IP and Asset Management- India Specific - Additions to Chapter-1 - 7

that point of view, we can say that home country bias has stayed longer than we have understood it ourselves. For example, the opportunity of investing in performing internet and technology companies of the US, more specifically the oft-quoted FAANG stocks or Facebook, Amazon, Apple, Netflix and Alphabet (Google), caught the imagination of India’s high net worth investors. The cumulative growth in the market capitalization of these select companies outweighs the remaining companies by over three times during the period 2012-2020. It is not uncommon therefore for savvy investors to up their radars to catch a part of this outperformance in their global portfolios. Also, the noise made around such outperformance lately seems to increase the visibility and the eventual selling of the concept of international investments. Financial Planners advise their clients to have optimized portfolios, both across asset classes and within specific asset classes, to have the right diversification of risk tied to financial goals. The investment abroad diversifies a part of the non-diversifiable market risk attributed to a single territory. Usually, more the diversification, horizontal or vertical, less pronounced are returns in a single direction, which is the returns smoothen toward average. The international investments thus sort of indicate twin benefits of better diversification and more upside of growth. It is recommended however that such investment should be made with the expert advice of advisers and fund managers. There are several mutual fund schemes which provide a dedicated exposure to international stocks. It is further advised that such investments themselves should be diversified among geographies such as the US, emerging markets and the Asia-Pacific, apart from exposure through ETFs rather than direct stocks. There are other risks such as currency risk, geopolitical risk and adverse taxes which should be considered as well before investing Optimizing Diversification and Portfolio Turnover Optimizing Diversification Diversification is a basic tenet to reduce the unsystematic risk. Mutual fund schemes have this feature ingrained as the moneys of retail investors are gathered to invest in multiple securities of one or more asset classes so that the performance is not skewed in any one direction, and the return is duly adjusted for risks. Whether in the same asset class or by combining asset categories, it is the concentration risk that gets reduced by diversification. However, there are many other risks that get covered in the process like credit risk, interest rate risk, market risk, liquidity risk, etc. By containing various investment risks, fund managers optimize returns working within those constraints. Direct investors usually are constrained, if not by the knowledge they possess about such risks, then due to having limited investment resources to address all these risks together. This is the reason they are advised to take market exposure through mutual funds. High net worth individuals, IP and Asset Management – India Specific Page 151

however, are in search of high returns which they believe can be obtained from concentrated portfolios. Although diversification is good, it impacts long-term performance by moving their portfolio return more towards the overall market performance. They prefer to go with portfolio management schemes (PMS) or Alternate Investment Funds (AIFs) where they can have frequent interaction with fund managers and get their portfolios customized to generate returns for the additional risks assumed. The moot question for everybody therefore is how much diversification is enough? It is well understood that as the number of companies in an equity portfolio increases, it impacts the overall quality of the companies, and hence the financial strength of the portfolio. Benjamin Graham writes in “Intelligent Investor” that only between 15 and 30 stocks would be enough for a diversified portfolio, provided those stocks have several quality parameters such as adequate market capitalization, sustained earnings stability and growth, dividend record, reasonable price - to earnings ratio and price- to-sales ratio. These qualities are well captured in a market index. The major factors to consider in diversification are the size, the sector, the geography and the style. What is too-much-diversification for an investor who either creates its own portfolio or goes for mutual funds or other collective investments? For own creation of portfolio, if one has more than 40 stocks it would be difficult to monitor the portfolio for its sustained quality. Mutual fund schemes generally have between 30 and 50 stocks in portfolio. As the schemes follow different benchmarks like Nifty, Sensex, or their larger variants, they end up holding a good majority of stocks in common. In that case, if an investor has invested in more than two schemes of the same category, like a diversified growth fund, it simply becomes over-diversification. Riskier assets would however require more diversification. For instance, small cap and mid-cap companies’ universe is much larger than large-cap companies. It may happen that a larger and varied space is covered by more than two schemes to have the required upside of returns from such companies while containing stock-specific risks if a single scheme is opted. The other reason is that the return profile of such small-and-mid-cap funds has a wider range than the large cap funds universe. The riskier the asset, the more diversification is needed. It does not apply just to equities. It is squarely applicable in case of bond funds, though the return profile of bonds is not volatile. To have adequate protection against the credit risk and liquidity risk, it is advisable to invest in as many as 3-4 bond funds, with differentiation in their invested company profile. Thus, an exposure to approximately 80- 100 bonds across companies is enough assurance as against one or two schemes holding same bonds or covering limited number of companies. In such a scenario of high overlap, in case some individual company defaults, it would affect both the bond schemes, and the return may be severely impacted. IP and Asset Management – India Specific Page 152

Portfolio Turnover As we have seen in the ‘retail therapy’ above, stress can even lead to an investor or trader indulging in too many and too frequent transactions, just to feel better or have a sense of control. Financial Planners do not advise to have high turnover in investments. It drains the money due to loads and transaction charges. Trading may lead one to be high on some occasions and equally low on identical number of other occasions. Our financial transactions should be guided by our short and long-term goals and the tax efficiency in achieving such goals. Too many frequent transactions, apart from associated charges and tax inefficiency, may lead us astray in our goal vision. A systematic approach of investing for a financial goal, and disinvesting to realize that goal is key to have a control, including under periods of high emotions and stress, as compared to a penchant for the number of financial transactions. It is also worthwhile to remember that a decision to not transact is a decision too. We almost always equate a decision to action taken as a follow up to that decision. There are decisions in personal finance that require no action to be taken. A classic example is a decision to stay the course – not to veer away from the path to the goal. Tendency of Chasing Past Performance A part of the disclaimer run by Indian mutual funds, as mandated by SEBI, reads, “………the past performance of the mutual funds is not necessarily indicative of future performance of the schemes. ……”. It is common world over that the regulators prescribe that fund houses, managers and intermediaries sensitize investors about past performance of funds. The SEC (US) would thus prescribe, “….past performance is no guarantee of future results……” or some fund managers would state, “past returns are not a predictor of future performance”. Surprisingly, this warning comes attached with the advertisement or other material that has direct reference to a fund boasting performance over the recent year gone by, or three years, or five years. Even intermediaries rely on such past performance to choose the funds that they advise and sell them to their investors and clients. Many a performance tracker website have these prominently embedded into their decision inducing pages, though a number of risk parameters associated with such fund returns may also be available to compare. So, what should one believe? The catch word is – carefully evaluate. Past performance certainly tells us something about what the manager has been doing with our funds. If the returns generated over a sufficient period are not good enough as compared to the chosen benchmark, it calls for caution. But there may be a lot lying underneath. Driving is not recommended only by looking at the rear-view mirror, right? Look at the investment objective and theme followed by the fund manager. Also scrutinize the individual stocks held in the fund portfolio and that of the IP and Asset Management – India Specific Page 153

benchmark index. Is the benchmark performance due to some racy stocks outperforming in the recent past? Do the outperformers have such outlier stocks that do not form your invested fund portfolio? Does the investment style followed by the fund manager remain consistent with what has been stated in the offer document? It may happen that the present market condition changes, and the investment style of your fund starts to yield the expected performance. This is driving with looking through the windscreen… beyond just the rear-view mirror! After all, the money withdrawn shall be invested, incurring transaction charges and loads, and probably finds its way into another fund which has performed due to the some currently outlier stocks; a flash in the pan performance that may no longer be sustained. It is not a right expectation to have from your invested fund to beat the market consistently over short stints, like quarterly performance. The outperformance over quarters can be just random, and it can be volatile as well, affecting good and average performing managers alike. An ideal portfolio should perform, with the theme in mind, over such periods of time that is in line with its investment objectives and the discipline it follows in portfolio construction. One should also have realistic expectations from the invested fund in alignment with one’s financial goals. Decision-making by Clients Behavioral finance can be defined as the science of applying psychology to finance. While traditional finance indicates that markets are efficient and rational, behavioral finance disputes that notion. Behavioral finance suggests that human beings are not always rational and do not always act in a rational manner. We cannot overstate the impact of this on financial markets, and, more specifically, on individual investors. The basic model of economic behavior assumes that individuals (along with organizations and even territories and countries) act in their own self-interest. Additionally, they do so with absolute rationality, and with more or less total access to all necessary information. To various degrees, this model has infused most economic assumptions over the years. Experience, however, does not always support the universal applicability of these concepts. There are theories that show that individuals do not make absolute rational decisions the two most widely used, is Bounded rationality and Prospect theory. Bounded Rationality Bounded rationality was developed by Herbert Simon, who bases bounded rationality on the unreasonable belief that man can make rational optimisation decisions, he proposed that man IP and Asset Management – India Specific Page 154

“satisfices”. In simple terms satisfice is a decision-making process that aims for acceptable decisions rather than optimal decisions (a mix of sacrifice and satisfy). In behavioural finance this would equate to investors sacrificing better options for acceptable options. Bounded rationality looks at the constraints an individual has in decision making such as information, cognitive capacity and time restraints. Rationality within these restraints cannot lead to optimisation decisions, however decisions that are made are the best given the restraints. With time sensitive decisions, investors will use heuristics which are mental shortcut that allow us to make quick decisions. These mental shortcuts are constrained to an individual’s knowledge and cognitive capacity. Prospect Theory Daniel Kahneman and Amos Tversky’s prospect theory is a behavioural model of individual’s decisioning making when required to choose an option from a set of risky options. In prospect theory individuals will evaluate their options using a reference point as a starting point which is usually status quo. There are three key behaviours: 1) Individuals do not have one risk preference. Risk aversion and risk seeking is dependent on the context. Individuals are risk averse with gains and risk seekers with losses. For example, if an individual is faced with a choice of walking away with $100 right now or waiting a day for 50% chance of walking with $200 the individual will choose the $100 now as this is certain. If an individual has an option of losing $100 now or waiting a day and having a 50% chance of losing $200 tomorrow, they will choose the latter. Individuals would not want to risk the certain income and they would take a risk if it meant a chance of not losing money. 2) Gains and losses are defined relative to a reference point. When people have been presented two options with the same outcome, but different routes to the outcome, they will most likely choose the option with a perceived gain. For example, you have Rs.1000; option A - you can lose Rs.500 and gain Rs.300, and option B - you can gain Rs.200 and Loose Rs.400. The outcome is the same you will end up with Rs.800. However, most individuals will choose option B because there is a perceived gain. 3) Losses and gains are not treated equally, gaining money is not as important as losing money. For example, winning Rs.200, then losing Rs.80 feels like a net loss even though you are ahead by Rs.120. But loosing Rs.80 first and then winning Rs.200 will feel like a gain All necessary investment information may not be readily available. One need only look at the 2007- 2009 global recession and market meltdown to see that key information was, in fact, not available. As a result, people made choices, based, at least in part, on faulty and incomplete information. The results plunged the world into a multi-year period of deep economic recession. IP and Asset Management – India Specific Page 155

A psychologist can tell you that people do not always act rationally or in their own best interest. There in fact, the opposite is often true. When it comes to investing, research has shown that people often are affected by internal biases. The basis for these biases may be hereditary (i.e., children believe what parents taught) or more experiential (i.e., the result of personal history). Benchmarking and Peer Group Analysis Characteristics of Indices for Benchmarking and Errors When selecting a benchmark, the index used needs to be reflective of the investment strategy that the manager uses. A benchmark needs to exhibit the following: free of conflicts, providing objective pricing and having a transparent methodology. Therefore, the characteristics that a good benchmark must have are the following:  The securities chosen and weighting that makes up the index must be evident.  The benchmark must be investable, meaning that should an investor decided against active managements then holding the benchmark must be possible.  The benchmarks should be measurable; the return should be easily calculated.  The benchmark needs to be appropriate, meaning it must match the manager’s investment philosophy and area of expertise.  Reflective of current investment opinions.  The benchmark must be chosen and species before the start of the evaluation period. The investment manager must take ownership of the benchmark. Strength, weakness of the benchmark and the reasons for the deviation of the client’s portfolio away from the benchmark should be known. A benchmark which would not reflect one or more of the above stated features would suffer from the limitations. Moreover, measuring errors may creep in if the chosen parameters of the benchmark are lagging in certain constituents of the benchmark. As the benchmark analogy will be reflective in a fund manager’s investment philosophy or investment policy, such lagging securities may create a distortion. Hence, a benchmark must be self-innovating and self-correcting in replacing such lagging securities with those that most appropriately reflect the overall character of the benchmark, the sooner the better. On the other hand, from the viewpoint of a fund manager, a benchmark error will occur if the benchmark that was chosen was not appropriate to match the portfolio performance. Either way this could lead to unnecessary losses or a loss of confidence of investors in the portfolio. Another error that IP and Asset Management – India Specific Page 156

