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If one steps back and looks at the last 30 years, one realizes that the markets and the environment has always posed a challenge. Your character is tested. Your temperament is challenged. Risk plays out in different ways. It is never the same, but there is always a learning.
The IPO boom of the 1980s
As an investor, one saw the IPO market of the 1980s. They were not called IPOs that time, but Public Issues. The Controller of Capital Issues regulated the price at which a company can issue shares. The changes in the Foreign Exchange Regulation Act (FERA) had forced many top-notch blue chip companies to dilute at bargain prices. The issues would get oversubscribed multiple times, and those who were lucky would win a small holding in companies like Colgate and Glaxo. The public issues were seen as a sure fire way of creating wealth, with practically no downside. The Reliance Empire was built at this time. The innovative idea of convertible debentures was introduced for the first time. Public at large could participate in this and they created enormous wealth. Equity cult had reached common households.
The leasing boom - an early warning of manias to follow
This was followed by the boom in leasing and finance companies. Companies changed their names and objectives to become financial companies overnight. You did not need to set up a factory to be in business. Mushroom growth followed. Cheery consensus and irrational exuberance was seen. Most of these stories ended up in tears. This was my first experience in the financial markets which taught a lot about how markets work. Aquaculture, Technology and Infrastructure Booms over the next twenty years were similar in character, but the magnitude differed. The experience in the leasing company boom helped.
Mutual funds with 400% listing gains!
In the early 90s, the lure of the investment field drove me to give up my CA Certificate of Practice and go full time in the financial markets. This was a time like no other. We were witness to the biggest revolution as the Indian economy opened up. Industrial licensing was scrapped. Currency was floated on the current account. Liberalization, Privatization, Globalization were the new mantra. And we saw the mother of all booms in the stock market. The BSE Sensex went from 780 in March 1990 to 4,285 in March 1992 - a jump of 549% in just two crazy years! This was the period of my introduction to mutual funds. Public issues of Unit Trust schemes like Master Plus saw massive listing gains of over 400%. The investors were applying the company public issue logic to mutual fund issues - little realizing that finally it is NAV which will matter. There was also the story about mutual funds winning bids and getting large parcels of PSUs at cheap prices that fuelled the boom. The public issue of Master Gain raised 4,500 Crores - equivalent to US$1.5 Billion at that time! I think this is a record which will never be broken.
We started to understand the NAVs and mutual fund sale prices. While some schemes quoted at premium to NAV, a whole lot of seemingly assured return schemes quoted at a large discount to NAV. This meant that there was a decent tax-efficient return for the patient, hold-to-maturity investor. We could help many investor buy these units from the secondary market and reap a handsome reward on maturity. The NAV pursuit also helped moving investors away from units inexplicably quoting at a premium and realize their money in time, before some crisis broke out.
Demat and online trading revolutionized equity markets
A boom will inevitably be followed by a bust. The Sensex lost 56% over the span of just 15 months. This period also saw the emergence of strong regulation with a dedicated regulator for the capital market. Revolutionary changes took place. On-line trading replaced the trading floor and jobbers. 2 and 3 week settlement periods moved to one week, before further change to a daily settlement. A well-regulated derivatives market was established. Dematerialization was a huge change. Today it will appear unbelievable, but brokers fought this tooth and nail. The bad delivery risk in the stock markets was eliminated and brokerage business was now much safer, quicker and yes, cheaper! Over the last 20-odd years, we have seen stock brokerage rates drop from 2% levels to today's rates below 0.05%. The volume in the same period has multiplied 4,000 times!
From equity broking to FD broking
In the sustained bearish and stagnant period in the stock market over the next 5 to 7 years, brokerage income vanished. To survive in the business, one found solace on the fixed income side. This was a less volatile business and fixed income investors outnumbered the equity participants. Company Fixed Deposits was a simple and straight forward investment. The deposits were unsecured. A number of companies, many of them financial companies, floated their FD schemes. These companies had a credit rating. They also paid attractive brokerage. Investors would be paid an "incentive" or sub-brokerage at the time of investment itself. We can today call it a "reverse" entry load. Companies accepting deposits would compete by paying higher incentive to attract more deposits. We were worried about the safety of the investors' money. In addition to the credit rating, we started tracking the stock prices of the companies as an alert. This helped us in stopping this business and helping clients to withdraw money pre-maturely before the sector ran into trouble.
Debt funds take centre stage
The understanding of the fixed income market helped in understanding the colossal advantage debt funds offered as a safe, liquid and highly tax-efficient investments. In 1995 - 1998 period, AAA Corporate Bonds used to carry 16-18% interest. With long term capital gains treatment and inflation indexation benefits, equivalent pre-tax return in Income Funds worked out to over 26%. This insight helped us in building the fixed income funds business. An added advantage was that this segment always operated on annualized commission or trail model. Since fixed income constituted more than 70% of the business, we were not brought up on the concept of 'upfront' commissions. This turned out to be a major advantage in 2008, when entry loads were abolished, the first generation 'direct' option was introduced and upfront commissions were capped. This period saw prolific rise in NFOs of closed-ended schemes with high upfront commissions. We did not distribute most of these schemes as our business model did not depend on upfront.
