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Tuesday, April 29, 2008

Insurance Basics Part V: Child Plan

This article explains the basic concept of a child plan, as is available in the market today.

What is a Child Plan?

It has typically two components to it:

  • A life insurance on the parent

  • An investment vehicle that accumulates your savings on a regular basis and pays it back around the time the child reaches college (typically when he/she turns 18-21)

These two components are thus very different in what they achieve to secure the child’s future, and any analysis must keep this distinction in mind at all times.

The Insurance Component

Life insurance in the child plan ensures that the monies payable to the child for higher education are protected against untimely death of the earning parent. I cannot overplay the importance of this insurance – in fact, my observation has been that most people underinsure their life in these policies.

By mandate, the minimum life cover that you have to opt for in a child plan is

Sum Assured = Term * Annual premium / 2

Thus, if you take an 18-year plan, paying Rs. 50,000 every year, the minimum life cover is Rs. 4.5 lakh. Now, if you have no other life insurance, a little bit of thinking would reveal to you that this life cover is woefully inadequate. After all, if you can afford to save Rs. 50,000 a year towards a single plan, it is likely that your annual income is at least Rs. 5 lakh. Thus, the insurance for the child does not even cover one year of income!

Instead, one would recommend a life cover of at least 7-10 times your annual take home pay, if not more. This provides adequate security and cover for your spouse and child to financially sustain in the event of your untimely demise.

The Investment Component

As mentioned earlier, the other function of a child plan is to enable you to save regularly and pay back the money (with returns) when the child is entering college. Here, it is important to note that the plan is simply a pass-through – it invests the money in a set of securities on your behalf, for a fee. The plan in itself does not have a mechanism to generate returns, let alone freebies. Depending on how the securities perform, the amount available to the child gets decided.

Thus, there is no such concept as a freebie here – any benefit that the plan offers you (flexibility to switch, loan facility, premature withdrawal, waiver of premium, etc) is paid for by you in full as part of the premium. For instance, if a college promises your child ‘free laptops’ after charging a fee of Rs. 10 lakh, you would recognize that the laptop is not really ‘free’. All that the college is doing is allocating a portion of the fee to purchase laptops and distribute them. Similar is the case with additional features thrown in by insurance companies. Each feature has a cost that gets cut from your premium payment.

The investment can be either in debt securities (in the traditional plans) or in equity instruments (the unit linked plans). Given the strength of equities in the long term, any plan that is greater than 5-7 years in duration should be invested predominantly in equities. Else, it is likely that you will end up earning very low returns and not covering the inflation in education costs.

Of course, as in case of insurance, the alternative here is to invest in equity mutual funds instead of child plans. Analysis reveals that this (equity mutual fund) may actually be a much better option, since it has much lower transaction costs and is more flexible and liquid. Most child plans have upfront allocation charges in excess of 15%, as against only ~2% for mutual funds!

Putting it together

In summary, the child plans available today fare poorly on both the insurance and the investment parameters, as compared to alternatives available in the market. The term insurance beats the child plan hands down, while the mutual funds provide a lower cost way of investing the corpus.

Insurance Investment

Rule of thumb Insure your life to at least For tenures greater than 5-

7-10 times your annual Income 7 years, invest in quities (or unit linked plans); for lower tenures, invest in traditional schemes

Yes, these alternatives require somewhat of a more hands-on approach to financial planning. But given that it’s your child’s future that we are talking about, it is probably well worth it!!

Friday, April 25, 2008

Insurance Basics Part IV : Unit Linked Insurance Plan ( ULIP )


Understanding the cost structure of Unit Linked Insurance Plan is necessary before taking the leap

A person, 40-year-old investor, was disgruntled with his investments in Unit-Linked Insurance Plan (ULIP). While the equity markets have been rolling, he realized after some research that he was yet to recover the money he had invested three years ago. This, he realized, was not on account of poor fund performance but because of higher initial fund costs. While the people crib is about the non intimation of such expenses by his/her broker, insurance regulator IRDA has come to his rescue, making it mandatory to disclose all charges upfront to the buyers.

Basic rules have to understand the cost structure of a fund before buying into ULIPs. And a basic understanding would save them from heartburn. So how are the cost structured for an ULIP?


1) Premium Allocation Charge

The cost structure of ULIPs is such that it starts working to your benefit only after 5-8 years of investing. A part of your premium payment goes into Premium Allocation Charge, which is calculated as a percentage of the premium. This percentage is generally higher in the first few years—the main reason: it takes years to break even on investments. It could be as high as 40% of each year’s premium.

2) Policy Administration Charge

A monthly fixed amount that usually rises every year with inflation or as a percentage of the sum assured.

3) Mortality/Rider Charges

ULIPs also have mortality/rider charges, which depends on age, sex and the level of risk cover in a particular year. If you don’t avail risk cover, mortality charges can be zero. The mortality charge per Rs 1,000 of the sum assured varies from 1.3 for a 30-year-old to 6.4 for a fifty-year-old.

4) Fund Management Charge (FMC)

Then you have the fund management charge, an adjustment to net asset value (NAV) on a daily basis. Usually, insurers charge it as a percentage of funds under management. ULIPs could have a fund management charge between 0.5%-2.0% per annum.

So with so many chargers around what should be the strategy to get good retuns from ULIPs


If you are ready to cool your heels for 10 years, ULIPs will be a viable financial option. If you anticipate some liquidity need in one to three years from now, ULIPs are not for you. You should look at this investment product only if you leave your money untouched for beyond five years. A good time horizon would be around five years to 30 years. ULIPs are meant for disciplined, regular and systematic investment towards a goal.

