Remember, nine months ago when the market suddenly collapsed when it seemed to be smoothly sailing over the 12,000 mark. That caught most investors unawares. It bounced soon after, again catching investors by surprise. Yet the volatility saw a certain class of funds provide good returns for their unit holders. Since then, the price movements continue unabated. The market has lost 1,245 points in the last two weeks since February 9. The swinging market often leads to huge differences in the spot and futures markets. And here's where arbitrage funds step in. They make the best use of the markets (MIS)pricing mechanisms to generate returns for you.
Last year, many fund houses launched derivative or arbitrage funds, and most outperformed their benchmarks by considerable margins. As arbitrage funds seek to capitalise on price differences between cash and derivatives, they managed to leverage on the bullish trends of the market. It provides fund managers with large enough spreads to make successful arbitrage gains.
But arbitrage funds, unlike an equity product, aren't too risky. They essentially aim to protect your capital by locking on to risk-free strategies that take advantage of the price differences. They aim to lock in the gains and realise them when futures contracts expire. An arbitrage fund is more like a fixed income fund. Says Delhi-based Mukesh Gupta, MD, Wealthcare Securities: "Derivative funds don't take naked exposures to equity. Returns from these instruments are predictable, and more tax efficient. Corporates and high net worth individuals usually opt for these funds."
As a result, these funds are best suited for investors who generally park their money in fixed deposits or bonds. "These funds have primarily been working well with those investors who have been parking their money in fixed deposits or bonds, and are tailored to increase the investor's base in a conservative market," says Nilesh Shah, Chief Investment Officer (CIO), Prudential ICICI Asset Management Company.
Arbitrage funds as a category have generated superior returns as compared to a host of offerings within the debt mutual funds industry, but with varying amounts of volatility. In view of the volatility of this product, this category should bode well for investors with a minimum time horizon of at least six months. "Rising interest rates have made returns from income funds unpredictable and sometimes negative. Liquid fund returns are not adequate. Moreover, returns from these instruments are not tax efficient," says Gupta.
Essentially, arbitrage funds buy a stock in the cash market and sell its futures simultaneously to lock in the price difference. This is also called the arbitrage spread. This spread is realised irrespective of the stock's price at expiry. There's a simple way in which it works. Say 'A' stock trades in the cash (spot) market and the futures market. Since the underlying stock is the same, the only factor accounting for different prices for spot and futures is the interest rate, which is also called the cost of carry. If equal but opposite positions are taken in the spot and futures markets, there is no equity exposure, because it cancels out. But one can earn the cost of carry (equal to the interest).
Here's how it works with specific stocks. On March 31, 2005, Punjab National Bank (PNB) was selling in the cash market at Rs 398.4046 and on the same date, futures (delivery April 28) were selling at Rs 403.2024. By buying PNB in the cash market for Rs 398.4046 and selling PNB futures for Rs 403.2024, one pockets the difference in price of Rs 4.7978. Hence, the profit from the transaction works out to 15.16 per cent per annum.
Fund houses such as UTI, which manage a Rs 300 crore-plus spreadFund, contend that the equity scenario may well remain robust over the long term, leading to extended spreads. Arbitrage funds have a mix of equity and equity-related securities and debt instruments in their portfolios and have been actively chasing these opportunities. It's not always that the markets will have big spreads because arbitrageurs are quick to cash in. But on days of extreme price movements, there's some chance that the arbitraging spreads could be higher, leading to higher yields for the funds.
Their performance will, in future, generally depend on two factors. Firstly, how much spreads a fund can lock-in courtesy of high volatility in the market, and secondly, how high are the yields on low credit risk, short-term debt instruments. Most fund managers are also of the view that arbitrage funds have come of age and there will be more of them in the future. "Till now, mf firms have been providing general products like large-cap equity funds, income funds and hybrid funds, and now that that space is almost saturated, they are looking at specialised catering to varying risk appetite across investor classes," says Shah. More specialised products like thematic funds, derivative funds, structured products and alternate asset class funds will be the order of the day, says Shah.
