Diversified funds for core portfolio?
The core-satellite framework is an optimal form of portfolio construction. In this framework, investors use index funds to construct the core portfolio and some genre of active funds to build the satellite portfolio.
A question many investors ask is: Can active funds be used to construct the core portfolio?
This article discusses the characteristics of active funds available in India.
It shows the problems in using such funds as part of the core portfolio.
It then suggests why some active funds provide optimal exposure within the satellite portfolio.
Style mandate
Active funds are those funds that strive to beat their benchmarks.
The portfolio managers of such funds take active bets — either through stock selection with simultaneous diversification across industries or with sector rotation, which is actively picking sectors that outperform the market and holding diversifying positions within those sectors.
Such funds then ought to be a natural choice for investors.
The problem, however, is the funds’ style mandate. This refers to the investment style that an active portfolio manager follows.
A large-cap value, for instance, is an investment style where the portfolio manager will pick large-cap stocks based on certain parameters such as price-earnings or price-to-book multiples.
If investors use active funds to form the core portfolio, they should ensure that the portfolio is style-diversified to avoid concentration risk.
The problem is that most active funds do not have clearly defined style mandates. This poses problems in portfolio construction.
Take an investor who buys three active funds. With no distinct style mandate, the portfolio managers of all three funds can technically load their portfolios with similar stocks. And that could expose the investor to concentration risk.
That is not the case with index funds. With the portfolio constituents of such funds clearly defined and broad-based, an investor has to buy one index fund or at best two (based on fees and tracking error) to construct the core portfolio.
Actives and MERs
The objective of the core portfolio is to take beta exposure through large-caps. The problem is that active funds generate returns from some combination of exposure to large-caps and mid-caps.
It is moot whether consistent excess returns can be generated from the large-cap space.
If, indeed, diversified funds generate active returns primarily from mid-cap exposure, why should investors pay active fees for large-cap exposure as well?
Consider this. The management expense ratio (MER) for active funds ranges between 2 and 2.5 per cent; the MER for an index fund is around one per cent.
Do active funds deliver returns commensurate with the higher fees?
Based on statistics from valueresearchonline.com, the median r-squared for diversified funds is 0.91 while the average r-squared is 0.89. That means, on average, 89 per cent of the variation in the fund returns can be explained by the changes in the benchmark index.
Of course, despite the strong relationship with benchmarks, some active funds do generate excess returns.
But when such returns primarily come from mid-caps, investors might as well take exposure to pure active mid-cap funds and settle for a low-cost large-cap exposure through index funds.
This argument sits well within the core-satellite portfolio framework, which encourages large-cap exposure through the core portfolio and all other exposure through the satellite portfolio.
Conclusion
The argument then is not against active funds per se but the investment style of most diversified funds.
It logically follows that style-specific active funds would be optimal for the satellite portfolio. This portfolio is set up to take exposure to sectors that can generate excess returns or alpha returns.
Active mid-cap funds and small-cap funds, for instance. The reason is that investors do not have low-cost alternatives in this investment space. Besides, the likelihood of beating benchmarks is higher.
Finally, these funds have clearly defined style mandates.
All these factors make them suitable for the satellite portfolio. And the index funds for the core portfolio.
Monday, March 30, 2009
REAL ESTATE SCENARIO - COIMBATORE
Builders in Coimbatore grapple with shortage of quality sand for construction because the city is far removed from areas where sand is mined . The builders source sand from the Cauvery river bed near Tiruchi, 200 km away. The distance and the fact that the vehicles are overloaded to make it profitable for operators puts a premium on sand availability. The problem gets accentuated during the monsoons when sand mining on river beds becomes difficult or impossible due to floods.
The price of one unit of river sand, which had gone up to Rs 2,800/unit, has come down to around Rs 2,200/unit now. The advantage of using good river sand is that it mixes easily with cement and bonds well, making the plastering work less cumbersome for the masons and giving a good finish to the buildings. But on the other hand, the continuous mining of sand causes environmental problems.
Tirupur company upbeat
In such a scenario, artificial sand is seen as a welcome alternative to natural sand. A Tirupur-based company, i Blue Minerals Pvt Ltd, has hit upon the idea of manufacturing sand from blue metal for which it has put up a plant at Thennilai near Karur at an investment of Rs 18 crore. While the production of blue metal as the base product has commenced, sand manufacture as a by-product is expected to begin in about three months.
Mr Veerappan Ganesh, CEO, i Blue Minerals, said the plant has the capacity to produce 300 tonnes/hour of blue metal while the sand manufacture capacity would be 100 t/hr which could be scaled up to 300 t/hr. He said the manufactured sand would be of better quality than even crusher sand and the sand would be produced using Japanese technology.
Explaining the advantages , he said the sand would be 100 per cent pure and it would not contain impurities such as clay particles and stones. The artificial sand would be available in two grades — 1-3 mm for plastering and 3-5 mm for all construction work. Since it was factory manufactured, its availability would not be subjected to the vagaries of the monsoon.
As it would be double-washed and silt-free, it would bond better with cement and would require lesser curing time than river sand.
Referring to the potential demand for man-made sand, he said even if the factory produced 1,000 tonnes of sand per day, it would be just a fraction of the total demand for sand in the Coimbatore region. Hence, he was confident of marketing the entire sand produced by his unit.
Competitive price
Mr Ganesh said the price would be competitive and he intends to sell it 20-30 per cent lower than the price of river sand — in the price range of about Rs 1,300/unit. Another marketing strategy being planned is to sell the sand in 50 kg bags through retail hardware stores/cement dealers so that people who need small quantity of sand could buy this ready-to-use product.
But builders feel the benefits of artificial sand are yet to be established.
Col (retd) A. Sridharan, Managing Director, Covai Property Centre (India) Private Ltd, Coimbatore, said pricing and the long-term strength of buildings built using artificial sand were key issues that would have a bearing on builders deciding to use it in lieu of natural river sand though he was in favour of it from an environmental point of view.
He said the manufacturers of artificial sand were yet to establish with the help of a credible source such as IIT the long-term impact of using it in construction.
The colour of this sand made from blue metal was not an issue since after plastering, the walls would have to be covered with putty and paint and hence, in terms of aesthetic value, both artificial and river sand would be equal. It was the long-term impact of the artificial sand in mixing that was required to be ascertained.
Col Sridharan pointed out that there were doubts even when fly ash was offered as an alternative to red bricks.
But now those misgivings have largely gone. He said builders need to stock large quantities of river sand during monsoon season fearing shortage but once the artificial sand is proved to be as good as river sand, this would not be needed.
Mr Ganesh said once production begins, he would seek quality certification from institutions such as IIT. He also plans to organise meetings of masons, builders and architects to convince them about the benefits of using artificial sand and its long-term environmental value.
The price of one unit of river sand, which had gone up to Rs 2,800/unit, has come down to around Rs 2,200/unit now. The advantage of using good river sand is that it mixes easily with cement and bonds well, making the plastering work less cumbersome for the masons and giving a good finish to the buildings. But on the other hand, the continuous mining of sand causes environmental problems.
Tirupur company upbeat
In such a scenario, artificial sand is seen as a welcome alternative to natural sand. A Tirupur-based company, i Blue Minerals Pvt Ltd, has hit upon the idea of manufacturing sand from blue metal for which it has put up a plant at Thennilai near Karur at an investment of Rs 18 crore. While the production of blue metal as the base product has commenced, sand manufacture as a by-product is expected to begin in about three months.
Mr Veerappan Ganesh, CEO, i Blue Minerals, said the plant has the capacity to produce 300 tonnes/hour of blue metal while the sand manufacture capacity would be 100 t/hr which could be scaled up to 300 t/hr. He said the manufactured sand would be of better quality than even crusher sand and the sand would be produced using Japanese technology.
Explaining the advantages , he said the sand would be 100 per cent pure and it would not contain impurities such as clay particles and stones. The artificial sand would be available in two grades — 1-3 mm for plastering and 3-5 mm for all construction work. Since it was factory manufactured, its availability would not be subjected to the vagaries of the monsoon.
As it would be double-washed and silt-free, it would bond better with cement and would require lesser curing time than river sand.
Referring to the potential demand for man-made sand, he said even if the factory produced 1,000 tonnes of sand per day, it would be just a fraction of the total demand for sand in the Coimbatore region. Hence, he was confident of marketing the entire sand produced by his unit.
Competitive price
Mr Ganesh said the price would be competitive and he intends to sell it 20-30 per cent lower than the price of river sand — in the price range of about Rs 1,300/unit. Another marketing strategy being planned is to sell the sand in 50 kg bags through retail hardware stores/cement dealers so that people who need small quantity of sand could buy this ready-to-use product.
But builders feel the benefits of artificial sand are yet to be established.
Col (retd) A. Sridharan, Managing Director, Covai Property Centre (India) Private Ltd, Coimbatore, said pricing and the long-term strength of buildings built using artificial sand were key issues that would have a bearing on builders deciding to use it in lieu of natural river sand though he was in favour of it from an environmental point of view.
He said the manufacturers of artificial sand were yet to establish with the help of a credible source such as IIT the long-term impact of using it in construction.
The colour of this sand made from blue metal was not an issue since after plastering, the walls would have to be covered with putty and paint and hence, in terms of aesthetic value, both artificial and river sand would be equal. It was the long-term impact of the artificial sand in mixing that was required to be ascertained.
Col Sridharan pointed out that there were doubts even when fly ash was offered as an alternative to red bricks.
But now those misgivings have largely gone. He said builders need to stock large quantities of river sand during monsoon season fearing shortage but once the artificial sand is proved to be as good as river sand, this would not be needed.
Mr Ganesh said once production begins, he would seek quality certification from institutions such as IIT. He also plans to organise meetings of masons, builders and architects to convince them about the benefits of using artificial sand and its long-term environmental value.
UNDERSTANDING ULIPS
Insurance is usually bought by an investor seeking to transfer risk from an individual to a pool to protect against untoward incidents and to provide for monetary compensation to his family. With the introduction of ULIPs, investment plans vended by insurance companies, this logic has been turned on its head. Unit linked insurance plans (ULIPs) are pitched as an investment product rather than as a risk shield and it is the unit holder who bears the risk of market swings in these products.
While insurance companies pitch ULIPs as a product for the long term, there is considerable mis-selling of ULIPs in today’s market scenario and many investors sign up for ULIPs without really understanding their risks. Here are some points about ULIPs that your agent probably won’t tell you:
Guaranteed vs illustrative returns: Many ULIPs are today marketed as products that offer a “certain” return over a specific time period. “Invest Rs 15,000 and double your money in five years”, is the kind of pitch often used to sell ULIPs. But investors need to distinguish between an “illustration” provided by an agent (which is based on assumptions) and an actual “guarantee” by an insurer. If the product is a ULIP, it carries market risks — usually there are options of investing in various proportions of equity and debt, based on the individual’s risk appetite.
There can be no assured returns possible unless the insurer states guarantee in the offer document of the product.If you are invested in the pure equity option for a ULIP, it requires you to monitor the performance of equity markets closely, especially closer to the goal. It’s always advisable to switch a sizable portion of the fund value to debt at least a couple of years ahead of the goal, to protect the corpus.
Paperwork is important: The Insurance Regulatory Development Authority (IRDA) makes it mandatory for every insurer to provide an illustration to accompany every ULIP sold. This illustration should project returns assuming 6 and 10 per cent annualised returns and take the signature of the policy holder on the same. Unitholders should note that the “returns” shown in the illustration are based on assumptions and may or may not really materialise. They also need to note that their effective returns will be reduced by expenses.
In general, for a 10-year plan, the net effective returns will be between 5.5 and 6.0 per cent, net of expenses charged, if the plan earns annualised returns of 10 per cent. Returns are higher if the plan has a maturity beyond 10 years.
If one reads the product brochure closely, one will find various expenses such as premium allocation charges, policy administration charges, mortality charges and fund management charges in a ULIP. If a fund charges 0.80 per cent as fund management charge, it has potential to deliver much higher returns than one charging 1.25 per cent, even if the premium allocation charge is lower in the latter case.
The expense structure also implies that ULIPs are meant only for long-term goals and are not a good avenue for the short term. Marketing agents often try to sell ULIPs as three-year products and suggest you withdraw the proceeds at the end of three years. But that is a surefire way to lose money as expenses will be particularly high in the initial years and surrender charges also may apply for premature termination!
One reader cites an instance where he paid premiums for three years in a ULIP totalling Rs 52,000. When he approached the insurer to surrender his policy, he was informed that he would receive only Rs 19,800!
Use the switches and redirection: Those who buy ULIPs should understand the importance of switches and redirection options that come with the product. These two options are very useful in protecting the corpus in a highly volatile market.
Switches come in handy in turbulent times such as the past year. If you are worried about stock markets steadily declining, you can shift your accumulation from equity to debt plans without any charge. Similarly, in those periods where your renewal premiums are due, you can give direction to the insurance company to invest the fresh premium in the debt option.
Claims can be repudiated: ULIP products usually bundle a life cover with investments, but remember that claims can be repudiated if you’ve not met the formalities correctly. One insurance player points out that the repudiation ratio (claim ratio in death) is as high as 20-30 per cent of the total claims, mainly due to non-disclosure facts.
This generally arises in cases where the agent fills in the application form. Though it is not wrong for an agent to fill the application form on your behalf, the policy holder has to understand the importance of the medical questionnaire that comes as part of the application form.
The family case history, your occupation, place of work, pre-existing diseases and your life style risks (e.g. if you consume alcohol, the frequency) all are very important for the underwriter (read as insurance company) to evaluate your risk profile.
So, leaving these details to the agent and simply signing on the dotted line exposes you to the risk of the claim not being met, when the time comes. It is mandatory to go through these clauses and get clarifications from the agent before writing out your cheque for the first premium.
If you have mis-stated some points you still will have fifteen days’ grace period from the date of receiving the policy document to rectify them. But if you want to return your policy at this point, you will incur some charges.
Orphan policy holder: If your insurance agent moves out from one insurance company to another or stops working for the insurance company, you, as a policy holder, will not be in a position to use the services of the agent.
That may lead to your missing out on renewal premia and forfeiting the policy. Of late, due to increase in lapsation rates, insurers are trying to reach out to policy holders directly, to remind them to pay the renewal premium.
One good way to avoid lapsation of policy is to opt for ECS debits for the premium amount. It is also mandatory for one to inform the insurance company immediately if there is a change in the communication address.
While insurance companies pitch ULIPs as a product for the long term, there is considerable mis-selling of ULIPs in today’s market scenario and many investors sign up for ULIPs without really understanding their risks. Here are some points about ULIPs that your agent probably won’t tell you:
Guaranteed vs illustrative returns: Many ULIPs are today marketed as products that offer a “certain” return over a specific time period. “Invest Rs 15,000 and double your money in five years”, is the kind of pitch often used to sell ULIPs. But investors need to distinguish between an “illustration” provided by an agent (which is based on assumptions) and an actual “guarantee” by an insurer. If the product is a ULIP, it carries market risks — usually there are options of investing in various proportions of equity and debt, based on the individual’s risk appetite.
There can be no assured returns possible unless the insurer states guarantee in the offer document of the product.If you are invested in the pure equity option for a ULIP, it requires you to monitor the performance of equity markets closely, especially closer to the goal. It’s always advisable to switch a sizable portion of the fund value to debt at least a couple of years ahead of the goal, to protect the corpus.
Paperwork is important: The Insurance Regulatory Development Authority (IRDA) makes it mandatory for every insurer to provide an illustration to accompany every ULIP sold. This illustration should project returns assuming 6 and 10 per cent annualised returns and take the signature of the policy holder on the same. Unitholders should note that the “returns” shown in the illustration are based on assumptions and may or may not really materialise. They also need to note that their effective returns will be reduced by expenses.
In general, for a 10-year plan, the net effective returns will be between 5.5 and 6.0 per cent, net of expenses charged, if the plan earns annualised returns of 10 per cent. Returns are higher if the plan has a maturity beyond 10 years.