The reason is that if you invest the same amount in a mutual fund as well as a ULIP, the former gives better returns than the latter because of the cost structure. There is a point of inflexion at six years, then on the ULIPs begin to give better returns than mutual funds.


Start Early: If you start at the age of 30-35, you can create a 20-year long-term investment by investing in SIP route.

Invest Regularly: Do not get deterred by market swings. A systematic long-term periodic investment will help you go a long way.

Choose your fund:

Depending upon your age and risk profile. Use the switches effectively.

You may have opted for a mix of 75% equity and 25% debt on your ULIP. But when you inch closer towards maturity, minimize your exposure to equity as low as 20%. If the market turns bearish, it may slash your assets at the time of maturity. It’s better to bet safe as you are close to retirement, Also have a rein on the number of switches though they come free of cost. Frequent change in asset allocation might not be a wise move after all.

You should always have a balanced approach to your investments in your middle age. It protects you better from risks. Now, even if you go for a long-term ULIP, it works to your advantage as it isn’t adversely affected by the vagaries of the equity market.

Tuesday, April 22, 2008

How to trawl for dividend stocks in a troubled Market

Stocks offering healthy dividends can pay off in tough economic times. But be careful of high yields in the financial and utility sectors

EVEN if stocks go nowhere this year—a distinct possibility as US recession looms—investors can get returns by hunting for companies that pay healthy dividends. You receive the company’s quarterly payouts even if its stock, and the entire market, heads south. While this is a popular and often successful strategy during bear markets, it also entails some dangers.

Watch out for stocks that offer an especially high dividend yield. That could signal that a company might not pay its dividend. For example, since the credit crisis began in July, financial firms have been disappointing investors by slashing dividends.

At the other end of the spectrum, profitable companies with airtight balance sheets often offer pitifully low dividend yields. The other traditional dividend play is the safe, boring utility sector. Heavily regulated, utilities offer slow growth but high, consistent dividends.

However, most managers warned of problems ahead for this sector. Utilities have already had a good run and many market observers think the stocks are overvalued. A good place to find healthy dividend yields is the consumer staples sector, where products like food and tobacco provide steady cash even in recessions.

Another necessary product that often sells well even during recessions is health care and pharmaceuticals. However, big pharma faces challenges. It’s a tough political environment, with increased regulation of the health-care system. Telecom service providers also offer healthy dividends. These companies pay significant dividends and have strong balance sheets.

Energy firms tend to have lower dividends than some sectors, but they’re generating huge profits. Because high dividends are often concentrated in particular sectors, fund managers say it’s important to diversify. Many dividend-focused investors got burned by too much financial exposure in 2007.

Dividend-paying stocks should continue to be popular in the next decade because of demographic shifts. As baby boomers retire, they’ll seek out more stable investments with steady payouts. One fact should hearten dividend-focused investors: Company boards will only cut dividends as a last resort. While there’s no such thing as an entirely safe dividend, stocks with healthy yields are a good place to park money in turbulent times.

Tuesday, April 15, 2008

Stock Market: Some signs of an impending crash

After stock market correction since Jan'08 there are many learnings for new/first time investors to protect their investment and minimize losses. How do you predict a fall in the markets? Tell-tale signs you need to look out for.

The domestic Indian markets as well as global markets are going through a long-term bull run that started in the year 2003. We have seen many phases of rallies making new highs and consolidation thereafter in this long-term bull market. This phase of the market can be attributed to several factors including globalisation that resulted in work from abroad (outsourcing) and funds, opening up of the economy, and relative isolation of the domestic markets from the slowdown in developed markets. However, this phenomenal growth in the market has made it quite volatile.

We see markets react very quickly and sharply to any news and events. Last few months were some of the most volatile months for the domestic/International markets. We have seen panic selling on the first two days of the week triggered by news of a slowdown in the global economic activities. All key market indices fell over 20 percent in just a couple of days, and then the market recovered quickly to register the biggest single day gain then slipped again to the lows.

Every investor in the market likes to invest at the bottom and exit at the top. This is difficult as it is almost impossible even for market analysts to time the market. But smart investors try to read the market signals to guess the possible direction of broader markets. These are some triggers or indicators that can point to a possible correction in the near term. Investors should be cautious on fresh investments in the market and should start booking profits when one or more of these symptoms show up.

Global News and Events

Global events have a direct or indirect impact on the domestic stock markets. Investors can keep an eye on news from global markets (sales and employment data from US markets, news/action on USA sub-prime crisis), economic events and announcements at the global level (US Federal Reserve meetings/announcements), global market movements etc to get a sense of movements of the domestic markets in the short term.

Stretched Valuation

The market valuation is the sum of individual stocks' valuations. The valuation of a stock is derived from its expected future performance. In a bull market, stocks have a tendency to surpass their true valuation. When a lot of stocks go way beyond their true valuations, the market looks over-valued and signals a correction


Liquidity increases the risk appetite in the market, and as a result, pushes the market up. Therefore, any signals that indicate tightening of liquidity (actions of US Fed, Japanese Central Bank, RBI actions etc) may lead to a fall in the stock markets.

Fluctuations in Commodities

Commodities are used by traders the world over for hedging. Increased activities in the commodities market (especially gold and crude) also give an indication of a possible correction in the stock markets. Also, higher crude oil prices threaten the growth of the world economy, and hence, sharp upward movements in crude oil may trigger a market fall.

Government Actions

The government is the policy maker in a country. Therefore, stability of the government, new policies or changes in the existing policies is very closely tracked by the stock market. Any bad news on this front can trigger a sell off in the market. However, the happening of one or more of these factors does not guarantee a fall in the stock markets and investors should not try to time the market. They should invest in the market with a well thought-out strategy.