can occur is when the asset classes in the portfolio are changed, or their allocation modified while the benchmark remains the same. Also, a fund manager may not be quick enough in capturing the changing profile of the benchmark, which would result in errors in its tracking. Customized Benchmark For a benchmark to embody the above characteristics, it may mean that already existing (standard) benchmarks may not be suitable. In this case, the investment manager will need to customize a benchmark that will accurately reflect his/her investment style. The benchmark is constructed by selecting securities and weightings consistent with the investment manager’s process and the client’s restrictions. The investment manager will need to re-balance the benchmark portfolio on a regular basis so that it remains consistent with the manager’s investment process. Managers’ Universe Analysis Manager’s universe is a benchmark consisting of a group of investment managers with an investment style in common. This benchmark enables the performance of investment managers to be evaluated. The goal is to achieve above average manager returns. This type of benchmark is constructed according to asset class and investment style within that asset class. The benchmark however is flawed as the mangers with poor performance records are not included in this benchmark and therefore the average return is not a true representation of the average of all investment managers’ performance. These types of benchmarks are generally not investable and therefore will not meet the criteria of a good benchmark, leading to the risk of a benchmark error occurring. Manager’s universe can also be used to set return objectives on an institutional level. For example, an institution wanting to set a return objective of an endowment against the average of returns from similar institutions with endowments. In this case this benchmark is not constructed on asset class and investment strategy in that asset class and therefore these are unknown factors and may distort the calculations. Performance attribution analysis Performance attribution analysis is used to evaluate the performance of a portfolio and ultimately decisions made by the portfolio manager. Performance is determined by the performance of the portfolio relative to a benchmark. Attribution analysis seeks to determine why a portfolio underperformed or outperformed its benchmark by comparing the return generated by a portfolio with that of a portfolio benchmarked for evaluation. Three aspects of the portfolio that are affected by IP and Asset Management – India Specific Page 157

the portfolio manager’s decisions are evaluated; they are portfolio allocation, asset/security selection, and the interaction of these effects. Assets and Sector Allocation Asset allocation is the selection of asset classes and assigning weight to those asset classes for a portfolio. Sector allocation entails allocating weights to specific sectors such as mining and transport sectors. These asset class and sector weights are evaluated against a benchmark portfolio. What is being analysed is whether, or not the allocation of weighting contributes positively or negatively to the portfolio return. Positive allocation occurs when the portfolio is over weighted in a sector or asset class that outperforms the benchmark and underweighted underperforming the benchmark. Negative allocation occurs when the Selection, Market-timing versus Selectivity and Net Selectivity Selection is the selecting of individual securities within different asset classes relative to a benchmark. The performance of the portfolio is not really affected by the securities selection as the assigned weights in asset and sector allocation will determine the impact on performance. Larger the weighting larger the impact. Allocations are over weighted in an asset class or sector and underperform and underweighted in an asset class or sector that outperforms. Market timing versus selectivity Portfolio managers must have the ability of selectivity and market timing. Selectivity is the ability to select securities that will be able to deliver the expected returns given a level of risk. Market timing is the ability to predict the movement of the market and make the corresponding changes (buying and selling of securities) to the portfolio in order to outperform the market. Net selectivity Net selectivity indicates the excess return generated that is attributed to portfolio manager’s selectivity abilities. Net selectivity measures the excess return compared with a portfolio with the same total risk. Measure of selectivity is excess return gained from stock selection ability, i.e. (net selectivity) + (return required for diversification) Local currency versus foreign currency denominated investment return Local currency denominated investment return is impacted by the performance of the investment itself. However foreign currency denominated return is not only affected by the investments’ performance but also exchange rate risk. If the local currency appreciated against the foreign currency, then the foreign currency has weakened and therefore any return received converted to the local currency will be less and therefore have a lower return in the local currency compared to the return in foreign currency. If the foreign currency appreciates then this indicates the local currency has weekend which will result in a higher return in local vs foreign. IP and Asset Management – India Specific Page 158

For example: You live in the US and therefore your home currency is the USD. You decided to invest in a US fund that invests in South Africa (your investment will be in USD and the currency of the underlying assets is the South African Rand ZAR. The amount you invest is $20,000 on 28 January 2020. At the time of investment, the USD/ZAR exchange rate was $1/R14.4488. The investment you have made in R and S is (20,000*14.4488) = R288,916. A year later the Rand depreciated and was at $1/R15.064. The return that you had made on this date was 10%. Therefore, your investment value in Rands was 288,916*(1+10%) = R317,808. Converted to local currency (USD), the value would be (R317808/R15.064)= $21,097.16 with a return of (1,097/20,000) = 5.49%. Had the Rand appreciated to say ($1/R13), then your fund value in USD would be $24,447 and the return ($24447 - $20000) = 4,447/20000 = 22.23% Address few critical risks to Investing in Equities Market Risk Market risk arises when the market would move against your investments or not move at all. The movement of the market will depend on economic developments and other events such as change in law/regulation/government policies and the demand supply equation in the market. Changes in interest rates can affect the demand and supply in markets. Increased interest rates negatively affect the demand of shares as easy credit policy allows individuals to purchase shares and tighter interest rates lower the demand for shares. Increase in interest rates typically results n consumers saving more and spending less and the opposite occurs for a decrease in interest rates. This in turn may affect the company’s profits and in turn value. Sudden movement in the market where prices have risen faster than earnings, i.e. more than the fundamental value of shares, may result in a bubble scenario. Risks specific to Sectors and Individual Companies Sector specific risk is the risk that the movement in share price of stocks in a majority of companies within a sector due to a certain event such as a severe drought in the agriculture sector, would negatively impact the performance of portfolio. It may also happen that multiple sector within an economy or across the world suffer at the same time, like the one recently witnessed in the year 2020 due to Covid 19 pandemic. Many sectors suffered due IP and Asset Management – India Specific Page 159

to the consequent lockdown imposed especially freight and logistics, travel and tourism, airlines, automobiles, real estate, hotels, etc. However, few select sectors such as pharma, healthcare, internet retail and software applications did very well. Company risk is the risk that a company might fail, risk of a restructure and the effect on the company and lack of trust in the company’s risk management and executive team and their ability to navigate harsh economic climate, illegal activities, and unexpected events. Let’s look at the Steinhoff case: The firm recorded fictious transactions between 2009 and 2017 that amounted to $7.4 billion dollars. This overinflated the earnings and therefore company value and share price. Steinhoff shares were popular amongst fund managers and billions were wiped out from the companies’ market value. This was discovered through an investigation by PwC and there was no way for an investor to have foreseen this. Transactional Risk and Liquidity Risk Transactional risk can be best explained by way of exchange rate fluctuations. It is the difference in price due to the change in exchange rate between the time the contract was entered into and its eventual settlement. An individual living in the United States wants to add 100 shares that are listed on the London stock exchange to his portfolio. This transaction will therefore be in pounds. If the price per share is £10 at the time of sale and the exchange rate at the time of sale is $1/£0.72, the exchange value for the cost of share purchase equivalent to £1000 pounds is $1389. However, payment does not occur at time of purchase. When payment is made the exchange rate fluctuates which results in a depreciation of the dollar to $1/£0.65 pounds, resulting in a cost of $1,538. Liquidity risk arises when an investor is not able to sell shares quickly enough without a loss of capital or reduction in price. Buyers will not buy shares that they think will not make a profit. To find buyers and entice them back prices will need to drop, and this could lead to a correction in prices. Liquidity risk can also be considered specific to a company. The risk for the company is that the company may not be able to meet its short-term debt obligations. This could cause investors to sell shares increasing supply and a potential drop in share price. The company could go into bankruptcy which will result in a capital loss for the investor Stock Analysis process Sector Classification and Sectoral Rotation An investor who is investing in equities needs to understand how companies (stocks) are classified for purposes of diversification. This is because stock prices move up or down depending on the impact trends or the economic cycle have on an entire sector or industry. Without this information an investor may potentially invest only in sectors that have a IP and Asset Management – India Specific Page 160

significant correlation to the economic cycle and thereby increasing risk of losses but also buying high and selling low. There are four different sectors in the economy (i) Primary (raw materials), e.g., mining, and agricultural (ii) Secondary (finished products from the primary market), e.g., manufacturing and construction (iii) Tertiary sector (companies that provide a service to the consumer) e.g., retail and financial services (iv) Quaternary sector (these are companies that provide inter textual and/or knowledge service). e.g., education and consulting. Sector analysis entails looking at companies that thrive in the conditions of an economic upswing/expansion. These companies are those that benefit from the expansion phase due to factors such as low interest rates that lead to increased consumer spending and borrowing. This generally would be companies in the tertiary sector. In a contraction phase, investors will look for companies that are stable and perform well regardless of the economic cycle. There are two different types of sector analysis, top-down approach and the sector rotation approach. The sector rotation approach entails moving in and out of different sectors according to the market cycle and trends. Investors will invest in sectors as they start to move in the upswing of the market cycle and then sell at the peak. Sector rotation does not have to follow the market cycle, it may follow seasonal or annual trends. The sectors in this approach are classified is a variety of ways, however there are two common classification standards that investors use. These are the Global Industry Classification Standard (GICS) and the Industrial classification benchmark (ICB). These standards provide a standard for assigning companies to specific economic sectors. The sectors are then further divided into Industry group, industry, and sub-industries. Sector rotation is specialised as it requires in depth research on the economy and various sectors and trends. It is also very costly as there is a significant amount of market trading taking place and great amount of liquidity is required. Buy-side Research versus Sell-side Research Fundamental analyst may work for brokerages or investment banks where the focus is on the sell side, raising equity capital by the selling of shares. Alternately, she/he may work for investment funds, mutual funds, pension funds or endowments where the focus on the buy side, wanting to invest in IP and Asset Management – India Specific Page 161

equity. Even though the analysts are on the opposite end and their research criteria differ, the foundation of research for either side remains the same that is fundamental analysis. Both the buy side and sell side will, among other criteria, look at the following: • Valuation - company valuation vs company stock price • Growth and stability - is the earnings growing or stable? • Financial health - the company’s balance sheet, debt obligations. • Operations - Management’s ability to effectively manage operations to drive profit and earnings. Each criterion on its own is not sufficient to effectively analyse the company, to determine if it is a good investment to buy, to hold or an investment that potentially may go south in which case selling will have to be considered. Buy side Buy side research will focus on criteria that indicates that stock is a good investment or not. Individuals would value a company and compare it to the ruling stock price to determine if a sufficient profit can be made. That would determine if the investment is good or not. This is a mistake, just valuing a company is not enough to determine if the stock is a good investment or not. The poor performance of a company does not necessarily equate to bad investment. The risk here is that using just one criterion or too little may lead to investing in a company that seem like a good investment, but the opposite is true. Let us look at the buy-side criteria in more detail. Staying Power: Does the company have the necessary resources to survive an economic downturn? If a company is not performing well or share price has decreased, this does not mean that the company is a bad investment. If the company has the resources and the ability to survive the downturn, shares in good companies can be bought at low prices. What do you look for in staying power? Liquidly, low debt, stable cash flow, stability, and discipline to avoid excessive debt. Liquidity – quick access to cash if needed, to pay obligations due in a year. Low debt - reasonable level of debt indicates the companies’ ability to handle a downturn. Even if a company has a good and stable cash flow, if the debt obligations are too high, the likelihood that company can survive the downturn decreases. IP and Asset Management – India Specific Page 162

Stock price vs cash per share - if the stock price is below the cash per a share, lower than cash in the bank, the share can be purchased for less than its actual value. The reason as to why the price of share has fallen below cash levels needs to be considered, lack of trust in managements, high debt levels may indicate the company does not have the ability to survive the downturn. Revenue and earnings trends - Fundamental analysis can be used to find companies with continuing earnings and revenue growth. These companies have the potential to be good investments with reasonable price, and there are no red flags regarding other fundamental analysis criteria. Management capabilities and performance - Part of determining if a company has the resources to survive an economic downturn or harsh economic environment is looking not only at the balance sheet and income statement but looking at the Human Capital as well, especially the decision makers. To determine the performance of the management team, return on equity, return on capital as well as return on assets can be used. Return on assets indicates the profit that is generated from the assets under the company’s control. This excludes debt that the company uses to generate revenue. As an investor wanting to buy, you want to see the management team boosting profits, managing all the assets effectively and efficiently to generate revenue. Valuation - Is the company itself been over valued or undervalued and how does the value compare to other companies in the same industry? Is the share price less than the value of the share to be able to make a profit? Dividend payment - Investing in companies that pay a dividend is a way to earn income from your investments as well as growth. Looking at the dividend yield can provide some insight into the operations of the company. Also look at the dividend yield comparison to similar companies in the industry, the growth and sustainability of such dividends. Companies with high dividend yield are not necessarily good investments if the dividend yield is too high compared to the market average, this could indicate a potential cut in future. The dividend pay-out ratio will indicate the affordability of the dividend pay-out. If the company is paying a significant portion of their earnings or all the earnings as dividends, then it could be that there the likelihood of the dividend increasing in the future is slim and could remain the same or even be cut. However not declaring a dividend also does not necessarily mean that the company is in stormy waters, it could indicate that the company has profitable projects to invest in to drive up profits. Sell side Sell side research will focus on criteria that indicate if a company could potentially be in trouble and that will result in share price and value falling. This will indicate that the investor should sell. IP and Asset Management – India Specific Page 163

