Research has shown that 9 out of 10 families loses all wealth by the 3rd Generation.
Multiple reasons assigned to it are :
1. Poor investment choices
2. Prolonged period of high inflation during a particular time horizon
3. Higher taxes
4. Higher spending by the younger generation in the family
5. Family extension over a period of time.
6. Protracted Legal battles between family members

One of the simple ways to help transfer, build and preserve the family’s wealth is creating ‘Multiple Portfolios’ for you and your family.

The first step towards creating multiple portfolios is to identify you and your spouse’s needs to cover your personal life style expenses.
This would be the core portfolio that needs to be created to withstand all market conditions and last through your life time. One may also add an emergency reserve fund to cushion the portfolio during extreme events that could last for many years.
The core portfolio would be the corner stone for all planning purposes, since it would give you and your spouse the financial security during your life time. The Allocation for this core portfolio would be a conservative one skewed towards liquid and traditional asset classes. This amount would need to be always there in the estate.

The second step would be to identify goals for your children, grand children, others in the family and philanthropy. This would form a set of satellite portfolios that would have to be created to meet the respective goals.
Based on the time frame of the goals and risk profile of the individual family member, the portfolios could be conservative, balanced or aggressive.
For instance, children and other family members’ regular expenses could have a conservative portfolio, whereas their education and other goals could be a balanced or aggressive portfolio depending on the time horizon to reach their goals.

It is crucial to identify the timing of the transfer of the satellite portfolio’s capital from the core portfolio and develop strategies to move it.

The sound cash flow management and clear investment strategies helps to meet expenses on a regular basis as well as to fulfill the many aspirations of the family members . At this stage, it is equally important to establish appropriate wills/trusts to transfer assets at the right time that reduces large tax out flows for your family members.

The third step is to implement investment strategies for both core & satellite portfolio, monitor and actively manage it.

Many Indian families have their wealth tied into the business. It is important to create ‘liquidity’ and carve out assets to meet the financial goals of the families. We believe, if the wealth transfer and estate planning strategies are planned and implemented early on, there is a fair chance to retain wealth for multiple generations.

In the last few weeks, Greece has taken the center stage in the financial markets. Within the next two months, Greece has to pay back the maturing bonds [to investors across the world] and finance its budget deficit. The country needs to borrow around $ 40 billion from the international markets. With 10 year Greek Government bond interest rates of  around 7% [more than 3% to 4% higher than 10 year U.S. Treasury Bonds and German Government Bonds], this has led to fresh worries over a potential default by the Greek Government. What has added to the problem over the last two days is a rapid withdrawal of deposits from Greek banks by its citizens. Unless Greece agrees to the terms set forth in the rescue package put together by the European Union and IMF [ to reduce government spending and increase taxes], it is difficult to get the support of this consortium to raise the $ 40 billion to stave off the crisis. As you can see from the graph, Greece’s debt is over 111% of GDP. We believe the situation in Greece is getting grimmer day by day and could be a trigger for a crisis in other European nations – Portugal, Italy and Spain.

The China Bubble

The fiscal stimulus initiated by China last year through bank lending to the tune of $ 1.2 trillion has led to potentially unstable conditions in their economy. According to well known investor James Chanos – with 60% of the country’s GDP relying on construction, ‘China is on a treadmill to hell’. Marc Faber a long time optimist on China and well known economist Kenneth Rogoff have also spoken of a China Bubble recently. With the Chinese government trying to enable a slow down in real estate speculation via a recent tax on sale of homes owned less than 5 years, one cannot rule out a rapid decline in prices which would have a negative impact on the economic growth.

Any one or combination of the two global factors identified above could trigger a mild to deep correction in the financial markets and slow down the world economy. Due to the strong financial linkages with the U.S. and the rest of the world, India will not be spared.

Srinivasa Sharan contributed to this article.

Graph Source : DNA

In September 2008 the failure of investment bank Lehman Brothers set off a negative domino effect across various asset classes with the exception of US Treasury Bonds and Cash. The bedrock on which Asset Allocation rests – different asset classes perform differently at various times in an economic cycle was undermined. This meant that conventional Asset Allocation also had to include some form of insurance which was guaranteed to perform well in a market crisis.This could have been in the form of deep out of the money put options on the stock market benchmarks which would have protected investors from the severe losses they experienced (similar to protecting another valuable asset – an automobile).

