yr, diversified equity funds (38.37 per cent CAGR) have outperformed index funds (32.91 per cent CAGR). The degree of outperformance further widens over 5-Yr; diversified equity funds (41.05 per cent CAGR) fare better than index funds (32.38 per cent).

    In a nutshell, in the Indian context, index funds have proven their mettle over shorter time frames. It’s the opposite over longer time frames (3-5 years), where actively managed funds rule the roost.

    However the same should not be seen as a blanket recommendation for actively managed funds. Not all actively managed funds are invest-worthy and capable of generating superior returns vis-?-vis benchmark indices (passively managed funds).

    There are many laggards in the category as well who have failed to match the benchmark indices (in this case BSE Sensex). To substantiate this, we have outlined some non-performing actively managed funds (from diversified equity funds category), based on their performance over 3-Yr and 5-Yr (as these are the ideal time frames for evaluating equity funds).

    Laggards: 3-Yr CAGR

    Actively Managed Funds NAV (Rs) 3-Yr (%)
    LIC Equity Plan (G) 22.79 23.11
    Birla Div. Yield (G) 43.81 26.17
    UTI Mastershare (G) 36.23 28.76
    UTI Growth & Value (G) 60.87 29.27
    ING Vysya Equity (G) 31.61 29.52
    BSE Sensex 35.22
    		  Laggards: 5-Yr CAGR

    Actively Managed Funds NAV (Rs) 5-Yr (%)
    DBS Chola Opp. (G) 29.08 26.93
    LIC Equity Plan (G) 22.79 29.90
    UTI Mastershare (G) 36.23 30.14
    ING Vysya Stocks (G) 28.91 30.65
    Birla MNC (G) 128.26 34.71
    BSE Sensex 33.20

    (Source: Credence Analytics. NAV data as on February 8, 2007. CAGR - Compounded Annualised Growth Rate)

    Hence, investors would do well to understand that, though the actively managed funds category has delivered impressive performances over the long-term, there are duds within the category whose performance is nothing to write home about.

    This in turn, necessitates that investors add to their portfolios well-managed diversified equity funds with proven track records over longer time frames and market phases. Given the performance of diversified equity funds and how domestic markets are placed, risk-taking investors would do well to hold a larger portion of their portfolio in actively managed (diversified equity) funds. Index funds, on the other hand can occupy a smaller portion therein, but purely from a diversification perspective.

    (Source: Rediff.com/Getahead)

    Buddies, soon there will be a complete tutorial about Mutual Tunds. Dont miss that. Keep participating by posting comments and writing articles.

     

     

     

    Posted in Investments, Mutual Funds | No Comments »

    ULIPs Vs. Mutual Funds : Who’s better

    Posted by sushilgirdher on 11th June 2008

    Unit Linked Insurance Policies (ULIPs) as an investment avenue are closest to mutual funds in terms of their structure and functioning. As is the case with mutual funds, investors in ULIPs are allotted units by the insurance company and a net asset value (NAV) is declared for the same on a daily basis.

    Similarly ULIP investors have the option of investing across various schemes similar to the ones found in the mutual funds domain, i.e. diversified equity funds, balanced funds and debt funds to name a few. Generally speaking, ULIPs can be termed as mutual fund schemes with an insurance component.

    However it should not be construed that barring the insurance element there is nothing differentiating mutual funds from ULIPs.

    Despite the seemingly comparable structures there are various factors wherein the two differ.

    In this article we evaluate the two avenues on certain common parameters and find out how they measure up.

    1. Mode of investment/ investment amounts

    Mutual fund investors have the option of either making lump sum investments or investing using the systematic investment plan (SIP) route which entails commitments over longer time horizons. The minimum investment amounts are laid out by the fund house.

    ULIP investors also have the choice of investing in a lump sum (single premium) or using the conventional route, i.e. making premium payments on an annual, half-yearly, quarterly or monthly basis. In ULIPs, determining the premium paid is often the starting point for the investment activity.

    This is in stark contrast to conventional insurance plans where the sum assured is the starting point and premiums to be paid are determined thereafter.

    ULIP investors also have the flexibility to alter the premium amounts during the policy’s tenure. For example an individual with access to surplus funds can enhance the contribution thereby ensuring that his surplus funds are gainfully invested; conversely an individual faced with a liquidity crunch has the option of paying a lower amount (the difference being adjusted in the accumulated value of his ULIP). The freedom to modify premium payments at one’s convenience clearly gives ULIP investors an edge over their mutual fund counterparts.

    2. Expenses

    In mutual fund investments, expenses charged for various activities like fund management, sales and marketing, administration among others are subject to pre-determined upper limits as prescribed by the Securities and Exchange Board of India.

    For example equity-oriented funds can charge their investors a maximum of 2.5% per annum on a recurring basis for all their expenses; any expense above the prescribed limit is borne by the fund house and not the investors.

    Similarly funds also charge their investors entry and exit loads (in most cases, either is applicable). Entry loads are charged at the timing of making an investment while the exit load is charged at the time of sale.

