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Friday, June 27, 2008

Hold On to Cash - CASH IS KING

While there’s no silver bullet here are some advice that gob smacked small retail investors can use to mitigate their nightmares



RAJESH (Just a Name used in this article) works as a system analyst at one of the top IT companies of India. Apart from forwarding emails, which his job requires him to do, he passionately tracks the domestic equity market. His favorite anecdote about the market until recently was: “Each time the market crashes, if you sell your house and invest in the stock market, in a month, you’ll be able to move a couple of suburbs closer to South Mumbai.” Two months ago, all you had to do was name a stock and he would have told you its last traded price. You name a brokerage and he would have told you which stocks they were betting on. Any news or rumor, no matter how trivial, as long as it was remotely related to the equity market, he had it covered.



A day didn’t pass by without him arguing, disputing, advising or seeking advice on various message boards on the internet. He was a much sought-after man by friends and acquaintances, who had all heard of his uncanny ability to spot a multi-bagger and wanted to find a better avenue for their cash than the low-risk low-return bank deposit. He followed his own advice and put all the money he had to spare into stocks — for he believed that stocks were king.



But that was then. Today, with the Sensex in a free fall and bears mauling virtually every stock, Rajesh is in a funk. He has not logged on to his demat account for the past couple of days and zaps the business channel the moment it comes on. His portfolio has lost over half its value and every passing day seems to erode it further. Ditto with the message boards, which are now filled with jokes like: ‘the easiest way to make a million through the stock market is to start with two million’.



He just can’t understand what went wrong. During the past three years, each time the market had corrected sharply, he had bought into it and turned in a heavy profit. He had done his own analysis, mapping the Sensex against the Dow and had been convinced that decoupling was taking place. This time round, too, he had bought into the Sensex when it first fell in January and sure enough, it had rebounded. Then, when it fell again he bought even more. Unfortunately, it has never recovered since and he suddenly finds himself sitting on a mountain of useless paper.



Most investors are likely to identify with Rajesh’s predicament. Suddenly, that demat account is a nightmare and the fixed deposit a dream investment. While there may be many who are undergoing this traumatic experience for the first time, old market hands will tell you that this is just an umpteenth rerun of greed melting into fear. The real predicament that they now face is: Where does one go from here? While there is no one-size-fits-all solution, here is some advice that small retail investors can use to mitigate the nightmares they are enduring...



Never Hold On To What You Won’t Buy Now



There’s no point in burying your head in the sand like an ostrich and waiting for a miraculous rebound. An active interest in the state of affairs is a must. The first thing you should do is take a long, hard look at your portfolio. Does it have more of established companies with proven track records, or does it consist more of stocks like Nagarjuna Fertilizers & Chemicals and Reliance Natural Resources (RNRL), which you bought because they were ‘momentum plays?’



Having done that, get rid of the momentum stocks. After all, with the momentum gone, it’s time for these stocks to go as well. The rule is simple: ‘Never hold on to something that you wouldn’t buy now’. Never ‘hope’ or ‘pray’. It is either a ‘buy’ or a ‘sell’.



So, it doesn’t matter at what price you bought such stocks — just dump them and collect whatever cash you can. If you have blue-chips in your portfolio like Reliance Communications, Bharti Airtel, Hindustan Unilever or ICICI Bank, to name but a few, you can actually choose not to sell them. In the long run of say, 3-5 years, there is a good chance that you will still earn a return higher than what a bank deposit can give you in the same time period.



Once Bitten Twice Shy



Having lost money in the market, it is but natural that you may have decided to stay away from it totally. That, however, is not such a smart thing to do. As any seasoned investor will tell you, the best time to buy is during a bear market. That said, it is important to keep returns expectations realistic and ensure that you get into stocks, which have a sound business model and visible cash flow. When you invest in a stock, you are basically buying a small stake in a company.



For The Love Of Money



GENERALLY, PEOPLE tend to ignore this fact. But the moment you ask yourself about the company you want to own, the answer is definitely, Reliance Industries and not Nagarjuna Fertilizers; it is definitely Infosys, but certainly not Himachal Futuristic. It is important to buy stocks for their intrinsic worth and not on the basis of expected short-term gains.



