By Dhirendra Kumar
Besides gold, gilt is the other category that has caught the fascination of investors. While gold has grabbed attention due to its nature as an asset of the last resort, gilt's reasons for coming into the limelight is its sudden resurgence in performance. In 2008, when equity was coping with negative returns, gilt funds were able to deliver a return of 25.33%. For most of 2008, gilt funds were either non-performers or their usual selves. But this changed when RBI got into action to combat the liquidity crisis with a series of rapid cuts in the repo rate between October and December 2008. With a cut of 2.5% in repo rate and a cut of 3.5% in Cash Reserve Ratio, gilts funds' returns shot through the roof. This over performance was due to 20.69% returns in the last quarter in particular with 12.43% return from just the month of December 2008.
To understand the reason behind this sudden resurgence of gilt funds, we first have to understand what gilt funds are. They are mutual funds that predominantly invest in government securities (G-Secs). Unlike conventional debt funds that invest in debt instruments across the board, gilt funds target just a given category of debt instruments i.e. G-Secs. These are securities issued by RBI on behalf of the government. Being sovereign paper, they do not expose investors to credit risk. They are also the most heavily-traded paper in the market. Banks, insurance companies and provident funds invest in them for safety and statutory reasons. This also ensures adequate liquidity and in turn volatility for G-secs in the market.
Since the market for G-Secs is largely dominated by institutional investors, gilt funds offer retail investors a convenient means to invest in G-Secs. For gilt funds the main source of their income, apart from earning fixed interest, is from the trading gains that accrue due to trading in gilts. With inflation going southward from its peak value in August, for any gilt fund manager it was a foregone conclusion that policy rates would be heading down too. Hence it was only a matter of 'when' not 'if'. Gilt fund managers bought into G-Secs of higher and higher maturity.
Because rate cuts make the older G-Secs with higher interest rates more attractive, with the rise in demand their prices go off the charts enabling the fund manager to make trading profits by selling them. That's exactly what happened: the 10-year benchmark paper's yield (as there is negative correlation between yield and prices) dropped over 320 basis points between October and December 2008. Gilt funds turned in astounding returns of up to 35% in the quarter. These fabulous gains got investors excited. Gilts looked like the obvious way to recoup losses made in equity. Gilts funds assets almost doubled from Rs 2,500 crore in November to Rs 4,800 crore at the end of February, 2009. Falling inflation numbers and increasing uncertainty in the economy forced the RBI to announce a cut in the repo rate by 50 bps on March 4, 2009. But to the dismay of many, the yields refused to budge in response. The gains expected by investors were nowhere to be seen. The reason for this was the on going borrowing programme of the government. Till March 31, 2009, the government needs another Rs 34,000 crore to meet with the current year's budget deficit. In normal course the government would have to issue new bonds to fill this gap. In anticipation of this flood of new bonds, the markets are shying away from any new purchases. The result is that the yield is going up rather than falling. Between March 4, 2009 and March 12, 2009 the yields have gone up by 10%. RBI is on a war footing to soften the yields from this level but the supply of new issue is just too great to provide any relief.
The gilt funds performance for the week ended March 6, 2009 has been lacklustre. The returns of the gilts funds over last one week have been -1.09% (March 1-6, 2009). Furthermore, the fiscal stimulus announced by the government to kick-start the economy has done nothing to help the gilt funds. The only thing it has done for the money market is that it has fuelled a growing apprehension about how the government would be able to finance all the recent expenses. The 10-year G-Sec from the low of 5.02% in January, 2008 has gained 39.86% to touch 7.03% on March 12, 2009. Hence after the spectacular performance in December, most gilt funds are languishing in red. For January and February, gilt funds turned in -6.23 and -1.74% respectively.
Looking at the month-on-month return of gilt funds, it may seem that these have become too risky an investment option. But the fact is this is how gilt funds have always been. Back in 2001 and 2002 when rates were coming down gilts funds were the prime beneficiary. Their returns were comparable with the equity funds returns, but the moment there is a long period of inactivity in the interest rate or if rates are on a upward trend then gilts funds become a very dull investment option. Many a time, interest rates will change in unpredictable ways. At other times, interest rates may be predictable, but their impact on bond prices may hold surprises. There are plenty of funds that increase or decrease maturity violently at the slightest sign-real or imagined-of rate movements. A gilt fund managers' job is to take calls on rates and yields but that doesn't mean that a call has to be taken all the time. Nor does it mean that maturity must always be jerked from one extreme to the other whenever a call is taken. In these unpredictable times, circumspect beliefs and moderation of action is the path that takes care of investors' interests the best. Thus, we have selected three funds that are not the top-performers of the past few months. Nor are they the biggest. But we believe that they fit the above profile well.
It is important to always keep in mind that notwithstanding the credit quality, medium and long-term gilt funds are the most unpredictable animals in the fixed-income zoo. Invest at least for a year and be prepared for short-term shocks.
The author is CEO, Value Research
Canara Robeco Gilt PGS
Over the last few years, Canara Robeco Gilt PGS has established itself as one of the steadier performers of this category. In the five years since 2004, it has more than kept pace with its peers, either outperforming the average gilt fund handsomely, or lagging by a small margin. All in all, Rs 1 lakh invested in this fund would be Rs 1.42 lakh today, as against Rs 1.26 lakh for the average gilt fund. In fixed income terms that's a significant difference. During 2008, which has been a signature year for gilt funds, the fund's returns were an astounding 35.17%, which gave it the 6th rank for the year. However, what impressed us more was the fund's progression through what was an exceptionally turbulent year. During the first three quarters, the fund was ahead of the category average by an average of 2.64% every quarter, adding up to a cumulative lead of 7.92%. In the last quarter, it exploited RBI's interest rate bonanza just as well as the rest, with returns of 20.63% for the three months.
However, the fact that, the fund matched the average and did not do as well as the top funds during the quarter, looks like a positive sign to us. When we observe the maturity changes that fund manager Ritesh Jain affected during that phase, we see a degree of conservatism which we like. During the October liquidity crisis, the fund manager dropped the maturity. When RBI unexpectedly softened rates in November, the fund gained less than its peers.
Investors shouldn't mind this because dropping yields during the global liquidity crisis was a safer course of action. The point is proven when we look at how things played out in 2009. All gilt funds have suffered during this period. However, the funds' lower maturity has helped in containing the downside well in January and February 2009. Canara Robeco Gilt PGS was down by 3.01% and 0.76%, while the category was down by 6.23% and 1.74% (January and February) respectively. It must be noted that the fund's 2008 performance was at the hands of two fund managers. Suman Prasad was at the helm till June 2008, when Ritesh Jain took over. Jain came from Kotak (KOTAKBANK.NS : 274 -27.7) Mutual, where he ran Kotak Floater LT, Kotak Flexi Debt, Kotak Gilt Inv Regular and Kotak Balance during his 3-year stint.
ICICI (ICICIBANK.NS : 345.45 -39.75) Prudential Gilt Investment PF
Make no mistake, this is an aggressive fund. Fund manager Rahul Goswami has been running the show since October 2005 and his reign has been marked by generally long maturities, aggressive calls and quick movements. For the most part, this has worked out well, especially in the recent past. While 2008 was a great year for practically all gilt funds, this fund was shining much brighter than all others. During the year, its returns were 45.44%, far higher than the average of 24.94%. Even the number two fund was way behind at 36.98%.
The returns were a result of a characteristically nimble action on the maturity front. When the yield came down from 9.33% (July 2008) to 8.67% (August 2008), the fund increased its maturity profile from 9 months to 12 years. As interest rates kept falling further, Goswami increased maturity further to 18.16 years by the end of December 2008. At that point, the average maturity of the other funds of the category was an average of 13.70 years. This gap is what produced the superb performance for the fund.
However, the next two months showed investors the flip side of the approach. In January and February 2009, the fund manager expected the interest rate to go down further and increased the average maturity to 20.19 years (February) while its peers reduced it to 10.82 years. However, when the yield moved up from 5.25% (December) to 6.40% (February) the fund lost money. Commendably, its losses in January and February were in line with the category average (-6.63% vs -6.23% and -2.07% vs -1.74%). During January and February, the fund held a rank of 18 out of 47 funds in the category. Still, this entire episode underscores the importance of scoring big whenever it's possible. Because the fund exploited 2008 so well, its very much top of the heap over the entire period (January 2008 to February 2009). Over a longer term too, this is an outperformer. Since its launch in November 2003, there has never been a year when its returns were less than the category average.
The bottom-line is that this is a smartly-run fund, albeit an aggressive one. If this is the profile you are looking for then ICICI PRU GILT Investment PF is a first rate choice.
Templeton India GSF Long-term
Templeton IGSF Long-Term is a gilt fund that has managed to implement a remarkably balanced approach. It has never raced ahead leaving other funds in the dust; but it has never suffered a severe reversal either. In the seven years since it was launched, its annual returns have always been ahead of the category average. Also, they've always been positive-even in 2004 when the going was tough and the category as a whole lost money (-0.40%), this fund made a reasonable gain of 2.95%.
The most interesting fact about this fund's performance history is that it has done well during both rising and falling interest rate regimes. Between February and July 2008 the yield of the 10-year benchmark paper rose from 7.56% to 9.33%, the fund generated on an average 0.20% return monthly while the category was down with a negative 0.19% return. The average maturity period of the fund was 3.40 years vis- -vis category's 4.09 years. From August the yield started declining and by the end of December it reached 5.25%. The fund gained 4.06% return in comparison to category 4.34%. The average maturity of the fund was 5 years while its category was at 8.74 years. Again in January 2009 when the yield rose to 6.21%, the fund was down by 0.35%, while its category was down 6.23%. The average maturity of the fund was 7.61 years while the category was 12.54 years. Incidentally, during this period (in June 2008), Vivek Ahuja replaced Ninad Deshpande as the fund manager. Deshpande had been at the helm for almost two years.
In its seven years, this fund has reported a maturity less than its stated three years for 13 months. This has helped it handle rising interest rate situations better than many others in the category. The conservative attitude has also meant that the fund exploited the 2008 Q4 bonanza less effectively than category leaders. However, returns for 2008 were still a solid 27.65%, well ahead of the category's 24.94%.
For investors who'd like to balance caution and aggression, Templeton IGSF Long-Term is ideally suited for trying out the occasionally troublesome category of gilt funds. It manages to deliver the better aspects of gilts while filtering out the worst.
Monday, March 30, 2009
Mutual Funds bank on rural, non-metro areas to boost AUM
By Chirag Madia
The Mutual Fund (MF) industry has got a new window to offset the redemption pressure faced by it during October 2008. Riding on the mop-up, which has been coming from the non-metro and rural, several fund houses have witnessed a steady increase in their asset under management (AUM). They have registered over 50% growth between November 2008 and February 2009.
LIC MF, ICICI (ICICIBANK.NS : 345.35 -39.85) Prudential and UTI MF's AUM constantly increased after October 2008. Between November 2008 and February 2009, LIC gained over 100% in their AUM, while ICICI added 45% and UTI's AUM rose over 30%. Market players sense that despite the recession and uncertainty in the markets, rural India is their latest target and they have been steadily increasing their exposure in the tier-II and III cities.
Nimesh Shah, MD and CEO of ICICI Prudential Asset Management said, "In the past few months, we have increased our exposure in the tier-II and tier-III cities. Though the markets are facing some pressure, there is tremendous growth in the rural areas."
In November last year, ICICI Prudential's AUM was Rs 37,055.67 crore which has increased to Rs 53,514.07 crore or 44.42%. However LIC MF remained a top performer in the last four months as its AUM gained Rs 12,584.12 crore (107.70%) for February 2009 at Rs 24,268.42 crore, compared to Rs 11,684.30 crore in November last year. IDFC MF also added over Rs 4,913.22 crore or 56.57% in the past four months. Its AUM, which in November 2008 stood at Rs 8,685.71 crore, increased to Rs 13,598.93 crore.
"After the downturn in the markets, eight major cities that used to invest in the MF have decreased their exposure while there has been constant rise from the investors in non-metros in the country," added Shah.
While UTI MF is considerably increasing their branch openings throughout the country, in the past four months they have opened over 17 branches and are planning to open more 20 branches in the next few months. UTI MF's AUM for February 2009 stood at Rs 49,224.93 crore, up Rs 10,866.79 crore or 28.33%, compared to Rs 38,358.14 crore in November 2008.
Officials from UTI MF on condition of anonymity said, "Our target is to complete 150 branches and till date we are with 130 branches. We will be opening rest 20 branches in the next two-three months."
Sunday March 29, 01:40 AM Source: Indian Express Finance
The Mutual Fund (MF) industry has got a new window to offset the redemption pressure faced by it during October 2008. Riding on the mop-up, which has been coming from the non-metro and rural, several fund houses have witnessed a steady increase in their asset under management (AUM). They have registered over 50% growth between November 2008 and February 2009.
LIC MF, ICICI (ICICIBANK.NS : 345.35 -39.85) Prudential and UTI MF's AUM constantly increased after October 2008. Between November 2008 and February 2009, LIC gained over 100% in their AUM, while ICICI added 45% and UTI's AUM rose over 30%. Market players sense that despite the recession and uncertainty in the markets, rural India is their latest target and they have been steadily increasing their exposure in the tier-II and III cities.
Nimesh Shah, MD and CEO of ICICI Prudential Asset Management said, "In the past few months, we have increased our exposure in the tier-II and tier-III cities. Though the markets are facing some pressure, there is tremendous growth in the rural areas."