These are some tried and Tested Strategies:

• Invest with a long-term horizon. It is not advisable for investors to trade in the market for short-term gains.

• Do not invest blindly in the stock markets. Analyze your investments and always maintain a profit/loss target on your investments. Book partial or full profit/loss in case your targets are triggered.

• Since the stock markets are quite volatile, keep a constant eye on your investments. If you cannot track your investments, you will be better off keeping your money in bank fixed deposits or mutual funds.

• Look for diversification of investments. Do not invest in one market instrument. Analyze your risk profile and accordingly invest in proportions into various instruments (stocks, equity and debt mutual funds, bank fixed deposits etc).

• Investors should invest their own risk money in the stock markets. This means investors should have enough liquidity in hand after investing in the stock markets. Investors should not borrow (take loan) to invest in the stock markets.

Friday, April 11, 2008

Portfolio: Say “Buy Buy Buy” to Stocks

The market has fallen, leading investors to think of safer havens to invest. But here’s why you may still bet on the equity market. Here we bring some of the strategies.

WONDERING whether to stay put in your stocks that may have been hit in the recent market crash or to liquidate and shift investments in other asset classes. Here are 10 reasons why it still makes sense to remain invested. Markets have come down from their recent highs in the past few weeks. While some of us might be thinking of cutting losses and putting money in safer havens, there are more than one reason still favoring the equity markets. Let’s check them out:

a) Long-term plan, lest we forget:

The basic principle that often gets buried in a bull market situation is that one should make investments with a long-term perspective. Any serious investor should remain invested in stocks, no matter what the current market situation is, for a couple of years but if the idea is to make quick bucks, probably he should sell and walk away. The intervening years may be volatile but the light at the end of the tunnel is what we all should look forward to.

b) Value-picking:

Perfect time for value picking, isn’t it? Stocks you always wanted to own but deferred, thinking they are a little overpriced. Experts believe that this is the opportunity to buy stocks, now available at better valuations. It’s like picking your favorite stuff from a superstore at, say 20-50% discount. So, hurry while the offer lasts.

c) Chance to diversify:

We all are aware of the need to diversify our investments, not just in different asset classes but also within classes. So if you had failed to do so, this is the time to add stocks of sectors missing in your portfolio. It might be that you had picked up stocks from sectors expected to give good returns in past but now have run out of favor.

Sectors that will participate in India’s growth momentum will be telecom, banking & financial services and engineering & construction. So take your pick from the buzzing sectors of today, now.

d) Bottom Fishing:

There are talks that the markets may have bottomed out. Which means one can make fresh investments during this downturn. Did anyone ask what if the markets correct further? Probably, it will be an even better buying opportunity!

e) E for Economy, I for Intact:

The growth story of Indian economy is largely in place. There were signs of some softening recently but again such policy matters are gauged with a long-term perspective. “There are no reasons why the outlook of Indian economy in the foreseeable period should change. Huge investments lined up in Indian companies are going to drive the economy further. Also, India’s contribution to the world GDP is on the rise and the current market situation is just a reflection of the global markets.

f) Invest step by step:

Can’t recall who said this: Time spent trying to time the market is better used analyzing stocks good for holding in the long term.’ No one can time the market; it’s like saying ‘when the next earthquake will hit Delhi’ with surety. Here, the rupee-cost averaging strategy becomes even more important. By doing so, the ups and downs of the market get smoothened out by investing a fixed amount of money on a regular basis over a longer period irrespective of the market situation.

g) Why hate volatility:

But markets are that way, or else how did we get the terms bulls & bears. Markets by their very nature move up and down. The real nature of the market doesn’t get reflected without this. In fact, volatility gives the chance to fund managers and small investors to revisit the market and pick stocks.

h) On your mark:

If you haven’t made investments in equities but always wanted to, now is the time to get started. From 21k level, not too long back, the Sensex is now trading in the 17,000-18,000 range. So, what are you waiting for? It’s all yours.

i) What about taxes:

How can we miss on taxes? Actual returns on any investment are known only after factoring in how much tax we pay on the gains. As far as equities are concerned, one is liable to pay short-term capital gain tax if investing in equities (stock per se or equity funds) for less than a year. This means one can save on these taxes by playing ‘long’. And lastly,

j) For returns, what else:

Sensex alone has given a historical record of 18% in the past 20 years or so. This means that if we simply invest in index stocks every year, the investment will generate better returns than from other avenues like FDs, PPF, post-office saving schemes, etc.

Balance portfolio in volatile market

You need to track your investments closely and ensure they are meeting objectives

Stock markets have been quite volatile from the beginning of this year. They saw a sharp decline on the back of a global market meltdown. Markets all over the world are in the grip of selling pressures. The recent volatility in the global markets is attributed to recession fears in the US economy. Currently, the markets are in a state of confusion and lack a convincing direction.

A rate cut in the US, data on the US economy, global liquidity crunch, activity in global commodities market and direction of crude oil prices, developments on rate cuts in domestic markets etc have been in the news. Analysts and large investment houses are watching these developments very closely. Therefore, in the short term, markets will be primarily driven by news (global as well as local) and as a result, we will see quite volatile moves. However, the economic and corporate fundamentals matter over the long term. Long-term investors should not worry much about this short-term volatility and in fact use it as an opportunity to pick fundamentally-sound stocks for their portfolios.