ONLY FOOLS RUSH IN WHERE ANGELS FEAR TO TRADE:



If you are someone who was sitting on the fence with cash, praying for a correction, ready to jump in for his first investment in equities, then remember to go easy. For only fools rush in where angels fear to trade. Although buying into a correction is something that has paid rich dividends in the past 3-4 years, the same may not necessarily be the case this time. With global financial markets in turmoil and a general election looming on the horizon, you would do well not to assume that the market has bottomed out. Just because the stock you were planning to buy has fallen to 50 from 100, doesn’t mean that it cannot go to 25. So, try and enter in a staggered manner. In times such as these, as the saying goes: ‘cash is king’.



SENSE AND SENSEX:



Often, investors get too obsessed with the level of the Sensex and forget to concentrate on the fundamentals of the stocks that they hold. There are umpteen instances of individual stocks underperforming in a bull market and those outperforming even in a bear market. This is because the index reflects the entire market and does not necessarily reflect what is happening with your stock. So, let analysts talk about Sensex levels while you track your stock.



INDIA, STILL SHINING:



With the garbage out of the house, we need to decide what stocks to buy, if any. Just because the decoupling theory has been thrown out of the window doesn’t mean that we are absolutely married to the US economy. Although a slowdown in the US will affect export-oriented industries in India, it will have a limited impact on most of India Inc, since by and large, the India story is about domestic consumption, rather than exports. And if the Budget is anything to go by, then the government is definitely in a mood to leave more money with consumers. With more money to spend, the sectors that are expected to benefit are consumer durables, FMCG and retail, to name a few. The relative out performance that these sectors have shown during the current turbulence is a good indicator that they may well hold their own even in a bear market.



MONEY MATTERS:



Lastly, and most importantly, the fact remains that we had an absolutely unbelievable and overtly extended bull run of around five years. During this period, the Sensex went up seven times, with most stocks going up exponentially. This couldn’t have continued till eternity. But at the same time, this doesn’t mean the end of the world. Equity markets always swing between over exuberance and absolute despair. So, don’t lose heart; there will be an end to this carnage. But to enjoy the fruits of the next boom, invest in fundamentally sound companies and always have a substantial amount of cash in hand. For, while you can buy a future multi-bagger today, tomorrow it may end up being a lot cheaper.

Tuesday, June 24, 2008

Why Inflation goes Up?

Inflation is part and parcel of any economy.

High growth economies usually have high inflation. So what is inflation and how it fluctuates and what causes this variation. Here is a small note on that.



Inflation

Inflation is a measure of rise in general price levels of goods and services. Inflation is measured by taking a set of goods and services, and then the prices of the items in the set are compared to prices one time period ago. In India, inflation is measured based on the wholesale price index (WPI) which measures the change in prices of a selection of goods at wholesale prices.



Types of Inflation


Inflation is primarily of two types - inflation due to cost push and inflation due to demand pull (supply side). Cost push inflation is due to rise in costs of input materials or labor, whereas demand pull inflation is due to increase in demand beyond installed capacity.



Controlled inflation is good for the economy as it increases motivation levels of people. The government, in consultation with the Reserve bank of India, decides the inflation threshold in the country (current inflation threshold range in India is 4-5 percent). The inflation target is one of the key parameters that go into determining fiscal and monetary policies.



Inflation went up quite a bit in the beginning of last year (around seven percent) on the back of high liquidity in the markets (huge funds inflows in the form of FII and FDI). The RBI controlled inflation by tightening the monetary policy (raising cash reserve ratio and interest rates) and letting the rupee appreciate against foreign currencies. Inflation came well within the control limits in the second half of last year. However, inflation is going up again this year from the last few weeks. Last week, it has gone above 6.5 percent. The reasons of rising inflation this time are quite different from those last year.