If one reads the product brochure closely, one will find various expenses such as premium allocation charges, policy administration charges, mortality charges and fund management charges in a ULIP. If a fund charges 0.80 per cent as fund management charge, it has potential to deliver much higher returns than one charging 1.25 per cent, even if the premium allocation charge is lower in the latter case.
The expense structure also implies that ULIPs are meant only for long-term goals and are not a good avenue for the short term. Marketing agents often try to sell ULIPs as three-year products and suggest you withdraw the proceeds at the end of three years. But that is a surefire way to lose money as expenses will be particularly high in the initial years and surrender charges also may apply for premature termination!
One reader cites an instance where he paid premiums for three years in a ULIP totalling Rs 52,000. When he approached the insurer to surrender his policy, he was informed that he would receive only Rs 19,800!
Use the switches and redirection: Those who buy ULIPs should understand the importance of switches and redirection options that come with the product. These two options are very useful in protecting the corpus in a highly volatile market.
Switches come in handy in turbulent times such as the past year. If you are worried about stock markets steadily declining, you can shift your accumulation from equity to debt plans without any charge. Similarly, in those periods where your renewal premiums are due, you can give direction to the insurance company to invest the fresh premium in the debt option.
Claims can be repudiated: ULIP products usually bundle a life cover with investments, but remember that claims can be repudiated if you’ve not met the formalities correctly. One insurance player points out that the repudiation ratio (claim ratio in death) is as high as 20-30 per cent of the total claims, mainly due to non-disclosure facts.
This generally arises in cases where the agent fills in the application form. Though it is not wrong for an agent to fill the application form on your behalf, the policy holder has to understand the importance of the medical questionnaire that comes as part of the application form.
The family case history, your occupation, place of work, pre-existing diseases and your life style risks (e.g. if you consume alcohol, the frequency) all are very important for the underwriter (read as insurance company) to evaluate your risk profile.
So, leaving these details to the agent and simply signing on the dotted line exposes you to the risk of the claim not being met, when the time comes. It is mandatory to go through these clauses and get clarifications from the agent before writing out your cheque for the first premium.
If you have mis-stated some points you still will have fifteen days’ grace period from the date of receiving the policy document to rectify them. But if you want to return your policy at this point, you will incur some charges.
Orphan policy holder: If your insurance agent moves out from one insurance company to another or stops working for the insurance company, you, as a policy holder, will not be in a position to use the services of the agent.
That may lead to your missing out on renewal premia and forfeiting the policy. Of late, due to increase in lapsation rates, insurers are trying to reach out to policy holders directly, to remind them to pay the renewal premium.
One good way to avoid lapsation of policy is to opt for ECS debits for the premium amount. It is also mandatory for one to inform the insurance company immediately if there is a change in the communication address.
Thursday, March 26, 2009
Secret lies in even wealth ownership
We all look to mitigate risks from time to time, business or personal. Many of us buy insurance policies to cover risks to our lives. However, succession-related risks, which impact the continuity of wealth creation in a family business, are outside the ambit of an insurance policy. That does not mean we keep that risk open. Proactive wealth structuring is the answer.
Family business
Family businesses have been, and will continue to be, the core growth drivers of most global economies. Even in countries with developed capital markets, several companies have been started and are owned by risk-taking entrepreneurs and operated by them or their family.
While the dominant part played by family businesses may lead us to believe that they tend to run successfully over generations, that is not necessarily true.
What keeps family businesses alive and well is the emergence of new entrepreneurs year after year who have the drive to emerge successful in their businesses.
As and when the management of these businesses have to be handed over to the next generation, the fragility of family businesses start to reflect.
Experience shows that few survive more than 10 years after the founder dies or turns the enterprise over to relatives. Fewer survive into the third generation.
Clearly, family businesses enjoy some major advantages when compared to corporations that are institutionally owned and professionally managed, or they would not be so prevalent. However, managing the transition from one generation to the next is a hazardous enterprise.
Who is the successor?
In India, there is a natural inclination for any current-generation successful businessman or woman to expect a direct descendant to take over from him or her.
The selection of Generation Next to run the family business is based on the perceived ability and traits of suitable successors. Further, if there is more than one successor, the next criterion is typically seniority.
While this may have worked in the past, in the current context where businesses are growing at a rapid pace – not only in terms of size and scale but also in terms of complexity and geography – decisions on business succession would only become increasingly difficult. Added to that, the current generation has a wider choice available to pursue their dreams; this may not necessarily be aligned to running the family business.
This makes it imperative for any successful entrepreneur to ensure that wealth generated is proactively structured from an ownership perspective to address possible misgivings on transition.
Some of the key issues that one would have to deal with include fairness in distribution where there is more than one successor, protection against unwanted interference in business and ensuring seamless ownership among a wide set of family members but with only a few key members involved in decision making.
So how do you structure the business for succession?
The trust route
The use of private trusts is seen as one of the most effective means to deal with succession issues. But while the use of appropriate vehicles such as trusts or a corporate structure are an important element, it is the process involved in arriving at the appropriate structure and the operational aspects that have a critical bearing on the success of such an exercise.
For the entrepreneur, a number of other aspirations – such as philanthropic pursuits and addressing specific watertight needs such as providing for a special child – can also be embedded into the scheme of things. Attention to detail and discipline would be key factors in developing the right framework and implementing it. Thus, making the right choice of professionals to help with the transition would make the process smooth and effective.
Such proactive wealth ownership frameworks reduce the risks associated with transition of management of business to the next generation, be it within the family or otherwise.
It allows the current generation running the business to look at more options at the time of transition. It eventually leads to a higher degree of wealth creation as the business does not get impacted by potential conflict situations.
Family business
Family businesses have been, and will continue to be, the core growth drivers of most global economies. Even in countries with developed capital markets, several companies have been started and are owned by risk-taking entrepreneurs and operated by them or their family.
While the dominant part played by family businesses may lead us to believe that they tend to run successfully over generations, that is not necessarily true.
What keeps family businesses alive and well is the emergence of new entrepreneurs year after year who have the drive to emerge successful in their businesses.
As and when the management of these businesses have to be handed over to the next generation, the fragility of family businesses start to reflect.
Experience shows that few survive more than 10 years after the founder dies or turns the enterprise over to relatives. Fewer survive into the third generation.
Clearly, family businesses enjoy some major advantages when compared to corporations that are institutionally owned and professionally managed, or they would not be so prevalent. However, managing the transition from one generation to the next is a hazardous enterprise.
Who is the successor?
In India, there is a natural inclination for any current-generation successful businessman or woman to expect a direct descendant to take over from him or her.
The selection of Generation Next to run the family business is based on the perceived ability and traits of suitable successors. Further, if there is more than one successor, the next criterion is typically seniority.
While this may have worked in the past, in the current context where businesses are growing at a rapid pace – not only in terms of size and scale but also in terms of complexity and geography – decisions on business succession would only become increasingly difficult. Added to that, the current generation has a wider choice available to pursue their dreams; this may not necessarily be aligned to running the family business.
This makes it imperative for any successful entrepreneur to ensure that wealth generated is proactively structured from an ownership perspective to address possible misgivings on transition.
Some of the key issues that one would have to deal with include fairness in distribution where there is more than one successor, protection against unwanted interference in business and ensuring seamless ownership among a wide set of family members but with only a few key members involved in decision making.
So how do you structure the business for succession?
The trust route
The use of private trusts is seen as one of the most effective means to deal with succession issues. But while the use of appropriate vehicles such as trusts or a corporate structure are an important element, it is the process involved in arriving at the appropriate structure and the operational aspects that have a critical bearing on the success of such an exercise.
For the entrepreneur, a number of other aspirations – such as philanthropic pursuits and addressing specific watertight needs such as providing for a special child – can also be embedded into the scheme of things. Attention to detail and discipline would be key factors in developing the right framework and implementing it. Thus, making the right choice of professionals to help with the transition would make the process smooth and effective.
Such proactive wealth ownership frameworks reduce the risks associated with transition of management of business to the next generation, be it within the family or otherwise.
It allows the current generation running the business to look at more options at the time of transition. It eventually leads to a higher degree of wealth creation as the business does not get impacted by potential conflict situations.
Furnished offices flourish amid gloom
Corporate revenues have shrunk, expenses curtailed and manpower numbers trimmed.
But amid this depressing scenario, the furnished offices business appears to be looking up, accommodating new clients who otherwise would have gone in for traditional space.
One-stop solution
Furnished offices provide a one-stop solution to companies and entrepreneurs, offering services such as executive offices, Internet connectivity, videoconferencing, wireless access, telephone and fax lines, receptionists and client service representatives, apart from on-site executive assistants, and meeting/board rooms on pay-as-you-use basis.
Such offices also offer a prestigious address for executives to print on their business cards.
Charges are competitive and substantially lower than traditional office space.
Ms Meenal Sinha, General Manager, Imperial Servcorp, says business is up 30 per cent in the last few months as multinational corporations and domestic players are looking at furnished office accommodation for convenience and cost-savings as team strength and expense sheets have been cropped. Occupancy rate, she said, was as high as 85 per cent.
Imperial Servcorp has a total of 50,000 sq.ft of office space in Mumbai and Hyderabad with the client list that includes MNCs as well as start-up firms. Imperial Servcorp is a joint venture between real estate major K. Raheja Corp and Australian serviced office provider Servcorp.
On expansion mode
Regus, which has over 2.25 lakh furnished space across the country, is looking to expand operations. “We are looking at strategic locations where we do not have a presence, said Mr Madhusudan Thakur, Regional Vice-President.
Globally, the Regus Group operates over 950 centres across 400 cities in 70 countries. The company said clients such as Google, GlaxoSmithKline and Nokia outsource their office and workplace needs to the group.
Mr Thakur said 40 per cent of the new large clients were those who owned offices before and the balance were new, who would have either gone in for traditional space or those who preferred to tread cautiously in current economic scenario.
Typically, clients need to sign a one-page agreement to move in almost immediately. On an average it costs Rs 20,000 to accommodate one person for a month in Mumbai.
Mr Thakur says his client mix include IT (25 per cent), project driven clients such as consultants (15 per cent), manufacturing companies (23 per cent), research and development (15-20 per cent) and financial institutions (20 per cent).
Occupancy rate is 85-95 per cent. About 75 per cent of the clients stay put for eight to nine months in general.
The slowdown has, however, not left the service providers unscathed. “Charges are a function of the rentals and today it is lower by 25-30 per cent than the year ago period,” he said.
But amid this depressing scenario, the furnished offices business appears to be looking up, accommodating new clients who otherwise would have gone in for traditional space.
One-stop solution
Furnished offices provide a one-stop solution to companies and entrepreneurs, offering services such as executive offices, Internet connectivity, videoconferencing, wireless access, telephone and fax lines, receptionists and client service representatives, apart from on-site executive assistants, and meeting/board rooms on pay-as-you-use basis.
Such offices also offer a prestigious address for executives to print on their business cards.
Charges are competitive and substantially lower than traditional office space.
Ms Meenal Sinha, General Manager, Imperial Servcorp, says business is up 30 per cent in the last few months as multinational corporations and domestic players are looking at furnished office accommodation for convenience and cost-savings as team strength and expense sheets have been cropped. Occupancy rate, she said, was as high as 85 per cent.
Imperial Servcorp has a total of 50,000 sq.ft of office space in Mumbai and Hyderabad with the client list that includes MNCs as well as start-up firms. Imperial Servcorp is a joint venture between real estate major K. Raheja Corp and Australian serviced office provider Servcorp.
On expansion mode
Regus, which has over 2.25 lakh furnished space across the country, is looking to expand operations. “We are looking at strategic locations where we do not have a presence, said Mr Madhusudan Thakur, Regional Vice-President.
Globally, the Regus Group operates over 950 centres across 400 cities in 70 countries. The company said clients such as Google, GlaxoSmithKline and Nokia outsource their office and workplace needs to the group.
Mr Thakur said 40 per cent of the new large clients were those who owned offices before and the balance were new, who would have either gone in for traditional space or those who preferred to tread cautiously in current economic scenario.
Typically, clients need to sign a one-page agreement to move in almost immediately. On an average it costs Rs 20,000 to accommodate one person for a month in Mumbai.
Mr Thakur says his client mix include IT (25 per cent), project driven clients such as consultants (15 per cent), manufacturing companies (23 per cent), research and development (15-20 per cent) and financial institutions (20 per cent).
Occupancy rate is 85-95 per cent. About 75 per cent of the clients stay put for eight to nine months in general.
The slowdown has, however, not left the service providers unscathed. “Charges are a function of the rentals and today it is lower by 25-30 per cent than the year ago period,” he said.
GOLD SAFE BUT NOT SO SAFE
There are confusing signals regarding gold as an investment option. On the one hand, there are reports which predict a price target of $2,000 an ounce for gold. On the other hand, there is already a feeling that a bubble is building up in gold given the slack demand. My questions are: How does one plan investments in gold? Given that the prices are at their heights now, what would be a good time to start an investment? Is SIP the recommended approach? Between Gold ETFs and mutual funds investing in gold mining companies, which is better, and why? Usually, gold and stock prices have an inverse correlation; so, if we assume that the stock market is going to rise say in the next two or three years, what then happens to gold investments?
Unlike stocks, where it is possible to arrive at a price target based on a company’s earnings potential, there is no scientific method to arrive at a “fair price” for a commodity. Commodity prices are purely a function of demand and supply factors, with the speculative element usually adding to the momentum on either side.
The prediction that gold will head to $2000 an ounce is thus based either on the study of charts (technicals) or on the fact that gold prices last peaked at $873 an ounce during the oil crisis of 1980. Adjusted for inflation, the 1980 peak equates to $2,500 at today’s prices. As is the case with all predictions, this one too is not foolproof.
Not so safe
Though gold has emerged as full-fledged asset class in recent years, it is a myth that gold is a “safe” investment or that it delivers steady returns. With gold prices remaining extremely volatile, investing in gold today for quick gains, requires as much of timing as do stocks.
Over the past year alone, gold prices have swung between a high of $1,030 and a low of $730 an ounce; that tells you that investments made at high prices in gold have eroded in value. If you are looking at regular or assured returns from your investments, fixed income options such as bank deposits are your best bet.
Gold’s ten-year returns, at about 7 per cent on a compounded annual basis, aren’t really superior to fixed income investments; and the yearly return has been far from consistent.
Only to diversify
Seen in this backdrop, we feel an investor should consider gold investments only for the purpose of diversification, based on the expectation that gold may protect the value of your portfolio during periods when stocks or bonds don’t. Therefore, you should look to gold, not for delivering a huge outperformance of stocks over the long term, but to make your portfolio more stable at times when stocks go through the wringer.
For instance, over the past one year, a portfolio 100 per cent invested in equity funds would have lost 41 per cent in value, but a portfolio with a 80:20 equity: Gold ETF allocation, would have contained the decline to 28 per cent, thanks to a 17 per cent gain in the Gold ETF value. Based on the above, we would recommend a 10 per cent allocation to Gold ETFs in your portfolio, if you already own stocks.
Yes, we do think this is a reasonable time to buy gold. Gold’s status as a safe haven investment has generally made sure that gold prices have shot up during periods of extreme economic distress or uncertainty. Based on this yardstick, it is a good idea for investors today to have some gold investments in their portfolio.
Economic data from the US, Europe and other Asian economies, as also India, has been getting steadily worse. The prospect of governments printing more fiat money to pump prime global economies also threatens to devalue paper currencies, which is a positive driver for gold.
Three key factors
The recent price history of gold suggests that three key factors may be needed for gold prices to deliver strong gains from here — a weaker dollar, renewed inflation fears and sustained investment demand. While higher gold prices tend to curb jewellery demand, this actually helps investment demand accumulation of gold by investment vehicles such as global gold ETFs.
If your objective is diversification and you want to make sure your gold holdings mirror global prices, Gold ETFs, traded on the stock exchanges, are the most cost-effective way to invest in gold.
Funds investing in gold mining stocks may have the potential to outperform physical gold, but they suffer from two disadvantages. Because of being a high-beta exposure to gold, they tend to suffer sharper swings (either way) than actual gold prices.