Investors must also focus on moving from a framework of Static Asset Allocation (i.e predetermined allocation percentages across asset classes) to Dynamic Asset Allocation. This would involve setting a wide range for Asset Allocation to particular Asset Classes with some form of valuation/ economic cycle based method to move to the lower or higher end of the range. For example if it were determined that an investor needs to maintain a 60 percent allocation to Equity, on the basis of where the market was trading on a historical valuation basis, Equity Allocation would be higher at 70 percent (if the market were trading at low valuations) or 40 percent (if the market were trading  at high valuations).

The third update on Asset Allocation would be to also evaluate concentration of Assets in particular sub- asset classes and make changes in these exposures to reduce portfolio risk. To follow up on the previous example this would be akin to reducing investments in Banks or Financial Services companies when there is an increased likelihood of an economic recession with a commensurate increase in investments in defensive FMCG companies. In Debt Asset Allocation this is akin to reducing investments in corporate bonds and increasing investments in Government securities on expectations of an economic slowdown.

To conclude while the market crisis of 2008-09 has prompted a review of Asset Allocation, we believe it still works in an updated form.

Ironically, the financial crisis in 2008 coupled with the rapid growth of  China and India, the trade is now shifting its balance to ‘South producing for South’.

In a recent article written by Manas Chakravarty , which is based on the latest World Bank paper on the changing balance of trade, he focuses on the raising consumerism in Asia. With de-leveraging playing out across consumers, private sector and sooner or later from Governments across developed economies, consumption would raise in key southern markets like China and India. According to the World Bank paper , Asian consumers would replace the North American and  European consumers [ who currently consume 26% and 38% respectively] by contributing 59% of world consumption by 2030. See the chart in the link for more details.

It is interesting to note that the structure of these markets would be very different from the markets in the North. Being low income economies, the south will consume more food as their incomes raise. To be a producer for south, these southern countries would need to invest more in infrastructure, manufacturing  and hence the demand for commodities – be it agricultural or industrial along with energy will continue to increase.

The other change to watch out for is the price sensitive nature of the emerging economies that would lead to product standardization, which at times may lead to lower quality standards.

The large Asian economies like India do have the potential to become a new hub for consumption what with its domestic consumption, raising income levels and a favorable demographic dividend.

How does one deal with these kind of extra-ordinary period of super normal returns and abnormal returns?

One of the better methods to overcome these anxieties of extremes in portfolio performance during these turbulent times is to stick to goal based approach to investing. An interesting report to improve wealth management for individual investors was proposed by Dan Nevins, where in he takes into account the various factors that impact the investment decisions for investors. Terms like ‘loss aversion’, ‘mental accounting’, ‘over confidence’, ‘hind sight bias’, ‘over reaction’, ‘belief perseverance’, regret avoidance’ from behavioral finance builds the case for ‘Goal Based Investing’ approach. More importantly, it specifies the need to look at risk from portfolio level as well as goals level and accordingly deploy assets to for specific time frames to achieve those goals .Though the report was written in 2003, it is all the more valid and increasingly being applied in the wealth management space. The report has also laid out some strategies to manage investments over different time periods and life style goal needs.

To conclude, it is important to understand that managing wealth involves marrying the traditional finance with modern finance.

Goal based investing is the way to go.

1. The U.S. will continue to do ‘quantitative easing’ to ease the credit crunch..Unfortunately, it has not yielded meaningful results till date. According to Meredith Whitney,the Small and Medium Enterprsises in U.S. [ which contribute to over one-third of the GDP] till date have been increasingly denied access to credit.The SMEs are the prime engines of innovation and employment revivals[represents 50% of the nation's workforce]. Lack of credit leads to lay offs and closure of businesses.

2. The U.S. Government’s intent to stimulate the economy through more consumption[ like cash for clunkers program, etc] would not work, since the consumers are paying off their debt and saving more.  The notion that  over 70% of GDP contribution would still come  through consumption seems to be history.

3. Dollar[due to zero interest rate policy] has now replaced the yen as the ‘carry trade’ for investors, fuelling asset bubbles across emerging markets.

4. Recent data put out by IMF indicates that Fiscal Stimulus doesn’t work in reviving the economy, when the fiscal deficit is beyond 60% of GDP. The U.S. has already reached that level.

5. When all mechanisms to revive the economy fails, drastic depreciation of the currency would be the only option for U.S. to revive its economy. This would temporarily bring down the soaring un-employment rates and push consumer prices upwards[deflation to inflation].

