Wednesday, December 31, 2008

Year 2008 in retrospect

Year 2008 will go down as the most turbulent year in the history of Capital Markets across the globe. Anyone who took the risk of making a prediction about the markets at the beginning of 2008 has been proven wrong by the time the year comes to a close. Here is a summary of the major events that made 2008 as an extraordinary year in the lives of 'Investors':
  • Stock Markets in India registered their largest annual decline in history. The sensex recorded a decline of 52.5% over calender year 2008 (Falling from 20287 to 9647). Amongst its peers it is one of the worst performing indices, next only to Shanghai Composite which declined by 65.4%. The valuations of BSE sensex companies (PE Multiple) declined from an average of 27.7 to 12.4 by the close of 2008. During the year the sensex declined to a low of 7697 intraday, and the valuations went down to a pathetic level of 9. Foreign institutional investors took away over $13 billion from the Indian markets.
  • Commodity Markets played havoc with the fiscal deficit of the Govt. of India. Prices of base metals the Copper, Nickle, Aluminium and Iron ore went through the roof during mid year, causing a lot of distress to countries like India that are net importers of many of these commodities. Crude oil jumped to a high of $147/ barrel in July amidst excessive speculation, only to fall back to under $40/barrel by the end of the year.
  • Inflation played havoc with the budgets of invidual investors. In india WPI inflation peaked out at 12.9% in July, and closed the year at a comfortable level of 6.6%. Due to demand softening, inflation is likely to come down further to the levels of under 4% by the end of this fiscal. This leaves enough room for the Monetrary and Fiscal authorities to increase liquidity and cut interest rates aggressively.
  • Gold emerged as one of the best performing asset classes during 2008 giving a return of 4%, making it a eighth consecutive year of gains. Gold continues to glitter and is looking to extend its dream run in the next year as well.
  • Political Climate: After a lot of uncertainty and bloodbath, 26/11 marked a turnaround in Indian political scenario. The countrymen and the political leadership rose from their slumber to unite as a nation. The elections conducted immediately after 26/11 gave a clear message that sincerity and hard work will be rewarded by the electorate. By the year end the prospect of a new govt. in J&K under a young CM augers well for return of democracy in the troubled state. In the aftermath of terror attacks, Pakistan was pushed into a corner through diplomatic initiatives, and the involvement of LeT as the perpetrators of terror across the world was established beyond doubt. India also emerged as a strong nation by getting access to nuclear fuel without signing CTBT. ISRO's mission moon 'Chandrayan' also raised the image of India in the world.

The year 2008 has come to a close, let us hope year 2009 will bring a lot of cheer and prosperity to the 'Investor Community'.

Saturday, December 27, 2008

Significance of Volatility Index (VIX)

Volatility index is a tool aimed to help investors understand market risks better and take decisions accordingly. Volatility Index is a measure, of the amount by which an underlying Index is expected to fluctuate, in the near term, (calculated as annualised volatility, denoted in percentage terms) based on the order book of the underlying index options.
VIX, introduced in 1993, is the ticker symbol for the Chicago Board Options Exchange Volatility Index, a popular measure of the implied volatility of S&P 500 index options. Often referred to as the fear index, it represents one measure of the market's expectation of volatility over the next 30 day period. Investors believe that a high value of VIX translates into a greater degree of market uncertainty, while a low value of VIX is consistent with greater stability. Since inception till October 2008, the average value of VIX was 19.04. It reached an intraday high of 89.53% on October 24, 2008.
The chairman of the Securities and Exchange Board of India, Shri C.B. Bhave, launched the index called India VIX in April 2008. It captures the implied volatility embedded in options prices, and is based on the Nifty 50 Index Option prices. India VIX is a barometer of investor consensus on market volatility expressed through option pricing. Whereas the Nifty 50 signifies the directional moves of the market, India VIX indicates the expected near term volatility. How to measure the fear or uncertainty in the market? Generally, if the VIX is going up it means the fear in the market is going up leading to a market decline, and if we see the VIX falling it means the fear in the market is reducing leading to markets rising. Higher the implied volatility, the markets tend to correct to appropriate levels and vice-versa. India VIX after hitting a range of over 70% during October-November 2008, has since come down significantly. It closed at a level of 45.16% on December 26, 2008. However, a level of more than 40% still indicates a lot of fear amongst the market participants. The markets may not be out of the woods yet.

Tuesday, December 23, 2008

Insurance Update: Terror Cover

The recent terror attacks in Mumbai have raised an issue of 'Insurance against terror attacks'. As far as Life Insurance is concerned, there is no need for a separate terror policy if one is adequately insured. The thumb rule for adequate insurance is about 6-8 times your annual income. A typical life insurance policy covers death due to any reason other than suicide in the first year of the policy. Other options to cover the risk of terror attacks are: A personal accident insurance cover or a simple term insurance plan with a 'personal accident' rider. However, recently a unique exclusive terrorism insurance policy has been introduced jointly by a Delhi based insurer 'Optima Insurance Brokers' and 'Oriental Insurance Company'. The policy offers a 5 lakh cover at the annual premium of Rs 99 only, and can be availed through the online portal 'click2insure.com'. Policies like this are directed at middle class and lower middle class people who suffer from inadequate life insurance cover.
However, non-life insurance against terror is woefully inadequate in our country. Many companies are unaware of the level of terror risk faced by them. And, even after buying terror covers for their properties and possible business disruptions, companies do not clearly know how the personal and property claims from a terror attack could impact their balance sheets. Terrorism insurance is mostly offered as a rider or add-on cover to the main policies by domestic insurers. Internationally, it is available even as a standalone policy. Individuals can protect their property and valuables by opting for a terrorism cover under the householder's policy. This can be bought at an extra premium of 0.08%.
Terror claims are settled through a 'terror insurance pool' created by the non life insurers. The maximum rate of an add on terror cover is 0.22%, which is now proposed to be raised to 0.3% on the advise of the underwriting committee. There is also a suggestion to allow policy holders to opt for mid term purchase of terror cover.

Wednesday, December 17, 2008

Corporate Governance: Investor Concerns

The fiasco attempted by 'Satyam Computers Ltd' promoters for the benefit of family owned companies has brought the issue of 'Corporate Governance' to the fore. The backlash from shareholders to the move by the Satyam board was unprecedented, and the management had to backtrack on its decision within hours of its announcement. The promoters who hold less than 9% stake in the company have tarnished the image of the company, which may have negative global consequences on the future of the company.


What is Corporate Governance? It is as an internal system encompassing policies, processes and people, which serves the needs of shareholders and other stakeholders, by directing and controlling management activities with good business savvy, objectivity and integrity. Report of SEBI committee (India) on Corporate Governance defines corporate governance as the acceptance by management of the inalienable rights of shareholders as the true owners of the corporation and of their own role as trustees on behalf of the shareholders. It is about commitment to values, about ethical business conduct and about making a distinction between personal & corporate funds in the management of a company.” The definition is drawn from the Gandhian principle of trusteeship and the Directive Principles of the Indian Constitution. Corporate Governance is viewed as ethics and a moral duty.


In India, Kumar Mangalam Birla committe was constituted in 1999, to promote and raise the standard of corporate governance amongst corporate entities in India. It is applicable to all listed companies with paid up capital of Rs. 3 crores and above. It is implemented through clause 49 of the listing agreement between the company and the stock exchanges. Provisions of clause 49 are:

  • The Board will be comprised of 50% executive directors and 50% non executive directors, where there is a full time chairman
  • Constitution of audit committee with 3 independent directors and chairman having sound financial background- responsible for review of financial performance on a yearly/ half yearly basis
  • remuneration of non executive directors to be decided by board, disclosure of this information to shareholders
  • Atleast 4 meetings by the board in a year, directors not to be members of more than 10 committees
  • Management discussion and analysis report to include: outlook, risks and concerns, internal control systems, DISCLOSURE BY DIRECTORS ON MATERIAL FINANCIAL AND COMMERCIAL TRANSACTIONS WITH THE COMPANY.

Some more changes are in the offing as a part of the Company Law ammendment Bill.

Satyam promoters have violated the basic tenets of Corporate Governance, which has sent a wrong message to Foreign investors. The Govt. (Company Law Board) and the regulator SEBI have a responsibility to take requisite action against the defaulters to assuage the feelings of the shareholders of the company. This will send a strong signal to other promoters also, who may be thinking on the same lines.

Monday, December 15, 2008

What is 'Value Investing'?

Investors the world over have suffered huge losses in the current global financial crises, the impact of which has been catastrophic. Most of the countries in the developed world have slipped into a recession. Indian stock markets have also been negatively impacted by the global crises. Investors in India are a worried lot. To make money on the markets we need to understand the concept of 'Value Investing'.
This concept has been developed by ‘Benjamin Graham’ and ‘David Dodd’ in the 1930’s, and has been put to practice by many of their students, notable amongst them being the legendary billionaire Warren Buffet, Chairman and founder of Berkshire Hathaway.Value investing generally involves buying securities that appear underpriced by some yardstick of ‘Fundamental Analysis’. These securities may be stocks in public companies that trade at discounts to book value, have high dividend yields, have low price to earning multiple (PE ratio) or have low price to book ratio. According to Buffet value investing is buying stocks at less than their ‘Intrinsic value’. However, finding the ‘Intrinsic value’ of a stock is not an easy task. There is an element of subjectivity in arriving at the true intrinsic value of a stock. To overtcome this drawback, another important concept in value investing is that of ‘margin of safety’. The discount of the market price to the intrinsic value is called the ‘margin of safety’. Fundamental analysis is an attempt to study everything that can affect the security's value. It includes macroeconomic factors affecting the overall economy and industry such as inflation and intertest rates, and individual specific factors effecting the financial condition and management of companies.
Warren Buffet has identified four filters to succesful value investing:
· Invest in businesses that you understand
· Invest in companies that have favourable long term prospects
· Invest in conpanies with able and trusted management
· Invest in stocks that carry a reasonable price tag
The current market turmoil offers a great opportunity to identify 'Value stocks' and hold them for a reasonably longer period to see your investments grow. Buy on market declines to improve your 'Margin of Safety'.