They therefore, carry a risk element that is as high as, or even higher than normal equities. Further, they may fail to mirror gold price movements during periods when equity markets are in the doldrums. In fact, that is precisely what has happened over the past one year.
Coming to the query on how and when to buy gold, a certain degree of timing is necessary to ensure a reasonable return from the metal. Over the past year, gold investments made at levels of about $800 an ounce have delivered good returns. For investors who cannot time their investments, we would suggest buying gold ETFs in small lots, much like an SIP in an equity fund, phased out over the next two or three months.
Unlike stocks, where it is possible to arrive at a price target based on a company’s earnings potential, there is no scientific method to arrive at a “fair price” for a commodity. Commodity prices are purely a function of demand and supply factors, with the speculative element usually adding to the momentum on either side.
The prediction that gold will head to $2000 an ounce is thus based either on the study of charts (technicals) or on the fact that gold prices last peaked at $873 an ounce during the oil crisis of 1980. Adjusted for inflation, the 1980 peak equates to $2,500 at today’s prices. As is the case with all predictions, this one too is not foolproof.
Not so safe
Though gold has emerged as full-fledged asset class in recent years, it is a myth that gold is a “safe” investment or that it delivers steady returns. With gold prices remaining extremely volatile, investing in gold today for quick gains, requires as much of timing as do stocks.
Over the past year alone, gold prices have swung between a high of $1,030 and a low of $730 an ounce; that tells you that investments made at high prices in gold have eroded in value. If you are looking at regular or assured returns from your investments, fixed income options such as bank deposits are your best bet.
Gold’s ten-year returns, at about 7 per cent on a compounded annual basis, aren’t really superior to fixed income investments; and the yearly return has been far from consistent.
Only to diversify
Seen in this backdrop, we feel an investor should consider gold investments only for the purpose of diversification, based on the expectation that gold may protect the value of your portfolio during periods when stocks or bonds don’t. Therefore, you should look to gold, not for delivering a huge outperformance of stocks over the long term, but to make your portfolio more stable at times when stocks go through the wringer.
For instance, over the past one year, a portfolio 100 per cent invested in equity funds would have lost 41 per cent in value, but a portfolio with a 80:20 equity: Gold ETF allocation, would have contained the decline to 28 per cent, thanks to a 17 per cent gain in the Gold ETF value. Based on the above, we would recommend a 10 per cent allocation to Gold ETFs in your portfolio, if you already own stocks.
Yes, we do think this is a reasonable time to buy gold. Gold’s status as a safe haven investment has generally made sure that gold prices have shot up during periods of extreme economic distress or uncertainty. Based on this yardstick, it is a good idea for investors today to have some gold investments in their portfolio.
Economic data from the US, Europe and other Asian economies, as also India, has been getting steadily worse. The prospect of governments printing more fiat money to pump prime global economies also threatens to devalue paper currencies, which is a positive driver for gold.
Three key factors
The recent price history of gold suggests that three key factors may be needed for gold prices to deliver strong gains from here — a weaker dollar, renewed inflation fears and sustained investment demand. While higher gold prices tend to curb jewellery demand, this actually helps investment demand accumulation of gold by investment vehicles such as global gold ETFs.
If your objective is diversification and you want to make sure your gold holdings mirror global prices, Gold ETFs, traded on the stock exchanges, are the most cost-effective way to invest in gold.
Funds investing in gold mining stocks may have the potential to outperform physical gold, but they suffer from two disadvantages. Because of being a high-beta exposure to gold, they tend to suffer sharper swings (either way) than actual gold prices.
They therefore, carry a risk element that is as high as, or even higher than normal equities. Further, they may fail to mirror gold price movements during periods when equity markets are in the doldrums. In fact, that is precisely what has happened over the past one year.
Coming to the query on how and when to buy gold, a certain degree of timing is necessary to ensure a reasonable return from the metal. Over the past year, gold investments made at levels of about $800 an ounce have delivered good returns. For investors who cannot time their investments, we would suggest buying gold ETFs in small lots, much like an SIP in an equity fund, phased out over the next two or three months.
Wednesday, March 18, 2009
TITAN INDUSTRIES - TESTING THE TEST OF TIMES
Titan Industries: Buy
A retailer of branded jewellery, watches, and eyewear, Titan Industries is among the few retailers to have managed strong growth in the ongoing slowdown. A presence across price points in both its key businesses —watches and jewellery — and an extensive network spanning 461 outlets, ensure that the company can capitalise on most areas of consumer spending, premium or mass market, urban or semi-urban. Currently at Rs 743 as on 18 March 2009, the stock trades at 15 times its trailing earnings. Fears that higher gold prices will impact Titan’s jewellery business appear overdone, as its focus on premium clients and steadywedding-related demand hold potential to drive sales growth. Gold price upswings are unlikely to dampen margins as prices are passed through to the customers. Sales in the watches segment moderated late last year, growing just 4 per cent in the December ’08 quarter, but picked up from late January, with youth brand, Fastrack, and new launches helping sales.
Titan’s precision engineering business broke even in the December quarter, though eyewear business Eye+ is yet to achieve that. The business has good potential given the robust expansion — 30 stores in the last quarter alone — and the high margins possible in eyewear. Though Titan’s profits took a hit in the December quarter, it was mostly attributable to one-time extraordinary expenses and employee gratuity costs. Gross profit margins of jewellery actually improved 2.5 percentage points to 6.4 per cent. Titan Industries has the highest return on capital employed among its retail peers. Turnover of working capital, too, has steadily improved to its present eight times. A franchise mode of expansion and low leverage of 0.4 times also cushion it against funding constraints, a challenge to other retailers.
AXIS BANK - INVEST FOR ONE -TWO YEAR HORIZON
Investors with one-two year horizon can consider buying the Axis Bank stock as it is attractively valued. At the current market price of Rs 341.25 as on 18 March 2009, the stock trades at just 1.2 times its December book value of Rs 279 and at a PEM of 7.5. Axis Bank fell on the back of growing concerns over its asset quality due to high exposure to cyclical sectors, slowdown in lending activity and higher vulnerability due to lower provision coverage.
However, asset quality concerns appear overdone as the non-performing assets formed only 0.9 per cent of advances in December. Most of the corporate advances are investment-rated and the bank is adequately capitalised (13.8 per cent) to shelter from the credit risk. Steady fee income (43 per cent) and low-cost deposits (38 per cent) and strong advances growth (45 per cent CAGR for last five years) are the arguments in favour of the bank. Axis Bank has been consciously reducing the proportion of retail advances in its loan book (down to 20.7 per cent).
Axis Bank’s net profit for the nine months ended December 2008 grew by 74 per cent. While a fall in the proportion of low-cost deposits reduced net interest margins (3.36 per cent), exceptional growth in fee income (up 75 per cent), helped manage higher operating profit growth. Going forward, the bank’s cost of funds may decline as rates fall, but the pressure on NIM may continue due to lower lending activity and lower-yielding investments. Fee income from debt syndication may continue to flow in as more companies float debt issues. Though overall net profit growth may not be as high as it was in the preceding quarters, the stock’s valuation seems to capture lower expectations.
SAIL INVEST FOR LONG TERM
Investors can consider buying the Steel Authority of India (SAIL) stock (Rs 85)as on 18 March 2009, given its low valuation. The stock trades at a price-to-earnings multiple of 4.5 times the trailing 12 month earnings. Though the jury is still out on whether the recovery in steel demand seen so far in 2009 is sustainable, SAIL remains one of the better-placed companies in the steel sector to weather the challenging times. A sharp drop in contract prices for coking coal and iron ore, expected to be negotiated for the coming year, suggests scope for margin expansion, even if steel prices continue to soften.
Low dependence on international orders, a focus on orders from government agencies which may benefit from higher public spending and low leverage and strong cash flows, make the company a preferred exposure in the steel sector. Investors in the stock, however, should be prepared for high volatility, as the stock’s performance may continue to carry strong linkages to global commodity price trends.
Domestic focus helps
The prospect of slowing and even recessionary trends in much of the developed world has weakened the demand for steel from user industries such as forgings, castings, automotive and construction. Both the US and Europe have seen a decline in construction and industrial activity in the last two quarters of 2008. Falling demand prompted production and price cuts by the global steel majors, with players such as Corus, Tokyo Steel and many others cutting back output by up to 30 per cent in October-November ’08.
In India, however, demand has held up better than in the other regions, with the industry’s production still up by about a per cent in the April-December 2008 period. Higher infrastructure spending by the government as a part of its two stimulus packages and a pick up in construction activities following low interest rates could help stimulate growth.
CMIE expects domestic steel production to grow by 1.5 per cent in 2008-09 and achieve a growth of 6.5 per cent in 2009-10. Responding to softening demand, steel prices have been under pressure since last year; hot-rolled coil prices fell 20 per cent from a high of Rs 48,500 per tonne in June 2008 to Rs 39,200 in December 2008.
SAIL’s sales fell in the quarter ended December 31, 2008, given a 11 per cent cut in HRC prices in November. While the effect of price cuts may continue to show up on revenues, a revival in steel volumes (up 9 per cent y-o-y in February ’09), driven by automobile and construction demand, offers some hope. On the cost front, iron ore contracts for the coming year are expected to see a price correction of 30 per cent-plus and coking coal prices are also expected to be 40 per cent lower for the year. Lower input costs would bring substantial margin relief for SAIL, given its high reliance on imported coking coal.
In the December quarter of 2008, SAIL’s profits took a hard blow (down 56 per cent) following a substantial increase in raw material costs as international coking coal prices shot up from $98 per tonne in 2007 to $300 per tonne in 2008.
Resilient to current slowdown
SAIL also looks better placed than its peers to tackle an uncertain global demand environment. SAIL derives just 3 per cent of its revenues from overseas, even as peers such as Tata Steel and JSW Steel have a much larger global exposure.
Within the domestic market too, 40 per cent of the orders are from the government agencies. With the stimulus packages promising higher infrastructure spending by the government, the company may sustain healthy order inflows in the coming quarters.
A diversified customer base is also an advantage, with the company serving a wide range of industries from construction, engineering, power, railway, to automotive and defence. The company has also been realigning its product mix, with value-added products now accounting for 40 per cent of production.
Even as other steel companies are shelving their capex plans, SAIL appears well-placed to bankroll its own expansion. The company had Rs 13,760 crore in cash balances by end-FY08, following strong operating cash flows of over Rs 8,300 crore during the year.
The company’s debt-to-equity ratio of 0.18:1 (in FY08) is low, allowing room to increase borrowings for the planned capex. SAIL has outlined a capex of Rs 53,000 crore for expanding its capacity from 14 million tonnes to 26 million tonnes by 2010-11. Of this, the company has already spent Rs 3,230 crore and has placed orders for equipment worth Rs 36,000 crore. As there are certain equipment sourcing-related delays, the projected additions to capacity may be delayed.
Given its relatively strong balance-sheet, we expect SAIL to reap benefits from recent interest rate cuts, though it may still contract higher borrowings for capex.
Tuesday, March 17, 2009
Everonn Systems - Buy on lows
Buy Everonn Systems in any correction around Rs 105 and it has a target of Rs 265, says Shailesh Morfatia of LSK, technical analyst. The stock is currently trading at Rs 156, up 26% on the BSE.
TV18 BUY ON DIPS
Buy Television Eighteen on dips with a target of Rs 110 in 30 days, says Jagmohan Mathur, technical analyst, Tulip Investments. The stock is currently trading
at Rs 61.
Monday, March 16, 2009
Keep the Faith - Keep Investing ??
Given that returns from equities will come only in the long run and alternative investments are not faring that good either, investors just have to go by historical trends.
Sometimes large contradictions are concealed within public data. For example, official projections suggest that 2008-09 GDP growth will be somewhere between 6.5-7.1 per cent, depending on Q4 results.
The interim Budget seems to project 2009-10 GDP at around 5 per cent – a drop of 150 basis points compared to 2008-09. The political establishment is patting itself on the back and claiming its do-nothing policy is vindicated by the fact that India’s 2009-10 GDP will outperform most other nations.
There’s general consensus that this is the worst recession since World War II. There’s also general consensus, borne out by the share of trade (including invisibles) in GDP, that India is more globally integrated than ever. Ergo, India may suffer its worst recession since 1991-92. Well, the projections don’t gel with hopes of a fast rebound. In the past two recessions of 1997-98 and of 2001-02 through 2002-03, GDP dropped to 4.3 per cent or lower. If this recession is worse, it should bottom at below 4 per cent. Advisories suggesting bottoming out at 3 per cent seem more credible than 5 per cent growth in 2009-10.
Whatever the nadir, it’s better if it’s reached quickly. Given the state of official statistics and the politicisation of projections, it’s likely the contradiction will be resolved. The Budgetary Estimates will prove optimistic and the Revised Estimates will nosedive.
But doubts about GDP translate automatically into shifting ground for corporate valuations. On historical evidence, Indian corporate earnings growth is 2.5 times GDP growth plus inflation or approximately (2.5x GDP) +WPI. The WPI year-on-year is down below 2.5 per cent and liable to fall further, given price spikes in May-September 2008. Let’s say it averages out at 3 per cent for 2009-10.
In that case, with 3 per cent GDP growth, we’re talking about 10-11 per cent EPS for India Inc. If it’s 4.5 per cent GDP, the EPS would be around 14 per cent. These are crude back-of-the-envelope calculations but sophisticated models offer similar numbers.
There are major differences in index levels when those numbers are plugged into standard valuation models. Two perfectly respectable models throw up a valuation range where the top-end of the most optimistic valuation is 120 per cent higher than the bottom-end of the most conservative.
If fair-value with a PEG ratio is assumed to be 1, the market PE could be anywhere between 10 and 15, depending on GDP growth and corporate EPS multiplier. That’s a 50 per cent difference.
Using an interest rate model, with the risk-free 364 Day T-Bill at 4.5 per cent and inverting earnings yield, we get an equivalent fair-value PE of 22. Commercial lending rates are still far higher at around 9-10 per cent and suggest fair value PEs of 10-11.
During a recession, investors turn instinctively conservative. Let’s assume that PEs of 10 or less will be in demand. That too, only with corporates capable of scoring 10 per cent EPS growth or better.
As far as can be figured, the Nifty’s PE over the EPS of the past four trailing quarters stands around 12 and it bottomed at below PE 11 in October 2008. That implies there are lots of blue chips in the target zone for conservative investors. A glance at other ratios such as price-book value and dividend yield also suggest many shares are trading at fair valuations or lower. But that’s no reason why the market index couldn’t lose more ground. If 2009-10 EPS growth struggles to reach double-digits, the Nifty could be placed at around 2100 in the next 12 months. Of course, if 15 per cent EPS growth is achieved, commercial rates slide and the interest rate models hold good, it could rise to over 4400.
Given the paucity of cash and the risk-averse nature of investors at the current moment, it’s difficult to imagine the upper end of that valuation will be reached. There is also a big question-mark over the quality of governance of the next coalition.
Most likely, capital gains from equity investments will accrue only over a two-year timeframe or longer. The problem is, alternative investments don’t promise much more. This seems a situation for gritting one’s teeth and keeping faith with historical trends. Equity always pays the most in the long-run but it will be the long run.
Sometimes large contradictions are concealed within public data. For example, official projections suggest that 2008-09 GDP growth will be somewhere between 6.5-7.1 per cent, depending on Q4 results.
The interim Budget seems to project 2009-10 GDP at around 5 per cent – a drop of 150 basis points compared to 2008-09. The political establishment is patting itself on the back and claiming its do-nothing policy is vindicated by the fact that India’s 2009-10 GDP will outperform most other nations.
There’s general consensus that this is the worst recession since World War II. There’s also general consensus, borne out by the share of trade (including invisibles) in GDP, that India is more globally integrated than ever. Ergo, India may suffer its worst recession since 1991-92. Well, the projections don’t gel with hopes of a fast rebound. In the past two recessions of 1997-98 and of 2001-02 through 2002-03, GDP dropped to 4.3 per cent or lower. If this recession is worse, it should bottom at below 4 per cent. Advisories suggesting bottoming out at 3 per cent seem more credible than 5 per cent growth in 2009-10.