Building a portfolio

The first step in designing an investment portfolio is to identify the investment objective and risk tolerance of the investor. The investment objective could be funds to buy a house, savings for retirement, saving for children's education/marriage etc. The risk tolerance of investors depends upon several factors like age of investor, earning potential of investor, savings, assets owned by the investor etc. Investors with a higher risk tolerance can invest higher percentages of their total funds in equity and related instruments. Investors with lower risk tolerance should invest a higher percentage of their total funds in safer instruments.

These are some points investors can follow in the current market condition to balance their portfolios:

i) Buy Potential Stocks

Markets have corrected around 20 percent from their peak levels and currently are looking to be in a consolidation mode. Many blue chip stocks are available at quite attractive prices. Investors should identify and invest in fundamentally-good stocks, preferably large-cap (index companies) and some select mid-cap companies. Small investors should avoid trading in small-cap companies.

ii) Go Long Term

In volatile market conditions, it is difficult to predict the short-term direction of market as well as stocks. It is advisable to stagger your entry (or exit) into the market. Identify fundamentally good stocks and invest in a systematic pattern by buying in small lots so that you get a good average entry (or exit) point. Day trading or short-term trading is not advisable for small investors (especially in these volatile market conditions). Investors should take positions with medium to long term horizons in mind.

iii) Weigh Risk Appetite

Investors with a low risk tolerance should reduce their exposures to equities and especially their madcap/small-cap stocks investments.

Since investments in market instrument come with a risk of loss, investors should always invest their risk capital in the market. Investor should never borrow and invest in the market just because the valuation of certain stocks is looking attractive.

iv) Patience is the Key

It is recommended to create a well-diversified portfolio of 6-8 fundamentally good stocks. Investors should review the performance of their portfolio every quarter or six monthly and change the allocation as required. Active investors can keep a small portion of their funds liquid to cash in on short-term opportunities in the market. These investors should keep an eye on the markets and use any opportunity to enter into good stocks or exit from underperforming stocks. However, trading in stock markets is not recommended for investors who are risk-averse.

Tuesday, April 8, 2008

New Indices: Mini Contracts

New Indices

The New Year has set in and is bringing with it a lot of new things. Amongst many events in the financial sector - like the Reliance Power IPO and the market crash - 2008 may well see the launch of two new indices. They will not be sector indices like the recent Power Sector index. We are talking of a Volatility Index and the Dharma Index.

Volatility Index

The Volatility Index will be launched by the Bombay and National Stock Exchanges (NSE). The exchanges have been given a green signal by the market regulator, Securities & Exchange Board of India (SEBI), to go ahead and launch the index. At the same time, SEBI has also given the exchanges a free hand to decide whether they want to adopt a global model for this index or develop their own model. The Volatility Index, along with Futures and Options on it, was a recommendation by the SEBI-appointed Derivatives Market Review Committee (DMRC).

The Volatility Index will measure market expectations of near-term volatility conveyed by the prices of stock index options or a basket of options on stocks. Don't worry if you can't figure out what that means. According to a SEBI circular, a detailed methodology of the Volatility Index would be distributed by exchanges for the benefit of investors.

Dharma Index

The other index that may come up this year is the Dharma Index. This one is targeted at Hindu and Buddhist investors. The Dharma Index is being developed by Dow Jones and a private investment company, Dharma Investments (hence the name). The stocks in this index will be screened on the parameters of environment and corporate governance. The environment screens will take into consideration factors like emissions by the company and waste management measures while the corporate governance screens will consider factors like labor relations, industrial disputes, working conditions and wages.

The constituents of this index will be reviewed on a quarterly basis. While it is not clear as to exact date of launch of these indices, one thing is for sure, the indices will give investors something to think about and provide a different angle to investing.

Mini Contracts

The one that has been out of the reach of the small retail investor has been the derivatives segment. This segment has always been a place for the big ticket size investors who look to multiply their wealth by paying just marginally for their purchases. This is an extremely high-risk segment, especially in the futures section where the profits and losses can be limitless. This has been due to the big lot size involved and the high margin money required to be paid up front. And as a result, a majority of the trading done on the bourses everyday is in the derivatives segment, whereas the cash segment gets a minuscule share.

To change this scenario and increase participation of retail investors, the Securities and Exchange Board of India (SEBI) has allowed smaller sized contracts to be introduced. Subsequently, the National Stock Exchange (NSE) launched the mini-Nifty contract and the Bombay Stock Exchange (BSE) launched the 'Chhota Sensex'. As the name suggests, these are small lot size contracts with a lot size of five (Chhota Sensex) and 20 (mini-Nifty).

These new contracts will give the smaller retail participants an option to enter the derivative segment with lesser money. These contracts would involve lower trading costs and lower capital outlay (for margin). Investors would also benefit from better and precise hedging, flexible trading options and more arbitrage opportunities.

The security symbol for the smaller Sensex contracts is MSX and for the mini-Nifty contract is MINIFTY. The contracts would be available for monthly and weekly options just like existing future and option (F&O) contracts. SEBI has allowed trading in these contracts with effect from January 1, 2008. The value of a contract for a Nifty with lot size 50 is around Rs 2.5 Lakh. Hence the margin involved is also high. However, in the mini-Nifty contract, the lot size is 20 and the value of one contract will be around Rs 1.2 lakh. Likewise, the margin for a contract on Sensex was around 45,000 when the lot size is 25. For mini-Sensex the lot size is only 5 and the margin will be around Rs 9,000.

To make this a further attractive trading option, the NSE has even waived the transaction charges on all of its mini-Nifty contracts till March 31, 2008. This move was specifically targeted as the turnover on the smaller Sensex contracts was noticed to be higher than that on mini-Nifty in the initial days. This was surprising as generally the turnover on NSE F&O segment is much more than BSE. But before retail investors take the plunge and start experimenting, they should be aware that the derivatives segment can prove to be extremely risky. Futures and option require proper knowledge, guidance and a high risk appetite.

