GOLD is the proven, quality, long-term wealth store during a slide into deep crisis -the one which everyone else comes to in a bit of a panic. Even if, to begin with, the early buyers are buying gold purely to protect their wealth they still tend to multiply their money, because they are subconsciously anticipating future demand. The best investments do this."
Gold's Greatest Use
People always ask 'But what’s the use of gold?' which encourages some experts to pretend gold is vital for dentistry and electronics. It isn't. The fact is that gold is hardly useful at all in industry, but that certainly does not mean it is not useful at all.
So let's explain clearly why gold has repeatedly become one of the most fundamentally useful things there is in human society, and to do that let's first recognize its main quality - its reliably rare supply.
How Much Gold Is There?#
Even with modern technology gold is still incredibly difficult to find.
In total about 160,000 tonnes of gold have been taken out of the Earth.
That 160,000 tonnes is less than you might think. Formed into a single gold cube it wouldn’t quite cover a tennis court. In fact it would be 2 metres short. But that’s all the gold in the world.
Gold is being mined at about 2,600 tonnes a year, so the above ground supply is expanding at 1.6% per annum. This newly mined supply means the world's cube of gold - currently 20.2 metres across - is growing by just 11 cm per year.
All the world's gold will cover a tennis court when the above ground stock is 205,000 tonnes. This will be some time around 2025.
205,000 tonnes is approximately the sum of the current above ground stocks (approximately 160,000 tonnes) plus the aggregate un-mined known reserves of all the world's gold mining companies (approximately 45,000 tonnes).
That's all the world's gold - both above ground, and known about but still underground.
How Is That Gold Used?#
Gold is not consumed in any meaningful sense. A tiny amount finds some use as false teeth because of its inertness, and some is used in electronics because of its non-corrosive nature and excellent conductivity.
But currently well over 95% of the world's gold is held as a wealth store - either in bullion vaults or as jewelry, which is generally considered a private monetary reserve (particularly in India, the world's biggest gold customer).
This stock of gold isn't disappearing, and its supply is growing at a very slow rate (1.6% pa) compared to its overall stock. This feature of a nearly fixed above ground quantity, growing slowly, has been true for about 4,000 years.
So you can now see that there exists a large, but not too large, and almost fixed quantity of gold in the world, almost all of which is held by its owners as a tangible store of wealth. That is something which is true of nothing else.
By contrast to gold's restricted supply our money systems are currently expanding out of control. Modern loose monetary policies - designed to keep the factories busy - are expanding the supply of currency, under political direction, by at least 11% per annum; and that's for the Euro, the most hawkishly managed of the modern world's major currencies.
In such circumstances gold's reliable rarity is again noticed by savers. Its great use is as a money proxy when artificial forms of money (which are far more common) are not being properly restricted in supply. In such times gold's unexpandable supply causes it to be a much more reliable store of purchasing power than currency. Nothing does this job so reliably and so well as gold, because nothing matches the unimpeachable rarity and stability of gold's above ground supply.
Better still, as people come to remember and appreciate this unique quality their demand for gold causes not just a retention of purchasing power, but a multiplication of it.
Gold - A Tool of Trade#
Here's a 2,000 year old Roman explanation of a vital tool of trade.
"The origin of buying and selling began with exchange.
Anciently money was unknown, and there existed no terms by which merchandise could be precisely valued. Every one, according to the wants of the time and circumstances, exchanged things useless to him, against things which were useful; for it commonly happens that one is in need of what another has in excess.
But it seldom coincided in time that what one possessed the other wanted, or vice versa. So a device was chosen whose value remedied by its homogeneity the difficulties of barter."
Trade is right at the heart of human society, and it creates the need for this 'device' to store value for later exchange. The device needs homogeneity - constancy of form and quantity - which most governments attempt to deliver with paper money, and they are successful most of the time.
But when the going gets tough governments bend their own rules. They start to issue more and more money, and then nothing exists which matches the homogeneity of gold.
The Romans joined a long list of civilisations which chose gold as a reliable, apolitical, monetary medium. Before them there were the great classical civilisations of the Greeks, Persians, Ionians, and the Egyptians. After them there were many more, through the Spanish, French, Ottoman, British and American empires, all of them with gold based monetary systems.
Gold's Record As Money#
But every single one of those gold based currencies eventually failed - the gold stopped circulating as the money of normal transactions, as currency. So it’s best to avoid the misunderstanding of history which leads so-called “gold bugs” to regard gold as the world’s only true and permanent money, because the hard historical fact is that it has been tested - often - and it both disappears and re-appears, depending on the prevailing economic circumstances.
Yet what is different about gold and other forms of money is the way they disappear, and why. Because its natural qualities recommend it as a high quality form of money gold suffers from Gresham’s Law, a common sense law in economics which states that “bad money drives good money out of circulation”.