Whatever the nadir, it’s better if it’s reached quickly. Given the state of official statistics and the politicisation of projections, it’s likely the contradiction will be resolved. The Budgetary Estimates will prove optimistic and the Revised Estimates will nosedive.
But doubts about GDP translate automatically into shifting ground for corporate valuations. On historical evidence, Indian corporate earnings growth is 2.5 times GDP growth plus inflation or approximately (2.5x GDP) +WPI. The WPI year-on-year is down below 2.5 per cent and liable to fall further, given price spikes in May-September 2008. Let’s say it averages out at 3 per cent for 2009-10.
In that case, with 3 per cent GDP growth, we’re talking about 10-11 per cent EPS for India Inc. If it’s 4.5 per cent GDP, the EPS would be around 14 per cent. These are crude back-of-the-envelope calculations but sophisticated models offer similar numbers.
There are major differences in index levels when those numbers are plugged into standard valuation models. Two perfectly respectable models throw up a valuation range where the top-end of the most optimistic valuation is 120 per cent higher than the bottom-end of the most conservative.
If fair-value with a PEG ratio is assumed to be 1, the market PE could be anywhere between 10 and 15, depending on GDP growth and corporate EPS multiplier. That’s a 50 per cent difference.
Using an interest rate model, with the risk-free 364 Day T-Bill at 4.5 per cent and inverting earnings yield, we get an equivalent fair-value PE of 22. Commercial lending rates are still far higher at around 9-10 per cent and suggest fair value PEs of 10-11.
During a recession, investors turn instinctively conservative. Let’s assume that PEs of 10 or less will be in demand. That too, only with corporates capable of scoring 10 per cent EPS growth or better.
As far as can be figured, the Nifty’s PE over the EPS of the past four trailing quarters stands around 12 and it bottomed at below PE 11 in October 2008. That implies there are lots of blue chips in the target zone for conservative investors. A glance at other ratios such as price-book value and dividend yield also suggest many shares are trading at fair valuations or lower. But that’s no reason why the market index couldn’t lose more ground. If 2009-10 EPS growth struggles to reach double-digits, the Nifty could be placed at around 2100 in the next 12 months. Of course, if 15 per cent EPS growth is achieved, commercial rates slide and the interest rate models hold good, it could rise to over 4400.
Given the paucity of cash and the risk-averse nature of investors at the current moment, it’s difficult to imagine the upper end of that valuation will be reached. There is also a big question-mark over the quality of governance of the next coalition.
Most likely, capital gains from equity investments will accrue only over a two-year timeframe or longer. The problem is, alternative investments don’t promise much more. This seems a situation for gritting one’s teeth and keeping faith with historical trends. Equity always pays the most in the long-run but it will be the long run.
Investing in gold? - Think twice before you leap
The decline in jewellery demand is likely to make investments in this safe haven a risky proposition.
Investing during this period of global financial turmoil is a challenge. Stock markets around the world are at record lows. Commodities (except for gold) have corrected sharply. Oil is a prime example, having corrected to $45 per barrel from its peak of $147 a barrel in 2008. Real estate values continue to plummet. The global financial sector, i.e. banking and insurance, is in turmoil. And, the global economy is expected to contract sharply during 2009.
An asset that some analysts are trying to push to investors during these troubled times is gold. Gold is considered a traditional safe haven asset. Some hedge fund managers believe that because of its safe haven status, gold is a good bet during these troubled times. The sharp rally in gold prices in February 2009 to a high of $1,007 an ounce is believed to be attributable to buying by speculative hedge funds. Gold price has since corrected by approximately $77 and is currently trading around $930 per ounce.
A number of advisories are projecting that gold will climb higher. UBS, a prominent gold dealer, recently advised investors to increase their investment allocation to gold as it has an upside potential of $2,500 an ounce. (The UBS advisory mentions the downside risk at $500 an ounce). Mining CEO’s are doing their bit to highlight gold’s safe haven status so as to attract investors. Die hard gold enthusiasts, also known as gold bugs, believe that this is just the start of the gold rally.
The contra view
Contrarians believe that gold is overpriced and it is only a matter of time before it corrects sharply, similar to the correction experienced by other commodities. The information that is trickling in from different parts of the world on the demand destruction that is occurring on account of the high gold prices suggests that gold is in for challenging times and will be volatile. If you are thinking of investing in gold at current prices, you would be wise to consider the following:
Gold’s status as a traditional safe haven asset was a result of the world’s monetary system being based on gold.
The world’s monetary system is no longer based on gold.
75 per cent of the world’s demand for gold is jewellery based. The liquidity of gold is dependent on the demand for jewellery.
The demand for jewellery has a bearing on gold prices and vice-versa.
Jewellery demand down
The global picture for jewellery demand is gloomy. Jewellery demand in the United States, Europe and Japan is badly affected by the global slowdown. The Italian jewellery manufacturing industry is in the doldrums. Gold imports by Turkey, a major jewellery manufacturing centre, were reported to be zero during the months of January and February 2009. Gold sales in Dubai were reported to have fallen by 60 per cent year-on-year (y-o-y) in January 2009. Gold sales in Abu Dhabi were reported to have fallen 70 per cent y-o-y during the months of January and February 2009. Reports of jewellery demand in other countries including Russia, Saudi Arabia, etc are equally depressing.
Dips in India too
India is the world’s largest consumer of gold accounting for 25-30 per cent of the total gold consumption. India’s demand for gold is met through imports and recent gold import figures highlight the demand destruction that has taken place– imports of gold are reported to have fallen by 83 per cent in December 2008 and by 91 per cent in January 2009. India is reported to have imported zero gold in February 2009; imports so far during March 2009 is also zero.
The fall in gold imports is not the only indicator of demand destruction in India. Jewellery retailers across the nation are reporting that sales have been impacted drastically. As per reports, a prominent jewellery mall in Gujarat has reported that whereas the average customer flow was 80 to 90 a day, they are getting not more than 8 to 9 customers a day. The high price of gold has led to unprecedented demand destruction in India. A factor that has worked as a force multiplier in increasing domestic gold prices is the 33 per cent depreciation of the rupee (against the dollar) from 39 a year ago to about 52 now.
Jewellers in India offer their customers a buy back option at the prevailing rate of gold. Customers are using the opportunity of high gold prices to book profits. The demand destruction in India has been unprecedented. Many jewellery manufacturers in India have scaled down their operations and are moth-balling capacities to cope with the slowdown. Till such time as the global economy gets back on track, the demand for jewellery will be tempered by the fact that the Indian economy is facing challenging times. And, if the rupee continues to weaken, gold prices will further increase. India’s growth rate will in all likelihood slip to around 4.5 per cent from the 9 per cent that was being clocked before the global financial crisis hit. Although India is not in a recession, the fear factor is making people cautious.
The way ahead
The above factors suggest that the unprecedented destruction of jewellery demand that is currently underway will trigger a correction in gold prices. Gold bulls, on the other hand, are convinced that increased investment demand for gold will compensate for the destruction of jewellery demand. In such an eventuality, gold prices will continue to rise as investment money continues to pour in. The further increase in gold prices will lead to the acceleration in demand destruction. As and when investment inflows abate or reverse, gold prices will correct. The further the rise - the steeper the fall.One consequence of the high gold prices is that the government of India has directed the Geological Survey of India to begin the groundwork for indentifying mining blocks for India’s potential reserves of 20,000 tonnes of gold. The government is planning to open up its mining sector to private players to tap these reserves. This will impact gold prices in the long term.
In the existing global financial environment, there is an element of risk in all asset classes, be it commodities, stocks or real estate. Even a traditional safe haven asset such as gold is not immune to risk. Especially because of the volatility brought about by the huge amounts of money that speculative hedge funds are able to bring into play. Investing in any asset class, including gold, should be a well thought out decision. To invest in an asset merely because it is recommended that a certain percentage of one’s investment allocation should be to a particular asset amounts to investing one’s hard earned wealth without doing the homework.
Investing during this period of global financial turmoil is a challenge. Stock markets around the world are at record lows. Commodities (except for gold) have corrected sharply. Oil is a prime example, having corrected to $45 per barrel from its peak of $147 a barrel in 2008. Real estate values continue to plummet. The global financial sector, i.e. banking and insurance, is in turmoil. And, the global economy is expected to contract sharply during 2009.
An asset that some analysts are trying to push to investors during these troubled times is gold. Gold is considered a traditional safe haven asset. Some hedge fund managers believe that because of its safe haven status, gold is a good bet during these troubled times. The sharp rally in gold prices in February 2009 to a high of $1,007 an ounce is believed to be attributable to buying by speculative hedge funds. Gold price has since corrected by approximately $77 and is currently trading around $930 per ounce.
A number of advisories are projecting that gold will climb higher. UBS, a prominent gold dealer, recently advised investors to increase their investment allocation to gold as it has an upside potential of $2,500 an ounce. (The UBS advisory mentions the downside risk at $500 an ounce). Mining CEO’s are doing their bit to highlight gold’s safe haven status so as to attract investors. Die hard gold enthusiasts, also known as gold bugs, believe that this is just the start of the gold rally.
The contra view
Contrarians believe that gold is overpriced and it is only a matter of time before it corrects sharply, similar to the correction experienced by other commodities. The information that is trickling in from different parts of the world on the demand destruction that is occurring on account of the high gold prices suggests that gold is in for challenging times and will be volatile. If you are thinking of investing in gold at current prices, you would be wise to consider the following:
Gold’s status as a traditional safe haven asset was a result of the world’s monetary system being based on gold.
The world’s monetary system is no longer based on gold.
75 per cent of the world’s demand for gold is jewellery based. The liquidity of gold is dependent on the demand for jewellery.
The demand for jewellery has a bearing on gold prices and vice-versa.
Jewellery demand down
The global picture for jewellery demand is gloomy. Jewellery demand in the United States, Europe and Japan is badly affected by the global slowdown. The Italian jewellery manufacturing industry is in the doldrums. Gold imports by Turkey, a major jewellery manufacturing centre, were reported to be zero during the months of January and February 2009. Gold sales in Dubai were reported to have fallen by 60 per cent year-on-year (y-o-y) in January 2009. Gold sales in Abu Dhabi were reported to have fallen 70 per cent y-o-y during the months of January and February 2009. Reports of jewellery demand in other countries including Russia, Saudi Arabia, etc are equally depressing.
Dips in India too
India is the world’s largest consumer of gold accounting for 25-30 per cent of the total gold consumption. India’s demand for gold is met through imports and recent gold import figures highlight the demand destruction that has taken place– imports of gold are reported to have fallen by 83 per cent in December 2008 and by 91 per cent in January 2009. India is reported to have imported zero gold in February 2009; imports so far during March 2009 is also zero.
The fall in gold imports is not the only indicator of demand destruction in India. Jewellery retailers across the nation are reporting that sales have been impacted drastically. As per reports, a prominent jewellery mall in Gujarat has reported that whereas the average customer flow was 80 to 90 a day, they are getting not more than 8 to 9 customers a day. The high price of gold has led to unprecedented demand destruction in India. A factor that has worked as a force multiplier in increasing domestic gold prices is the 33 per cent depreciation of the rupee (against the dollar) from 39 a year ago to about 52 now.
Jewellers in India offer their customers a buy back option at the prevailing rate of gold. Customers are using the opportunity of high gold prices to book profits. The demand destruction in India has been unprecedented. Many jewellery manufacturers in India have scaled down their operations and are moth-balling capacities to cope with the slowdown. Till such time as the global economy gets back on track, the demand for jewellery will be tempered by the fact that the Indian economy is facing challenging times. And, if the rupee continues to weaken, gold prices will further increase. India’s growth rate will in all likelihood slip to around 4.5 per cent from the 9 per cent that was being clocked before the global financial crisis hit. Although India is not in a recession, the fear factor is making people cautious.
The way ahead
The above factors suggest that the unprecedented destruction of jewellery demand that is currently underway will trigger a correction in gold prices. Gold bulls, on the other hand, are convinced that increased investment demand for gold will compensate for the destruction of jewellery demand. In such an eventuality, gold prices will continue to rise as investment money continues to pour in. The further increase in gold prices will lead to the acceleration in demand destruction. As and when investment inflows abate or reverse, gold prices will correct. The further the rise - the steeper the fall.One consequence of the high gold prices is that the government of India has directed the Geological Survey of India to begin the groundwork for indentifying mining blocks for India’s potential reserves of 20,000 tonnes of gold. The government is planning to open up its mining sector to private players to tap these reserves. This will impact gold prices in the long term.
In the existing global financial environment, there is an element of risk in all asset classes, be it commodities, stocks or real estate. Even a traditional safe haven asset such as gold is not immune to risk. Especially because of the volatility brought about by the huge amounts of money that speculative hedge funds are able to bring into play. Investing in any asset class, including gold, should be a well thought out decision. To invest in an asset merely because it is recommended that a certain percentage of one’s investment allocation should be to a particular asset amounts to investing one’s hard earned wealth without doing the homework.
Top-line and bottom-line - Technical Jargon unleashed
Top-line and bottom-line
Sift through any business newspaper or equity research report and it is unlikely that you will not come across the two words — top-line and bottom-line. Well, though the jargon may sound complex, it points to two simple things that help comprehend a corporate entity’s performance. Top-line and bottom-line refer to nothing but the sales and profit numbers reported by companies. But, if you are still wondering whose line is it anyway, here goes:
Topline
When reporting performance, corporate entities post the period’s sales number as the first entry in the top-line of the income statement. So, generally, when people make remarks on revenue growth of a company they refer to it as ‘top-line growth’. This figure assumes significance as it brings to fore the company’s business prospects. Breaking up the sales figure to know what helped its growth is essential as it would only aid in deciphering whether the increase is sustainable or not. Higher sales can be a result of either increase in volumes (units sold) or increase in realisation. By ‘realisation’, we mean revenue (selling price) made per unit sold.
Again, there could be two scenarios when a company can see higher realisation. One is when the demand for the specific product goes up and the price shoots up on tight supplies and, two, when the company delivers value-added products that command better price in the market over peer products. Top-line growth speaks of how efficient the company has been in exploiting the opportunities in the market.
Bottom-line
The bottom-line or the bottom figure in an income statement is the ‘net profit’ of the company. This is what the company is left with after paying all its expenses (both operating and administrative) for the period reported. A company’s bottom-line generally denotes the efficiency of the management in controlling costs even as it delivers higher sales.
Higher sales in the period will push up net profits, similar to how reduced expense would. In other words, growth in net profits does not necessarily mean fall in expenses; it could be bolstered by higher sales too. Suppose, ‘X’ company registers a 30 per cent increase in sales and a 10 per cent increase in total expenses, its net profit could be higher despite higher expenditure on higher revenues.
That, however, may be the least of the challenges for corporates, as the real big challenge comes during recessionary times like now when demand slumps and so does sales, making reduced or negative growth. Posting profits in such times is possible only through identifying cost-reduction possibilities and reducing operational inefficiencies. In the December quarter of 2008, only a few companies were seen posting bottom-line growth despite a fall in top-line. Few companies such as Siemens, MIC electronics and Cadila Healthcare managed to grow profits despite a fall in sales. However, here again not all cases were examples of operating efficiencies. Some saw profits soar due to higher other income. What’s other income? Well, that’s a different story altogether.
Sift through any business newspaper or equity research report and it is unlikely that you will not come across the two words — top-line and bottom-line. Well, though the jargon may sound complex, it points to two simple things that help comprehend a corporate entity’s performance. Top-line and bottom-line refer to nothing but the sales and profit numbers reported by companies. But, if you are still wondering whose line is it anyway, here goes:
Topline
When reporting performance, corporate entities post the period’s sales number as the first entry in the top-line of the income statement. So, generally, when people make remarks on revenue growth of a company they refer to it as ‘top-line growth’. This figure assumes significance as it brings to fore the company’s business prospects. Breaking up the sales figure to know what helped its growth is essential as it would only aid in deciphering whether the increase is sustainable or not. Higher sales can be a result of either increase in volumes (units sold) or increase in realisation. By ‘realisation’, we mean revenue (selling price) made per unit sold.
