TIME TO INVEST IN GILTS

Gilt/income mutual funds have two types of returns:
1. The interest return from the investment
2. Movement in the NAV, due to movement of the yield of the fund. If the yield goes up, the NAV falls, and if the yield goes down the NAV rises.


Current Yields

Currently the 10 year Gilt yields are 7.97%. They did go up to 8.15%. However, with the RBI announcement on 2nd November, of a 25 bps increase in repo and reverse repo rates, the 10 year bond yields actually fell. This is because the RBI clearly indicated that there is likely to be no more interest rate changes in the near future.

The average 10-year g-sec yield since January 2002 has been around 7.04%. Also, whenever yield crossed 8% during this period, it has not sustained that level for a long time. It did stay well over 8% for over four months in 2008, when there was a severe credit crisis.

Currently, only in 3 other countries - Pakistan (13.4%), Venezuela (13.05%) & Greece (8.82%), 10 yr G-sec trades at a yield higher than India. YTD, the yields in India has increased but decreased 295 bps in Indonesia, 232 bps in Philippines, 143 bps in South Korea, 121 bps in Thailand, 149 bps in Brazil and 130 bps in US.


Factors which are likely to cause fall in yields

1. Inflation
Inflation as measured by the Wholesale Price Index (WPI) peaked in April 2010. It is likely to moderate further because:
(a) RBIs policy of tightening liquidity.
(b) High base effect
(c) Positive impact of good monsoon.
(d) US/Euro region continue to show weak economic growth. China is showing signs of a slow down. This should result in commodities remaining stable on moving lower.

2. Fiscal Deficit
The fiscal deficit is expected to show an improving trend over the coming years, due to the following:
(a) High realizations from 3G and BWA auctions
(b) Increased prices of petrol and diesel (to be de-regulated over time). Prices of LPG and kerosene were also increased. Government finally showing signs of controlling oil subsidies burden.
(c) Tax collections have been above budget estimates
(d) Inflows to the Government due to disinvestments in PSUs

3. Increase in FII Limit
Government has recently raised the limit for FII investment in Government bonds to $ 10 bn from the earlier $ 5 bn, subject to certain maturity restrictions. The large rate differential between developed markets and India could attract offshore investors and potentially lead to increased flows in longer maturity government bonds.

4. Credit Off take unlikely to Surprise
Non-food credit growth is likely to move in the range of 20-22%. With RBI’s tightening measures over the past few quarters, credit off take is unlikely to be significant higher than market expectations.


HENCE, yields are likely to fall over medium term. Therefore, allocation to long-term bonds/ gilts is preferred and should give double digit annualized returns.

Sensex 20,000 + levels

Do not look at 20,000 Sensex level as a peak, which was attained more than two years ago. This is only a level in the journey of the Sensex.

In the Short Term, the Sensex level will depend upon the following:
1. Events in India and globally.
2. Liquidity flowing into the market
(a)Foreign Institutional investors are continuing to invest in the equity
market. Net FII investment during the last three months were
i. Rs. 24978.5 crores in September 2010
ii. Rs. 11587.5 crores in August 2010
iii. Rs. 16617.4 crores in July 2010

(b)As the risk free returns in countries around the world are low, there are
opportunities of returns higher than the proportionate risk they are
taking, and hence the flows into our markets.
(c)If global recovery is stalled, Governments are already talking about
Quantitative Easing 2, which will result in further liquidity.
(d)As long as the dollar continues to remain weak, flows will continue into
India, as there are additional returns from the weakening dollar.
3. Sentiment
(a) There is no euphoria in the markets. Retail investors continue to be
skeptical. Equity mutual funds saw the largest outflows ever in September
at Rs. 72,000 crores.
(b) The last stage of the bubble is normally a surge in small and mid cap
stocks. The BSE Mid Cap Index is 19.9% below its peak and the BSE Small
Cap Index is 26.7% below its peak.


