Viksit set up his independent practice in Oct 2011, after 17 long years partnering Anil Khera, one of Delhi's leading IFAs. He now has a successful independent practice, with a MF AuM of around 55 crores and an overall AuM close to 100 crores. In this article, Viksit takes us through a fascinating real life case study involving one of his HNI clients, to show us how BIG an opportunity lies ahead of us, if we are able to help our clients understand risk better and help them deal with risk.

One of the biggest challenges for the MF industry is that risk averse investors have stayed away from it, due to a wide variety of perceptions - some correct, some imagined. Our job as advisors, I believe, is primarily to help these investors understand and appreciate risk correctly and help them deal with risk appropriately. If we are able to do this job, we can build very successful practices for ourselves. If we do this job well, the vast majority of Indian savers who stay away from mutual funds because they perceive funds as risky, will be willing to consider these products - which in turn means many more business opportunities for all of us.

A real life case study

Let me take you through an actual experience with an HNI client whom we signed up a few months ago. The client is in his mid 40s and is a senior executive in a large private sector company. When I first met him, his portfolio consisted only of bank FDs and some postal investment schemes. His bank FDs alone ran into a few crores of rupees. No equity exposure at all. No mutual fund investments.

Show him that you can add value

In my first conversation with him, on a closer inspection of his FDs, I saw that they were all cumulative FDs, which he had invested as the effective yield was higher. I drew up a cash flow statement to show him how much pressure these FDs were putting on his annual cash flows - as there was no inflow but tax @ 30% was being paid anyway, because he was clearly in the high tax bracket. I showed him how, if he continued with this strategy, the cash flow issue would impact him more and more. This got him thinking that at least there was a need to review his present thinking. That allowed me to get into a deeper discussion with him.

I asked him if he was aware about better tax efficient investment avenues. His answer was clear : yes, there are more tax efficient avenues, but they come with risk, and he is not interested in taking risk.

Lets understand risk better

I then engaged him in a discussion on how he understood and defined risk. Is risk an accident or a probability of an accident happening. If it is a probability, should risk be defined in terms of probability of such an accident happening? He agreed that his perception of risk was about probability of an accident and not certainty of an accident.

I then asked him whether, if I discussed some tax efficient investment avenues with a low probability of accidents - ie low risk, would he be interested? He said yes, but immediately came with a rider - that he wants liquidity. He did not want to lock up his money in anything.

Lets define liquidity requirements better

We then went into defining better his actual liquidity requirements. I asked him to discuss why liquidity was important to him. What are the financial obligations in the near term that must be provided for? How much contingency reserve does he always want to have, to take care of medical emergencies, unexpected impulse spending etc? Step by step, we were able to agree exactly how much liquidity he really needed on an instant basis. I then asked him how comfortable will he be if the rest were to be parked in investments that provided liquidity on a T+2 or T+3 basis. He became a little more relaxed on the liquidity front, after doing these calculations.

I then tried to understand his level of familiarity with other fixed income instruments like tax free bonds. He was somewhat familiar, though he did not have an indepth understanding of things like secondary market for tax free bonds etc.

Old wounds are still fresh in memory

One thought that bothered me was how come an HNI of his standing did not have any debt funds in his portfolio and did not so far even mention mutual funds once in the conversation. I asked him what he thought about mutual funds. His answer was instant : he disliked mutual funds because he lost a lot of money in equity funds way back in the 2000 tech meltdown. Ever since then, mutual funds became a taboo subject for him.

At least I knew what I was up against

This obviously became an uphill task for me, but at least I knew what I was up against. I went through a few sessions with him, taking him through the different types of mutual funds and explaining clearly that there exist a vast variety of mutual funds that do not invest anything in equity, and can give high levels of tax efficiency through full debt portfolios. We discussed in detail how funds by law have to stay strictly within the mandates in offer documents and the checks and balances in the system that do not allow a fund manager any discretion beyond the mandate of each fund. We discussed the risks involved in debt funds, how these risks are mitigated and what are the probabilities of accidents happening - which for a long term investor like him, was more about credit risk and less about day to day MTM related risks.

Understand the importance of transparency as a risk mitigant

We discussed the transparency aspect and how in a debt fund, you know exactly where your money has been deployed and can question the fund manager about certain instruments he has invested in, if you have any doubts or worries. Contrast this with any company or bank deposit you place - where you do not know what is happening with the money you lent them and have no right to seek clarifications on whom they are lending to. As an investor, you are much more in control of the probabilities of accidents when you have a fully transparent portfolio, when you can take an independent call on the level of credit risk that a fund manager is taking and decide whether you want to remain invested in a fund or not.

Use the right instrument for the right phase in the cycle

We then discussed interest rate cycles and how mutual funds offer you an opportunity to capitalise on the downward phase of the rate cycle, much better than traditional fixed income products can ever do. Taking advantage of the rate cycle on both ways, with appropriate instruments for each phase, is something we discussed in some detail.

Start with 100% debt funds portfolio

After all these discussions, we agreed to create a portfolio of mutual funds with minimal risk. We focussed purely on a range of debt funds - from ultra short term to short term and a small exposure to income funds. Exposure to income funds was done only through STPs.

Move gradually to a more balanced asset allocation

Over time, once his comfort grew with our advice, I broached the topic of equity investing through SIPs and STPs, which would help control volatility and build wealth over time. After a few rounds of discussions, he agreed to start investing in diversified equity funds through STPs from ultra short term funds. Today, the portfolio is 75% debt - with an exposure to all categories of debt funds and 25% has been earmarked for equity, which is being invested gradually through STPs from the ultra short term funds.

What worked was helping the client understand and deal with risk

When I look back at how we moved from a full bank FD portfolio to a full MF portfolio with a 75 debt - 25 equity asset allocation, it simply boils down to one thing : helping the client understand risk and deal effectively with risk. So many investors make poor investment choices only because of their risk perceptions. Some of these risk perceptions are real, some are perhaps exaggerated. Our ability to help them deal with these exaggerated risk perceptions, is what can help us make them more successful investors.

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