    Insurance companies have a free hand in levying expenses on their ULIP products with no upper limits being prescribed by the regulator, i.e. the Insurance Regulatory and Development Authority. This explains the complex and at times ‘unwieldy’ expense structures on ULIP offerings. The only restraint placed is that insurers are required to notify the regulator of all the expenses that will be charged on their ULIP offerings.

    Expenses can have far-reaching consequences on investors since higher expenses translate into lower amounts being invested and a smaller corpus being accumulated. ULIP-related expenses have been dealt with in detail in the article “Understanding ULIP expenses”.

    3. Portfolio disclosure

    Mutual fund houses are required to statutorily declare their portfolios on a quarterly basis, albeit most fund houses do so on a monthly basis. Investors get the opportunity to see where their monies are being invested and how they have been managed by studying the portfolio.

    There is lack of consensus on whether ULIPs are required to disclose their portfolios. During our interactions with leading insurers we came across divergent views on this issue.

    While one school of thought believes that disclosing portfolios on a quarterly basis is mandatory, the other believes that there is no legal obligation to do so and that insurers are required to disclose their portfolios only on demand.

    Some insurance companies do declare their portfolios on a monthly/quarterly basis. However the lack of transparency in ULIP investments could be a cause for concern considering that the amount invested in insurance policies is essentially meant to provide for contingencies and for long-term needs like retirement; regular portfolio disclosures on the other hand can enable investors to make timely investment decisions.

    ULIPs vs Mutual Funds

      ULIPs Mutual Funds

    * There is lack of consensus on whether ULIPs are required to disclose their portfolios. While some insurers claim that disclosing portfolios on a quarterly basis is mandatory, others state that there is no legal obligation to do so.

    4. Flexibility in altering the asset allocation

    As was stated earlier, offerings in both the mutual funds segment and ULIPs segment are largely comparable. For example plans that invest their entire corpus in equities (diversified equity funds), a 60:40 allotment in equity and debt instruments (balanced funds) and those investing only in debt instruments (debt funds) can be found in both ULIPs and mutual funds.

    If a mutual fund investor in a diversified equity fund wishes to shift his corpus into a debt from the same fund house, he could have to bear an exit load and/or entry load.

    On the other hand most insurance companies permit their ULIP inventors to shift investments across various plans/asset classes either at a nominal or no cost (usually, a couple of switches are allowed free of charge every year and a cost has to be borne for additional switches).

    Effectively the ULIP investor is given the option to invest across asset classes as per his convenience in a cost-effective manner.

    This can prove to be very useful for investors, for example in a bull market when the ULIP investor’s equity component has appreciated, he can book profits by simply transferring the requisite amount to a debt-oriented plan.

    5. Tax benefits

    ULIP investments qualify for deductions under Section 80C of the Income Tax Act. This holds good, irrespective of the nature of the plan chosen by the investor. On the other hand in the mutual funds domain, only investments in tax-saving funds (also referred to as equity-linked savings schemes) are eligible for Section 80C benefits.

    Maturity proceeds from ULIPs are tax free. In case of equity-oriented funds (for example diversified equity funds, balanced funds), if the investments are held for a period over 12 months, the gains are tax free; conversely investments sold within a 12-month period attract short-term capital gains tax @ 10%.

    Similarly, debt-oriented funds attract a long-term capital gains tax @ 10%, while a short-term capital gain is taxed at the investor’s marginal tax rate.

    Despite the seemingly similar structures evidently both mutual funds and ULIPs have their unique set of advantages to offer. As always, it is vital for investors to be aware of the nuances in both offerings and make informed decisions.

    Posted in Investments, Mutual Funds | 1 Comment »

    Interest From Kisan Vikas Patra Must Be Shown Every Year!

    Posted by sushilgirdher on 9th June 2008

    Can paying tax on interest accrued on investments in KVP / NSC / GOI bonds be deferred for a year ie based on receipts? Melwyn D’souza

    Interest income is generally assessed under the head “Income from other sources”.There are two general methods of accounting of income or expense. The receipt basis (Cash accounting ) or accrual basis (mercantile system).Section 145 of the I T Act prescribes “method of accounting” to be followed for computation of income . The said provision states as under

    145.

    (1) Income chargeable under the head Profits and gains of business or profession or Income from other sources shall, subject to the provisions of sub-section (2), be computed in accordance with either cash or mercantile system of accounting regularly employed by the assessee.

    As one can see from the aforesaid provision that in case of business or income from other sources , an assesse has the option of maintaining accounts either on cash(receipt) basis or accrual basis. The interest on National Savings Certificate or GOI Bonds or other savings instruments falls under the category of the income from other sources. So , one can show the income from these saving instrument either on receipt basis or accrual basis. However, the interest on Kisan Vikas Patra has to be necessarily shown on accrual basis . This is an exception. The CBDT circular No. 687, dated 19-8-1994. which is given below, clarifies the exceptional provision regarding interest from Kisan Vikas Patra

    Kisan Vikas Patras were introduced on 1st April, 1988. The Department of Economic Affairs, Ministry of Finance, in its notifications dated 23-3-1988, 16-12-1991, 24-4-1992 and 2-9-1993 had specified the amount payable on these after 2½ years and up to the date of maturity. However, interest and maturity amount during 2½ years had not been provided in these notifications.