Among the usual debt funds, derivative funds generated superior returns as compared to a host of offerings within the debt mutual funds industry, but with varying amounts of volatility. But due to the short-term vagaries of the market, this category should bode well for investors with a minimum time horizon of at least six months. Investors looking for a shorter period face the risk of lower returns as compared to a debt fund, because of the arbitrage opportunities. Not all fund houses are enthused by these products because their returns are lower. "These funds generally have low returns ranging between 5 and 9 per cent," asserts Mumbai-based consultant Gaurav Mashruwala. "These have been popular with people who feel that these are new products and have something assured to offer, but over a period time, they could lose appetite," he adds.
But going by the way the market's moving, more funds are coming out with arbitrage funds. Benchmark Asset Management has filed a draft offer document for a 100 per cent equity arbitrage fund. Since June 2006, 100 per cent arbitrage funds have been allowed. Earlier, funds could invest only a part of their corpus in arbitrages. Because of their strategy of locking-in to returns, these funds may make better returns than a liquid fund. However, entry is restricted to certain days in most derivative funds. Fund inflows and outflows have to coincide with the expiration of futures contract or the strategy of the fund. Some funds allow redemptions only after the settlement of derivative contracts.
There are about half-a-dozen funds that make up the category at the moment. These funds, mf circles believe, generally have the scope of outdoing the average short-term options, including liquid funds, because of their strategy. Prudential ICICI Blended Plan A is among the first derivative schemes that enjoys tax treatment of an equity scheme. The minimum and maximum exposure the scheme intends to have to equities and derivatives is 65 and 80 per cent, respectively. The fund manager seeks to capture the spread which is higher than the returns being generated by the debt portfolio. Apart from that, ICICI Pru Blended Plan B caters to international clients. It's a conservative fund offering lower allocation to equity and equity-related instruments.
UTI spread Fund is the latest entrant in the derivative segments. As per the offer document, the scheme strives to maintain varying asset allocation depending upon the market movement. The scheme can have an exposure of up to 90 per cent in equities when there's high opportunity. But Benchmark Derivative Fund, which is India's first derivative fund, is open for subscription only on the last day of the month due to expiry of contracts. Fund managers try to find arbitrages that maximise the gains.
JM Equity and Derivative Fund is a retail savvy derivative fund due to its low investment amount. The scheme has high exit loads to ensure that the investors stay for a longer period of time. From the same fund house, the JM Arbitrage scheme enjoys the tax treatment that equity funds are offered. The scheme maintains an exposure of 65 per cent to equities with a maximum cap of 80 per cent. Kotak Cash Plus offers flexibility of liquidity for the investor. He can enter and exit on any working day. This scheme usually rolls over its position to generate higher returns.
Check out the strategy of the arbitrage fund before signing on the dotted line. If you are looking for pure arbitrage strategies, then go for a fund that has a higher exposure to equity arbitrages. Arbitrage funds are meant for risk-averse investors who want equity exposure. Essentially, arbitrage funds are for investors who seek "debt-plus" returns with low risk.
The straight Advantage
There are endowment plans and there's Jeevan Saral with a flexible life cover plan. Is it for you?
Nitya Varadarajan
If you aren't happy with the rigidity of traditional term plans because there's no return on your investment or aren't comfortable with the uncertainty of the payback in a unit linked plan where returns are highly dependent on the market, endowment schemes could turn out to be what you are looking for. Endowment plans have two advantages: insurance and savings.
In vanilla endowment plans, a policy holder pays regularly during the term of the policy. But if the policy holder dies during the policy term, the nominee gets the death benefit, including the sum assured and the accumulated bonus. If the policy holder survives, he gets the survival benefit and all the bonuses. But there's another plan that allows for partial surrender without penalties and yet keeps much of your benefits intact. In fact, Life Insurance Corporation's Jeevan Saral is not dependent on one's age or term of the policy, unlike many other endowment plans.
For a monthly premium of just Rs 100, one gets a life cover worth Rs 25,000. Additionally, the cover increases every year by the amount of yearly premium you pay, so in many ways it's like an increasing cover benefit plan. Besides, LIC's Jeevan Saral offers your premium back if five annual premiums have been paid, excluding the first year premium.
