Baba Sehgal

Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund. 

Post-WPI, Subbarao’s music may be more Baba Sehgal than Ilaiyaraaja


As I sit down to write this it is a rather cloudy, dull and insipid morning in Mumbai. An old Tamil number Vaa Vennila composed by the music maestro Ilaiyaraaja and sung by S P Balasubrahmanyam and S Janaki, is playing in the background. I happened to discover this song a few days back, quite by chance, and it has been playing nonstop on my laptop since then. It’s the most melodious composition that I have heard in a long-long time.
Dear Reader, before you start breaking your head over why am I talking about an old Ilaiyaraaja number, when the headline clearly tells you that I should be talking about other things, allow me to explain.
For a music director to be able to create melody a lot of things need to come together. First and foremost the tune has to be good. On top of that the musicians have to be able to flesh out the tune in a way that the music director had originally envisaged it. The lyrics need to make sense. The singers need to get the right emotion into the song and of course not be out of tune. The director of the movie needs to have the ability to recognize a good song when he hears one and not fiddle around with it. And so on.
The point I am trying to make is that “melody” cannot be created in isolation. A lot of things need to come together to create a melodious song and to have an individual born and brought in erstwhile Bihar of Kashmiri Pandit parents, who does not speak a word of Tamil (and not much Kashmiri either), humming it nearly 26 years after it was first released.
What is true about Ilaiyaraaja’s ability to create melody is also true about the ability of Duvvuri Subbarao, the governor of the Reserve Bank of India(RBI), to influence the Indian economy and take it in the direction where everyone wants him to.
The inflation number
The wholesale price index (WPI) inflation number for the month of June 2012 was released sometime back. The inflation has fallen to 7.25% against 7.55% in the month of May. The number has come in much lower than what the analysts and the economists were expecting it to be.
This is likely to lead to calls for the Reserve Bank of India (RBI) RBI to cut the repo rate.
The first quarter review of the monetary policy of the RBI is scheduled on July 31,2012. Industrialists, economists and analysts would want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
The first quarter review of the monetary policy is scheduled on July 31,2012. Industrialists, economists and analysts want the RBI to cut the repo rate on this day. The repo rate is the interest rate at which RBI lends to the banks.
So what is the idea behind this? When the RBI cuts the repo rate it is trying to send out a signal to that it expects the interest rates to come down in the months to come. If the banks think that the signal by the RBI is credible enough then they lower the interest rate they pay on their deposits. They also lower the interest rates they charge on their long term loans like home loans, car loans and loans to businesses. With people as well as businesses borrowing and spending more it is expected that the slowing economic growth will be revived.
That’s how things are expected to work in theory. But economic theory and practice do not always go together. The trouble is that even if the RBI cut the repo rate right now, the credibility of the signal would be under doubt, and banks wouldn’t cut interest rates. This is primarily because like Ilaiyaaraja, Subbarao and the RBI also do not work in isolation.
More loans than deposits
The incremental credit deposit ratio of the banks in the six month period between December 30,2011 and June 29,2012, has been 108%. What this means that during this period for every Rs 100 that banks have borrowed by raising deposits, they have loaned out Rs 108. Hence, banks have not been able to match their deposits to loans. They have been funding their loans out of deposits they had raised in periods previous to the six month period considered here. Given the shortage of deposits that banks are facing it doesn’t make sense for them to cut the interest rates on their deposits, even if the RBI were to go ahead and cut the repo rate. And if they can’t cut interest rates on their deposits there is no way the banks are going to cut interest rates on their loans. But why are banks facing a shortage of deposits?
The oil subsidy for this year is already over
The budget for the year 2012-2013 had made a provision of Rs 43,580 crore for oil subsidies. This provision is made to compensate the oil marketing companies (OMCs) Indian Oil Corporation, Bharat Petroleum and Hindustan Petroleum, for selling diesel, kerosene and LPG at a loss. Four months into the financial year the government has already run out of this money. The government has compensated the OMCs to the extent of Rs 38,500 crore for products at a loss in the last financial year (i.e. the period between April 1, 2011 and March 31,2012). This payment was made in this financial year and hence has been adjusted against the Rs 43,580 crore provisioned against oil subsidies in the budget for the current financial year.