Here are some of the main reasons behind rising inflation:

a) Price rise of essential commodities

The prices of the basic commodities - milk, vegetables, cereals, dairy products, cement, steel, edible oil etc - have gone up quite significantly, especially in the last few weeks. This is due to supply concerns. There is fear in the market that the supply of basic commodities is not increasing in proportion to population growth. This has triggered a wave of speculation in commodities and hence the prices are going up rapidly.



b) Commodity prices rise at global level

Rise in commodity prices at the global level is another factor that contributes to higher inflation in the country. The correction in global stock markets resulted in a rise of commodity prices all over the world as investors are using commodities, especially precious metals, to hedge their risk.



c) Rising oil prices

Crude oil prices have gone up significantly in the last few weeks. Although the government is controlling fuel prices in the country, rising crude oil prices plays a crucial role in general price rise.



d) Increasing demand

India's economy is growing at around 7-8 percent per annum over the last few years. The per capita income levels have gone up and as a result, the demand for many commodities has increased significantly.



Basically, inflation does not have any direct relation to a fall or rise in the stock markets in the short term. However, when inflation goes up beyond the comfortable limit of the RBI and government, they take some strong policy measures such as tightening of monetary policies, regulatory controls, subsidy etc.

Friday, June 20, 2008

Arbitrage Funds - Smart way to improve your returns

Investing money for short-term, say up to 1-11/2 years has generally been an issue. As it is the interest rates / returns are quite low. On top of this, there could be taxation issues, which will further reduce the effective returns.

Equity/equity funds may not be a prudent option for short-term. Therefore, we need to consider mainly the interest-based investment options.



What do we usually do?



Since it is quite convenient, very often the money keeps lying in the Savings A/c itself (also, maybe it is psychologically satisfying to see a big balance in one’s account). But don’t forget - this earns you just 3.5% p.a. interest and that too taxable. Hence, it is not good to keep too much money in the Savings A/c.



The next common thing to do is to make a Fixed Deposit (FD). This may earn you 6-9% interest depending on the tenure. But this too is taxable (if you are in the highest tax bracket, even a 9% FD will fetch you just 6.3% post-tax returns). So, given the fact that there are better alternatives, this too may not be a very intelligent choice.



What are the Alternatives?



Certain debt MFs offer an attractive alternative to Bank FDs. In case you are sure about your investment horizon, you can opt to invest in Fixed Maturity Plans. Else, if you want quick liquidity, liquid plus/floating rate funds could be considered.



The pre-tax returns from these funds will be more or less in line with the returns from the Bank FDs. However, it is the difference in tax treatment on interest from bank FDs and returns from MFs, which enables MFs to give much better post-tax returns.



Interest from Bank FDs is fully taxable as per one’s slab rate. As against this, returns from Debt MFs will be taxed as either Dividend (@14.1625%) or Capital Gains (LT – @11.33% and ST – as per one’s slab rate).



Let’s assume that both FD and MFs give 8% returns. Then if you are in the 30% tax bracket, your post-tax return from Bank FD will be 5.60%. But, if you invest in MFs, you will earn either 7.01% (dividend if period is less than 1 year) or 7.09% (LTCG if period is more than 1 year).



Besides this, there is lot of convenience with MFs. MFs will deduct this Dividend Distribution Tax and pay you the net amount. You don't have to do anything. But in case of interest earning you will have to show it in your returns and pay tax, including advance tax. Also banks will deduct TDS on interest income. So at the year-end you will also have to get the TDS certificate from them.



How Arbitrage Funds fit in?

Before we see how arbitrage funds can be useful, let’s first understand the concept of such funds.



Though, arbitrage funds invest in equity and derivatives such as futures & options, they are essentially debt funds. This is because when they invest in equity, they also take an exactly opposite position in futures. The objective is to capitalize on the difference in the prices in the cash market and the futures market (and hence the term arbitrage) rather than making money on equity or derivatives.



For example, say they buy Infosys shares @ Rs.1800/share in cash market on Aug 1. At the same time, they will sell Infosys shares in the futures market, which would be quoting for say about Rs.1815 (the difference in financial parlance is called the ‘cost of carry’).