Think about it for a moment and you’ll see that given a choice of spending good money (gold) or bad money (inflating paper) you’d spend the paper and keep the gold as a store of value. So in an economy where economic and political considerations have combined to produce a paper currency running in parallel with gold, and where that currency is showing the early signs of being dangerously expanded in supply, then people will elect to hold on to gold and spend paper. Magnified millions of times by everyday transactions in a typical economy this eventually stops gold circulating as money.
For much the same reasons when their time is up paper currencies will pour into circulation as people look to buy hard assets, until eventually the best value you will get from the banknote is to use it as heating fuel.
This is the key difference. While paper money forms disappear permanently, and lose all their value, gold disappears temporarily, and retains its value over the very long term.
Every few years, and when circumstances are right, gold returns. It has a history of doing so which has lasted those 4,000 years.
Gold Can Multiply Your Wealth #
The trick with gold is to understand the causes for these rolling phases, to recognise them, and to act appropriately. If you own gold at the right time you will own a fast appreciating asset when normal business assets, and money itself, are tumbling in value.
Owning gold in good phase is very profitable. In the 5 years after the 1929 crash gold's investment purchasing power rose 17 times.
In the decade of the 1970s gold's investment purchasing power rose 15 times.
So far in gold's current re-emergence, with the economic situation looking every bit as as hostile as the 30s and the 70s, gold's price has multiplied by about 3 times. By comparison with those previous cycles it is still nearer the bottom than the top.
And Gold Can Destroy It Too#
But don't forget gold lost nearly seven eighths of its investment purchasing power between 1980 and 2000. That was during the best period for growing businesses in the twentieth century.
That price slide shows that smart investors should not grow too fond of their gold! Even though it's currently pretty grim the time will come when the outlook for business has improved, and most people either will not have realised it, or will still be too nervous to do anything about it.
Then it will be smart to sell your gold, and use its purchasing power to invest in people and businesses, and to participate once again in the dynamic creation of wealth.
The people who manage to do this will be the smartest of all gold buyers. They are not hoarding gold for its own sake. They are positioning themselves to be able to invest actively in a recovery which is a long way off. By doing this they will be both profiting themselves and serving their communities at the same time. Capital which has not been adequately protected right now will simply not be there to invest in the business opportunities of the future
Thursday, December 17, 2009
Bajaj Hindusthan
For Q4FY09, Bajaj Hindusthan reported numbers were in line with our estimates. Net sales dipped by 10.3% YoY on account of lower sugar sales volume while increased by 8.2% on sequential basis. However, on account of higher other operating income of Rs88 cr (up 543.6% YoY) from unwinding of swap transaction on long-term ECB loans, total income grew by 5.5% YoY and 26% QoQ. The company has closing stock of about 0.17 million tons as on Sep 30,2009. The company reported net profit of Rs69 crore (up 15% QoQ) as compared to a loss of Rs87 cr corresponding period last year.
Upturn in sugar cycles led to revival of Bajaj Hindusthan
For Q4FY09, Bajaj Hindusthan reported numbers were in line with our estimates. Net sales dipped by 10.3% YoY on account of lower sugar sales volume while increased by 8.2% on sequential basis. However, on account of higher other operating income of Rs88 cr (up 543.6% YoY) from unwinding of swap transaction on long-term ECB loans, total income grew by 5.5% YoY and 26% QoQ. The company has closing stock of about 0.17 million tons as on Sep 30,2009. The company reported net profit of Rs69 crore (up 15% QoQ) as compared to a loss of Rs87 cr corresponding period last year.
Margins improved on YoY basis
On sequential basis, EBITDA registered a de-growth of 23.3%, driven by higher employees cost (up 39.4%) and stock in trade and consequently EBITDA margins decreased by 1178 bps to 18.3% during the quarter. Led by significant reduction in interest outlays (down 47.7% QoQ) PAT margins improved marginally by 97 bps on QoQ basis. Foray into power will offset the sugar cyclicality To reduce dependence on the cyclical nature of the sugar industry, BHL had proposed expansion of its power generation capacity by 400 MW for Rs1,600 cr. The company plans to set up a 80 MW coal based power capacity each at five locations in Uttar Pradesh. The power plants are expected to be operational by the next 20 months, which would take the total power generation capacity of BHL to 830 MW. The company expect to sell half of the power to the UP government while the other half would be sold in the open market. The management has guided average power selling price at Rs5 per unit while the cost of power is likely to be around Rs2.5-2.8/unit. We have valued coal based power
generation units at Rs36/share based on DCF valuation with a cost of equity of 14.7%.