Friday, April 4, 2008

Portfolio: Long term strategy good in correction phase

Go for value stocks when the market is in a correction mode

The last few years have been remarkable in the history of the domestic stock markets. They have given 40 to 50 percent returns year-on-year in the last 3-4 years. Investments in market instruments have given more than the expected returns from the last five years. But a correction phase has started from the beginning of this calendar year - 2008. This correction in the markets - all over the world in fact - was triggered by news related to the global economic slowdown triggered by the US recession. Also, there has been a tremendous amount of intraday and short-term volatility in the domestic markets. Volatility indicates the amount of price fluctuations in the market movements. The higher the volatility, the riskier it is to invest in the short term. However, medium to long term investors should not worry much about volatility as the economic and corporate fundamentals matter over the long term.

Fundamentals of the Indian corporate sector and economy remain healthy from a long-term perspective. According to some data released by the Reserve Bank of India (RBI) recently, the industrial and credit growth in the retail segment has come down a bit, but from a broad perspective, there no major change in the fundamental story of the economy. As per the RBI projection, the economy will grow by a healthy rate of around eight to 8.5 percent this year. This could be slightly lower than last year's growth, but otherwise India would continue to be the second fastest growing economy in the world, after China.

Here are some basic guidelines investors can follow while identifying and picking stocks to build or reshuffle an equity portfolio:

i) Choose Stocks with Potential

Identify fundamentally good stocks based on your investment objectives. You can take advice from your stock broker to identify stocks for your portfolio. Usually, it is recommended to identify 5-8 stocks for an individual portfolio. Diversify your stock portfolio by investing in multiple sectors (steel, auto, banking, energy, pharma, FMCG etc).

ii) Go for Safe Sectors

It is always noticed that there are some sectors that are highly volatile in the markets (hence high risk against returns) and others are quite stable. Balance your portfolio by investing in momentum as well as stable stocks. It is always advisable to invest in large-caps or selected mid-caps only. Small investors should avoid investing in small-cap stocks.

iii) Stay Invested

Do not panic during the volatile market moves. Use this volatility to enter into your identified scripts or exit from your positions slowly and gradually. Pick your stocks slowly by accumulating the stocks in small quantities at every buying opportunity (dip) in the market. Don't hurry to invest your full corpus at one go.

Historically, investment in stock markets gives better return over the long term but your percentage gains largely depends on your stock selection and your entry price into the stock. Therefore, it is advisable to transact in small quantities. Smaller transactions help in averaging your entry or exit price.

iv) Plan for long term

Invest with a long-term horizon in mind. Don't try to trade in the market (buy today, sell tomorrow). Keep in mind that trading in market involves transaction costs.

Always have a profit/loss target in mind. Once the profit/loss target is achieved, analyze your investments and decide (book profit, book part profit, book loss, book part loss, revise the target) based on a sound analysis. Often, investors fall into a trap by not booking profit/loss once the target is achieved.

Trading in the stock market is an active investment strategy. You have to keep a constant watch on your stock market investments (at least once 2-3 days). If you cannot afford to do that, you will be better off investing in mutual funds with a good track record of outperforming the markets.

Staying afloat in turbulent times

You can use a stock market crash to buy fundamentally good stocks.

These are volatile times. The movement of the stock index is erratic and at most times unexplainable. At times, there could be promising upward sways and at other times, disheartening falls. While some investors have made lot of money, many others have lost tons of it in the market. Those who burnt their fingers keep away from the market in volatile times. Then there are novices who feel that the market is not a safe place to lock their money. They simply abstain from it looking for safer investment alternatives. Be it a seasoned investor or a novice, if the risks increase investors start fearing the market.

What causes a market crash?

Political instability in a country is the chief reason for a market crash. A simmering turmoil that threatens the government is bad news for the markets. Unfavorable events might ensue like foreign institutional investors (FII) may draw out their money and hunt for stable pastures to invest in. Stock markets are known to usually plummet in a situation of political instability.

Strong economic growth and healthy employment rates is good news for the markets. Rumors can cause havoc in a consistently increasing index level. Global increase in oil prices, slump in economic growth and such disastrous news can deal a severe blow to market performance. So much are our markets transparent to global events that one must not be surprised at a crash here owing to some crisis miles away in the US.

Finally, scandals and scams of huge proportions can adversely impact the markets.

What is a market crash?

In times of a surging market, investors are busy churning out profits. A bull market is an indicator of strong economic times. However, investors must not forget that after a bout of good times follows the downturn. Throughout history, we have seen this cyclic pattern of market ups and down. If there is incomprehensible surge and the market appears over-heated, predict a slide anytime. The safest thing to do would be to book profits and invest elsewhere. Being too ambitious can cost the investor big.

In a crash, it is not a single company whose stock is impacted. The value of stock drops drastically across the board. The market crash sees dropping of price across sectors. Investor panic adds fuel to the fire. Perceiving a fall many investors prefer to get out with what they can lay hands on. So they rush to sell their stocks. This further brings down the stock price.

Investing in volatile times

  • The thumb rule is never invest more than what you can afford. Borrowing money or selling your properties to invest in the market is perhaps the riskiest thing to do. Never lock all your savings in the market. Older investors must not rely heavily on the markets as preservation of capital is of greater concern.

  • Pick stocks that are fundamentally sound. This is a crucial decision and must be done after considerable research. The picks of good companies will do well when the economy rebounds.