In November last year, ICICI Prudential's AUM was Rs 37,055.67 crore which has increased to Rs 53,514.07 crore or 44.42%. However LIC MF remained a top performer in the last four months as its AUM gained Rs 12,584.12 crore (107.70%) for February 2009 at Rs 24,268.42 crore, compared to Rs 11,684.30 crore in November last year. IDFC MF also added over Rs 4,913.22 crore or 56.57% in the past four months. Its AUM, which in November 2008 stood at Rs 8,685.71 crore, increased to Rs 13,598.93 crore.
"After the downturn in the markets, eight major cities that used to invest in the MF have decreased their exposure while there has been constant rise from the investors in non-metros in the country," added Shah.
While UTI MF is considerably increasing their branch openings throughout the country, in the past four months they have opened over 17 branches and are planning to open more 20 branches in the next few months. UTI MF's AUM for February 2009 stood at Rs 49,224.93 crore, up Rs 10,866.79 crore or 28.33%, compared to Rs 38,358.14 crore in November 2008.
Officials from UTI MF on condition of anonymity said, "Our target is to complete 150 branches and till date we are with 130 branches. We will be opening rest 20 branches in the next two-three months."
Sunday March 29, 01:40 AM Source: Indian Express Finance
Tuesday, March 24, 2009
Equity funds shy away from pre-poll bets
Indian stock fund managers are opting to sit on cash or even raise it, ahead of a general election which poses a serious event risk to a choppy share market, already spooked by a slowing economy.
The Lok Sabha election between April 16 and May 13 comes amid a decline in the economy, expected to expand 7.1 per cent in fiscal 2008/09, the slowest pace in six years, with analysts predicting even slower growth next year.
Demand has slumped and exports have dipped sharply and a widening fiscal deficit has many investors worried.
Adding to the fund managers' concerns are doubts over the stability and composition of the new government, seen critical to fix the moderating economy, as allies of the two main coalitions bargain for more seats and as some old alliances fall apart.
In response, they are seeking safety in cash and cutting exposure to shares of medium and small-sized firms, seen as being more vulnerable to the market volatility expected before the new government takes oath by early June.
Until the elections end "it is a bit difficult for the market to really start moving up on a consistent basis," Srividhya Rajesh, vice president for equity funds at Sundaram BNP Paribas Asset Management said in an interview last week.
Her firm, an unit of BNP Paribas, holds a fifth of its stock fund assets in cash and sees no major trigger for actively buying stocks ahead of the election.
This concern is shared by many fund firms who have raised the average cash levels held by stock funds to a multi-year high of 18 per cent, at the end of February from about 14 per cent during the start of the year, according to data from fund tracker ICRA.
Allocation to relatively riskier mid- and small-cap stocks dropped to 31.43 per cent at end-February from 36.44 per cent during the start of the year.
Adding to these complexities is a burgeoning fiscal deficit, seen at 6 per cent of the gross domestic product in FY09, its highest since 2001/02, and sharply above the budget estimate of 2.5 per cent.
UNCERTAINTY
"Most of these portfolio managers are acting very conservative... they want to protect the downside," said Chintamani Dagade, a senior research analyst with the Indian arm of US fund research firm Morningstar, said.
Citing his interactions with domestic fund managers, he said "they are really uncertain" as they see a sharp downside risk ahead of the polls.
"It is certainly a big risk in this situation and they certainly don't want to bet on that," Dagade said. But he added that the jitters are limited to the short-term, and expects managers will resume taking long-term bets after the election.
"If you look at the current visible signals, they don't give you a lot of conviction," said Sanjay Sinha, chief executive of DBS Cholamandalam Asset Management.
But Sinha added that timing the market perfectly is an unwise exercise, and has consequently trimmed cash levels.
Tuesday March 24, 12:12 PM Source: Financial Express
The Lok Sabha election between April 16 and May 13 comes amid a decline in the economy, expected to expand 7.1 per cent in fiscal 2008/09, the slowest pace in six years, with analysts predicting even slower growth next year.
Demand has slumped and exports have dipped sharply and a widening fiscal deficit has many investors worried.
Adding to the fund managers' concerns are doubts over the stability and composition of the new government, seen critical to fix the moderating economy, as allies of the two main coalitions bargain for more seats and as some old alliances fall apart.
In response, they are seeking safety in cash and cutting exposure to shares of medium and small-sized firms, seen as being more vulnerable to the market volatility expected before the new government takes oath by early June.
Until the elections end "it is a bit difficult for the market to really start moving up on a consistent basis," Srividhya Rajesh, vice president for equity funds at Sundaram BNP Paribas Asset Management said in an interview last week.
Her firm, an unit of BNP Paribas, holds a fifth of its stock fund assets in cash and sees no major trigger for actively buying stocks ahead of the election.
This concern is shared by many fund firms who have raised the average cash levels held by stock funds to a multi-year high of 18 per cent, at the end of February from about 14 per cent during the start of the year, according to data from fund tracker ICRA.
Allocation to relatively riskier mid- and small-cap stocks dropped to 31.43 per cent at end-February from 36.44 per cent during the start of the year.
Adding to these complexities is a burgeoning fiscal deficit, seen at 6 per cent of the gross domestic product in FY09, its highest since 2001/02, and sharply above the budget estimate of 2.5 per cent.
UNCERTAINTY
"Most of these portfolio managers are acting very conservative... they want to protect the downside," said Chintamani Dagade, a senior research analyst with the Indian arm of US fund research firm Morningstar, said.
Citing his interactions with domestic fund managers, he said "they are really uncertain" as they see a sharp downside risk ahead of the polls.
"It is certainly a big risk in this situation and they certainly don't want to bet on that," Dagade said. But he added that the jitters are limited to the short-term, and expects managers will resume taking long-term bets after the election.
"If you look at the current visible signals, they don't give you a lot of conviction," said Sanjay Sinha, chief executive of DBS Cholamandalam Asset Management.
But Sinha added that timing the market perfectly is an unwise exercise, and has consequently trimmed cash levels.
Tuesday March 24, 12:12 PM Source: Financial Express
Free pricing of MFs could aid investors
While the investment markets go through ups and downs, many mutual fund distributors are increasingly concerned about the new commission rules that the Securities and Exchange Board of India (SEBI) may be in the process of introducing.
Since I last wrote about this a few weeks ago, I have come across a number of distributors who feel that the new rules will completely disrupt this business. Mutual fund distributors have thus far been paid a commission by the fund company, deducted from the investment an investor has made, with the commission decided between the distributor and the company.
The proposed rules envisage a system under which the distributor and the investor will negotiate a commission, which would be paid either directly by the investor to the distributor or through the fund company. Regardless of the route, if the proposals become rules, there will be free, negotiated pricing. And that is scary for distributors.
Are these fears justified? I'm not sure, but the situation does remind me of an article I read on cnn.com a couple of days back. In a town in Ohio, USA, a caf and #233;, of all businesses, has switched to an open pricing policy and is apparently thriving. Sam Lippert, the caf and #233;'s owner, has removed all prices from his menu.
When patrons finish their meal, they tell him what they thought the food was worth - and pay it. He accepts whatever they offer without complaint or comment.
Sales are up due to the novelty factor, and Lippert finds that his price realisation is also higher: some pay less than what he would have charged, but others pay more. Lippert got the idea from his Bulgarian girlfriend, who told him that in parts of Europe, some cafes allowed customers to decide on a meal's worth.
Will free pricing work in the distribution of retail financial products? I believe it will. Also, I believe that smaller distributors may be at an advantage if this happens. A recently-sacked sales guy from a top-flight 'wealth management' outfit told me in a confessional conversation that the big outfits consciously churned investor holdings because that was the only way they could make any profit. If an investment is uselessly churned four times a year, the company makes eight per cent instead of two. This would be harder to do under the kind of transparency new rules will bring in.
A differentiated market where different suppliers offer different prices depending on the depth of services will eventually be better for all concerned. From what I hear, there are plenty of lobbies at work to maintain the status quo.
Since I last wrote about this a few weeks ago, I have come across a number of distributors who feel that the new rules will completely disrupt this business. Mutual fund distributors have thus far been paid a commission by the fund company, deducted from the investment an investor has made, with the commission decided between the distributor and the company.
The proposed rules envisage a system under which the distributor and the investor will negotiate a commission, which would be paid either directly by the investor to the distributor or through the fund company. Regardless of the route, if the proposals become rules, there will be free, negotiated pricing. And that is scary for distributors.
Are these fears justified? I'm not sure, but the situation does remind me of an article I read on cnn.com a couple of days back. In a town in Ohio, USA, a caf and #233;, of all businesses, has switched to an open pricing policy and is apparently thriving. Sam Lippert, the caf and #233;'s owner, has removed all prices from his menu.
When patrons finish their meal, they tell him what they thought the food was worth - and pay it. He accepts whatever they offer without complaint or comment.
Sales are up due to the novelty factor, and Lippert finds that his price realisation is also higher: some pay less than what he would have charged, but others pay more. Lippert got the idea from his Bulgarian girlfriend, who told him that in parts of Europe, some cafes allowed customers to decide on a meal's worth.
Will free pricing work in the distribution of retail financial products? I believe it will. Also, I believe that smaller distributors may be at an advantage if this happens. A recently-sacked sales guy from a top-flight 'wealth management' outfit told me in a confessional conversation that the big outfits consciously churned investor holdings because that was the only way they could make any profit. If an investment is uselessly churned four times a year, the company makes eight per cent instead of two. This would be harder to do under the kind of transparency new rules will bring in.
A differentiated market where different suppliers offer different prices depending on the depth of services will eventually be better for all concerned. From what I hear, there are plenty of lobbies at work to maintain the status quo.
Tuesday, March 17, 2009
The ABC Of Arbitrage
Hi, one of my favourite asset classes during times when Equity Markets were on a bull run or were volatile was ARBITRAGE SCHEMES. I had tried to allocate some portion of my clients portfolio in these schemes and made them part of the core portfolio. This gave both stability and consistent returns to my clients. Arbitrage schemes were the flavours when equity markets were on a roll. To recapitulate; these schemes follow the strategy as mentioned below:
This class of investment gives market neutral returns without taking any directional exposures to the underlying stocks & shares.
For an investor this is nothing but a BUY & SELL transaction i.e. lending money which is secured & without taking any price risks.
• Difference between the SPOT & FORWARD rate is nothing but interest rate ( traditionally known as Badla).
• This is similar to Reverse REPO undertaken by RBI with Banks or SWAP transactions in the Forex market.
• Difference between the SPOT & The FORWARD price is COST of CARRY or the interest rate.
• In the Futures market, all the trades are done on the exchange either BSE or NSE to ensure performance. However, if an investor enters into a Futures contract with a broker directly, who is a Member of any of the above named Exchanges, he runs the risk of broker default & there is no guarantee from the Exchange. Under the said circumstances, the investor is only protected to the max. of Rs.10 lacs under the Investor Protection Fund & hence is never fully protected.
• As opposed to this, if an Investor invests in Futures market through the Mutual Fund route, the Exchange transfers the transactions from participating Brokers to the Custodians & custodians are banks with large networth.
As you will recall, during bull period of equity markets, Fund managers got opportunities of locking in arbitrage returns varying between 10-15% p.a. and then unwinding the same on the expiry date or rolling it over to the next month ( if next month gave similar opportunities of locking in arbitrage returns); thereby generating close to 10-12 % tax free returns in the hands of the investors (As these schemes invest 80% in Arbitrage and 20% in Money Market, these schemes are treated as equity schemes for tax treatment purposes but with a risk profile of a liquid scheme).
Even in current times of bearish markets where arbitrage returns are as low as 5-6% & futures are going into negative, Fund Managers have been able to generate very decent higher single digit or lower double digit returns. The said is possible when Fund Manager locks in lower arbitrage yields of 40/50 bps i.e. 5-6% p.a. and when the same stock future goes into negative on days markets correct, they unwind the position earlier than 30 days.
Lets understand this better with following example:
Day 1: Buy Cash @Rs.100 & Sell Future @Rs.100.50
On day 15 Future goes into negative and quotes at say Rs.99.50; In such a situation the Fund Manager unwinds the position on day 15 and makes a clean Rs.1/- on the whole transaction ( Rs.0.50 locked in on day 1 and Rs.0.50 when Future quotes at discount) and that too in 15 days and lets the unwound position earn additional money market returns over next 15 days i.e. till the end of the month.
The above is called discount arbitrage (though not called officially, but is used as a common parlance in the Arbitrage Markets). As you will see from the returns comparative given below, that even in these bearish equity market days, the said asset class has generated very handsome returns.
If one invests in the said schemes with 6 months view, one should expect post tax return of close to 8.50-9.00% p.a. (which in the current market conditions is not available in any other asset class, except for Income/G Sec schemes with some intermittent volatility).
Let me spell out the advantages and analyse point by point whether assumptions mentioned have been proven correct or not.
Major advantages of Investing in Futures Market through the Mutual Fund Route are as follows:
1. Rate of Return is quite high. Generally Liquid plus returns. If the Fund does not get any arbitrage opportunity, then, the funds are invested in Fixed Income Securities like Liquid Funds.
2. Investment in these Schemes through the Mutual Fund routes reduces the credit risk to practically nil as the counter parties are Custodians & not the brokers.