Sell side research is published and it is what the buy side uses as data. It is important to understand what you are looking for when looking to invest or looking to sell. Let us look at the sell side criteria: Stalling or declining earnings or revenue growth - If a company’s growth is consistently stalling or slowing this may indicate that the company may not have the resources to survive in an economic downturn. • Going concern - Deteriorating financial ratios that have an impact on the company’s going concern such as debt and liquidity ratios. Apprehension or worry about a company’s going concern could indicate that the company may not have the ability to continue business. • Ineffective management team and poor corporate governance - Management’s ability to utilise resources effectively and efficiently to drive profits becomes questionable. Lack of faith in managements, lack of proper reporting and governance. Management’s integrity gets called in to question, scandal involving management. • Overvaluation - The Company’s valuation declines to the extent that the share price is higher than the value of the company. This means that the company is overvalued, and stock prices are rapidly increasing to unsustainable levels. This may cause sellers to sell at a discount. If all the criteria have been met, this does not mean that the investment must be sold. An investor may want to hold and not sell if the investor is confident that despite the declining earnings or going concern being called into question, the management team can turn things around Fundamental Analysis DCF and other Valuation Driven Models There are two valuation models that are used to value equity, Absolute valuation model and Relative valuation model (also known as Comparable). The absolute valuations model estimates the intrinsic value of the company which then can be compared to the market price. Intrinsic value is what the company is worth using by using fundamentals to calculate the return on investing in that company. The return is the cash flow that an investor gets paid or has a claim to. Present value of cash flow models is used in absolute valuation models. Relative valuation estimates a company’s value in relation to similar companies in the same industry or sector. The relative valuation models use price or enterprise multiples to value a business relative to another similar business or market average. IP and Asset Management – India Specific Page 164

Discounted Cash Flow Methodology Cash flow has always been important to bankers in their analyses of financial statements of potential borrowers. Most stock analysis has focused on earnings per share instead of cash flow per share. Cash flow is defined in different ways. The most basic definition might be EBITDA, which includes operating income after all cash expenses excluding income taxes (not under the control of management) and interest expense (a financing decision, not an operating decision). EBITDA is a look at cash generated from operating the business. Discounted Cash Flow Methodology Cash flow has always been important to bankers in their analyses of financial statements of potential borrowers. Most stock analysis has focused on earnings per share instead of cash flow per share. Cash flow is defined in different ways. The most basic definition might be EBITDA, which includes operating income after all cash expenses excluding income taxes (not under the control of management) and interest expense (a financing decision, not an operating decision). EBITDA is a look at cash generated from operating the business. Discounted cash flow model is used to determine the intrinsic value of stock by discounting the value of future cash flows to a present value. There are two cash flows that are commonly used: dividends (if a company does pay dividends) and free cash flow. If future cash flow of dividends is used to calculate the intrinsic value of the company, then the dividend discount model is used. Dividend discount model is less volatile than earnings and often viewed as a long-run intrinsic value. Free cash flow is cash from operations that is not earmarked for operational or capital expenditure. It can be separated into free cash flow to equity (FCFE) and free cash flow to firm (FCFF). FCFF which is unlevered cash flow assumes that the company is debt free. FCFF is calculated by taking cash flow from operations minus capital expenditures (reinvestments in assets and working capital). This is an after- tax cash flow. The PV of FCFF is used to calculate the enterprise value of a company which is the value of the whole business. FCFE is levered cash flow, meaning that the cash flow is what is available to common shareholders after debt expense has been paid. FCFE is FCFF less total net debt, this is the equity valuation. The mechanics of a discounted cash flow methodology (DCF) can be quite complicated, but in basic form, the DCF methodology consists of six steps: (i) Forecast the discretionary cash flow that a company is expected to generate in each of the next few years, generally three to five years. To calculate discretionary cash flow: IP and Asset Management – India Specific Page 165

Earnings before interest and taxes (‘EBIT’) - cash income taxes = net income before financing costs + depreciation and amortization - capital expenditure requirements - incremental working capital required to support growth = discretionary cash flow The discretionary cash flow for each year of the forecast period is discounted to a present value amount using a discount rate. The discount rate represents the required rate of return for a particular investment opportunity given the associated risks. This required rate of return is generally assumed to equal the risk-free rate and the required compensation for the risk of the cash flow. The discount rate is generally the cost of capital. Capital can be raised either through equity or debt or both. Hence, the cost of capital is either cost of equity, cost of debt or the combination of both. Generally, it is a combination and the after tax-weighted average cost of capital (WACC) is used to determine the discount rate for PV of free cash flows. WACC = (E/V x Re) + ((D/V x Rd) x (1 – T)) Where: E = market value of the firm’s equity (market cap) D = market value of the firm’s debt V = total value of capital (equity plus debt) E/V = percentage of capital that is equity D/V = percentage of capital that is debt Re = cost of equity -Capital asset pricing model(CAPM) is used to calculate the cost of equity Rd = cost of debt- After-Tax Cost of Debt = Cost of Debt x (1 – Tax Rate) T = tax rate A ‘terminal value’ is calculated by estimating the annual discretionary cash flow beyond the forecast period, divided by a capitalization rate. The capitalization rate represents the discount rate less a long- term growth factor. The terminal value represents the estimated enterprise value of the company beyond the forecast period. (iii) The terminal value is discounted to a present value amount using the same discount rate applied to the discretionary cash flows. (iv) The present value of the terminal values is added to the present value of the discretionary cash flows to calculate the enterprise value of the company, which is the absolute value of the company, however, to find the value per share to compare to market price, the equity value needs to be calculated. (v) Interest bearing debt is deducted from enterprise value to derive the shareholder value of the company (FCFE). The equity value is then divided by the number of outstanding shares to obtain value per a share. IP and Asset Management – India Specific Page 166

Residual income = NOPAT – (C% × TC) NOPAT is the company’s net operating profit after taxes, C% is the cost of capital, and TC is total capital. Asset-based model is based on assets minus liabilities and looks at what the business could sell for in the current market based on net assets. The value of assets and liabilities will differ from the value reported on the balance sheet and the market value as factors such as timing and accounting for depreciation will impact the values. Another differentiating factor is net assets adjustments for assets that may not be on the balance sheet such as intangible assets as well as adjusting liabilities. Relative Valuation in Market Driven Models EVA and MVA; EV/EBITDA Ratio; EV/Sales Ratio EVA and MVA EVA is economic value added, the economic profit that a company has made. EVA is also another name for residual income. EVA looks at the economic success of a company over a period. Simply put how well that company does utilised total capital invested to create value. MVA is market value added which is the additional value that the company has created for common shareholders due to the EVA over a period. MVA is calculated by deducting total capital invested from the enterprise value. MVA of a company is dependent on the EVA of the company as a company needs to generate sufficient EVA over time to increase MVA. EV/EBITDA Ratio This ratio is the enterprise value over EBITDA. It is the total value of the whole company relative to its true cash earnings and is used to compare companies in the same industry as it is a valuation indicator for the company. EV/EBITDA is generally used with the P/E ratio or as its replacement, as the latter is not as comprehensive as it only considers the value of equity over earnings after tax which is not a true reflection of the companies’ real cash earnings. EV/Sales Ratio Enterprise value to sales is a major alternative to the price-to-sales ratio. P/S does not consider that some of the proceeds from the company’s sales will be used to pay interest and principal to the providers of the company’s debt capital and therefore does not belong to the common shareholders. Therefore P/S can only be used for comparable companies that have similar debt structures. EV/S is a ratio that can be used when comparing companies with diverse capital structures. Dividend Yield and Earning Yield Dividend Yield Dividend yield is the dividend rate over the current market price per a share. This ratio indicates the percentage of dividends that a company pays out in relation to the market price of the IP and Asset Management – India Specific Page 167

share (the return based on dividends). Companies declare dividends over varying amounts of periods in a year. Therefore, the dividend rate is the annualized value of the most recent dividend paid to shareholders. Earnings Yield Earnings yield is the reciprocal of P/E, it is earnings per a share over price per a share. This yield indicates the return based on earnings, which is the percentage of earnings in relation to the price of a share. If price indicates value, then a low earnings yield could indicate an overvalued investment, or a valuable investment for which the investors are willing to pay the market price for. The opposite could be true for a high earnings yield, it could indicate an undervalued investment or a drop in price if earnings remained the same. Looking at the company’s history is important to know what the trend of EPS has been. Industry/sector specific valuation metrics As discussed in sector analysis each sector and therefore industry is different. The operations, profit margin and growth rates differ from industry to industry and therefore the different industries must have their own valuation methodology and therefore specific metrics. Metrics must match how the value is created and measured in a specific industry or sector. Take the banking sector for example; Banks’s profits are predominantly from the interest spread. The book value of the lending book is seen as an indicator of the net value. For this reason, investors will look at the P/BV to evaluate the stock. P/E ratio is normally used for established companies with constant growth. Combining relative valuation and discounted cash flow models It is not wise to use only relative or absolute valuation models because of the diverse nature of companies in different industries or even the same industry. Using only one will distort the results. Combining these two valuation models will give a much more accurate picture in determining if the company is a good investment or not. A company may be undervalued compared to its market price (absolute valuation), however compared to market average it may be overvalued (one may be paying less for the stock than it is worth but the share itself can be overvalued in the industry or sector). IP and Asset Management – India Specific Page 168

Advantages of Technical Analysis 24 The advantages of applying technical analysis are: Technical analysis can be used for any market or instrument that has historical price and volume data. All indicators are treated the same across these markets and instruments and therefore no new knowledge is required to do technical analysis across different markets. • Because technical analysts believe that all information that impacts or potentially impacts market is already reflected in the price there is no need to gather information such as fundamentals to apply technical analysis. • A clear picture of the market’s volatility and behaviour can be seen with charts, this will further enhance the investors understanding of the markets risk and behaviour than just numerical numbers. • Exact time and entry and exit prices are provided through technical analysis. • Being able to see clear and obvious price triggers market participants are more likely to react the same which helps create a more reliable trade. Fixed-income Securities and Technical Analysis Technical analysis can be used to forecast the price movement of any tradable instrument that is affected by supply and demand and has historical data on price and volume. This includes fixed income securities for which the most common instrument is Bonds. Because the market interest rate which is a significant factor in the value of a bond, is effectively set by governing bodies, it is therefore not subject to the behaviour of the market that Technical analysis attempts to predict. Therefore, it would seem that technical analysis cannot be used for Bonds. However, technical analysis can be used to measure market influence directly where more than one factor can affect demand or supply in opposite directions. For example, if rates go up, demand decreases which mean prices of bonds should decrease. If at the same time market participants choose to move into bonds because of the increase in rates this will increase demand. Fusion Investing The Efficient Market Theory (EMH), developed by economist Eugene Fama in 1960s, stated that prices of all securities are completely fair and reflect an asset’s intrinsic value at any given time. A fund manager who uses passive strategies cannot be outperformed by another fund manager who uses active strategies minus the transaction costs and fund management costs. All active management therefore would utilize to the fullest the pricing anomalies found, which the EMH negates. IP and Asset Management – India Specific Page 169