As this is a flexible plan, opt for the maximum term, which is till the age of 70 or a term of 35 years. Jeevan Saral is a 'for profit' plan, you cannot surrender the policy for 10 years-the minimum lock-in period, if you want to receive loyalty additions, which are paid out after 10 years. But you can surrender 'a portion' of the policy any time. Loyalty additions are payable even if death occurs. However, under this policy, the premium and risk cover reduces after each 'withdrawal'.
Jeevan Saral comes closer to a term plan with premium payback. Says Rahul Aggarwal, CEO, Optima Risk and Management Services, "This is a plan that could suit all sections of society, particularly those whose incomes are uncertain.'' According to Aggarwal, the plan has a very low premium for the cover offered. "The plan has been designed in such a manner to prevent lapses, so it ensures some cover till maturity. That is why it is finding many takers,'' he says.
Returns for the policy are not that great, but decent enough (see The Maturity Benefits). "Jeevan Saral does not offer annual bonuses because of the plan's innate withdrawal flexibility which would make annual computations difficult,'' says Ramakrishnan, a retired actuary from LIC. "But loyalty additions in Jeevan Saral are equivalent to terminal bonuses of other policies and would not be lower than those,'' he says. But for a premium of Rs 100 a month without the hassle of a health check-up, Jeevan Saral fills a gap for individuals looking for lower life covers, with the added benefit of returns.
The Saral Edge
Against other insurance plans, Jeevan Saral stands apart.
Jeevan Saral
PREMIUM COST: Highly affordable
EASY ENTRY: @ Rs 1,200/ year
FLEXIBILITY: Allows for partial surrenders, its key USP
RETURNS: Below average compared to Post Office and other financial instruments
SCORE ON SIMPLICITY: Agent not required
RISK COVER OR RETURN? Risk primarily, but there are rewards
Pure Term Insurance
PREMIUM COST: Highly affordable
EASY ENTRY: Starts at Rs 3,000/ year, depending on company
FLEXIBILITY: Rigid
RETURNS: No returns. Some term plans offer a premium back; but no bonuses
SCORE ON SIMPLICITY: Agent's help is needed
RISK COVER OR RETURN? Risk only
Traditional Endowment Insurance
PREMIUM COST: Expensive
EASY ENTRY: Starts at Rs 5,000/ year, depending on company
FLEXIBILITY: Rigid
RETURNS: Returns better than Jeevan Saral, but poor compared to other financial instruments
SCORE ON SIMPLICITY: Agent's help is needed
RISK COVER OR RETURN? Greater emphasis on return
Unit Linked Plans
PREMIUM COST: Expensive
EASY ENTRY: Starts at Rs 5,000/ year, depending on company
FLEXIBILITY: Allows for withdrawal from fund
RETURNS: Depends entirely on fund mix; risk cover is guaranteed only in a Capital Guarantee ULIP plan
SCORE ON SIMPLICITY: Agent's help is needed
RISK COVER OR RETURN? Emphasis only on return
Irrespective of entry age and the term of the policy, the premium is Rs 1,200 for a cover of Rs 25,000 and in multiples thereof
Opting for a maximum term up to age 70 or a term of 35 years is best as the policy allows for partial surrender with full maturity benefits and loyalty benefits till the surrender period
Unlike a ULIP plan offering similar flexibility, you can compute the exact money you will receive at any time and add to it loyalty additions of a conservative minimum of 6 per cent, though this could be more
The amount by which the annual premium can be reduced has to be a multiple of Rs 600 and should not be less than Rs 1,200
After a partial surrender, the sum assured payable on death reduces and term and accident rider benefits get correspondingly reduced
Super Saver
Embarking on your savings plan early enough will earn you a lot more than you can imagine.
Clifford Alvares
If you embark on a savings strategy and stick to it for long enough, there's a guaranteed chance that you will make money, loads of it, over time. Anyone who saves money knows that it adds up to a tidy sum. But run the numbers for yourself and you will be startled by the results. Assume you are 25, and that you will retire at 65. If you save Rs 5,000 a month for 40 years that grows at 10 per cent per annum (calculated monthly), it balloons to over Rs 3.46 crore.
But if you start, say, just five years later at the age of 30 and save the same amount for 35 years, your corpus adds up to a little Rs 1.89 crore. That's a loss of more than Rs 1.56 crore in five years. For most people, that could spell the difference between a cosy retirement and a struggled one. There are many benefits of starting a savings plan early. The power of compounding ensures that you make your money grow the fastest during the later years.
