GO GLOBAL

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. 

HOW THE BUDGET AFFECTS THE INVESTOR

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. 

INVESTMENT PLAN FOR 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 31^st 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. 

LAST CHANCE TO PROFIT FROM THE INTEREST RATE CYCLE

           

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 1/3^rd 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%.

Budget 2012 – 2013

Overview of the Economy:
1. GDP is estimated to grow by 6.9% in 2011-12, after having grown at 8.4% in the preceding two years. For the Indian economy, recovery was interrupted this year due to the intensification of the debt crisis in the Euro zone, political turmoil in the Middle East, rise in crude prices and inflation.

2. With agriculture and services continuing to perform well, India’s slowdown can be attributed completely to slow down in industrial growth.

3. In 2012-13, India’s GDP growth is expected to be 7.6% +/- 0.25%.

4. Headline inflation is expected to moderate further in the next few months and remain stable thereafter.

5. The fiscal deficit was 4.8% of the GDP in 2010-11 (due to auction of 3G spectrum), down from 6.5% in 2009-10. The fiscal consolidation was expected to continue in 2011-12 with a budgeted fiscal deficit of 4.6% of the GDP. However, the actual deficit is estimated to be 5.9% of the GDP, due to slippages in direct tax revenue and increased subsidies.

6. The government has pledged to cut the fiscal deficit to 5.1% of GDP in the next year. The Net market borrowing by the Government to finance the deficit is estimated to be Rs. 4.79 lakh crores in 2012-13. Disinvestment target is Rs. 30,000 crores, with at least 51% ownership and management control to remain with the Government

7. Endeavor to keep central subsidies to under 2% of the GDP in 2012-13 and over the next 3 years reduce it to 1.75% of the GDP.


Key Focus Areas of the Budget:
1. Revival of Domestic Consumption
2. Achieve an Enabling Environment for Revival of High Growth
3. Remove Supply Bottlenecks
4. Intervene decisively to address Malnutrition
5. Expedite improvement in Delivery Systems and address Black Money

Legislative Reforms
1. The Direct Taxes Code was introduced in Parliament in August 2010. Report of Parliamentary Standing Committee has just been received. Will take steps for the enactment of DTC at the earliest.
2. Goods and Service Tax Bill was introduced in Parliament in March 2011. Awaiting the recommendations of the Parliamentary Standing Committee.
3. GST Network has been approved by the Empowered Committee of State Financial Ministers and will be set up as a National Information Utility and will become operational in August 2012. Use of PAN will be the common identifier in both Direct and Indirect Taxes.
4. There are 10 big-ticket bills and amendments to be moved in the Budget session.

Agriculture
1. Total planned outlay for the Department of Agriculture and Cooperation is being increased by 18% to Rs. 20,208 crores
2. Missions in the Twelfth Five Year Plan
(a) National Food Security Mission
(b) National Mission on Sustainable Agriculture
(c) National Mission on Oil Seeds and Oil Palm
(d) National Mission on Agricultural Extension and Technology
(e) National Horticulture Mission
3. Short Term Crop loans given to farmers at 7% will be continued in 2012-13.

Infrastructure Development
1. First Infrastructure Debt Fund with an initial size of Rs. 8000 crore launched this month to tap the overseas markets of long tenure pension and insurance funds.
2. Tax Free Bonds doubling to Rs. 60000 crores in 2012-13.
3. External Commercial Borrowings (ECB) funding allowed for Power, Aviation, Roads & Bridges, Ports & Shipyards, Affordable Housing, Fertilizer and Dams where Withholding tax has been reduced from 20% to 5% for three years.


