Food inflation has been on an uptrend in India for past several quarters. Budgets of poor and middle-class consumers have been hit hard due to rising prices of staples like cereals, pulses and vegetables. Data released by the Central Statistical Organization (CSO) showed consumer price index (CPI) for February 2013 stood at 10.91%, the second highest among emerging economies; it rose from 10.79% in the previous month. This was the third consecutive month when inflation remained in double digits. The share of Food, Beverages and Tobacco as a category is 49.71% in CPI. Cereal prices rose an annual 17.04% in February, while pulses and products shot up 12.39% year-on-year.
Apart from stretching the pockets of consumers, rising food prices have forced the central bank to go slow on an expansionary monetary policy. While the central bank cut the repo rate by 25 bps this month in an attempt to fuel the sluggish economy, the monetary authority also cautioned that the possibility of further rate reduction was limited.
Price rise vs excess stock?
The rise in cereal prices in India is certainly not due to shortage of supply, as data shows that supply of food stock has been on a rise. There has been a 20% rise in cereal prices in February, despite overflowing granaries.
In June 2012, India’s foodgrain stocks were estimated to be over 82 million tonnes (mt), almost 10-12 mt more than last year. This is also far above India’s storage capacity of 66 mt. During 2012-13 crop year, India’s foodgrain production is estimated to have crossed 250 mt, compared with 260 mt last year, despite drought in several parts of the country.
Foodgrain stocks are projected to hit an all-time high of 92-93 mt by June-end, beating last year’s record of 82 mt. The government currently has an excess rice stock worth Rs 25,400 crore and excess wheat stock worth Rs 36,300 crore, or more than Rs 60,000 crore in total.
The question is: if production is adequate, what is the cause for price increase? There is reason to believe that food prices are rising due to some level of hoarding by the Food Corporation of India (FCI). Secretary,Economic Affairs, Arvind Mayaram, has also agreed to this in a statement made in a speech earlier this month. Excess stock held by FCI appears to be the prime reason behind the sharp spike in wheat and rice prices, thereby bleeding the consumer.
FCI is a government agency that procures rice and wheat at the minimum support price (MSP) to feed the public distribution system (PDS). It maintains buffer stock for release during famines or food emergency. So procurement by FCI is supposed to serve two purposes. Give farmers an assured and fair price and create food security. Though MSP are announced for all crops at the time of sowing, only wheat and rice are procured.
The warehouses of FCI contained food stock of over 66 mt in February – 35 mt rice and over 30 mt wheat, despite carrying out liberal exports to offload stock. Our food stock level is way above the government-prescribed buffer stock norms. In July 2012, FCI hoarded 82 mt wheat and rice, equivalent to $30 billion (Rs 165,000 crore) – four times the mandate for food security. This was despite the officially covered storage space being 52 mt. High inventory also comes with high carrying and administrative costs, besides an increase in wastage.
Is MSP working?
Hoarding by FCI is fallout of MSP. Though the idea of MSP is noble, it has actually exacerbated food price inflation. With an assured price, more rice and wheat lands up with government than what it can distribute through PDS. With FCI obligated to purchase rice and wheat from farmers, its godowns overflow. Market prices rise further since more grain lands in FCI godowns than in the open market. Clearly, the current MSP system has failed. MSP for rice and wheat has been continuously raised by about 10% ever year. This makes these cereals a preferred choice for farmers to grow, leading to surplus stocks.
MSP for some commodities has almost doubled in last five years, which is partly responsible for rise in food prices. The current system of MSP drives up food prices, but doesn’t necessarily benefit farmers, as the middle man continues to make most of the money.
High state levies
Besides hoarding by FCI, high-state levies also lead to a spike in prices. For example, Punjab levies 10% tax on grains as against 5% in normal cases. States like Madhya Pradesh and Rajasthan offer bonus over MSP, compounding the problem further by pushing up foodgrain costs.
The need of the hour is to ensure there are no bottlenecks in last mile connectivity between the consumer and distribution system. The government plans to take stern action to prevent hoarding of foodgrains supplied through FCI. It is high time the Competition Commission of India investigates the practices of these agencies. Unless anti-competitive practices are checked, they will defeat one of the key purposes for which FDI has been allowed in the retail sector.
