Sunday, June 28, 2009

Understanding the 'BETA'

Investment in equities is marked by higher risk as compared to investment in debt or fixed income securities. Capital Asset Pricing Model (CAPM) describes the relationship between risk and the expected return on an investment. The investor needs to be compensated for the time value of money and the additional risk undertaken for investing in a risky security. The CAPM says that the expected return of a security or a portfolio equals the rate on a risk-free security plus a risk premium.

Beta is a measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.
The beta of an index measures the average volatility of the stocks comprising the index and is always equal to 1. A beta of less than 1 denotes that the security will be less volatile than the market and a beta of greater than 1 denotes that the security's price will be more volatile than the market. Stocks having a higher beta have the potential to give higher returns but they also carry a higher risk.

Analysis of 'Nifty' Stocks:
Past 12 month data of Nifty (May 2008- April 2009) reveals that the following stocks had the highest beta: Reliance Infra (1.81), Unitech (1.68), ICICI Bank (1.64), Suzlon (1.62), DLF (1.59), Reliance Capital (1.59), RCom (1.51). On the other hand stocks having the lowest beta are: Sun Pharma (0.28), Hero Honda (0.36), HUL (0.43), BPCL (0.49), ITC (0.50), CIPLA (0.52), Infosys (0.69). Traditionally, stocks with high beta, also known as momentum stocks, have given exceptional returns during bull markets. On the contrary low beta stocks, also known as defensive stocks, have given respectful returns during bear markets. One can take an investment decision by identifying the phase of the market and choosing the stocks accordingly.

Wednesday, June 24, 2009

Transparency in MF Investments

With a view to enforce transparency in Mutual Fund transactions, SEBI vide their order dated 18th June 2009 has proposed as under:
"There shall be no entry load for the schemes, existing or new, of a Mutual Fund. The upfront commission to distributors shall be paid by the investor to the distributor directly. The distributors shall disclose the commission, trail or otherwise, received by them for different schemes/ mutual funds which they are distributing or advising the investors."

This ruling is going to have far reaching consequences for MF investments in India. While the distributors are up in arms against the SEBI order, retail investors are confused about its impact on their pocket. Let us try to understand the impact of this order:
  • Indian Investors are largely dependent upon distributors for their investment needs. Last year SEBI had allowed investors the benefit of 'No entry load' for direct investments through the fund houses. Despite this benefit, less than 5% MF investments have been routed through the direct route. The apprehension of distributors losing out on business is thus quite unfounded.
  • Another apprehension is that investors may not be matured enough to understand the meaning of upfront fee. The relationship between the investor and the advisor is based on trust, and as long as the trust is maintained it may not be difficult to charge an upfront fee, like the brokerage in the case of equity investment. However, it will put the onus of record keeping of the commission earned on the distributor.
  • The level of advice to the investor may suffer, as the distributor may be inclined to sell MF schemes of large fund houses offering him higher 'trail commission'. But since disclosure of trail commission is also being made mandatory, the investor can decide after taking a view.
  • Initially, schemes like ULIP may score over MF schemes, as distributors continue to get higher commissions on these schemes. There is an urgent need to allow a level playing field by improving transparency of ULIP schemes, which fall under the purview of the insurance regulator (IRDA).

The SEBI move is likely to benefit all the market participants in the long run, after the initial hiccups. However, the need for investor education at this stage is very high, to enable the investor to understand the implication of the recent changes, and to ensure movement to the new regime in a smooth manner.

Friday, June 19, 2009

Indian Stock Markets and 'Budget Blues'

Presentation of the Annual Budget, the fiscal document of the Central Govt., forms a very significant event for the Indian Stock Market. Ever since the Government of India embarked upon the liberalisation process in 1991, this annual event has become all the more important for the market participants. This year this historic event is going to fall on Monday the 6th July 2009. Historically stock markets have given a negative return post budget (returns for one month after budget announcement) in 14 of the 18 years since 1991. Will the markets be able to break the post budget jinx in 2009?

Fortunately, the markets have entered a new orbit with the installation of a stable Govt. at the Centre, so a significant downward risk is almost ruled out post budget. The initial pre-budget euphoria has almost peaked out at around 15600 on the Sensex and 4700 on the Nifty. At the moment markets are not expecting too much from the budget, given the limited options available with the Finance Minister. If the markets witness a reasonable correction in the run up to the budget, it will be good for the long term health of the markets, since the valuations seem stretched at these levels. The events that could cast a negative shadow over the markets in the short term are: Spread of the 'Swine Flu' epidemic and the unsatisfactory advance of 'Monsoon' during the month of June. These events have the potential to pull down the indices substantially (Sensex to around 13000 and Nifty to under 4000).