Saturday, December 13, 2008

Indian Economy is not in 'Recession'

The worst fears have come true: India's IIP numbers for October '08 have turned out to be a negative 0.4%. IIP numbers are likely to stagnate for the month of November '08 also, putting pressure on the earnings growth of Indian corporate sector for quarter ending December '08. These may seem like dark clouds on the horizon. Does this mean that Indian economy is moving towards recession? The answer is an emphatic 'NO'.
Let us try to focus on the silver lining amidst the dark clouds to find an answer:
  • Inflation has moderated to reasonable levels, and is likely to decline further to below RBI's benchmark level of 5% in a few weeks time. The prices of food articles have also seen a decline in the past week. Crude oil prices, which accounted for a major portion of India's woes, have corrected substantially, and despite OPEC's call to cut production are not threatening to cut loose any time soon.
  • Interest rate cycle has peaked and we can hope to see drastic cuts in interest rates by the banks in the next few weeks. A further rate cut on REPO front by RBI may be expected towards the end of December. Demand will see a revival after the excise cuts announced by the govt. All this augers well for Corporate India, as the much needed money will be available at reasonable price to sustain growth projects.
  • FII outflow from Indian markets may be coming to an end. The signs are evident with the Rupee stabilising against the dolllar. India may benefit when overseas fund allocations are made for emerging markets at the beginning of 2009. As liquidity position eases in world markets, India will emerge as one of the preferred destinations for 2009, because the Indian economy continues to be one of the fastest growing economies amidst the global turmoil.
  • The mood of the people is quite upbeat, and more importantly the country stands more united to fight external threats. However, the political instability ahead of general elections may have a subdued effect on the markets in the short term. The slowdown in earnings also threatens towards one more leg of downward move on our stock market, but the base building exercise thereafter will lay the foundations of a strong upmove post May-June 2009, that is after the new Govt. takes charge at the centre.

The negative growth in IIP numbers may have been caused by the severe liquidity crunch faced by the industry in October '08. The situation has improved since then, and the positive factors discussed above should lead to a rebound in the last quarter of this fiscal. An economy growing at 6-6.5% in the worst case scenario, cannot be classified as an economy in recession.

Wednesday, December 10, 2008

Global Recession: How to cope with it

Economic recession is defined as: "a significant decline in the economic activity across the economy, lasting more than a few months, resulting in negative real GDP growth, fall in personal income, employment, industrial production, and wholesale-retail sales." In macroeconomics, a recession is a decline in a country's gross domestic product (GDP), or negative real economic growth, for two or more successive quarters of a year. IMF regards periods when global growth is less than 3% to be global recessions. The latest World Bank report has estimated that Global economy will grow by 2.5% in 2008, and the growth is likely to fall to a mere 0.9% in 2009. Going by this definition global economy is in the grip of a serious recession led by the largest economy USA which accounts for around 25% of World's GDP.
Economists and Central Banks across the world are grappling with the situation by cutting rates across the board, cutting taxes to spur investment and consumption. Although Indian economy is not in the grip of a recession, but a severe economic slowdown is feared due to the world economic crises. Recessionary conditions are often preceeded by stock market meltdowns and fall in real estate prices. India is also witnessing these depressing signals. But given its strong growth during the past 3 years and the fact that Indian economy is not an export driven economy, it is likely to bounce back to the normal growth trajectory ahead of the developed world and even China. But this may take atleast 6 months if not more.
Investors, who have seen their net worth/ investment erode rapidly in the recent past, are a worried lot. How can we cope up with this turbulent phase in the stock market? The volatility in the market has gone up substantially, and the daily movements are sometimes baffling the investors. The current uptrend in the markets has come as a pleasant surprise to many, especially after the Mumbai terror attacks. The Indian indeces are probably trying to catch up with the global indeces: India has been one of the worst performing global markets since November 21, 2008. There is still some steam left in the current upmove. It would be prudent to book partial profits/ losses if the market goes up by another 8-10% in the next few days. This cash may be kept safe to be re-invested in the next downturn. Negative news from the US could catch up with the markets soon. The slowdown in IIP numbers back home may also spell doom for the markets in India. If the markets are able to stay above the previous lows (2250 on the Nifty and 7600 on the Sensex), then we could see the end of this long Bear phase. Till then keep your fingers crossed.

Saturday, December 6, 2008

Fluctuating Crude Oil Prices: A crises brewing!

Crude oil for January delivery ended down $2.85, or 6.5%, at $40.81 a barrel on the New York Mercantile Exchange this Friday, the lowest closing level since December 2004. Oil lost 25% during the week, the largest drop since the week ended Jan. 18, 1991. Having fallen over $100 from the July 2008 peak of $147 a barrel, questions are being asked about the 'Fair Value' of Crude Oil.
Saudi Arabia’s King Abdullah has said $75 is a “fair price". Saudi Arabia has the world’s largest oil reserves and is OPEC’s biggest producer. When the king talks about a “fair price”, perhaps what he is referring to is a price which keeps afloat the Saudi treasury, not the state oil company. Citigroup Inc. estimates that Saudi Arabia, the world’s largest holder of crude reserves, must sell oil for an average of about $70 a barrel next year to finance its imports and domestic projects. The United Arab Emirates also requires $70 next year to balance its current account and fiscal spending, while Kuwait and Qatar both need $55 a barrel to break even.
How do we determine the Fair Price for oil? A fair price is one that gives producers an incentive to continue investing but does not compromise consuming countries’ economic growth. Global demand for oil is expected to climb from its present level of 82 million barrels a day, to 120 million barrel a day in 2025. For a matching increase in supply to occur, oil prices have to go up to encourage further investment. Europe and newly industrialized Asia (Including China and India ) import as much as 30 to 60% of their Oil needs. Japan is worst placed, where almost all of its Oil is imported. Let us turn to a bit of history: In 1971, an agreement between OPEC and oil companies recommended a gradual rise in oil prices of 2.5 per cent to keep up with inflation. The price of a barrel of oil then was only about $2, but the idea of adjusting prices to inflation was a reasonable. At present, a fair price for oil, after correction for inflation, is anywhere between $40 and $50 a barrel. And this price needs to be adjusted annually to compensate for inflation and to stimulate investment in the industry.
Let us find out what speculators have to say about Crude prices. "Crude oil prices could fall to as low as $20 a barrel in 2009 as falling U.S. demand outstrips Chinese growth", Hedge fund manager Jacques Mechelany told Reuters this week. Having already profited handsomely from the steep decline in crude prices, Mechelany intends to continue to take short positions in crude oil futures and selected oil-related stocks. "When oil prices begin falling leveraged investors have to unwind positions, further depressing prices," he said.
It is uncertain times ahead. In the short run it may benefit net oil importers like India, but falling oil prices leave little incentive for new oil exploration and it also reduces the political will to push through costly renewable energy initiatives. This may be detrimental for the global economy in the long run. All we require is stable crude oil prices, for which global steps need to be taken like curbing excessive speculation in commodity markets. The last round of global crises (market turmoil) was triggered by ballooning oil prices, the next round will perhaps be triggered by the falling oil prices.

Sunday, November 30, 2008

Economic Fallout of Terror Attacks

I had hoped that this time it is going to be different, and so it has been. The public outcry against terror is much more visible this time as compared to the past. While the country gets ready to fight terror on the political front (people are demanding a safe environment to live, heads have started to roll, irresponsible politicians are scurrying for cover, international community is being mobilised), it is the economic threat that looms large on the Indian economy.
India's external deficit has been mounting, with a slowdown in export growth. India's current account deficit was being financed through Foreign direct investment and NRI remittances. But the global financial turmoil has lead to flight of capital from India, it is estimated that about $12 billion worth foreign investment in Indian markets has been taken out since the beginning of 2008. This has lead to a lot of pressure on the Rupee. The impact of declining commodity prices including crude, which is a positive for Indian economy, has largely been offset by the declining Rupee.
Investors operating in international markets deploy capital in overseas markets based on their perception about the ability of the respective Governments to safeguard their citizens against terror attacks. Indian Government's ability to protect its citizens has suffered a severe jolt. The Indian market is not only facing flight of capital but the ability of Indian firm's to raise funds through ECB and Bonds is also drying up. The recent terror attacks are likely to accentuate the situation further. This may lead to a severe economic crises with the pressure on Indian rupee mounting.
India is a deficit ridden economy, which needs huge overseas capital infusion at this juncture. The Govt. needs to give positive signals to the world that it means business in tackling the menace of terrorism, but it has to rise above the vote bank politics. Luckily the Govt. has the tacit support of the masses to take some harsh political/economic measures in the long term interest of the Nation.