The government needs to work out a solution to manage high inventory of foodgrains. This will control food inflation and will also bring down fiscal deficit. Another solution, as suggested by Dr. Rangarajan-led high powered panel, is to distribute additional grains through ration shops and increase exports to wean away excess inventories.
There is also a need to pay attention to all vital links in the value chain. As the situation currently stands, the private sector has been driven out of the market. A workable solution is needed to usher in increased participation by the private sector and making the release mechanism for food stocks more transparent.
RGESS is an innovative initiative as it kills two birds with one stone – it boosts capital formation while encouraging more and more Indians to participate in equity-led wealth creation. In the long term, the scheme seeks to bring in a new class of investors whose savings will deepen the stock markets, help the government reduce its fiscal deficit and improve the prospects of the government’s disinvestment drive. RGESS is designed to benefit all the stakeholders: government, corporates, mutual fund (MF) industry as well as retail shareholders. Promoted as an alternative financial instrument, the scheme seeks to encourage investors to divest their savings from illiquid instruments such as gold. If this objective is achieved, the scheme will have a positive impact on the economy’s financial stability. It goes without saying that a healthy economy promotes financial inclusion.
But is this enough to make first time retail investors embrace this scheme? To be sure, even though the scheme provides tax breaks, the benefits that RGESS offers may not be evident to those who have never invested in equities before. Moreover, since there are no guaranteed returns, a prime feature of other government-sponsored schemes, viz., post-office savings scheme, life insurance policies etc., investors may take time to convert.
Ideally, investors should be allowed to participate in RGESS without enforcing any cap on the income level, as this will slow down deeper retail participation. The cap on the INR 50,000 investment for 50% deduction from taxable income should be increased in order to lure more investors from the 10% and 20% tax bracket. Sure, the product may not work well at the individual level, but it is likely to gain popularity with MFs and ETFs, which would provide first-time investors with the much needed reassurance and encouragement. This partnership can help the individual investors mitigate the inherent risk prospects of the scheme while maximizing its profitability potential.
For the Indian MF Industry, which has witnessed rather low levels of investments in equity schemes over the last many quarters owing to the underperformance of the markets, the scheme comes as a harbinger of renewed hope and opportunities – it is likely to open an entirely unexplored market of prospective investors beyond the top 15 cities in the country, reaching out to semi-urban and rural populace in Tier II and Tier III cities. However, the ambiguities in the operational guidelines need to be quickly resolved by the government. The product requires some clarity on the lock-in period of the investment and management of the investment.
Nonetheless, RGESS is a bold step by the Finance Minister to not only build confidence in making the Indian capital markets more robust but is a genuine effort to give a fillip to greater retail participation in the Indian stock markets, thereby creating a more inclusive and equitable wealth creation eco-system. It is for India’s financial industry, especially mutual funds and ETFs, to quickly understand the finer points of the scheme better, create suitable products and awareness among retail customers, and match the policy actions of the government through smart business decisions.
Appeared in Business Standard
How would you describe the current state of affairs in the Indian MF industry?
I think the mutual fund industry is at a point of inflection. On the one hand, the industry is grappling with a growth slowdown; on the other, there are promising opportunities in terms of products and distribution that are starting to emerge. You have the problem of diminishing margins for key stakeholders, but there is the emergence of a new strata of financial planners. The sentiment towards the asset management business has been affected, partly because of macro-economic conditions. But the fact remains that mutual funds are one of the most effective mediums to channelise individual savings into growth. The long-term future of this business still remains robust
The MF industry, a few years ago, had set tall targets for itself. How far are we from achieving those targets?
How do you grow the coffee industry? In the most elementary terms, there are two ways to do it. Have new customers drink coffee or have existing customers drink more coffee. The same is true for mutual funds. If you look at the annuity book (customers who have stayed for a certain period of time), that portion continues to grow steadily. I think the industry is on track with those numbers. However, getting in new customers has been difficult, particularly over the last few years. In fact, there has been a net attrition of investors across various schemes in the industry. The good news, however, is that we have seen growth in retail investors in the fixed income and gold ETF space.
