Monday, January 26, 2015

Equity: Expectations for 2015

The equity markets is at an all time high, and has given 30% returns in 2014. Most people are under the impression that our markets have moved due to relentless FII buying. However, although 20% returns was due to PE expansion/liquidity, 10% returns was due to earnings growth.

India is in a sweet spot due to the following reasons:

  1. Have a strong, stable Government which is committed to reform.
  2. Falling oil prices. Oil accounts for 5% of the GDP. It is not only oil, but it appears that the Commodity Super Cycle with started in the 1980s may finally be over. This would help India’s manufacturing.
  3. Best demographics with a young working population
  4. There is still a very low penetration of durables in India. A small percentage increase in ownership of durables, would result in massive sales.
  5. Unlike other countries, we have no fear of deflation. Deflation is more difficult for government to handle. Japan has been trying unsuccessfully for the last 20 years.
  6. We are one of the countries who are at peak interest rates and are looking at cutting the same. This will improve Corporate India’s bottom line and spurt consumption.

The equity market is likely to continue to move up due to the following reasons:

  1.     Our GDP growth is still at 5.3 and we are looking at going back to 7% GDP growth by 2017.
  2.    Every $10 fall in oil prices boosts our GDP growth by 20 bps. Hence 1% growth should come from falling oil prices.
  3.      A well designed GST can boost GDP growth by 2%
  4.      Removal of slippages in Subsidies.
  5.    Corporate profits have historically contributed between 4-7% of the GDP. Currently corporate profits are at the lower end of the spectrum at 4.2%. EBITDA margins are at 18 years low – hence there is a huge scope for improvement. Falling commodity prices and interest rates will improve margins.
  6.      Government policy is affecting the factors of production
                   (a)  Land with Land Acquisition Act
            (b)  Labour with Labour reforms like 500 new trades included in the Apprentice Act, Firms employing less than 40 worker have some relaxation on the stringent labour laws, over time limit increased from 50 hour to 100 hours per quarter, night shift for women allowed,, etc
             (c)  Capital with FDI relaxation is areas like insurance, Defence, etc. Interest rates too are falling.
                  (d) Entrepreneurship – Government is trying to improve the ease the of doing business

4.     The Sensex is at all time highs. However it has to be kept in mind that in November 2004, the Sensex retouched a new high of 6100 (after February 2000) and then between that date and January 2008, when it touched 21000, the market kept on touching all time highs. You cannot miss out on this ride which if likely to happen again.

What should investors do now?

In Europe and the Americas, households prefer to put in 25-50 percent of their savings in equities. In India, the share is dismally low at around 3-4 percent. Indians invest in real estate, non-productive gold and fixed deposits. However it is with equity, can wealth be created over a long time.

Although it is good to know that equities future looks bright for the next 2-3 years, time in the market, rather than timing the market is what is important. HDFC Equity Fund was launched on 1 January 1995. In these 20 years there was the Asian Crisis, Pokhran blast and US sanctions, Tech bubble burst, Ketan Parikh scam, UTI crisis, BJP loses election, Lehman crisis, 2nd term for UPA, 2G, 3G and coal scam, QE 3 tapering warning, etc. In spite of this continuous turbulence, an investment of Rs 1,00,000 in HDFC Equity fund would now be worth Rs. 49,70,000 – and better still all returns tax free.

However, is should be remembered that investing is a plan and not a product. Although, the note is on the future prospects of equity, the plan would have to include some debt -  an asset allocation depending upon your risk profile and term of investment. It is only by sticking to the plan, that emotions of greed and fear will  not affect your investments. Otherwise see a Certified Financial Planner to assist you on your investment journey.          

