Plutus Capital

Interest rates and the impact on your investment return

The world has witnessed massive swings since March 2020. We are nowhere close to economic normalcy. Let’s understand what is happening in the world and how does that impact your investment returns.

The world that never existed

Any student of finance will appreciate that the current scenario is a textbook version of how the world should be dealing with slow growth and inflation. However, a new variable, supply chain disruption is added to this equation.

A central bank increases interest rates to reduce inflation in the economy. Similarly, central banks reduce interest rates to provide growth stimulus. To maintain growth, developed countries reduced interest rates to their historical lows in 2020. Additionally, provided free money to everyone so that growth momentum doesn’t break.

When interest rates drop, investors pursue risky asset classes. In 2021, every day we heard unicorns being created. There was no change to cash flows (still negative) but suddenly the founders and a lot of employees with ESOPs became wealthy. Most of these people thought they are so skilful, but a lot was happening just because the wealthy lot of the world started allocating in these asset classes (private equity/VC).

In late 2021, the music stopped. Inflation started mounting and the central bank started to increase interest rates. Suddenly, investors started to look at asset classes that were not risky. Startups relying on external funding started running out of cash leading to problems for banks providing these startups credit (SVB etc.).

As the world was tackling the situation of rising inflation, Russia and Ukraine war broke out. As we all know, Russia is a leading oil and gas producer in the world. It was obvious that the oil and gas supply will get disrupted leading to higher prices. So much so countries like Germany went back to burning coal to keep industrial production going.

Although the Covid health crisis is history now, a lot of economic issues planted due to Covid are still going on. USA, UK and others are still dealing with high inflation, the central banks are still increasing interest rates. These countries are already at a high-interest rate level, if this continues, they may be looking at flattish growth for a few years.

China’s growth rate is impacted due to its internal policy issues. The world started to look at China with scepticism and a lot of companies started to evaluate setting up plants outside China. China is currently dealing with low inflation and low growth. With US and China playing immature trade games, the supply chain globally is under strain.

India’s RBI governor Shantikanta Das has done phenomenal work managing inflation and interest rates. Additionally, the government’s decision to trade with Russia and now with other countries provides good support to INR against USD. Global supply chain disruption finding its way into India can be a game changer. I hope we don’t create another example of lost opportunity the way we did in textile, Bangladesh and Vietnam became recipients.

Now what does all this mean for your investment portfolio?

US Equities

In the US, the cost of capital continues to be elevated. The market has recovered in 2023 but if inflation is not managed, a lot of froth will settle as the industry profitability may decline.

Indian Equities

Although India’s inflation is under control, rising oil prices can put severe pressure on Indian equities. The recent market surge is supported by profitability, but global pressure will continue to prevail, and Indian equities can see some swings.

Indian Real Estate

Although India has seen rising interest rates in the last year, real estate has been on the upswing. The music may continue for some time now. A lot of future disappointment is getting baked into current prices.

Indian Debt

Banks have now started offering 6.5-7% FD rates. This is in line with historical trends. Given the global and Indian economic conditions, an interest rate pause is a more probable scenario.

US Bonds

A lot of investors have started investing in US debt because these kinds of interest rates were not seen in the recent past. India and US interest rate differential (GSec 10 yr yield) is at an all-time low. One interesting trend is the difference has reduced not because India has reduced the interest rates, but it's primarily because the US increase the interest rates. What if the US continues to increase the interest rate to manage inflation?

I understand mean reversion, but what if mean reversion does not follow a usual time pattern and it takes longer than anticipated?

Now the other argument is USD appreciation against INR. Historical averages indicate a 4% p.a. USD appreciation. Rising inflation in the USA with India doing INR-based bilateral trade, we will see how the trend emerges. See the chart below, last year is more flattish.

One scenario of allocating in US debt is to pick short-term to medium-term US GSec and link the investment amount to your needs outside India. A lot of old allocation in US debt is still bleeding and the respite is far-fetched.

The world may look like an old version but from an economics standpoint post covid a lot of economists are staring at new developments and only time will tell how it all pans out.

Disclaimers

Investments in the securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337

Trying to simplify finance, does it work?

Updated: May 10

These days there are so many finance influencers on YouTube, authors of personal finance books, and online and in-person courses on managing money, but are the investors getting any better?

Seeing things the way they are

A lot of YouTube influencers pass on strong advice to the novice investor. There are so many influencers who were promoting crypto until the fall happened.

There is no problem listening to these videos, but acting upon them can be disastrous. I believe that knowledge can help you advance but too much information will make you not act at all.

Here is a simple step-by-step process for managing your money better.

1. Cash flow analysis and net worth: Understand your inflow and outflow of funds, your current asset and liability position and what you want to achieve. There are many calculators to do this assessment. https://www.plutuscapital.co/calculators

2. Asset allocation: Based on the cash flow surplus and financial goals arrive at an asset allocation. You must also consider the risk profile that you would like to maintain whether it is aggressive, moderate, or conservative.

3. Execute and monitor: Implement the allocation and keep a watch.

These steps are so simple yet so difficult to implement.

Any financial outcome is a combination of your life situation, capital market conditions and your behaviour. All these three areas are dynamic and ever-changing.

Some things can be known, and some things cannot be known.