3. If an investor invests in say Corporate Bonds; the investor is running the risks of corporate defaults. However, through this route the risk is on the Exchange which is as good as taking a Sovereign risk.
4. This is one way of diversifying your investments portfolio.
5. Investment through the Mutual Fund route has an obvious tax advantage vis a vis direct investment in the same product.
6. It is simpler to deal in complex products through the Mutual Fund route vis a vis investing directly.
Though the said product is an Equity related product, it has no price risks, credit risks, etc generally attached to this segment of investment. It is for all practical purposes a risk free investment that has the potential to give far superior returns than Liquid Funds with all the features of safety, liquidity, etc. associated with Liquid fund schemes.
Let us analyse based on some parameters & assumptions whether what we had predicted for the said asset class has been proven correct or not:
1. Has it generated higher returns than liquid & other debt schemes? Following Chart will make it clearer:
2. There have been no credit or liquidity risks even during market meltdowns from May 11’2006.
3. This was a good diversification strategy as most of the asset classes had some risks like interest rate & credit risk attached to them. The said product gave excellent returns without either of the risks attached.
4. It was a much simpler way of dealing with a complex product like this & let the professionals handle the same. They have been able to enhance returns on both counts
a. Identifying right arbitrage opportunities &
b. Enhancing returns by squaring off positions before expiry; thereby enhancing returns further.
5. It is more tax efficient way of getting into arbitrage schemes than doing it directly.
6. None of the months have Arbitrage Funds given negative returns. What this means is the Redemption NAV of each subsequent months have been higher than the previous month.-Following slide showing 1/3/6 month rolling returns will prove this assumption right
This class of investment gives market neutral returns without taking any directional exposures to the underlying stocks & shares.
For an investor this is nothing but a BUY & SELL transaction i.e. lending money which is secured & without taking any price risks.
• Difference between the SPOT & FORWARD rate is nothing but interest rate ( traditionally known as Badla).
• This is similar to Reverse REPO undertaken by RBI with Banks or SWAP transactions in the Forex market.
• Difference between the SPOT & The FORWARD price is COST of CARRY or the interest rate.
• In the Futures market, all the trades are done on the exchange either BSE or NSE to ensure performance. However, if an investor enters into a Futures contract with a broker directly, who is a Member of any of the above named Exchanges, he runs the risk of broker default & there is no guarantee from the Exchange. Under the said circumstances, the investor is only protected to the max. of Rs.10 lacs under the Investor Protection Fund & hence is never fully protected.
• As opposed to this, if an Investor invests in Futures market through the Mutual Fund route, the Exchange transfers the transactions from participating Brokers to the Custodians & custodians are banks with large networth.
As you will recall, during bull period of equity markets, Fund managers got opportunities of locking in arbitrage returns varying between 10-15% p.a. and then unwinding the same on the expiry date or rolling it over to the next month ( if next month gave similar opportunities of locking in arbitrage returns); thereby generating close to 10-12 % tax free returns in the hands of the investors (As these schemes invest 80% in Arbitrage and 20% in Money Market, these schemes are treated as equity schemes for tax treatment purposes but with a risk profile of a liquid scheme).
Even in current times of bearish markets where arbitrage returns are as low as 5-6% & futures are going into negative, Fund Managers have been able to generate very decent higher single digit or lower double digit returns. The said is possible when Fund Manager locks in lower arbitrage yields of 40/50 bps i.e. 5-6% p.a. and when the same stock future goes into negative on days markets correct, they unwind the position earlier than 30 days.
Lets understand this better with following example:
Day 1: Buy Cash @Rs.100 & Sell Future @Rs.100.50
On day 15 Future goes into negative and quotes at say Rs.99.50; In such a situation the Fund Manager unwinds the position on day 15 and makes a clean Rs.1/- on the whole transaction ( Rs.0.50 locked in on day 1 and Rs.0.50 when Future quotes at discount) and that too in 15 days and lets the unwound position earn additional money market returns over next 15 days i.e. till the end of the month.
The above is called discount arbitrage (though not called officially, but is used as a common parlance in the Arbitrage Markets). As you will see from the returns comparative given below, that even in these bearish equity market days, the said asset class has generated very handsome returns.
If one invests in the said schemes with 6 months view, one should expect post tax return of close to 8.50-9.00% p.a. (which in the current market conditions is not available in any other asset class, except for Income/G Sec schemes with some intermittent volatility).
Let me spell out the advantages and analyse point by point whether assumptions mentioned have been proven correct or not.
Major advantages of Investing in Futures Market through the Mutual Fund Route are as follows:
1. Rate of Return is quite high. Generally Liquid plus returns. If the Fund does not get any arbitrage opportunity, then, the funds are invested in Fixed Income Securities like Liquid Funds.
2. Investment in these Schemes through the Mutual Fund routes reduces the credit risk to practically nil as the counter parties are Custodians & not the brokers.
3. If an investor invests in say Corporate Bonds; the investor is running the risks of corporate defaults. However, through this route the risk is on the Exchange which is as good as taking a Sovereign risk.
4. This is one way of diversifying your investments portfolio.
5. Investment through the Mutual Fund route has an obvious tax advantage vis a vis direct investment in the same product.
6. It is simpler to deal in complex products through the Mutual Fund route vis a vis investing directly.
Though the said product is an Equity related product, it has no price risks, credit risks, etc generally attached to this segment of investment. It is for all practical purposes a risk free investment that has the potential to give far superior returns than Liquid Funds with all the features of safety, liquidity, etc. associated with Liquid fund schemes.
Let us analyse based on some parameters & assumptions whether what we had predicted for the said asset class has been proven correct or not:
1. Has it generated higher returns than liquid & other debt schemes? Following Chart will make it clearer:
2. There have been no credit or liquidity risks even during market meltdowns from May 11’2006.
3. This was a good diversification strategy as most of the asset classes had some risks like interest rate & credit risk attached to them. The said product gave excellent returns without either of the risks attached.
4. It was a much simpler way of dealing with a complex product like this & let the professionals handle the same. They have been able to enhance returns on both counts
a. Identifying right arbitrage opportunities &
b. Enhancing returns by squaring off positions before expiry; thereby enhancing returns further.
5. It is more tax efficient way of getting into arbitrage schemes than doing it directly.
6. None of the months have Arbitrage Funds given negative returns. What this means is the Redemption NAV of each subsequent months have been higher than the previous month.-Following slide showing 1/3/6 month rolling returns will prove this assumption right
Five basics for a solid financial future
The stark truth about managing our money these days is that we are mostly on our own. Few employers want us around for 40 years, so our income is likely to have ups and downs and disappear altogether for brief periods between jobs. Saving for retirement is now mostly our responsibility, too. Health insurance, for those of us who have it and manage to keep it, requires increasingly large amounts of money out of our pockets. The list goes on and on. At the same time, all sorts of individuals and institutions have smelled opportunity and lined up to peddle their wares, resulting in an explosion of credit cards, bank products and advisers of various stripes. Some of this is helpful because competition has led to lower costs. But in other instances - say, newfangled adjustable-rate mortgages - the result has been painful.
Complicating all of this is the housing downturn, which has affected the largest asset in many portfolios. Rising fuel and food prices along with tougher loan standards do not help. Given the stakes, it is hard to avoid the persistent low-grade fear that we have made wrong choices or cannot find the right ones, even though they are out there somewhere.
"There's no guarantee that the choices will be available, attractive or appropriate for everyone," said Jacob S Hacker, a political science professor at Yale University and author of "The Great Risk Shift," which looked at how corporations and governments have pushed financial responsibility onto individuals.
So as I take on the Your Money column (and later this year, a companion personal finance site at nytimes.com), I want to devote some space to treating the subject in much the same way that this newspaper's critics treat new films or restaurants. Important new offerings - whether mutual funds or a shopping search engine - will merit a review. And one by one, we will figure out what is worth using and what is best to ignore. Until then, here are five basic guidelines. Think of them as the first principles of Your Money, guidance that can be useful in making just about any financial decision.
Topics
1.Investing is simple
2.Have the talk
Investing is simple
The author Michael Pollan offered an elegant seven-word mantra in his best-selling book "In Defense of Food" that provides clarity amid the bounty of choices on supermarket shelves: "Eat food. Not too much. Mostly plants." Boiling down investing is a similar exercise: Index (mostly). Save a tonne. Reallocate infrequently.
For most of us, investing in index mutual funds and similar vehicles - and sticking with them - is the hardest part of the mantra to accept. It would seem that with such an array of choices, we should be able to create portfolios that can outperform the market averages.
The fact is, however, besting the overall market in most investment classes is nearly impossible over long periods of time. Sure, it may be fun to try. But if you enjoy that sort of thing, do it with a tiny piece of your portfolio. And remember to call it what it actually is: gambling.
The rest of us should save as much as we can in a collection of low-cost index funds. Divide the money among stocks, bonds and other investments according to your time horizon and risk tolerance. Then adjust that allocation occasionally. Opinions vary on the frequency, but most experts agree that adjusting the mix more often than every 6 to 12 months is unnecessary and possibly costly.
It still may be worth paying for help
Investing, however, is only one small part of your financial life. Mortgages, taxes, college savings, insurance and debt are a few of the hugely important tasks we have to figure out.
Perhaps the best thing a versatile professional - whether it is a financial planner, accountant, stockbroker or lawyer - does is provide discipline. It is difficult to get most of this stuff right. And to get it done at the right time. Professionals help make sure it all happens on schedule.
Most of us would rather avoid paying for help. Many financial planners charge 1 percent of a client's assets annually for advice on anything and everything, including investing. So if you have $200,000 saved for retirement, that is $2,000 a year.
The best defense I have ever heard for this level of compensation comes from Roger Streit, a financial planner at Key Financial Solutions in Roseland, NJ. He says that only 1% of us are wise enough and regimented enough to manage our own financial affairs. The other 99%, meanwhile, could almost certainly improve their investment performance at least 1 percent, thus justifying the annual fee.
Sure, this sounds self-serving. But it is also probably true.
Peers may know more than professionals
Financial planners may not have all the answers, or the best answers, all of the time. Moreover, they tend to be stronger on core areas of money management like insurance and taxes and less so on day-to-day financial decisions.
Thankfully, a number of web communities and blogs have grown up around almost every aspect of spending and saving. Travelers and collectors of frequent-flier miles have FlyerTalk. FatWallet is terrific on credit cards. Another site, the Bank Deals blog, is a great resource for new high-rate account offerings. A separate site, Consumerist (both the blog posts and the comments), is strong on advice for anyone who feels as if they have gotten a bad deal from a particular retailer or service provider. And committed index-fund investors hang out at the Bogleheads investment forum.
Reading all these sites regularly is impossible. But they are great for researching particular questions, and most of the expert consumers who congregate there are open to inquiries from newcomers (as long as you search the archives first to make sure the answer isn't there already).
Everything can (and should) be automated
One of the great consumer-friendly innovations in the world of money in recent years has been the automation of bill paying. Practically every utility, mortgage lender and credit card company now has a way of getting its money each month without you lifting a finger. Most will take the money directly from a bank account, and many also allow payment with a credit or debit card.
As a result, I do not need a monthly bill-paying session anymore. The electric and mortgage companies debit my bank account each month. The cable, cellphone and other companies charge my credit card, which helps me to collect piles of rewards. Then the credit card companies pull the full balance from my bank account, too, just as the mortgage company does.
This has a number of advantages: no stamps, no envelopes, no late fees. But the real gift is that I do not have to worry about getting it all done. And with the time I win back, I can do things that are a lot more fun. Automating the payments can have some hitches. It is tempting to neglect to look at the bills once they start paying themselves.
It is a pain to turn the whole bill-paying machinery off and on again if you switch bank accounts. And you need to be sure you have enough of a cash cushion in your primary checking account to prevent overdrafts.
Have the talk
As fewer people have pensions and more retirees live longer, an increasing number of people may need financial help from their children. The question is whether your parents will be among them. Trying to pry financial information out of your parents does not make for a pleasant conversation. But the fact is, we are entitled to demand some answers if our parents do not initiate the discussion themselves.
This is not a case for callousness. They took care of us for 20 or so years, and we will take care of them, too, if it comes to that. But it is not fair of them to withhold warnings of deteriorating finances. If we do not know what is coming, we cannot help them plan for it. Just as we should talk about money with our parents, we should be less reticent about discussing it with others.
NY Times / Ron Lieber
Complicating all of this is the housing downturn, which has affected the largest asset in many portfolios. Rising fuel and food prices along with tougher loan standards do not help. Given the stakes, it is hard to avoid the persistent low-grade fear that we have made wrong choices or cannot find the right ones, even though they are out there somewhere.
"There's no guarantee that the choices will be available, attractive or appropriate for everyone," said Jacob S Hacker, a political science professor at Yale University and author of "The Great Risk Shift," which looked at how corporations and governments have pushed financial responsibility onto individuals.
So as I take on the Your Money column (and later this year, a companion personal finance site at nytimes.com), I want to devote some space to treating the subject in much the same way that this newspaper's critics treat new films or restaurants. Important new offerings - whether mutual funds or a shopping search engine - will merit a review. And one by one, we will figure out what is worth using and what is best to ignore. Until then, here are five basic guidelines. Think of them as the first principles of Your Money, guidance that can be useful in making just about any financial decision.