Thursday, May 29, 2014

A Revolution in India

BJP won the elections with an overwhelming majority. Narendra Modi campaign focused on development and reviving the economy and the electorate has shown overwhelming support for this. Modi has proved himself in Gujarat. With a clear majority he will be able engineer structural reforms.
Modi has been fortunate enough to take over when the market is showing signs of bottoming out and there have been small signs of improvement. The Current Account deficit has definitely improved. The fiscal deficit was in line with the Budget, however that was the result of creative accounting. The weakening of the rupee as been arrested and with the prospect of the Modi government – has strengthened. Inflation is still high, but not going further higher.
“Modinomics” is likely to include the following:
·                         -   Enhance manufacturing competitiveness to create jobs.
·                         - Increase fuel availability to improve power generation.
·                         - Make railways a key enabler of the economy – “The Diamond Quadrilateral” project
·                          -  Maintain fiscal discipline to contain inflation
·                          - Improve agricultural productivity.
·                           -  Focus of tourism as an employment opportunity.
However, the equity markets have already run up by 31% from the multi-year range of 5500 of the Nifty.  Hence is there more to go?? Are the valuations of the market still attractive? To understand the markets, let us look at the last 10 years and also the next 10 years.

There are 3 things to look at when you study the equity market: GDP growth, Corporate profitability growth and valuations
     (a)   In the last 10 years the GDP has grown from Rs. 28.38 lac crores in 2004 to Rs. 112.13 lac crores in 2014 – CAGR of 14.72%.  Out of this 7.6% was real GDP growth and 7.1% was inflation. 
           (b)   Corporate profits have been in a range of 2% of GDP to a maximum of 7% of GDP. Currently it is 4.2% of GDP and in 2004 it was 4.7% of GDP.
           (c)   At 19+ times actual PE and 16.8 times forward PE the valuations are at the long term average. Between 2004 (Nifty-1772) and 2014 (Nifty-6704) there was a growth of 14.2% in line with GDP growth.
Hence realistically in the next 10 years:
  a. If the GDP growth is 13% and Corporate profits are 4% of GDP, and forward PE is at 16 times – all of the assumptions are very conservative – the Nifty will be at 22014.
 b.  Further, our GDP growth is at all time lows at less than 5%. Improvements in GDP growth and corporate profits, with increase the “E” – Earnings and hence the valuations will be more attractive.

400 years ago, the East India Company took the wealth of India by force. Currently they are taking over our wealth by stealth as FII holding in Indian companies have hit a record high of 25%.

Hence to get returns on your investment:
1           -  Believe in India’s future
2           - Have discipline to invest as per a plan.
3           -  Have patience to wait for the results. Investor returns have been much less than investment returns.
             -  Asset Allocation
5.          - Diversification
                          -   Re-balance


Wednesday, May 15, 2013


The Indian rupee has been weakening over the last 2 years. The question is that with the huge current account deficit, recovery may not be any time soon. A weak rupee, however, can help you make money – if you own International funds. These funds have given about 5% returns just with the rupee depreciation. Further it gives you geographical diversification too and the top 10 global funds available in India have given an average return of 22%, whereas Indian equities have been flat.

In the last 10 years in Asia, India has been the best performing county in 2007 and 2009. However, the year in between India was the worst performing country and our crash had been overdone, which resulted in a spike up the following year.

This year till date, the best performing funds are Japan and the US. Although, currently we have no way to invest in Japan, but there are currently 3 funds which have US dedicated investments, two of which started in the last one year. Hence in the last 6 months, the US funds have given the following returns:
  1. FT India Feeder Franklin US Opportunities Fund                  21.21%
  2. ICICI Prudential US Blue Chip Fund                                    18.25%
  3. DSP BR Flexible Equity Fund                                              17.23%

However, the standout global fund has been JP Morgan ASEAN Equity Offshore Fund, which has given a return of 23.54% over the last 6 months and 36% over the last one year. The major trading partners for ASEAN countries are other ASEAN countries and trading with Europe is just 1% of the GDP. ASEAN region is one of the few regions around the world where domestic demand is holding up well in a weak economic growth environment. The ASEAN region will continue to attract foreign investment seeking to take advantage of the consumption story. Indonesia and Thailand are in a strong investment led growth phase.

JP Morgan Greater China Equity Offshore also gave 21.75% during the last one year. This is inspite of the fact that the economic indicators coming out of China continue to be uninspiring. This is mainly because China has been underperforming in 2010 and 2011. China’s Price to book is currently at 1.6 times, which is at the lowest end of the valuations of the last 10 years.