“Fusion investing is a relatively new approach that attempts to integrate traditional and behavioral paradigms to create more robust investment models”. The term, fusion investing, was first presented by Lee (2003). Bird and Casavecchia, in 2007, expanded the idea of fusion investing. They suggested three approaches to exploit price anomalies - the ‘value approach’, the ‘fundamental approach’ and the ‘momentum approach’. Value shares are identified as those having low Price to Earnings P/E), low Price to Book (P/B) and low Price to cash Flow (P/CF). They usually underperform in the market relative to the growth shares which have high above-mentioned multiples. To the extent that value shares would correct these valuations in time and would thus over perform growth shares, they would ascribe a value premium inherent in this investing. If we go by the EMH, the value premium can be ascribed to judgemental mistakes of majority of investors, but to a select few it would be contrarian investing. The relative valuation multiples used would appear to reflect the systematic errors made by investors in their forecasting. A low P/B value, or low current share price relative to its book value, would imply an irrational attribution to the company’s poor past performance and continuance of the same in the future as well. If such investors’ expectations do not fructify, the P/B multiple would correct itself to reflect the recent information, and hence a mean reversion in the market performance. Thus, greater the distance from mean, the higher the probability that the share’s price would adjust to reflect the multiples’ accepted level. The essence lies in determining when this reversion will occur and therefore delay the purchase of the value share until its eventual turning point. A fundamental analysis approach, on the other hand, works to identify shares whose current prices lag their values ascertained by earnings forecasts and accounting-based valuation models. It is possible as an essential research tool to develop strategies to predict future changes in earnings, based on various financial ratios obtainable from historic financial statements. This is done without taking into account changes in the macro economy at broad level, as well as earnings innovations at the firm level. So, within the universe of value firms, we can identify those firms which offer a reliable estimate of financial health and investment potential. Momentum investing can be defined as continuing to profit from the direction of prior stock returns buy using the relative strength trading strategy, i.e. buying past winners and selling past losers for a significant but short holding period. Jegadeesh and Titman, in 1993, discovered the momentum effect. They showed that significant profits can be made using this strategy which is contra to the traditional finance theory. It can be a dual reason: first, a delayed price reaction to firm-specific information; and second, an escape from the systematic risk of the trading strategy. Historic annual share returns are calculated each month on a rolling 12-month horizon. The shares are then sorted based on these IP and Asset Management – India Specific Page 170

historic returns, in ascending order, into quintiles. The top quintile, the winner portfolio, is taken more exposure to while the bottom quintile is shorted. The fusion strategy, develop by Bird and Casavecchia, enhances the value style portfolios by combining the earnings forecast method as a fundamental indicator. A specific momentum indicator is used as an acceleration indicator. The momentum indicator is used to split the top momentum stocks that exhibit more winning characteristics. They find that both enhancements (momentum and fundamentals), independently and in combination, improve the timing ability of the manager in selecting value and growth stocks and that the momentum enhancement subsumes the fundamental enhancement in better identifying value shares. Specifically, the success rate of enhancing a value style with a momentum indicator increases from 42% to 53% over a one year holding period. One downside of using a fusion strategy is that the number of shares in the portfolio are small and hence diversification is challenged. However, the very purpose of fusion strategy is to identify particular shares in an attempt to earn above-average returns. It is more a statistical selection over economic selection, although the returns obtained are economically significant for an average investor. The relative advantages scored are lower transaction costs, no need of a sector rotation, and better risk-adjusted returns so as to outperform both active funds and leading benchmarks. Diversification of Risk - Equity and Other Assets Cross Sectional vs Time Series One of the primary goals of investors, especially the fund managers who manage portfolio of investors is to increase the terminal value of investments. In other words, the primary goal is to maximize the growth of an investment over a given period of time for a desired level of risk. Most portfolios tend to maximize per period averages per unit of average risk, like in Sharpe ratio. This comes in contrast with maximizing terminal value over a given period, as maximizing Sharpe ratio is rooted in the assumption of repeatable single-period investing against a multi-period maximization of portfolio value. It is of essence to note that the factors and the overall investment environment can vary significantly from one period to the. The cross-sectional diversification can be achieved by diversifying holdings over a single period. As we target the growth in terminal value over a multi-period, the diversification across time gains more credence, or at least equal in importance to diversifying across asset classes. This brings time-series more into focus as a method of diversifying risk. This is because the level of risk in an asset class may fluctuate sometimes violently across time. The volatility around realized returns may result in a drag on compound returns of a portfolio, thus giving rise to excess portfolio risk which needs to be managed. IP and Asset Management – India Specific Page 171

Diversifying across time reduces the drag on compound returns by decreasing the fluctuation in risk levels. Thus, a constant risk level is sought to be maintained from period to period, called a ‘target risk’ level. This is attained by reducing the tail risk, or the chance of a loss occurring due to a rare event, as predicted by a probability distribution. This tail risk is the financial risk of an asset or portfolio of assets moving more than three standard deviations from its current price. Clearly the left tail, concerned with losses is what may destabilize compound returns. Hence, efforts should be made toward reducing the variability of portfolio risk from the target risk over time. Ignoring changes in risk over time may have serious implications for terminal portfolio values and hence realized returns over a multi-period. Even balanced portfolios can have dramatically varying risks from one identical time period to the other. The average performance is realized over identical and repeatable periods. However, the time periods for risks may not follow identical periods. The averages ignore the effect of compounding across non-identical periods. The investment in practical scenario cannot be regarded as made over repeatable single periods but across non-identical multi-periods. It is more about embracing an Adaptive Asset Allocation that seeks to change portfolio weights to changing risk levels that helps either to avoid a detrimental tail loss or participate in a favourable tail gain. This adaptive asset allocation adds the element of time diversification while retaining the virtues of cross-sectional diversification. While macro-shocks are infrequent and unpredictable, the micro- shocks that emanate within asset classes or sub-classes are more common and predictable. These can be earnings announcement locally or commodity price shocks globally which can be monitored to timely effect portfolio weights. The above cross-sectional and time-series diversification strategy can be true of a portfolio of single asset class or multi-asset-classes. While managing such a multi-asset portfolio it is important to keep in the purview the economic foundation or theoretical basis of various strategies – carry, momentum or value. It may be useful then to determine why certain strategies work better in the time-series while others are best applied in cross-section. Qualitative Evaluation of Stocks - Corporate Governance Aspect The Indian corporates are governed by The Companies Act, 2013. The pattern of holding of majority of private companies is closely held by the founder or promoter, family and associates. The organizational framework for corporate governance initiatives in India consists of the Ministry of Corporate Affairs (MCA) and the Securities and Exchange Board of India (SEBI). SEBI monitors and regulates corporate governance of listed companies in India through Clause 49. IP and Asset Management – India Specific Page 172

The four basic objectives of corporate governance are – disclosure, transparency, and accountability. Timely and accurate information should be disclosed on the matters like the financial position, performance. The factors which analysts look at include: 1. Economic Ownership and Voting Control 2. Board of Director Representation 3. Remuneration and Company Performance 4. The Effect of Investors in the Company 5. The Strength of Shareholder's Rights 6. The Management of Long-Term Risk Earlier good governance was not a mandated legal requirement and adherence was voluntary, but owing to corporate failures on account of unethical practices at top level management, most of the countries have initiated mandatory norms and guidelines to strengthen corporate governance framework. Corporate governance reforms are more significant for developing economies as they make the corporate structures more effective, help in competing with multinational corporations and increase investors’ confidence. Though, corporate governance norms and other disclosure guidelines have been introduced in India but owing to weak implementation, the extent of compliance by the Indian companies is still questionable. Countries with weak legal norms have suffered higher depletion in exchange rates and stock market decline. Most of the previous studies highlight the impact of corporate governance on financial performance but surprisingly there is dearth of literature on impact of corporate governance reforms on corporate disclosures and reporting. This backdrop gives an interesting case to study the impact of reforms and amendments on improvement corporate governance disclosures in Indian companies The management strength is one of the most important evaluations of a company while investing. If ethical and prudent policies are followed by a corporate, it gives ample confidence to the entire ecosystem - the partnering firms and associates, creditors, suppliers and vendors, the auditors and other stakeholders. The positive impact of clean accounts and transparency in operations, timely discharge of taxes, resolution of investor and shareholder grievances all add up to a vibrancy which is embraced by investors to give the company’s stock a premium valuation. Such stocks get invested into by the institutional investors, MFs, FPIs and high net worth investors, lending it credibility of turnover and good liquidity aspect. Environment, Social, Governance (ESG) is a currently popular norm to evaluate stocks of companies and the management. IP and Asset Management – India Specific Page 173

The sensitivity of the company toward environment - the reduction in carbon footprint by adopting renewal energy sources in production, reducing emission and treating waste and affluent while conserving water resources and green cover are some of the important yardsticks on which FPIs, foreign pension funds base their investment decisions. If the companies use their resources for a social good, e.g. increasing rural employment and women empowerment, participating in charitable activities, while proactively containing the prospects of money laundering activities and not dealing in sin products, their social metric is considered favourable. As such stocks enjoy funds inflow of institutional investors, ESG becomes an important parameter of management evaluation while investing. Sources of Performance Data - Mandated by the Regulator and Industry The regulators are not supposed to mandate performance of funds by the institutions vested with the responsibility of investing the savings of investors. It is more market driven, and the non-performers are sooner or later weeded out from the business. Even the schemes which are oriented towards protection of capital are not with guaranteed returns. The orientation towards protection of capital originates from the portfolio structure of the scheme and not from any bank guarantee or insurance cover. However, it is an important role of the regulator to set the rules of the game, certain operational parameters that helps in the hygiene of management of funds and efficiency of transactions. It happens in most of the situations that the industry bodies or individual constituents set their parameters which are on a higher side than those mandated by the regulators. With passage of time, such prudent norms become the standard for disclosure and transparency and hence the operational performance of the constituents. Mutual Funds The following are some of the standards of services imposed by SEBI and the industry’s response toward maintaining such standards: The performance of a mutual fund scheme Page 174 IP and Asset Management – India Specific

• The performance of a scheme, reflected in its NAV, is required to be disclosed on daily basis which is published on the web sites of mutual funds. All mutual funds are also required to put their NAVs on the web site of the industry body Association of Mutual Funds in India (AMFI) www.amfiindia.com Each MF is required to have a dashboard on its website providing performance and key disclosures pertaining to each managed scheme. • The mutual funds are also required to publish their performance in the form of half-yearly results which also include their returns over a period of time i.e. last six months, 1 year, 3 years, 5 years and since inception of schemes. • Investors can also look into other details like percentage of expenses to total assets as these have an effect on the return and other useful information in the same half-yearly format. • The mutual funds are also required to send annual report or abridged annual report to the unit holders at the end of the year. Investors can compare the performance of their schemes with those of other mutual funds under the same category. • They can also compare the performance of equity oriented schemes with the benchmarks. On the basis of performance of the mutual funds, the investors should decide when to enter or exit from a mutual fund scheme. PMS schemes -Performance disclosure requirement The following disclosures toward portfolio performance are required to be made by a portfolio manager to its client: The performance of the portfolio manager shall be disclosed with segregated performance as per the different investment approach. The time weighted rate of return for the preceding three years shall be disclosed toward performance indicator in case of a discretionary portfolio manager. • The audited financial statements for the preceding three years shall also be included along with the portfolio performance. The contents of the disclosure document shall be certified by an independent Chartered Accountant. • The portfolio manager shall furnish periodically (not exceeding 3 months) a report to the client consisting of details such as the composition and the value of the portfolio; description (with number and value) of each of the securities and goods held in the portfolio and cash balance; details of purchase and sales transactions undertaken and the beneficial interest (in the form of interest, dividend, bonus, rights, etc.,) received during the period of report; expenses incurred in managing the portfolio including details of commission paid to distributor(s); and the risks foreseen by the portfolio manager and those relating to the securities recommended for investment or disinvestment. Cut-off timings: Page 175 Liquid schemes – Subscription IP and Asset Management – India Specific

Where the application is received up to 2.00 p.m. on a day and funds are available for utilization before 2:00 p.m. without availing any credit facility, the closing NAV of the day immediately preceding the day of receipt of application. • Where the application is received after 2.00 p.m. on a day and funds are available for utilization on the same day without availing any credit facility, the closing NAV of the day immediately preceding the next business day; and Irrespective of the time of receipt ofapplication (before or after 2:00 p.m. on a day), where the funds are not available for utilization before 2:00 p.m. without availing any credit facility, the closing NAV of the day immediately preceding the day on which the funds are available for utilization. Liquid schemes – Redemption • Where the application is received up to 3.00 pm – the closing NAV of the day immediately preceding the next business day; and • Where the application is received after 3.00 pm – the closing NAV of the next business day Other than Liquid Schemes – Subscription For amount less than INR 2 lakh • Where the application is received up to 3:00 p.m., closing NAV of the day on which the application is received. • Where the application is received after 3:00 p.m., closing NAV of the next business day. For amount equal to or more than INR 2 lakh • Where the application is received up to 3:00 p.m. and funds are available for utilization before 3:00 p.m., closing NAV of the day on which the application is received. • Where the application is received after 3:00 p.m. and funds are available for utilization, closing NAV of the next business day. • Irrespective of the time of receipt of application (before or after 3:00 p.m.), where the funds are not available for utilization, closing NAV of the day on which the funds are available for utilization. Other than Liquid Schemes – Redemption • Where the application is received up to 3.00 pm – closing NAV of the day on which the application is received; and • Where the application is received after 3.00 pm – closing NAV of the next business day. Chapter-7: Financial Advisory and Financial Planning IP and Asset Management – India Specific Page 176