Why should retail investors invest in funds when the future of many fund houses itself is in doldrums?
There is bound to be consolidation, as there are strategic partnerships in any industry. However, one should be cognizant about the fact that the entire MF industry currently holds only about 3% of the investors’ wallet. Over the longer term, players will adapt, evolve and survive. For an investor, there are two important points to consider – one, who is your financial advisor and, two, what is the track record/suitability of the scheme being recommended. I would seriously doubt whether any investor is even interested in knowing more than that.
Should the retail investor (today) go by the fund house or the scheme performance’s , especially if the scheme belongs to a smaller fund house?
A consistent track record of risk-adjusted returns should be the first benchmark for evaluating funds. A brand with a vintage definitely adds comfort to the investment decision, but increasingly customers are becoming more aware, and more demanding of the scheme’s performance. Clearly, scheme performance takes precedence over any other factor.
What do you think is the future of relatively smaller and newer fund houses?
It is up to the smaller fund houses to create a strategy, establish a clear positioning and build on mind share with distributors and customers. In every crisis there is an opportunity which begs to be noticed and built upon. Usually, smaller fund houses are nimble footed enough to introduce new perspectives that work as catalysts to the growth of the category. Smaller fund houses need to not just be consistent, but also be persistent in their strategic endeavors. The rest will automatically take care of itself.
Do you think the industry will consolidate in the coming years?
In the last two decades, the industry has been through phases of consolidation and has emerged stronger. Like any other industry, the asset management industry has its own imperatives. We are still a very young industry with a serious amount of growth beckoning us over the horizon. In the meantime, there will be opportunities for serious players to look at growth, both organically and inorganically.
In current times, when survival of the fittest holds water, what steps have you taken to ensure your existence? What are your strategies to sustain this business?
Primarily being an equity fund house, we have very strong capabilities in quantitative strategies and risk management. We also believe we possess a range of cutting-edge products which are very relevant to customers in these volatile times. Needless to say, some of these in the ” Absolute Return” category are niche products. We have been in the process of building a consistent track record for some of these products over the past 2-3 years. We’re in discussion with various distributors to showcase the prowess of our products. Creating an organization is a process, not an event. We are quite optimistic about the long-term play this industry offers and are building the blocks currently.
Do you think it is time the industry explored newer investment avenues – beyond equities, fixed income and gold?
It is already happening. Speaking for ourselves, we are already looking at ideas in the Portfolio Management and Alternate Investment Fund space. The recent Sebi guidelines on AIF, as well as the tightening of PMS regulations enthuse us. We believe that given these guidelines, the growth trajectory of this industry in the coming years could be completely different.
What is your advice to retail investors with respect to investing in mutual funds and equity markets?
Retail investors should not be reactive in terms of dealing with their current investments. They should consult their financial advisors before any decision to buy or sell an asset. The biggest mistake investors make is to get carried away by the noise around them. Very rarely will you find fixed income, equity and gold together in a state of fluidity as they are currently. One needs to allocate resources in consultation with financial advisors.
The article was published in ‘The Economic Times’ 21 May 2012
The Economic Times
A fund having a large corpus indicates investor confidence. A scheme’s corpus may possibly grow due to factors such as the fund’s investment process and its steady performance. Larger corpus funds have lower costs as expenses are spread over a larger base. As a fund grows, fixed costs become a smaller proportion of the expenses, which improves its effectiveness.
At the same time, a huge corpus may not be simple to manage and a fund manager may run out of investment opportunities to deploy the cash. In this regard, schemes with a small corpus can be more responsive and flexible and can make the best of the changing market scenario by changing the composition of securities held.
The size of assets under management of a fund house should not be the only influencing factor in an investor’s choice of a fund. Instead, one should also go by the track record of the fund and its manager. It is more important to see the fund’s performance and whether it is sticking to the stated mandate, since a consistent fund is expected to help you realise your wealth creation objectives.
Factors to be considered
There are a number of other factors that you should consider which choosing your investment.