Topics
1.Investing is simple
2.Have the talk
Investing is simple
The author Michael Pollan offered an elegant seven-word mantra in his best-selling book "In Defense of Food" that provides clarity amid the bounty of choices on supermarket shelves: "Eat food. Not too much. Mostly plants." Boiling down investing is a similar exercise: Index (mostly). Save a tonne. Reallocate infrequently.
For most of us, investing in index mutual funds and similar vehicles - and sticking with them - is the hardest part of the mantra to accept. It would seem that with such an array of choices, we should be able to create portfolios that can outperform the market averages.
The fact is, however, besting the overall market in most investment classes is nearly impossible over long periods of time. Sure, it may be fun to try. But if you enjoy that sort of thing, do it with a tiny piece of your portfolio. And remember to call it what it actually is: gambling.
The rest of us should save as much as we can in a collection of low-cost index funds. Divide the money among stocks, bonds and other investments according to your time horizon and risk tolerance. Then adjust that allocation occasionally. Opinions vary on the frequency, but most experts agree that adjusting the mix more often than every 6 to 12 months is unnecessary and possibly costly.
It still may be worth paying for help
Investing, however, is only one small part of your financial life. Mortgages, taxes, college savings, insurance and debt are a few of the hugely important tasks we have to figure out.
Perhaps the best thing a versatile professional - whether it is a financial planner, accountant, stockbroker or lawyer - does is provide discipline. It is difficult to get most of this stuff right. And to get it done at the right time. Professionals help make sure it all happens on schedule.
Most of us would rather avoid paying for help. Many financial planners charge 1 percent of a client's assets annually for advice on anything and everything, including investing. So if you have $200,000 saved for retirement, that is $2,000 a year.
The best defense I have ever heard for this level of compensation comes from Roger Streit, a financial planner at Key Financial Solutions in Roseland, NJ. He says that only 1% of us are wise enough and regimented enough to manage our own financial affairs. The other 99%, meanwhile, could almost certainly improve their investment performance at least 1 percent, thus justifying the annual fee.
Sure, this sounds self-serving. But it is also probably true.
Peers may know more than professionals
Financial planners may not have all the answers, or the best answers, all of the time. Moreover, they tend to be stronger on core areas of money management like insurance and taxes and less so on day-to-day financial decisions.
Thankfully, a number of web communities and blogs have grown up around almost every aspect of spending and saving. Travelers and collectors of frequent-flier miles have FlyerTalk. FatWallet is terrific on credit cards. Another site, the Bank Deals blog, is a great resource for new high-rate account offerings. A separate site, Consumerist (both the blog posts and the comments), is strong on advice for anyone who feels as if they have gotten a bad deal from a particular retailer or service provider. And committed index-fund investors hang out at the Bogleheads investment forum.
Reading all these sites regularly is impossible. But they are great for researching particular questions, and most of the expert consumers who congregate there are open to inquiries from newcomers (as long as you search the archives first to make sure the answer isn't there already).
Everything can (and should) be automated
One of the great consumer-friendly innovations in the world of money in recent years has been the automation of bill paying. Practically every utility, mortgage lender and credit card company now has a way of getting its money each month without you lifting a finger. Most will take the money directly from a bank account, and many also allow payment with a credit or debit card.
As a result, I do not need a monthly bill-paying session anymore. The electric and mortgage companies debit my bank account each month. The cable, cellphone and other companies charge my credit card, which helps me to collect piles of rewards. Then the credit card companies pull the full balance from my bank account, too, just as the mortgage company does.
This has a number of advantages: no stamps, no envelopes, no late fees. But the real gift is that I do not have to worry about getting it all done. And with the time I win back, I can do things that are a lot more fun. Automating the payments can have some hitches. It is tempting to neglect to look at the bills once they start paying themselves.
It is a pain to turn the whole bill-paying machinery off and on again if you switch bank accounts. And you need to be sure you have enough of a cash cushion in your primary checking account to prevent overdrafts.
Have the talk
As fewer people have pensions and more retirees live longer, an increasing number of people may need financial help from their children. The question is whether your parents will be among them. Trying to pry financial information out of your parents does not make for a pleasant conversation. But the fact is, we are entitled to demand some answers if our parents do not initiate the discussion themselves.
This is not a case for callousness. They took care of us for 20 or so years, and we will take care of them, too, if it comes to that. But it is not fair of them to withhold warnings of deteriorating finances. If we do not know what is coming, we cannot help them plan for it. Just as we should talk about money with our parents, we should be less reticent about discussing it with others.
NY Times / Ron Lieber
The emotional investor
The emotional investor
If you are caught in a dilemma whether to further invest in a weak stock in which you have lost, say, more than Rs 1 lakh, so that you can average out your investments or put your money in a promising company that could reap you rich dividends, which would you choose? It's a dilemma that faces many of us and often comes in the way of making a rational investment decision.
Very often, investors choose the former to cover up losses in their portfolio or just hold on to the stock in the hope that it will bounce back soon. Behavioural finance experts say investors tend to behave in this way because the pain of loss far exceeds the pleasure from gains. It's this emotion of loss aversion that many investors unwittingly succumb to when making investment decisions. Often, not understanding one's emotions when investing in the stock market leads to big financial losses for investors
Plenty of research has gone into how emotions affect investment decisions of individuals. Emotions are shaped by a lot of influences in our daily lives, including basic things like how we react to money or how our parents reacted to money. Emotions also determine how we react to different situations. Says Parag Parikh, stock broker and author of Stocks to Riches (Tata McGraw-Hill): It also stems ourselves and seek immediate pleasure or whether we can postpone pleasure. It's how you deal with these emotions that will determine whether you will make money or lose your shirt during these tough times.
Markets are not efficient in the short term: Long-time broker Parag Parikh and author of Stocks to Riches explains how individual investors behave in the short run and how they can use emotions to their advantage.
On emotional biases: People are influenced by various emotions and one of them is sunkcost fallacy , which results in putting good money after bad. You essentially want to justify your earlier decision and soothe your ego. If you bought a bad stock and bought more after its price fell, it's this fallacy at work. When you average out, you may be prone to sunk-cost fallacy . On the other hand, you can use the effect to your advantage by averaging downwards in a good stock.
On investing today: Often, people find it difficult to understand stock markets. It's said that markets are efficient. But behavioural economists believe that markets are not efficient in the short run. It's precisely in such times that people don't make rational decisions. When these days a liquidator is selling stocks at any price, can you imagine the potential you have when you invest today? Right now, everyone wants to avoid a loss while it may be the time to buy.
On market emotions: If I sell a share after the market falls, I make a loss. So, my actions have produced a loss for me. But other shareholders, by merely holding the same shares, too, see their values plummet. It's when you don't do anything and yet there's a reaction, then you get confused. This is when greed and fear overcome us. Right now, everyone wants to avoid a loss, which is known as loss aversion in behavioural finance. This is the time to buy.
Topics
1.Weigh your emotions
2.Balance the decisions
Weigh your emotions
Consider the gambler's fallacy that nearly everyone from housewives to corporate head honchos falls for. Say, you are playing a game of coin tossing and nine times out of nine, the coin shows heads. What are the chances that it will show heads on the next toss? Many might think it's slim because it showed heads nine times out of nine previously. Yet, the chances are fifty-fifty the same as the last coin toss or the previous nine coin tosses. Each wager is unique to the chances that it gives an investor and it has got nothing to do with the previous results. This is where investors can recognise that each investment is different. If you had been winning on a particular stock before, it does not mean that you will win the next time you invest in the same. It calls for a fresh understanding of the market conditions and the circumstances that will allow your stock to do well.
Investors get easily swayed by another similar emotion: the sunkcost fallacy . This means that investors are throwing in good money after bad. On the other hand, if your investment is in a weak stock, then no matter how much you invest in it, chances are that you will still lose money. But sometimes you can use this psychological effect to your advantage. Let's say you buy a gym membership for a year rather than for a month. Here you sink the money for a year, but it psychologically forces you to go to the gym rather than forego a huge sum. In investing, it works when an individual investor rupee costaverages on a good stock.
A common trap investors fall into when they are driven by emotions is when they try to recover a loss. At such times, an investor has to commit a bigger sum of money to recover his loss in the market. In doing so, he fails to recognise that his risk capital and exposure to the market has increased.
Balance the decisions
The first step to clearing the mental cobwebs is to make a note of why you are taking the decision in the first place. There are some key questions you should ask yourself before taking a decision to invest. Do you want to recover your losses? Do you find the investment worthy at the current market prices? Are you keeping away from the stock market for fear of losing money? Or are you investing right now because you find stocks very attractive? Are you afraid of losing money or are you afraid of taking risks?
It's not difficult to understand your emotions over time. Question every investment decision you make with your own experience. Ask hard questions about the prospects of the company and whether the price you are paying for it is right. Circumstances can change for a company (as the Satyam episode has shown), so not every investment might turn out to be right. Shrug off your losses and move on to the next story. As Parikh puts it: Don't get married to your stocks.
On the other hand, don't latch on to every new idea that comes your way at the cost of your old ones that might still have potential, but rather weigh your investment decisions before you take a call. The key to wealth building is to balance your investment decisions with your objectives and the circumstances of the market. Exploit the emotions of the market when there's an opportunity. Chances are that it will leave you better placed than the rest of the market and well-prepared for further opportunities or downturns.
Reproduced From Business Today. © 2009. LMIL. All rights reserved
If you are caught in a dilemma whether to further invest in a weak stock in which you have lost, say, more than Rs 1 lakh, so that you can average out your investments or put your money in a promising company that could reap you rich dividends, which would you choose? It's a dilemma that faces many of us and often comes in the way of making a rational investment decision.
Very often, investors choose the former to cover up losses in their portfolio or just hold on to the stock in the hope that it will bounce back soon. Behavioural finance experts say investors tend to behave in this way because the pain of loss far exceeds the pleasure from gains. It's this emotion of loss aversion that many investors unwittingly succumb to when making investment decisions. Often, not understanding one's emotions when investing in the stock market leads to big financial losses for investors
Plenty of research has gone into how emotions affect investment decisions of individuals. Emotions are shaped by a lot of influences in our daily lives, including basic things like how we react to money or how our parents reacted to money. Emotions also determine how we react to different situations. Says Parag Parikh, stock broker and author of Stocks to Riches (Tata McGraw-Hill): It also stems ourselves and seek immediate pleasure or whether we can postpone pleasure. It's how you deal with these emotions that will determine whether you will make money or lose your shirt during these tough times.
Markets are not efficient in the short term: Long-time broker Parag Parikh and author of Stocks to Riches explains how individual investors behave in the short run and how they can use emotions to their advantage.
On emotional biases: People are influenced by various emotions and one of them is sunkcost fallacy , which results in putting good money after bad. You essentially want to justify your earlier decision and soothe your ego. If you bought a bad stock and bought more after its price fell, it's this fallacy at work. When you average out, you may be prone to sunk-cost fallacy . On the other hand, you can use the effect to your advantage by averaging downwards in a good stock.
On investing today: Often, people find it difficult to understand stock markets. It's said that markets are efficient. But behavioural economists believe that markets are not efficient in the short run. It's precisely in such times that people don't make rational decisions. When these days a liquidator is selling stocks at any price, can you imagine the potential you have when you invest today? Right now, everyone wants to avoid a loss while it may be the time to buy.
On market emotions: If I sell a share after the market falls, I make a loss. So, my actions have produced a loss for me. But other shareholders, by merely holding the same shares, too, see their values plummet. It's when you don't do anything and yet there's a reaction, then you get confused. This is when greed and fear overcome us. Right now, everyone wants to avoid a loss, which is known as loss aversion in behavioural finance. This is the time to buy.
Topics
1.Weigh your emotions
2.Balance the decisions
Weigh your emotions
Consider the gambler's fallacy that nearly everyone from housewives to corporate head honchos falls for. Say, you are playing a game of coin tossing and nine times out of nine, the coin shows heads. What are the chances that it will show heads on the next toss? Many might think it's slim because it showed heads nine times out of nine previously. Yet, the chances are fifty-fifty the same as the last coin toss or the previous nine coin tosses. Each wager is unique to the chances that it gives an investor and it has got nothing to do with the previous results. This is where investors can recognise that each investment is different. If you had been winning on a particular stock before, it does not mean that you will win the next time you invest in the same. It calls for a fresh understanding of the market conditions and the circumstances that will allow your stock to do well.
Investors get easily swayed by another similar emotion: the sunkcost fallacy . This means that investors are throwing in good money after bad. On the other hand, if your investment is in a weak stock, then no matter how much you invest in it, chances are that you will still lose money. But sometimes you can use this psychological effect to your advantage. Let's say you buy a gym membership for a year rather than for a month. Here you sink the money for a year, but it psychologically forces you to go to the gym rather than forego a huge sum. In investing, it works when an individual investor rupee costaverages on a good stock.
A common trap investors fall into when they are driven by emotions is when they try to recover a loss. At such times, an investor has to commit a bigger sum of money to recover his loss in the market. In doing so, he fails to recognise that his risk capital and exposure to the market has increased.
Balance the decisions
The first step to clearing the mental cobwebs is to make a note of why you are taking the decision in the first place. There are some key questions you should ask yourself before taking a decision to invest. Do you want to recover your losses? Do you find the investment worthy at the current market prices? Are you keeping away from the stock market for fear of losing money? Or are you investing right now because you find stocks very attractive? Are you afraid of losing money or are you afraid of taking risks?