Thursday, November 27, 2008

Mumbai Terror Attacks: A serious blow to 'India Growth Story'

The nerve centre of India's commercial capital Mumbai is under siege by terrorists. Commando oprerations to flush out terrerists have started as I write this piece. In the past, markets have rebounded with vengeance after each terror attack. We have become so used to hearing the same old explaination of the 'Never say die spirit of the Mumbaikars' after each successive attack on Mumbai. Will this time be different?

Our hearts go out to those who have suffered during the troubled times. This is a time for serious introspection. This time it is going to be different, because this is a war on India, much worse than the 9/11 in the US. The anguish of the ordinary Indian has to come out openly to let the terrorists and the rulers think alike that enough is enough. It spells bad times for the markets, but then our survival as a nation is far more important than making a few bucks on the markets.

These attacks have come at a time when the economy is reeling under the impact of severe recession in the developed world. It will further erode the investor confidence in the Indian economy. Consumer confidence is also likely to suffer adversely. The immediate impact will be a pressure on the Rupee and falling bond prices. The end result will be a severe slowdown in the economic growth. The 'India growth story' will take a back seat for the time being. The ruling party at the centre is bound to fare poorly in the state elections under way. Meanwhile, investors should brace up for a turbulent period ahead in equity markets, the market may be heading for new lows in December. The worst hit sectors would be hospitality and transportation.

Let us hope our polity takes some positive measures to rescue the economy from this unprecedented crises, that essentially stems from our callousness in the past. This is a war on India and perhaps the last chance for the polity to revive the 'Spirit of the Nation'.

Saturday, November 22, 2008

Bond Market Investments

Bonds are a core element of any financial plan for investment and wealth creation. A bond is a debt security and the purchaser of a bond is a lender of money to a government, corporation, or any other entity known as the issuer. In return for the loan, the issuer promises to pay the lender a specified rate of interest during the life of the bond and to repay the principal (face value of the bond) on maturity. It is recommended that investors maintain a diversified investment portfolio consisting of bonds, stocks and cash in varying percentages, depending upon individual goals and objectives. Because bonds typically have a predictable stream of payments and repayment of principal, many people invest in them to preserve and increase their capital and to receive consistent interest income. Whatever the purpose—saving for your children’s higher education, buying a new home, planning for a stable retirement income or any other financial goal—investing in bonds can help you achieve your objectives. The diversity of fixed-income securities presents investors with a wide variety of choices to tailor investments to their individual financial objectives.

After you decide to invest in bonds, you then need to decide what kinds of bond investments are right for you as the bond market offers investors a lot more choices than the stock market. Asset subclasses of bonds include:
* Different maturities: long-term (10 years or longer), intermediate-term (3-10 year) or short- term (3 years or less)
* Different issuers: government agencies, corporate, municipal, international entities
* Different types of bonds: callable bonds, zero-coupon bonds, inflation-protected bonds, high- yield bonds, etc.

Bonds are considered less risky than stocks because bond prices have historically been more stable and because bond issuers promise to repay the debt to the bondholders at maturity. The bond markets are extremely active, with interest rates constantly changing in response to a number of factors including changes in the supply and demand of credit, monetary & fiscal policy, exchange rates, economic conditions, market psychology and, above all, changes in expectations about inflation. In the recent past, rising interest rates and expectations for economic slowdown have impacted bond prices. As interest rates change, so do the values of all bonds in the marketplace. However, changes in interest rates don't affect all bonds equally. Generally speaking, the longer the bond's maturity, for example a bond that matures in ten years is more affected by changing interest rates. Also, the lower a bond's "coupon" rate, the more sensitive the bond's price is to changes in interest rates.
Virtually all investments carry some degree of risk that you might lose some or all of your investment. When investing in bonds other than government-guaranteed securities, it's important to remember that an investment's return is linked to its credit as well as market changes. The higher the return, the higher the risk. Conversely, relatively safe investments offer relatively lower returns. Bonds that are below investment grade are considered speculative, sometimes they are also called 'junk bonds'. A government bond is a bond issued by a national government denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds. Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or simply print more money to redeem the bond at maturity.
In India, individual investors can consider investment in Bonds by direct investment in Bond issues or through Debt oriented Mutual Funds. The options for direct investment in Bonds include:
  • Govt. securities issued by RBI through banks- the tenure of these bonds can be between 2-30 years and interest is paid semi-annually. These can be held in a Subsidiary General Ledger (SGL) acccount maintained with your bank.
  • RBI savings Bonds- these are taxable and the tenure is fixed by RBI, interest is paid semi-annually or you can opt for the cumulative option as well
  • Infrastructure Bonds- issued by specific institutions such as NHAI, REC etc., they carry special tax exemptions under section 80C of IT Act, but have a 3 year lock in period. These bonds are rated by credit rating agencies. Loans can be availed under all the above bonds from banks.

Sunday, November 16, 2008

CHALLENGES FACING THE INDIAN BANKING INDUSTRY

Indian Banking sector has emerged almost unscathed from the recent global financial crises. The regulatory system in India has stood the test of time, as many renowned global banks have fallen from grace. The nemesis of the global financial system lay in their high-risk lending and ambitious derivative plays. In fact, the financial soundness of India's banking system means the sector "approaches the current financial turmoil from a position of strength," said Goldman Sachs economist Tushar Poddar. Comparing the subprime lending debacle that originated in the US to the "activities of a casino," Prime Minister Manmohan Singh said this month he wanted reform of the global financial system to tackle the "economically damaging role of excessive speculative activity".
The current crisis will not have a big impact on the health of India's banking system simply because the country did not have the exotic derivative instruments or permit the unsupervised mortgage lending that triggered the meltdown. Bureaucratic and regulatory controls that frustrated many international investors proved to be a good firewall for India's banking system against the credit virus from the West.
The major challenges facing the Banking industry are:
  • Development of new skills in Sales and Marketing: The growth is being driven by new products and services such as smart cards, e-banking, consumer finance and wealth management services in retail segment, and investment banking in the wholesale banking segment. All these activities require a high level of skill development amongst employees.
  • Windfall treasury income: The volatility of interest rates will ensure that the banks are no longer able to generate enough profits through treasury gains. With net interest margins already under pressure, weaker banks will suffer an erosion in profitability.
  • Competition from foreign banks: In the past few years the share of foreign banks in India has been declining, due to the restrictions on their expansion. With the implementation of the Basel II norms and the liberalization of branch licensing policy, foreign banks will emerge as a formidable force in the years to come.
  • Enhanced service quality: With the demographic shift in the profile of customers, the demands for higher level of customer centric approach are becoming evident. Banks will have to constantly upgrade their service platform to provide quick and efficient customer service. The redressal of customer grievances will also play a greater role in the choice of banks by customers.

Thursday, November 13, 2008

Inflation at 8.98%: Unravelling the 'Jigsaw Puzzle'

The rabbit is out of the hat. Inflation (That is measured by Wholesale price Index - WPI in India) is down to 8.98% as on 1st November 2008, as compared to the figure of 10.72% declared for the week before. This is likely to have a ripple effect on the mindset of the analysts, market operators. But for the common man the inflation data still remains a jigsaw puzzle: with the price of fruits and vegetables at their peak (tomatoes at 40 Rs. a kilo or potatos at 20 Rs. a kilo in the retail market), he is unable to appreciate the fall in the inflation rate.
In this blog on 24th August 2008, when WPI was at its peak of 12.6%, I had carried an analysis of inflation under the title 'Inflation: What lies beyond the figures!'. Let us once again try to unravel the mystry behind the figures:
  • In India the benchmark for measuring headline inflation is WPI (Wholesale price index), which is released every Thursday by the Department of Industrial Policy & Promotion (DIPP) under Ministry of Commerce & Industry.
  • As a consumer you and me are more impacted by the CPI (Consumer Price Index), generally CPI follows WPI with a lag effect, that is retail prices start falling at a later stage as compared to wholesale prices.
  • The WPI figures released every week, that haunt the headlines, must be taken with a pinch of salt. They represent the growth in inflation rate on a year to year(YOY) basis, so are influenced by the base inflation rate. In India the WPI during November 2007 was only 3.4%, so the low base effect makes the comparison look absurd.
  • The composition of WPI is loaded towards manufactured articles which account for 64% of the weightage, food articles and fuel & lubricant catagories account for 22% and 14% respectively. Whereas the CPI carries a weightage of over 50% for Primary articles.
  • The sharp fall in inflation figures on a week on week basis, as on 1st November 2008, is due to the sharp decline in commodity prices especially steel goods, and the sharp decline in price of unadministered petroleum goods such as Naphtha and Aviation Turbine Fuel (ATF)
  • If the Govt decides to reduce the price of Petrol and Diesel marginally, as is being widely anticipated, the WPI will fall below the 8% levels soon.
  • The spike in inflation in the past few months was due to international factors, namely the 'commodity bubble', which has burst leading to the sharp decline in inflation numbers. Authorities in India extended the inflation argument to the extreme and have stifled the economic growth in the bargain.
  • The collection of inflation data also leaves a lot to be desired, the Govt. machinery is inept in collating the figures realistically leading to distortions. That is why the provisional figures released are revised on a regular basis.