Fund performance: Compare the mutual fund’s performance with that of similar funds. While there is no assurance that the fund will repeat the previous year’s performance, you can get a fair idea of the fund and the manager’s strategy.
Risk: Risk is measured by the standard deviation of the fund, which indicates the degree of risk the fund manager has taken with investors’ money. Analysing this parameter helps match the risk profile of the fund with your own risk appetite.
Risk-adjusted returns: This parameter is normally measured by the Sharpe ratio, which shows the returns a fund has delivered vis-à-vis the risk taken. Higher the ratio, better the fund’s performance.
A fund with a higher Sharpe ratio delivers higher returns for a unit of risk that you undertake. It thus helps you evaluate whether a fund’s high returns are a result of good investment decisions or higher risk.
Other factors such as liquidity, average maturity, turnover rates, low expense ratio and load structure should also be taken into account before you select a mutual fund scheme. Schemes with higher liquidity, lower average maturity and low turnover rate are typically favoured.
If you are not an active investor it is also more prudent to select a scheme with a well-diversified portfolio rather than a concentrated one, as the former carries a lower risk. Portfolios can be reviewed on the basis of a company and sector/industry focus.
Keeping these factors in mind, an investor can reduce risk and invest in quality funds systematically over the long term. There are thus more aspects to deciding the choice of funds than mere size of assets under management.
(This article was published in the Business Line print edition dated June 10, 2012)
The Securities and Exchange Board of India (Sebi) allows mutual fund investments to be held in demateri-alised (demat) form. Like shares, investors can now convert their mutual fund units into an electronic format and store in their demat account. Once converted into demat format, investors can sell units either directly like stocks or through a depositary participant (DP).
The major advantage of this step is that it enables a centralisation of all the funds you have invested in. Instead of multiple account statements, you can have a consolidated statement of your holdings. This makes it simple to track investments. Also, a single snapshot of all mutual fund units in a demat account allows you to buy/sell units without difficulty. The growing popularity of exchange-traded funds, or ETFs, is also driving home the importance of demat accounts.
Sebi’s move is a positive one in the sense that it offers an additional path for transacting in mutual funds and provides a single platform to transact across multiple fund houses and their allied schemes. For a majority of existing demat account holders, this platform is fairly opportune and favourable. According to some estimates, roughly 50 per cent of mutual fund investors already own demat accounts.
Large distributors of mutual funds are also encouraging clients to hand over their paper certificates (in the form of account statements) to NSDL, India’s largest depository, and hold them in electronic form. Industry experts say this would help distributors save on postage, stationery and infrastructure costs. However, despite the advantages, many new retail investors have not warmed up to the idea of holding mutual fund units in demat form citing a number of problems.
Additional Costs: Holding mutual fund units in a demat account means investors pay account opening and annual account maintenance fees. Even if you have a demat account, there are transaction costs. This is critical for low-yield debt funds which are further impacted by transaction costs.
No Physical Statement: The investor ceases to receive a physical account statement from the AMC/ registrar and transfer (R&T) agent.
AMC Cord Cut: Once units are dematerialised, the fund holder loses the comfort of dealing directly with the issuer or the R&T agent.
Cumbersome Procedure: With a demat account you obtain a conversion request form (CRF) and submit it along with your account statement to your DP. After due verification, the DP coordinates with the AMC and its R&T agent, which after verification credits the mutual fund units to your demat account.
More Players: Units held in paper form do not carry any risk for the issuing company or for the holder. In the non-demat format, only two persons are involved — the unit holder and the fund house. On the other hand, holding MF units in demat form means you have the demat provider, the clearing house, the bank and the stock exchange in the fray. Then there is the 12.5 per cent service tax. This makes the demat facility a costly affair for a new investor.
It must be remembered that a large number of retail investors in mutual funds do not have demat accounts. Besides, online trading tools lack an advisory interface that retail investors need.
To conclude, while it is smart to use the demat route for investing in mutual funds, ground realities and the cost of taking this route for no tangible additional benefit will continue to act as a barrier to its widespread use.
(This story was published in Businessworld Issue Dated 30-04-2012)