Think BIG : Think Retail Debt 6th May 2013
There is BIG potential for distributors in this customer segment
Dhiraj Mittal, Prime Capital Services, New Delhi


One of Northern India's fastest growing advisors, Dhiraj discusses how debt funds can help advisors and distributors gain wallet share in a large and growing customer segment - retired people who are looking for regular inflows as well as preservation of purchasing power of their capital. Dhiraj also argues that debt funds are perhaps a surer way to help your clients towards wealth creation and articulates the reasons for this assertion. While the distribution fraternity can certainly harness many such opportunities in diverse customer segments using debt funds, Dhiraj believes there are two critical things that AMCs must also do in this regard, for the industry as a whole to truly leverage the BIG untapped opportunity of debt funds.

As advisors and financial planners, all of us are very well versed with helping investors save up for retirement, save up for children's education and so on. Most goal based products from insurance companies and mutual funds also are targeted at helping investors save up for future financial goals. Almost the entire industry is focused on the accumulation stage of an investor's life. Much less attention is given, in my view, on an equally important phase of the investor's life, and one that holds immense potential for advisors, distributors and AMCs - the distribution phase, or the phase when the individual retires and starts spending from the amount he has accumulated in his working life.

Debt funds are ideal for the distribution phase of an investor's life

The distribution phase - where a retiree invests significant lumpsums in safe avenues to secure a steady monthly income, has for long been a bank FD oriented space. Some investors who are not happy with the effective yields on bank FDs venture into company FDs and other "high-interest" bearing deposits with varying degrees of risk, and these risks are getting increasingly highlighted with the recent scams. Annuities from insurance companies are also becoming popular in this space and are increasingly being seen as one of the best alternatives in the market today for helping retired people lead a comfortable life in their golden years.

Annuities are not the best alternative for retirees

Annuities are however in many cases, not the most efficient way to help retirees achieve a reasonable after tax income and help preserve the purchasing power of their capital. Income from annuities is taxable as pension and gets charged to tax at the rate applicable to the investor. There is also a service tax that gets charged at the time of purchasing the annuity, which reduces the corpus invested. The best yield that one can get these days from annuities is around 7% and that too taxable. Further, most annuities don't provide for an early exit and are therefore not helpful when dealing with emergencies.

A real case study of my client

I believe a smarter way of helping retirees get a reasonable monthly inflow is to invest the corpus in a judicious mix of debt funds and use the SWP option to generate the monthly inflows. Here is an actual case of a client, which I wrote about recently in TOI. A client of mine, Vijay (name changed) came to me in Fen 2012 with an investible amount of Rs. 1.5 crores and wanted a post tax monthly withdrawal of Rs. 1 lakh. On our advice, he invested Rs. 1.385 crs in the growth option of medium term debt funds, which have now grown to around Rs. 1.52 crs. The remaining Rs.11.5 lakhs was put into daily dividend reinvestment option of ultra short term debt funds and a monthly SWP of Rs. 1 lakh was set up from these ultra short term funds for a 12 month period starting April 2012. With the last withdrawal in March 2013, the amount in ultra short term funds got exhausted, as planned.

Meanwhile, the investment in the medium term debt funds has now completed 1 year and SWPs of Rs. 1 lakh per month have commenced from here, starting April 2013. Since these funds deliver on average 9% returns, which are broadly in line with the inflation index under the Income Tax Act, it results in almost nil capital gains tax, and consequently, the post tax return is effectively the same as the pre-tax return. Since the funds are now invested for more than a year, there is no exit load either, and portions of this can be used by Vijay for emergencies, if required, without attracting any penalties.

Mutual fund distributors have a BIG opportunity in my view to pitch a mix of debt funds as a very effective post-retirement solution, which can compete very well against any other plans in the market.

Lack of familiarity could be your biggest impediment

While this may be the case, in reality, if you approach a retired person, who has never invested in a debt fund, and give him this kind of a plan, chances are that you will face stiff resistance from the client - not because your plan is flawed, but because he is completely unfamiliar with debt funds and therefore these have a high risk perception in his mind.