If the pre-Budget fall materialises, it will be a good buying opportunity for long term investors.
The Budget is likely to spring some positive surprises, and if that happens markets can break the post-Budget jinx and head higher towards Sensex levels of 16000 and above. But the gains post budget will be selective and not across the Board. One can take calls on individual sectors after analysing the budget impact.

Sunday, June 14, 2009

Economic Recovery as seen by G8

The Group of 8 (G8) is a body of World's Top 8 industrialised nations. The G8 Summit was formed in the year 1975 by eight member nations: Russia, USA, UK, Japan, Germany, France, Italy & Canada. The European Union (EU) is its 9th member. The G8 Finance Ministers recently met at Lecce (Italy) to review the progress of global economic recovery. The view expressed by them is: "The global economic outlook is improving but the situation remains uncertain, and unemployment may continue to increase even after the growth begins picking up". The concluding statement made by G8 FMs is: "We are in the middle of the worst crises since the Great Depression".

Although the Group supported the government action in the wake of the financial crises, it noted that the stimulus must be consistent with the price stability and medium term fiscal sustainability. In view of the stimulus packages being detrimental to public debt putting inflationary pressure on the economies, several ministers felt it was time to scale back government action. The "Lecce framework" agreed to strengthen corporate governance, market integrity, financial supervision, and transparency of macroeconomic policy. The undercurrent of the Lecce summit was the concern about inflationary pressures and continued unemployment. These issues will be presented at the extended G20 meeting scheduled to be held at Pittsburgh, USA in September '09.

Wednesday, June 10, 2009

Principles of Value Investing: Margin of Safety

Timing the Equity Markets is a very tricky issue: otherwise how would one explain a near 100% gain in Sensex and Nifty levels from their March 2009 lows. Understanding the principles of 'Value Investing' propounded by Benjamin Graham and Warren Buffet will help investors earn a decent profit on their equity investments, despite the volatility on the markets. One of the underlying principles of Value Investing is 'Margin of Safety'.

In simple terms Margin of Safety (safety margin) is the difference between the intrinsic value of a stock as compared to its market price
. The term margin of safety was coined by Benjamin Graham & David Dodd in their seminal 1934 book, Security Analysis. Using margin of safety, one should buy a stock when it is worth more than its price on the market. This is the central thesis of value investing philosophy which espouses preservation of capital as its first rule of investing. Benjamin Graham suggested to look at unpopular neglected companies with low P/E (Price to Earnings) and P/B (Price to Book Value) ratios. As fair value is difficult to accurately compute, the margin of safety gives the investor room for error, and protects the investor from both poor decisions and downturns in the market.

Valuation is the process of determining the current worth of an asset or company
. There are many techniques that can be used to determine value, some are subjective and others are objective. An analyst valuing a company may look at the company's management, the composition of its capital structure, prospect of future earnings, and market value of its assets. Benjamin Graham defines "Margin of Safety" as the price at which a share investment can be bought with minimal downside risk. This concept is very important for investors, as value investing can provide substantial profits once the market inevitably re-evaluates the stock and its price moves closer to fair value. It also provides protection on the downside if things don't work out as planned and the business falters.

Analysing the current global scenario, nothing has changed so dramatically between March 09 and June 09 to warrant such euphoria on the markets. Some stocks have gone past their intrinsic value and do not merit investment at current levels, rather it would be worthwhile to book some profits at these levels.

Wednesday, June 3, 2009

General Motors Bankruptcy: End of an Era

General Motors Corp.(GM), once one of the biggest and the most profitable companies in the US, has finally filed for bankruptcy under Chapter 11. Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. Founded in 1908 by William C. Durant, it was initially set up as a holding company to acquire businesses of other auto makers. It went past Ford Motor Co. as the World's largest automaker in 1932, a position it held on for close to 76 years. Faced with stiff competition from Japanese car makers like 'Toyota' and 'Honda' in the late 80's, GM started offering heavy discounts to its dealers to push sales. However, it lost out to the competition on fuel efficiency parameters. GM reported a loss of US$ 8.6 billion in 2005, and since then it has been a downhill story for the once prized company. The recession of 2008 was the last nail in its coffin.

The bankruptcy is likely to lead to major changes and job cuts at the battered automaker. But President Obama and GM CEO Fritz Henderson both promised that a more viable GM will emerge from bankruptcy. The US Federal Govt. will pump in funds to the tune of US$ 50 billion to fund its operations during re-organisation. GM will ultimately become a state owned company with 60% Govt. stake, a victim of 'Laissez Faire' capitalism. The re-organisation will result in closing down Brands and dealership and cutting fresh jobs in excess of 100,000. Owners of current GM shares, which closed at under $1 a share on Friday, will have their investments essentially wiped out. According to GM's bankruptcy filing , the company has assets of $82.3 billion, and liabilities of $172.8 billion. That would make GM the fourth largest U.S. bankruptcy on record. The company that lost the global sales title to Toyota last year, is likely to slip further.