It is very important to understand how to invest your hard earned money. This money in turn can be useful in every other situation if invested properly. Therefore I have created a case study which helps in understanding importance of mutual funds (one of the important investment vehicles) which is as follows:
CASE STUDY
55 yr old man , director for
a leading pharma company. Existing assets include ESOPs from his current
and previous employer ( both Pharma companies ) worth 4 Cr. Fixed deposits for
4 Crs, and 40 lacs of equity mutual funds. Survived by two sons who are working
and wife who is a home maker.Recommend options that maximize his portfolio
returns . He has term insurance for 2 Crs and intends to retire at age 60 . He
requires 2 lacs per month for maintenance and expects to survive till 85 yrs.
Portfolio Construction for
the Case Study:
Assets currently
Owned
ESOPs worth 4 Crores.
Fixed Deposits of 4 Crores.
Equity Mutual Funds – 40 Lakhs.
Term Insurance – 2 Crores.
What the Client
requires?
2 Lakhs per month for maintenance.
About the Client
The client is at the age of 55 years. At this age, the risk
profiling of the client doesn't allow him to invest a large amount in equity.
Therefore the portfolio has to be constructed in such a way that 90% - 95% of
his savings have to be under safe investments such as debt investments.
Let’s look at his assets along with the advantages and
disadvantages.
Employee Stock Option Plan
Stock Option is ownership in a company which means that client
owns a part of company in the form of shares which is an equity component.
Given his age, 4 Crores of equity investments involve a high risk. He owns the
shares (ESOPs) of pharmaceutical companies (Both his previous and current
employer) of worth 4 Crores which is not advisable as the stock of the
pharmaceutical companies are very dynamic in India due to the following
reasons:
·
Regulatory obstacles
·
Lack of proper infrastructure
·
Lack of qualified professionals
·
Expensive research equipments
·
Lack of academic collaboration
·
Underdeveloped molecular discovery program
·
Divide between the industry and study curriculum
·
Parallel drug in the market (Loss of Market
size)
We shall look at the required investment plan later in the
case study.
Fixed Deposit of 4 Crores
Fixed Deposit is considered to be one of the safest investments
in India. The Client has a very minimal risk if he invests in fixed deposits
but at what cost?
Assume the Client invests in a Fixed Deposit which yields him
9% on the 4 Crores investment he made.
The amount earned on interest per annum is 36,00,000/- (9% of
4,00,00,000)
Since he falls under the highest income tax bracket he has to
pay tax of 30% on the interest income which is 10,80,000/- (30% of 36,00,000)
Bank deducts 10% on the interest income as TDS which amounts
to 3,60,000/- (10% of 36,00,000)
Therefore the balance tax paid by the Client as Self
Assessment Tax is (10,80,000 – 3,60,000) which is 7,20,000/-
This amount is a big amount and shouldn’t be paid as tax by
any individual and in this case, the client who is nearing his retirement cannot
lose 7,20,000/- per year in taxes.
Above all the complete amount is locked in for a certain period
and includes penalty if redeemed before maturity.
Equity Mutual Funds
Investments in Equity Mutual Funds is one of the best things
to earn a super normal profit but only for those people who fall in the age
between 20-27 (age may vary few years depending upon the person’s goals and
responsibilities). More returns are possible in equity investments because more
risk is being taken (though it is not the only reason) but even if the person
lost the money, he can recover himself from the loss given his age. But the
client at the age of 55, having equity investments of worth 45,00 000/- which is
not advisable because it’s a risky
investment.
Term Insurance
Term Insurance of 2 crores is a very good plan by the client
which adds security for his wife and children. One more thing the client has to
do is to take a medical insurance policy so that he will be covered. This
medical policy which the client takes, its premium can be funded from the cash
obtained through ESOPs (converting ESPOs into debt scheme and returns from debt
schemes).
Suggestions for the
client:
Mutual funds are one of the best investments which can be
considered and most importantly debt mutual funds in this case.
Therefore client should opt for the following funds:
·
HDFC High Interest Fund – Dynamic Plan (G)
·
Axis Capital Protection Oriented Fund - Series 2
(3 Years) (G)
HDFC High Interest
Fund – Dynamic Plan (G)
This is an open – ended long term debt fund provided by the
HDFC Asset Management Company. The following reasons are considered for the
selection of this debt fund:
·
CRISIL rating agency rated this fund with 5
Stars.
(This shows that the
fund has invested in bonds which are safe as it gets)
·
It’s an open – ended fund.
(This means client
can enter and exit anytime he wants with no entry/exit load{exit load=0.5% if
redeemed within 3 months})
·
It is a debt fund
(This states that
the fund operates on a very low risk)
·
Assets under Management (AUM) is 17,354.7
crores.