Brazil is a commodity rich country and with the global economy not doing too well. HSBC Brazil fund gave just 5% return in the last one year. The HSBC Brazil fund price has not yet reached its launch price in April 2011.

There are other commodity stocks available – but these should be avoided until there are clear indications of a global recovery.

There is one thing to note – International funds are taxed like debt funds i.e. capital gains are payable.

In conclusion:
About 20% of your equity allocation should be in global funds to give you geographical allocation and also booster in returns due to rupee weakening. Hence I recommend half the amount be invested in US funds and most of the balance in the JP Morgan ASEAN fund and the rest in JP Morgan China fund. 

Thursday, March 14, 2013


Overview of the Economy

1.     The slowdown in the Indian economy is seen in the context of a global slowdown. Only China and Indonesia has grown faster than India. Growth has therefore fallen to 5%. Getting back to the potential growth rate of 8% is going to be a challenge. GDP growth this year is expected to be between 6.1% - 6.7%.

2.     WPI inflation is at 7% and core inflation has gone down to 4.2%. Food inflation is a worry, but steps are taken to increase supply side.

3.     Fiscal deficit will be at the planned level of 5.2% in the current year, and will go down to 4.8% next fiscal. The FM has pledged to reduce the fiscal deficit to 3% by 2016-17.

4.     Net market borrowing has been pegged at Rs. 484,000 crores. This is higher than what was expected. Gross borrowing is at Rs. 629,000 crores out of which Rs. 50,000 crores will be borrowed to buy back bonds maturing later, to smooth out the maturity profile. Hence gross borrowing is at Rs. 579,000 crores against Rs. 558,000 crores in the current year.

5.     Expenditure is expected to grow at 16.7% YOY, up from 9.7% in FY 13

6.     Gross Tax Revenues are budgeted to grow at 19.1% in FY14, up from 16.7% this year. This could disappoint unless growth picks up.  Total estimated receipts are up 23% from this year, which could be a stretch.

7.     Disinvestment target of Rs. 40,000 crores targeted.

Key Focus Area of the Budget

1.     Women: to stand in solidarity with the girl children and women. Pledge to do everything possible to empower them and to keep them safe and secure.
2.     Youth: to be motivated to voluntarily join skill development programmes.
3.     Poor: to benefit from the direct transfer scheme: this will be rolled out throughout the country.

Budget proposals, which will directly affect the Investor

1.     There is no change on Slab rates for personal income tax. However:
(a)   Tax credit of Rs. 2000 to be provided to every person having an income upto Rs. 5 lakhs.
(b) Surcharge of 10% for individuals whose taxable income is over Rs. 1crore.

2.     Surcharge increased to 10% from 5% on companies with a taxable income of over Rs. 1 crore. (5% for foreign companies). This increase is for 1 year only.

3.     Surcharge on Dividend Distribution Tax raised to 10% from 5%

4.     Direct Tax Code to be introduced in Parliament the current parliamentary session.

5.     First housing loan of Rs 25 lacs (value of property Rs. 40 lacs) would get an additional deduction of interest upto Rs. 1 lakh. This deduction can be claimed for a maximum of 2 years.

6.     TDS at 1% payable on the value of transfer of immovable property where the consideration exceeds Rs. 50 lakhs.

7.     Securities Transaction Tax has reduced for Mutual funds, equities, ETFs and Futures. However there will be a Commodities Transaction Tax on non-agricultural commodities.

8.     Rajiv Gandhi Equity Saving Scheme to include mutual funds as well. Further it will be applicable to those first time investors having an income upto Rs. 12 lakhs and will be applicable for 3 years.

9.     Inflation Indexed Bonds will be launched.

10.            Tax free bonds allowed upto Rs. 50,000 crores in 2013-14 based strictly on the capacity to raise funds in the market.

11.            Biggest blow to the debt mutual funds is the Dividend Distribution Tax of 25% + surcharge which comes to a total of 28.325%. Hence holding investment for a year and paying capital gains, would be the tax efficient way to invest in debt funds going forward.
Impact on the Equity Markets

As there were such high expectations from the Budget, the initial impact was negative. There were no specific steps to spur growth in the economy. After years of high fiscal deficit, it has become inevitable that the economy would need to go through a phase of fiscal consolidation.