In the long run, the Sensex movement will depend on Corporate earnings. The Indian markets have traded around 15 to 16 times one year forward earnings. Today we are trading at about 18 times one year forward earnings. So let’s remember the fact that we are trading above our historical averages of the last 15 to 20 years. However, we are still lower than the peaks of 25 times in 2000 and 23 times in January, 2008. With the growth in corporate profits, and subsequent re-rating, this PE ratio should come down.

Hence going forward, the corporate earnings have to be watched very, very closely to ensure that they are not faltering. The positives in the market are:
1. We are domestic consumption driven economy with a young population
2. National Rural Employment Scheme, which results money in the hands of the rural population
3. Oil Sector deregulation
4. GST Reform
5. Direct Tax Code.
6. Fiscal situation improving with higher than expected 3G auction, and regular disinvestment.

IF YOU ARE ALREADY INVESTED IN THE EQUITY MARKET
1. Re-balance you portfolio, to maintain the equity: debt ratio you are comfortable with. Studies have shown that 94% of your returns come from maintaining a disciplined asset allocation
2. If you are mainly in equity, then do book out profits regularly. Do not allow greed to swamp your emotions. If the market then subsequently falls, you can then add to equity again.
3. Fresh investments too have to be in the ratio your asset allocation.

IF YOU ARE STARTING INVESTING IN THE EQUITY MARKET
1. Look for the long term, minimum of 3 – 5 years.
2. Invest through a Systematic Investment Plan or Systematic Transfer Plan.
3. Invest in proportion to your asset allocation, although if you are looking at a long term of more than 5 years, can take a larger exposure to equity.


There is no other investment opportunity that gives you the possibility of 15% + tax free returns, and hence there is no option but to invest into the equity market. However do understand the risks involved on the short term, and plan for the long term.

However, never try and time the market. This can have disastrous results on your returns For example:

1. Since April 2000, the Sensex has given an absolute return of 276%.
2. If you had missed the 10 best days, the return would be 216%
3. If you had missed the 20 best days, the return would be 159%
4. If you had missed the 30 best days, the return would be 110%

“Far more money has been lost by investors preparing for corrections, or trying to anticipate corrections, than has been lost by the corrections themselves.”
Peter Lynch – legendary fund manager

INVESTMENT IN CHINA

According to British author Sir John Bagot Glubb, the seven stages of an empire’s life cycle are as follows:
1. The age of outburst / pioneers
2. The age of conquests
3. The age of commerce
4. The age of influence
5. The age of intellect
6. The age of decadence
7. The age of decline and collapse.

“The 19th century was the century of UK, the 20th century was the century of the US, and the 21st century is going to be the century of China.”
- Jim Rogers.

“China is going to be an enormous force that will make the Japanese threats of the seventies and eighties look like a water pistol.”
- Jack Welch

HOWEVER IS THIS THE RIGHT TIME TO INVEST IN CHINA?

1. .Valuations
a. China has been one of the weaker markets in 2010.
b. The market is currently trading at 12.3x 2010 earnings (12m forward earnings as at 28 June) with an EPS growth of 24% in 2010, 16% in 2011 and a trailing price to book of 2.4 times. India PE is currently 16x 2010 earning with an EPS growth of 27% in 2010, 9% in 2011 and a trailing price to book of 3.5 times. Hence currently India is more expensive that China.
c. Market is now pricing in too many concerns about future growth.
d. The numbers suggest that China is trading in line with its long-term historical average and at a discount to India.


2. Announcement on RMB
a. The latest announcement on the RMB has been a welcome step in the right direction.
b. This step was long awaited by not only investors but also governments across the world. We feel that this step might not provide any immediate impetus to the markets, but it does give the citizens of China better purchasing power in dollar terms over the next several years as China resumes its managed appreciation of the RMB.
c. The gradual approach is a positive step for exporters who could have been badly hurt had the Government decided to facilitate a one-off appreciation of the RMB.