All said and done the WPI continues to decide the policy of the Govt. of India as well as RBI. In that sense this current fall is significant: it signals a softer interest rate regime, forcing the RBI to reduce Repo/ Reverse Repo rate shortly. This will reduce the interest burden on the companies, thereby improving their profitability. But the result will be seen from the Quarter ending March 2009, the results for Quarter ending December 2008 are likely to be depressed. The markets may initially cheer the good news. The fact to be appreciated is, that the long term India story still remains good despite the forecasts of a severe slowdown, but then forecasting in these tubulent times is fraught with a lot of risk.

Remember, Merril Lynch who forecasted Indian stock market (BSE sensex) to rise to 25000, when the index was around 20000 in December 2007, Merril Lynch itself got lynched in the process. Investors should, therefore, think long term and not get bothered by the whole lot of data dished out at regular intervals, who knows the fairness of the data. The real economy is much more than just a few sets of figures!

Monday, November 10, 2008

'ASBA' : SEBI's gift to small investors

The process of refund of application money to unsuccessful applicants is a cumbersome process which is responsuble for delay in listing of new issues on the bourses. To overcome these drawbacks, SEBI has introduced an innovative payment mechanism for retail investors applying for new issues and select rights issues. This payment mechanism is called Applications Supported by Blocked Amount (ASBA), and has been introduced with effect from September 1, 2008.
The salient features of the scheme are:
  • Available for retail investors (investors with application amount upto Rs. 1 lakh) for IPOs
  • All existing shareholders can avail of the facility in a Rights issue, provided shares are held in DEMAT form
  • Bidding allowed only at cut-off price
  • Bids cannot be revised
  • Bids may be in physical form or electronically through a branch of a Self Certified Schedule Bank (SCSB), where the investor maintains his account
  • The application money remains blocked in the account till the announcement of basis of allotment by the Company
  • In case of a successful bid the appropriate ammount is unblocked and transferred to the issuer company's account

The first company to benefit from the issue was '20 Microns Ltd'. The efficacy of this system will be tested only in a buoyant market. The system is expected to provide an incentive for small investors to aggressively participate in IPOs/ Rights issues.

Saturday, November 8, 2008

ULIPs De-mystified

Unit linked Insurance plans (ULIPs) are increasingly becoming popular with the investors. Of the new insurance plans sold during 2006-07, ULIPs accounted for 57% of them. Private insurers have been aggressively marketing ULIPs. Although ULIPs may be seen as a product akin to mutual funds, since they are sold by insurance companies they are to be treated as exotic insurance products, regulated by the insurance regulator IRDA. Let us try to unravel the mystry behind ULIPs:
  • What are ULIPs: ULIPs are essentially Term insurance plans with an add on investment option. ULIPs retain a portion of the premium towards risk cover and invest the balance in a mix of equity/ debt instuments. Being treated as an insurance products they are also entitled to tax benefits under section 80C of IT Act.
  • Flexibility: ULIPs offer more flexibility as compared to the traditional Insurance plans, where your money is mostly invested in debt. ULIPs allow the investor to choose an investment plan according to his risk appetite. They are thus structured as long term wealth creation products. Additional benefits available on a ULIP are riders to cover accidental death, medical insurance; and the facility for top up (additional investment) under the existing plan.
  • Charges: Generally, ULIPs levy charges in the shape of fixed upfront charges, as compared to Mutual funds where the the fund management charges are back ended. Thus the explicit costs in case of ULIPs are recovered in the initial years of the policy term. ULIPs may charge more than 30-40% of the premium as administrative costs in the inintial years, however, these charges reduce to about 1% by the 5th year. On the other hand, Mutual funds charge 2-2.5% as fund management expenses on an ongoing basis. Over a 10 year period, ULIPs are able to catch up with the returns vis-a-vis mutual funds, due to low recurring costs. It is, therefore, advisable to hold on to ULIP investments for long term.
  • Investment Risk: Traditionally, life insurance is seen as a risk mitigating proposition. Mixing investment with risk coverage may sound funny to some, as ULIPs expose the individual to a disproportionately higher risk as compared to pure term insurance. Ideally, a pure term insurance plan is suited to your insurance needs, but since an insurance agent gets a very low commission on term plans they are seldom promoted by them.

Considering the above facts, if you have decided to go for a ULIP policy, try to understand and evaluate the following facts before acting:

  • Administrative Charges payable
  • Amount of death claim payable
  • Exit charges payable
  • Partial withdrawals allowed
  • Flexibilty of Switching between plans
  • Don't get lured by fancy returns promised by your advisor.

Wednesday, November 5, 2008

Obama's landslide win: Is it a time to rejoice?

Barack Obama's meteoric rise to the head of the largest economy of the world has been greeted with euphoria across the world. A campaign that started off as a showdown against Bush administration's inept handling of international affairs culminated in the American people's resolve to get out of the financial mess that has been created by the meltdown at Wall Street. Obama may be entering the 'White House' with a lot of hope but the financial mess will require a lot of grit and patience to be cleaned up. Obama's relative inexperience will mean that a lot will depend upon the team that he is able to put in place to deal with the worst economic crises that the US is facing after the 'Great Depression'.

It is too early to analyse the impact of this change on the Indian economy, but going by Obama's utterings in a run up to the Presidential election, it could be a mixed bag for India:

Positives: Leaning towards socialism, a pro middle class approach; Likely increase in R&D spending in the US; Economic policy to promote alternative energy (Solar & Wind energy): Affordable Healthcare- increase in spending on healthcare. A caliberated, less threatening security environment, including a possible pull out of US troops from Iraq, Afghanistan may de-escalate the global threat to the security of India.

Negatives: Increasing tax rates on higher income groups - a threat to US spending; Massive increase in State controlled regulation over insurance, banks, hedge funds etc; Pricing power of Pharma exporters to US will decrease; Not likely to accept India as Nuclear state, may force us to sign CTBT; Lesser outsourcing - a dampner for Asian expats; May like to play the role of mediator in resolving Kashmir issue.

The world markets after the initial euphoria are likely to decline or settle in a groove, till such time concrete measures are taken to resolve the global economic crises. The road ahead for Obama is laid with a lot of landmines, where he has to tread cautiously - the entire world will be anxiously watching the steps of the 'New World Hero'.

Friday, October 31, 2008

One Year Period is too short to Evaluate Equity Portfolio

There has been a lot of turmoil in the equity markets around the world. October 2008 has been an extraordinary month for equity markets, with stock indeces sinking to their 3-5 year lows and the volatility index reaching alarming levels. But all said and done it is not fair to evaluate equity investments from a short term perspective. The longer your perspective the lesser the probability of your equity investments giving you a negative return.
The probability of loss in equity investments with a 1 year perspective is as high as 10/26 (ie. you are likely to witness an erosion in equity values in 10 out of 26 years. This probabilty keeps on reducing as your investment horizon increases: The probability of loss is 5/24 (3 years), 3/22 (5 years), 1/17 (10 years). That means that the chances of an investment giving negative returns is almost negligible in a 10 year period. And the average return given by BSE sensex over its history (1979 - till date) has been more than 17% per annum, doubling the value of your investment in slightly over 4 years. Is it possible to get these kind of returns from any other investment? Probably the answer will be no. The bad times in the equity markets will end over a period of time, investors have to be patient to reap the rewards from equity. But do keep booking profits from time to time to shore up your liquidity levels.

Monday, October 27, 2008

Samvat 2065: A Prognosis

The official Indian Calender goes by the Vikrami era: Currently we are in Samvat 2065 which kicked off on 7th April 2008. The Vikram era or Vikrami Samvat originated in 57 B.C. and the date marked the victory of King Vikramaditya over the Sakas who had invaded Ujjain. The official Indian Calender or the Vikrami Samvat is based on both the sun and the moon, it uses a solar year- divided into 12 lunar months . For stock market participants Diwali day marks the start of a new era, when they start their accounting year afresh. So it is customary to take stock of your investments from Diwali to Diwali every year.
Let us try to analyse what is in store for Indian stock markets for Samvat 2065. Since stock markets do not move according to individuals but according to the combined wisdom/acts of a large number of individuals, I am giving you a perspective on what different people feel about the markets in Samvat 2065, to enable you to understand and take informed decisions for the safety of your investment portfolio. I do not intend to give "My top picks", but to guide you to be able to pick your own Top picks.
Samvat 2065 is kicking off on Dalal Street on a positive note: I say a positive note because the worst is behind us, Sensex has made a new 3 year low of 7697 on 27th October 2008 (corresponding Nifty level is 2252). This gives us enough headroom for an upside till next Diwali. Let us consider 3 different views on the movement of the stock prices for the next one year:
  • Technical view: As I am not a qualified technical analyst, the views expressed here are of technical analysts on various media channels. Technical analysis should always be taken with a pinch of salt because it takes a short term view on the markets. Most technical analysts are of the view that the worst is not over, the sensex can dip to levels of around 6000 (corresponding Nifty level is 1600) before making a rebound, a scary picture indeed! But since the markets are oversold a sharp recovery of 25-30% in the immediate future cannot be ruled out.
  • Fundamental Analysis: This allows us to identify potential Blue chips based on certain parameters: 1. Earning Per Share(EPS) is the most important criteria to judge the intrinsic worth of a share. Growth companies show a consistent upward trend in their EPS. 2. The price that an investor is ready to pay for a share is the PE Multiple, which is measured as the current price of the share divided by its EPS. Since Debt or fixed income securities are giving a return of around 10% on your investment, a PE ratio should be higher than 10 for equities because of their high earning potential in the long run. The current PE of the sensex at 8500 levels is exactly 10 (on the basis of 2007-08 earnings). So fundamentally markets should not dip below these levels, but the markets do not always behave rationally. In January 2008 this ratio was as high as 28, however the average PE ratio of Indian markets has been in the range of 14-16. According to this analysis the fair value of sensex at the time of next Diwali should be between 13000-15000. However, all stocks in the sensex do not have the same PE ratio, which varies from sector to sector. A few blue chip stocks with a PE of below 10 at current prices are: Tata Steel(2.1), Hindalco(1.8), ONGC (3.5), DLF (4.5), Maruti Suzuki (6.8), RCom (7.2), RIL (7.4). To buy a particular low PE stock will depend upon its future growth potential because markets always discount the future. 3. Cash Ratio: Companies with a high cash in their books, will be able to tide over the liquidity crises in a much better way. On this basis real estate companies would be in more trouble in a crunch situation. Even those companies that have gone for acquisitions through high cost debt are vulnerable: eg. Tata motors, Tata steel, Hindalco.
  • Astrological View: As I am not a qualified astrologer, the views expressed here are of prominent astrologers like Bejan Daruwalla. Stock indeces, it is beleived, have some correlation with planetary configurations. The month of October 2008 was volatile because of the confluence of Saturn and Jupiter, which are now moving in a much favourable position from November 3, 2008. December 2008 will again be a volatile month when US markets are expected to plunge to new lows. The situation will start taking a better turn from February 2009, and June- July 2009 will mark the return of the bull run.