Going forward equity investors would have to focus on earnings growth, and the global news flow. Rate cuts and continued FII inflows would help spur on the equity market.

Impact on the Debt Markets

The RBI should be pleased with the measures in the budget as it makes the right moves to tackle the Current Account situation and also addresses inflationary pressures. Hopefully, it can undertake monetary easing with a greater degree of confidence.

As most of the borrowing programme is normally front loaded, Open Market Operations are likely to continue as a theme. Interest rate cuts to the tune of at least 75 bps are expected this year, and hence a duration call can continue. 

Sunday, February 3, 2013


2012 was a great year for both the equity and the debt investments.

The Sensex moved up 25.7% during the year to close at 15455.  During the same period, true to form as an outperformer in up-markets, the midcap index gave a return of 38.5% to end the year at 7113. This is however following year 2011, where the Sensex fell 24.2% and the Midcap index fell 33.4%. In fact the Midcap index is still not at the 31st December 2010 level of 7715.  India has been amongst the best performing markets in 2012.

Debt market also gave great returns. The year started with yield of between 9-10% for very short term funds, medium and long term funds. The yields tightened further by March 2012. RBI had already announced that they would be no more interest rate rises during the year. However the 50 bps rate cut in April 2012 was unexpected and very welcome. The short term debt funds yields immediately fell giving capital gains in that category. By December, the clamour for further rates cuts, even by the Government was strident, and yields fell drastically in December. The Open Market Operations undertaken by the RBI (where they were buying Government Securities) ensured the 10 year GSec rates fell by about 30 bps in one month. However, the RBI governor gave only 25 bps repo rate cut in January, 2013, the run up of which has already happened in December.

How much can this all be repeated in 2013?

1.  Global Scenario

        With what started as a Lehman crisis and housing crisis in the US, swiftly spread all over the globe, especially to Europe. However, the European Union has not broken up although Portugal, Greece and Spain are in a depression and the rest of Europe is in recession. US GDP has started growing, however last month there was a negative figure. Shale gas discover in the US will be a game changer for that country.  China’s Purchasing Managers Index has been increasing indicating that the country’s manufacturing activity is gaining some momentum after slowing last year. The final EMI report for 2012 stated that although economic activity rose during the year, it was at a rate weaker than the average shown over the 4 years since the economic crisis in 2008.

     2. Foreign Institutional Investor inflows

             During the year, FIIs invested Rs. 24 billion in our equity markets. As the Indian investors are absent in the market and as the Domestic Institutions have to sell at every rise in the markets, we are reliant on FIIs to push the markets further up. However, with China’s improved manufacturing data, there is going to be a competition to being the recipient of FII flows.

 3.  Political Reforms

           There was a flurry of reforms in the last quarter of 2012 with the FDI in retail and aviation being passed, cap on LPG subsidies, hike in diesel and petrol prices and cash transfers and this all has boosted the market sentiment. Passing of the Goods and Services Tax and the Land Reform bill, if done, will be a game changer. However, the Government will start to focus on 2014 elections, and there will be no desire to control expenditure.

4.  Gold

       Gold which has shone brightly over the last few years lost their sheen in 2012, giving a 10.5% returns. In dollar terms the return has fallen to just 7%. With this run up in equities, the Mutual fund industry witnessed an outflow, whereas gold purchases continue to remain positive.

5.   Oil

        Brent crude averaged 2012 at $ 111 per barrel. It gained just 3.5% in the year after rising 13.3% in 2011. However as India imports most of its oil requirement, we could not take advantage of this low growth because of the weakening rupee. However the oil market rose sharply in January to $ 117 per barrel, and this is going to put further stress on our deficit.  US shale discovery has the country less dependent on importing oil.  Last month, Australia too discovered huge reserves of oil.

6.   Valuations of the market

              At the end of 2011, the Price/Earnings of the Sensex were 16.41 times and the Price to Book Value was 3.13 times. At the end of 2012, after a 25% growth in the Sensex, the PE of the market is now 17.53 times but the price to book value has gone down to 2.97 times. The average PE of the market has been over 19 times, hence we are below average valuations. Further in the December quarter results many companies are beginning to show a bit of a turnaround and will be re-rated.  We are coming to the end of the earnings downgrade cycle. However revival of the investment cycle may take some time.