Incumbent FCCB redemption in Feb-2011 could pressurize balance sheet
BHL had issued US$120 mn zero coupon convertible bonds due 2011. Out of which, the company had repurchased FCCBs aggregating to face value of US$19.9 mn. The aggregate principal amount of bonds which remained outstanding after repurchase is US$99.6 mn. We estimate cash flow from operations at about Rs1,183 crore during FY10-11E. We estimate balance sheet would be little stretched if these bonds will be redeemed at 133.57% of its principal amount on the maturity date. BHL to raise Rs2,000 cr to fund its expansion plans Bajaj Hindusthan had announced for raising of additional long term funds up-to Rs2000 crores in line with our earlier projections, by further issue of equity shares and/or securities convertible into or exchangeable with equity shares, in domestic and/or international market in one or more tranches. Price settlement between UP mills and farmers in line with our estimates After month-long row between farmers and UP mills over cane price, the UP mills agrees to pay Rs190 per quintal for the common variety and Rs 195 for the early variety, which is in line with our earlier estimates of Rs200 per quintal. The impasse between farmers and mills has already delayed crushing season in the state by about a month.
FY09 Performance review
On consolidated basis, the company reported marginal dip of 2.1% YoY in its net sales. However, on account of 557% YoY growth in other operating income total income grew by 8.8%. Led by lower cane crushed (down 39.7% YoY) during the year raw material costs decreased 10.8% YoY. EBITDA registered impressive growth of 193% on account of lower raw material costs and other expenditure (down 15.5% YoY) and consequently margins improved 1386 bps YoY to 20.8% during FY09. The company reported net profit of Rs57.9 cr during FY09 as compared to a loss of Rs197.6 cr same period last year.
Upturn in sugar cycles led to revival of Bajaj Hindusthan
For Q4FY09, Bajaj Hindusthan reported numbers were in line with our estimates. Net sales dipped by 10.3% YoY on account of lower sugar sales volume while increased by 8.2% on sequential basis. However, on account of higher other operating income of Rs88 cr (up 543.6% YoY) from unwinding of swap transaction on long-term ECB loans, total income grew by 5.5% YoY and 26% QoQ. The company has closing stock of about 0.17 million tons as on Sep 30,2009. The company reported net profit of Rs69 crore (up 15% QoQ) as compared to a loss of Rs87 cr corresponding period last year.
Margins improved on YoY basis
On sequential basis, EBITDA registered a de-growth of 23.3%, driven by higher employees cost (up 39.4%) and stock in trade and consequently EBITDA margins decreased by 1178 bps to 18.3% during the quarter. Led by significant reduction in interest outlays (down 47.7% QoQ) PAT margins improved marginally by 97 bps on QoQ basis. Foray into power will offset the sugar cyclicality To reduce dependence on the cyclical nature of the sugar industry, BHL had proposed expansion of its power generation capacity by 400 MW for Rs1,600 cr. The company plans to set up a 80 MW coal based power capacity each at five locations in Uttar Pradesh. The power plants are expected to be operational by the next 20 months, which would take the total power generation capacity of BHL to 830 MW. The company expect to sell half of the power to the UP government while the other half would be sold in the open market. The management has guided average power selling price at Rs5 per unit while the cost of power is likely to be around Rs2.5-2.8/unit. We have valued coal based power
generation units at Rs36/share based on DCF valuation with a cost of equity of 14.7%.
Incumbent FCCB redemption in Feb-2011 could pressurize balance sheet
BHL had issued US$120 mn zero coupon convertible bonds due 2011. Out of which, the company had repurchased FCCBs aggregating to face value of US$19.9 mn. The aggregate principal amount of bonds which remained outstanding after repurchase is US$99.6 mn. We estimate cash flow from operations at about Rs1,183 crore during FY10-11E. We estimate balance sheet would be little stretched if these bonds will be redeemed at 133.57% of its principal amount on the maturity date. BHL to raise Rs2,000 cr to fund its expansion plans Bajaj Hindusthan had announced for raising of additional long term funds up-to Rs2000 crores in line with our earlier projections, by further issue of equity shares and/or securities convertible into or exchangeable with equity shares, in domestic and/or international market in one or more tranches. Price settlement between UP mills and farmers in line with our estimates After month-long row between farmers and UP mills over cane price, the UP mills agrees to pay Rs190 per quintal for the common variety and Rs 195 for the early variety, which is in line with our earlier estimates of Rs200 per quintal. The impasse between farmers and mills has already delayed crushing season in the state by about a month.