3. CBRC and the Banking Sector
a. CBRC, the banking regulator in China, has indicated that "Stress Tests" have been undertaken to determine the sensitivity of loan books to the property sector. CBRC has concluded that property prices could fall by up to 30% in China before the banks would likely experience any material adverse effects.
b. CBRC also has strict liquidity requirements for Chinese banks and Tier 1 capital requirements in China now exceed those most developed markets. The capital raisings are a function of the extra-large loan growth seen in 2009 as the banks financed part of the Government's stimulus package.

4. Real Estate sector - prices
a. Real Estate or Property Sector has been hit the most in the current downturn.
b. Many Property companies are currently trading at well below their Net Asset Values.

5. Inflation
a. Inflation currently stands at 3.1% (May 2010).
b. Food price inflation has moderated since 2009, especially pork prices, which is an important meat staple in China.

6. Exports
a. Export data continued to surprise on the upside in May and June. Stronger than expected recovery in exports to USA and Europe and continued strength in exports to other emerging markets are driving growth.
b. Expect exports to developed markets to moderate in the coming months but exports should provide modest positive growth contribution in 2010.

7. Other Positives
a. Strong income growth for many years, and wages rising this year.
b. Almost no household debt, except mortgages.
c. Gradual rising availability of consumer finance.
d. Urbanisation means size of consuming population is increasing.
e. Retails sales rose 16.8% last year up from 2.1% in 2008
f. Urban household expenditure rising 9% YOY for last 3 qtrs.
g. Supportive Government policies/



CONCLUSION

Although our markets are likely to give us great returns going forward, do take a small exposure (of a maximum of 5% of your portfolio) to China. Further, as the Chinese market is also likely to be volatile, make this investment in small installations. Currently the easy ways to invest in China are:

1. Hang Seng ETF through the stock market
Return of 9.3% over the last three months.
2. JP Morgan JF Greater China Equity Offshore Fund
Investments, apart from China, also includes HongKong and Taiwan. Fund was launched in July 2009 and the returns till date is 8.04%. Returns of 10.66% over the last three months
3. Mirae Asset China Advantage fund
This is a pure China fund and was launched in India in October 2009. Return of 11.49% r over the last three months.

ASSET ALLOCATION – THE KEY TO INVESTING

Studies have shown that Asset Allocation is the key to investment success. 94% of investment success is explained by asset allocation where as the product selection and timing contributes 4% and 2% respectively. And yet most of us spend the majority of our time trying to time the market – a totally futile exercise.

Asset Allocation normally refers to investments in Equity and Debt in a certain proportion. Equity means investments in shares of companies and brings growth to the portfolio. Debt refers to lending and brings regular income to the portfolio. The allocation between equity and debt would depend on the risk you are willing to take and the term of investment. Having an asset allocation would give the following benefits:

1. When the equity market moves up, you would reduce your holding to equity and hence book profits when the market is high – sell high
2. When the equity market moves down, you would add to your holding in equity and hence – buy low.
3. Sticking with the asset allocation would remove the disadvantages of the emotion of “greed” and “fear” in investing.

The easiest way to manage your asset allocation is to invest in balanced mutual funds. A balanced mutual fund invests 65-70% in equity and 30-35% in debt. There are many advantages of holding balanced funds as a means to maintaining an asset allocation:

1. The fund is rebalanced every month, it would be difficult to maintain that kind of discipline
2. When the market crashed the way it did in 2008, you did not have to add your own funds to equity to rebalance your portfolio. The fund automatically rebalanced.
3. When you book profits to rebalance your portfolio, there would be capital gains implication – especially with the new Direct Tax Code. When the fund rebalances there is no capital gain implication. You would have to pay capital gains only when you sell your balanced fund.

The Sensex has been very flat over the last 6 months, and going forward, unless the situation in Europe improves, this year is likely to be a flat year. Balanced category has outperformed the Sensex in all periods. The more volatile the market, the more likely that the balanced fund would out perform the Sensex.