Debt funds can actually be a surer solution for wealth creation

The need of the hour for distributors is therefore to introduce the concept of debt funds as early as possible in the financial journey of their clients. We believe debt funds are suitable to ALL investors - whether they are young or old, whether they are in accumulation phase or in distribution phase. In fact, if you really think about it, debt funds are actually a surer way of creating wealth that equity funds. Surprised? Well, let's consider the facts. We know that equity funds are capable of delivering long term wealth creation and beating inflation. We know they have done so for many years in our market, and performance track records of many equity funds stand testimony to this fact. However, for a majority of investors, due to mis-timing their investment and exit decisions from equity funds, this wealth creation potential very often does not translate into actual wealth creation in their portfolios. While clearly more work needs to be done by all of us to bridge this gap, we must also realise at the same time that debt funds too help stay ahead of inflation and due to their vastly lower volatility, will see investors staying the course and actually creating wealth by successfully fighting inflation and taxes in the long run. Let us not only talk about equity as a wealth creation vehicle - debt funds too can do this job, perhaps more effectively for retail investors simply because you can avoid mis-timing related blunders.

Coming back to our retiree segment, a retired person will be happy to consider the kind of debt funds oriented retirement solution that we discussed above only when he has already invested in debt funds during his pre-retirement phase and has a successful experience with this category. It is really up to all of us therefore to ensure that we do proper asset allocations for all our clients who are saving up for retirement and ensure that debt funds find a place in these accumulation oriented savings plans. If we do this properly, we can seamlessly move the accumulated corpus into a mix of debt oriented funds once the investor retires and seeks regular monthly inflows.

I would not recommend hybrids as a way to get the debt allocations for clients, because of two shortcomings in hybrids. First, it becomes difficult to isolate and review the performance of the debt component in a hybrid fund due to the volatility of the equity component. Second, when choosing a hybrid, you are necessarily choosing the same fund house for debt and equity allocations, while in reality, the same fund house need not be equally high in your assessment on both asset classes.

2 things we need from AMCs to jointly harness this BIG opportunity

AMCs on their part, I think, need to do a lot more to really make the most of this BIG opportunity. We see so many presentations from AMCs that talk about the tiny fraction of household savings that find their way into mutual funds. Out of the total annual household savings of around Rs.22 lakh crores in FY13, around Rs. 8 lakh crores went into financial assets in FY 13. The amount invested in one year by Indian households is equal to the entire corpus of the MF industry - and we know that the majority of this corpus comes from institutional investors and not from households. If 8 lakh crores are being invested each year in financial assets - a majority of which goes into safety oriented fixed return instruments, why is the MF industry not able to attract a decent portion into debt funds?

What we need from AMCs, to realistically get more meaningful allocations from Indian households into debt funds is two things, in my view :

  1. A lot more focused education which can include the following :

    1. Campaigns that focus on how financial solutions can revolve around debt funds. Why can't the fund industry for example have an aggressive campaign that talks to retired people about how debt funds can be relevant to them? Likewise, campaigns on more goal based financial solutions that can be achieved through debt funds. Talking about solutions that can be driven with debt funds rather than features of debt funds, will connect better with investors.

    2. A lot more communication from AMCs on how debt funds can help investors protect the purchasing power of their hard earned savings. In this context, the industry must take the lead in building awareness of how the inflation index is computed, what are the implications of this index, how do you measure loss of purchasing power using this index and related communications that help investors measure and relate to the concept of preservation of purchasing power.

    3. SIP campaigns continue to focus largely on equity. Why can't we have far more aggressive education campaigns focussing on the benefits of saving with SIPs in debt funds?

  2. Recognise that debt fund money mobilised through advisors and distributors can actually be long term money, and not just money that's coming in from a rate cycle perspective. If you really want to encourage distributors to attract quality long term flows, incentivise them through higher trails that motivate them to bring in long term money, which create a win-win-win proposition for the investor, the AMC and the distributor.

Invest in education and distribution and you can get sizeable and stable long term flows into debt funds, which are not at the mercy of volatile cycles that characterise equity markets.

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