FY09 Performance review
On consolidated basis, the company reported marginal dip of 2.1% YoY in its net sales. However, on account of 557% YoY growth in other operating income total income grew by 8.8%. Led by lower cane crushed (down 39.7% YoY) during the year raw material costs decreased 10.8% YoY. EBITDA registered impressive growth of 193% on account of lower raw material costs and other expenditure (down 15.5% YoY) and consequently margins improved 1386 bps YoY to 20.8% during FY09. The company reported net profit of Rs57.9 cr during FY09 as compared to a loss of Rs197.6 cr same period last year.
14 tax-free incomes for FY 2009-10
The taxing season is going to start in next couple of months and following are few items of income which are fully exempt from Income tax.
1. Dividends on shares and units - Section 10(34) & (35)With effect from the Assessment Year 2004-05, the dividend income and income of units of
mutual funds received by the assessee completely exempt from income tax.
2. Long-term capital gains of transfer of securities - Section 10(38)With effect from FY 2004-05, any income arising to a taxpayer on account of sale of long-term capital asset being securities is completely outside the purview of tax liability especially when the transaction has been subjected to Securities Transaction Tax.Thus, if the shares of any company listed in the stock exchange are sold after holding it for a minimum period of one year then there will be no liability to payment of capital gains.This provision would even apply for the old shares which are held by an assessee and are sold after the Finance (No.2) Act, 2004 came into force.
3. Agricultural income:Under the provisions of Section 10(1) of the Income Tax Act, agricultural income is fully exempt from income tax.However, for individuals or HUFs when agricultural income is in excess of Rs 5,000, it is aggregated with the total income for the purposes of computing tax on the total income in a manner which results into "no" tax on agricultural income but an increased income tax on the other income.Agricultural income which fulfils the above conditions is completely exempt from tax. The manner of calculating tax on total income and agricultural income, is explained in the following illustration:
For the assessment year 2010-2011 a male individual has a total income from trading in cloth amounting to Rs 162,000 besides, he has earned Rs 40,000 as income from agriculture.
The income tax payable by him will be computed as under:
On the first Rs 1,60,000 of taxable non-agricultural income - Nil
On the next Rs 40,000 of agricultural income (falling under 10% slab) - Nil
On the next Rs 2,000 of taxable non-agricultural income @ 10% - Rs 200
IT on aggregated income of Rs 202,000 (Rs 162,000 + Rs 40,000) - Rs 200
4. Receipts from Hindu undivided family (HUF)
Any sum received by an individual as a member of a Hindu undivided family, where the said sum has been paid out of the income of the family, or, in the case of an impartible estate, where such sum has been paid out of the income of the estate
belonging to the family, is completely exempt from income tax in the hands of an individual member of the family under Section
5. Allowance for foreign service
Any allowances or perquisites paid or allowed as such outside India by the Government to a citizen of India, rendering service outside India, are completely exempt from tax under Section 10(7).This provision can be taken advantage of by the citizens of India who are in government service so that they can accumulate tax-free perquisites and allowances received outside India.
6. Gratuities Under the provisions of Section 10(10) of the IT Act, any death-cum-retirement gratuity of a government servant is completely exempt from income tax.
In respect of private sector employees, however, gratuity received on retirement or on becoming incapacitated or on termination or any gratuity received by his widow, children or dependants on his death is exempt subject to certain conditions. The maximum amount of exemption is Rs 3,50,000. Of course, this is further subject to certain other limits like the one half-month's salary for each year of completed service, calculated on the basis of average salary for the 10 months immediately preceding the year in which the gratuity is paid or 20 months' salary as calculated. Thus, the least of these items is exempt from income tax under Section 10(10).
7. Commutation of pension :The entire amount of any payment in commutation of pension by a government servant or any payment in commutation of pension from LIC pension fund is exempt from income tax under Section 10(10A) of IT Act.However, in respect of private sector employees, only the following amount of commuted pension is exempt, namely -
(a) Where the employee received any gratuity, the commuted value of one-third
of the pension which he is normally entitled to receive; and
(b) In any other case, the commuted value of half of such pension.
It may be noted here that the monthly pension receivable by a pensioner is liable to full income tax like any other item of salary or income and no standard deduction is now available in respect of pension received by a tax payer.
8. Leave salary of central government employees:Under Section 10(10AA) the maximum amount receivable by the employees of central government as cash equivalent to the leave salary in respect of earned leave at their credit upto 10 months' leave at the time of their retirement, whether on superannuation or otherwise, would be Rs 300,000.
9. Voluntary retirement or separation payment:Under the provisions of Section 10(10C), any amount received by an employee of a public sector company or of any other company or of a local authority or a statutory authority or a cooperative society or university or IIT or IIM at the time of his voluntary retirement (VR) or voluntary separation in accordance with any scheme or schemes of VR as per Rule 2BA, is completely exempt from tax.The maximum amount of money received at such VR which is so exempt is Rs 500,000. As per Finance (No. 2) Act, 2009 an assessee cannot enjoy both the exemption in respect of VRS upto Rs 500,000 and also a deduction under Section 89.