Based on the combination of above factors it appears that Samvat 2065 will bring a lot of cheer to the stock markets in the latter half. Historically the bear run takes around 18 months to complete, so June- July 2009 meets the target for the start of the new bull run. In the meantime, volatility would be high so keep booking your profits at regular intervals to keep your liquidity intact, which can be used for buying blue chips when prices are down. Happy investing in the Samvat year 2065.

Sunday, October 26, 2008

Global Markets Turmoil: A time to introspect

Diwali is round the corner, and there is a pall of gloom over the markets and in the minds of the investors. This will probably go down as the darkest Diwali in the living memory of most of us. This is because the sensex has lost over 53% of its value since last Diwali. It has fallen from 18737 (last diwali) to 8701 on 24th October 2008. The gains in the past 5 years (diwali to diwali) had been 50%, 57%, 32%, 27%, 61% respectively. So we are in a situation of doom after 5 years of boom.
Most of us have been teribbly off the mark in estimating the unprecedented fall in the markets. It's a time to introspect. Where did we go wrong:
  • Greed factor: Many investors entered the markets at the wrong time to make a quick buck, and have burnt a deep hole in their pockets. This definitely is not the time to sell and wow not to enter the markets ever again, rather it is the time to take a break, do not focus on the movement of the sensex for a few days. Maybe you can get out of the market in the next rally (or relief rally) which could give you an upside of 20-25% soon.
  • Fear Factor: Those investors who are having sleepless nights due to the fear of further losses, must take due care to address their stress levels, because inability to control stress can be fatal. Just remember, that the market was at unreasonable levels at 21000 on the sensex and even now at 8700 on the sensex. The fair value of the sensex is somewhere in between these two extremes. Wait for the cycle to complete, things will be back to normal in the next 6-9 months time.
  • Notional Gain/Loss: Those of us who have enterted the market with a long term perspective (long term would mean a period of atleast 3-5 years) have no need to worry. Do not count your paper losses, but wait for the market to stabilise. There should be no doubt in your mind that your investments would fetch you a decent return in the long term. If your liquidity position permits you may add to your investments at these levels to bring down your average cost of acquisition.

It will be wrong to hazard any guess on the immediate movement of the sensex, but historic factors tell us that the rebound in the markets is also ferocious after steep falls. So this time too the markets would rebound with vengeance, once the liquidity crises is addressed. But we have to wait patiently to catch the next outbound flight, you never know how much delayed that flight is.

Wishing all investors a happy and prosperous 'DIWALI'. May this Diwali bring back the happiness to the markets and in the lives of all of us.

Sunday, October 19, 2008

Liquidity crisis and RBI's dilemma

In January 2008 it was the case of excess liquidity driving the markets to crazy heights. Today it is the lack of liquidity which is driving the markets to unprecedented lows, which is far away from the fundamentals of the economy. RBI in its endeavour to give excessive importance to inflation management has stiffled liquidity in the markets. Inflation in India was mainly due to the commodity bubble which had burst in August- September 2008. RBI did not relax liquidity at that time, which has now cast its shadow on growth. The last weeks reaction of cutting CRR by 250 basis points and temporary repreive in SLR by 150 points is a step in the right direction, but it has come a tad too late. The impact of the cut is evident on some key rates, call money rates have eased to around 7% from 17%-18% last week. There is an urgent need to signal the end to the high interest rates by lowering the reverse repo rate by 50 basis points or more in the RBI policy announcement later this week. The market is gasping with baited breath for that 'lifeline'. Fundamentals of the economy remain qiute strong, hovever, the confidence of investors needs to restored at the earliest. Let us wait for the right signals from RBI on the 24th of this month.

Sunday, October 12, 2008

Gold as an Investment Option

Gold jewellery traditionally has been a favourite of the Indian women. Investment in gold has often been a bone of contention between the spouses in the family. So the next time if the lady of the house wants to buy gold the men folk should not discourage her, but guide her to buy and store gold in a more profitable way. Let us see how?
Historic perspective: The world stock of Gold as at the end of 2007 was 161,000 tons of which 51% existed in the form of jewellery. Demand for gold is widely spread around the world. East Asia, the Indian sub-continent and the Middle East accounted for 72% of world demand in 2007. 55% of demand is attributable to just five countries - India, Italy, Turkey, USA and China, each market driven by a different set of socio-economic and cultural factors. Jewellery accounts for around three-quarters of gold demand. In the 12 months to December 2007, this amounted to US$54 billion, making jewellery one of the world's largest categories of consumer goods. In terms of retail value, the USA is the largest market for gold jewellery, whereas India is the largest consumer in volume terms, accounting for 25% of demand in 2007.
There are a wide range of reasons and motivations for people and institutions seeking to invest in gold. And, clearly, a positive price outlook, underpinned by expectations that the growth in demand for the precious metal will continue to outstrip that of supply, provides a solid rationale for investment. Of the other key drivers of investment demand, one common thread can be identified: all are rooted in gold's abilities to insure against uncertainty and instability and protect against risk. On average, governments hold around 10% of their official reserves as gold, although the proportion varies country-by-country.
Asset allocation is an important aspect of any investment strategy. To counter adverse movements in a particular asset or asset class, many investors now strive to achieve more effective diversification in their portfolios by incorporating alternative investments such as commodities. Even a small allocation to gold may significantly improve the consistency of portfolio performance during both stable and unstable financial periods. Gold is widely considered to be a particularly effective hedge against fluctuations in the US dollar, the world's main trading currency. Gold is unique in that it does not carry a credit risk.
What is the most rewarding way of investment in Gold?
  • Investment in Jewellery/ Gold bars: Investment in jewellery form is the most innefficient way of investment in gold, as the making charges are too high and resale value is very low. Gold bars are an alternative, but they carry the risk of storage and theft.
  • Buying Gold on Commodity Exchanges: It does not tentamount to investment but speculation and the brokerage paid is quite high.
  • Buying Gold ETF's: By design, these forms of securitised gold investment, all regulated financial products, are generally referred to as Exchange Traded Commodities or Exchange Traded Funds (ETFs), and are expected to track the gold price almost perfectly. Unlike derivative products, the securities are 100% backed by physical gold held mainly in allocated form. In Indias currently 5 Mutual Funds are offering Gold ETF's. If you have to invest in gold, invest through this option. Your investments are totally safe and are subject to long term capital gains after one year like other MF schemes.

Ideally, one's portfoilo should hold 5-10% in gold.

Thursday, October 9, 2008

End of Off season 'Sale' on BSE/NSE !

It's time for investors to loosen their purse strings and embark on a buying spree: The great sale on BSE and NSE is about to end. Remember, The glorius Thursday (10th January 2008) when BSE sensex scaled an all time high of 21207. Exactly 9 months after that glorius acheivement, black Friday (10th October 2008) is going to unfold before your eyes. Where will the index go: 10,500 or maybe 10,200 or a four figure mark (maybe not).
There is mayhem in stock markets world over, this panic all around signals that the worst may be nearing an end. Authorities the world over are taking drastic measures to restore the confidence of investors with a slew of measures. Our authorities are the last to react. You will hear several positive announcements from the Govt. and the regulators in the next couple of days. The markets are poised for a decent recovery thereafter. Don't panic, buy good quality stocks from a long term perspective and relax. Sectors such as Automobiles, Banking, Oil & Gas and Infrastructure development will be good bets at this juncture. These kinds of off season sales do not last forever!

Monday, October 6, 2008

Global Economic Crises: Is Indian Economy in good health!