  • Invest systematically. With a disciplined approach, though there may be temporary set backs, over the long term the results will be worthy.

  • Do not track the index minute by minute. Over obsession with the markets can upset investors and set them into panic mode. Investors should bear a long-term perspective and not buy/sell at inappropriate times. Shrewd investors can use the opportunity to deploy prudent investment strategies.

Tuesday, April 1, 2008

Union Budget: Promising Sectors after Budget

Some sectors that hold promise, with excise cuts in this fiscal budget making them more profitable

Post-budget, some sectors look good from an investment perspective. This is by virtue of the exceptional budget allocations and provisions shown towards these sectors. The focus of the budget has been to boost consumption coupled with keeping inflation under control. The reduction in excise duty for several sectors/products will give a boost to consumption.

The sectors which will benefit include education, healthcare, hotels and pharma. However, long-term investment decisions need not be a hasty reaction to the budget recommendations. The investment approach should be proactive rather than being reactive. Investors can wait for markets to stabilize before investing.


This will be a sector to watch out for, as it is already a beaten down sector and there is no reason for a further downfall in this sector. Also, the budget is favorable to this sector as the FM has cut the customs duty on life-saving drugs from 10 to five percent.

The budget has given in to demands of the pharma sector related to excise and customs duties, which could reduce the cost of drugs. Lower duties might spur an increased off-take of formulations, which is a positive for the pharma sector as a whole.

Excise duty on all drug formulations has been reduced to eight percent, from an earlier 16 percent. Companies that have no presence in excise-exempt zones and, thus, had to shell out excise duty, will now have some relief on this expense. Smaller players as well as local units of multinational companies may benefit from this. A cut in excise duty would reduce healthcare costs rather than the tax outgo of medical equipment/accessory companies.

Research organizations

Any sum paid to an approved scientific research association, approved university, college/institution (outsourced R&D work) by a company will benefit the latter by way of a weighted deduction to the extent of 125 percent of the outlay. This could lead to more linkages between public and private stakeholders in research.

Smaller R&D-focused companies, which are handicapped in making sizeable investments for building in house scientific facilities, would benefit more from this proposal.


Another sector to watch out for is power. The Finance Minister announced a Transmission and Distribution Reform Fund and setting up of a coal regulator. General project import duty has been reduced from 7.5 to five percent. However, for power projects, other than mega projects, withdrawal of exemption from additional customs duty of four percent and additional customs duty introduced on goods for high voltage transmission and sub-transmission and distribution projects will increase the project cost.

The FM also announced a special countervailing duty on power imports, in addition to this he has allocated Rs 800 crores for accelerated power reforms programme. The FM mentioned that considerable improvement is needed in the power and coal sectors to sustain economic growth.

The power budget also clearly indicates the Government would be pushing for at least five more ultra mega power projects (UMPPs), which is a positive sign for the economy, going by the results of the three UMPPs already awarded. The creation of the T&D fund and the development measures for the secondary debt market, which will make long-term debt available for the power sector, would be huge during the 11th plan.

FMCG and Auto

These companies can be another option. The excise cut for packaging materials is also seen as a positive for certain food processing players in the FMCG sector. The budget has proposed a reduction in excise for packaging for food processors by half to eight percent.

The domestic auto industry got a major boost with the four percentage point reduction in excise duty on two wheelers, three wheelers, passenger cars, buses and chassis to 12 percent from the current 16 percent. The Government reduced excise duty on two wheelers to help the segment revive after witnessing months of declining sales due to high interest rates. The Government also extended a similar reduction in the excise duty of small cars to make India a hub for small cars.

In February 2006, the Government had reduced the duty on small cars from 24 to 16 percent. It was at that time that specifications for small cars had been laid out in terms of length and engine size. As per these guidelines, cars with a length less than 4,000 mm and a petrol engine of 1.2 litres or less and a diesel engine of 1.5 litres would qualify for the small car benefits.

The budget has offered an excise duty reduction on hybrid cars from 24 to 14 percent. This helps the domestic companies. The Government has also removed excise duty on electric cars (from eight percent to nil).



The total market size (including exports) of automobiles is expected to touch Rs 129,000 crore in 2007-08 — a growth of 4.3% over ’06-07. Tighter credit disbursement and increased interest rates have resulted in lower two-wheeler and tractor sales. Commercial vehicles have seen a mixed trend with medium and heavy commercial vehicles (MHCVs) showing a decline but light commercial vehicles (LCVs) reporting a strong growth. Growth continues to be healthy for cars and utility vehicles (UVs). In ’08-09, automobile sales are expected to grow around 12% in value terms, mainly driven by favorable demographic trends, anticipated growth recovery in commercial vehicles and robust export growth.


The cut in excise duty will benefit automobile manufacturers, as it is expected to be passed on to the consumer, thus resulting in increased demand.

Besides, increased exemption limit for income tax will lead to higher disposable income among the salaried class. This, in turn, will benefit two wheeler and car demand. The impact of loan waiver for small and marginal farmers will have a neutral effect on tractor sales.

Positive for:

Tata Motors

M & M


Bajaj Auto

Hero Honda



The moderating credit growth (22-23%) is comforting for the Reserve Bank of India. There is a visible deceleration in demand from interest-rate sensitive sectors, including housing and other retail credit. The possibility of easier interest rates, thus, remains strong.

Interest rates have probably peaked and are likely to move southward after the busy season ending March 2008. This is evident from the recent rate cuts by many nationalized banks.

In balance, we expect nonfood credit to grow 23-25% in ’07-08, while aggregate deposits are seen rising 21-23%.