A bubble usually doubles, before it is pricked
The technology - media- telecom boom in the stock markets in 1999 - 2000 was stunning experience for most investors. Prices of technology companies sky-rocketed and investors chased these stocks in droves. Interaction with mature and rational fund managers helped in realizing that this was a bubble building up, and the dire consequences once it burst would be unbearable. We could get investors to reduce the TMT exposure and re-allocate their money to preserve capital. Today it may not appear so, but the bear market that followed in 2001-2003 was like a mini global financial crisis for us. This harrowing experience woke us up to the severe impact a bubble can have and the need to preserve capital. This helped in facing the real global crisis in 2008 much better. A senior fund manager showed us an article in the Economist in June 2005 about the bubble that was building up in U.S. Housing market. They say, till it is pricked, the bubble will double. This is exactly what happened over the next two years. The importance of asset allocation and re-balancing was underlined by this situation and the experience from the earlier bubble came in handy.
The essence of investment products distribution
Distributing investment products is different from selling physical products. It is essentially a concept sale. A test drive while buying a car is now quite common. When you buy any consumer durable product, you have the liberty to check out the actual features before you buy it. In investment products, the real outcome is deferred. It may be as long as 10 to 20 years, before the final outcome of a Deep Discount Bond, ULIP, Health Insurance Policy or Children's Gift Growth Fund is known. The investor, however, needs to invest today. He may have neither prior experience nor theoretical knowledge about it. The degree of difficulty of the challenge goes up, when some of the asset classes move in cycles. Approaching them with a linear mind-set will be counter-intuitive. The apparent obvious solution may be exactly the wrong one. We all experience this when investment decisions are taken looking at the past performance. At the top of the cycle, the past performance may be brilliant. Buying at this stage may not benefit the investor. At the bottom of the cycle, past performance may look abysmal. Looking at this, there will be a big opportunity loss. This calls for a rational investment decision framework as a support system together with common sense and judgment. If this need is recognised, it is not difficult to visualize why each investor needs an active, alert, trusted friend as sounding board.
Need for regulation in investment products distribution
Because investors need to rely on the judgment of an experienced person, proper regulation of those who make recommendations is more important. This issue came centre-stage after the global financial crisis. Across all countries, regulation is being re-defined. There is also a global co-operation and co-ordination among regulators. For a professional who is acting with the clients' interest in mind, the real task is how to maintain a proper documentation trail. If the processes of assessing the risk profile and suitability of the products can be demonstrated from records, it will give him peace of mind regarding compliance.
Taking a decision and implementing the decision are very different
Taking investment decisions in one aspect. Successfully implementing it needs professional help. When we speak of technology, we find that programmers who write a software package are paid 20 dollars an hour and consultants who actually implement that package may be paid ten times as much! The importance of implementation consultants cannot be underestimated.
Determining a revenue model for this service
Sticking to the strategy through the ups and downs is even a bigger challenge. Human mind is fickle. Its pendulum will swing between the extremes of fear and greed. A stabilizing effect is necessary. Many times, support is needed for sitting tight and not taking any action! This behavioural aspect is the most important ingredient of success. Staying focused and not getting distracted is the difficult part. This support can come from a trusted person, whether you call him distributor or advisor. I am convinced that we all accept the value proposition of this trusted person. What currently we are debating is the revenue model for this service. The direct model of mutual funds does not eliminate the role of an advisor. With the expected availability of data feeds on direct transactions, a system will evolve to define, charge and recover the advisory fees. In my opinion, regular plans without fees and direct plans with fees are the two structures which will co-exist for some time.
Like with all professions, it all about people
By God's grace, we have also been blessed with very good like-minded team members. Apart from my co-promoter director Ajit, we have the strength of Mangesh, Mayur, Mandar and Vedkumar who have been with the company for almost 15 years. It is their belief in the core ideology, patience, perseverance and maturity at a much younger age than the promoters that has made this journey possible. They also bring more energy and enthusiasm. We believe that we should develop the firm more as a professional practice than a business. This will call for a different approach to the revenue model and remuneration matrix. It also presupposes cultivating knowledge and expertise on one hand and even better alignment of interests with the clients.
Role of technology in our business
Use of technology in financial markets is an issue which is rightly attracting significant attention. Anyone who waited in long lines to book railway tickets will vouch for the difference IRCTC has made. We have live examples of how on-line trading and dematerialization revolutionized Indian markets. I am proud to say that our financial markets have been at the leading edge in adopting to these changes. We need not look at technology only as a threat, but must also look at the advantages it can impart. In my thinking, technology can be useful in the following 5 areas in our line of work:
Financial Planning Analytics On-Line Transactions Client Engagement Communication and Marketing
Out of the above, client engagement is the most crucial part. I am sure that solutions like packages and platforms will evolve in the other four parts, which help us to automate these processes and have more time for understanding clients and communicating with them.
If one door closes, another one opens
Many studies show that India's GDP will grow and will create more wealthy families over the next two decades. More finance professionals will be needed to help clients take care of their wealth. If we can instil self-regulation and create more robust and transparent systems, we can become the chosen professionals for this responsibility. The environment has constantly evolved and changed, but it has always meant - "If one door closes, another one opens!"
Content is prepared by Wealth Forum and should not be construed as an opinion of HDFC Mutual Fund.
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Wise Advice
Wisdom, humility and uncommon insights make Bharat Phatak one of the most respected advisors in the country. An ability to harness these qualities in the advisory profession make him one of the most successful IFAs in the country. Wealth Managers, which he and his partner Ajit Khasnis promoted 12 years ago, has grown to a 35 member team, advising corporate, UHNI and HNI clients, with a staggering AuM of over Rs.2500 crores, putting them on top of the IFA league table. Wealth Managers has a distribution arm, a SEBI licensed PMS arm and more recently, a SEBI licenced Investment Advisory arm.