10. Life insurance receipts:Under Section 10(10D), any sum received under a Life Insurance Policy, including the sum allocated by way of bonus on such policy, other than u/s 80DDA or under a Keyman Insurance Policy, or under an insurance policy issued on or after 1.4.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20% of the actual capital sum assured, is fully exempt from tax.However, all moneys received on death of the insured are fully exempt from tax Thus, generally moneys received from life insurance policies whether from the Life Insurance Corporation or any other private insurance company would be exempt from income tax.
11. Payment received from provident funds:Under the provisions of Sections 10(11), (12) and (13) any payment from a government or recognised provident fund (PF) or approved superannuation fund, or PPF is exempt from income tax.
12. Certain types of interest payment:There are certain types of interest payments which are fully exempt from income tax u/s 10 (15).
These are described below -
(1) Income by way of interest, premium on redemption or other payment on such securities,bonds, annuity certificates, savings certificates, other certificates issued by the Central Government and deposits as the Central Government may, by notification in the Official Gazette, specify in this behalf.
(2a) In the case of an individual or a Hindu Undivided Family, interest on such capital investment bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf (i.e. 7% Capital Investment Bonds);
2b) In the case of an individual or a Hindu Undivided Family, interest on such Relief Bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf (i.e.,9% or 8.5% or 8% or 7% Relief Bonds); (iid) Interest on NRI bonds;
(3a) Interest on securities held by the issue department of the Central Bank of Ceylon constituted under the Ceylon Monetary Law Act, 1949;
(3b) Interest payable to any bank incorporated in a country outside India and authorised perform central banking functions in that country on any deposits made by it, with the approval of the Reserve Bank of India or with any scheduled bank
(4) Certain interest payable by Government or a local authority on moneys borrowed by it,including hedging charges on currency fluctuation (from the AY 2000-2001), etc.;
(5) Interest on Gold Deposit Bonds;
(6) Interest on certain deposits are: Bhopal Gas victims;
(7) Interest on bonds of local authorities as notified, and
(8) Interest on 6.5% Savings Bonds [Exempt] issued by RBI
(9) Stipulated new tax free bonds to be notified from time to time.
13. Amount received by way of gift, etc - Section 10(39):As per the Finance (No.2) Act, 2004, gift, etc. received after 1-9-2004 by individual or HUF in cash or by way of credit, etc. is being subjected to tax if the same is not received from relative,etc. However, Section 56(2) provides that the amount received to the extent of Rs 50,000 will, however, be exempt from the purview of income tax.Similarly, amount received on the occasion of marriage from a non-relative, etc. would also be exempted. It may be noted that the gift from relatives. as mentioned in the Section can be received without any upper limit.
14. Tax exemption regarding reverse mortgage scheme - sections 2(47) and 47(x)Any transfer of a capital asset in a transaction of reverse mortgage for senior citizens under a scheme made and notified by the Central Government would not be regarded as a transfer and therefore would not attract capital gains tax. The loan amount would also be exempt from tax.
These amendments by the Finance Act, 2008 apply from FY 2007-08 onwards.10. Life insurance receiptsUnder Section 10(10D), any sum received under a Life Insurance Policy, including the sum allocated by way of bonus on such policy, other than u/s 80DDA or under a Keyman Insurance Policy, or under an insurance policy issued on or after 1.4.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20% of the actual capital sum assured, is fully exempt from tax.However, all moneys received on death of the insured are fully exempt from tax Thus, generally moneys received from life insurance policies whether from the Life Insurance Corporation or any other private insurance company would be exempt from income tax.
1. Dividends on shares and units - Section 10(34) & (35)With effect from the Assessment Year 2004-05, the dividend income and income of units of
mutual funds received by the assessee completely exempt from income tax.
2. Long-term capital gains of transfer of securities - Section 10(38)With effect from FY 2004-05, any income arising to a taxpayer on account of sale of long-term capital asset being securities is completely outside the purview of tax liability especially when the transaction has been subjected to Securities Transaction Tax.Thus, if the shares of any company listed in the stock exchange are sold after holding it for a minimum period of one year then there will be no liability to payment of capital gains.This provision would even apply for the old shares which are held by an assessee and are sold after the Finance (No.2) Act, 2004 came into force.
3. Agricultural income:Under the provisions of Section 10(1) of the Income Tax Act, agricultural income is fully exempt from income tax.However, for individuals or HUFs when agricultural income is in excess of Rs 5,000, it is aggregated with the total income for the purposes of computing tax on the total income in a manner which results into "no" tax on agricultural income but an increased income tax on the other income.Agricultural income which fulfils the above conditions is completely exempt from tax. The manner of calculating tax on total income and agricultural income, is explained in the following illustration:
For the assessment year 2010-2011 a male individual has a total income from trading in cloth amounting to Rs 162,000 besides, he has earned Rs 40,000 as income from agriculture.