If you wish to know which balanced funds to invest in contact me at malgonkar@vsnl.com or at veena@veenamalgonkar.com

INDIA UNSTOPPABLE

The economic face of India has been changing over the last couple of decades. The mind set of the politicians and entrepreneurs have switched from a licensed, inward looking, risk adverse past to an economy that has global aspirations, a higher risk appetite and entrepreneurs that are willing to embrace competition. Capital has lost its nationality and is in abundance. In the past the capital markets had a narrow investable universe. Currently there are more than 170 companies with a capitalization of over US$ 1 billion.

Infrastructure is getting a boost through a mixture of Government and private spending. India’s road network is the world’s second largest, but in need of further upgrades. Power outages are common in Indian cities. India plans to spend nearly US$ 500 billion on infrastructure over the next 5 years. Power generation should increase 14% annually over that span. India’s ports and railways are getting a face lift. India is a nation of savers – about 37% of GDP is saved. Savings can be a big positive in a weak external funding environment. Currently infrastructure development is being done by funding from banks, where deposits are more short term. Hence there is an asset-liability mismatch. In future, insurance and pension reforms will fund infrastructure development. Private Equity funds will also remain active.

India’s fiscal deficit is about 6.7% of GDP, which is a scary number. However, India’s recently the 3G auction garnered Rs 67,700 crores for the Government. If the Government just disinvests 10% of the listed companies it will result in US$ 27.79 billion. The tax reforms of GST will curtail Government revenue leakages in the system. The Direct Tax Code will also simplify direct taxes. The Unique identity card will further reduce outflows into the parallel black economy.

India has a sound banking system. The Capital adequacy is comfortable, NPA’s are mostly falling, the banks are better capitalized and the return on equity is higher than others in this region. Consumer loans are only about 10% of the GDP. 35% of the savings are in property and gold, and the balance in bank fixed deposits. There is very little in equity. However insurance and pension reforms are gaining momentum and this will help in channelising retail savings into equity.

India’s GDP grew at 8.6% in the last quarter resulting in an overall annual growth of 7.4%, one of the highest in the world. Domestic consumption continues to be a big theme. The contribution of domestic consumption to GDP remains stable between 65-70%. India’s population is young and likely to continue that way for many years. The growing middle class will keep the economy on an upswing. Rural consumption is on the increase due to National Rural Employment Guarantee Scheme, rising minimum support price putting more funds in the Indian farmer’s pocket and the loan waiver scheme. The VI Pay Commission has resulted in an additional outflow of $250 billion – all of which has resulted in increased domestic demand.

India’s service industry remains robust. Our IT industry has developed a strong IT global delivery model which results in win-win situation to the customer and the Indian service provider. Indian Pharmaceuticals are moving from confrontation models to collaboration. Indian Auto sales are robust with both Maruti in the car segment and Hero Honda in the 2 wheeler segment reporting record sales in May. Even the Tata Motors, India’s largest truck manufacture reported a 41% increase in sales in May.

India is not totally isolated from the global contagion and will also be affected by FII flight to safety. Aggressive rate hikes by the RBI will also stall growth. Rampant inflation is also a huge fear.

However, in 10 years India’s economy will be bigger than UKs and in 20 years bigger than Japan’s The JAGGERNAUT THAT IS INDIA – OVER THE LONGER TERM - IS UNSTOPPABLE.

MEANING OF BEING WEALTHY

Being wealthy is not about how much you earn, or what car you drive, or what size home you live in. Real Wealth is about securing a regular income stream, without you physically working, of more than double your living expenses.

Bringing home a huge salary, or being a very successful entrepreneur, does not make you rich. Although it is easier to become rich if you are earning well, however you do need to fulfill this Wealth Building Potential.