Let’s say the price of Infosys on the expiry date of the futures contract (last Thursday of the month) is Rs.1900. Thus, the fund will make a profit of Rs.100 in the cash market [Rs.1900 – Rs.1800] and loss of Rs.85 [Rs.1815 – Rs.1900] in the futures market. (On the expiry date the cash and future prices are same). The net gain is Rs.15.



Or suppose the price of Infosys drops to Rs.1700. Thus, the fund will make a loss of Rs.100 in the cash market [Rs.1700 – Rs.1800] and profit of Rs.115 [Rs.1815 – Rs.1700] in the futures market. Again, the net gain is Rs.15



This way, the market movement does not affect them. They earn Rs.15, whatever may be the final price, which in this case works out to about 10% p.a. assured returns (@Rs.15 on Rs.1800 in one month).



In nutshell, arbitrage funds will yield returns more or less in line with liquid funds / floating rate funds or FMPs; and, more importantly, with practically very little risk.



For example, in last 6-12 months’ arbitrage funds have given about 9.25% p.a. average returns, while floating rate funds have given around 7.5% returns, liquid plus funds around 7.9% returns and FMPs around 8.5% returns.



Now, the key point – for tax purposes arbitrage funds are treated as equity funds. Hence, they enjoy lower tax vis-à-vis debt funds (see table below).



Particulars Arbitrage Funds Debt Funds

Dividend Distribution Tax Nil 14.16%

Long Term Capital Gains Tax Nil 11.33%

Short Term Capital Gains Tax 11.33% As per slab

Securities Transaction Tax(STT) 0.25% Nil



Thus they could give even better post-tax returns than debt MFs.



If the period is less than 1 year, both Debt Funds and Arbitrage Funds will give almost the same returns. At 8% pre-tax returns, the post-tax return works out to about 7%. But, if the period were 1 year, then post-tax yield would be 7.09% in debt funds and 7.73% in arbitrage funds.



Are Arbitrage Funds OK to invest in?



There are no major risks associated with arbitrage funds unlike market-risk in equity funds or interest-rate risk in normal debt funds.
However, there could some minor risks. There may not be any arbitrage opportunities available, especially in bearish markets. In such cases, the arbitrage funds will work like liquid funds. Or on the expiry, the rates in cash and futures markets may not match exactly. This could marginally affect the returns. Or there could be some problems in executing the deals due to low liquidity.



Apart from this, one must keep certain points in mind:


  • Arbitrage funds usually have an exit load for investment period less than 3 months. So make sure that you won’t need this money for at least 3 months.

  • The returns are linked to expiry of contracts (which happens on the last Thursday of the month). So you need to be a bit careful about your redemption dates.

Concluding, therefore, one can say that arbitrage funds can be a good alternative to invest our short-term money, where we can earn high post-tax returns – with reasonable degree of safety and surety.

Tuesday, June 17, 2008

Putting old PF in a new job

Your provident fund is your social security. When you switch jobs, make sure you update your PF account also



THE ONLY thing constant in life is change. Golden words. But it’s one stark reality that you may have to face one day. Harsh Mehta, a middle-level executive, was in a similar state of mind while handing over his resignation letter. For the 36-year-old, who worked for more than a decade in the company, it was an emotional moment, since this was the place from where he started his career. Mehta, in need of funds, decided to withdraw money from his provident fund account, little realizing the implications of the decision. A year down the line, Mehta, unable to perform in line with the expectations of the new firm was thrown out of the job. The old company refused to reinstate him. He was caught off guard. He took up a job in a little-known company at a much lower salary to support his family. Most people in India don’t realize the importance of a PF account. Here’s a lowdown on what you should know when you withdraw or transfer your PF account.





FIRST THINGS FIRST



Tax planners advise that as a priority you should immediately furnish your PF account number, as registered with your previous employer, upon joining a new employer. This ensures that your accumulated balances – Employees Provident Fund (EPF) and Family Pension Scheme (FPS) – are brought forward in the same PF account number and fresh contributions get added thereto. However, in case you need to transfer the accumulated balances to the fresh PF account with the new employer, you need to submit Form 13 to the PF department through your current employer.