The emphasis is on agricultural banking. With the debt waiver scheme’s implementation by the first quarter of ’08-09, banks would have to bear a one-time write-off charge. This may negatively affect their bottom-line. However, the manner of reimbursement will determine the extent to which this impact is mitigated. The cut in growth target (17%) for farm credit will help banks consolidate their origination systems for farm loans.

Positive for:





LIC Housing



Strong demand from end-user segments has contributed to a 9.8% year-on-year growth in cement demand during the April-November 2007 period. Over the next four years, demand for cement is expected to increase at a compound annual growth rate (CAGR) of 9%. However, large capacity additions are likely to be commissioned during the fourth quarter of ’08-09, which will result in softer prices.


The excise duty on bulk cement has been revised from Rs 400 per tonne in ’07-08 to Rs 400 per tone or 14% ad valorem, whichever is higher.

This proposal is expected to increase the cost of bulk cement for consumers, like ready-mix concrete producers, infrastructure companies and large builders, who account for an estimated 10-15% of the total cement consumption. The impact on the industry will be neutral, as producers will be able to pass on this increase to customers.

Further, excise duty on clinker has been hiked from Rs 350 to Rs 450 per tonne.

This will also have a neutral impact, as players possess pricing flexibility to pass on the increase to end consumers.

Positive for:

Gujarath Ambuja

India Cement

Shree Cement




While global prices of aluminum and zinc fell during April 2007-January 2008, lead and copper rose over the corresponding period of the previous year. In 2008, aluminium prices are expected to remain steady at current levels ($2,450-2,650 per tonne) due to a balanced global market. However, copper and zinc are likely to soften due to expected surplus. Domestic aluminium players’ profitability is likely to remain stable while it will be under pressure for copper smelters.


The reduction in central value-added tax (Cenvat) rate on all goods, from 16% to 14% will result in a fall of around Rs 2,000 per tonne in aluminium and zinc prices, and around Rs 5,000 per tonne in copper, notwithstanding the future trend in international prices. However, it will not have a significant impact as these items are sold to industrial buyers. Excise duty on these items is MODVAT-able. Thus the buyer industry’s cost remains unchanged. Lowering of customs duty on aluminium scrap to nil is unlikely to have much impact given the low share of recycled aluminium.

Positive for:
Hindustan Copper
Hindustan Zinc
National Alliminium
Sterilite Industries



Sales of major appliances are expected to grow 9-11% in value terms to Rs 20,900 crore in 2007-08.

Growing urban demand and the free distribution of color televisions by the Tamil Nadu government aided volume growth. But falling prices led to lower value growth. The consumer durables industry is expected to grow 12-14% in value terms in ’08-09. Although volume growth is expected to be lower for all product categories, continued shift towards higher value segments and the marginal increase in prices will support value growth.


Alteration in income-tax slabs will result in an increase in disposable income for the salaried class, inducing higher demand. Reduction of basic excise duty from 16% to 14% is unlikely to benefit the household appliances industry, as a significant part of the production of the major manufacturers comes from excise free zones. The resultant reduction in countervailing duty will have a negligible impact due to unique product specifications and competitiveness of the domestic industry.

Positive for:
MIRC Electronics



The Indian IT services industry is expected to see a healthy 27% annual growth to touch $22.8 billion in 2007-08. Similarly, the ITeS segment is also expected to grow 24% to touch $10 billion by March ’08.

IT players have resorted to measures such as diversifying their geographical mix and increasing utilization of employees to face the rising rupee and double-digit wage inflation.

The Indian hardware industry touched $7.9 billion in ’06-07 — an annual growth of 21.3%.


The focus on building the talent pool, considering the IT sector is a major recipient of knowledge resources, is expected to benefit in the long run.

However, the hike in excise duty from 8% to 12% on packaged software and the addition of customized software in the service tax net is expected to negatively affect application development players in the domestic software industry.
Maintenance service providers will not be impacted.

With no comment on extension of the IT tax exemption (sections 10A and 10B), the overall impact is expected to be marginally negative.

Positive for:
HCL Tech
Moser Baer
Zenith Computers



An appreciating rupee and higher refining profits due to tighter global product markets have helped the industry enhance its operating profits in ’07-08. The government’s loss-sharing mechanism, in the form of upstream assistance and oil bonds, also contributed to it. In ’08-09, crude oil prices are likely to average higher in dollar terms, whereas refining margins are expected to be lower, due to easing product markets. The subsidy under-recovery on auto and cooking fuels would continue to be dependent on the government’s stand on aligning the domestic retail prices with international prices, as well as the extent of support.


The imposition of the 5% custom duty on naphtha for the manufacture of polymers is expected to marginally improve refining profits by Rs 700 crore to Rs 800 crore. Further, the 2.5% reduction in customs duty on project imports is likely to reduce the capital costs of players. The replacement of ad valorem portion of the excise duty (6.2%) on unbranded petrol and diesel by an equivalent specific duty of Rs 1.35 per litre will be revenue neutral. The overall impact is marginally positive.

Positive for:
Indian Oil



Demand is expected to grow 6-7% over the medium term. Capacity additions of around 50 GW are expected in the 11th Plan (60% of government targets). Addressal of key issues such as fuel supply, land availability, environmental clearances and equipment supply are key to success.


There were no major announcements impacting the sector. The basic customs duty on project imports has been reduced from 7.5 to 5%.

However, the exemption on additional duty of 4% has been withdrawn for non-mega power projects. Thus, the overall impact of duty changes on power sector project imports is neutral. The budgetary allocation for Accelerated Power Development and Reforms Programme (APDRP) has been maintained at Rs 800 crore in ’08-09. The government has proposed to set up a National Transmission and Distribution Fund to address higher losses at the transmission and distribution level and for the sector’s development as well. The overall impact on the sector is neutral.

