SEBI has again changed the method for valuing liquid funds. Currently, the net asset value (NAV) of such funds are not marked-to-market if the funds hold securities with residual maturity of 30 days or less.
SEBI now wants all liquid funds to be marked- to-market. In this article, we discuss a broader risk that such regulatory changes impose on your goal-based portfolios. We also discuss how you can manage such risks.
The trade-off
You can chase returns, or you can achieve your goals, but you cannot pursue both these objectives within a single portfolio. The easiest way to achieve both is to have separate portfolios.
You can chase returns by managing a trading portfolio to capture short-term gains in the market, and you can chase your goals by setting up individual goal-based portfolios.
The problem arises when you chase returns for your goal-based portfolios. Liquid funds are a case in point. These funds are expected to offer higher returns than interest earned on savings account. So, have you been keeping your short-term cash in liquid funds? And why should that pose a problem?
You would have had short-term cash when you rebalanced your goal-based portfolio to buy into a liquid fund.
That is, you sold your equity investments to change your equity allocation as you approached the end of the time horizon for your life goal.
Or, perhaps, you wanted to reinvest in equity after the market fell. SEBI’s decision to mark-to-market all liquid funds means that your nominal capital invested in such funds is no longer protected. Should you take such a risk on your goal-based investments?
You are exposed to similar risk when keeping your contingency money in liquid funds. This is the money you maintain for unexpected expenses including medical emergencies.
Liquid funds are just an example. Some years ago, fixed maturity plans exposed individuals to similar risk due to a change in SEBI regulation. Such risks can also arise due to changes in tax structure. So, it is moot if you should invest in a product because it is offers tax benefits or utilises a favourable market regulation, for such benefits can be easily withdrawn. So, what can you do?
Moderating risk
You should preferably not choose products only for their special tax benefits or differential market regulation.
For instance, you should buy unit-linked insurance plans (ULIPs) because you like its features, not because it offers tax benefits. What if the tax benefits are withdrawn or reduced? You cannot discontinue your ULIPs without incurring costs.
So, one way to moderate regulatory risk is to stop chasing returns for your goal-based portfolios. Suppose you need to earn just 4 per cent return in the next six years to buy a house. Why would you invest in equity when you can achieve your goal by buying taxable bank deposits, even if an exotic equity product is structured to take advantage of tax benefits or market regulation?
The above argument does not mean that you will not run regulatory risk if you invest in products that help you achieve your goals. But that is a risk you should assume at the minimum to achieve your goals.
So, your investment process should be as follows: First, decide the time horizon for your goal. Second, determine how much you can save each month to achieve the goal. Third, based on your time horizon and savings, calculate the required investment return. And finally, choose products whose expected return is closer to your required return. This process could help you moderate the regulatory risk in your goal-based portfolios.
The writer is founder of Navera Consulting. Send your feedback to portfolioideas@thehindu.co.in