Learning Objectives  Illustrate the need for financial advisory services  Determine the financial position of clients  Assess insurance needs and requirements  Construct the retirement planning process  Analyze tax efficiencies  Understand estate planning Introduction Financial advisory encompasses a wide range of services, on limited basis as well as going into extreme details with respect to one or more aspects of financial situation of a client. The financial aspect addressed may exclusively be limited to obtaining best return from investments within constraints of the concerned investor. It may solely relate to choosing an instrument to accumulate funds for a client’s after-work life. It may just address pure risk that a client is exposed to in various spheres. It may also be a strict professional assessment of a client’s one-time or on-going taxation aspect of finances, or complex legal segregation of financial assets. Financial advice and financial advisory are not specifically controlled terms by the regulators across financial sector in India. However, depending on the sector to which they address, e.g. insurance and retirement, the respective regulators IRDAI and PFRDA define channels within which such advice should lie, the adherence to ethical guidelines, and the risk factors with respect to a client situation. They also encourage separation of advisory from plain distribution of financial products, and foster a pathway where a client’s suitability to hold a certain financial product is taken into account even in a simple sale transaction. The terms ‘investment advice’ and ‘investment adviser’ are however regulated by the securities market regulator SEBI. The investment advice is in relation to securities and investment products, and investment portfolios which contain such securities and investment products. The investment adviser would mean any person, who for consideration, is engaged in the business of providing investment advice to clients or group of persons. Any person cannot hold out himself/herself as an investment adviser, by whatever name called, unless duly registered with SEBI to do so. Financial Planning is a wholesome discipline which covers all areas of a client’s personal finance. FPSB maintains financial planning as a process of developing strategies to help people manage their financial IP and Asset Management – India Specific Page 177

affairs to meet life goals. A financial planner may choose to specialize in a certain domain of personal finance, or a specific component of financial planning, but he/she is expected to be well-versed with other related areas of a client’s financial situation to assess the impact of his/her advice. SEBI, in their Investment Advisers regulations, have defined financial advice to include financial planning. SEBI has also defined financial planning under the regulations as analysis of clients’ current financial situation, identification of their financial goals, and developing and recommending financial strategies to realize such goals. A financial planner may choose to be on the execution side only, but wherever he/she chooses a fee-for-advice from clients, it necessitates registering as Investment Adviser with SEBI. Need for Financial Advisory Services Financial advice for long has been treated by the public in India as not something for which they should pay separately and directly. They have been rather content to pay higher costs by way of commissions which are even front-loaded when a sale transaction is executed through agents or distributors. Financial advisors have not been considered as professionals in their own right, on par with Lawyers/Advocates, Chartered Accountants, Cost Accountants and Company Secretaries who have statutes under which such professions are enshrined. Financial institutions and product manufacturers have differentiated remuneration for their intermediaries to sell certain products to suit the business proposition. The intermediaries have thus been solely agents of the financial product manufacturers and have naturally catered to the manufacturers’ interest. There have been unsavoury events, whether of the proportion of global financial crisis of 2008 or any country-specific ones which have affected the consumers, certain sections or at large, of such financial products disproportionally. The ensuing public unrest has awakened the authorities concerned to take appropriate measures in the interest of consumers. The International Organization of Securities Commissions (IOSCO) has been vigilant in sensitizing member nations on scenarios of miss - selling of financial products, including complex ones, unsuitable to the consumer’s risk profile. The regulators across the financial sector in India: the RBI, the SEBI, the IRDAI and the PFRDA, on one hand have been proactive in monitoring the product manufacturers, so that the products serve the interests of financial consumers at affordable costs of administration and reasonable share of profits to manufacturers. The intermediation costs are regulated as well, on the other hand, in order to ensure that no product is pushed with a lopsided incentive/ commission involved therein. The financial advice is sought to be increasingly segregated from distribution and the process of distribution is made to adhere to a mandated code of ethics. IP and Asset Management – India Specific Page 178

It is here that the financial advisors and investment advisors are seen to be the agents of consumers, offering advice in their best interest and seeking remuneration for advice directly from them. It serves to aptly allocate the responsibility of financial decisions among the concerned, right from the consumers and their advisors to the product manufacturers and their intermediaries. The need for professional advisory services in finance and investment is underlined by a desire to effectively meet the financial goals of individuals with a well aligned risk management system. Such advisory services would enable a robust system to settle the inadequacies on its own, rather than stalling the system and searching for new alternatives. Financial Advisory and Execution The execution or implementation of financial advice is an important step in the process. The right implementation is equally necessary for a given recommendation. In the investment space, SEBI has clearly stated in Investment Advisers regulations that an individual who practices investment advice shall maintain an arms-length relationship with the distribution process. Needless to say, a registered investment advisor cannot involve him/ her in distribution as well. The trend of regulations in this space even seeks to have this consistency in corporate bodies who act as distributors and practice advisory through a separately identifiable department or entity. This position of separating advice from execution is not maintained in insurance and retirement domains. The management of conflicts of interest is however emphasized along with adherence to a code of conduct. Scope of Financial Planning Services and Process Financial planning is defined as a process of developing strategies to help people manage their financial affairs to meet life goals. The financial planning components are spread across the components of financial management, investment planning and asset management, risk management and insurance planning, retirement planning, tax optimization, estate planning and wealth transfer. The combined effort to synthesize advice across all these components and deliver a full-fledged financial plan comes under Integrated Financial Planning. A financial planner can specialize to offer his/her services in one or more components of financial planning, however, FPSB requires that financial planning professionals should master each of the Financial Planner Competencies at an appropriate level. A financial planner and client can specify in their engagement any one, more or all of these components to be chosen, and whether the scope of engaging financial planner is limited to developing strategies and presenting recommendations only, or extends to implementation and review, or both. IP and Asset Management – India Specific Page 179

In developing strategies to manage financial affairs to meet their clients’ life goals, financial planners help their clients to fairly understand their financial situation and proposed strategies, and help them to stay on track. Their recommendations are mostly based on review of all relevant aspects of a client’s situation across breadth of financial planning activities, including interrelationships among often conflicting objectives. When holding out as a financial planner, regardless of whether he or she is engaging in financial planning services or in product sales, a duty of care consistent with that of a fiduciary is owed to the client. Evaluating the financial position of clients: Assets, Liabilities and Net worth There is comprehensive process of data collection, both qualitative and quantitative, in order to determine the financial position of a client. A financial planning professional creates a repository of all financial assets, valuables and physical assets by securing the physical certificates of holdings, Demat accounts, records of land and property, jewellery and bullion, precious stones, art/artefacts, collectibles, vehicles, etc. A rough valuation of assets, wherever needed, is also done. The liabilities of client are taken on record across long-term debts like mortgage loans, car loan, etc., and short-term loans like personal loans, credit card loans, etc. Details like contracted amount of loans, tenure, finance costs and other terms, and their current outstanding loan amounts are recorded. The professional also ascertains any other financial obligations not on record such as loan guarantees given to friends/relatives. The gross amount of assets as reduced by the liabilities standing against them gives the net worth of client. Depending on situation, the professional advises a client to make adequate provisions for doubtful assets as well as the illiquidity position of certain assets to arrive at actual net worth. The financial planning professional assesses the annual income of the client from all sources, as well as current and foreseen expenses/financial obligations in order to arrive at net annual disposable income. This may be required to assess the current financial position of client and how it is likely to change in the near future. This income level seen against assets, liabilities separately, as well as in combination as net worth, are the parameters necessary to arrive at various financial ratios to adjudge the financial situation of a client and the quality of financial health. Trade-off between Investing Money and Paying-off Loans Should you invest excess cash or use your excess cash to repay outstanding debt? Simply put, choosing between the options to grow your cash or using it to reduce the interest cost on a loan. This is a decision that all individuals are faced with when they have intermediate surplus cash out of certain event such as a matured investment or a bonus. IP and Asset Management – India Specific Page 180

Debt vs Investment Both debt and investment have interest rates. The interest on debt is a cost while interest on an investment is income. When looking at the rate of return from investments, the real rate of return after inflation and tax must be used as the net income will be reduced by taxes. Often the cost of debt is higher than the real rate of return an investment may earn. Should that be the only criterion, the decision would be a no brainer! Example: consider a loan of Rs.1, 00,000 for five years at a rate of 7% per annum to be paid monthly. The equated monthly instalment would be Rs.1980 (rounded off). The total interest cost of the Rs.1,00,000 loan is Rs.18,800 over a 5-year loan term. Suppose, in the 12th month into the loan repayment schedule the client gets a cash flow of Rs.30, 000 and utilizes the same toward reducing the loan burden. By doing so, the loan is paid off in just 41 months, incurring a total interest burden of Rs.11.190. Thus, by repaying a part of loan toward the end of 1 year, the client saves Rs.7610towards interest costs. Compare this to risk free investments which would yield in the region of 2% generally. Moving into riskier assets will give better rate of return however volatility would be an added risk too. If the cash surplus after 1 year is invested in these risk-free assets for the period of outstanding loan tenure, it would return extra money of Rs.2470. Compared with the available cash grown the interest saved would be by an excess amount of Rs.5140. However, like most of personal finance decisions you need to consider more than just numbers. Financial needs and goals must also be considered. Using the above example: What if the client’s one goal was to save for a holiday? Does the client have an emergency fund to take care of the unexpected situation that may arise in the interim, if the decision is taken to paying off debt early? View above; it does not have to be either debt or investments. It can be split between the two options. Putting the moneys towards the financial need and if the full surplus cash is not required, the balance can be put towards paying off debt. A financial planner would look into all aspects and advise the right allocation of excess funds to go toward reducing debt burden as well as toward other avenues. It would be a holistic picture instead of justifying numbers to save on interest to be expended or additional gains out of investments. Strategies to get rid of debt faster - Avalanche, Snowball, Blizzard IP and Asset Management – India Specific Page 181

The only way to reduce debt quicker without it costing you more or selling assets to pay off debt is to increase payments above the minimum amount. This would require excess income over and above expenses. If an individual needs to reduce debt and does not have the additional income, then assessing expenditure to find areas where expenses can be reduced to free up money will be required. The equated monthly instalments consist of a portion toward capital repayment and the other toward interest. As you progress through the term of the debt, the interest portion which at the beginning of the term is a significantly large portion of the instalment amount. This would decrease as the term progresses, and the ratio will eventually become in favour of the capital portion. Any amount paid above the equated instalment, will go toward decreasing the capital and thereby make paying the debt quicker. If an individual has several different debt obligations such as car loan, student loan, credit card debt, etc., it may be confusing to know which debt obligation to reduce first. There are three methods that an individual can apply to reducing debt by increasing minimum payments namely: the Avalanche, the Snowball and the Blizzard. Each method has its advantages and disadvantages. Let us look at the three methods in more detail. Avalanche In Avalanche method, the debt with the highest interest rate will be paid off first, regardless of what the individual debt amount owed is. Once the highest interest rate debt is paid off, the focus will be on next highest rate debt if the amount still remains after discharging toward first loan. If one wants to make every rupee count, the avalanche method works the best. Snowball In Snowball method, the focus is on repaying the smallest debt (the outstanding principal amount of loan), regardless of interest rate. When the smallest outstanding amount is repaid, the focus would shifted to the next smallest balance. Because the focus is on the amount and not the cost, compared to the avalanche method this method may not be as cost-effective. However, paying off the debt with the smallest balance first will mean one is able to free up cash faster and therefore be able to utilize the cash available to top up the EMI of the next debt or use for any other purpose. The snowball method will give one a sense of progress in reducing total number of debts, and will keep the individual motivated to pay up other debts that have piled up. Blizzard Page 182 IP and Asset Management – India Specific