(This helps in
understanding the liquidity of fund and the client doesn't face problem
regarding withdrawal as it is highly liquid and the cash is readily available)
·
The fund’s benchmark is CRISIL Composite Bond
Fund.
·
The return on fund is 15.3%. The average of
similar debt funds is 11.6% and this fund has performed better than the average
with exceeding the returns of 3.7%.
·
Expense Ratio is 1.57%
(The cost for the
mutual fund to run the scheme is low)
Current Net Asset Value of the fund is 48.103
The fund has invested a large amount in GOI bonds which are
safe.
Following is the pie chart which depicts the fund structure:
Fund Managers
Anil Bamboli
Anil Bamboli is working with HDFC Mutual Fund. He has 16 years
experience in the mutual fund industry has been in area of Research and Fund
Management. Previous to HDFC AMC, he worked from May 1994 - July 2003 with SBI
Funds Management Pvt. Ltd. Last Position held - Asst. Vice President.
Shobhit Mehrotra
Prior to joining HDFC AMC, had worked with Templeton AMC as
AVP and Portfolio Manager (Fixed Income). He was Business /Investment Analyst,
Member Executive Rating Committee.with ICRA
The client can invest in the HDFC High Interest Fund – Dynamic
Plan (G). The client should sell ESOPs and convert it into cash and put the
entire amount in the above mentioned fund. Then he can opt for SYSTEMATIC
WITHDRAWAL PLAN. This plan, if opted, funds the client’s account
weekly/monthly/ yearly with the amount desired by the client which is
2,00,000/- in this case and the rest of the amount will remain invested in the
above fund earning an interest.
The tax on capital gains is low when compared to the taxes
levied on bank’s fixed deposits. The minimum lock in period for the fund to
avoid tax on capital gains is 3 years. As the client has 5 years of service, he
can relax by putting this amount and by the time he retires, the 3 year lock in
period will come to an end and tax on capital gains will be much lesser. Till
then, he has his salary to fall back upon.
According to the current NAV of this fund, the number of units
the client gets is (40000000/48.103) which is 831548.97
The Client has to withdraw 4157.74 units every month for his
monthly maintenance.
One thing the Client has to understand is that the fund is a
long term debt fund and bears the risk of interest rates. For example: If there
is a BOND A with 9% of interest rate in the year 2015 and BOND B with 10%
interest in 2016 then, the value of BOND B will fall because investors will opt
for BOND A so that they can pay less interest. Therefore, there is always an
inverse relationship between bonds price and interest rates. If interest rate
rises, the bond rate falls and vice versa.
From the fixed deposits which client has, he is mostly looking
for the preservation of the capital. The biggest disadvantage of the FD is
taxed levied on it as mentioned with an example earlier. Therefore the amount
present in FD can be transferred into a capital protection scheme mutual fund
such as:
Axis Capital
Protection Oriented Fund - Series 2 (3 Years) (G)
The main reason for selecting this fund is because it provides
the protection for capital and a very small amount is invested in equities for
capital appreciation.
For example: If the Client invests 10,000/- in a capital
protection scheme with 10.725% interest rate for four years. Only 7,000/-
amount can be invested in the capital protected scheme and remaining 3,000/-
can be invested in equities. The 7,000/- amount with interest rate comes up to
10,000/- in four years along with the 3,000/- amount invested in equities.
Here, the capital is preserved anyways and if there is any appreciation on the
equity component, the client is at an advantage.
The AUM for this fund is 7.94 Crores.
Therefore, the client can preserve his capital under this fund
and also have an equity advantage if he invests in this fund with the amount
which is invested in FD. There is a lock in period for three years and tax
advantage as well when compared to fixed deposits.
(Please note: The information of this fund is not given in the internet
websites and due to this difficulty, I couldn’t perform more analysis on the
same. I just wanted this idea of capital protection to put forth.)
The 45lakhs which he has invested in equity mutual funds is
also a risky investment. Looking at the current scenario of the stock market
and Nifty performance, the stock market will fall further more as the Nifty P/E
multiple is at 22.4. The Client can be asked to wait and watch till the market
corrects and then start investing in a debt fund through SYSTEMATIC TRANSFER PLAN (STP). STP helps the Client to transfer
money from equity fund systematically into a debt fund.
Conclusion
Client should create an investment plan for his wife in case
of any unforeseen situation so that she can be secured with a monthly income
generation for her as well.
The client also must understand the longevity of his survival
and must manage the same by parking some funds in case he starts surviving for
more than 85 years.
Finally, the client must understand how much amount he is
receiving from all the debt / capital protected schemes and write a will which
includes his wife and after she is no more, the amount and property whatever
available goes to his sons as per the client’s desired proportion.
Disclaimer: The investment advise above is just an example and doesn't hold for every other investor. These are completely based on my opinion and I would request you to seek advise from an Independent Financial Advisor before investing.