It's not difficult to understand your emotions over time. Question every investment decision you make with your own experience. Ask hard questions about the prospects of the company and whether the price you are paying for it is right. Circumstances can change for a company (as the Satyam episode has shown), so not every investment might turn out to be right. Shrug off your losses and move on to the next story. As Parikh puts it: Don't get married to your stocks.
On the other hand, don't latch on to every new idea that comes your way at the cost of your old ones that might still have potential, but rather weigh your investment decisions before you take a call. The key to wealth building is to balance your investment decisions with your objectives and the circumstances of the market. Exploit the emotions of the market when there's an opportunity. Chances are that it will leave you better placed than the rest of the market and well-prepared for further opportunities or downturns.
Reproduced From Business Today. © 2009. LMIL. All rights reserved
Wednesday, March 4, 2009
Personal Tax: 10 things to do before March 31 Indian financial
Year runs from 1 April to 31 March. Accordingly, the Income-Tax Return is to be prepared and filed for the relevant financial year.
31st March is an important date as it marks the end of a financial year. The last few weeks are when we rush for the documents/investment proofs, based on which we compute our tax liability.
The income-tax department has done away with the requirement of filing any supporting documents like investment proofs, etc, along with the return of income. It is, however, prudent to collect the same before the end of the financial year and keep them in records for future reference. These would also be required, in case your return is picked up for assessment.
Here are ten things to do before March 31, 2009 i.e. before the current financial year ends:
1. Submit to your employer the proof of investments/expenses that you have incurred to claim deduction under Section 80C. These includes receipt for insurance premium paid, deposits made in your public provident fund account, investment made in equity-linked savings schemes, National Savings Certificates purchased, children’s tuition fees paid, etc. Your employer would require the details and the documentary proof to provide you the deduction under Section 80C.
2. If you are claiming deduction for house rent allowance, then ensure that you have submitted the necessary details and proofs like rent receipt, etc, to your employer for claiming the benefit.
3. Collect all your bank statements and Tax Deducted at Source (TDS) certificates, if any, from your bank. This will help you to compute interest income on bank deposits and pay balance tax, if any.
4. If you have a running home loan, you must collect the certificate of repayment of principal amount and the interest paid during the financial year from the bank/financial institution from which you have taken the housing loan. You are required to provide a computation to your employer specifying the income under the head ‘House Property’ along with the proof of interest and principal repayment, to claim deduction.
5. In case you have changed employment during the financial year and not collected your Form 16, then you should collect the same now.
6. If you have made a donation to any charitable organization during the year, then ensure that you collect a valid receipt to claim deduction u/s 80G.
7. If you are claiming deduction under Section 80D for payment of health insurance premium for self and family, then ensure that you have obtained receipt for the premium paid.
8. If you are claiming deduction for interest on educational loan then ensure that you have the necessary records to substantiate the same.
9. If you have sold/transferred any asset like house property, shares, mutual funds etc. then compute the capital gains and check the exemptions available to you. A distinction is to be made between long term and short term capital gains.
10. Compute your tax for the year and assess whether you are required to pay any balance tax.
These are few of the important steps that one should take care of while preparing one’s tax computation. It would be a good idea to take the necessary action now to avoid the last minute rush of collecting the details and ensuring that all the available exemptions/deductions are claimed.
31st March is an important date as it marks the end of a financial year. The last few weeks are when we rush for the documents/investment proofs, based on which we compute our tax liability.
The income-tax department has done away with the requirement of filing any supporting documents like investment proofs, etc, along with the return of income. It is, however, prudent to collect the same before the end of the financial year and keep them in records for future reference. These would also be required, in case your return is picked up for assessment.
Here are ten things to do before March 31, 2009 i.e. before the current financial year ends:
1. Submit to your employer the proof of investments/expenses that you have incurred to claim deduction under Section 80C. These includes receipt for insurance premium paid, deposits made in your public provident fund account, investment made in equity-linked savings schemes, National Savings Certificates purchased, children’s tuition fees paid, etc. Your employer would require the details and the documentary proof to provide you the deduction under Section 80C.
2. If you are claiming deduction for house rent allowance, then ensure that you have submitted the necessary details and proofs like rent receipt, etc, to your employer for claiming the benefit.
3. Collect all your bank statements and Tax Deducted at Source (TDS) certificates, if any, from your bank. This will help you to compute interest income on bank deposits and pay balance tax, if any.
4. If you have a running home loan, you must collect the certificate of repayment of principal amount and the interest paid during the financial year from the bank/financial institution from which you have taken the housing loan. You are required to provide a computation to your employer specifying the income under the head ‘House Property’ along with the proof of interest and principal repayment, to claim deduction.
5. In case you have changed employment during the financial year and not collected your Form 16, then you should collect the same now.
6. If you have made a donation to any charitable organization during the year, then ensure that you collect a valid receipt to claim deduction u/s 80G.
7. If you are claiming deduction under Section 80D for payment of health insurance premium for self and family, then ensure that you have obtained receipt for the premium paid.
8. If you are claiming deduction for interest on educational loan then ensure that you have the necessary records to substantiate the same.
9. If you have sold/transferred any asset like house property, shares, mutual funds etc. then compute the capital gains and check the exemptions available to you. A distinction is to be made between long term and short term capital gains.
10. Compute your tax for the year and assess whether you are required to pay any balance tax.
These are few of the important steps that one should take care of while preparing one’s tax computation. It would be a good idea to take the necessary action now to avoid the last minute rush of collecting the details and ensuring that all the available exemptions/deductions are claimed.
Saturday, January 31, 2009
Maket This Week
Indian bourses witnessed a strong rally on Tuesday, a day after Republic Day celebrations, and the Sensex surged by an impressive 330 points to close at 9004, while the broader Nifty registered a gain of 93 points to end strongly at 2771.
The market breadth was positive and the rally was led by banking stocks such as SBI, ICICI Bank, HDFC Bank. Although FIIs continued to be the sellers, domestic institutions and mutual funds turned net buyers.
The Reserve Bank of India, in its quarterly monetary policy review, on Tuesday left key rates unchanged and lowered the GDP growth rate projections to 7% from its earlier forecast of 7.5 % in view of recession in the USA and European countries.
The new board of Satyam Computers has appointed Goldman Sachs and Avendus Capital as investment bankers and asserted that the company will not be sold in parts. It has further assured that the employees will get their January salary on schedule.
One of the board members, Mr Manoharan, has stated that the board had no clue as to the motive behind L&T's bid to acquire Satyam, while asserting that the bid will be devised in a fair and transparent manner in consultation with SEBI and the Government.
Following a strong global sentiment, the markets continued to rally on Wednesday as the Sensex closed the session with a gain of 253 points at 9257. Similarly, the Nifty opened on a positive note, rose 78 points to end positively at 2850.
The share price of Satyam Computers on Wednesday surged by 17 per cent to Rs 55 on media reports that L&T might further enhance its stake. Apart from this, there was heavy short covering in this counter as Thursday would be the last day that Satyam shares will be traded in the F& O segment, said market participants.
In a late evening development on Thursday, Mr B.K. Modi, Chairman, Spice Group informed that Spice Innovation is interested in acquiring 51 per cent stake in Satyam.
Explaining the rationale behind the move, he said "they are also in the same line of business. our board had decided to look at Satyam even before the financial fraud came into light."
The benchmark Sensex ended Thursday's session marginally lower by 21 points at 9236 after paring the initial gains.
Similarly the Nifty faced resistance at higher levels and lost 25 points and closed at 2824.
According to data from SEBI, FIIs have been net sellers of equity for $1.2 billion in the month of January. They have been net sellers since January 7.
Apart from the worst fears over the gloabl economic recession, the Satyam episode had dampened FII sentment further, aver market players.
The Sensex on Friday gained 188 points supported by positive global trends and buying by domestic funds in blue-chip stocks to close 9424.24. The Nifty index also rose by 51 points to end firmer at 2874.80.
The market breadth was positive and the rally was led by banking stocks such as SBI, ICICI Bank, HDFC Bank. Although FIIs continued to be the sellers, domestic institutions and mutual funds turned net buyers.
The Reserve Bank of India, in its quarterly monetary policy review, on Tuesday left key rates unchanged and lowered the GDP growth rate projections to 7% from its earlier forecast of 7.5 % in view of recession in the USA and European countries.
The new board of Satyam Computers has appointed Goldman Sachs and Avendus Capital as investment bankers and asserted that the company will not be sold in parts. It has further assured that the employees will get their January salary on schedule.
One of the board members, Mr Manoharan, has stated that the board had no clue as to the motive behind L&T's bid to acquire Satyam, while asserting that the bid will be devised in a fair and transparent manner in consultation with SEBI and the Government.
Following a strong global sentiment, the markets continued to rally on Wednesday as the Sensex closed the session with a gain of 253 points at 9257. Similarly, the Nifty opened on a positive note, rose 78 points to end positively at 2850.
The share price of Satyam Computers on Wednesday surged by 17 per cent to Rs 55 on media reports that L&T might further enhance its stake. Apart from this, there was heavy short covering in this counter as Thursday would be the last day that Satyam shares will be traded in the F& O segment, said market participants.
In a late evening development on Thursday, Mr B.K. Modi, Chairman, Spice Group informed that Spice Innovation is interested in acquiring 51 per cent stake in Satyam.
Explaining the rationale behind the move, he said "they are also in the same line of business. our board had decided to look at Satyam even before the financial fraud came into light."
The benchmark Sensex ended Thursday's session marginally lower by 21 points at 9236 after paring the initial gains.
Similarly the Nifty faced resistance at higher levels and lost 25 points and closed at 2824.
According to data from SEBI, FIIs have been net sellers of equity for $1.2 billion in the month of January. They have been net sellers since January 7.
Apart from the worst fears over the gloabl economic recession, the Satyam episode had dampened FII sentment further, aver market players.
The Sensex on Friday gained 188 points supported by positive global trends and buying by domestic funds in blue-chip stocks to close 9424.24. The Nifty index also rose by 51 points to end firmer at 2874.80.
Thursday, January 15, 2009
Monday, January 12, 2009
Top honchos' cover puts insurers in a fix
With Satyam (SATYAM.BO : 34.25 10.4) founder and former chairman B Ramalinga Raju along with his brother and former chief financial officer (CFO) behind bars, the insurers are in state of quandary over the claim settlement of the country's largest directors' and officers' liability insurance policy (DandO) in the name of the top management of Satyam Computer Services.
ICICI (ICICIBANK.NS : 434.5 -22.1) Lombard General Insurance, Tata General Insurnace and New India Assurance have designed the Rs 400-crore DandO cover for the Satyam top management, who are being dragged to courts after Raju confessed about a Rs 7,000-crore fraud.
A DandO policy covers the cost of legal expenses of a policy holder in both domestic and overseas operations. Some leading corporates and private sector banks have bought these policies to protect their top management and members of their boards from any act of commission and omission committed in the discharge of their duties.
Two US law firms-Izard Nobel LLP and Vianale and Vianale LLP have also filed class action lawsuits against Satyam on behalf of shareholders of the software services firm's American depository receipts.
"A lawsuit seeking class action status has been filed in the United States district court for the Southern District of New York on behalf of those who purchased the ADRs of Satyam Computer between January 6, 2004 and January 6, 2009," Izard Nobel LLP said in a statement.
Another law firm Vianale and Vianale LLP has also announced that it has filed a class action lawsuit on behalf of purchasers of the American depository shares of Satyam Computer during the class period January 6, 2004 through January 6, 2009.
However, the insurers are now trying to find out the legal sanctity of Raju's confession, as any fraud committed intentionally by the holder of a DandO policy would not be entitled to any claim settlement.
Particularly the insurers are citing the official statement of the capital market regulator, Sebi, which has said that Raju's confession may not have a legal standing to convince a magistrate. Sebi said it needed to have its own investigation before filing complaint against the top management to implicate it.
Speaking to FE, insurers who have provided the DandO policy to Satyam said it would be now a long-drawn process to have any claim settlement under the policy.
In the US, DandO policy is one of the most bought policy by corporates against class action.
ICICI (ICICIBANK.NS : 434.5 -22.1) Lombard General Insurance, Tata General Insurnace and New India Assurance have designed the Rs 400-crore DandO cover for the Satyam top management, who are being dragged to courts after Raju confessed about a Rs 7,000-crore fraud.
A DandO policy covers the cost of legal expenses of a policy holder in both domestic and overseas operations. Some leading corporates and private sector banks have bought these policies to protect their top management and members of their boards from any act of commission and omission committed in the discharge of their duties.
Two US law firms-Izard Nobel LLP and Vianale and Vianale LLP have also filed class action lawsuits against Satyam on behalf of shareholders of the software services firm's American depository receipts.
"A lawsuit seeking class action status has been filed in the United States district court for the Southern District of New York on behalf of those who purchased the ADRs of Satyam Computer between January 6, 2004 and January 6, 2009," Izard Nobel LLP said in a statement.
Another law firm Vianale and Vianale LLP has also announced that it has filed a class action lawsuit on behalf of purchasers of the American depository shares of Satyam Computer during the class period January 6, 2004 through January 6, 2009.
However, the insurers are now trying to find out the legal sanctity of Raju's confession, as any fraud committed intentionally by the holder of a DandO policy would not be entitled to any claim settlement.
Particularly the insurers are citing the official statement of the capital market regulator, Sebi, which has said that Raju's confession may not have a legal standing to convince a magistrate. Sebi said it needed to have its own investigation before filing complaint against the top management to implicate it.
