Sunday, September 25, 2011

Volatility is here to stay – Manage It

It is going to take many years for the global economy to recover from the 2008 crash. With the Lehman collapse, the banks around the world froze and liquidity was very tight. At the time, impact was to the tune of $ 2.7 trillion. The US Government took prompt action to form Troubled Asset Relief Programme to purchase assets and equity from its financial institutions to strengthen the financial sector. Currently the estimated impact from all the PIIGS countries is US$ 600 billion, but the European Stability Fund or the EU is unwilling to commit funds to rescue these countries. 29th September, is going to be a crucial date to see how this problem can be solved.

In recent history, creditors seem to be more willing to cut slack to the defaulters as bailouts are facilitated through the International Monetary Fund. The Emerging Market Debt crisis in the 1980’s/90s lasted for just three years. However, for political reasons, the European leaders are willing to take small steps only when the debt problem teeters on the verge of disaster. Delay in inevitable debt restructuring is what is causing the markets to be volatile. To prepare for the default and to try and re-capitalize their Balance Sheets, European Banks are calling back their loans, and that is why there is currently a huge demand for dollars. Hence the dollar is up, while all currencies, including the rupee weakens. As Hong Kong is the most liquid market after the US, this too is being sold off. Even the safe heavens, gold and silver, are being off loaded, to meet this insatiable demand for dollars.

With Sovereign Debt levels as all time highs and with growth stalled, it is going to take years for the World Economy to recover. Hence over the years, these crises are going to come again and again, and the inevitable volatility in the markets would have to be managed.

Case for Indian Equities:

1. 80% of the World Growth is coming from the Emerging Markets.
2. Although our growth is slowing down, we will still be growing, as per the worst estimate, at 7%+.
3. Valuation of our markets is currently below the long term average. When analysts start considering earnings of FY 2013, then our market’s valuations are at crisis levels.
4. The next quarter results are likely to be painful, but this is already known and factored in.
5. The interest rates should have almost peaked, and lowering interest rates going forward would stimulate growth. Once the RBI signals peaking of interest rates, as the equity markets are forward looking, the markets should rally.
6. Oil prices have already come down, but we are not feeling the impact because of the weakening rupee. However falling oil prices are going to be a huge benefit to us. Further cooling off of commodities, due to global slow down will result in increased profitability of our companies.
7. Monsoons have been good, and are likely to have a bumper rabi crop.
8. Corporate leverage is quite low and cash levels are high. Although companies are currently not building capex, they seem to be willing to buy other businesses, and hence Mergers &Acquisition activity is high.
9. Cement, which is a lead indicator, has not fallen so much in the current melt down. When the capital expenditure and capacity growth re-starts again, the seller of capital goods books profit immediately, where as the buyer depreciates over time, and this leads to excess profits.

Managing the Volatility

1. Stock picking is going to become crucial. On the same day in August, Bharati Airtel reached its 52 week high, Reliance Industries reached its 52 week low. In a rampant bull market all stocks go up, but in these volatile times stock picking is going to become very important

2. Regular booking of profits and re-balancing portfolios would need to be done, to be prepared to face the next crisis. Hence if you were re-balancing every 6 months, you would have to re-balance every three months.

3. Your asset allocation would have to keep on changing depending upon the valuations of the market. As they become cheaper, larger allocation to equity and vice versa. r

Consult a Certified Financial Advisor to assist you through these difficult times.

Sunday, September 4, 2011

Real Estate vs Equity

As an investment advisor, many times I hear people tell me about the fantastic returns they have got in the real estate markets, where as equity have not given any returns at all since 2007. And what can I reply to this indisputable fact!!!.

Recently I had a friend tell me that he bought a flat in 2002 for just Rs. 28 lacs and it is now worth over Rs. 1 crore. “It has given me Rs. 8 lacs per year, as much as my annual salary.” Simple math told me that it gave a respectable 15.2% CAGR over the last 9 years. In the same period equities have given 19.5% returns and gold, which was $300 per ounce at that time is now over $1800 per ounce and have given a CAGR 22%.

National Housing Board has come out with an index of real estate “Residex” of 15 cities in India from 2007. Between 1st January 2008 to 31st March 2011, as per that index:
- Four cities, Jaipur, Hyderabad, Kochi and Bangalore have given negative returns.
- Chennai has given the best returns of 24.7% CAGR
- Pune has given just 12.2% CAGR.

Investors’ love affair with real estate is well known. It is an asset of bricks and mortar, instead of an intangible piece of paper which represents your equity investment. You have the potential of getting regular rental returns, and also watching your asset increase over a long period. Every HNI will give me stories of the fantastic returns a longer period or even the super returns in a few months. Forgotten is the 267% returns the Sensex gave us in 1992 or even closer in time, the 152% annualized returns got between April and September 2009.

The problem is that real estate advisors quote absolute numbers when they talk about returns. It sounds a lot more than CAGR returns. For e.g. a flat in Powai, which cost Rs. 40 lacs in 1996, is worth Rs. 4 crores today – a CAGR of 18%. The same Rs. 40 lacs invested in HDFC Prudence fund, would be worth Rs 9.5 crores today – no comparison really!!! An investor cannot really envisage a CAGR of 23.6%.


1. Smaller investment amounts
You can choose the amount you wish to invest in equity mutual funds. You can diversify this investment over different categories of equity funds, over different fund houses. In real estate you have to put a substantial amount in one real estate holding.

2. Liquidity
Bull or bear market, you can always liquidate your equity mutual funds in just 3 working days. The price you get is efficiently determined and not based on your desperate need for funds. In an economic slow down, selling your property is extremely difficult and the price you will get is inversely proportionate to your need for funds.

3. Transaction Costs
Purchasing a property attracts both stamp duty and registration costs. This is prohibitively high. In a regime of zero entry load, there is no cost in purchasing equity mutual funds.

4. Maintenance Cost.
Apart from property tax, there are regular maintenance costs in keeping your property ship shape like painting, repairs, etc. The equity fund manager on the other hand, charges around 1.75% - 2% to maintain an equity portfolio of the best performing equity shares.

5. Regular Income
You can get regular income in the form of rent from your property. The rental income is normally about 3-5% of the value of your residential property and maybe a little more in the case of a commercial property. This rental return is taxed in your hands. You can get tax free returns of the amount you wish i.e. 8%, 10% or even upto 15% (the long term return of the Sensex) through a Systematic Withdrawal Plan from your equity mutual funds.

6. Taxation
You pay zero long term capital gains on equity mutual funds. There is no way that property, with its 20% indexable tax can ever beat a 0% rate.

How then to convince property investors to invest too in equity mutual funds? Did they sell their property in 2008 when the economy slow down started? Do they check the price of their property every month or even every day? Did they snap up great deals when the equity market was on sale at Sensex 8000 level? Do they compare their house in their locality and switch it to another house in another locality which did better in the last 6 months? When they buy an equity mutual funds, do they mentally allocate it to their son/daughter as a legacy?

In Conclusion:

Real Estate has its role in wealth creation as a diversification from Equity. However equity mutual funds need to have an equal allocation to your portfolio of wealth. It is only when you see equity too as an inter generational legacy to be passed down, that real wealth will be created through equity.

Veena Malgonkar
Certified Financial Planner