Currently, efforts are underway by the PF office to provide an unique Social Security Number (SSN) to every salaried person. After this, no employee will be allotted multiple PF account numbers. As the salaried person, you will have to provide this social security number to your new employer and the accumulated balances in the EPF account will be automatically brought


For those not in the know, you need to submit Form 19 (for PF) and Form 10-C (for pension fund) to the PF office for withdrawal of the accumulated PF balances, irrespective of the time lapsed. The system should be made more transparent and information such as balance funds, accumulated interest, and status of the application for transfer of funds/withdrawal should be made available online by the government. The process results in a lot of hardship for the common man. Until SSN is available, it is advisable that you should transfer PF balances to the new employer, instead of withdrawing them and spending them earlier.



DOCUMENT PROOF



In case you decide to withdraw your PF money after three years of leaving the service, certain additional documentation may need to be furnished for identification and check purposes, such as affidavit, indemnity bond. These forms also require the signature attestation of the previous employer. An advance stamped receipt also needs to be provided along with the other documents.



Further, if you’ve taken a loan against your PF, the outstanding loan amount balance would be adjusted against the accumulated PF account balances at the time of settling the PF dues upon separation. It may be difficult to get the outstanding loan balance with the previous employer transferred to the new employer. Also, in case of employer’s own trust PF trust, the terms and conditions of the specific trust are required to be followed.



MULTIPLE STRATEGY



If you’ve multiple PF account number, there is a provision that you can club the PF money from all your previous employer’s and transfer to your current employer PF account number through Form 13. Let’s say that you worked in three companies — A, B and C — before joining your current employer, D. In this case, you will need to submit three separate Form 13 (for company A, B and C) to your current employer, D. D will then get your accumulated PF balances transferred to your current PF account number being maintained with D. The same remains the process even in case you had worked for employers in different cities.



The outstanding balances in your PF account represent your long-term savings and hence tax planners believe that the decision to withdraw it prematurely should be taken carefully. Eventually, it depends on your financial circumstances. In case you feel that the amount withdrawn have more utility while you are still young and are switching jobs (say for capital acquisition, social demands), then the option of withdrawing may seem justified.

Friday, June 13, 2008

Personal Finance - Inflation v/s Volatility

Mr. Iyer made very clear to his investment advisor that he does not like taking risk. A normal thought that would cross any advisor’s mind when an investor states what Mr. Iyer said is either that the investor does not want to risk his capital and wants to ensure that his capital remains intact or the second thought is that the investor does not want to face the risk of running out or falling short of money when he is nearing his financial goal. While a lay investor might struggle to put both the above in perspective, reality is there can be vast difference in perseverance of risk.



When normally an investor opts for so called safe investment avenues such as fixed deposit, he is protecting himself against the risk of volatility. He seeks comfort under the disguise shelter of safety of capital. However at the very same moment he is risking himself against the risk of losing out to inflation in the long run. His investments earn negative real rate of return. This means he may not have enough money to fund his long-term financial goal.



Most investors cannot withstand transparency. When they invest in equity market, they can literally see value of their investments rising or falling based on market condition. Volatility scares them and they find equity investing risky. In case of fixed deposit they do not see the hidden inflation, which is eroding actual value. They can only see that their principal has remained intact. Therefore they believe their investments are free of risk.



Inflation is much larger, long term and hidden risk compared to volatility. Volatility is transparent. Also over a long period of time impact of volatility reduces.

Whenever an investor decides to seek shelter from risk, he should make himself specific. Does he want shelter from volatility and hence he is seeking protection of capital or is he willing to face volatility in short term but in the longer run wants to ensure that his corpus outgrows inflation and that he has enough to meet his financial goals?



Following table shows value of Rs 1 lakh, if we were to get 4% p.a. less return than inflation i.e. 4% p.a. negative return.