Again, there could be two scenarios when a company can see higher realisation. One is when the demand for the specific product goes up and the price shoots up on tight supplies and, two, when the company delivers value-added products that command better price in the market over peer products. Top-line growth speaks of how efficient the company has been in exploiting the opportunities in the market.
Bottom-line
The bottom-line or the bottom figure in an income statement is the ‘net profit’ of the company. This is what the company is left with after paying all its expenses (both operating and administrative) for the period reported. A company’s bottom-line generally denotes the efficiency of the management in controlling costs even as it delivers higher sales.
Higher sales in the period will push up net profits, similar to how reduced expense would. In other words, growth in net profits does not necessarily mean fall in expenses; it could be bolstered by higher sales too. Suppose, ‘X’ company registers a 30 per cent increase in sales and a 10 per cent increase in total expenses, its net profit could be higher despite higher expenditure on higher revenues.
That, however, may be the least of the challenges for corporates, as the real big challenge comes during recessionary times like now when demand slumps and so does sales, making reduced or negative growth. Posting profits in such times is possible only through identifying cost-reduction possibilities and reducing operational inefficiencies. In the December quarter of 2008, only a few companies were seen posting bottom-line growth despite a fall in top-line. Few companies such as Siemens, MIC electronics and Cadila Healthcare managed to grow profits despite a fall in sales. However, here again not all cases were examples of operating efficiencies. Some saw profits soar due to higher other income. What’s other income? Well, that’s a different story altogether.
Sunday, March 15, 2009
SBI SmartULIP
With market-linked products finding fewer takers, insurance companies are launching more “guaranteed” products to lure investors. The latest to join the bandwagon is SBI Life insurance with SBI Smart ULIP, a product that guarantees returns based on the highest NAV recorded by the fund in the first seven years.
How it works
This is a 10-year limited premium ULIP where one can choose to pay premium either for a three or five-year period, to be specified at the start of the policy. The sum assured is five times of the annualised premium.
The premium paid by the policy-holder, after deduction of allocation charges, is invested in a money market fund. On the 8th and 23rd of each month, your investments will automatically be moved to the Flexiprotect Fund. This fund, which invests in a mix of equity and debt, attempts to optimise returns, while providing significant capital protection, through dynamic asset allocation.
The guaranteed maturity NAV of Flexiprotect fund will be based on the highest NAV recorded over the first 168 fortnights or seven years (NAVs on 8th and 23rd of each month to be reckoned) from the investment.
Maturity Benefit: On completion of the policy term, the fund value will be paid. The NAV will be higher of the NAV as on the date of maturity or the guaranteed maturity NAV of 168 fortnights.
Death benefit: In the case of death during the policy term, the nominee will get sum assured or fund value, whichever is higher. .
Fund options: The two investment options currently offered are Flexiprotect and Money Market. Under Flexiprotect, the fund has the option to switch between 100 per cent in equity or debt and money market instruments. In the money market option, it will invest a maximum of 20 per cent in debt and between 80 per cent and 100 per cent in money market instruments.
Eligibility: The minimum age at entry is 8 and maximum is 60 years. Premium mode: Yearly, half-yearly, quarterly and monthly.
Minimum premium: Rs 50,000 in the annual option, Rs 25,000 half-yearly, Rs 15,000 quarterly and Rs 5,000 in the monthly mode.
Charges: The premium allocation charge, policy administration charge and fund management are applicable. Comment on product: In ULIPs, risk is usually transferred to the investor. In such products, insurers offer a guaranteed return to deal with the investor’s risk aversion. SBI Smart Life guarantees the highest NAV prevailing in the first seven years (168 fortnights).
The advantage of this feature is that if the market undergoes a sharp correction at the end of a seven-year term, and if you held on to the policy till maturity, then you can earn higher returns as per the guarantee rather than returns based on the prevailing NAV.
You will receive the highest NAV during this period as your fund value. This product adopts a dynamic asset allocation strategy to offer this guarantee. Such a strategy, if properly implemented, may prevent the fund from maximising returns; but downside may be better protected. A dynamic asset allocation strategy, however, is not easily implemented, as much will rely on the fund manager’s ability to time each switch.
Based on its allocation pattern, the fund is roughly comparable to a balanced mutual fund. If one compares the returns generated by the pure diversified funds and balanced funds over a long time-frame, the latter usually fall short due to their lower equity exposure. The best performing balanced fund’s 10-year compounded annualised return is 14 per cent.
Now, consider a male investor (40 years old) who invests Rs 50,000 per annum for a five-year period. If the plan earns an annualised return of 10 per cent, at maturity, the corpus will be Rs 4.09 lakh, taking into consideration the various charges associated with the product. The effective yield will be 5 per cent, after covering risk. Since the fund will invest in equity, there is every possibility that it might earn a higher return than 10 per cent. To put this in perspective, if one invests in a fixed deposit that will earn 8 per cent annually, his effective yield, post-tax, works out to 5.6 per cent if he falls in the highest tax bracket.
Those in the highest tax bracket can consider investing in this fund, assuming higher risk for higher return. Alternately, if you prefer to park your money in National Savings Certificates and take a term assurance for Rs 6 lakh, you may yet receive marginally higher returns than this provided redeploy the maturity proceeds of the NSC at 5 per cent until a 10-year term is completed.
This would however, require constant monitoring and transfer of funds, although the term assurance will provide a higher risk cover. Instead, with SBI Smart ULIP, you may be able to settle for a marginally lower return but hassle-free investment.
How it works
This is a 10-year limited premium ULIP where one can choose to pay premium either for a three or five-year period, to be specified at the start of the policy. The sum assured is five times of the annualised premium.
The premium paid by the policy-holder, after deduction of allocation charges, is invested in a money market fund. On the 8th and 23rd of each month, your investments will automatically be moved to the Flexiprotect Fund. This fund, which invests in a mix of equity and debt, attempts to optimise returns, while providing significant capital protection, through dynamic asset allocation.
The guaranteed maturity NAV of Flexiprotect fund will be based on the highest NAV recorded over the first 168 fortnights or seven years (NAVs on 8th and 23rd of each month to be reckoned) from the investment.
Maturity Benefit: On completion of the policy term, the fund value will be paid. The NAV will be higher of the NAV as on the date of maturity or the guaranteed maturity NAV of 168 fortnights.
Death benefit: In the case of death during the policy term, the nominee will get sum assured or fund value, whichever is higher. .
Fund options: The two investment options currently offered are Flexiprotect and Money Market. Under Flexiprotect, the fund has the option to switch between 100 per cent in equity or debt and money market instruments. In the money market option, it will invest a maximum of 20 per cent in debt and between 80 per cent and 100 per cent in money market instruments.
Eligibility: The minimum age at entry is 8 and maximum is 60 years. Premium mode: Yearly, half-yearly, quarterly and monthly.
Minimum premium: Rs 50,000 in the annual option, Rs 25,000 half-yearly, Rs 15,000 quarterly and Rs 5,000 in the monthly mode.
Charges: The premium allocation charge, policy administration charge and fund management are applicable. Comment on product: In ULIPs, risk is usually transferred to the investor. In such products, insurers offer a guaranteed return to deal with the investor’s risk aversion. SBI Smart Life guarantees the highest NAV prevailing in the first seven years (168 fortnights).
The advantage of this feature is that if the market undergoes a sharp correction at the end of a seven-year term, and if you held on to the policy till maturity, then you can earn higher returns as per the guarantee rather than returns based on the prevailing NAV.
You will receive the highest NAV during this period as your fund value. This product adopts a dynamic asset allocation strategy to offer this guarantee. Such a strategy, if properly implemented, may prevent the fund from maximising returns; but downside may be better protected. A dynamic asset allocation strategy, however, is not easily implemented, as much will rely on the fund manager’s ability to time each switch.
Based on its allocation pattern, the fund is roughly comparable to a balanced mutual fund. If one compares the returns generated by the pure diversified funds and balanced funds over a long time-frame, the latter usually fall short due to their lower equity exposure. The best performing balanced fund’s 10-year compounded annualised return is 14 per cent.
Now, consider a male investor (40 years old) who invests Rs 50,000 per annum for a five-year period. If the plan earns an annualised return of 10 per cent, at maturity, the corpus will be Rs 4.09 lakh, taking into consideration the various charges associated with the product. The effective yield will be 5 per cent, after covering risk. Since the fund will invest in equity, there is every possibility that it might earn a higher return than 10 per cent. To put this in perspective, if one invests in a fixed deposit that will earn 8 per cent annually, his effective yield, post-tax, works out to 5.6 per cent if he falls in the highest tax bracket.
Those in the highest tax bracket can consider investing in this fund, assuming higher risk for higher return. Alternately, if you prefer to park your money in National Savings Certificates and take a term assurance for Rs 6 lakh, you may yet receive marginally higher returns than this provided redeploy the maturity proceeds of the NSC at 5 per cent until a 10-year term is completed.
This would however, require constant monitoring and transfer of funds, although the term assurance will provide a higher risk cover. Instead, with SBI Smart ULIP, you may be able to settle for a marginally lower return but hassle-free investment.
Are tax-saving investments optimal?
March is a month for tax savers. Investors typically take exposure to equity linked savings scheme (ELSS) to lower their tax liability.
Some, of course, invest in public provident fund (PPF) and other such savings scheme to gain tax advantage. But are tax-advantaged investments optimal in the overall portfolio context?
However, investors’ compelling urge to save taxes may a time forces them to lose sight of how such investments sit with other assets in the portfolio.
The article suggests that investors should look at tax-advantaged investments within the core-satellite framework.
Tax saving optimal?
That ELSS is fairly popular as a tax-advantaged investment is clear from the fact that assets under management for this fund class was Rs 11,130 crore as of February 2009.
Investors typically invest in tax-advantaged investments with the primary objective of saving taxes.
And that could turn out to be sub-optimal, for the primary objective should be to optimise post-tax returns, not to save taxes.
Consider an investor wanting to buy a tax-exempt bond that carries 8 per cent interest.
If this investor has another investment avenue that can fetch risk-adjusted returns of 15 per cent, the post-tax returns will be 10.5 per cent, assuming 30 per cent tax rate. It would then be sub-optimal to invest in the tax-exempt bond just to save taxes.
Tax-advantaged equity
The case with ELSS is different. This investment can generate higher returns due to equity exposure.
The problem, however, is that such an investment may not be optimal within the core-satellite portfolio framework. Why?
ELSS is essentially a tax-advantaged active fund. The problem then is two-fold. One, active funds may not sit well within the core portfolio. A core portfolio is optimal when it carries low-cost beta (market) exposure.
It is primarily set-up to achieve specified investment objectives such as buying a house or funding higher education.
Active funds do not provide such low-cost exposure. Index funds do.
Can ELSS form part of the satellite portfolio? It can, but only if the fund carries an investment style. And this is the second problem.
Most tax-advantaged funds do not carry a distinct investment style. Franklin India Taxshield is a case in point.
The portfolio manager is within his mandate to load stocks ranging from large-caps to small caps.
Such a diversified fund may interfere with other structures in the investor’s satellite portfolio.
If the portfolio has an aggressive mid-cap fund and ELSS also carries sizable exposure to mid-caps, the investor will be over-exposed to that sector.
Fixed-income exposure
All portfolios have exposure to fixed-income securities as part of the strategic asset allocation policy. What if investors take tax-advantaged exposure to this asset class? That way, the investor can save taxes and also fulfil the requirements under the asset allocation policy.
Employees already carry such exposure through provident fund (PF).
They can also invest in PPF. Besides, investing in PPF or PF carries a longer lock-in period. This feature enables the investment to sit well inside the core portfolio alongside index funds.
It is important to remember that a fixed-income exposure is not about generating high returns.
Rather, this asset class helps investors’ lower portfolio volatility.
This is does not mean that tax-advantaged mutual funds with bond exposure are optimal.
The problem is that such mutual funds carry price risk- risk that bond prices may decline when investor redeems the units.
Investors who prefer shorter lock-in periods can consider tax-advantaged fixed deposits — five-year deposits with commercial banks. The problem, however, is that the interest on investment is taxable. Another alternative is the National Savings Certificate, where interest is tax-exempt.
Conclusion
Investors buy ELSS with a primary objective of saving taxes.
The objective instead should be to exhaust the investment deductions under the Income-tax Act in such a way that they sit well within the overall investment objectives. Compared with ELSS, a tax-advantaged fixed-income investment serves the purpose well.
Some, of course, invest in public provident fund (PPF) and other such savings scheme to gain tax advantage. But are tax-advantaged investments optimal in the overall portfolio context?
However, investors’ compelling urge to save taxes may a time forces them to lose sight of how such investments sit with other assets in the portfolio.
The article suggests that investors should look at tax-advantaged investments within the core-satellite framework.
Tax saving optimal?
That ELSS is fairly popular as a tax-advantaged investment is clear from the fact that assets under management for this fund class was Rs 11,130 crore as of February 2009.
Investors typically invest in tax-advantaged investments with the primary objective of saving taxes.
And that could turn out to be sub-optimal, for the primary objective should be to optimise post-tax returns, not to save taxes.
Consider an investor wanting to buy a tax-exempt bond that carries 8 per cent interest.
If this investor has another investment avenue that can fetch risk-adjusted returns of 15 per cent, the post-tax returns will be 10.5 per cent, assuming 30 per cent tax rate. It would then be sub-optimal to invest in the tax-exempt bond just to save taxes.
Tax-advantaged equity
The case with ELSS is different. This investment can generate higher returns due to equity exposure.
The problem, however, is that such an investment may not be optimal within the core-satellite portfolio framework. Why?
ELSS is essentially a tax-advantaged active fund. The problem then is two-fold. One, active funds may not sit well within the core portfolio. A core portfolio is optimal when it carries low-cost beta (market) exposure.
It is primarily set-up to achieve specified investment objectives such as buying a house or funding higher education.
Active funds do not provide such low-cost exposure. Index funds do.
Can ELSS form part of the satellite portfolio? It can, but only if the fund carries an investment style. And this is the second problem.
Most tax-advantaged funds do not carry a distinct investment style. Franklin India Taxshield is a case in point.
The portfolio manager is within his mandate to load stocks ranging from large-caps to small caps.
Such a diversified fund may interfere with other structures in the investor’s satellite portfolio.
If the portfolio has an aggressive mid-cap fund and ELSS also carries sizable exposure to mid-caps, the investor will be over-exposed to that sector.
Fixed-income exposure
All portfolios have exposure to fixed-income securities as part of the strategic asset allocation policy. What if investors take tax-advantaged exposure to this asset class? That way, the investor can save taxes and also fulfil the requirements under the asset allocation policy.
Employees already carry such exposure through provident fund (PF).
They can also invest in PPF. Besides, investing in PPF or PF carries a longer lock-in period. This feature enables the investment to sit well inside the core portfolio alongside index funds.
It is important to remember that a fixed-income exposure is not about generating high returns.
Rather, this asset class helps investors’ lower portfolio volatility.
This is does not mean that tax-advantaged mutual funds with bond exposure are optimal.
The problem is that such mutual funds carry price risk- risk that bond prices may decline when investor redeems the units.
Investors who prefer shorter lock-in periods can consider tax-advantaged fixed deposits — five-year deposits with commercial banks. The problem, however, is that the interest on investment is taxable. Another alternative is the National Savings Certificate, where interest is tax-exempt.
Conclusion
Investors buy ELSS with a primary objective of saving taxes.
The objective instead should be to exhaust the investment deductions under the Income-tax Act in such a way that they sit well within the overall investment objectives. Compared with ELSS, a tax-advantaged fixed-income investment serves the purpose well.
Be home-loan wise in a slump
Declining interest rates and property price discounts could well be a blessing for those looking forward to owning a home. However, a slowing economy, pay cuts and fear of job losses appear to offset the positives. Added to this, inflation at 2.4 per cent (close to June 2002 levels) threatens to drag the economy down further.