The Options
Most financial planners are advising the young investors to start immediately on a savings plan. "Even if you start five years late, the kind of impact it has on your financial corpus of the future is enormous," says Amar Pandit, Chartered Financial Planner (CFP), My Financial Advisor, a financial planning firm, adding, "The sooner you start, the better it is for you." Not only that, one must also make sure that savings instruments that one chooses has a compounding element built into it. Instruments such as the public provident fund (PPF), stocks and mutual funds (MFs) enjoy the benefits of compounding, whereas other vehicles such as insurance don't.
Financial planners like Pandit recommend a pay yourself first concept for today's youth. "Youngsters focus far too much on spending," he says, adding, "but if they focus on paying themselves rather than others, they will gain a lot. If you cannot control your spending, make sure you pay yourself first." Among the easiest ways to start on a savings plan immediately is to open an automatic debit account facility where a periodic constant amount gets socked away every month. One must do this at the beginning of the month just as you get your paycheck. You can temporarily park your funds in an open-end mutual fund or floater fund till you find the right equity fund to invest for the long-term. Once you've begun, start a systematic investment plan (SIP) with the fund for the long haul.
The Plan
Additionally, financial planners recommend that you start with saving at least 25 per cent of your gross salary if you are on the younger side so that you can have a sizeable corpus in a short period of time. Higher savings are the building blocks of creating wealth and take a staggered approach to investing as against saving all at one go.
Thirty-somethings who have nothing in their bank account may have to start with a much higher savings budget of around 30-35 per cent annually. That's because of the loss of time and because compounding works harder in the later years. And those in their 40s who previously ignored savings have to allocate close to 40 per cent to catch up with retirement. Consider this, a 30-year-old targeting savings, say Rs 12,000 for 30 years, accumulates a little over Rs 1.97 crore at the age of 60. But anyone who starts five years later has to up the yearly outflow to over Rs 20,000 to reach close to the same corpus. That means an investor, who neglects saving earlier, puts an additional burden on his savings allocations in the latter years.
But even if you aren't able to up your savings ante, it's better that you start with modest sums rather than not start at all. Says Pandit: "Even if you postpone your savings for a year, it makes a lot of difference in the long run." You don't need to start on an aggressive savings plan. Increase your savings rate modestly by starting from, say, 10 per cent of your income in the first year to 12 per cent the next year and 15 per cent and so on. Even that will go a long way in making the most of your cost of savings.
Financial planners say that to begin to save, you must start identifying and reach realistic goals. In other words, you must set a target of the corpus you want to achieve at the end of 30 years, and then break it down into smaller targets of five or 10 years. Over the longer haul, step up your targets and keep scaling up the savings plan. Says Pandit: "Set a savings target and an asset allocation plan and compare it periodically to see where you stand." If you are falling behind your targets, then make adjustments in your lifestyle to update your plan. That's the only way to "keep up with the Joneses".
Destination Caribbean
A sporting carnival draws its own kind of tourists. But the ICC Cricket World Cup 2007 is a one of its kind tourism attraction. It is not very often that one gets a chance to go to the West Indies. After all, it is the first time that the World Cup is going to be held in the Caribbean, the land of beautiful beaches. Besides, the next World Cups of 2011, 2015 and 2019-to be held in the subcontinent, Australia, New Zealand and England, respectively-have been decided and it could be a while before you get an excuse to savour the Caribbean experience.
For most people, the Caribbean is not the most accessible of places which explains why families in India prefer options like a holiday in Europe or the United States. Of course, Asia and Australia are large attractions. There are some issues like flight connectivity in the West Indies which has prevented most Indians from taking a holiday to that part of the world. With an attraction like the World Cup, there appears to be more than one reason to get your bags together and head to that part of the world. So, what deals beckon the traveller?