Speaking to FE, insurers who have provided the DandO policy to Satyam said it would be now a long-drawn process to have any claim settlement under the policy.
In the US, DandO policy is one of the most bought policy by corporates against class action.
Three Investor Lessons from the Satyam Scandal
The Satyam (SAY) scandal has provided a stark reminder to many about the dangers of investing. There are, however, diverging trains of thought on what to take away from this. One school says that this goes to show that the rest of the world is not that much unlike America and that an Enron or Madoff scandal can happen anywhere. Underlying this belief seems to be the idea that these sorts of scandals are somewhat random and unpredictable.
A second school of thought says this exposes the dangers of investing abroad and particularly in emerging markets where business culture, auditing standards, accounting rules, regulatory structures, and social customs can differ markedly from the United States. The thought here is that the developing world might not have quite as strong checks to insure accuracy of data reported by businesses and that American investors will inevitably experience a lack of awareness of many issues in any particular nation that might differ from the US.
For my money, I am in the latter school of thought. This is not to suggest that one should completely shy away from investing in the rest of the world and the emerging markets; rather, one needs to be aware of the different risks involved by investing in the international sphere.
There are several reasons why I do not view this scandal as simply India’s version of Enron. Certainly, this event has rocked the Indian markets in the same sense that Enron did the American markets, but that does not mean the scandals are necessarily similar in nature and that this could happen in the United States any time. The nature of the fraud involved is key to me. If one were to examine the fraud cases in the United States, a lot of them involve complex schemes and companies taking advantage of auditors’ lack of knowledge about difficult-to-price assets. While auditors might work in particular industries more than others, they still do not have the expert knowledge of asset classes that one who works in an industry every day might have.
Look at a company like Intel (INTC), for instance, that produces high-tech devices that rapidly depreciate in value. From an auditor’s perspective, it might be difficult to tell the difference between a new chip with high-value and an obsolete chip with virtually no value. These types of situations can create opportunities for fraudsters.
While a lot of facts from the Satyam scandal are still missing and I imagine we will learn more over the coming weeks and months, the one particularly frightening thing about this is the seeming ease with which this fraud was committed. This does not appear to be a case of complicated and difficult-to-value assets vexing auditors. Satyam had a cash balance over $1 Billion and 94% of it was fictitious! Surely, one would think, that auditors should have noticed such a large amount of cash that did not seem to exist. Cash is a much more difficult asset to “fake” or create an illusion of heightened value on than microprocessors, oil supplies, or mortgage-backed securities. How could a massive store of missing cash escape the attention of auditors?
If a company could fake this much cash on its balance sheet without auditors even batting an eyelash, could this mean that any company in India is potentially vulnerable? It’s worthwhile to note that as a publicly-traded company traded on an American exchange, Satyam was subject to US Generally Accepted Accounting Principles (GAAP) and Sarbanes-Oxley. Yet, even this did not protect investors. But why?
There’s a whole host of possible reasons and it’s difficult to say what the truth behind the matter is without all the fact. Some possibilities:
(1) Satyam was audited by Price Waterhouse of Hyderabad, India, which is connected to PricewaterhouseCoopers. It’s not clear to me what sort of people would be brought in to do this audit, however. Obviously, you would need people familiar with US GAAP. Was the auditing staff largely based out of India? Or did PwC bring “experts” over from the United States?
There is potential for problems with either option you choose. Would Indian-educated accountants necessarily be familiar with US GAAP and GAAS on more than a shallow level? Keep in mind, these auditors could possibly only use these standards once per year while auditing Satyam. Perhaps an audit, while theoretically falling under American standards, is carried out more closely to Indian standards in actuality.
If Americans were brought in to examine Satyam, would they necessarily have more than a shallow understanding of Indian business practices, regulations, and cultural customs? Would the Americans be “taking the word” of people at Satyam due to their own lack of expertise?
(2) Another possibility is something about Indian business practices and the regulatory environment make it easy to conceal this type of thing from the view of auditors. As a foreigner, one is simply left guessing about conditions in a particular country. An American operates with a lot of assumptions that are mainly based on their own experiences in America; those assumptions may be completely invalid when carried over to a nation halfway across the globe.
(3) Its also possible that auditors or financial institutions were acting in collusion with Satyam. Thus far, there is no evidence of this, but it can’t be ruled out yet. Ironically, this would probably be the least damning of the options because it would suggest that there was a lack of effective checks involved here and this might be remediable. Though, it still might expose the ease with which such collusion could occur overseas.
These are just a few possibilities. I am sure there are many others and it all cuts into the harsh reality of investing: we are all making decisions based on limited information. The best we can do is maintain awareness of this and seek out investing strategies that minimize the effects of this. With that, I offer these thoughts on investing:
(1) When Investing in Emerging Markets, Be Aware of Heightened Risks from Greater Uncertainty
Personally, I have never analyzed any companies in India and do not have that much knowledge of the Indian market. However, I do examine a number of companies from China. One thing I’ve found is that the financial statements are not necessarily as illuminating as they might be for American companies, even when they are prepared in accordance with US GAAP. This goes back to a previous thought: accountants in foreign nations may not necessarily have that great of an understanding of American standards, culture, and laws. While this is true in an auditing capacity, it’s also true in an in-house capacity. A company may hire accountants who have limited understanding of American standards and culture.
On that note, one thing I’ve personally noticed from examining Chinese solar companies is that the financial statements for some of the companies are extremely difficult to understand and gather important information from. I found myself particularly vexed reading through Yingli Solar’s (YGE) 20-F filing. Due to this, I have shied away from Yingli personally. This does not mean that Yingli is a bad investment --- merely that I made a conscious decision based on a general feeling I got from reading the financial statements that the company might not have totally understood American investors. If this was the case, it was also possible the company did not fully understand American accounting standards. Based on this, I assigned a higher level of risk to Yingli.
I don’t mean to single out Yingli, as it may indeed be a great investment and I have encountered some very smart investors who think highly of the firm, but my thought was that if I was having particular difficulty understanding their disclosures, maybe I should steer clear rather than *assume* that everything was alright.
(2) Different Countries, Different Rules, Different Cultures, Different Education
Every country has its own set of laws and customs. However, most of us are not lawyers. Instead, we gain our understanding of the law through observation. We have a sense that something is not legal. We have a sense of what is acceptable and what is not. Those standards do not necessarily carry over to every nation. This might seem somewhat obvious in a way. What might be less obvious is that people born in another nation might have a completely different way of learning and a completely different education.
This becomes especially important when we are talking about accounting and auditing. Are Russian accountants necessarily well-schooled in American accounting standards? I have no clue how one becomes an accountant in Russia, but I imagine they have their own procedures and their own system of education and that it differs in many respects from the system here in America. If a company in Russia is traded on an American exchange, how does it find the accountants who are to do the American reporting? Are Russian accountants simply given a two-week crash course? Is an American brought over to teach others? Are Americans running the whole operation? As mentioned earlier, no matter which way you look at it, there are a potential host of problems.
The main takeaway here is to simply be aware that other nations operate differently and even abiding by American standards does not necessarily mean that all differences immediately disappear.
(3) Diversify, Diversify, Diversify!
The most important takeaway here is that investing involves a lot of uncertainty. No matter how skilled or knowledgeable you are in finance, accounting, business, or the particularly industry you are looking at, there is always something out there that you did not know about and that you will not anticipate. The best way to deal with this uncertainty is to mitigate the risks by diversifying your portfolio. This is true even if you are investing only in American companies, but I think it’s even more true when investing in emerging markets.
A few parting notes: while I would not necessarily discourage anyone from investing in emerging markets, I will suggest that it might be prudent to have a great deal of reluctance towards investing in India for the near-future. Until we know how the Satyam fraud went undetected by auditors for so many years and until we see some evidence that this is not happening all over India, I would veer away. Naturally, anyone is free to disagree with my assessment.
Finally, a lot of what I have offered here is speculation about what might be happening in overseas companies and auditing firms. If anything is not factual, feel free to inform me. My bigger point here is that sometimes, we don’t know all the facts. All the same, we should seek as many of those facts as we can get.
Disclosures: No position in SAY or any Indian/emerging market ETFs
A second school of thought says this exposes the dangers of investing abroad and particularly in emerging markets where business culture, auditing standards, accounting rules, regulatory structures, and social customs can differ markedly from the United States. The thought here is that the developing world might not have quite as strong checks to insure accuracy of data reported by businesses and that American investors will inevitably experience a lack of awareness of many issues in any particular nation that might differ from the US.
For my money, I am in the latter school of thought. This is not to suggest that one should completely shy away from investing in the rest of the world and the emerging markets; rather, one needs to be aware of the different risks involved by investing in the international sphere.
There are several reasons why I do not view this scandal as simply India’s version of Enron. Certainly, this event has rocked the Indian markets in the same sense that Enron did the American markets, but that does not mean the scandals are necessarily similar in nature and that this could happen in the United States any time. The nature of the fraud involved is key to me. If one were to examine the fraud cases in the United States, a lot of them involve complex schemes and companies taking advantage of auditors’ lack of knowledge about difficult-to-price assets. While auditors might work in particular industries more than others, they still do not have the expert knowledge of asset classes that one who works in an industry every day might have.
Look at a company like Intel (INTC), for instance, that produces high-tech devices that rapidly depreciate in value. From an auditor’s perspective, it might be difficult to tell the difference between a new chip with high-value and an obsolete chip with virtually no value. These types of situations can create opportunities for fraudsters.
While a lot of facts from the Satyam scandal are still missing and I imagine we will learn more over the coming weeks and months, the one particularly frightening thing about this is the seeming ease with which this fraud was committed. This does not appear to be a case of complicated and difficult-to-value assets vexing auditors. Satyam had a cash balance over $1 Billion and 94% of it was fictitious! Surely, one would think, that auditors should have noticed such a large amount of cash that did not seem to exist. Cash is a much more difficult asset to “fake” or create an illusion of heightened value on than microprocessors, oil supplies, or mortgage-backed securities. How could a massive store of missing cash escape the attention of auditors?
If a company could fake this much cash on its balance sheet without auditors even batting an eyelash, could this mean that any company in India is potentially vulnerable? It’s worthwhile to note that as a publicly-traded company traded on an American exchange, Satyam was subject to US Generally Accepted Accounting Principles (GAAP) and Sarbanes-Oxley. Yet, even this did not protect investors. But why?
There’s a whole host of possible reasons and it’s difficult to say what the truth behind the matter is without all the fact. Some possibilities:
(1) Satyam was audited by Price Waterhouse of Hyderabad, India, which is connected to PricewaterhouseCoopers. It’s not clear to me what sort of people would be brought in to do this audit, however. Obviously, you would need people familiar with US GAAP. Was the auditing staff largely based out of India? Or did PwC bring “experts” over from the United States?
There is potential for problems with either option you choose. Would Indian-educated accountants necessarily be familiar with US GAAP and GAAS on more than a shallow level? Keep in mind, these auditors could possibly only use these standards once per year while auditing Satyam. Perhaps an audit, while theoretically falling under American standards, is carried out more closely to Indian standards in actuality.
If Americans were brought in to examine Satyam, would they necessarily have more than a shallow understanding of Indian business practices, regulations, and cultural customs? Would the Americans be “taking the word” of people at Satyam due to their own lack of expertise?
(2) Another possibility is something about Indian business practices and the regulatory environment make it easy to conceal this type of thing from the view of auditors. As a foreigner, one is simply left guessing about conditions in a particular country. An American operates with a lot of assumptions that are mainly based on their own experiences in America; those assumptions may be completely invalid when carried over to a nation halfway across the globe.
(3) Its also possible that auditors or financial institutions were acting in collusion with Satyam. Thus far, there is no evidence of this, but it can’t be ruled out yet. Ironically, this would probably be the least damning of the options because it would suggest that there was a lack of effective checks involved here and this might be remediable. Though, it still might expose the ease with which such collusion could occur overseas.
These are just a few possibilities. I am sure there are many others and it all cuts into the harsh reality of investing: we are all making decisions based on limited information. The best we can do is maintain awareness of this and seek out investing strategies that minimize the effects of this. With that, I offer these thoughts on investing:
(1) When Investing in Emerging Markets, Be Aware of Heightened Risks from Greater Uncertainty
Personally, I have never analyzed any companies in India and do not have that much knowledge of the Indian market. However, I do examine a number of companies from China. One thing I’ve found is that the financial statements are not necessarily as illuminating as they might be for American companies, even when they are prepared in accordance with US GAAP. This goes back to a previous thought: accountants in foreign nations may not necessarily have that great of an understanding of American standards, culture, and laws. While this is true in an auditing capacity, it’s also true in an in-house capacity. A company may hire accountants who have limited understanding of American standards and culture.
On that note, one thing I’ve personally noticed from examining Chinese solar companies is that the financial statements for some of the companies are extremely difficult to understand and gather important information from. I found myself particularly vexed reading through Yingli Solar’s (YGE) 20-F filing. Due to this, I have shied away from Yingli personally. This does not mean that Yingli is a bad investment --- merely that I made a conscious decision based on a general feeling I got from reading the financial statements that the company might not have totally understood American investors. If this was the case, it was also possible the company did not fully understand American accounting standards. Based on this, I assigned a higher level of risk to Yingli.
I don’t mean to single out Yingli, as it may indeed be a great investment and I have encountered some very smart investors who think highly of the firm, but my thought was that if I was having particular difficulty understanding their disclosures, maybe I should steer clear rather than *assume* that everything was alright.