In the current situation, buyers may have to take a conservative approach when going for a home loan. Existing borrowers can re-look at prepaying loans in advanced stages, though the lower interest rates may seem to make a case for staying on. Others, bogged down by pay cuts or job losses, may seek a way out with their bankers. Here are a few tips on how future and current borrowers can make the best of the current financial environment.
New borrowers
Do not go overboard. While you can thank your lucky stars if you are in a job that is relatively stable, it is perhaps wiser to err on the side of caution when it comes to borrowing in these tough times.
When you seek a new home loan, remember that your real ability to repay the loan may not be the same as what the banker assumes it to be. A bank typically assumes the percentage of your income available to service debt (based on the bank’s own experience and the available data on spending patterns) on the basis of which it will determine your loan eligibility.
For instance, for a Rs 10 lakh loan at 9.25 per cent interest for 10 years, the equated monthly instalment (EMI) works out to Rs 12,800 a month. If the bank assumes that about 40 per cent of your monthly income, of say Rs 40,000, is available to pay EMIs, Rs 16,000 would be the money disposable towards the EMI. Based on this assumption, your loan eligibility would be (16000/12800) x 1000000, which is Rs 12.5 lakh. In other words, you are eligible for an amount higher than the Rs 10 lakh that you wanted.
In case more aggressive assumptions are made, the eligibility may be much higher. Such a calculation should not misguide buyers into believing that they can go for a property of higher value, unless they are willing to plough in more of their own capital.
Remember, the surplus that you generate every month may turn out to be as low as 20 per cent (Rs 8,000 a month in this example), after various commitments that your banker may not be aware of. In such a case, you may have to end up draining your savings to meet the EMI or request for a longer tenure.
But what are the expenses/incomes one should consider for arriving at disposable income? Apart from your regular monthly expenses, provide adequately for contingencies such as medical expenses. Your savings commitments such as SIPs, if you are already running one, should also not be heavily compromised. Loan repayment should not hinder your long-term wealth building plan.
Besides, if you favour prudence, do not add your variable pay package to calculate your disposable income; some companies tend to spread the variable pay across the 12 months. You can always accumulate such sums to prepay a part of your loan periodically.
As far as possible, factor in a disposable income not exceeding 30 per cent of the income, even in case of double income families. This way, any temporary out-of-job situation of a spouse may not provide much reason for alarm.
Avoid galloping EMI. Banks offer home loan schemes that would allow you to step-up your repayments (EMIs) based on the expected increase in your income.
Such schemes are offered with an intention of qualifying an individual for a higher loan/property value. This would essentially require the bank to make an assumption on your pay hikes. So in year three, you may be paying an EMI higher than year one. Banks may well assume a past pay hike of say 5-15 per cent to be your future increase in income.
In an economic downturn such as the present one, this equation could well convert into a 5-15 per cent decline in pay. So beware. Go for a fixed EMI and avoid ambitious schemes.
Bear in mind that in the long term your repayment tenure/EMIs could well rise due to higher interest rates. In those times, any surplus would come in handy.
Existing borrowers
If you own a home and a bulky loan, you may have to take a re-look at your liability and your ability to repay on a periodic basis.
The brighter side of an economic downturn is that it provides an opportunity to reduce liabilities. A slowing economy also provides stable income-earners an opportunity to prepay at least a part of their loan. Two factors will determine this:one, the surplus available in hand; two, the net interest cost of loan versus investment opportunity by parking the surplus elsewhere.
If you have accumulated a reasonable sum as surplus and plan to invest it at a time when interest rates are falling, chances are that you will get low yield on such investments.
Take an example: A bank deposit with, say, an interest rate of 8 per cent would provide a 5.6 per cent yield net of tax (assuming a 30 per cent tax bracket). At the same time if you have been servicing a home loan of say 9.75 per cent, the net cost after tax benefits comes to 6.8 per cent. It makes economic sense to pay a high-cost debt instead of locking money in a low-yielding FD.
But why prepay now, during an economic downturn, when the floating rate of your loan may actually become lower? This is simply because of the lack of alternative opportunity to park your surplus and also the widening gap between interest rates and inflation. In other words, in makes sense to prepay during a time when inflation is declining at a pace higher then the falling interest rates.
However, ensure that you have paid your other loan commitments such as credit card, auto or personal loans before prepaying home loan. Remember the latter enjoys tax benefits on repayments, while the other loans do not.
Also note that it may not be wise to prepay early on in to your borrowing years especially when you decide to repay in full. For one, the prepayment charges are higher in the initial years, two, given the high interest component in the EMI in the initial years, the tax benefits enjoyed are quite substantial.
Struggling to repay?
Talking of prepayment, what about those who have received pay cuts or lost jobs? Here are a couple of options for you. Approach your bank and ask for a solution. If you have had a clean record of repayment, the bank may consider a reduction in EMI and prolong the tenure.
Alternatively, if you hold an investment that is earning a low interest (do the calculation suggested above for prepayment), do not hesitate to break it and prepay a part of the loan and settle for a lower EMI instead.
Check with your bank on the consequences of a couple of months of default and keep the banker posted on other job options that you have considered/received. The idea here is provide some comfort to your banker as to your ability to meet your commitments.
All said, for those who have invested in the boom phase and are seeing their first downturn now, you would emerge more money-wise and prudent at the end of this.
In the current situation, buyers may have to take a conservative approach when going for a home loan. Existing borrowers can re-look at prepaying loans in advanced stages, though the lower interest rates may seem to make a case for staying on. Others, bogged down by pay cuts or job losses, may seek a way out with their bankers. Here are a few tips on how future and current borrowers can make the best of the current financial environment.
New borrowers
Do not go overboard. While you can thank your lucky stars if you are in a job that is relatively stable, it is perhaps wiser to err on the side of caution when it comes to borrowing in these tough times.
When you seek a new home loan, remember that your real ability to repay the loan may not be the same as what the banker assumes it to be. A bank typically assumes the percentage of your income available to service debt (based on the bank’s own experience and the available data on spending patterns) on the basis of which it will determine your loan eligibility.
For instance, for a Rs 10 lakh loan at 9.25 per cent interest for 10 years, the equated monthly instalment (EMI) works out to Rs 12,800 a month. If the bank assumes that about 40 per cent of your monthly income, of say Rs 40,000, is available to pay EMIs, Rs 16,000 would be the money disposable towards the EMI. Based on this assumption, your loan eligibility would be (16000/12800) x 1000000, which is Rs 12.5 lakh. In other words, you are eligible for an amount higher than the Rs 10 lakh that you wanted.
In case more aggressive assumptions are made, the eligibility may be much higher. Such a calculation should not misguide buyers into believing that they can go for a property of higher value, unless they are willing to plough in more of their own capital.
Remember, the surplus that you generate every month may turn out to be as low as 20 per cent (Rs 8,000 a month in this example), after various commitments that your banker may not be aware of. In such a case, you may have to end up draining your savings to meet the EMI or request for a longer tenure.
But what are the expenses/incomes one should consider for arriving at disposable income? Apart from your regular monthly expenses, provide adequately for contingencies such as medical expenses. Your savings commitments such as SIPs, if you are already running one, should also not be heavily compromised. Loan repayment should not hinder your long-term wealth building plan.
Besides, if you favour prudence, do not add your variable pay package to calculate your disposable income; some companies tend to spread the variable pay across the 12 months. You can always accumulate such sums to prepay a part of your loan periodically.
As far as possible, factor in a disposable income not exceeding 30 per cent of the income, even in case of double income families. This way, any temporary out-of-job situation of a spouse may not provide much reason for alarm.
Avoid galloping EMI. Banks offer home loan schemes that would allow you to step-up your repayments (EMIs) based on the expected increase in your income.
Such schemes are offered with an intention of qualifying an individual for a higher loan/property value. This would essentially require the bank to make an assumption on your pay hikes. So in year three, you may be paying an EMI higher than year one. Banks may well assume a past pay hike of say 5-15 per cent to be your future increase in income.
In an economic downturn such as the present one, this equation could well convert into a 5-15 per cent decline in pay. So beware. Go for a fixed EMI and avoid ambitious schemes.
Bear in mind that in the long term your repayment tenure/EMIs could well rise due to higher interest rates. In those times, any surplus would come in handy.
Existing borrowers
If you own a home and a bulky loan, you may have to take a re-look at your liability and your ability to repay on a periodic basis.
The brighter side of an economic downturn is that it provides an opportunity to reduce liabilities. A slowing economy also provides stable income-earners an opportunity to prepay at least a part of their loan. Two factors will determine this:one, the surplus available in hand; two, the net interest cost of loan versus investment opportunity by parking the surplus elsewhere.
If you have accumulated a reasonable sum as surplus and plan to invest it at a time when interest rates are falling, chances are that you will get low yield on such investments.
Take an example: A bank deposit with, say, an interest rate of 8 per cent would provide a 5.6 per cent yield net of tax (assuming a 30 per cent tax bracket). At the same time if you have been servicing a home loan of say 9.75 per cent, the net cost after tax benefits comes to 6.8 per cent. It makes economic sense to pay a high-cost debt instead of locking money in a low-yielding FD.
But why prepay now, during an economic downturn, when the floating rate of your loan may actually become lower? This is simply because of the lack of alternative opportunity to park your surplus and also the widening gap between interest rates and inflation. In other words, in makes sense to prepay during a time when inflation is declining at a pace higher then the falling interest rates.
However, ensure that you have paid your other loan commitments such as credit card, auto or personal loans before prepaying home loan. Remember the latter enjoys tax benefits on repayments, while the other loans do not.
Also note that it may not be wise to prepay early on in to your borrowing years especially when you decide to repay in full. For one, the prepayment charges are higher in the initial years, two, given the high interest component in the EMI in the initial years, the tax benefits enjoyed are quite substantial.
Struggling to repay?
Talking of prepayment, what about those who have received pay cuts or lost jobs? Here are a couple of options for you. Approach your bank and ask for a solution. If you have had a clean record of repayment, the bank may consider a reduction in EMI and prolong the tenure.
Alternatively, if you hold an investment that is earning a low interest (do the calculation suggested above for prepayment), do not hesitate to break it and prepay a part of the loan and settle for a lower EMI instead.
Check with your bank on the consequences of a couple of months of default and keep the banker posted on other job options that you have considered/received. The idea here is provide some comfort to your banker as to your ability to meet your commitments.
All said, for those who have invested in the boom phase and are seeing their first downturn now, you would emerge more money-wise and prudent at the end of this.
The well-heeled look ahead - REAL ESTATE SCENARIO
Recent weakness in both the traded asset markets as well as real estate may have diminished their earlier insatiable appetite, but investing in real estate still remains a viable asset class for the discerning high net worth investor (HNI). Historically, HNIs have always demonstrated proclivity towards acquiring real estate. The difference between then and now is that earlier these HNIs were working more on their gut feel, whereas today they take a relatively more scientific approach towards acquiring real estate.
Wealth management companies, such as ASK Wealth Advisors, recommend that 5 per cent of total assets of a client with an assertive risk profile should be invested in alternative assets such as real estate. For a client with an aggressive risk profile, the proportion can go up to 10 per cent of the total assets.
More investor friendly
Further, the HNI interest in real estate has been buoyed by the availability of leverage, most often from the developer himself. While leverage benefits investors to the extent that they can obtain marketable title upon a small down payment, it also benefits developers as they can offer supplies that can be developed presently with borrowed money.
Presently, despite the credit squeeze, many developers are not asking for anything more than the down payment until project completion and possession. This may, to some extent, be a reflection of the present tepidness of appetite and a demand-supply imbalance. However, financial institutions are still willing to lend to buyers on viable projects.
What drives investor interest in real estate is that a larger pool of available options between commercial and residential properties has been created in recent years. So in effect, investors are looking at a menu of options, each with a different projected internal rate of return, project completion risk and time frame of completion. Never has the property market in India looked so investor-friendly.
Although the market for real estate is not liquid in the strict sense, the fact that there is a spectrum of risk-reward profile among investors also means that early investors may have an opportunity to resell their investment to later-stage investors.
To take a simple example, a moderate risk-taking HNI with an eye to investing would typically invest in a leased commercial property with regular cash flows. A more aggressive HNI would most likely prefer either buying an under-construction residential dwelling and turning it over for a profit, or investing in land and then either develop it or partake in share of profits once the developer develops and sells the project.
At the other end of the spectrum, are investors who may not wish to participate in deal-making directly, and instead want a professional manager to manage their funds.
More realistic
In the recent past, HNIs have also shown an inclination to invest in real estate private equity funds. Typically, these funds have a lock-in period and ‘project’ a IRR (internal rate of return) to their investors. Some PE funds have an objective of investing in income generating properties and then passing on the revenue streams as dividends to the investors. But this is not to say that investment in real estate is a free lunch for everyone.
During the quasi-bubble that we witnessed till the beginning of this year, HNIs were sector, builder and geography-agnostic, as there were profits to be made everywhere. However, as values have come to more realistic levels in 2008, HNIs have become more discerning in terms of their preferences, including geographical preferences.
In earlier times, HNIs were investing in Tier 1, 2 as well as Tier 3 cities. In Tier 1 cities, they were pretty indifferent between city centres and properties in the suburbs. But now the foolhardiness has vanished. At present, HNI behaviour is to tread in shallow rather than in uncharted waters. This means investing more in Tier 1 cities such as Delhi NCR, Mumbai, Bangalore, Chennai and some parts of Kolkata.
Interestingly, there is a pattern witnessed of HNIs purchasing properties abroad. Some favourite destinations are New York, London and Dubai. This has been facilitated by the newly available $200,000 remittance per year allowed by the RBI. So, a family of four can remit up to $800,000 each year, and this amount can get you a decent property in any of the above mentioned international cities.
Sound advice
A significant reason for this trend of increased allocation and geographical preference is that HNIs have the benefit of sound investment advice. It is abundantly clear that over the long term — greater than five years — Indian real estate is still a bullish story. Some of the excesses that had got built into the system have been priced out, so there is some level of sanity. But at the same time, it cannot be denied that India will continue with strong GDP growth. The fundamentals of the economy remain strong, and a growing economy needs to fill gaps in infrastructure, including residential and commercial property.
Real estate is an integral part of the India growth story, and any investor in the India story cannot avoid looking at real estate.
In terms of short to intermediate term downturn, retail may probably be the worst hit followed by commercial and residential. In this process, however, smaller developers who don’t have hoards of cash will be the hardest hit. Some large developers sitting with cash raised recently through IPOs and private equity will fare better.
Further the excessive supply of space in certain micro markets will affect all developers irrespective of their size. Within this present downturn in the real estate cycle there is an opportunity for a buyer to pick up great values that weren’t available till even a few months ago.
Wealth management companies, such as ASK Wealth Advisors, recommend that 5 per cent of total assets of a client with an assertive risk profile should be invested in alternative assets such as real estate. For a client with an aggressive risk profile, the proportion can go up to 10 per cent of the total assets.
More investor friendly
Further, the HNI interest in real estate has been buoyed by the availability of leverage, most often from the developer himself. While leverage benefits investors to the extent that they can obtain marketable title upon a small down payment, it also benefits developers as they can offer supplies that can be developed presently with borrowed money.
Presently, despite the credit squeeze, many developers are not asking for anything more than the down payment until project completion and possession. This may, to some extent, be a reflection of the present tepidness of appetite and a demand-supply imbalance. However, financial institutions are still willing to lend to buyers on viable projects.
What drives investor interest in real estate is that a larger pool of available options between commercial and residential properties has been created in recent years. So in effect, investors are looking at a menu of options, each with a different projected internal rate of return, project completion risk and time frame of completion. Never has the property market in India looked so investor-friendly.
Although the market for real estate is not liquid in the strict sense, the fact that there is a spectrum of risk-reward profile among investors also means that early investors may have an opportunity to resell their investment to later-stage investors.