The Blizzard method is a combination of the avalanche and snowball methods. Starting with the snowball method first, the focus is on the debt with the smallest balance. Once this is paid off the focus then shifts to the debt with the highest interest rate, the avalanche method. The blizzard method first tackles the psychological aspect of debt management by creating a positive environment and motivation to stick to the plan. Once this progress is seen and one debt is eliminated, the motivation sets in to focus on the cost-effectiveness. The blizzard method is the best of both worlds. To feel motivated and to clear your dues, keep alternating between the two strategies. Which method to choose? If you look at the three methods from the numbers point of view, you would choose the method that is most cost-effective. However, we know that personal finance is never just about numbers. Deciding on a particular option is after evaluating financial needs, goals, sustainability of surplus discretionary income and the client’s personality. If a client is self-disciplined, the motivation factor may not be needed and the focus can be on cost effectiveness, the avalanche method. If a client has a discretionary income, or irregular surpluses, freeing up cash in order to have consistent surplus income may be bigger priority than saving on interest costs. Analysis of Household Budget and Contingency Planning The annual income from all sources: salary, rental, interest/dividends, etc. is needed by a financial planning professional to ascertain all cash inflows along with their frequency/regularity and time periods of accrual. Similarly, he/she records a detailed statement of various heads of expenses: non- discretionary and discretionary. The non-discretionary expenses cover regular household expenses on food, shelter, clothing, utilities, personal upkeep, insurances and general entertainment. The discretionary expenses are generally those which one can avoid or postpone or downsize suitably. Visits made to fine dining places, expensive holidays, luxury car and gadgets and designer clothes may be categorized under this category depending on the status and income level of client. The professional juxtaposes income and expenses to arrive at disposable income by duly accounting for the estimated personal taxes applicable to the client. This gives a statement of regular cash flow and can be extrapolated to give annual budgets of the client projected for a foreseeable period. After assessing the impact of potential changes in income and expenses, a financial planning professional develops financial management strategies for a client. The above data is not just quantitative collection of all income and expense heads. A financial planning professional articulately gets information from the client on his/her personal proclivities, tastes, sensitivity and attitude towards money. The cash flow position indicates whether the client is living within financial means. This may call for several changes by identifying conflicting demands on cash flow, financing/refinancing alternatives. An IP and Asset Management – India Specific Page 183

important view of this exercise is to assess the adequacy of emergency fund a client actually needs, or supplement needed if he/she already has one in place. Ideally, depending on client situation a fund size of 6 to 8 months household expenses needs to be set aside in risk-free and easily accessible funds like short-term bank fixed deposits, liquid schemes, etc. This is to avert any emergency foreseen in job change or job loss, as well as certain disabilities or medical exigencies Determination of Financial Goals of Investments/Assets and Strategies It is essential for a financial planning professional to engage with the client and his/her family to know their financial objectives and other goals in the short and medium term as well as long term. The viability of financial goals and life goals has to be seen in context with current assets and regular income visibility. The aspiration and desires have to be separated from essential financial objectives, which obviously need prioritization for time-bound achievement. A professional may apply the well- established logic of SMART goals (Specific, Measurable, Achievable, Relevant/Realistic and Timely/Time-bound) to institute priority of goals. A financial planner conducts a detailed exercise to determine the risk profile of client. It is vital, before preparing investment strategies, to understand the client’s risk tolerance so that in the short and medium term he/she does not get unduly perturbed if significant losses occur. The planner also assesses the capacity to bear risk, both in the short term and long term, by assessing asset size and income level. Hence, the professional arrives at the risk appetite that profiles a client for appropriate investment strategies to achieve the goals. The financial planning professional ascertains the client’s current asset allocation and the optimum allocation for investing for different goals as per the sensitivity, priority and time- horizon of achieving each financial objective. In consultation with the client, various assumptions are made on the return expectations from different asset classes. The professional makes potential investment strategies by calculating the required real rate of return to achieve respective goals. The planner modifies an investment strategy so that the investment return expectation is in alignment with the client’s risk capacity. He/she assesses potential investment vehicles that can be used in client portfolio. The planner evaluates that advantages and disadvantages of each asset management strategy developed and optimizes strategies to make recommendations. An In Attribute Portfolio Performance and Evaluate Investment Alternatives Page 184 IP and Asset Management – India Specific

Mutual Funds vs Portfolio Management Services (PMS) vs AIF Mutual funds are established in the form of a trust by a sponsor to raise monies through the sale of units to the public under one or more schemes for investing in securities in accordance with these regulations. It is guided by investment objectives spelled out in the offer document. It is the guiding principle of the management of scheme. Investors can expect performance of their chosen scheme as per the benchmark specified. Mutual fund investments are meant for every type of investor. One can start investing in mutual fund schemes with as low as Rs 100. However, there is no limit for upper band of investment. It is open to retail investors and even to corporate for parking their surplus funds. The scheme categories are equity, fixed-income (debt), hybrid, liquid and money market funds. The investment is majorly in marketable securities unless otherwise specified in offer document in unlisted securities subject to limits. There is high transparency and disclosure required The next in line in terms of sophistication of financial products is the Portfolio Management Schemes (PMS). It requires higher ticket size of investment (the minimum investment amount is Rs 25 lakh) compared to mutual fund and have more concentrated portfolios, which makes PMSmore risky compared to MF. Hence, the PMS is more suited to a mature investor who understands the market and its dynamics. It is mostly used by the high net-worth individuals (HNIs) to invest primarily in stocks (but not necessarily only in stocks) with the help of portfolio managers. There are primarily two types of PMS - discretionary and non-discretionary. In the case of the discretionary option, the portfolio manager at his own discretion makes investment decisions on your behalf and does not need to consult you for every transaction. In non-discretionary PMS, your fund manager will consult you before making any investment on your behalf. You have full control on your portfolio. PMS investment is for the investors with deep pockets as it requires large investment amount. Since PMS can also be customised, it can also be used by investors to fulfil a peculiar financial objective. The expense ratio in PMS is much higher than mutual funds, even performance-based fee is applicable. Alternative Investment Funds or AIFs are in for the last 8 years in the Indian investment space. In this time period only it has seen 30% compounded rate of growth in its committed funds to Rs 4 trillion with more than 750 registered AIFs. These have a ticket size of Rs 1 crore. The three categories of AIFs are category I for angel investors, venture capital, social and infrastructure funds; Category II includes private equity, real estate, distressed funds investment; and Category III includes funds with diverse trading strategies, hedge funds or ones with an eye on short-term returns. Unlike the first two categories of AIFs, the third type of funds can be open-ended in nature. AIFs are generally close-ended hence the liquidity aspect is limited. They have specific objective laid out and hence the returns are volatile and not comparable. As against low-to-average risk in MFs and IP and Asset Management – India Specific Page 185

medium-to-high in PMS, AIFs come with high-to-very-high risk profile. They have a drawdown advantage which is not available in MFs and PMS. Direct Equity vs. Equity Mutual Funds Equity markets hold their peculiar place when it comes to enigma as well as charm. They are viewed as nothing short of a gamble by some, or at least similar to what has been projected down the generations especially in small towns. The risks of investing are over amplified in case of equity investments when compared with other assets in the investment landscape, viz. debt investments, bank and company deposits, assured return schemes, gold and real estate. The risks are usually compared with the mother of all risks – the risk of losing capital. Of course, there are ways to do that in equity investment as with any other investment; if an individual is reckless Stock markets are a marketplace of listed equity of public and private sector companies, banks and financial institutions. The equity is inherently risky as there is no obligation on companies to service their equity by way of regular dividends. The return by way of dividend is only a small aspect of overall return from equity investment. However, it is a crucial indicator of the earnings and other health indicators of a company. The dividend is paid out from the earnings during a year. The whole matter converges to the earnings capacity and growth of a company. Those who slag in this aspect, have the price of their stock beaten down in the markets. So, investors dynamically assess this aspect of earnings and several other important financial indicators to invest or disinvest in stocks. Few savvy investors who can do this research on their own should directly invest in stock markets. Others who are not well initiated in this aspect are recommended to adopt the equity mutual fund route to benefit from the expertise of professional fund managers. They conduct thorough macro and micro level analysis of economic fundamentals, sector and industry dynamics and then choose individual companies not just on the earnings potential and future growth prospects but also on their management, governance and the sustainability aspect of the business conducted. The next most important benefit that equity mutual fund schemes offer over direct equities is diversification. It can be among the various industry sectors as per the current flavour and longterm potential as well as among companies within a chosen industry. Direct equity investment requires a lot of capital to put in place a diversified portfolio of stocks. A mutual fund investor can set aside a small amount to catch this metric of diversification. There is no higher limit and wealth can be accumulated over time by reducing concentration risks. One more advantage is systematic way of investments and their equally systematic withdrawal when needed to optimize taxes. The application of taxes is same in direct equity investment and through an equity MF product. The way such returns are treated can be changed in a limited way to tax efficiency. A per current norms, all IP and Asset Management – India Specific Page 186

dividends from equity stocks are added to income of investors and taxed at slab rate. Mutual fund schemes themselves are exempt from paying such taxes on income received on dividends as well as capital gains, by virtue of section 10(23D) of the Income-tax Act, 1961. If an investor chooses the growth option in an equity MF product, such income accumulates in the scheme and gets reflected in the NAV. At opportune times, or when needed, the units of MF equity scheme can be redeemed suitably so as to benefit from exemption up to Rs 1 lakh of realized gains. The equity mutual fund route of market exposure offers other benefits like investing in thematic funds of a sector or industry or in small cap or mid cap companies. Fund managers have the benefits of own research or that shared by research of brokerage houses to select the right companies within a sector as well as from a larger pool of small/mid companies. Such investments made on individual basis (direct investing) can become highly risky. Moreover, it is possible to have exposure to more than one scheme to further diversify the active management risk or the fund manager risk. Actively Managed Equity Mutual Funds vs Index Funds We talked briefly about fund manager risk, i.e. the risk of actively managing the portfolio of an equity MF scheme. Fund managers may err on the research inputs and the directional call in some specific stock or a specific industry, which may not fructify in the desired returns during a period under study or even over a prolonged period of time. The gamut of active investing involves expenses charged to an actively managed equity scheme as investment fund management expenses. They can be along with other operational and statutory expenses can be as high as 2.5% in a certain managed scheme. If a certain scheme is not performing to the expectation of investors or lagging among peers or is not able to beat the chosen benchmark, such expenses ae a drag. We talked about the benchmark above. The fund manager risk arises on the fact that a managed scheme is not able to beat the benchmark, the purpose the scheme is chosen for. There is a whole scenario of passive investing or index funds which have been introduced by John Bogle. An index fund is constructed to mirror the same stock in portfolio weight ages as they are in the benchmark index. This does not require any fund management skill. Hence, there is benefit of reduced expenses ratio and a reasonable surety that the chosen index fund at least performs close to the market. The performances of index funds are measured by ‘tracking errors’ which are around 0.5% for such funds. The expenses ratio is also around 0.75%. Hence, index funds give market returns at low cost. There is no risk or highly reduced risks of mark under performance. The studies show that investment through index funds provides returns which in long term are even better than a majority of actively managed funds etc. IP and Asset Management – India Specific Page 187

ETFs versus Index Funds We have learned the concept of index funds in the para above. Exchange Traded Funds of ETFs, as the name suggests are portfolios that mirror a benchmark and are actively traded on exchanges. The expenses are similar like that in an index funds. While an index fund can be bought or sold at the day- end NAV, there is opportunity to trade in ETFs at intraday values of a benchmark index. In case of volatile markets, the intraday range can be enormous and some savvy investors who track the pulse of the markets and technical indicators can actually buy ETFs at low values and sell intraday at higher values to lock-in gains. On costs aspect, index funds have slightly higher expense ratio. However, transaction costs on exchange get added to ETF costs. The ETFs generally have ask-bid spreads which tend to be more if the trading volume in those ETFs is not more. ETFs also provide the convenience of traded just like other stocks, the reduced time periods of registering in the demat accounts and thus the eligibility of bought units to be traded further. Mutual funds vs ULIP It is different debate – that of pure investing through mutual funds and having a benefit of insurance mixed with investments, as through Unit Linked Investment Plans. Naturally, ULIP will have a different cost structure due to covering the mortality risk and hence a slightly higher cost structure. A certain portion of the periodic investment amount, depending on age of the investor primarily and some other factors, go toward buying a life insurance for the specific amount. The remaining portion of the investment, after deducting other expenses, is available for the fund managers to invest in the chosen style – aggressive, balanced or conservative. It is a tendency for investors to mix more than one feature in an investment product to have dual benefits. Sometimes this tendency is aggravated by tax benefits as well. ULIP is a product where this is highlighted. The insurance cover amount is very limited as compared with term plans. ULIP is exactly not comparable with endowment plans as the investments are market linked and are more transparent in the number of units allotted and tracked. But due to a higher cost structure, mainly due to mortality premium, the performance is not exactly comparable with equivalent mutual fund products – pure equity, hybrid or pure debt. ULIP investment provides tax benefits within the overall ceiling for 80C under Income-tax Act. One should not be blinded by the tax benefits offered and should secure a high coverage separately first. Investors should not construe ULIP investments as enough to cover the extent of their liabilities due to life risk. Otherwise, ULIP investments are like their equivalent mutual fund investments and more or less provide same returns, sans mortality premium. ULIP comes with a lock-in period of 5 years within IP and Asset Management – India Specific Page 188

which if redemption is pressed, the equivalent tax benefits are to be foregone. Due to ULIPs term of 5 or 10 years, they impose a discipline of investment which allows the maturity proceeds to be linked to some life goals. The debate on mutual funds versus ULIP is an age old at least. However, the din over this is gradually reduced with low-cost structures recommended over the years by the insurance regulator and followed by the insurers. The returns therefore are comparable with the like mutual fund products, more so on comparing tax-adjusted returns. It is recommended by financial planners and investment advisers that one should have insurance and investment goals will aligned and separate than mixing the two unless synergies are sought to be exploited in certain circumstances. ELSS vs Other Tax Saving Instruments Equity Linked Saving Schemes had been crafted by the government to induce savings in the equity markets some 30 years ago in early 1990s. They come under section 80CCB and continue to remain. The investment under this section toward ELSS in included in the overall limit of Rs 1, 50,000 for deduction from gross total income before computing tax for an assessment year. The umbrella of 80CCE for this limit includes sections 80C, 80CCB, 89CC and 80CCD. The tax benefits create an anomaly of sorts in the mind of investors who like to save the last Rupee possible by investing in the eligible insurance plans and investment products. A 3-year lock-in has been imposed in ELSS to infuse disciplined investing in the stock markets. The investment goes into a basket of value and growth stocks, well diversified, to tune in with market returns. No exclusive bets are taken on specific sectors or low-and-mid cap stocks, though a universe of stocks is taken into account beyond the companies included in leading stock market indices. Other tax saving instruments include, under section 80C, insurance schemes, term plans and endowment plans and ULIPs too subject to a metric of sum assured to annual premium, PPF account contribution, deductions under approved provident funds and EPFO, Sukanya Samriddhi Yojana, the principal amount repaid out of instalments to banks/housing finance companies per financial year, children’s tuition fees, 5-year cumulative deposits with banks, etc. The contributions made to NPS account are permitted under section 80CCD(1) subject to limits of basic salary as defined. The contributions to approved annuity plans of insurance companies come under section 80CCC The allocation to the above avenues to save income tax should be appropriate as per the financial situation of the individual. It should not be lopsided, and should not be done without the provision of the same to align with one’s financial goal. The savings for taxes should not be for the sake of saving and should be optimized to provide the best solution keeping in mind the tenets of safety, liquidity and return. IP and Asset Management – India Specific Page 189