(2) Different Countries, Different Rules, Different Cultures, Different Education
Every country has its own set of laws and customs. However, most of us are not lawyers. Instead, we gain our understanding of the law through observation. We have a sense that something is not legal. We have a sense of what is acceptable and what is not. Those standards do not necessarily carry over to every nation. This might seem somewhat obvious in a way. What might be less obvious is that people born in another nation might have a completely different way of learning and a completely different education.
This becomes especially important when we are talking about accounting and auditing. Are Russian accountants necessarily well-schooled in American accounting standards? I have no clue how one becomes an accountant in Russia, but I imagine they have their own procedures and their own system of education and that it differs in many respects from the system here in America. If a company in Russia is traded on an American exchange, how does it find the accountants who are to do the American reporting? Are Russian accountants simply given a two-week crash course? Is an American brought over to teach others? Are Americans running the whole operation? As mentioned earlier, no matter which way you look at it, there are a potential host of problems.
The main takeaway here is to simply be aware that other nations operate differently and even abiding by American standards does not necessarily mean that all differences immediately disappear.
(3) Diversify, Diversify, Diversify!
The most important takeaway here is that investing involves a lot of uncertainty. No matter how skilled or knowledgeable you are in finance, accounting, business, or the particularly industry you are looking at, there is always something out there that you did not know about and that you will not anticipate. The best way to deal with this uncertainty is to mitigate the risks by diversifying your portfolio. This is true even if you are investing only in American companies, but I think it’s even more true when investing in emerging markets.
A few parting notes: while I would not necessarily discourage anyone from investing in emerging markets, I will suggest that it might be prudent to have a great deal of reluctance towards investing in India for the near-future. Until we know how the Satyam fraud went undetected by auditors for so many years and until we see some evidence that this is not happening all over India, I would veer away. Naturally, anyone is free to disagree with my assessment.
Finally, a lot of what I have offered here is speculation about what might be happening in overseas companies and auditing firms. If anything is not factual, feel free to inform me. My bigger point here is that sometimes, we don’t know all the facts. All the same, we should seek as many of those facts as we can get.
Disclosures: No position in SAY or any Indian/emerging market ETFs
Thursday, January 8, 2009
MFs get extra-cautious after Satyam fracas
MUMBAI: The crisis over Satyam has left the mutual fund industry in the wilderness as to what extra precautionary measures can be taken to judge
the quality of a management while investing. Anticipating similar like fiasco in the future too, MFs plan to be more vigilant in scrutinising balance sheets.
Terming the incident as ‘detrimental to Indian Inc’ industry players are keeping close watch on all Satyam related developments, especially with respect to auditors and bankers of the company. “Auditor’s role is very crucial in this entire saga. We would like to hear from PwC as well as from all the bankers of the company. Their views will put more light into it. Based on that, we shall strengthen our efforts in judging corporate governance of a company,” said Waqar Naqvi, chief executive, Taurus Asset Management.
The balance sheet of Satyam carries inflated cash and bank balances of Rs. 5,361 crore as against Rs.5,040 crore and accrued interest of Rs.376 crore which is non-existent. Industry players express their helplessness over it. Said N K Garg, CEO, Sahara Mutual Fund, “It is not feasible for industry players to cross-check with every banker of a company about the cash in hand or any other item like accrued interest.”
However, Garg added, “it is not enough for MF investors to check only two pages of a balance sheet to draw a conclusion about a company. One will have to go through the schedules and notes of accounts mentioned with the balance sheet. Corporate governance gets 52% of the total scores in asset management in our house.”
As on 31 December, 2008, HDFC Growth and HDFC Equity had Satyam investment of 1.95% and 2.64% to their NAVs. Birla Sun Life Equity had 2.75%. Three schemes of UTI AMC and two schemes of Franklin Templeton had also holdings between 1.75% and 8%. As on November, 2008; Reliance Advantage fund and Reliance RSF had 1.19% and 2.83% respectively.
However, all those stakes have been brought down substantially in view of recent developments in Satyam. Most of the MFs offloaded their stake booking the loss to minimum possible extent when the scrip was traded at 3 digit figures on Wednesday in a losing streak. Fund houses refuse to be quoted on Satyam exposure.
Mentioned Sanjay Sinha, chief executive officer, DBS Cholamandalam Asset Management, “for investments, there is no ready formula to counter such situation. In determining the quality of management we do every needful exercise. Going ahead, there could see many such cases of deliberate frauds.”
In a probable solution to mitigate the risk of investment in such unprecedented fraud case, Anoop Bhaskar, head – equity, UTI Asset Management, presents a case. He said, “It is great learning experience for all of us as it is the first Indian company involved in a fraud of this magnitude. We need to concentrate more on diversification of portfolios. If fund managers restrict a particular company investment to the tune of 2-3 per cent investment, the loss gets limited.”
Going through the annals of ENRON and Worldcom, fund managers are not surprised over Satyam but are scouting for ways to put more focus on corporate governance.
the quality of a management while investing. Anticipating similar like fiasco in the future too, MFs plan to be more vigilant in scrutinising balance sheets.
Terming the incident as ‘detrimental to Indian Inc’ industry players are keeping close watch on all Satyam related developments, especially with respect to auditors and bankers of the company. “Auditor’s role is very crucial in this entire saga. We would like to hear from PwC as well as from all the bankers of the company. Their views will put more light into it. Based on that, we shall strengthen our efforts in judging corporate governance of a company,” said Waqar Naqvi, chief executive, Taurus Asset Management.
The balance sheet of Satyam carries inflated cash and bank balances of Rs. 5,361 crore as against Rs.5,040 crore and accrued interest of Rs.376 crore which is non-existent. Industry players express their helplessness over it. Said N K Garg, CEO, Sahara Mutual Fund, “It is not feasible for industry players to cross-check with every banker of a company about the cash in hand or any other item like accrued interest.”
However, Garg added, “it is not enough for MF investors to check only two pages of a balance sheet to draw a conclusion about a company. One will have to go through the schedules and notes of accounts mentioned with the balance sheet. Corporate governance gets 52% of the total scores in asset management in our house.”
As on 31 December, 2008, HDFC Growth and HDFC Equity had Satyam investment of 1.95% and 2.64% to their NAVs. Birla Sun Life Equity had 2.75%. Three schemes of UTI AMC and two schemes of Franklin Templeton had also holdings between 1.75% and 8%. As on November, 2008; Reliance Advantage fund and Reliance RSF had 1.19% and 2.83% respectively.
However, all those stakes have been brought down substantially in view of recent developments in Satyam. Most of the MFs offloaded their stake booking the loss to minimum possible extent when the scrip was traded at 3 digit figures on Wednesday in a losing streak. Fund houses refuse to be quoted on Satyam exposure.
Mentioned Sanjay Sinha, chief executive officer, DBS Cholamandalam Asset Management, “for investments, there is no ready formula to counter such situation. In determining the quality of management we do every needful exercise. Going ahead, there could see many such cases of deliberate frauds.”
In a probable solution to mitigate the risk of investment in such unprecedented fraud case, Anoop Bhaskar, head – equity, UTI Asset Management, presents a case. He said, “It is great learning experience for all of us as it is the first Indian company involved in a fraud of this magnitude. We need to concentrate more on diversification of portfolios. If fund managers restrict a particular company investment to the tune of 2-3 per cent investment, the loss gets limited.”
Going through the annals of ENRON and Worldcom, fund managers are not surprised over Satyam but are scouting for ways to put more focus on corporate governance.
Satyam's Valuation-CLSA
Hi,
Satyam's Founder and Chairman Ramalinga Raju has quit. In a letter to the Board and exchanges, he has admitted that:
Satyam over-stated cash assets: Rs50.4bn out of Rs53.6bn cash assets are "inflated or non-existent"
Satyam over-stated revenues: In Sep quarter, revenues were reported as Rs27bn whereas revenues were actually Rs21.12bn
Satyam over-stated operating profits: Real operating profits in Sep08 quarter were 3% of revenues, which were stated as 24% of revenues.
Satyam also has under-stated liabilities - more details in the attached release sent to the exchanges.
Satyam is now India's Enron. Recent chatter on value emerging in the Satyam stock based on cash per share has been rendered irrelevant. The independence of the Board was already in question, now the auditors' (PwC) complicity in what seems to be a multi-year mis-statement of financials will also be explored.
An embarrassing and shocking episode for Indian corporate governance continues to unravel, surprising all at every step. Legal measures may follow, and introspection too, by regulators, corporates, auditors, and of course, by analysts like us. The 10th January Board meeting now becomes irrelevant. When there is no cash, how can there be a buy back? And where did the cash go? Only an investigation can tell.
So much for the "moral outrage", which is the easy way out. Is there any way Satyam can be valued now? What about 50,000+ employees (is the count of employees real?), and hundreds of customers (the large ones are real for sure); and what about UPaid which had filed a forgery litigation against Satyam?
Book value becomes meaningless, with cash out and asset/debtors unknown or uncertain. A different approach could be that the business, or SOME PART OF THE BUSINESS, is real
M Cap per employee for Indian IT majors = $100-120k
Assume a 70% discount for Satyam
Assume Satyam DOES NOT have 50k+ employees but only 30k in reality
Satyam could be valued at = $120k x 0.3 x 30000 = $900m
Remove still unknown (yet to be disclosed) liabilities of $300m (assumed). Value becomes $600m or about Rs40 per share
Based on the declared real EPS for Sep quarter, and a 8x multiple, price could be Rs25 per share.
Satyam's Founder and Chairman Ramalinga Raju has quit. In a letter to the Board and exchanges, he has admitted that:
Satyam over-stated cash assets: Rs50.4bn out of Rs53.6bn cash assets are "inflated or non-existent"
Satyam over-stated revenues: In Sep quarter, revenues were reported as Rs27bn whereas revenues were actually Rs21.12bn
Satyam over-stated operating profits: Real operating profits in Sep08 quarter were 3% of revenues, which were stated as 24% of revenues.
Satyam also has under-stated liabilities - more details in the attached release sent to the exchanges.
Satyam is now India's Enron. Recent chatter on value emerging in the Satyam stock based on cash per share has been rendered irrelevant. The independence of the Board was already in question, now the auditors' (PwC) complicity in what seems to be a multi-year mis-statement of financials will also be explored.
An embarrassing and shocking episode for Indian corporate governance continues to unravel, surprising all at every step. Legal measures may follow, and introspection too, by regulators, corporates, auditors, and of course, by analysts like us. The 10th January Board meeting now becomes irrelevant. When there is no cash, how can there be a buy back? And where did the cash go? Only an investigation can tell.
So much for the "moral outrage", which is the easy way out. Is there any way Satyam can be valued now? What about 50,000+ employees (is the count of employees real?), and hundreds of customers (the large ones are real for sure); and what about UPaid which had filed a forgery litigation against Satyam?
Book value becomes meaningless, with cash out and asset/debtors unknown or uncertain. A different approach could be that the business, or SOME PART OF THE BUSINESS, is real
M Cap per employee for Indian IT majors = $100-120k
Assume a 70% discount for Satyam
Assume Satyam DOES NOT have 50k+ employees but only 30k in reality
Satyam could be valued at = $120k x 0.3 x 30000 = $900m
Remove still unknown (yet to be disclosed) liabilities of $300m (assumed). Value becomes $600m or about Rs40 per share
Based on the declared real EPS for Sep quarter, and a 8x multiple, price could be Rs25 per share.
Monday, January 5, 2009
Year Of The Bond
2009 shall be the year of The Bond (market). Bonds have already started off the upward journey on the face of lackadaisical interest in equities and a speculative opportunity arising out of yields going up significantly in the past few months. Expected downgrades and fears of default had pushed up bond yields to high levels in the past few months. Added was fact that they yield on the benchmark 10 year Gsec paper, had climbed to a high of 9.5% in late July 08.
A bond or fixed income security is an instrument issued by a borrower with a certain interest rate (referred to as coupon rate), and a fixed maturity. Bonds are thus fixed obligations to return principal and make fixed tenor payments of interest to the holder of the bond. Long duration (more than one year) Bonds issued by the Government are often referred to as G-Secs or Gilts. Gilts are supposed to be the safest instruments and carry zero credit risk. Bonds are often tradable securities which gives rise to an opportunity to benefit from the change in prices of these bonds.
Bonds and fixed income securities are sensitive to various factors. Interest rates prevailing in the economy, risk premiums attached to different securities, often measured by their credit rating, and factors affecting demand and supply of bonds decide bond prices. Some other factors like liquidity risk also play a part. Lets consider how each of these affects bond prices.
Interest Rate Risk: Bond prices are inversely related to the interest rates prevailing in the economy. Lets consider a scenario where you make a FD with a bank at 8% pa for 5 years. After 6 months you realize that deposit rates have risen to 10%. A rational investor would break the old FD and tell the bank to make a new one at 10%. Now suppose instead of a bank FD you were really holding a tradable bond, with interest rates going up to 10% the 8% bond has become less attractive. This would reflect in the price of the bond, which would fall to a price so that the 8% coupon would work out to a yield of 10%. Thus the new price would be 8%/X = 10%. The new price thus would be Rs 80 representing a fall of Rs 20 from the original price of Rs 100. The same logic would apply if the interest rates fall, bonds carrying a higher rate become more attractive and their price would go up to come in line with the higher yields prevalent in the bond market.