To take a simple example, a moderate risk-taking HNI with an eye to investing would typically invest in a leased commercial property with regular cash flows. A more aggressive HNI would most likely prefer either buying an under-construction residential dwelling and turning it over for a profit, or investing in land and then either develop it or partake in share of profits once the developer develops and sells the project.
At the other end of the spectrum, are investors who may not wish to participate in deal-making directly, and instead want a professional manager to manage their funds.
More realistic
In the recent past, HNIs have also shown an inclination to invest in real estate private equity funds. Typically, these funds have a lock-in period and ‘project’ a IRR (internal rate of return) to their investors. Some PE funds have an objective of investing in income generating properties and then passing on the revenue streams as dividends to the investors. But this is not to say that investment in real estate is a free lunch for everyone.
During the quasi-bubble that we witnessed till the beginning of this year, HNIs were sector, builder and geography-agnostic, as there were profits to be made everywhere. However, as values have come to more realistic levels in 2008, HNIs have become more discerning in terms of their preferences, including geographical preferences.
In earlier times, HNIs were investing in Tier 1, 2 as well as Tier 3 cities. In Tier 1 cities, they were pretty indifferent between city centres and properties in the suburbs. But now the foolhardiness has vanished. At present, HNI behaviour is to tread in shallow rather than in uncharted waters. This means investing more in Tier 1 cities such as Delhi NCR, Mumbai, Bangalore, Chennai and some parts of Kolkata.
Interestingly, there is a pattern witnessed of HNIs purchasing properties abroad. Some favourite destinations are New York, London and Dubai. This has been facilitated by the newly available $200,000 remittance per year allowed by the RBI. So, a family of four can remit up to $800,000 each year, and this amount can get you a decent property in any of the above mentioned international cities.
Sound advice
A significant reason for this trend of increased allocation and geographical preference is that HNIs have the benefit of sound investment advice. It is abundantly clear that over the long term — greater than five years — Indian real estate is still a bullish story. Some of the excesses that had got built into the system have been priced out, so there is some level of sanity. But at the same time, it cannot be denied that India will continue with strong GDP growth. The fundamentals of the economy remain strong, and a growing economy needs to fill gaps in infrastructure, including residential and commercial property.
Real estate is an integral part of the India growth story, and any investor in the India story cannot avoid looking at real estate.
In terms of short to intermediate term downturn, retail may probably be the worst hit followed by commercial and residential. In this process, however, smaller developers who don’t have hoards of cash will be the hardest hit. Some large developers sitting with cash raised recently through IPOs and private equity will fare better.
Further the excessive supply of space in certain micro markets will affect all developers irrespective of their size. Within this present downturn in the real estate cycle there is an opportunity for a buyer to pick up great values that weren’t available till even a few months ago.
Some alternatives to stocks
As the global financial crisis cuts a notch deeper and many economies officially go into recession, stock markets have turned quite choppy. Liquidity is significantly tight at this point, interest rates are on a generic basis cooling off. Business confidence is glum, job-cuts have become the order of the day. It is pertinent now to evaluate some alternative investment avenues to suit the current scenario.
Income and Gilt Funds
Income funds invest in corporate bonds, government securities, PSU Bonds and, to some extent, in Commercial papers and Certificate of Deposit.
The maturity period of the underlying assets could vary between 0.6 years and 3/5 years depending on interest rates scenario. Unlike Income funds, Gilt funds invest in government securities. The average maturity period for Gilt funds is around 5.5 years – 16.5 years, depending on whether it is a short/ medium/long-term fund.
Falling interest rates are favourable to income/gilt funds, there exists an inverse relation between interest rates and bond prices. Bond prices go up when interest rates move southwards, this, in turn, reflects in capital appreciation, whereby the returns from income/gilt funds turn out to be attractive.
Here is a simple example to understand the dynamics of bond prices and interest rates. Let us assume that the interest rate was 10 per cent and given a cooling interest rate scenario, the interest rate has fallen to 9 per cent in the market.
The bond with a coupon of 10 per cent on a face value of Rs 100 will continue to earn the same interest even when interest rates in the market fall down.
Thus, the demand for bond paying 10 per cent coupon will go up in the market and the price of the bond will increase such that the new investor gets 9 per cent on market value, on the day the new investor purchases the bond. The reverse situation holds good when the interest rates are peaking and income funds can generate negative returns in such periods. Hence, one could use income funds for a part of one’s overall debt investments.
Outlook: Though returns have been very good in gilt funds, there could be limited upside left from hereon. However, income funds could have some steam left. Corporate spreads are key indicators whilst deciding the entry and exit points of income funds. Corporate spread refers to the difference between yields of corporate bonds and equivalent Government Bonds.
There is speculation that there would be further rate cuts with the impending elections. Due to base effect (sudden spike in interest rates last year), there could be further downside in inflation rates, and this will, in turn, ease the liquidity.
One more round of rate cuts is anticipated, which will help the income funds to perform well. That would make income funds a good investment with a 12-24-month perspective. Income funds also have the flexibility of altering their maturity periods, hence narrowing of corporate spreads could see income funds investing in bonds with higher maturity, thereby locking into higher interest rates.
Gold
With the financial markets remaining chaotic, gold is considered a safe haven. This asset class is likely to provide a balance if your portfolio has a large capital market exposure. Historical evidence shows that bullion moves in negative correlation with equities.
Outlook
While from a demand perspective, one could see lower demand as gold prices skyrocket demand may continue to hold steady for gold as an investment option. One could consider investment in gold in the form of ETFs; one can also consider investment in Gold Mining Funds.
This will give better liquidity, will lower the risk of holding physical gold and reduces transaction costs (transaction charges levied by banks, wastage and making charges, and storage costs). One can allocate about 5-10 per cent of one’s portfolio to Gold. However, considering that gold has run up recently, it maybe a good idea to phase out your investments and not invest a lumpsum at a single time.
While central banks are likely to increasingly use gold for their reserves in the long term due to high volatility in currencies, in the short term, some central banks could sell their gold holdings as a means to fund their debt repayments. Gold is suggested for a time frame of one-three years.
Keep scouting
Consistent scouting for investment avenues is the rule to ensure that you are dwelling with the best in your portfolio. We have outlined just two such options in this article.
There are other avenues, such as fixed deposits including in banks and public sector financial institutions. Commercial real-estate that has high rental yield can also be considered at such times for an investor willing to put in larger sums of money.
The author is Founder & CEO Right Horizons Consulting.
Income and Gilt Funds
Income funds invest in corporate bonds, government securities, PSU Bonds and, to some extent, in Commercial papers and Certificate of Deposit.
The maturity period of the underlying assets could vary between 0.6 years and 3/5 years depending on interest rates scenario. Unlike Income funds, Gilt funds invest in government securities. The average maturity period for Gilt funds is around 5.5 years – 16.5 years, depending on whether it is a short/ medium/long-term fund.
Falling interest rates are favourable to income/gilt funds, there exists an inverse relation between interest rates and bond prices. Bond prices go up when interest rates move southwards, this, in turn, reflects in capital appreciation, whereby the returns from income/gilt funds turn out to be attractive.
Here is a simple example to understand the dynamics of bond prices and interest rates. Let us assume that the interest rate was 10 per cent and given a cooling interest rate scenario, the interest rate has fallen to 9 per cent in the market.
The bond with a coupon of 10 per cent on a face value of Rs 100 will continue to earn the same interest even when interest rates in the market fall down.
Thus, the demand for bond paying 10 per cent coupon will go up in the market and the price of the bond will increase such that the new investor gets 9 per cent on market value, on the day the new investor purchases the bond. The reverse situation holds good when the interest rates are peaking and income funds can generate negative returns in such periods. Hence, one could use income funds for a part of one’s overall debt investments.
Outlook: Though returns have been very good in gilt funds, there could be limited upside left from hereon. However, income funds could have some steam left. Corporate spreads are key indicators whilst deciding the entry and exit points of income funds. Corporate spread refers to the difference between yields of corporate bonds and equivalent Government Bonds.
There is speculation that there would be further rate cuts with the impending elections. Due to base effect (sudden spike in interest rates last year), there could be further downside in inflation rates, and this will, in turn, ease the liquidity.
One more round of rate cuts is anticipated, which will help the income funds to perform well. That would make income funds a good investment with a 12-24-month perspective. Income funds also have the flexibility of altering their maturity periods, hence narrowing of corporate spreads could see income funds investing in bonds with higher maturity, thereby locking into higher interest rates.
Gold
With the financial markets remaining chaotic, gold is considered a safe haven. This asset class is likely to provide a balance if your portfolio has a large capital market exposure. Historical evidence shows that bullion moves in negative correlation with equities.
Outlook
While from a demand perspective, one could see lower demand as gold prices skyrocket demand may continue to hold steady for gold as an investment option. One could consider investment in gold in the form of ETFs; one can also consider investment in Gold Mining Funds.
This will give better liquidity, will lower the risk of holding physical gold and reduces transaction costs (transaction charges levied by banks, wastage and making charges, and storage costs). One can allocate about 5-10 per cent of one’s portfolio to Gold. However, considering that gold has run up recently, it maybe a good idea to phase out your investments and not invest a lumpsum at a single time.
While central banks are likely to increasingly use gold for their reserves in the long term due to high volatility in currencies, in the short term, some central banks could sell their gold holdings as a means to fund their debt repayments. Gold is suggested for a time frame of one-three years.
Keep scouting
Consistent scouting for investment avenues is the rule to ensure that you are dwelling with the best in your portfolio. We have outlined just two such options in this article.
There are other avenues, such as fixed deposits including in banks and public sector financial institutions. Commercial real-estate that has high rental yield can also be considered at such times for an investor willing to put in larger sums of money.
The author is Founder & CEO Right Horizons Consulting.
Saturday, March 7, 2009
Buy on negative news and sell on good news’ PHILOSOPHY WHICH MAY PROBABLY WORK
Buy on negative news and sell on good news’ appears to be the simple yet difficult-to-implement philosophy of Mr Sankaran Naren, Chief Investment Officer Equities, ICICI Prudential Asset Management. In an interview with Business Line, Mr Naren talks on why the equity market is less risky now than it was in the heady bull market of 2007. He also gives his opinion on which sectors are less prone to be hurt by the slowdown.
There have been three sets of stimulus measures including excise duty and service tax. Do you see that having an impact on specific sectors?
It has helped in confidence building. The revival in the auto industry may happen as a result of the stimulus, rural consumption, Government bus orders — a combination of these three factors. So, slowly, the economy may be moving out of the ICU, except in case of export-oriented industries.
Secondly, my belief today is that capex outside power is also having a problem. When the capacity utilisation of the entire industry is lower why would they want to invest in capex?
For CY09, corporate capex will significantly come down. You will see improvement in consumption based industry, in rural based industry but not in export industries and capex industries whose user industry is in trouble.
When are the lower commodity prices and borrowing costs likely to be reflected in corporate earnings?
In the April-June quarter. I think the entire inventory cleaning up process would be by March.
What I would like people to realise is that our index benchmarks are very commodity-oriented. I am not very sure if these companies will show any dramatic improvement in the April-June phase although the users of these commodities will show improvements.
If you see, the auto sector weight is low while metals and oil and gas is high. So April-June onwards, the non-index stocks will start doing better than commodity stocks.
In the ICICI Pru Growth Fund, you have an ‘underweight’ view on realty and are overweight on banking stocks. Will you hold on to this view even now, given the stimulus given to realty sector?
The problem with the real estate sector is that there is no history backing the companies. We had some marginal positions in one or two real estate stocks. But those were companies that had clearly identified one or two parcels of land, which one can understand.
Otherwise we have to get a conviction that the de-leveraging cycle in real estate has started to happen in a big way. This means that we want land bank to go down by way of sale of land or apartments; the borrowings of real estate companies should start coming down as a result of such sales. We will not otherwise look at the sector.
Bank stocks have been de-rated sharply on worries about margin pressures. What is your view?
Banking is a very mixed bag right now. One factor is in that the sector has already turned in high profit growth in the last quarter or so. NPAs will definitely go up from here. But are these risks already factored in to the current share price? There are today public sector bank stocks that trade at a significant discount to their book value.
That suggests that some part of the losses are already recognised in the valuations. My current view on banking is neither a strong buy nor a sell. Do the corporate earnings suggest that banks are better off being cautious in their lending?
My belief is that you ought to have been cautious in 2007 – in the up cycle. Take mutual funds – if you had been aggressive in choosing stocks in 2007, you paid the penalty in 2008. Today the so-called aggressive stocks are trading at very low levels. Is the risk now as high as in 2007? The answer is no. That is true even for banks. And after the downturn, you are looking at everything such as collateral values more carefully.
I think banks received too much in deposits in October to December and they do not have a mechanism to lend that avalanche of deposits aggressively. The problem for the banks was that the big borrowers were the oil and fertiliser companies. So all long as the big borrowers were oil and fertiliser companies, it was easier for the banks.
The second point is that working capital requirements for commodity companies are down. Suppose you have one tonne of steel that you need to finance. The money required to fund steel is 30 per cent lower than six months ago because steel price has come down. So also with petrochemicals and aluminium. So to maintain the same level of stock you need 30 per cent less money from the banking system.
Two, companies aren’t holding that much inventory. If you believe that steel will go up you will keep three tonnes instead of one. Today, you believe that steel will go down or stay flat.
So you bring down your inventory from three tonnes to one tonne. So the combination of price drop and inflation expectations being down, results in lower lending. So it makes it much more difficult for banks to lend in this environment.
In quite a few of your funds you are holding stock-specific call/put options. What is the strategy behind this?
Our strategy is that we want to be invested because we do not see any risk in being fully invested at this point. But we want to be invested as defensively as possible. The defensive routes include writing puts and in some cases, writing covered calls.
The strategy is used across fund-houses. We don’t think we should be in cash at this level of the market.
For a long time it was believed that consumption-oriented sectors are more immune to a slowdown. But now there are signs of slowdown in consumption and retail sales.
We have taken a call that consumption is of two types – rural and urban. We do not see any evidence of slowdown in rural consumption. In fact there are signs of growth. So we plan to focus on rural consumption industries (consumption with low unit value) and not urban discretionary spending industries.
This is why we have cut our exposures to sectors such as hotels and airlines. 2009 could be a very bad year for companies that rely on urban discretionary consumption. Our FMCG fund has also moved out of retail stocks.
Which segments within infrastructure are likely to revive quickly from the stimulus?
Power and gas based industries do not have a problem. Remember we have three years of explosive growth 2006-08 in capital goods and infrastructure industries. 2009 will see a slowdown in these sectors despite the stimulus. But it may look up in 2010. Just after election, work doesn’t gather pace.
Which sectors are well-poised to face the slowdown?
FMCG, healthcare and, selectively, power and telecom. Automobile may be seeing a bottoming out. Then there are sectors such as banks with attractive valuations but with some concerns on the earnings front. So also with commodities. Not to forget that next year, both oil and gas production will increase in India providing a fillip to the entire economy.
If you were to take an asset allocation call today, would it be tilted towards debt or equity?
Equity by a mile. In our opinion market is very attractive for investment. The initial phase will see interest rates going down, during which time you should switch in to equities.
If you look back when steel or cement touched their all-time highs and you bought the stocks then, you would have lost 75 per cent or 35 per cent respectively.
Had you bought equities when GDP growth was at 9.6 per cent, you would have lost 60 per cent. So today, when GDP is at 5.3 per cent, the risks are actually much lower. Equity is an asset class to be bought on negative news and sold on good news. The negative news will come in the next six months and you have to use the opportunity to buy.
There have been three sets of stimulus measures including excise duty and service tax. Do you see that having an impact on specific sectors?
It has helped in confidence building. The revival in the auto industry may happen as a result of the stimulus, rural consumption, Government bus orders — a combination of these three factors. So, slowly, the economy may be moving out of the ICU, except in case of export-oriented industries.
Secondly, my belief today is that capex outside power is also having a problem. When the capacity utilisation of the entire industry is lower why would they want to invest in capex?
For CY09, corporate capex will significantly come down. You will see improvement in consumption based industry, in rural based industry but not in export industries and capex industries whose user industry is in trouble.