ELSS is just one of these products where safety is subject to market risks, the returns follow the cycle of markets and the liquidity is less. It should be seen from the perspective of other equity products which have these metric addressed more dynamically. That is, there should not be a rush to save in ELSS product ahead of other avenues of tax savings. Generally, provident fund, NPS, insurance premium exhausts a bulk of the limit Rs 1.5 lakh. If someone still has balances to be covered, ELSS is a good option to savour the equity market risks and returns. Risk Management and Insurance One of the most urgent and important areas to be addressed by a financial planning professional is the identification of risk which a client carries with regard to his/her life, assets, liabilities, health and other disabilities. Next is devising right strategies to reduce the likelihood or the severity of loss caused by a particular risk. The risk retention may not be intentional in some situations, where the client either is not fully aware of the potential damage or liability of a risk event, or is casual inaddressing a risk timely. The role of a financial planning professional is to help client make proactive choices with regard to all risks and make informed decisions to retain a portion of risk, to minimize loss in the event of risk, or to transfer risk. The vehicle of insurance is used to transfer the risk. He/she also examines client’s current risk management strategies which can be co-opted and optimized in devising potential risk management recommendations. Life Insurance Needs analysis, economic value, future income stream A financial planner should identify potential financial obligations of the client in terms of any life exigency, e.g. the needs of survivors in terms of living expenses, crucial life goals of education of children, shelter, etc. The full impact of this financial obligation is the minimum life insurance cover required by a client. The planner may make provision to reduce the same by any existing cover already in place or available through employer commitment, as also by a portion of financial assets. This is to optimize any undue premium outgo. It is also worth determining the characteristics of existing insurance coverage in terms of cash flows accruing apart from life cover sum assured. Another way to arrive at the life cover is to assess the economic value of a client in terms of his/her potential future earnings and discounting them at a suitable investment rate. The idea is to replace the future potential income of a client in the event of life exigency so that the family/survivors are not deprived of funds to meet their individual financial objectives. As regular income is ideally presumed to leave a savings component, the cover assessed by this method is usually larger, which may entail more outgo towards premium. Assets Coverage, Health and Mortgage Insurance, Liability Cover IP and Asset Management – India Specific Page 190

A professional determines health issues of client and members of his/her family. It is of essence for the professional to investigate the medical history of all members and the existence of hereditary ailments, if any. The lifestyle and other habits such as drinking and smoking among members are also taken into account. The safeguarding of property and other assets of clients is an important risk management strategy. Professionals advise on an ideal insurance cover which ensures the availability of equivalent cash to replace a piece of property or other assets due to an accident or other catastrophic event, e.g. fire, flood, earthquake, cyclone, etc. The accident insurance which may result in death or disability, temporary or permanent, and thus may deprive client and his/her family a regular source of income, has to be safeguarded against as well. Also in the same line are disproportional financial burden and/or income loss caused by disability due to critical illness. Suitable riders are present in the life insurance policies to cover them as well. The potential liabilities which a client is exposed to are duly assessed by a financial planning professional, who determines them and sensitizes client to the potential damage that may ensue there from. Such liabilities may arise from damage caused to third parties or the general public due to their using or coming in contact with the assets/properties of client. The environmental impairment may come into purview if a client has certain related businesses. A client may also require professional indemnity. Therefore, a financial planning professional takes a complete micro and macro-overview of a client situation; his/her functions, businesses, health issues to arrive at the exposure to potential financial risk, and takes appropriate risk management measures to protect the client’s interests. Evaluation of Alternative Strategies Critical illness policy vs. Critical illness rider There are certain specified life-threatening diseases which may involve significant expenditure in their cure when identified for an individual. These illnesses are specified and are common amongst insurers covering them in the policy document. In critical illness insurance, the amount of insurance cover purchased in the policy is provided on a diagnosis of such as disease, and a lump sum benefit is provided in order that the beneficiary utilizes the same toward cost of treatment. Such critical illnesses identified by insurers include cancer, heart/kidney ailments, cardiovascular disease, multiple sclerosis, etc. A critical illness cover is supposed to lapse once the payment as assured under a policy is made by the insurer. It is made after a period of around 30 days, ‘survival period’, surviving post the diagnosis of the identified illness. A rider toward critical illness cover can also be purchased in one’s life insurance policy. The following are two types of critical illness riders: Additional Benefit: The sum assured toward critical illness is IP and Asset Management – India Specific Page 191

added as an additional cover, i.e. as a supplement to the life cover. The assured sum toward life contingency continues post the use of critical illness rider. Accelerated Benefit: In this case, once the specified critical illness is diagnosed identified, the sum assured toward that benefit is reduced from the life insurance sum assured. Once this sum is paid, the reduced life cover continues. At this point we understand that hospitalization expenses ae not covered in a typical term life insurance even though the critical illness is one of the hazards against which the life is assured. Apart from the cost of treatment, there may be so many other uses of such critical illness cover separately assured either standalone or as a rider in term life insurance. A suffering individual may not be in active job for a prolonged period of treatment during which the living expenses and other financial liabilities need to be discharged. A sufficient cushion for disability after recovery from the disease may be built though a separate rider toward the same is also available. The cost and other aspects are the issues to be deliberated here in choosing a better option while affording enough protection. A standalone critical illness policy can be purchased either from a lifer insurer or a health insurer. It is akin to a term policy which is activated on diagnosis of the specified critical illness as against death in case of pure term life policy. In case it is combined with a health insurance policy, a lump sum covered in the policy gets paid on diagnosis and survival period, while the hospitalization expenses are covered separately. It depends however on the policy type and the insurer. Generally, there is a cap, say Rs 50 lakh, on the critical illness cover. It has also been observed that a standalone critical illness policy is more comprehensive as well as flexible. For instance, a minor ailment (of the covered critical illness) may pat a specified percentage, say 25% or 33%, and on the discovery of a full-blown illness the entire 100% covered amount is paid. The premiums are also worked out accordingly. It is also observed that the range of critical illnesses covered is more comprehensive in standalone policies of critical illness than the attached riders. Moreover, the riders sometimes cost more. As we see from the above, an analysis of all factors needs to be made, e.g. cost versus benefits in a policy, a consultation with a medical practitioner with regard to health including family history of diseases, and consulting with a financial planner or insurance advisers. The costs may not be the only criterion to compare between choosing a rider for critical illness and a standalone policyto cover a disease. Also, one should not be complacent to just cover critical illness, accidental cover, etc. by way of riders in term life insurance policies. Hospitalization expenses, recuperation expenses, financial liabilities for the period of associated disability have to be evaluated before taking an informed decision. Personal Accident insurance v/s Life insurance IP and Asset Management – India Specific Page 192

They may look like the one covers the other, especially when fatality occurs due to an accident. If the life insurance policy is taken, the assured amount is payable in case of accidental death. Also, the accident insurance policy covers death as well apart from disability, full or partial. Personal accident insurance, however, has its own unique purpose much in the same way as we have discussed critical illness insurance above. And that is the residual life after accident which can fortunately be very long but may be scarred with some kind of disability which may keep one from realising full earning potential. This may have consequences on the living expenses and other financial goals and liabilities. Accident insurance can also be purchased as a rider in a term life insurance policy. There can be a small premium for such rider. Like in case of critical illness, the personal accident cover amount is also capped, usually at Rs 1 crore. Riders usually provide a plain cover like accidental death and disability cover. The standalone accident insurance policies provide many other benefits such as a monthly income for the period of disability (with a cap on number of months), ambulance charges, hospitalization and post-hospitalization treatment such as physiotherapy which can be very costly and prolonged. It is necessary; therefore, that a good amount of cover should be purchased keeping in the purview one’s unique circumstances such as frequent travel by road, hazardous occupations, environmental factors, etc. Health insurance covers hospitalization expenses on account of an accident. However, there may be other expenses that can be much larger that hospitalization as the period of hospitalization in case of accidents may be short followed by a long time for recuperation such as in bon fractures. The normal health policy does not cover disability. Hence, keeping in view one’s circumstances one should have a proper balance of life insurance, personal accident insurance and health insurance. The premiums charged for accident insurance are small but the policy provides immense benefits which do not get covered elsewhere. Retirement planning Planning for a client’s retirement is one goal which is all-prevailing in terms of time taken to achieve a desired retirement fund and the draw down years thereafter. It is also among the largest in terms of financial resources consumed. An astute financial planner has a right balance of the retirement goal of his/her client in relation to various other goals some of which may be purely aspirational like annual vacations, a farmhouse, luxury apartment, et al. It is a wholesome goal that takes into account a client’s all the assets and their earning potential through life. There are crucial decisions in the journey of a retirement goal; a shortfall expected in retirement funds, extending retirement age, retrenching expenses in the initial few years of retirement, etc. Retirement Objectives: Living Expenses, Gifts/Bequest and Charity IP and Asset Management – India Specific Page 193

A financial planner determines in consultation with a client, his desired retirement income objective, and other low priority but aspirational objectives like leaving a bequest, gift and charities. The retirement objectives may go much beyond just the quantum of money a client will need to spend during his/her retirement years. A financial planning professional very well realizes the psychological aspect of retired life and prepares a client well in accordance, to avoid any aftershocks to the client. It is more on the lines of ‘life planning’ which takes into account a client’s personal values and the exact manner a client wishes to lead his/her life. A planner asks relevant questions to help client discover his/her value system. The financial aspect, however, is the most important one which, if not aligned, may lead to other aspirations go haywire. The finances need to be strong if a client wishes to give back to the society, or pursue hobbies and travel, or gifts his/her money to loved ones, or plans a bequest. While health and relationships are important pillars to have a psychological and an emotional edge during retirement years, the spirituality adds to the fulfilment. A financial planning professional through a series of engagements and meaningful interactions, both with client and his/her spouse, elicits the right structure of retirement planning and the true objectives of client. Assessment- Personal and Economic Indicators, Returns, Special needs A financial planner in consultation with client learns about the desired retirement age, if the retirement age is not determined by his/her employment terms and conditions. The life expectancy should be assessed by the specific demographic data of the jurisdiction in which client operates, in case the retirement is a distant goal in the future. If the goal is 10-15 years away, a careful assessment needs to be made considering health condition of the client and his/her spouse, their medical history, hereditary diseases in the family and a general life parameter assessment in the immediate as well as extended family of the client. The planner and the client jointly narrow down in using economic indicators, especially about inflation, both during pre and post-retirement periods, in the retirement strategy. Also arrived at in consensus with the client are estimates about investment returns from the asset allocation if the funds are managed. Even if the funds are left to accumulate in statutory retirement funds like NPS, EPFO, and other employer managed provident funds, a careful estimate of market and economic parameters is required by the planner to have a tab on the average returns that a client would obtain while accumulating funds. The planner consults with client and takes on record any special needs situation, such as a disability or other medical condition which may require an adequate provision to be made in the retirement funds. Analysis of Retirement Products: Provident Funds, NPS, Other Vehicles IP and Asset Management – India Specific Page 194