Recent Report published by David Rosenberg on The case for commodities captures the above premise very well and also suggests how investors now should re-align their portfolios.

It clearly raises a strong case for commodities. As history shows, during high inflation its the commodities and precious metals which not only acts a hedge to our portfolios but performs better.

What does all this mean to the Indian Investor?  Our country and other nations across the world has very high correlation to U.S. and hence what happens there does impact us. For eg. 16% of world GDP consumption is still driven by U.S. investors.

To sum up, it would be prudent to  trim equity portfolios , add commodities & precious metals [with a 20-25% exposure] and  increase fixed income allocation  in your portfolio.

After all, Portfolio Diversification and Dynamic Asset Allocation is the way to preserving and managing our wealth in these uncertain times.

Employers also increasingly recognize that many employees lack the most basic money management skills, and that the resulting financial problems they experience affect their productivity and performance.

Though the survey is dated and is U.S. centric, one would agree that due to twin effects of increasing financial linkages between our country with other emerging & developed markets along with the excess leverage taken by individuals in the last 4 years, has brought in lot of financial distress and wealth erosion among individuals.

Some other insights on studies undertaken recently are :

1. An employee’s financial stress and anxiety can have a negative impact on your bottom line. It’s estimated that employers pay $2,000 per employee per year for lost productivity. Source :  2004 Occupational and Environmental Medicine Journal, New Cornell University Study
2. 4 hours of lost productivity due to financial concerns. Source:  Garman, E. T., Leech, I. E. & Grable, J. E. (1996). The negative impact of employee poor personal   financial behaviors on employers . Financial Counseling and Planning, 7,157-168.

Most corporations in the developed world offer the EAP benefits to their employees which helps improve productivity and reduce attrition levels.

In India specifically, the time has come to introduce financial planning and advice under employee assistance programs for the following reasons;

1. Aspirational levels have lead to leverage among individuals, which has gone up thrice from 5% of GDP in 2003 to almost 15% of GDP
2. Global slowdown has brought in job losses across sectors and fear of job loss specifically in certain sectors which are export dependent.
3. In metros and tier 1/ tier 2 cities, the young urban population have bet on their future cash flows and leveraged far more than they could afford.
4. The bull run that started from 2004 and ended in early 2008 brought in its wake easy money and in the process destroyed the wealth creation opportunities that could have been achieved in a sustained and consistent manner.
5. The nuclear family concept has come of its age which has changed the social fabric in the country and emotional support systems [for the migrant white collar workforce]are either nil or marginal.
6. Due to financial stress, health and family issues takes center stage thereby reducing productivity levels of employees and higher attrition levels,specifically in sectors like I.T. and ITES.

It is time that Indian corporations take a pro-active approach to assist employees in the most crucial sphere of their personal lives. Like the statistics and studies bear out, its a win-win situation for both employers and employees!.

We believe there is a way out. Personal Financial Planning is it.

Yes! Focusing on ‘goals’ rather than ‘returns’ could help us avoid asset bubbles.
This in turn detaches the investors from the ‘greed and fear’ experiences in the market.

An interesting study done by Dr Conrad S Ciccotello of University of Atlanta, Georgia bears some very interesting observations:

1. Returns estimation expected by clients varied from overly optimistic during bull runs and overly pessimistic during bear phases.
2. How could one avoid the herd mentality?
3. Goal setting as part of the financial planning process holds the key to avoiding asset bubbles.

Most importantly, the study showed that people would always want to achieve their goals.

]]> http://blog.accretus.in/financial-planning/saving-ourselves-from-asset-bubbles/feed/ 0 http://blog.accretus.in/market-chronicle/india-market-chronicle/ http://blog.accretus.in/market-chronicle/india-market-chronicle/#comments Mon, 06 Jul 2009 12:56:21 +0000 Partha Iyengar http://blog.accretus.in/?p=64 At the end of last year,while I was in Sharekhan,our team embarked on an unique project called ‘India Market Chronicle’.

The project had twin objectives :
1. Will stocks deliver positive returns in the long run?
2. Will Portfolio Diversification along with Portfolio Re-balancing or Dynamic Asset Allocation deliver consistent returns as well as minimize the downside risks to the Portfolio.

India Market Chronicle chart [based on back testing data of 26 years] threw up some surprising and interesting results.

Two clear conclusions emerged out of the project :

1. In the long run, equities could still deliver negative real returns.
2. Portfolio Diversification and Dynamic Asset Allocation could indeed minimize downside risks and provide consistent returns.

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