Capital Markets
1. In 2011-12, FII limit was raised in long term infrastructure bonds, corporate bonds and government securities. The limit on ECB was raised and qualified foreign investors were allowed to invest in mutual funds and equities.
2. Now allowing Qualified Foreign Investors to access Indian Corporate Bond market
3. Simplifying the process of issuing IPOs
4. Providing wider shareholder participation through electronic voting.
5. Permitting two way fungibility in Indian Depository Receipts.
6. Restriction of Venture Capital Funds to invest only in nine specified sectors is removed.
7. It is also further proposed to remove the cascading effect of Dividend Distribution Tax in multi-tier corporate structure.
8. Propose to allow repatriation of dividend from foreign subsidiaries of Indian companies at a low tax rate of 15% as opposed to 30% for one more year.
9. Exemption of Capital Gains tax on sale of Residential property, if sale proceeds is used for subscription in equity of a manufacturing SME for purchase of new plant and machinery.


Tax Proposals
1. Direct Taxes
(a) Exemption limit for Direct taxes increased to Rs. 200,000 from Rs. 180,000.
(b) The upper limit of the 20% tax slab was been increased from Rs. 8 lacs to 10 lacs.
(c) Hence the exemption limit for Senior Citizens remains at Rs. 250,000 and the definition of senior citizen remains at 60 years.
(d) Further the exemption limit for Super Seniors, those about 80 years remain at Rs. 500,000

2. Individual tax payers will be allowed Rs. 10,000 for interest on saving bank deposits. This will allow small tax payers with salary income upto Rs. 5 lacs exemption from filing returns.

3. Within the limit for Health insurance, Rs. 5000 to be allowed for preventive health check up

4. Senior citizens, who do not have any business income, are exempt from paying advance tax.

5. Rajiv Gandhi Equity Saving Scheme will allow for income tax deduction of 50% to new retail investors, who invest upto Rs. 50,000 directly in equities and whose annual income is below Rs. 10 lacs. This scheme will have a lock in of 3 years (Hopefully it will be extended to Equity Mutual Funds too).

6. However, Infrastructure Bonds upto Rs. 20,000 may no longer be tax deductible, as this was applicable for just one year, and then extended for another year.

7. No change in the tax rates for Corporates.

8. Indirect Taxes
(a) Service Tax
i. On all services except those in the negative list, comprising of 17 heads.
ii. Service Tax is raised from 10% to 12%
(b) Securities Tansaction Tax reduced 20% to 0.1% for delivery transactions.
(c) Standard Rate of Excise Duty to be raised from10% to 12%, merit rate from 5% to 6%, and lower merit rate fro, 1% to 2%, with a few exceptions.
(d) Excise duty of large cars to be enhanced
(e) No change in proposed peak rate of customs duty of 10% on non-agricultural goods.



Hence based on the budget proposals the following are the outlooks in the equity and bond markets.

EQUITY MARKET OUTLOOK
1. Budget turned out to be a non-event for the equity markets with no major structural reforms
2. Budget proposes a law that could overturn the Supreme Court ruling in the Vodafone tax case. That is certain to shock foreign investors.
3. Not clear if the investment under Rajiv Gandhi Equity Saving Scheme would be applicable to only new retain investors who had not opened a demat account yet.
4. The markets are likely to be disappointed by the continued fiscal profligacy of the Government and lack of any credible plan for fiscal consolidation. Further oil price assumed in the budget was $115.
5. As the equity markets have already run up 20% this year, and the FII have invested bout $8 billion, hence we might witness some consolidation.
6. Market will watch out for incremental news flow on global economic development, movement in crude oil, political re-alignments and RBI’s policy moves.

BOND MARKET OUTLOOK
1. Net Borrowing of Rs. 4.79 lac crores is 10% higher than the current year, and this led to sell off in longer year bond yields. Going forward, due to the huge borrowing programme, there is going to be pressure on long term yields.
2. Expenditure estimates (except oil subsidy) seems more realistic leading to the belief that the numbers may not be revised too often. However there is no definite road map to curtail expenditure.
3. The short term spreads in the Bank CD’s and 1-3 year AAA bonds are likely to present interesting opportunities once the liquidity pressure unwinds.

DEBT ALLOCATION

As a part of your debt allocation, the choices open to you are:

- Fixed Deposits of banks, post office, corporates, etc.
- Tax Free bonds
- Fixed Maturity Plans of Mutual Funds
- Short Term Debt Mutual Funds
- Longer Term Debt or Gilt Mutual Funds


There are inherent pros and cons for all these options.