When are the lower commodity prices and borrowing costs likely to be reflected in corporate earnings?
In the April-June quarter. I think the entire inventory cleaning up process would be by March.
What I would like people to realise is that our index benchmarks are very commodity-oriented. I am not very sure if these companies will show any dramatic improvement in the April-June phase although the users of these commodities will show improvements.
If you see, the auto sector weight is low while metals and oil and gas is high. So April-June onwards, the non-index stocks will start doing better than commodity stocks.
In the ICICI Pru Growth Fund, you have an ‘underweight’ view on realty and are overweight on banking stocks. Will you hold on to this view even now, given the stimulus given to realty sector?
The problem with the real estate sector is that there is no history backing the companies. We had some marginal positions in one or two real estate stocks. But those were companies that had clearly identified one or two parcels of land, which one can understand.
Otherwise we have to get a conviction that the de-leveraging cycle in real estate has started to happen in a big way. This means that we want land bank to go down by way of sale of land or apartments; the borrowings of real estate companies should start coming down as a result of such sales. We will not otherwise look at the sector.
Bank stocks have been de-rated sharply on worries about margin pressures. What is your view?
Banking is a very mixed bag right now. One factor is in that the sector has already turned in high profit growth in the last quarter or so. NPAs will definitely go up from here. But are these risks already factored in to the current share price? There are today public sector bank stocks that trade at a significant discount to their book value.
That suggests that some part of the losses are already recognised in the valuations. My current view on banking is neither a strong buy nor a sell. Do the corporate earnings suggest that banks are better off being cautious in their lending?
My belief is that you ought to have been cautious in 2007 – in the up cycle. Take mutual funds – if you had been aggressive in choosing stocks in 2007, you paid the penalty in 2008. Today the so-called aggressive stocks are trading at very low levels. Is the risk now as high as in 2007? The answer is no. That is true even for banks. And after the downturn, you are looking at everything such as collateral values more carefully.
I think banks received too much in deposits in October to December and they do not have a mechanism to lend that avalanche of deposits aggressively. The problem for the banks was that the big borrowers were the oil and fertiliser companies. So all long as the big borrowers were oil and fertiliser companies, it was easier for the banks.
The second point is that working capital requirements for commodity companies are down. Suppose you have one tonne of steel that you need to finance. The money required to fund steel is 30 per cent lower than six months ago because steel price has come down. So also with petrochemicals and aluminium. So to maintain the same level of stock you need 30 per cent less money from the banking system.
Two, companies aren’t holding that much inventory. If you believe that steel will go up you will keep three tonnes instead of one. Today, you believe that steel will go down or stay flat.
So you bring down your inventory from three tonnes to one tonne. So the combination of price drop and inflation expectations being down, results in lower lending. So it makes it much more difficult for banks to lend in this environment.
In quite a few of your funds you are holding stock-specific call/put options. What is the strategy behind this?
Our strategy is that we want to be invested because we do not see any risk in being fully invested at this point. But we want to be invested as defensively as possible. The defensive routes include writing puts and in some cases, writing covered calls.
The strategy is used across fund-houses. We don’t think we should be in cash at this level of the market.
For a long time it was believed that consumption-oriented sectors are more immune to a slowdown. But now there are signs of slowdown in consumption and retail sales.
We have taken a call that consumption is of two types – rural and urban. We do not see any evidence of slowdown in rural consumption. In fact there are signs of growth. So we plan to focus on rural consumption industries (consumption with low unit value) and not urban discretionary spending industries.
This is why we have cut our exposures to sectors such as hotels and airlines. 2009 could be a very bad year for companies that rely on urban discretionary consumption. Our FMCG fund has also moved out of retail stocks.
Which segments within infrastructure are likely to revive quickly from the stimulus?
Power and gas based industries do not have a problem. Remember we have three years of explosive growth 2006-08 in capital goods and infrastructure industries. 2009 will see a slowdown in these sectors despite the stimulus. But it may look up in 2010. Just after election, work doesn’t gather pace.
Which sectors are well-poised to face the slowdown?
FMCG, healthcare and, selectively, power and telecom. Automobile may be seeing a bottoming out. Then there are sectors such as banks with attractive valuations but with some concerns on the earnings front. So also with commodities. Not to forget that next year, both oil and gas production will increase in India providing a fillip to the entire economy.
If you were to take an asset allocation call today, would it be tilted towards debt or equity?
Equity by a mile. In our opinion market is very attractive for investment. The initial phase will see interest rates going down, during which time you should switch in to equities.
If you look back when steel or cement touched their all-time highs and you bought the stocks then, you would have lost 75 per cent or 35 per cent respectively.
Had you bought equities when GDP growth was at 9.6 per cent, you would have lost 60 per cent. So today, when GDP is at 5.3 per cent, the risks are actually much lower. Equity is an asset class to be bought on negative news and sold on good news. The negative news will come in the next six months and you have to use the opportunity to buy.
LIC’s Jeevan Varsha: Appealing to some
Traditional insurance products such as endowment and money-back policies, which were on the backburner for the last few years, are now being relaunched by insurance companies.
While their absence was explained by the shift in preference to ULIPs, whose sales were pepped up by the bull rally, their resurgence now can be credited to the waning interest in equities. In this context, it comes as no surprise that LIC, after the huge successes of its single premium product, Jeevan Astha, has now launched a money back policy — the Jeevan Varsha..
A look at the salient features of the product.
LIC’s Jeevan Varsha is a close-ended money back plan with guaranteed additions. The plan provides for periodic payments of a proportion of sum assured at specified durations — on survival during the term of the policy and on maturity.
The plan provides for payment of sum assured on death, while guaranteed additions are payable on death and maturity.
Loyalty additions may also be payable during the last year of the policy on both maturity and death.
Eligibility condition: The minimum age at entry is on completion of 15 years and maximum is 66 years (nearest birthday).
Policy term is 9 and 12 years and the premium-paying term is nine years. Maximum maturity age is 75 (nearest birthday).
The minimum sum assured is Rs 75,000 for monthly ECS mode and Rs 50,000 for other modes. The sum assured can be increased in multiplies of Rs 5,000 and there is no cap on the maximum sum assured.
Premium payment modes are yearly, half-yearly, quarterly and monthly (ECS mode).
Survival benefits at the end of the third year are 10 per cent of the sum assured, 20 per cent at the end of sixth year, 30 per cent at the end of the ninth year and 40 per cent on maturity.
The Jeevan Varsha money back plan offers rebate of premium for the mode and sum assured. If the policy holder opts for yearly mode, the rebate is two per cent of the tabular premium.
The same is one per cent for half-yearly mode. For higher sums assured, it varies from Rs 2 for less than Rs 2 lakh and Rs 3.50 for Rs 5 lakh and above.
Guaranteed additions: The policy guarantees Rs 70 per year for a 12-year term and Rs 65 for nine years for Rs 1,000 of sum assured.
Who should go for it
In general, money back policies are more expensive than traditional endowment policies and Jeevan Varsha is no exception. However, it is an investment option that generates reasonable returns for investors in the higher tax brackets, who can reinvest the proceeds in a disciplined way.
Being a money back policy, there will be regular cash flows once every three years. For instance, at 30, if one takes the plan for a sum assured of Rs 5 lakh, the annual premium outgo will be Rs 78,497.
If he falls in the 33.9 per cent tax bracket, the net effective premium outgo will be Rs 51,887, after considering tax savings. At the end of the third year, he will receive Rs 50,000 (10 per cent of sum assured) as the first tranche of “money back”.
Let us assume he redeploys this money at the rate of 7 per cent and repeats this in the sixth and the ninth year. On maturity — the end of the 12th year — he will receive a sum assured of Rs 2 lakh (40 per cent of the sum assured) and guaranteed additions of Rs 70 per year for the 12-year period. For the sum assured of Rs 5 lakh , this will work out to Rs 4.2 lakh.
Taking into account a loyalty addition of Rs 50,000 at the end of the tenure, one will receive Rs 10.95 lakh for an investment of Rs 4,66,983, and this translates into a compounded annual return of 7.3 per cent.
However, the returns would be much lower for investors in the lower tax brackets. If one is in the 20 per cent tax bracket, his yield will drop to 5.7 per cent. Further, returns from this product will also be low for those who are not in tax bracket ; the return will be 3.7 per cent even if they reinvest the returns received from time to time. This plan, therefore, can be considered by investors who have not fully exhausted their options under Section 80 C.
While their absence was explained by the shift in preference to ULIPs, whose sales were pepped up by the bull rally, their resurgence now can be credited to the waning interest in equities. In this context, it comes as no surprise that LIC, after the huge successes of its single premium product, Jeevan Astha, has now launched a money back policy — the Jeevan Varsha..
A look at the salient features of the product.
LIC’s Jeevan Varsha is a close-ended money back plan with guaranteed additions. The plan provides for periodic payments of a proportion of sum assured at specified durations — on survival during the term of the policy and on maturity.
The plan provides for payment of sum assured on death, while guaranteed additions are payable on death and maturity.
Loyalty additions may also be payable during the last year of the policy on both maturity and death.
Eligibility condition: The minimum age at entry is on completion of 15 years and maximum is 66 years (nearest birthday).
Policy term is 9 and 12 years and the premium-paying term is nine years. Maximum maturity age is 75 (nearest birthday).
The minimum sum assured is Rs 75,000 for monthly ECS mode and Rs 50,000 for other modes. The sum assured can be increased in multiplies of Rs 5,000 and there is no cap on the maximum sum assured.
Premium payment modes are yearly, half-yearly, quarterly and monthly (ECS mode).
Survival benefits at the end of the third year are 10 per cent of the sum assured, 20 per cent at the end of sixth year, 30 per cent at the end of the ninth year and 40 per cent on maturity.
The Jeevan Varsha money back plan offers rebate of premium for the mode and sum assured. If the policy holder opts for yearly mode, the rebate is two per cent of the tabular premium.
The same is one per cent for half-yearly mode. For higher sums assured, it varies from Rs 2 for less than Rs 2 lakh and Rs 3.50 for Rs 5 lakh and above.
Guaranteed additions: The policy guarantees Rs 70 per year for a 12-year term and Rs 65 for nine years for Rs 1,000 of sum assured.
Who should go for it
In general, money back policies are more expensive than traditional endowment policies and Jeevan Varsha is no exception. However, it is an investment option that generates reasonable returns for investors in the higher tax brackets, who can reinvest the proceeds in a disciplined way.
Being a money back policy, there will be regular cash flows once every three years. For instance, at 30, if one takes the plan for a sum assured of Rs 5 lakh, the annual premium outgo will be Rs 78,497.
If he falls in the 33.9 per cent tax bracket, the net effective premium outgo will be Rs 51,887, after considering tax savings. At the end of the third year, he will receive Rs 50,000 (10 per cent of sum assured) as the first tranche of “money back”.
Let us assume he redeploys this money at the rate of 7 per cent and repeats this in the sixth and the ninth year. On maturity — the end of the 12th year — he will receive a sum assured of Rs 2 lakh (40 per cent of the sum assured) and guaranteed additions of Rs 70 per year for the 12-year period. For the sum assured of Rs 5 lakh , this will work out to Rs 4.2 lakh.
Taking into account a loyalty addition of Rs 50,000 at the end of the tenure, one will receive Rs 10.95 lakh for an investment of Rs 4,66,983, and this translates into a compounded annual return of 7.3 per cent.
However, the returns would be much lower for investors in the lower tax brackets. If one is in the 20 per cent tax bracket, his yield will drop to 5.7 per cent. Further, returns from this product will also be low for those who are not in tax bracket ; the return will be 3.7 per cent even if they reinvest the returns received from time to time. This plan, therefore, can be considered by investors who have not fully exhausted their options under Section 80 C.
Gold funds glitter : REALLY ??
Gold funds have been the best performing funds in the international funds category. Given that gold is viewed as a safe investment haven, the outlook for gold and gold mining companies remains bullish for the foreseeable future. In India, there are three funds either directly or indirectly invest in gold mining stocks.
Two prominent gold funds, DSPBR World Gold and AIG World Gold, delivered a whopping return of nearly 40 per cent in the last three months. DSPBR Gold, with a track record of over a year, fell just 12 per cent compared to a year ago levels.
This return has also been aided by the fact that the rupee has appreciated over 16 per cent in the last six months, and 28 per cent in the last year. Both these funds beat the benchmark FTSE Gold Mines index substantially, despite its being adjusted to rupee terms.
The returns generated by these funds don’t track the physical prices of gold, but ‘funds of funds’. They invest in overseas funds that invest in stocks of companies engaged in gold and other precious metals mining.
Similar profiles
The DSPBR World Gold Fund invests over 98 per cent of its portfolio in Blackrock Gold Fund, while AIG World Gold Fund invests nearly 86 per cent of its portfolio in AIG PB Equity Gold fund. Both these funds also invest in platinum, silver and diamond mining companies though limiting them to 9-15 per cent of their portfolios.
The return profile of both funds for the last several months has been broadly similar, as they invest in more or less the same set of same stocks. Unlike Gold ETFs, which passively mirror physical gold prices, “gold stock” funds may not always track the performance of physical gold.
Gold funds don’t immediately gain from a rise in gold prices as their performance depends, will in addition, on the earnings of mining companies and on the broader sentiment towards equity markets. In that sense a rise in gold price may translate into gain for gold stocks with a time lag.
Gold funds
The data from the financials of gold mining companies suggests that the cost of producing an ounce of gold has increased considerably over the last few years. But the realised rate per ounce of gold sold has also been increasing proportionately. With the costs now stabilising, the realisations may improve for these companies, which could have positive impact on such stocks.
Investors should note that those looking for a hedge against stock market swings may be better off with Gold ETFs, which faithfully replicate short-term gold price movements.
Gold stock funds, such as the one mentioned above, are for investors who are bullish on gold and are comfortable assuming higher risk, for a higher return from gold stocks.
Good fundamentals for gold, on the back of lower output and higher investment demand and an environment of escalating global uncertainty, augur well for gold-related investments at this juncture.
Two prominent gold funds, DSPBR World Gold and AIG World Gold, delivered a whopping return of nearly 40 per cent in the last three months. DSPBR Gold, with a track record of over a year, fell just 12 per cent compared to a year ago levels.
This return has also been aided by the fact that the rupee has appreciated over 16 per cent in the last six months, and 28 per cent in the last year. Both these funds beat the benchmark FTSE Gold Mines index substantially, despite its being adjusted to rupee terms.
The returns generated by these funds don’t track the physical prices of gold, but ‘funds of funds’. They invest in overseas funds that invest in stocks of companies engaged in gold and other precious metals mining.
Similar profiles
The DSPBR World Gold Fund invests over 98 per cent of its portfolio in Blackrock Gold Fund, while AIG World Gold Fund invests nearly 86 per cent of its portfolio in AIG PB Equity Gold fund. Both these funds also invest in platinum, silver and diamond mining companies though limiting them to 9-15 per cent of their portfolios.
The return profile of both funds for the last several months has been broadly similar, as they invest in more or less the same set of same stocks. Unlike Gold ETFs, which passively mirror physical gold prices, “gold stock” funds may not always track the performance of physical gold.
Gold funds don’t immediately gain from a rise in gold prices as their performance depends, will in addition, on the earnings of mining companies and on the broader sentiment towards equity markets. In that sense a rise in gold price may translate into gain for gold stocks with a time lag.
Gold funds
The data from the financials of gold mining companies suggests that the cost of producing an ounce of gold has increased considerably over the last few years. But the realised rate per ounce of gold sold has also been increasing proportionately. With the costs now stabilising, the realisations may improve for these companies, which could have positive impact on such stocks.
Investors should note that those looking for a hedge against stock market swings may be better off with Gold ETFs, which faithfully replicate short-term gold price movements.
Gold stock funds, such as the one mentioned above, are for investors who are bullish on gold and are comfortable assuming higher risk, for a higher return from gold stocks.
Good fundamentals for gold, on the back of lower output and higher investment demand and an environment of escalating global uncertainty, augur well for gold-related investments at this juncture.
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