There is panic all around, markets world over are nervous. How about the health of the Indian Economy? Fortunately, the ground reality does not suggest any major danger signals for the health of the Indian economy. As per the latest data the growth in bank deposits and credit has been to the tune of 23% and 26% respectively. The credit deposit ratio is over 73%. However, the pinch of RBI's tight monetary policy was being felt on the liquidity position of the banks which has been duly addressed by RBI through reduction of CRR by 50 basis points.
Inflation is showing signs of cooling off: Crude oil continues to drift below the $90/ barrel mark, prices of essential commodities have stabilised- open market price of wheat is now below the minimum support price announced by the Govt., commodity prices have come down to reasonable levels. Although reduction in CRR has been termed as a temporary repreive, it signals the end of the high interest regime and the interest rate cycle seems to have peeked. All these factors auger well for the Indian economy. A temporary spot of bother, however, is the rapidly depreciating rupee. Once a trend reversal is evident in the price of rupee, foreign investors will return to India. Even a GDP growth of 7-7.5% for the Economy for FY09 should be considered excellent in the backdrop of global meltdown.
What about the Equity markets? The all round panic situation suggests that the markets have bottomed out. The bear phase that started in January 2008 is expected to last for about 18 months. We are midway through that period currently. While the first phase saw forming of lower tops and bottoms, we will soon see formation of higher tops and bottoms. While the policy in the first leg of the bear phase is 'Sell on every rise', the policy in the second leg of the bear phase is 'Buy on every decline'. It is time to accumulate blue chips for building a long term portfolio.

Monday, September 29, 2008

Have the Equity Markets Bottomed Out?

Their is Panic after the Euphoria. And equity markets are close to making a panic bottom in the next few days. In January 2008 nobody in the world would have told the Investors to book profits, similarly nobody is now telling the investors to buy into equity. The final panic signs are evident in the markets. With the rejection of US bailout package, world markets are in a state of panic, because of the liquidity crunch. These are clear signs of the markets bottoming out after a free fall.
Fortune favours the brave. Only those who will venture out in these turbulent times with their shopping bags will reap rich rewards in the future. It has happenned in the past, this time around there won't be an exception. At around 12000 BSE, the risk reward ratio is positive, as the markets trade at 12- 12.5% FY09 PE multiple. Anything lower than that is your bonus. The brave have to make a choice in favour long term investment. It is the right time to increase exposure to equity in your portfolio, because equity has always been a good long term bet.

Thursday, September 25, 2008

The American Business Culture

The rot in American business culture is a matter of public outcry now. Many CEO's have had such an obsession with the stock prices of their companies that they have often neglected their core businesses. These CEO's have many times taken decisions which only had temporary effect on their share prices, but jeopardised their long term business prospects. Perhaps the system of fat pay packets/ incentives is directly linked to the profits generated by the company. This leads to the root cause of the problem ie. 'Overleveraging'.

The very survival of a nation devoted to 'free enterprise' has been questioned by honest tax payers - Why should they be liable to bail out the unscruplous executives who have inflicted this financial pain, forcing the unprecedented Govt. bail out package. Consider this: Mr. Stanley O'Neil pocketed $161 mn. package before quitting Merril Lynch last year, Mr. Richard Fuld was able to pull out over $490 mn., while Lehman brothers was tottering. This smells of total lack of accountability, the role of Govt. regulators is highly questionable.

These and many other questions about the well being of the Financial system/ Business culture will continue to disturb investors and tax payers alike. We must bear in mind that markets are not a perfect reflection of the underlying worth of the companies you have invested in. But then is a State regulated system better than a Free market system? Given a choice the free market system is always better beacuse it helps in the price discovery process and also increases the efficiency. Markets at times may behave in a chaotic manner, but it is the duty of the regulators to restore normalcy in the long run. The investors, on the other hand, must not expect miracles from the markets in terms of returns, because the markets may not neccesarily always move up. Reasonable expectations from the markets are always fulfilled in the long run.

Monday, September 22, 2008

End of the 'Investment Banking' era on Wall Street

The memories of the 'Great Depression' of 1930's have returned to haunt Wall Street in 2008. It's an end to the 'Era of Investment Banking', with the last two surving Investment Banks viz. Goldman Sachs and Morgan Stanley opting for transformation into ordinary banks. The total bailout package announced by US authorities this year amounts to US$ 1.8 trillion, which is equivalent to 13% of US GDP. For academic interest this figure stacks up to 180% of India's GDP. Why was there a need for such a massive bailout? Are there any lessons to be learnt?


The 'Great Depression' of 1930's resulted in passing of the "Glass Steagall Act" in the US to promote stability of the Commercial Banks. It separated the business of traditional Commercial Banks from the more risk taking, glamorous banks known as 'Investment Banks'. The act provided for close regulation of the Commercial banks, but allowed more freedom and more leverage to the Investment banks. The Investment banks came under the purview of Securities Exchange Commisions (SEC's). The SEC's were deregulated in 1970's and in 1990's Glass Steagall restrictions on separating commercial banking from investment banking were relaxed. In this scenario Investment banks were forced to enter new businesses such as distribution of complex derivative securities to protect their profitability. The 2001 recession in US saw Federal Reserve cut interest rates drastically, leading to a negative savings rate and gave rise to a illusionary credit boom.


The US regulators failed to tighten the Capital inflows and Lending mechanism at that time leading to a runaway boom in US spending. The regulators failed to gauge the quantum of disproportionate risk taken by these investment banks. Investment banks like Bear Sterns and Lehman Brothers were leveraging their equity to the extent of 30 to 40 times. In this case even a 5% drop in valuation of assets would neccessarily lead to the company going 'bankrupt'. And that is exactly what has happened to these investment banks as a fallout of the sub prime crises. The credit rating agencies, unfortunately all the major credit rating agencies are US firms, failed to gauge the risk and continued to rate these investment banks higher than what they desreved. Whatever has happenned in US is more in nature of a 'Regulatory failure' rather than a 'Systemic failure'.


The US continues to be the most powerful economy despite the crises. Threfore, the tremors of this crises will continue to rock the financial markets world over. India may not be impacted directly by the crises, but the failed institutions have substantial investments in our markets. It will take some time before the crises blows over. Long term investors in the equity markets are advised to grab the opportunity to build a long term portfolio on steep market declines, preferably by investing in blue chip stocks or equity oriented mutual funds.

Friday, September 19, 2008

Wall Street Meltdown: A Blessing in Disguise for Indian Consumers

The recent crises on Wall Street, capitulation of Lehman Brothers, crises for Merril Lynch has had a catastrophic effect on commodity markets world over. The 'commodity bubble' has burst. This augers well for India which is dependent on imported energy. The commodity markets were subject of rampant speculation and the traditional rules of trading ie., the matching of demand and supply were thrown to the winds. With the commodity price correction, sanity has been restored in these markets.
The punters in global commodity markets are exiting in a hurry, because of the liquidity crises. The reduction in crude oil prices to around 90$/ barrel augers well for India's import bill. Oil will stabilse around the $100/ barrel mark in the short term, and the chances of a spike remain subdued, bacause of the slowing of demand. The demand for agricultural commodities for bio-fuel has also come down substantially after the crude oil crash. This will put less pressure on agricultural product prices. All this augers well for India in controlling the runaway inflation. The inflation has almost peaked out with the sanity returning to commodity markets. Indian Government's decision to sell wheat in the open market has cooled down the prices of cereals, and the record soyabean crop to be harvested soon will have a sobering effect on edible oil prices.
The prices of base metals on London Metal Exchange (LME) have moved southwards. Even steel producers are feeling the pinch. This may have a temporary negative effect on metal stocks, it augers well for the consumers of metals. This will ultimately lead to the peaking of interest rate cycle. The rate sensitive sectors like Banking and Automoblies are hoping for good times, with input cost reduction leading to a pick up in demand.
The myth that global commodity prices can only rise has been broken.

Saturday, September 13, 2008

FMP Vs FD: Where to invest?

With the stock markets on a decline FMPs have emerged as a popular investment option for retail investors. FMP's are essentially closed ended debt funds with fixed maturity offering indicative yield. Due to their tax efficient status they are being marketed as an alternative to Bank Fixed deposits (FD's). Several FMP schemes launched by various Fund houses have mopped up over Rs. 44,000 crores in the year 2008. The tenure of FMP starts from 3 months and the minimum investment amount is Rs. 5000.

How do FMP's compare with FD's?

  • The investment depends upon the risk profile of the investor. While FMPs may appeal to investors willing to take a little risk for that extra return; FDs will find favour with investors who are satisfied with a lower but assured return. This is because FMP's do not offer an assured return (the return mentioned is only indicative).
  • For investors in highest tax bracket FMP's are more tax efficient. In FDs, the interest income is added to the investor's income and is taxable at the applicable tax slab (or the marginal rate of tax).
    As far as FMPs are concerned, the tax implication depends upon the investment option -- dividend or growth. In the dividend option, investors have to bear the Dividend Distribution Tax. Whereas in the growth option, returns earned are treated as capital gains (short-term or long-term depending on the investment tenure). In the case of short-term capital gains (i.e. if investments are held for less than 365 days), the interest income is added to the investor's income and is taxed at the marginal rate of tax.
    As for long-term capital gains (if investments are held for more than 365 days), the tax liability is computed using two methods i.e. with indexation (charged at 20 per cent plus surcharge) and without indexation (charged at 10 per cent plus surcharge); the tax liability will be the lower of the two.
  • The liquidity aspect tilts the balance in favour of FD's. Bank FD's can be instantly encashed any time by paying a 0.5% foreclosure charge. Easy loans are also available against FD's. Banks these days offer attractive two-in-one accounts where Fd's can be switches to liquid deposits (Savings/ Current accounts) and vice versa. Premature payment on FMp's may still take a few days to realise. FD's thus come in handy in case of emergencies.