Positive for:
Power Grid
Reliance Energy
Tata Power



Margins remained stable during the first nine months of ’07-08 due to the parallel increase in the prices of raw materials and products. Domestic consumption rose 11%, driven by increased demand from the construction and infrastructure segments.

Rising global operating rates along with a substantial increase in the prices of coke and iron ore will push global steel prices northward. However, domestic prices could be influenced by government intervention.


Reduction in the central value added tax (CENVAT) rate from 16% to 14% is likely to result in lower steel prices by around Rs 500 per tonne, notwithstanding the future trend in international prices. However, the impact of the same on the industry is neutral, as the excise duty on most of the steel sold is MODVAT-able, except where the output is directly used by the retail buyer. Thus, the cost to the industrial buyer remains unchanged.

Reduction in customs duty on melting scrap from 5% to nil is unlikely to have a significant impact on the industry, given the low share of imported melting scrap in the raw material mix of the industry.

Positive for:
Essar Steel
Ispat Industries
JSW Steel
Tata Steel



At end-January ’08, the wireless subscriber base stood at 242.4 million, making India the third-largest wireless market in the world after China and the US. The total telecom subscriber base stood at 281.6 million, indicating an overall teledensity of 24.63%. The wireless subscriber base is expected to touch 490 million by March-end ’12. The growth is expected to be driven by opportunities arising out of low penetration, rising incomes, ever falling handset costs and local tariffs. Currently, around seven players operate in each circle. The entry of new players is expected to intensify the already tight competition, resulting in declining tariffs and cost of subscription to subscribers.


The excise duty cut on wireless data card from 16% to nil is marginally positive, as the effective duty would reduce from 21.7% to 4%. This will help raise the penetration of wireless internet services. With an average handset priced at Rs 2,500, the 1% National Calamity Contingent duty would have a negligible impact. Cellular services’ penetration will thus not be affected.

Positive for:
Bharthi Airtel
Vodaphone - Essar



While the domestic market for garments and made-ups continues to show a robust growth, the rupee’s appreciation has affected exports. The industry continues to be characterized by a high level of fragmentation and a weak weaving and processing sector. Although the Technology Upgradation Fund (TUF) scheme has encouraged investments, there has been a skew towards spinning.

Investments in weaving and processing must improve for better competitiveness as a global supplier. Exporters should move towards high-value products and focus on EU, which offers considerable opportunities.


The measures are largely positive. The budget has maintained the provision for integrated textile parks (SITP) scheme at Rs 450 crore and increased the allocation of funds under TUFs to Rs 1,090 crore. This will continue to provide incentives for investment. Removal of the 1% National Calamity Contingent (NCC) duty on polyester filament yarn is expected to be passed on. The initiative on cluster development is also positive.

Positive for:
Gokuldas Exports
Vardhaman Textiles
Welspun India
Indo Rama Synthetic
Arvind Mills



The domestic formulations market and pharmaceutical exports (bulk drugs and formulation), estimated at $6.2 billion and $7 billion respectively in ’06-07 grew at a CAGR of 14% and 33% in ’04-05 and ’06-07, respectively.

Pharmaceutical exports are expected to be twice the size of the domestic formulations’ market by ’11-12, driven by rising contract manufacturing and research opportunities, and the rising share of Indian players in the regulated generics market. The domestic formulations market and pharmaceutical exports are expected to reach $11.4 billion and $22.2 billion, respectively, by ’11-12, growing at a CAGR of 13% and 26%, respectively.


The reduction in excise duty on pharmaceutical products from 16% to 8% will only be marginally positive, as most large and mid-sized players are already in excise-free zones.

The 125% deduction on research and development (R&D) outsourcing expenditure will increase the competitiveness of domestic research players.

The reduction in customs duty on select life-saving bulk drugs from 10% to 5% will be marginally positive.

Positive for:
Dr Reddy's Lab
Nicholas Piramal

No bad news is good news for foreign investors’ money

The status quo is largely to remain for foreign funds who had last year pumped in over $17 billion into Indian equities. Although the finance minister proposed a hike in short term capital gains tax on stocks, most foreign institutional investors (FIIs) would be unaffected even if they sell stocks within a year of purchasing.

This is because most of the FIIs here operate through places like Mauritius, Singapore and countries covered under the double tax avoidance treaty, institutional dealers and foreign brokerage house officials said.

However, there could be some additional outflows from the Indian market in case the FIIs who are not from tax-friendly places decide to sell now to avoid higher short-term capital gains tax that will be applicable soon, a top broking house official pointed out.

‘‘Also it would be important to note when this change in tax rate would be effective. Will it be applicable from April 1, the start of the new financial year or after the budget proposals are passed by the parliament, which could probably be end of April or early may. ‘In case it is applicable from April 1, those FIIs have one month to sell.

FIIs also heaved a sigh of relief at the lack of changes in rules governing these investors. There was talk that FM might propose some tax on inflows from places like Mauritius and other so called ‘tax friendly’ places for FIIs.

Against the general apprehension of taxing FIIs routing through Mauritius route, the finance minister has maintained the status quo, which is a great relief to market sentiment. As per Sebi data, foreign funds have already taken nearly $2.7 billion out of the Indian equity market so far.

With the budget being largely a non-event for the FII segment, they did not react strongly and responded by offloading Indian equities worth Rs 334 crore according to provisional NSE data. The NSE data show gross buying of Rs 3,712 crore and gross sales Rs 4,047 crore.

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