    7.  Interest rates.

                RBI governor had indicated at the end of 2011 that he was done with rising interest rates, which was hurting growth. So far the RBI governor has cut 75 bps repo rates. However, he did sound a note of caution that if inflation remains stubbornly high, interest rates might not fall as fast as expected.

All the above points only let us know what the current situation is and do not let us really know in which asset class we should invest.

There are a few simple rules which allow us to take the stress out of investing:

  1.  Decide on your asset allocation between debt, equity and even gold, if you wish, depending upon the amount of risk you are willing to take. However, understand that equity will give the best returns of the three over the long term. 
  2.  If your financial goal is less than 5 years, invest only in debt funds. However, do consider the effect of inflation on your wealth creation, and ensure that your debt investment post tax gives you a higher return than inflation. This would mean investing in debt mutual funds which are more tax efficient. 
  3. If your financial goal is more than 5 years, then invest in equity. However profits in equity should be booked as the valuation of the market goes up. 
  4. If your goal is wealth management, then invest as per your asset association. Your asset allocation should be maintained when the PE of the markets are between 16 and 19 times. For every 1 point below 16 times add 5% to equity and for every 1 point above 19 times reduce 5% from equity.

As Bruce Greenwald, who is recognised widely as a value investor expert, said,           “There are no bad days in the market. When the market is down, you’ve got a bargain, and it’s lovely to think what you are buying at low prices. When the market is up, the bargains have gone, but you’re rich.”

Hence do not agonise at what the market is doing now and likely to do going forward. Follow the rules, or better still work with a Certified Financial Planner, and you will not have to worry achieving your financial goals or creating wealth. 

Tuesday, November 27, 2012


2008 crisis

With the collapse of Lehman Brothers, liquidity dried up, and so RBI cut repo rates severely – 9% to 3.5% in 6 months. Repo rates between Feb 2009 and May 2009 did not change, but the Government went in for some sort of quantitative easing and started spending and so without any changes in repo rates the yield went up to 6.5%. China went for investment stimulus and India went for consumption stimulus.- NEGRA, VIth Pay Commission, farmer loan waivers, excise duty cuts, etc. As there was no corresponding investment, there developed supply side constraints and the inflation pushed up. Current account deficit became a problem – India was borrowing from abroad to fund consumption.

3.50% repo rate bounded upto to 8.5% very fast. Exiting the 3 year interest rate hike cycles is not going to be easy. However going forward inflation will not lead to a rate hike by RBI, and ultimately there will be a rate fall. With a 5.5% growth rate,  RBI will have to do something to stimulate growth.

Current Situation:

RBI has been concentrating more on liquidity in the markets by reducing CRR by 25 bps in September, 2012.  There was an additional CRR cut by 25 bps in October, 2012.  Cash reserve ratio is the proportion of their deposits that they have to maintain in cash. They deposit this cash with the RBI. RBI uses CRR to drain excess liquidity or to release funds into the economy.

Growth is still very low. The June 2012 quarter GDP growth at 5.5% was slightly better than the March 2012 quarter growth. Growth was driven by Construction and services. The whole year’s growth is expected to be around 5-5.5%.

Exports declined 9.7% and dropped to $22 bn in August 2012 compared the normal range of $24-$25 bn per month. Trade deficit has therefore widened. The only positive was the slowing down of gold imports.

The tax revenues will be impacted due to the considerable slowdown in economic growth. There is also a grim outlook for budgeted receipts from disinvestment and telecom auctions. This would all adversely impact the fiscal deficit. The recent increase in diesel prices reduces the under recovery for diesel. The government has also confirmed that they will not be increasing their borrowings in the second half of this year.

Forex reserve at US$ 290.5 bn are at the same level of January 2008.  India’s import cover of 7-8 months is the lowest of the last decade. The average import cover for the last 10 years has been about 11.5 months. This is putting pressure on the rupee. To counter the rupee fall, RBI intervened in the forex market selling reserves of about $25 bn. However, the latest development on policy front has given some boost to the rupee. USD/INR will find it difficult to go below Rs. 53.