The investors can make their choice after considering the above mentioned facts. Ofcourse, please read the offer document carefully before investing!

Sunday, September 7, 2008

India N-abled: What lies ahead?

India has been able to obtain the Nuclear Suppliers Group (NSG) waiver, post Pokhran - 34 year nuclear trade embargo has ended. What are the ramifications of this historic achievement for the markets?
The way forward for India has been articulated by Dr. Manmohan Singh, the architect of this waiver: "We look forward to establishing a mutually beneficial partnership with freindly countries in an area which is important for both global energy security as well as to meet the challenge of climate change." It opens up business opportunities for technology flows for generating nuclear power in the country as well as export of technology from India. India has already established global leadership in research involving Pressurised Heavy Water Reactors (PHWR) and Fast Breader Reactors. India is exploring the possibility of exporting upto 220 MW reactors to developing nations interested in nuclear power generation. Private sector entry into nuclear power generation is possible only after Parliament ammends the Atomic Energy Act. However, private sector companies can supply equipment for nuclear energy as per existing arrangement. It is expected that in the long run i.e. by 2020, this deal will help India generate over 40000 MW of nuclear power.

The deal is positive for sectors such as Power, Defence, Engineering, IT, and Pharma research. How will the markets react?

  • Short Run: The markets are expected to greet the deal with a gap up opening on monday of anywhere between 3-5%. The benefits accruing to certain companies will be visible only in the very long term (5-10 Years). If the rise is too swift, marked by excessive speculation, these counters should be used for profit booking in the immediate short term.
  • Medium Term: The market looks good for a reasonable rise in the next few days, given the favourable economic data on inflation and commodity prices. The index has a potential to rise upto 15800 (NIFTY 4750) with ease. It can take the markets higher towards 16800 (NIFTY 5050), if liquidity improves and FIIs oblige. These levels certainly call for profit booking.
  • Long Term: The deal is good for long term prospects of PSU power generation companies, and defence suppliers like BEL. Engineering companies like L&T may also benefit substantially, but their high PE multiples put a question mark on their already stretched valuations.

It is time to celebrate and we can expect some fireworks on our bourses. But don't be carried away in the euphoria!

Saturday, September 6, 2008

REIT as a vehicle for Real Estate investment

In my last post I had discussed the prospects of real estate as an investment option. Real Estate Mutual Funds also known as Real Estate Investment trusts (REITs), offer an alternate investment option in Realty market. According to global consultancy firm KPMG 'Indian real estate sector is currently facing strong headwind due to the credit turmoil and rising inflation. REITs should help ease the situation and compensate to some degree the relative absence of public equity and challenging debt markets'.

What is a REIT?

  • An entity which pools in money and invests in real estate
  • Provide a similar structure for investment in real estate
    as mutual funds provide for investment in stocks
  • Can be publicly or privately held
  • Generally listed on exchange
  • Assets of the trust are managed by a Fund Manager
  • Provide taxation benefit to investors
  • Pass through available in some countries like USA if
    specified conditions are met.

REMFs are ideally suited for investors who are keen on investing in real estate but lack the technical knowledge or resources for such investment. Moreover, real estate market in India lacks proper regulation and is guided my rampant speculation. SEBI has come up with a draft proposal for launch of REITs in India. When approved, it will be known as SEBI REIT regulations 2008. This will have two main objectives:

  • Help meet the capital needs of the Real Estate sector,
  • Allow small investors to participate in the Real Estate growth.

The salient features of the SEBI draft guidelines are:

  • The trust and management company must have a net worth of minmum Rs. 5 crores
  • All schemes offered bt REITs will be closed ended and will be compulsorily listed.
  • The net asset value (NAV) of the schemes will be disclosed yearly based on the valuation report prepared by the principal valuer.
  • The scheme will invest only in viable real estate, the contract value of uncompleted projects should not be more than 20% of NAV.
  • Investment in vacant land is not permitted.
  • A trust shall not have an exposure of more than 15% of any single real estate project, and not more than 25% in all real estate projects developed, marketed, owned by a group of companies.

The launch of such trusts/funds is taking time because of the shortage of professionals especially in the valuation of real estate. Effective valuation of each underlying property has to be extremely clear, before the decks are cleared for launch of REITs in India. Whever such an opportunity arises REITs will form an attractive option for retail investors to invest in Real Estate.

Wednesday, September 3, 2008

Real Estate Prices: Heading for a Crash!

Real Estate has been considered as one of the Investment options. How does it compare with other investment options? Real estate carries more risk than most other investments due to lower liquidity and a very high degree of speculative interest. According to projections by ASSOCHAM, retail and real estate sectors in India are expected to grow at over 30% qnd 40% respectively in the next 2-3 years. The market size of the real estate sector is currently estimated at US$ 15 billion.
In India the real estate boom took off in 2003 on the back of very low interest rates and low prices. However, the situation has changed now with realty prices going up 3-4 times, while interest rates are 60-70% higher. Incomes have certainly not grown four-fold in the past four years. The prices currently being quoted are simply atrocious. The question that bothers a lot of prospective home buyers is whether they will miss the bus if they wait any further. However, the right question should be: Can I afford to buy a house today? Unfortunately there is no index for the real estate market which allows us to measure the returns accurately.
The stock markets have historically moved ahead of the realty market. Stock markets have already entered a bear phase and realty sector is showing signs of weakness. Are we heading towards a crash in the real estate market? The ground reality is certainly pointing towards such a situation. Rising interest rates have lead to a slowdown in demand. Speculators are exiting the markets. The tightening policy initiatives of RBI have left little money for real estate development. The developers have finnced their projects through expensive private equity and are now feeling the heat. According to industry estimates over Rs. 8000 crores of real estate projects covering over 40 mn. sq. feet are facing delays, leading to cost overruns. And there are no genuine buyers at these rates.
Just like the Price-Earning multiple (PE) decides the worth of a stock, Price to Rent multiple is relevant for deciding the worth of a real estate investment. If you invest in a 2/3 BHK flat in Suburban Mumbai/Delhi NCR for 1.00 cr. ( priced at Rs. 30 lacs 3-4 years back), the expected rental would be around Rs. 25000 per month, which gives an annualised return of 3%, which is not even sufficient to cover your interest cost, assuming that most of the realty transactions are financed through banks. And you still think that you will find a buyer for this property if you wish to sell. Isn't it a bubble in the making?
Delhi Development Authority (DDA) has recently come out with a scheme to sell around 5000 flats through a draw of lots, and is expected to collect over 5,00,000 applications. Most of the applicants are speculators applying with the sole purpose of reaping allotment gains after 3 months. This reminds me of the Reliance Power IPO which was oversubcribed 72 times, and what happened to it on listing is history now.
Like in the stock market, it pays to be patient in the real estate market too. For realty market to sustain itself, there should be a steady inflow of end-users. Speculators and investors can only take it to a certain level. End-users can only come when prices are affordable and for that at least 30-40% correction is a must. If you are planning to buy a property now think twice before making a final decision. It may be a bubble waiting to burst!

Sunday, August 31, 2008

Pension Funds: Their impact on Equity Market

Pension Funds constitute a pool of assets created by contributors to a pension plan for the exclusive purpose of pension plan benefits. In India only about 10% of the citizens are covered by the defined benefit plans like the Govt. servants. Pension funds serve as an important vehicle for social security of the people not covered by defined benefit plans.
Pension Funds worldwide are important shareholders of listed and private companies. According to analysts Pension funds have assets worth more than US$ 24 trillion wordwide. It is estimated that about 5% of this corpus is likely to be invested in Indian equity markets. In the US pension funds invests 70% of their corpus in equity related instruments. In October 2007 SEBI allowed pension funds to register as FII's. About 40 such funds have registered with SEBI during the past eight months. This includes 15 of the world's top 20 pension funds. Pension funds due to their large capital base and longer term investment horison, are more stable amidst market turmoils.
In India pension funds were initially not allowed to invest in equities. Pension Fund Regulatory & Development Authority (PFRDA) was established in 2003, and it launched its New Pension Scheme (NPS) in January 2004. The scheme has collected funds of around Rs. 3500 crores so far. Under the scheme upto 15% of the corpus can be invested in equities and the balance 85% in fixed income securities. The amount to be invested in equity may be hiked, depending upon the PFRDA bill which is likely to be tabled in the Lok Sabha in the winter session next month. State Bank of India, the country’s largest bank, has floated SBI Pension Funds Pvt Ltd (SBIPFPL) to manage investment of the contributions made by the employees of central and state governments who choose to join the scheme, SBIPFPL has got the maximum share among the fund managers and will manage some 55% of the corpus. Life Insurance Corporation of India and UTI Asset Management Company Pvt. Ltd are the other fund managers.
The impact of such large inflow into Indian equity markets will have a positive impact on the markets, and at the same time will lend a semblence of stability to our markets. The full impact of Pension fund investments will be seen in our markets from January 2009 onwards. If you beleive in this story, and its potential for our equity markets, do get ready to board the stock markets - but wait for the next correction to increase your commitments. The long term story of Indian equity markets is going to be written by the Pension Funds.