Credit Risk: This simply put is the risk of default on the borrowings. Bonds issued by companies not perceived to be very safe would be issued at a lower price, thus making the yield attractive to investors. A Rs 100 bond with a coupon of 8% thus may be issued at Rs 96 thus making the yield 12% to the investor. Now if the outlook on this company falls further ie suppose its bonds are downgraded by the rating agencies, the prices would fall further (and yields would rise), thus resulting in a loss for the investor. Similarly the reverse would happen if there is a upgrade in the rating of the bond. Credit risk is sometimes reflected in the spread between government bonds and bonds issued by companies. So a widening yield spread between the benchmark 10 year G-Sec and AAA Corporate paper means that generally the markets believe there is a significant credit risk in corporates bonds.
Liquidity Risk: Bonds are traded in the secondary market which is not very deep. While G-Secs are actively traded securities, PSU and corporate securities are sometimes not actively traded. Liquidity risk represents the risk arising out of not being able to sell these securities when required. The holder of a bond may thus be forced to liquidate the security at a discount leading to a loss.
Some other factors affect the demand and supply of bonds and thus their prices. Fresh government borrowing represented by a higher supply of government bonds, changes in SLR ratio of banks, which is the percentage of deposits of banks that has to be held in Government securities and the speculative interest in bonds are some other factors affecting prices.
The last few moths of 2008 saw major volatility in the bond markets. In July 2008 the benchmark 10 year G-Sec (8.24% GOI, 2018) yield rose to a 9.5% in the face of rising interest rates in the economy. As the government’s focus shifts from controlling inflation by increasing interest rates to one of growth orientation marked by reducing interest rates, bond yields started falling. The 10 year G-Sec yield thus started it’s downward journey and reached a low of 5.44% in December returning huge profits to holders of these bonds.
The year 2009 also holds promise for the bond market. Lack of interest in equities would make it difficult to raise fresh capital from equities. Corporates would be forced to look at the debt market for their needs. Mutual Funds would become active and there are signs already, as the retail investor look towards options other than equity. My opinion is that the rally has only just begun and would continue to hold promise for better part of next year. What may not happen in a hurry is the yield contraction between corporate and government paper. There seems to be a wide spread opinion that all may not be well in the corporate bond market and some defaults are likely in the next quarter. Although the current spreads seem to have factored in the risk, actual defaults may further dampen spirits leading to a further expansion in spreads. While later in the year the fears may subside, the spread contraction theory may take a little while to take off. Personally I would prefer bond funds that hold government and PSU paper only.
A bond or fixed income security is an instrument issued by a borrower with a certain interest rate (referred to as coupon rate), and a fixed maturity. Bonds are thus fixed obligations to return principal and make fixed tenor payments of interest to the holder of the bond. Long duration (more than one year) Bonds issued by the Government are often referred to as G-Secs or Gilts. Gilts are supposed to be the safest instruments and carry zero credit risk. Bonds are often tradable securities which gives rise to an opportunity to benefit from the change in prices of these bonds.
Bonds and fixed income securities are sensitive to various factors. Interest rates prevailing in the economy, risk premiums attached to different securities, often measured by their credit rating, and factors affecting demand and supply of bonds decide bond prices. Some other factors like liquidity risk also play a part. Lets consider how each of these affects bond prices.
Interest Rate Risk: Bond prices are inversely related to the interest rates prevailing in the economy. Lets consider a scenario where you make a FD with a bank at 8% pa for 5 years. After 6 months you realize that deposit rates have risen to 10%. A rational investor would break the old FD and tell the bank to make a new one at 10%. Now suppose instead of a bank FD you were really holding a tradable bond, with interest rates going up to 10% the 8% bond has become less attractive. This would reflect in the price of the bond, which would fall to a price so that the 8% coupon would work out to a yield of 10%. Thus the new price would be 8%/X = 10%. The new price thus would be Rs 80 representing a fall of Rs 20 from the original price of Rs 100. The same logic would apply if the interest rates fall, bonds carrying a higher rate become more attractive and their price would go up to come in line with the higher yields prevalent in the bond market.
Credit Risk: This simply put is the risk of default on the borrowings. Bonds issued by companies not perceived to be very safe would be issued at a lower price, thus making the yield attractive to investors. A Rs 100 bond with a coupon of 8% thus may be issued at Rs 96 thus making the yield 12% to the investor. Now if the outlook on this company falls further ie suppose its bonds are downgraded by the rating agencies, the prices would fall further (and yields would rise), thus resulting in a loss for the investor. Similarly the reverse would happen if there is a upgrade in the rating of the bond. Credit risk is sometimes reflected in the spread between government bonds and bonds issued by companies. So a widening yield spread between the benchmark 10 year G-Sec and AAA Corporate paper means that generally the markets believe there is a significant credit risk in corporates bonds.
Liquidity Risk: Bonds are traded in the secondary market which is not very deep. While G-Secs are actively traded securities, PSU and corporate securities are sometimes not actively traded. Liquidity risk represents the risk arising out of not being able to sell these securities when required. The holder of a bond may thus be forced to liquidate the security at a discount leading to a loss.
Some other factors affect the demand and supply of bonds and thus their prices. Fresh government borrowing represented by a higher supply of government bonds, changes in SLR ratio of banks, which is the percentage of deposits of banks that has to be held in Government securities and the speculative interest in bonds are some other factors affecting prices.
The last few moths of 2008 saw major volatility in the bond markets. In July 2008 the benchmark 10 year G-Sec (8.24% GOI, 2018) yield rose to a 9.5% in the face of rising interest rates in the economy. As the government’s focus shifts from controlling inflation by increasing interest rates to one of growth orientation marked by reducing interest rates, bond yields started falling. The 10 year G-Sec yield thus started it’s downward journey and reached a low of 5.44% in December returning huge profits to holders of these bonds.
The year 2009 also holds promise for the bond market. Lack of interest in equities would make it difficult to raise fresh capital from equities. Corporates would be forced to look at the debt market for their needs. Mutual Funds would become active and there are signs already, as the retail investor look towards options other than equity. My opinion is that the rally has only just begun and would continue to hold promise for better part of next year. What may not happen in a hurry is the yield contraction between corporate and government paper. There seems to be a wide spread opinion that all may not be well in the corporate bond market and some defaults are likely in the next quarter. Although the current spreads seem to have factored in the risk, actual defaults may further dampen spirits leading to a further expansion in spreads. While later in the year the fears may subside, the spread contraction theory may take a little while to take off. Personally I would prefer bond funds that hold government and PSU paper only.
Friday, January 2, 2009
Lesson From 2008
A long and terrible year has come to an end. For mutual fund investors, this has easily been the worst year ever. This is hardly surprising given the way stock prices have collapsed across the board.
The mainstream equity category of diversified equity funds halved investors' money, falling an average of 55 per cent during the year. This 55 per cent loss represents more than Rs 60,000 crore of losses for investors who had invested in diversified equity funds.
This was actually slightly worse than the two large-cap indices, the Sensex and the Nifty which are both down about 53 per cent during the period. This is unusual-the average diversified equity fund generally beat the indices by a wide margin.
The depth of the collapse in 2008 has led to a certain fatalism among fund investors. People have just thrown up their hands, figuratively speaking, and abandoned any attempt at looking more deeply into what went wrong and what went right. Or at least, what went more wrong and what went less wrong. The 55 per cent is merely the average of the funds. There's rather a large range hidden within this. The worst fund is down about 80 per cent and the best one just about 35 per cent. The 80 per cent is not really an extreme case-in all there are eight funds that are down by more 70 per cent. At the other end of the performance continuum, there are about 10 funds that fell 45 per cent or less. This is not a small difference. If you started the year with Rs 20 lakh, the worst fund would have reduced it to Rs 4 lakh and the best one would have reduced it to about Rs 13 lakh.
Of course, the above numbers apply only to the worst-case investors-those who made their entire investment a year ago. Hopefully, there are many mutual fund investors out there who have imbibed the correct mantra and have been around for a longer-term. Such investors will appreciate the fruits of choosing good funds better. Over the past three years, the best funds would have grown your 20 lakhs to between Rs 25 lakh and Rs 28 lakh while the worst ones would have shrunk that amount to around Rs 10-12 lakh.
The best part of the story is that differentiation between the better and the worse is as predicted. Funds that were more aggressive, that dabbled more in smaller companies and took more concentrated bets are the worst performers. In fact, the three worst funds of 2008 were in the top five in 2007. This slide from the very top to the very bottom is not unexpected. It holds an old, well-worn but fundamental lesson-mutual funds that do the very best in bull runs fall suddenly and sharply when the good times turn to bad. It's an inevitable side-effect of how equity fund managers generate excessive returns during bubbles.
In many ways, the real surprise of 2008 was how debt funds fared. Debt funds are supposed to be stable and conservative so these surprises came as a shock to their investors. While I've discussed debt funds in detail in past weeks, it must be pointed out that the crises faced by these funds during 2008 fall into two categories. Interest rate changes, while unexpected, are very much part of the game and will remain so. But the liquidity freeze in October and November was a structural problem that is unlikely to happen again.
All in all, 2008 may have been a terrible year, but given what happened in the underlying markets, it did follow a pattern. Moreover, it was a year that clearly points the way forward for fund managers and investors.
The mainstream equity category of diversified equity funds halved investors' money, falling an average of 55 per cent during the year. This 55 per cent loss represents more than Rs 60,000 crore of losses for investors who had invested in diversified equity funds.
This was actually slightly worse than the two large-cap indices, the Sensex and the Nifty which are both down about 53 per cent during the period. This is unusual-the average diversified equity fund generally beat the indices by a wide margin.
The depth of the collapse in 2008 has led to a certain fatalism among fund investors. People have just thrown up their hands, figuratively speaking, and abandoned any attempt at looking more deeply into what went wrong and what went right. Or at least, what went more wrong and what went less wrong. The 55 per cent is merely the average of the funds. There's rather a large range hidden within this. The worst fund is down about 80 per cent and the best one just about 35 per cent. The 80 per cent is not really an extreme case-in all there are eight funds that are down by more 70 per cent. At the other end of the performance continuum, there are about 10 funds that fell 45 per cent or less. This is not a small difference. If you started the year with Rs 20 lakh, the worst fund would have reduced it to Rs 4 lakh and the best one would have reduced it to about Rs 13 lakh.
Of course, the above numbers apply only to the worst-case investors-those who made their entire investment a year ago. Hopefully, there are many mutual fund investors out there who have imbibed the correct mantra and have been around for a longer-term. Such investors will appreciate the fruits of choosing good funds better. Over the past three years, the best funds would have grown your 20 lakhs to between Rs 25 lakh and Rs 28 lakh while the worst ones would have shrunk that amount to around Rs 10-12 lakh.
The best part of the story is that differentiation between the better and the worse is as predicted. Funds that were more aggressive, that dabbled more in smaller companies and took more concentrated bets are the worst performers. In fact, the three worst funds of 2008 were in the top five in 2007. This slide from the very top to the very bottom is not unexpected. It holds an old, well-worn but fundamental lesson-mutual funds that do the very best in bull runs fall suddenly and sharply when the good times turn to bad. It's an inevitable side-effect of how equity fund managers generate excessive returns during bubbles.
In many ways, the real surprise of 2008 was how debt funds fared. Debt funds are supposed to be stable and conservative so these surprises came as a shock to their investors. While I've discussed debt funds in detail in past weeks, it must be pointed out that the crises faced by these funds during 2008 fall into two categories. Interest rate changes, while unexpected, are very much part of the game and will remain so. But the liquidity freeze in October and November was a structural problem that is unlikely to happen again.
All in all, 2008 may have been a terrible year, but given what happened in the underlying markets, it did follow a pattern. Moreover, it was a year that clearly points the way forward for fund managers and investors.
AUMs back on track after 2 mths as big houses shore up funds
After witnessing two months redemption pressure and an erosion in assets under management (AUM), the Indian mutual fund (MF) industry seems to be clawing back on track. The AUM numbers released by the Association of Mutual Funds in India (Amfi) indicates that there has been an overall growth with larger players shoring up the numbers. Top fund houses like Reliance Mutual Fund, ICICI (ICICIBANK.NS) Prudential, Tata and SBI (SBIN.NS) Mutual fund have registered decent growth in their Asset under Management (AUM) for the month of December 2008. Country s top fund Reliance Mutual Fund registered a growth of Rs 2,392.24 crores or 3.53 and its AUM stood at Rs 70,208.10 crores compared to Rs 67,815.86 crores in the month of November. According to numbers disclosed by 22 of the 37 fund houses the overall AUM has increased by 4.67% in December over the previous month. Waqar Naqvi, chief executive, Tauras Mutual Fund said, The fund houses having exposure in the equity market have gained their AUM in the month of December, 2008 as the over all market has gone up by 10% during the month. The equity market has gone up positively in the December. Some of the fund houses have also gained their AUM with the inflow of money into their liquid funds. It can be mentioned that in the month of December the benchmark index, the 30-share Sensex (^BSESN) of Bombay Stock Exchange (BSE) gained 1,063 points or 12.03%. ICICI Prudential MF s AUM for the month of December stood at Rs 41,877.51 crores, increase by Rs 4,821.84 crores or 13.01%. While there are several fund houses which continued to face the heat of global meltdown. Edelweiss MF saw dip in their AUM at Rs 77.21 crores in December compared to Rs 164.79 crores in November a decrease of Rs 87.57 crores or 53.14%.
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