The income tax payable by him will be computed as under:
On the first Rs 1,60,000 of taxable non-agricultural income - Nil
On the next Rs 40,000 of agricultural income (falling under 10% slab) - Nil
On the next Rs 2,000 of taxable non-agricultural income @ 10% - Rs 200
IT on aggregated income of Rs 202,000 (Rs 162,000 + Rs 40,000) - Rs 200
4. Receipts from Hindu undivided family (HUF)
Any sum received by an individual as a member of a Hindu undivided family, where the said sum has been paid out of the income of the family, or, in the case of an impartible estate, where such sum has been paid out of the income of the estate
belonging to the family, is completely exempt from income tax in the hands of an individual member of the family under Section
5. Allowance for foreign service
Any allowances or perquisites paid or allowed as such outside India by the Government to a citizen of India, rendering service outside India, are completely exempt from tax under Section 10(7).This provision can be taken advantage of by the citizens of India who are in government service so that they can accumulate tax-free perquisites and allowances received outside India.
6. Gratuities Under the provisions of Section 10(10) of the IT Act, any death-cum-retirement gratuity of a government servant is completely exempt from income tax.
In respect of private sector employees, however, gratuity received on retirement or on becoming incapacitated or on termination or any gratuity received by his widow, children or dependants on his death is exempt subject to certain conditions. The maximum amount of exemption is Rs 3,50,000. Of course, this is further subject to certain other limits like the one half-month's salary for each year of completed service, calculated on the basis of average salary for the 10 months immediately preceding the year in which the gratuity is paid or 20 months' salary as calculated. Thus, the least of these items is exempt from income tax under Section 10(10).
7. Commutation of pension :The entire amount of any payment in commutation of pension by a government servant or any payment in commutation of pension from LIC pension fund is exempt from income tax under Section 10(10A) of IT Act.However, in respect of private sector employees, only the following amount of commuted pension is exempt, namely -
(a) Where the employee received any gratuity, the commuted value of one-third
of the pension which he is normally entitled to receive; and
(b) In any other case, the commuted value of half of such pension.
It may be noted here that the monthly pension receivable by a pensioner is liable to full income tax like any other item of salary or income and no standard deduction is now available in respect of pension received by a tax payer.
8. Leave salary of central government employees:Under Section 10(10AA) the maximum amount receivable by the employees of central government as cash equivalent to the leave salary in respect of earned leave at their credit upto 10 months' leave at the time of their retirement, whether on superannuation or otherwise, would be Rs 300,000.
9. Voluntary retirement or separation payment:Under the provisions of Section 10(10C), any amount received by an employee of a public sector company or of any other company or of a local authority or a statutory authority or a cooperative society or university or IIT or IIM at the time of his voluntary retirement (VR) or voluntary separation in accordance with any scheme or schemes of VR as per Rule 2BA, is completely exempt from tax.The maximum amount of money received at such VR which is so exempt is Rs 500,000. As per Finance (No. 2) Act, 2009 an assessee cannot enjoy both the exemption in respect of VRS upto Rs 500,000 and also a deduction under Section 89.
10. Life insurance receipts:Under Section 10(10D), any sum received under a Life Insurance Policy, including the sum allocated by way of bonus on such policy, other than u/s 80DDA or under a Keyman Insurance Policy, or under an insurance policy issued on or after 1.4.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20% of the actual capital sum assured, is fully exempt from tax.However, all moneys received on death of the insured are fully exempt from tax Thus, generally moneys received from life insurance policies whether from the Life Insurance Corporation or any other private insurance company would be exempt from income tax.
11. Payment received from provident funds:Under the provisions of Sections 10(11), (12) and (13) any payment from a government or recognised provident fund (PF) or approved superannuation fund, or PPF is exempt from income tax.
12. Certain types of interest payment:There are certain types of interest payments which are fully exempt from income tax u/s 10 (15).
These are described below -
(1) Income by way of interest, premium on redemption or other payment on such securities,bonds, annuity certificates, savings certificates, other certificates issued by the Central Government and deposits as the Central Government may, by notification in the Official Gazette, specify in this behalf.