Current Value - Rs 100,000
Rate of Inflation - 4%
Value After Years - 5 Years - Rs 82,193
- 10 Years - Rs 67,557
- 15 Years - Rs 55,527
- 20 Years - Rs 45,639

We notice that as time increases the actual value of Rs 1 lakh is eroding. Longer the money stays in an avenue that is losing to inflation more risky is the investment.



On the other hand, the following table shows value of Rs 1 lakh, which is only generating 4% p.a. over and above rate of inflation.

Current Value - Rs 100,000
Rate of Inflation - 4%
Value After Years - 5 Years - Rs 121,665
- 10 Years - Rs 148,024
- 15 Years - Rs 180,094
- 20 Years - Rs 219,112

Mere 4% p.a. positive or negative return can generate drastically different results.

If we are saving for a financial goal that is less than 2/3 years away opt for safety of principal - even if it means losing to inflation. On the other hand if you are saving for financial goal which is more than 7/9 years away go for appreciation even if it means withstanding volatility in near term. For an interim goal invest in both kinds of asset classes.

Tuesday, June 10, 2008

Personal Finance: Making your credit card pay for you

Everybody cautions users about plastic money and debt traps, but if used intelligently, you could reap many benefits



When they picked London as the destination for their summer holiday this year, Nina and Rajiv Malhotra had a plan in mind. They wanted to fly business class, stay in luxury hotels and have a blast in London, but they also were sure about keeping the trip a low budget affair.



“It was a grand plan, but with meticulous planning it all fell into place,” says Rajiv, “most vacation plans start with saving months in advance, but ours started with spending. This might sound crazy but really what worked for us was transferring all our everyday expenses to our credit cards. This gave us enough reward points to convert them into Asia miles and get free tickets to London!”



All expenses paid:

Almost eight months in advance, they started using their credit card for everything, right from groceries, electricity bills, phone bills, insurance premiums, petrol bills and even donation to charities. Rajiv, who owns a furniture business, also used his card to pay his business expenses like procurement of material and company rent. In addition they planned their outings and eat outs after looking at the partner schemes their card company offered.



“We used to eat at only those hotels that had a tie up with our bank. This way our reward points got doubled. Similarly, for all our domestic travel we stuck to the online booking sites that our bank had a tie up with, this bumped up our points in a big way,” says Rajiv.



The most important part of the plan, however, was to instantly write a cheque to the bank for all the money spent, thus avoiding the debt trap. “This way, we were spending exactly what we would have spent in our daily lives, except that by making sure we used only plastic to pay, we piled up enough reward points to get free tickets,” says Rajiv.



The Malhotras’ case is an interesting example which only goes to prove that contrary to popular belief that ‘plastic is a source of all evil for the household economy’, if used wisely and with diligence, a credit card can in fact fetch you handsome rewards.



Look for tie-ups:

Subtleties are important, however. For instance, if you have an airline’s frequent flier privilege card, then go with a credit card that has a tie up with that airline. This way, each purchase will work toward your free ticket. Santosh Sawant, a software professional in Mumbai, uses his personal card for all his official travel, and then claims reimbursement from the company. “This way, it’s double gain for me. I stock up my reward points for the money I don’t even have to pay.”



Looking out for partners is indeed an intelligent way to double up your reward points. In fact, you can even combine your credit card reward points with loyalty points that the merchant establishments offer and quadruple your money like Radhika Raina from Mumbai did.



Shopper’s Stop has a tie-up with Citibank that offers bonus reward points if you pay for your shopping using Citi card. In addition, Shopper’s Stop also runs a separate loyalty card offer of their own. What Raina did was simply: she redeemed her reward points to get Shoppers Stop vouchers, which she combined with her loyalty points, thus quadrupling her money.



Cash prize:

If you don’t want to get into the hassle of having to claim the reward points, there are cards that offer you cash instead. Several banks offer cash back schemes that could get you up to 5% cash back on every purchase.