When you start living beneath your means, you are on the road to wealth creation. You need to invest the difference. As an aspirational spender, always wanting the branded clothes, watches, and later on cars, or a larger home, you will never develop real wealth. You need to sacrifice what you want now, for what you will need in the future.

Creating wealth can be started from any income level, but it is easier to become rich if you have a large income. It does not really matter which vehicle you use to create wealth. It can be real estate, shares, fixed deposit, commodities, etc. What is important is making a PLAN to be financially free. You can leverage your results by contacting a Certified Financial Planner – a CFP professional would have studied such diverse topics such as insurance, investments, estate planning, tax planning, retirement planning and would be able to take a more holistic view of the planning process.
Hence do make a plan today, to be wealthy in 10 or 15 years.

When to cash out your share

According to Warren Buffett, the best holding period is forever. That is how he has made his great wealth, by picking the right companies and holding them for long, long period of time.

I have worked out a plan, to make myself financial free. I have a target to invest every month. Whether I invest in equity or debt i.e. my asset allocation depends Price / Equity of the Sensex
- Below 12 times 90% equity and 10% debt
- 12 – 15 times 80% equity and 20% debt
- 15 – 20 times 70% equity and 30% debt
- 20 – 25 times 60% equity and 40% debt
- above 25 times 50% equity and 50% debt

I tend to have a core portfolio – blue chip shares which I will never sell, and the rest of the portfolio – shares which will book out when certain parameters have been met.

With the core blue chip portfolio, every time the Annual Report appears, I study the same, and on the basis of the conditions mentioned in my earlier blog, determine at which price I would add to my stock. If that price is reached, I buy.

Reasons to sell:
1. When a stock that has been historically traded at between 10-25 times earning, begin trading at 40 or more times earnings, for no other reason than that the stock market is going through a period of mass speculation, its time to get out.

2. A good rule of thumb, is to add up the expected per share earnings of a company over the next 10 years and them compare the sum with what you would earn if you sold the stock and placed the proceeds in bonds instead.

3. Other reasons:
(a) A better opportunity presents itself.
(b) The business or environment changes.
(c) When the target price of the security has been met.
i. First target price – sell quarter the stock when the price goes up by 50%
ii. Second target price – sell another quarter of the stock when the price doubles. (the stock is almost free)

INVESTING DIRECTLY IN THE SHARE MARKET

If you are not willing to put in the time and effort to study the share market and invest in the same, it would be better to invest through mutual fund. Spend at least that much time on your share investment study as you would do to buy a new fridge. Most people make their share purchase decisions based on the following:
1. Reference from your stock broker, who earns brokerage only when you buy and sell your shares.
2. Hot tips from your friends.
3. Noise on CNBC or other news channels

Just investing into blue chips would not protect you. Some of the blue chips are so overvalued that it could take years to get any returns on your investment. Sometime a mediocre company attractively priced could be a better investment than a blue chip company which is growing at 20% every year.

While going through the Annual Report, always read Directors / Chairman’s Report and check the auditors notes to the accounts. I am listing out some of the considerations to be taken into account while making a share purchase decision:

1. Understanding the company and its share
(a) When was it incorporated
(b) What is the business of the company
(c) Address / location
(d) Who are the promoters and what it their holding in the company
(e) Investor returns
i. Dividends
Company should be giving regular dividends over the last 5 years or if not they should be having great alternative investment opportunities
ii. Bonus shares
iii. Right shares
(f) Stock movement over the last 10 years.

All this would give you a feel for the company, it products and the share price movements



2. Profit and Loss account Over last 5 years minimum
(a) Income is increasing regularly
(b) Profit before depreciation, interest and taxation growing
(c) Profit after tax growing
(d) Profit after tax to income
Profitability should be more than that of its peers.