Life situations and capital market conditions can be observed, and a decision can be made. For example, you know that an increment or a promotion may happen, or you are about to change your job or get ESOPs encashed etc. These events can be known in advance and a decision can be made.

Similarly, capital market conditions can be sensed (over or undervalued markets) and a decision can be made.

However, personal behaviour is the most complex aspect that even professionals will have a challenge dealing with.

Here is a speech by Charlie Munger on “the psychology of human misjudgement”. This speech is all you need to know about human psychology.

Psychology+of+Human+Misjudgment

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Download PDF • 1.91MB

Reading can help but will that make you wise?

Not really!

Awareness of ourselves will make us wise.

A finfluencer or a book author cannot make you wise because they are dealing with their own biases. They are just passing on those biases to you, invest in start-ups, invest in ETFs, invest in crypto etc. Who knows, maybe keeping your money in a bank’s FD is the best option.

One of the ways you can become a better decision maker whether about money or any other thing is to see life the way it is without adding any extra meaning. Easier said than done.

Our Indian tradition has given a lot of importance to ‘consciousness’ and not so much to ‘mind’.

When you are looking at a problem, you need to reflect on which aspect of your mind is dominating - ego, intellect, or memory. If your mind is at work, chances are that the decision is not optimal.

Ego will always make you stick to your decision (status quo bias). Intellect will not help you look past your analysis (overconfidence). Memory will restrict you to what you have seen in the past (anchoring).

To evaluate any problem, you need to ensure there is neutrality in your emotions. You should be able to see the problem vertically and horizontally and once you have decided, it will just ‘feel right’.

This sense can be applied to any problem you are trying to solve - investing, life, hiring a professional, relationship etc. The decision that feels right will turn out to be right. Pre-condition is the neutrality of the mind and seeing things as they are.

Disclaimers

Investment in securities market are subject to market risks. Read all the related documents carefully before investing.
The securities quoted are for illustration only and are not recommendatory.
Registration granted by SEBI, membership of BASL (in case of IAs) and certification from NISM in no way guarantee performance of the intermediary or provide any assurance of returns to investors.

Details of the advisor

Advisor: Ankur Kapur
SEBI RIA No.: INA100001406
BASL Member ID: BASL1337

How can US and Canadian NRIs invest in India?

Updated: May 10

Mutual funds, AIFs etc. are not tax-efficient solutions for the USA and Canada-based NRIs. There are more straightforward options to address this issue.

USA and Canada NRI Investment Options

The global economic environment is challenging, and the respite is not any time soon. High inflation is expected to stay in the western world, and it will keep interest rates elevated for some time. So much so that the USA is dealing with inflation that they last experienced these elevated inflation levels a few decades back. Globally, the future growth prospects do not look bright.

On the other hand, India managed its monetary policies better than a lot of western countries. Although RBIs current inflation target is 4% (with a 2% threshold), the average inflation over the last 20 years has been around 7% p.a. The latest data indicates 6.5% as India’s inflation rate. India’s primary concern about inflation is the oil price. Given that the global economy might be under low growth headwinds, India stands strong.

As per the world bank report, India is expected to be the highest-growing economy in 2023 and 2024. A young population, China +1, Production linked incentives, and India’s payment stack are some of the areas that can help India double its GDP in the next 5-7 years.

It’s not a surprise that NRIs want to invest in their home country. Indian tax laws and security laws are pro-foreign and NRI investors. Like most of the major countries in the world, India has a bilateral tax treaty in place. This means double taxation can be avoided for investors. Recently, SEBI has made KYC norms more stringent for NRIs so that money laundering issues can be avoided. Irrespective, there is a massive inflow of funds to India to capture the expected growth.

In India, NRIs and Residents are treated at par. However, local tax laws can wary. In India, a simple way to invest is by using mutual funds. The process of mutual fund investments for a US / Canada-based NRI is as easy as for resident Indians.

However, the local laws (USA IRS and Canadian tax laws) are not tax efficient for mutual fund investments. If you are an Indian living in the USA, it is most likely that you have come across the term PFIC. PFIC is an acronym used for Passive Foreign Investment companies.

Simply put, if you are invested in an Indian Mutual Fund, you must declare the investment and income in the US. If you are a joint income tax filler in the US, you are exempted up to Rs 50 lakhs ($25,000 each). However, if you are invested more than Rs 50 lakhs (Rs 25 lakhs singly), you are not just required to report to IRS but also pay taxes on the unrealised gains.

Indian tax laws do not differentiate but must follow FATCA rules and report to the US counterparts. Even if you don’t report to IRS, still the information is shared with the US authorities. A few mutual funds offer investments to US-based NRIs but beyond $25k, it does not make sense for US investors to allocate to Indian mutual funds. Similar laws prevail in Canada too.

One way to address this issue is to hold investments directly and not in a fund structure. This way you don’t have to pay taxes on the unrealised gains.

Additionally, Alternative Investment Funds (AIFs) fall in the same category as PFIC, making AIFs also not a good investment vehicle for US-based NRI investors. Another, investment option is investing in India using Portfolio Management Scheme. Investment using PMS is tax efficient both in India and in the USA. Interestingly, there are not many PMS accepting money from US/Canada-based NRIs.