Divya Kapoor, a Mumbai resident, manages to pay off her credit card bills every few months simply by using the cash back offer on her card. “I find it very convenient to be able to adjust my bills against my cash back,” she says.



Time the billing cycle:

But financial planner Kartik Jhaveri, director of Transent Consulting India, has a better idea to get an extra bonus to rewards from your cards. “In addition to reward points, your card can make you good amount of money if you manage your billing cycles right,” he says. All cards come with a free credit period that usually ranges from 30 to 55 days, depending on the type of credit card and the issuing bank. In effect, this free credit period means that you can actually utilise other people’s money free of cost.



“This works best when you do large purchases and time them really well,” says Jhaveri. So, for instance, if you are buying an expensive LCD, make sure that you buy it right at the beginning of a new billing cycle. This way you can use that much money for almost 55 days, invest it in some liquid funds and make a decent profit.



Transferring your balance to another card, if you own one, just before the billing date to avail of a higher free credit period or lower interest rate on the second card, is a good idea too. Because this way you can earn good reward points as well as save on high interest charges.



Some caveats:

But all is not hunky-dory in the world of reward points, there are plenty of loopholes too says Suresh Sadagopan, chief planner, Ladder 7 Financial. For example, when using the bill pay facility, one should also look for any hidden charges, as banks have different rules governing their credit card services. Pay attention to the fine print when you sign up for perks such as addon insurance policies, says Sadagopan. “There are some funny clauses there. For instance, for many banks, to claim a travel accident insurance, you’d have to prove that you bought the tickets using that particular credit card.” Also, some people get lured by the reward points and spend money recklessly. “So you might make a few points, but remember, you still have to pay the bank what you spent in the first place,” he adds.



Of course, if you are not an organized person, simply avoid using plastic. Because if you don’t pay the dues within the free credit period, you will be charged interest as high as 2.95% per month for the outstanding amount. This adds up to a whopping 35.4% per annum, which doesn’t even hold a candle to the money you make using the reward points or investment planning!

Friday, June 6, 2008

Mutual Funds: Winners & Losers

Peter Lynch of Fidelity, used to mentally classify stocks as:



  • Perennials

  • Growth

  • Cyclicals

  • Utilities



  • Perennials

Perennials like FMCGs offered predictable growth. Utilities (in the 1980s US context) meant power and telecom companies that offered stable dividends.



  • Growth

Growth is self-explanatory and so is cyclical. His take was that growth stocks usually offered the highest potential returns but carried the highest risks. Perennials offered steady returns but ideally offered best value during bear markets.



  • Utilities

Utilities, he felt were dividend plays or quasi-debt instruments.



  • Cyclicals

Cyclicals offered great returns only if bought in downtrends.


Lynch's classifications are interesting in the context of India over the past two years, and especially, the past two months. The Sensex climbed from around 10,000 in February 2006 to a high of over 20,000 in December 2007. It has since corrected to a recent low of 16,608 and it's now trading at about 18,000. So we've seen a net return of around 75 -80 per cent. During that two-year period, perennials such as FMCG have offered poor returns, and so did cyclicals such as cement, non-ferrous metals, IT, etc. The biggest returns have come from real estate, capital goods, telecom, power, banks, private refiners, etc. Lynch's classification of power and telecom as utilities offering stable dividends scarcely holds in India. Telecom is a growth industry and power, a sick one hoping to recover on the basis of reforms. Real estate is a cyclical but one with growth impetus. Banks have grown on the basis of strong retail credit disbursal.


Earnings and turnover growth slowed over the past quarter (Oct-Dec 2007) and so did credit disbursal. Sentiment indicators such as real estate prices, auto and two wheeler sales and home loans flattened out. IT and pharma had bad times as the rupee appreciated against USD.

However until December 2007, a flood of liquidity pushed the stock market to a succession of new highs. Last year, (Calendar 2007) the Foreign Institutional Investors (FIIs) bought over Rs 70,000 crore while the Domestic institutional Investors (DIIs) bought Rs 5500 crore. In January 2008, that changed as the subprime crisis led to panic on the Wall Street. In that one month, the FIIs sold over Rs 17,000 crore.