3. Buisness Fuel Over last 5 years minimum
(a) Working Capital to Sales
The lower the better
Retail 10-15%
Heavy manufacturing 25-35%

(b) Current Ratio
Current Asset / Current Liabilities
It gives an idea of the company’s ability to pay the short term liabilities (sundry creditors and short term debt) with is short term assets (cash, inventory and receivables)
If the ratio is less than one, it means that the company cannot meet its short term liabilities. Normally should be around 2:1. Sudden spike in ratio shows a problem with efficiency

(c) Quick Ratio
Cash + Marketable securites / Current liabilities
(excludes inventory)
It is a measure of the company’s liquidity to meet the short term liabilities
Should be one. Less than one shows liquidity problem and too high shows efficiency problem,

4. Investments
Always check out this schedule in the accounts. See whether the company is investing in group companies
May or may not be a good thing.

5. Debt of the company
(a) Debt / Equity Ratio
Indicates how the company is financing its assets or how leveraged the company is.
2:1 debt equity ratio is desirable

(b) Interest Coverage
Earnings before interest and taxes / interest
This ratio is used to determine how easily a company can meet its debt obligations, if the earnings fall
Ideally should be in the range of 3-4 times

(c) Profit after Tax to Long Term debt.
According to Warren Buffett this should be less than 5 times, except for banks and financial institutions.

6. Bang for the Buck Over the last 5 years minimum
(a) Earnings per share
Profits divided by number of shares
Should be increasing every year.

(b) Profit after tax / Capital Employed (Equity + Reserves)
Should be more than 15%

(c) Historical Price Equity
PE ratio is calculated by dividing the share price by the earning per share.
Check the last 5 years PE ratio and the current PE ratio should be less than the average of the last five years.

(d) Beat Treasury returns
EPS divided by current share price gives the returns earned by the share at the current price.
Should be more than 8% which is Government security returns.

(e) Price to Book Value
If the company is trading less than the book value, it means the market believes the asset value of the company is over stated or the company is earning very poor (or negative) returns on its assets


According to Warren Buffett, you should understand the company’s business. You have to look for companies which have a durable competitive advantage. You need a product that wears out quickly or a service that you need to use again and again. If the company re-purchases its shares, it would be a positive.

This analysis is done by a layman without looking at future earnings, which is an unknown, or technicals of the market. It anyone has further points to add to this, please do add to the discussion on the subject to veena@veenamalgonkar.com or malgonkar@vsnl.com

Next week, I would look at when to sell the shares, although according to Warren Buffett the best holding period is forever.

Budget 2010

IMPLICATIONS FOR INDIVIDUALS WITH THE BUDGET 2010

Enclosed are only those parts of the budget which will affect you directly.
1. TAX RATES
Tax rates have widened to encourage consumption and saving

Revised Tax Rates Earlier Tax Rates
Unto Rs 160,000 - Nil Unto Rs 160,000 – Nil
Rs 160,000 to Rs 500,000 – 10% Rs 160,000 to Rs 300,000 – 10%
Rs 500,000 to Rs 800,000 – 20% Rs 300,000 to Rs 500,000 – 20%
Rs 800,000 and above – 30% Rs 500,000 and above – 30%

For women and senior citizens the tax free limit is Rs 190,000 and Rs 240,000 respectively.

2. New Direct Tax Code will be implemented by 1st April 2011. I will be looking at the implication of this shortly.

3. Deduction of Rs 20,000 allowed for investment in Long Term Infrastructure bonds over and above the 80C limit of Rs 100,000

4. Dividend:
Dividend on Equity and debt continue to be tax free. Dividend on equity mutual funds also not taxed. No dividend distribution tax for equity mutual fund. However for debt mutual fund the dividend distribution tax is 13.841% (22.145% for corporate) and liquid funds it is 27.681% for both individuals and corporate.

5. Renting:
Renting of immovable property to attract service tax

6. Auditing of Accounts:
(a) Professionals with income of more than Rs 15 lacs.
(b) Companies with business more than Rs 60 lacs.

7. New Pension Scheme
The Government will give Rs 1000 per year to each person who joins the NPS with an annual investment of upto Rs 12000.