Shyam Kartikeya, Business Head, SOTC Sport Abroad, says the objective has been to give something more exciting and different to the tourist. "Our target has been the high net-worth individuals (HNIS) like CEOs, MDs and the large corporates. The West Indies, the way we see it, can be a family destination," he says. SOTC, last week, reduced the cost on some of its twin-sharing packages by Rs 1 lakh. For sometime now, the West Indies has had a paucity of hotels and the current World Cup has resulted in hotel tariffs quite literally hitting the roof. One would be lucky to get a hotel room for $500 (Rs 22,000) per night which in most cases comes with a pretty steep rider-you will have to check in for at least seven nights.
Help has come from players like SOTC who are offering tourists the option of getting on to a cruise within the Caribbean. The cruise will take you to the destinations depending on which package you have opted for. This is what the tourist does-fly into the Caribbean after a stopover in London. In the Caribbean, the first landing destination is Bridgetown in Barbados. Here is where you get on to the cruise.
"The West Indies is far away and there have been concerns about the quality and availability of accommodation. The West Indies has been positioned as a resort and our packages are on land," says Gautam Sharma, Head (Marketing & Financial Services), Thomas Cook India Limited (TCIL). His company offers tourists the option of staying in resorts located in places like Antigua and Barbados, which means you get to watch matches being played there. You could choose a package which, for instance, could be for seven nights, in Antigua which will include all meals, a 24-hour snack service and unlimited land and water sports at the resort -all this is apart from the cricket, of course.
Most people in the travel and tourism industry agree that this is a one-time opportunity for tourists to enjoy the World Cup and also the destination. "For those who think it is expensive, we say there is the excitement of watching cricket. The West Indies can be a family destination with a lot of things to do," says Kartikeya. Sharma states that TCIL has over 200 corporate clients. "Our focus is on the corporate segment interested in cricket," he adds.
For an individual who loves to travel, West Indies, perhaps, seems to be a destination that's considered largely inaccessible. If there is an option of a cruise or a resort or a hotel, it's certainly worth a look. And, what's more, the West Indies bears a great deal of similarity to places like Goa. Yes, the whole trip has very few deals, but this is really a one-time opportunity. So, if sun and sand and cricket beckon you, start packing your bags. The Caribbean carnival is about to start.
The Caribbean Experience
Thomas Cook's packages:
Challenge with Down Under
Seven nights accommodation at Antigua's Sandals resort
All meals, 24-hour snacks and unlimited premium drinks
Tickets for two Super 8 India games at Antigua
Package
Double delux room Rs 1.60 lakh
Prices per person (twin sharing basis)
Cricket Lover's Delight
Seven nights accommodation at the Almond Beach Village Resort, Barbados
Economy class air ticket on Virgin Atlantic
All meals, 24-hour snacks and liquor
Tickets for two Super 8 India games at Barbados
Package
Double superior deluxe garden/pool view room Rs 3.10 lakh
Prices per person (twin sharing basis)
The Grand Finale
Eight nights accommodation at Bougainvillea Resort, Barbados
Economy class air ticket on Virgin Atlantic
Bed and breakfast included
Tickets for semi-final in Lucia and final in Barbados
Package
Double standard room Rs 3.10 lakh
Prices per person (twin sharing basis)
Cruise with Cricket
SOTC's packages:
Encounter in Barbados
12 cruise nights aboard Carnival "Destiny" cruise ship visiting Barbados and Grenada
Choice of meals on board
Tickets for three Super 8 India games at Barbados
Package
Ship's interior cabin Rs 2.88 lakh
Ocean view cabin Rs 3.37 lakh
Cabin with balcony Rs 3.89 lakh
Suite with balcony Rs 4.78 lakh
Prices per person (twin sharing basis)
Final Mission
Eight Cruise nights aboard Carnival "Destiny" cruise ship visiting St Lucia for the semi-final and Barbados for the final
Choice of meals on board
Tickets for the St Lucia semi-final and the Barbados final
Package
Interior cabin Rs 3.88 lakh
Ocean view cabin Rs 4 lakh
Ocean view cabin with balcony Rs 4.40 lakh
Suite with balcony Rs 5.30 lakh
Down Under Action in Antigua
Seven hotel nights at a luxury resort
Buffet meals with your stay
Tickets for two Super 8 India games at Antigua
Package
Prices per person (twin sharing basis) Rs 2.50 lakh
Assumption: India makes it to the Super 8 level, and plays at the specified venues