Life isn’t the final draft

Came across a beautiful video and this observation from the video struck a chord:

Life isn’t the final draft. It’s just breakfast over and over. You burn some. You get better.

Does your AMC act to protect your money?

I noticed a strange bump in the NAV history of Bank of India Short Term Income Fund. The fund’s NAV on 3rd November 2024 was ₹27.05. The NAV went up by 1.9% on 4th Nov to 27.57.

Screenshot from Value Research Online

I was curious what went on and started digging. To my surprise, there was no news coverage about this at all. Comparing the fund’s October and November fact sheets did not give any clue. After a bit of searching around, I found a letter BOI MF had written to their investors about this. The letter says that the fund’s NAV was reduced in 2022 following a default.

After recovery from selling of shares, the outstanding amounts for Bank of India Credit Risk Fund was Rs. 24.11 lacs and for Bank of India Short Term Income Fund was Rs. 6.75 crs.

In November 2024, the fund has received a settlement. The letter says:

After trying to recover the balance outstanding amounts since the default, Bank of India MF (“the Fund”) finally entered into OTS agreement with promoter group and the final OTS amount of Rs. 9.08 lacs for Bank of India Credit Risk fund and Rs. 2.54 crs for Bank of India Short Term Income Fund was received by the Fund respectively on 4th November 2024. The received amount was dully accounted in the NAV of the respective Schemes on 4th November 2024.

Anyone that invested in this fund before 2022 lost some of their money. I have no problem with that; investors sign up for such potential losses when they invest in debt mutual funds.

What makes me sad is that the AMC chose to not create a segregated portfolio with the Coffee Day NCD (despite the fund’s SID allowing portfolio segregation). Any investor that bought into this fund after the NAV fell in 2022 but before it increased in 2024 would have received this 1.9% rise in NAV “for free.” The AMC is essentially taking the previous investors’ money and gifting it to newer investors. Creating a segregated portfolio would have prevented this unfairness altogether. But, for whatever reason, the BOI AMC chose to not create a segregated portfolio.

I wrote an email to the AMC asking about this more than 10 days ago, but they have not responded (other than an automated reply with a ticket reference number).

This is the kind of behaviour—I don’t know what to call it… laziness, lack of integrity, or incompetence—that an investor should be weary of when choosing an AMC. Bank of India AMC has shown that they will not do what’s right for the investors. It is up to us how we act on that information.

Can we invest in high-yield bonds?

There are bond investment platforms that let retail investors buy bonds directly. Many of these platforms sell high yield bonds issued by private organisations. For debt/bond allocation in a long-term portfolio, can investors buy these bonds?

As an example, let’s look at this high yield bond that pays 10.75% fixed coupon, but available in the market at the yield of 11.415%. (This is just a random example; not a recommendation for/against investing in this bond.)

Screenshot from goldenpi.com

When I calculated the XIRR for this bond, it came out to an impressive 11.72%. But that’s before accounting for tax. Advance tax is due every quarter on the interest received, so let’s assume that we set aside the cash necessary to pay the tax as soon as we receive the interest. That causes the XIRR to drop.

Effective XIRR of the bond for 30% tax + various surcharge rates (source)

Some of you may point out that the after-tax XIRR of 7+% is actually great from a fixed income instrument. You are right, but we need to look beyond (the admittedly attractive) XIRR the following reasons:

• Investments with high XIRR are useful only if you can reinvest the incoming cash quickly. If the interest piles up in a savings bank account, you are not benefitting from the high XIRR. (See Don’t let attractive XIRR figures fool you.)
• These bonds usually have so little demand in the market that these bonds are held till maturity in practice. When the interest rate falls, you don’t benefit from the increase in the bond price. There is no inverse correlation with equity in practice.
• This means that you cannot rebalance your portfolio by selling bonds to buy equity. The bonds need to stand on their own, and cannot be part of a portfolio diversified across asset classes.
• A bond mutual fund that holds higher quality bonds, however, can be a great addition to a diversified portfolio. Such a fund may have a lower yield, but it’ll be liquid enough to be useful at all times.
• When you invest in a bond mutual fund, you can defer taxation until redemption. This could be years or even decades for a long-term investor. This will increase the effective after-tax return for those investors.
• Gains made from bond mutual funds are considered capital gain. Capital gain arising from bond mutual funds can be offset by short-term capital losses. No such benefit for the interest earned through holding bonds directly.
• If the bond issuer goes bankrupt and the bond value becomes zero, that may count as capital loss, but I don’t know the tax rules around it.
• A sovereign bond, which has virtually no credit risk, will likely give around 7% pre-tax yield. Consider holding a gilt mutual fund for 15 years. Your returns will be pretty good at a much lower risk. If we consider the risk-adjusted return, isn’t a gilt fund a much better choice for most retail investors?