The OMCs continue to sell these products at a loss. In the month of April 2012 they lost around Rs 17,000 crore by selling diesel, kerosene and LPG at a loss. In the last financial year the government compensated 60% of this loss. The remaining loss the government forced the oil producing companies like ONGC and Oil India Ltd, to compensate. So using the rate of 60%, the government would have to compensate around Rs 10,200 crore for the losses faced by the OMCs in the month of April. Add this to the Rs 38,500 crore of payment that has already been made, we end up with Rs 48,700crore. This is more than the Rs 43,580 crore that had been budgeted for.
The OMCs continue to lose money
The losses made by OMCs have come down since the beginning of the year. In April, the OMCs were losing Rs 563crore per day. A recent estimate made by ICICI Securities puts the number at Rs 355crore per day. At this rate the companies will lose around Rs 130,000 crore by the end of the year. Even if oil prices were to continue to fall the companies will continue losing substantial amount of money.
All this will mean an increase in expenditure for the government as it would have to compensate these companies to help them continue their operations and prevent them from going bust. An increase in expenditure would mean an increase in the fiscal deficit. Fiscal deficit is the difference between what the government spends and what it earns. The fiscal deficit for the current year has been budgeted to be at Rs 5,13,590 crore. It is highly unlikely that the government will be able to meet this target, given the continued losses faced by the OMCs.
Further borrowing from the government would mean that the pool of savings from which banks and other financial institutions can borrow will come down. This means that to banks will have to continue offering higher interest rates on their fixed deposits and hence keep charging higher interest rates on their loans.
High inflation
The consumer price index (CPI) inflation for the month of May stood at 10.36%, higher than the 10.26% in April. This is likely to go up even further in the days to come. The WPI inflation coming for the month of June has come in at xx%. And this is likely to push the CPI also in the days to come. CPI inflation will be pushed further given that the government increased the minimum support price on khareef crops from anywhere between 15-53% sometime back. These are crops which are typically sown around this time of the year for harvesting after the rains (i.e. September-October). The MSP for paddy (rice) has been increased from Rs 1,080 per quintal to Rs 1,250 per quintal. Other major products like bajra, ragi, jowar, soybean, urad, cotton etc, have seen similar increases. Also, after dramatically increasing prices for khareef crops, the government will have to follow up the same for rabi crops like wheat. Rabi crops are planted in the autumn season and harvested in winter. This will further fuel food inflation. Food constitutes around 50% of the consumer price index in India. In this scenario of higher inflation it will be very difficult for the RBI to cut the repo rate. And even if it does cut interest rates it is not going to be of any help as has been explained above.
To conclude
The way out of this mess is rather simple. Oil subsidies need to be cut down. That is the only way the government can hope to control its fiscal deficit. If things keep going the way they are I wouldn’t be surprised if the fiscal deficit of the government even touches the vicinity of Rs 6,00,000 crore against the budgeted Rs 5,13,590 crore.
Only once the government gives enough indications that it is serious about controlling the fiscal deficit, will the market start taking the interest rate policy of the RBI seriously. Before that even if the RBI were to cut interest rates it wouldn’t have an impact.
For Duvvuri Subbarao to make melody like Ilaiyaraaja does a lot of things which are not under his control need to come together. Ilaiyaraaja has control over the people he works with. He can tell his musicians what to play. He can ask his singers to sing in a certain way. He can ask his lyric writer to write a certain kind of song. And so on. Subbarao does not have the same control over the other players in the economy.
So in the meanwhile it is safe to say that try he might as much to make melody like Ilaiyaraaja, chances are he is likely to come up a song Baba Sehgal once made. It was called “Main Bhi Maddona”. For those who have heard the song will know that melody has never been “murdered” more.
(The article originally appeared on www.firstpost.com on July 16,2012. http://www.firstpost.com/economy/post-wpi-subbaraos-music-may-be-more-baba-sehgal-than-ilaiyaraaja-378448.html)
Vivek Kaul is a writer and can be reached at [email protected]