The sell off caused 13% correction in index levels in just about a month. It caused the failure of three large initial public offerings as confidence evaporated. It's possible that India is now in the early stages of a bear market, which could continue indefinitely. It's also possible the correction is over. That will depend on the return of liquidity to the bourses, which in turn, depends on many unquantifiable global factors. The Sensex is now trading at an average PE of about 21 with average earnings growth reckoned in the same range (19% in Q3, 2007-8). Long-term growth prospects remain excellent - this is a cyclical low that is higher than most countries' cyclical peaks!


But where should the investor go to best exploit this price-dip? Cyclicals could be most tempting. Many of these stocks have not gained at all in the past two years. The entire IT industry has lost ground. Automobiles have been flat. These are high-risk but they should be close to rock-bottom. However, one could easily make a case for banks - a rate cut may be around the corner and credit growth softened in the past six months. Also the big banks and financial sector players have extra embedded value due to their insurance JVs. Brokerages however, are likely to see sell offs and may generate negative Q4 results.


In the highly-valued corner, capital goods and construction/ engineering remain good bets. Telecom has an overhang of policy uncertainty; power will be impacted by election fever that slows down reforms. Real estate could also be impacted by policy uncertainty.


This is a classic situation where the investor could confidently expect to make money in the context of two-three years. However, he may well lose money through the next several months or more.

Tuesday, June 3, 2008

Stock Market: IPO payment after allotment is final

SEBI has changed the payment process for IPOs and this will benefit individual investors

There is some good news for the investors. The market regulator, Securities and Exchange Board of India (SEBI), has changed the payment process for subscribing to initial public offers (IPO) and rights issues. Under the new process, the application money will remain in the bank account of the applicant till allotment is finalized.

Currently, the money is debited from the bank account, and based on the number of shares allotted, the excess money is returned. According to SEBI, the new system would eliminate the refund process. The modalities of the entire process will be worked out separately.

The SEBI Board has approved, in principle, the concept of making a lien on the bank account an alternative mode of payment in public/rights issues. This means the money earmarked for the IPO will not be used for any other payment obligation during that period. At the same time, the applicant will get the interest payable on the amount. This would also reduce the burden on registrars and merchant bankers. But bankers to the issue can no longer enjoy the floating interest, said officials associated with the IPO process. Most important of all, investors would not have to wait for their refund money. It also ensures that a liquidity crisis such as that in January 2008 does not occur again. At that time, many investors were unable to buy scripts which were at attractive lows, as their money was locked up in a few big IPOs, and they could not meet their margin money requirements.

In the case of mega IPOs, which are oversubscribed many times, large amounts of investor funds is blocked for days. Investors don't need to wait for refund of their application money, if they are not allotted shares. Currently, retail investors have to make the full payment on application for shares, which are later refunded to the extent the shares are not allotted, which would normally take three weeks to a month. SEBI is planning to introduce a value-paid instrument, which would help banks freeze the application money till the allotment is made.

The SEBI Board also increased the minimum net worth requirement for registration as a portfolio manager to Rs 2 crores from Rs 50 lakhs. It said existing portfolio managers with lower net worth will have to increase it to at least Rs 1 crore within six months, and to the new prescribed limit in the next six months. SEBI said portfolio managers will not be allowed to pool the resources of clients like mutual funds and must keep assets of each client separately. Portfolio managers working on pooled basis have been given six months to convert their operations to individual basis.

At the same time, new IPO application forms are being designed. The new IPO application forms would avoid manual intervention. SEBI's Primary Market Advisory Committee (PMAC) has given an in principle nod for initiating steps to ensure 'no manual intervention' in the primary market issuance process. PMAC has endorsed the suggestions of the Group on Review of Issue Process (GRIP) on this matter. GRIP had recommended modified application forms that can be submitted physically as well as electronically. These measures will enable faster and more transparent processing of application forms, leading to a reduction in the time gap between closure of an IPO and its listing.

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