(2a) In the case of an individual or a Hindu Undivided Family, interest on such capital investment bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf (i.e. 7% Capital Investment Bonds);
2b) In the case of an individual or a Hindu Undivided Family, interest on such Relief Bonds as the Central Government may, by notification in the Official Gazette, specify in this behalf (i.e.,9% or 8.5% or 8% or 7% Relief Bonds); (iid) Interest on NRI bonds;
(3a) Interest on securities held by the issue department of the Central Bank of Ceylon constituted under the Ceylon Monetary Law Act, 1949;
(3b) Interest payable to any bank incorporated in a country outside India and authorised perform central banking functions in that country on any deposits made by it, with the approval of the Reserve Bank of India or with any scheduled bank
(4) Certain interest payable by Government or a local authority on moneys borrowed by it,including hedging charges on currency fluctuation (from the AY 2000-2001), etc.;
(5) Interest on Gold Deposit Bonds;
(6) Interest on certain deposits are: Bhopal Gas victims;
(7) Interest on bonds of local authorities as notified, and
(8) Interest on 6.5% Savings Bonds [Exempt] issued by RBI
(9) Stipulated new tax free bonds to be notified from time to time.
13. Amount received by way of gift, etc - Section 10(39):As per the Finance (No.2) Act, 2004, gift, etc. received after 1-9-2004 by individual or HUF in cash or by way of credit, etc. is being subjected to tax if the same is not received from relative,etc. However, Section 56(2) provides that the amount received to the extent of Rs 50,000 will, however, be exempt from the purview of income tax.Similarly, amount received on the occasion of marriage from a non-relative, etc. would also be exempted. It may be noted that the gift from relatives. as mentioned in the Section can be received without any upper limit.
14. Tax exemption regarding reverse mortgage scheme - sections 2(47) and 47(x)Any transfer of a capital asset in a transaction of reverse mortgage for senior citizens under a scheme made and notified by the Central Government would not be regarded as a transfer and therefore would not attract capital gains tax. The loan amount would also be exempt from tax.
These amendments by the Finance Act, 2008 apply from FY 2007-08 onwards.10. Life insurance receiptsUnder Section 10(10D), any sum received under a Life Insurance Policy, including the sum allocated by way of bonus on such policy, other than u/s 80DDA or under a Keyman Insurance Policy, or under an insurance policy issued on or after 1.4.2003 in respect of which the premium payable for any of the years during the term of the policy exceeds 20% of the actual capital sum assured, is fully exempt from tax.However, all moneys received on death of the insured are fully exempt from tax Thus, generally moneys received from life insurance policies whether from the Life Insurance Corporation or any other private insurance company would be exempt from income tax.
Friday, November 20, 2009
VALUE INVESTING
Equity markets around the world continue to be driven by the two powerful emotions of greed and fear, leading many an investor to chase the most talked-about ideas without perhaps as much consideration for the underlying fundamentals and therefore overlooking some great investment opportunities just because these do not find favour with the market. At the same time, far away from the day-to-day clamour of the stock markets, there is a school of investors who quietly work on a disciplined approach to stock picking, making sure that they are buying into low expectations and keeping valuations on their side. Investing to them is not just buying stocks, but using stocks as a conduit for buying into businesses. This is the essence of
Value Investing. This edition of the Perspective takes a look at the concept of Value Investing, its usefulness as an investment style and addresses some of the common misconceptions associated with it.
AT A GLANCE The basics of Value Investing
Value Investing has worked in markets across the world over the long term
Common misconceptions on Value Investing ZOOMING IN WHERE MARKETS REFUSE TO TREAD
"The market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities...The market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion,” said Benjamin Graham and David Dodd, professors of finance at the Columbia University in
the USA, who in the 1930s, laid out what is considered to be the framework for value investing. Their concept was actually very simple: identify and invest in companies trading below their inherent worth or intrinsic value.
THE QUEST FOR INTRINSIC VALUE
The value investor looks for stocks with inherently strong fundamentals - including earnings, dividends,book value, and cash flow - that are selling at a lower price, given their quality. The value investor tries to actively identify companies that seem to be incorrectly valued (undervalued) by the market and therefore whose share price has the potential to increase when the market corrects its anomalies in valuation. While a company’s market capitalisation reflects the value of its stock based on what investors are willing to pay for its shares, the intrinsic value seeks to identify what the company is really worth, based on the value of the underlying business. Value investment professionals use different techniques to calculate intrinsic value and there is no universally accepted measure. But, for the most part, they use criteria based on a company’s assets and earnings to evaluate its past performance and estimate its future prospects. Understanding the management, competition and the business model and fundamentals of the company, is also important
in determining the intrinsic value of a company. Then there are other variables such as brand name, trademark, and copyrights that are often difficult to calculate and sometimes not accurately reflected in the market price. Value investors would only be interested to invest in companies that are available at significant discounts
to their intrinsic values. Value investing combines the conservative analysis of determining intrinsic value with the requisite discipline and patience to buy stocks only when a sufficient discount from that value is available in the market.