Credit growth has slowed down substantially. The biggest indicator of loan slowdown is the fact that both deposit and lending rates have been cut just at the start of the busy season on credit. This is a bullish trigger.

Persistent high inflation diminishes hopes of further rate cuts. Headline inflation in August 2012 came in at 7.55% versus 6.87% in July 2012. However, RBI has said that they may not actually wait of the inflation numbers to fall; so long as the momentum is in line with their expectations.

Debt Mutual Funds:

1.     Increased liquidity resulted in the short term rates falling sharply. Call market rates fell to below 8% and 1 year CD rates are currently at below 9%. Previously there was not much rate difference between the money market instruments and the longer term debt, but the rates at the shorter end of the interest rate curve has fallen substantially.

2.     Banks have front run the RBI by cutting interest rates. This is because of increased liquidity and banks are not looking at any credit growth. Interest rates are a based on demand and supply.

3.     There is has been a large demand for AAA rated paper and hence the interest rates have fallen by 25 bps and 40 bps. The 5 year AAA Corporate paper has fallen more than the 10 year paper.

4.     At some stage RBI is going to have to cut interest rates again to stimulate growth. However, without cutting interest rates the rates have been falling, because of increased liquidity and demand for paper to invest in.

5.     With the falling of short term interest rates, capital gains have already been earned in the short term debt funds. Thus short term rates are expected to remain within the range: 3 months CDs 8.4% to 8.65% and 1 year CDs 9.00% to 9.15%.

Hence going forward
1.     Hence need to look at debt funds of a longer duration currently. These could be more volatile, but with the inevitable cut of interest rates to stimulate growth as some stage, these funds would give 12%+ returns over the next year or so. Some longer term gilt allocation would be needed in the portfolio to give alpha.

2.    There is still a spread of about 1% between Corporate Bond funds and Government bonds. Hence these funds, with a longer duration, will be likely to give better returns – although the exit loads for these funds are longer – going upto 2.5 years.

3.    There is going to reinvestment risk, as the interest rates start falling. Hence at least 1/3rd of the debt portfolio would need to be in 3 year  FMPs. This is because after you earn on falling interest rates, by getting capital gains – going forward where would you invest. Would not really currently be looking at longer FMPs as the interest rates have fallen so sharply, and by that time we might be in the next interest rate cycle.

4.     If you do not currently have any short term debt funds, although there has already been a run in the short end of the interest rate curve, a small amount can be kept for stability in your debt portfolio. Further these too should give double digit returns as the fall is not totally over.

5.     Although there are accrual debt products – i.e. they match the yields (less expense ratio) with the modified duration – hence the capital gains on these products are minimal, but in a falling interest rates scenario, they should give better returns than FMPs. A small part could be in this.

6.      Finally, you need to be prepared for volatility in the debt market. There is a huge amount of FMP funds to mature in the near future. As the one year FMP rates have fallen to about 8%, these funds are going into debt funds, and hence even demand for debt paper is going to be there in the near future

Triggers for a Gilt market rally:
-         Interest rate cuts
-         Open Market Operations
-         Supply and Demand – with all the FMP paper maturing and banks demanding gilts for the year end.

Hence, start investing in debt mutual funds with a long modified duration (and with some allocation to gilts) and also in Corporate Debt funds.

Fixed Deposit vs Debt Mutual Fund

1.     With a fixed deposit, you get interest and at the end of the term you get your capital back.

2.     With a debt funds, the yield would be about the same as a fixed deposit, but over and above there can be a capital gain, when the interest rate falls. (the reverse can happen with rising interest rates). We are currently in the rare situation where RBI has clearly announced that there will not currently be any rising interest rates.

3.     The tax treatment also makes debt mutual funds more attractive. Interest on FDs attract income tax at your tax rate. Dividends are tax free and the fund pays Dividend Distribution Tax of 13%.

4.     For longer term debt funds held over one year, capital gain tax would be payable. If inflation remains high, the tax would be nil (indexing benefit), and could go up to a maximum of 10% (without any indexing benefit. This is more attractive than the highest tax rate of 30%.