Even if the funds are left to accumulate in statutory retirement funds like NPS, EPFO, and other employer managed provident funds, a financial planning professional makes careful estimate of market and economic parameters to have a tab on the average returns that a client would obtain while accumulating funds. Other retirement planning vehicles such as unit based accumulation through dedicated retirement-focused mutual fund schemes and insurance-linked pension plans of insurance companies are also looked at. Financial planners see one advantage of investing through such vehicles due to their flexibility to manage funds with greater equity allocation. The retirement schemes of mutual funds are amenable to systematic withdrawal of units after retirement which may offer tax benefits. At least some part of retirement income should be optimized through such plans. Retirement Fund, Pension/Annuity, Asset Profile, Other Income Sources The crucial test of a retirement plan is to achieve the planned retirement corpus which should see the sustenance of retirement income through the lifetime of last surviving member, the client or his/her spouse. While optimizing an accumulation strategy, the planner may run through the employment terms of client to take on record all the superannuation benefits, like gratuity, leave encashment, etc. to make suitable provisions in the retirement corpus. By taking into account various streams that contribute to the retirement kitty, the planner has greater flexibility to invest in certain risk securities to optimize returns, especially when retirement goal is 20-25 years into the future. The likely changing profile of assets through the life stages is of importance to judge which assets can be continued through the retirement to generate a regular stream of income. A clean title to land assets near retirement helps in liquidating the asset in quick time to generate additional funds which can be invested in immediate or deferred annuity to constitute another income stream during retirement years. The financial planning professional prefers to diversify the income stream of client during retirement years to obviate the dependence of client on a single source of income. Evaluation of Alternative Strategies Market-linked Retirement Products (NPS, ELSS, MF, ULPP) vs EPF/PPF People who work in organized sector have a built-in feature in their salary structure to contribute a percentage, 10% to 12%, of their Basic and Dearness Allowance toward a retirement product, like an Employees’ Provident Fund (EPF) or National Pension System (NPS). Employers contribute an equal percentage (toward superannuation benefits in their employees’ compensation structure) to the EPF or NPS. Thus, an employee who continues through the employment, with the same employer or changing employment may aspire to accumulate a retirement fund on reaching a specific retirement age. IP and Asset Management – India Specific Page 195

EPFs may be approved by the commissioner of Income Tax to have the desired income tax benefits on such scheme of employee provident funds. Such tax benefits may be extended to regular (monthly) contributions by employee and employer, subject to limits; to accrual of interest on contributions in a financial year, again subject to limits as per revised tax norms, and the eventual withdrawal of matured amounts on retirement or prior to retirement. The accounts with the Employees Provident Fund Organization (EPFO) have such benefits as with other approved provident funds. Similar benefits are extended to NPS accounts as well, however the maturity withdrawal from NPS account is tax-exempt up to 60% of accumulated corpus while the balance 40% has to be used compulsorily to buy an annuity from approved insurers. Public Provident Fund (PPF) account can be opened by any Resident Indian. The account has the feature of Exempt-Exempt-Exempt from the taxes of contributions made, interest earned and maturity amount. PPF scheme has limit of Rs 1.50 lakh on annual contributions and a maturity cycle of 15 years, though extendable for 5 years at a time for any number of times. This unique feature makes it a safe and viable option to consider PPF as a supplementary accumulation plan for retirement. Presently, all interest earned in a financial year in a PPF account is tax exempt. However, the budget of 2021 imposes a limit of tax-free interest on such employee contributions only which do not exceed the limit of Rs 2.50 lakh. The interest earned on such deposits above this limit are added to the income and taxed at slab rate. A retirement fund’s optimum size has to be evaluated in consultation with a financial planner, RIA or Retirement Advisor. The funds accumulated by one’s annual contributions to EPF/PPF/NPS may not be enough to have the desired corpus to sustain retirement expenses for the residual life and the related life goals. Besides this, a good diversification of such retirement fund is also needed. This opens up opportunity for market-linked retirement products like retirement solutions oriented mutual funds schemes, other diversified mutual fund products across equity, debt, hybrid categories, or Equity Linked Savings Schemes (ELSS). The ELSS and approved retirement schemes of mutual funds provide tax deduction from income (up to a specified overall limit) of such contributions within a financial year. Such tax benefits are also extended to the insurance companies’ Unit Linked Pension Plans (ULPP) which are dedicated products for pension during retirement years. The market-linked products have the potential to generate market returns which comprehensively beat inflation, as compared to quasi-assured return products which provide just inflation-nudging returns. However, market returns come with associated market risks apart from other sundry risks with specific products. Nonetheless, they are worth considering for investment for the basic reasons of the healthy wealth-generating returns, the diversification of retirement fund, and the flexibility offered by such products to make withdrawal strategy or distributions during the retirement years. The IP and Asset Management – India Specific Page 196

retirement products of mutual funds offer the aggressive, moderate and safe options to accumulate funds. ULPP and ELSS come with 5-year and 3-year lock-in periods respectively, as they offer tax benefits. In that sense, they have liquidity constraints. It just remains in our mind that a specified retirement product only can cater to our retirement needs. A diversified mutual fund equity growth scheme, a hybrid scheme with equity orientation, an index fund or an ETF can as well fill the gap with potentiality of market returns, liquidity and flexibility and reduced tax implications on withdrawal. The expense ratio of market-linked products is an issue to consider as well and how the same is addressed with commensurately higher returns from such investments. NPS is one product which has the least expense ratio, the flexibility to move amongst investment options and healthy returns. The flexibility is restricted with a mandatory buying of annuity with 40% of accumulated corpus. If that can be combined in the distribution stage of retirement plan, it is a viable retirement vehicle. Aside, there is option to create a Tier-2 account in NPS which does not provide tax benefits but reduced expenses ratio can be taken advantage of. These can be invested/disinvested without any restriction and also without any tax benefits. NPS has a separate window of Rs 50,000 toward additional deduction from one’s income computed for income tax. This benefit is under section 80CCD(1B) which is over and above the limit of Rs 1,50,000 under section 80CCE of Income-Tax act, 1961. Therefore, a retirement plan has to be evolved considering the needs during retirement years, the flexibility of options with diversification in mind both at accumulation and distribution stages, and a cardinal rate of return that will clinch the retirement solution. This optimum return should be targeted from investment in a variety of above-mentioned products. Just going for absolute safety or pure growth is not a solution. The retirement solution should be optimized across the parameters of safety, liquidity and returns. The returns should be significantly above the ruling and expected inflation across all stages to ensure wealth creation, protection and consumption. Personal Tax Optimization, Tax incidence and Tax Efficiency Personal taxes are an unavoidable feature of a client’s income and assets. A financial planning professional correctly assesses the impact of taxes to avoid unnecessary transactions which attract taxes, and execute transactions strategically in timeframes to minimize tax impact and maximize cash flows. It is a planner’s drive to scrutinize all current and future financial transactions of client to have the best tax efficiency in place. Tax Compliances, Tax incidence on transfer and Liquidation of assets IP and Asset Management – India Specific Page 197

The professional realizes the importance of his/her client meeting all compliance schedules like paying advance taxes, filing returns by due dates, etc. The penalties drain a client’s financial resources apart from spoiling tax compliance history. A planner has up-to-date knowledge of tax laws and related statutes which govern tax incidence on acquiring a particular asset, the term required to hold the asset to have the tax efficiency, and the rules of transferring or liquidating the asset which may have consequences of taxes, apart from impact on other related transaction in the future. A planner is well aware that clients have a general tendency to save each and every Rupee of their income which is possible under the tax laws. The planner is adept to see through whether a tax saved now creates a possible distortion in the availability of financial resources for other goals; whether the stipulation to hold the asset so acquired has consequences on liquidity aspect of the asset; whether the tax benefits while saving taxes now would get frittered away when the maturity becomes due; and whether the post-tax real returns from holding the asset to its stipulated term is viable in terms of meeting the required return to achieve various connected goals. The financial planning professional attempts to set right such anomalies in a financial plan. Tax Efficiency of Investment Products and Other Transactions A financial planner is well updated on the tax rules which modify or completely change the tax incidence on various investment products. It may happen that the tax efficiency of a certain investment product used in an investment strategy loses its charm due to a changed rule, such as the long-term capital gains tax on equity and equity-oriented instruments would not only have the impact of return just after one year (the mandated long-term period), but many years down the line, when the equity assets are liquidated for a goal. The moderation in investment strategy and building the higher risk due to lower expected returns is an on-going process which a trained financial planner is adept at. A planner takes into account the maturity profile of an investment asset, such as bond, deep discount bond, mutual fund/insurance product, etc. and builds the prevailing tax impact in the initial strategy and its on-going review so that the net cash flow required after discharging tax liability for a goal is not compromised. Tax induced distortions - Buying Life Insurance for Tax Saving The government provides some tax incentives for certain investment, insurance, and pension products. These incentives are basically in long term retirement products (provident funds and NPS), pure insurances (life and health) and certain investments that have long-term positions on equity markets and long-term bank deposits. Financial Planners help their client to have exposure to such products to save taxes at the same time avoid over exposure or skewed positions in tax saving products. Such tax-induced distortions are common amongst individuals who wish to save every Rupee from given tax provisions. Buying insurance just to save taxes is one such distortion. The insurance, both life IP and Asset Management – India Specific Page 198

and health, is must for all individuals to safeguard the financial downside in a life or health contingency. How much is enough protection should not be dictated by tax incentives. It is possible to have a large life cover by paying a small premium (between Rs 20,000 and Rs 50,000) and use the remaining limit of tax-savings to own retirement products and other equity products to have better long-term return to achieve life goals. Similarly, the health insurance should be sufficient for the family’s health contingency even if the premium far exceeds the limit of Rs 25,000 afforded for a young family under tax-savings. Thus, there should be optimization of tax incentives across all products, and it should not be frowned upon if the limits are not exhausted in one or more years. The government has introduced revised tax slabs from the assessment year 2021-22 which are devised in a way to have the same level of taxation if no tax-saving related deductions are availed of. Therefore, the tax savers have flexibility to go for tax- savings linked old slabs or embrace the new slabs. Estate Planning A financial planner takes into account all the assets his/her client owns that make up the estate of the client. It may include securities held in the name of a client, physical securities as well as Demat account, all the money in cash, structured payments, life insurances, vested pensions, retirement plans and superannuation benefits, real estate: primary dwelling, farmhouse, vacation home, possessions like jewellery, bullion, art/artefacts, etc. Needless to say, the estate includes all debts and liabilities of a client as well. The common estate planning goals are to provide for loved ones, minimize taxes, protect assets and have control over them, plan for potential incapacity, and avoid disputes among family members. The planner prioritizes and monitors the managed distribution of a client’s all assets as per his/her wishes. Characteristics and Efficiency of Estate Vehicles - Wills and Trusts A financial planning professional consults his/her client to understand his/her estate planning objectives. The planner collects legal agreements and documents impacting estate planning strategies and identifies family dynamics and business relationships that could impact estate planning strategies. Depending on the situation of a client, with consultation, the appropriate succession plan is devised by way of Will or through the structuring of Trusts. A Will is easy to prepare and modify, has very low costs, and in an efficient vehicle for most of the clients who have a non-complex holding structure. A planner ensures periodic revision of a Will as per client’s wish, as and when the profile of assets undergoes a significant change. A financial planner uses Trusts as vehicle of succession planning where the client wants to protect his assets from business creditors, thus ring fencing his/her assets. In other cases, a planner may use IP and Asset Management – India Specific Page 199

Trusts for effective intergenerational transfer of assets. He/she may identify situation of dependents of a client who may be minors, aged parents, persons with disability and special needs, and create Trust structure to dedicate funds to such beneficiaries. A planner builds tax efficiency by choosing the non- discretionary structure where there is no income perceived from profits and gains of a business. Tax Efficiency of Gifts, Transfers on Succession Financial planners advise their clients the merit of Gifting by which the estate is distributed prior to death. A planner may identify the need of regular income for the client from a certain property and, while advising the client to gift property, designates that the client receives income for a certain period of time after which the property will be owned by the grantee. In other cases, aplanner may identify that the true ownership is retained by the client, while transferring beneficial use or income portion to a grantee for certain period to meet a specific need of the grantee. Similarly, the financial assets can be transferred in joint names with identified beneficiaries. Thus, while having the client to own them including all beneficial interests therein until his/her survival, it helps in smooth succession of the assets as per client’s wish. Succession Planning for Businesses: Family Office and Family Trust For clients who own businesses and for other high net worth clients, it is essential to project the net worth at death, and calculate potential expenses and taxes owed at death. A high net worth client having business interests may have apart from stake in business, intellectual property, copyrights, trademarks, titles, etc. The financial planning professional identifies that each aspect of the intangible asset has a current supporting valuation. The planner knows the objective in businesses is to keep things private when planning for succession and to have control of assets at all times. The avoidance of disputes with business partners is one of the primary goals to obviate legal proceedings and prolonged illiquidity of assets. The prime objective remains the transfer of business ownership to the rightful heirs of a client. Family offices ensure that the business proposition remains in the family with ensuring equitable distribution of income and a continued family control of all assets. IP and Asset Management – India Specific Page 200