    2. As interest on these Patras has to be assessed to income-tax on accrual basis, the amount of interest accrued on these Patras during initial 2½ years has also been determined in consultation with the Department of Economic Affairs. The amount of interest accrued on investment in Kisan Vikas Patras by an assessee is to be calculated on the basis of the following table received from the Department of Economic Affairs wherein rate of interest and maturity amount for Rs. 100 denomination of Kisan Vikas Patras are given

    Click here for the chart of interest Easy Chart To Compute Accrued Interest on NSC & KVP!

    Therefore, barring KVP, you have option to show the interest either on receipt basis or on accrual basis i.e when you get the interest. But remember even that option as per section 145 of the I T Act applies only when you regularly maintain the accounting . That means , it is not allowed that one year you show on accrual basis and in another year you show on receipt basis.

    Posted in Investments, Personal Finance | No Comments »

    REC Bonds Issued ….Hurry UP!

    Posted by sushilgirdher on 7th June 2008

    We want to invest interest gained on National Saving Certificates in REC or NHA bonds. Can we get benefit under Sec. 54-EC ? Babu hai Choudhari , Ahmedabad


    I sold my plot in Dec2007 and got Long Term Capital Gain of about Rs.7.6 Lacs. Currently there is no TAX Saving Bonds Scheme available from NABARD, REC & NHAI where this amount can be invested to save tax? VK Gupta- Sonipat

    The readers who have earned long term capital gains on any asset and were waiting for the bonds in the market for claiming exemption u/s 54EC should rejoice as the Rural Electrification Corporation Ltd has come to market for subscription of its Capital Gains Tax Exemption Bonds - Series-VIII which opened on 28th May 2008 .Further details can be from the links provided below
    Issue Highlights of 54EC Bonds - Series VIII Information Memorandum of 54EC Bonds - Series VIII Application Form of 54 EC Bonds - Series VIII (SAMPLE) (Application Form can be downloaded from the website : http://rec.rcmcdelhi.com)
    Have you read ?
    Interest on REC Bond Is Taxable Yearwise!

    Posted in General, Info, Investments, Personal Finance | No Comments »

    ULIP holders hit by more taxes

    Posted by sushil on 7th June 2008

    Undoubtedly, the life insurance industry has been growing at a steady pace over the last few years. From a low of 2.6 per cent contribution to the GDP figure in 2006, it rose to 3.26 per cent and 4.09 per cent in 2006 and 2007, respectively. The biggest propeller of this growth has been the unit-linked insurance plans (Ulips), which have, according to some estimates, accounted for nearly 90 per cent of the new business being generated by life insurers.

    The new edict    . The Finance Bill 2008-09 has brought the management of Ulips of life insurance companies under the service tax net. The mortality portion of the premium was already being taxed. The direct impact of this, however minimal, would be on the fund value of a policyholder.

    What gets taxed    . The charge is on the service provided by the insurer to the policyholder. The amount charged for levy of service tax will be the difference between the premium paid and the investible amount segregated for actual investment (including the mortality). For example, on a premium of Rs 100, if the mortality charged is Rs 10 and the investible amount is Rs 85, then the service tax is to be charged on Rs 5, that is 100 - (10 + 85). In the same scenario, if the investible surplus is Rs 75, the tax gets levied on Rs 15.

    In simple words, the service tax of 12.36 per cent on Ulips is going to be charged on the entire amount that the insurer keeps after deduction of mortality charges and the investible amount. Much of it is reflected in the front-end premium allocation charge. So, higher the charge, higher is the impact. Nitin Chopra, CEO, Bharti AXA Life Insurance says, “By placing the allocation charges of Ulips under the service tax fold, while the entry load of other market-led instruments are not, Ulips are not being provided a level playing field.”

    Elsewhere. In mutual funds, the service tax is charged only on the asset management charge. This fee is only a part of the recurring charges that the fund house can charge based on the size of the corpus. Usually it is 2.25 per cent of the corpus. The asset management charge is part of this and capped at 1 per cent.

    Anil Sahgal, director of strategy and chief investment officer, Aviva Life Insurance, says, “The intent of the Budget speech was to bring equality between mutual funds and Ulips, which, perhaps, is not the case according to the illustration given in the Finance Bill.”

    Further, the industry feels the tax will hurt insurance penetration in India. Chopra says: “Indian customers prefer investment-cum-insurance plans. Ulips as a category, promote buying of financial protection with the value-added benefit of market-led investments. Hence, Ulips need to be supported on the tax front to improve insurance penetration in India.”

    The impact. The service tax will lower the returns for a Ulip holder. Says V. Srinivasan, chief financial officer, Bharti AXA Life: “Our analysis indicates that the internal rate of return (IRR) to customers on our products will reduce by 20-40 basis points per annum over a 15-year holding period, on account of this service tax.”

    This would hold true with most other insurers as well. Shikha Sharma, CEO and managing director, ICICI Prudential Life Insurance, says: “The service tax, per