Friday, August 29, 2008

Current Economic Indicators: Is it a time for Euphoria?

WPI inflation rate down to 12.40% from 12.63%, GDP growth for first quarter at 7.9% - greeted by the markets with euphoria, BSE Sensex up 516 points and Nifty up 146 points. What are the reasons for this optimism? Are the markets out of the woods?
Let us try to analyse the ground reality to try and find an answer to the above questions:
  • Inflation Rate: The rate of WPI inflation for week ended 16.08.2008, has shown a marginal decline over the past week. The major reason for the decline is the decline in prices of non administered petroleum products like naphtha. But the statement from RBI chief are not assuring, calling for cautious optimism. The WPI which is heavily loaded with the weightage of manufactured articles, is not a better representative of inflation and often leads to misleading connotations. CPI (Consumer price index) is a better parameter, andthe effort on the part of authorities should be to track this index which has remained more stable as compared to WPI in the recent past. Any overoptimism on the part of RBI to furthen tighten interest rates may be catastrophic for the Economy.
  • GDP growth: The GDP figures for the first quarter of this fiscal at 7.9% (as compared to 9.2% a year ago) are the lowest in the past 14 quarters, and call for a closer scrutiny. The break up of the GDP figures are (Figures in brackets are the figures for last year): Agriculture 3.0(4.3), Mining 1.7(4.8), Manufacturing 5.6(10.9), Electricity & gas 7.9(2.6), Construction 7.7(11.4), Services sector10.1%. There are some alarming signals too: Gross fixed capital formation has decelerated to 9% from 16.7% a year earlier. However private consumption expenditure has remained stable at around 8%. Slowing of capital expenditure does not auger well for the economy, as it is a negative on the supply side impact on inflation.
  • Global Commodity prices: The decline in global commodity prices has been responsible for the euphoria in Indian Markets rather than our internal factors. Crude oil prices are in a range between 112-122 $/ barrel, which is considered positive for India. Indian equties are being seen as a good hedge against global commodity prices. This could lure FII's to India in the near term. The current uptrend is again going to be sustained on the back of foreign liquidity.

Our internals will take some time to improve. So don't be mislead by the euphoria so soon. It may not be the right time for fresh equity investments, but it certainly will be a profit booking opportunity if the markets go up by another 10%.

Sunday, August 24, 2008

Inflation:What lies beyond the figures!

In a layman's language inflation is a situation arising out of too much money chasing too few goods, leading to a rise in price level. Runaway inflation is detrimental for the consumers, especially the weaker sections of the society. The dilemma before the Govt/RBI is to strike a balance between growth and inflation. The frequent increases in CRR and REPO rates leads to hardening of interest rates across the board, which is detrimental for the producers leading to a slowing down of economic activity. If this situation continues for long, ultimately the consumers will have to bear the cost of the economic slowdown.
How far are our monetary authorities justified in sacrificing growth for the sake of controlling inflation, can be gauged by looking beneath the inflation figures released on a weekly basis. There are two kinds of inflation indeces in use in India: i) Wholesale Price Index (WPI), released on a weekly basis by the Ministry of Industry. ii) Consumer Price Index (CPI), declared on a monthly basis by the Ministry of Statistics and Programme implementaion (MoSPI). The figures that capture the headlines are the figures for WPI, which has reached a level of 12.6% for the week ended 9th August 2008. The latest available figures for the CPI for June 2008 are 7.3%, a good 5% lower than the WPI. Why this huge difference? The composition of WPI is Primary articles (22%), Fuel, Power. Light etc (14%), and Manufactured products (64%). Primary articles account for more than 50% weightage in the CPI. Another anomaly is in the calculation of point to point inflation. WPI shows the movement of prices on a Year on year (YOY) basis. A higher base effect reduces the figure while a lower base effect inflates the WPI. This is exactly what has been responsible for the unprecedented rise in WPI since May 2008.
How far is the Govt. responsible for this situation and what is the solution? The Govt. itself is to be blamed for the situation to a large extent. It cannot merely pass the entire blame of the rising prices on International commodity prices. The figures for WPI inflation are highly inflated because of the low base effect. In its endeavour to keep the inflation below the 5% level, Govt. kept the prices of petroleum products at depressed levels, even reducing the prices of petro products twice during the past year. It is now reflected in the higher WPI. Infact, in most of the countries CPI is considered to be a better representative of the price levels. MoSPI is in the process of revamping the CPI for Urban Workers, which is likely to replace the WPI as a broad measure of inflation by the middle of next year.
The International commodity prices including crude oil have started softening, therefore, there is little need for the RBI to pursue further tightening measures, which is likely to stifle growth rate.
Once the base effect blows over, WPI inflation will fall to single digits by the end of the year. The growth of Indian Economy remains intact despite the global slowdown. Investors with a long term perspective (minimum 12 months) can hold, even fresh buying can be initiated at lower levels.

Sunday, August 17, 2008

A slowing economy: Who bears the cost?

It's from the horses mouth! Prime Minister's Economic Advisory council (EAC) has projected the GDP growth rate at 7.7% for Fiscal 08-09. What is more disturbing is the projection of a higher inflation rate. Other concerns are on the deficit front: current account deficit is expected to mount to 3.2% of GDP as compared to 1.5% for the last year, off balance sheet(budget) liabilities are estimated at 5% of GDP. On the top of it their no let up in the hawkish stance of RBI, pointing to further tightening of strings, maybe leading to another round of interest rate hikes. All this does not auger well for the equity markets.
The cost of the economic slowdown will be borne by companies with high capex plans having good exposure to debt, and short sighted investors, who do not invest with a long term view. However, with the higher pay packets for govt. employees, and soon to be followed by PSU employees, consumption driven growth will be robust. Companies in the consumption space will continue to grow, provided they are able to reduce their costs, because most of the growth will be volume driven.
In such circumstances we have to rely on fundamental analysis. Most analysts have downgraded the growth in profits for fiscal 08-09 for sensex companies to under 15%. This broadly translates into a sensex EPS of around 950, and on a reasonable PE multiple of 15-16, this translates into a sensex number of 14250-15200. In a more pessimistic environment the PE multiple can go down to 12, and in a very optimistic environment (provided inflation stabilises at under 7% and crude oil stabilises in the 80-90 $/ barrel range) it may go up to 20. There is every possibility of the sensex going to 12500 levels again, which I feel will be a good time for long term investors to enter, provided you keep your aspirations at a reasonable level of gains at around 20% for one year. Do invest through good equity oriented mutual fund schemes at these levels.
Apart from equities, it will be prudent to invest some money in long term Bank deposits, as they will give you a decent real rate of return once the inflation falls to under 7% by March 2009, as expected by EAC.

Sunday, August 10, 2008

Make Hay while the Sun Shines

The stock markets are in an intermediate uptrend. Is the trend likely to continue? What are the factors contributing to this uptrend? What should I do at this juncture? These are the questions uppermost in every investor's mind. Many of us may have seen huge erosion in our portfolio in the past. This intermediate uptrend has reduced those losses to a large extent. It will be prudent to book partial profits/losses at this juncture, because the immediate fundamental factors do not point towards a runaway bull run. Even technically, the best case scenario for the Nifty is 4950, and for the Sensex close to 16500.
Let us analyse the factors responsible for the current uptrend and their sustainability:
  • Falling Commodity prices: The commodity prices have cooled off recently. Indian economy is largely dependent on imported crude and the fall in crude prices to around $115/ barrel augers well for our growth prospects. The same set of analysts who were projecting oil prices to zoom towards $200 are now predicting them to hit $90 per barrel very soon. Ultimately, global demand for oil will decide the course of oil prices. The demand from asian countries has not tapered off as yet, so oil can rebound towards the $140 mark, before heading back towards double digit mark, probably in the last quarter of calender 2008. The speculators would also fuel the bounce back for a safe exit from their speculative long positions in oil futures. The investors should take the current opportunity to book some profits in refinery/oil marketing companies.
  • Interest rates: The interest rate sensitive sectors like banks, real estate, automotives have been leading the current uptrend, not because any change in fundamentals, but because they were extremely oversold. The interest rates have not yet peaked out. The PSU banks have cleansed their books of NPA's due to the farm waiver scheme, but have not made due provisioning in their books to reflect the loan waiver. It will be good for the banks in the long run, when the deffered payment is received by them during the next four years, but this fiscal will put a lot of pressure on their profitability. Real estate prices are in for a rude shock. The demand has slackened, and credit is not available, so many real estate players may find it difficult to complete their projects on time, posing a threat to their profitability. Any bounce in the Bank, Realty stocks should be used as an opportunity to exit.
  • Political stability: Althuogh the govt is making a lot of noise about reforms, its ability to carry out big ticket reforms is limited. The season of agitation, dharnas, bandhs has already started, and will only escalate in the months to come, causing serious disruptions in economic activity. This situation is likely to have a negative impact on the profitabilty of companies and the markets.

The moral of the story is: 'Cash is King', so make hay while the sun shines.