I’ll likely buy a low-quality high-yield bond to hold in my fun portfolio. But that’s mostly for the cheap thrill of investing in this asset. Such bonds have no place in my more serious portfolios.

Do savvy investors need a financial advisor?

If you are capable of learning investment processes and evaluating investment assets and portfolios, do you still need to hire a financial advisor?

Maybe you do; maybe you don’t. That’s a decision only you can make. But I’ll show you a reason why I have been retaining my advisor for over 3 years now.

Back in 2022, my advisor had recommended me a portfolio with 20% allocation to bonds and 10% allocation to gold. I insisted that I’d not invest in gold. He agreed to change the recommendation to have 30% allocation to bonds instead (and 0% to gold).

2 years later, in 2024, I started researching different portfolio combinations. This is when I discovered that gold was a great ingredient to have in long-term portfolios. In September 2024, I wrote the following email to my advisor, asking him if I should allocate 20% of my portfolio to gold.

Email I wrote to my financial advisor; click to enlarge

I was vehemently against gold when my advisor had recommended gold. But now I was taking a U turn and asking if I should add gold to my portfolio.

This was his response:

Email reply from my advisor; click to enlarge

Eventually, I agreed to keep the gold allocation to 10%. Basically, I accepted the portfolio that he had originally recommended to me.

• • •

So, why do I need an advisor? To keep me grounded and stable when I am being blown away by something new I have learnt. Some investors can find such a balance naturally; for them, an advisor may not be needed (or they may need an advisor for a different purpose). I, however, need an advisor to keep me safe from myself. 🙂

My stance on gold: learning from the pros

I used to have no opinion about gold as an investment asset. Then I came across this Warren Buffett quote:

[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.

Thinking more, I came to the decision that investing in gold was a bad idea. I wrote 2 different blog posts declaring that gold was a bad investment (post 1 and post 2). Many months later, I hired a financial advisor, who recommended that I allocate 10% of my portfolio to gold. I told him that I wouldn’t hold gold, and I stood my ground.

A couple of years pass, and I discover the idea that the portfolio as a whole is more important than the individual components in the portfolio. I warmed up to the idea of having an allocation to gold, and I compared gold to spices such as bay leaf or star anise that are added to biryani. No one eats bay leaves on their own, but we all want bay leaves in our biryanis.

Image source: pickpik.com

I still didn’t like gold, but I was willing to add it to my portfolio because of what it brings to the table. I was still hesitant because gold is a speculative, non-productive asset. Then I came across the most complete write-up on gold I have ever seen: this is the memo that fund manager Howard Marks wrote to his clients in 2010, named All That Glitters.

I already knew that Howard Marks was not a fan of investing in gold, so I was expecting to see arguments against gold. I was also a bit nervous because if I am convinced by Howard Marks’ arguments, I may have to change my stance on gold once again. But that memo blew my mind. It was as rigorously seeking truth as an unbiased academic research paper would. Strangely, I am more at peace holding gold after reading the memo. (Confirmation bias, maybe?)

Here are the key points that I took from the memo:

• To profit from an investment, the question of intrinsic value may not be fully important. As long as we have other investors willing to buy the asset from us, we can make a profit.
• We call bonds and shares productive assets because they produce cash flow. But what is that cash? Cash is the fiat currency of some country. Do fiat currencies have intrinsic value? They don’t. They have value only because everyone agrees that they are valuable. Then how is gold different?
• Howard Marks’ investment framework requires knowing the intrinsic value of an asset and then buying it at a bargain price. For gold, no one knows what the intrinsic value is. Hence, Howard Marks cannot buy gold using his prudent methodology.

Gold is not compatible with Howard Marks’ strategy, but my investment strategy is a lot more passive, and I don’t usually care about valuations. That means I can buy gold according to my portfolio allocation without worrying about overpaying for it. (If I overpay, I’ll correct that mistake when I rebalance the portfolio next time.)

I still worry about a technological advancement making gold abundantly available and hence crashing its price. But I have grown a lot more comfortable giving allocation to gold in my portfolio.