1. Fixed Deposits of banks, post office, corporates, etc.
(a) Bank fixed deposit rates range between 9-10%. You do know exactly how much you get during the term.
(b) Fixed deposit of corporate rates is slightly higher depending upon the rating of the Corporate.
(c) For those in a top income tax bracket, even at 10% interest rates, the actual yield post tax (30.9%) would be 6.91%, where you would not be beating inflation.
(d) There is no scope for any capital gain or capital loss. What you give is what you get back at the end of the term.

2. Tax Free Bonds
(a) The Government of India has allowed four companies to issue tax free bonds. The first one to hit the market shortly will be NHAI. They will be 10 year and 15 year bonds.
(b) The interest rates, although not yet declared, will be 50 bps less than the 10 year GSec yield. The 10 year GSec yield has recently fallen sharply from around 9% to below 8.5%.
(c) At 8% interest rate on these tax free bonds, this would translate into 11.58% returns for those in the highest tax bracket.
(d) The bonds will be traded on the stock exchanges and hence there is scope for Capital Gains if interest rates of 10 year GSecs fall to the 10 year average of about 7%.

3. Fixed Maturity Plans
(a) The Fixed Maturity Plans are still giving 9.2 – 9.4% for a one year or 18 month FMP.
(b) There is a little uncertainty about whether the Direct Tax Code will be applicable next year or not. Hence for an 18 month FMP you do not know whether you will get double indexing (hence tax free returns) or single indexing, where some tax would be payable.
(c) However assuming the Dividend option the dividend distribution tax rate at 13.84% would give you net returns of 8.1% at 9.4% yield.
(d) Here too, you know what you are getting and at the end of the term there is no scope for capital gains.


4. Short Term Debt Mutual Funds
(a) The yield curve is currently quite flat. i.e. the short term and long term yield rates are the same i.e. around 9-10%.
(b) The RBI has announced that it will pause in the interest rate hikes. The bad IIP numbers of -5.1%, will ensure that the RBI should not hike rates on Friday.
(c) Government increased limit for FII investments in corporate bond and GSecs by US$ 5 billion each to US$ 15 bn and US$ 20 bn respectively. This has resulted in increase in demand.
(d) The Yield to Maturity of most short term debt funds are around 10% returns. After considering the expenses these yields to you should be around 9%.
(e) Short end of the yield curve offer attractive risk adjusted yields. The short term funds will continue to selectively increase duration as the yield curve is likely to steepen on the back of FII demand and improved liquidity.
(f) Hence, in the next one year, you are definitely looking at capital gains on the short term debt mutual funds and should be 10%-11%++ returns.


5. Longer Term Debt or Gilt Mutual Funds
(a) The was a large fall in the 10 year GSec yields in the last two weeks from over 9% to now below 8%. This was mainly because of:
i. RBI Open Market Operations
ii. Successful FII auction resulting in increased demand.
iii. Moderation in inflation and hope in interest rate easing
(b) However the Government of India is likely to over shoot the borrowing programme and that will result in hardening of interest rates again.
(c) RBI is not expected to cut interest rates before April or so.
(d) For those who can take the volatility in the debt portfolio, can invest in longer term debt mutual funds, to get 13-14% p.a. returns over the next 1-2 years. The average 10 year GSec yields are 7% and in the last GSec bull run the yields went down to 5% in 2009.


In Conclusion:
1. For any short term investments of 1 year or so duration invest in Short Term Debt funds. This is going to give you attractive 10%-11% returns without any risk.
2. However do keep 10-15% of your debt portfolio in longer term debt papers – to look at higher returns with volatility.
3. Take prompt action, because the last debt bull run lasted just 3 months.
4. For longer term investors, continue to stick to your asset allocation, which would depend upon your risk profile and the valuations of the market. It is never too clear when the equity bull market will re-start. The Sensex doubled from April 2009 to September 2009.

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.