Because value investing is as much an art as a science, value investors feel the need for a margin of safety to arrive at a decision to invest. A margin of safety is achieved when securities are purchased at prices sufficiently below their intrinsic values to allow for human error, bad luck, or extreme volatility in a
complex, unpredictable, and rapidly changing world.
According to Graham, "The margin of safety is always dependent on the price paid. For any security, it will be large at one price, small at some higher price, nonexistent at some still higher price."
Conventionally speaking, many of the value investors begin their search by looking for investing in stocks with low price-earnings (P/E) or low price-book value (P/BV) ratios in the tradition of Benjamin Graham. The other ratios used by Graham were Dividend Yield, Return on Equity (RoE), Return on Capital Employed (RoCE), Enterprise Value to Earnings before interest, taxes, depreciation and amortisation (EBITDA), Enterprise Value to Sales and Price to Cash Flow etc. Over time, these ratios have been used in the primary screening criteria by many value investors.
BENJAMIN GRAHAM’S VALUE INVESTING TOOLKIT
Based on years of empirical evidence, Graham developed a screening toolkit which he used extensively to identify value picks.
1. P/E of the stock has to be less than the inverse of the yield on AAA Corporate Bonds
2. P/E of the stock has to less than 40% of the average PE over the last 5 years
3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield
4. Price < Two-thirds of Book Value
5. Price < Two-thirds of Net Current Assets
6. Debt-Equity Ratio has to be less than 1.
7. Current Assets > Twice Current Liabilities
8. Debt < Twice Net Current Assets
9. Historical Growth in EPS (over last 10 years) > 7%
10. No more than two years of negative earnings over the previous 10 years.
VALUE INVESTING – THE WARREN BUFFETT WAY
Graham's most famous student, Warren Buffett, has taken value investing to another level. He chooses stocks on the basis of their overall potential as companies or businesses. Holding these stocks as longterm plays, Buffett seeks not capital gain but ownership in quality companies extremely capable of generating earnings.
WARREN BUFFETT’S TENETS FOR VALUE INVESTINGBusiness
The business the company is in should be simple and easy to understand.
The firm should have a consistent operating history, manifested in operating earnings that are stable and predictable.
The firm should be in a business with favourable long term prospects.
Management
The managers of the company should be candid. As evidenced by the way he
treated his own stockholders, Buffett put a premium on managers he trusted.
The managers of the company should be leaders and not followers.
Financial
The company should have a high return on equity. Buffett used a modified version
of what he called owner earnings:
Owner Earnings = Net income + Depreciation & Amortization – Capital Expenditures
The company should have high and stable profit margins.
Market
Use conservative estimates of earnings and appropriate discount rate.
Valuable companies can be bought at attractive prices when investors turn away
from them.
SOME OTHER SCREENERS
Here is a list of a few more thumb-rules that some value investors use as rough guides for picking stocks. Do remember that these are guidelines, not hard-and-fast rules:
1. Look at companies with P/E ratios at the lowest decile of all equity securities.
2. PEG (Price to Earnings Growth) should be less than 1.
3. Stock price should be no more than the tangible book value.
WHERE TO LOOK FOR VALUE?
Equity markets, from time to time, present situations which are called “Valuation Anomalies”, in which the market either overlooks or is ignorant of the value – either hidden or emerging out of a shift in business parameters. Value Investors wait for these situations to identify suitable investment opportunities.
There are basically three kinds of valuation anomalies that can be seen in the markets:
Over-pessimism – the entire market becomes pessimistic about something and the stocks start falling.Because the stocks are falling, no one wants to invest in them.
Under-estimated structural earnings potential – this structural change happens in an industry or a business which changes it from a fundamentally bad to a good business. And because the markets are so taken by what is happening currently, they miss the structural change.
Under-estimated change (the extent or pace) – this arises where the extent or pace of change is not properly estimated by the market.
The key point of note here is that market will always present such valuation anomalies. These anomalies in turn, are driven by risk-aversion of market players who would like to stay with the crowd and invest in stocks which are already going up no matter how expensive they are. Markets are going to be driven by greed and fear and this is what will create valuation anomalies.
THE VALUE – GROWTH CONUNDRUM
While Value Investing is focussed on valuation anomalies and buying stocks which trade at a price significantly lower than their intrinsic values, Growth Investing involves buying stocks which have a high earnings growth rate and are likely to be expensive as expectations are high. While both styles of investing have their merits as investment strategies and they come into prominence at different phases in the market cycle, empirical evidence is in favour of value investing over a sustainable period of time. This is mainly because in value investing, one buys into low expectations that are less likely to disappoint whereas investing for growth could lead to underperformance over a period of time as growth rate tends to revert to the mean in a capitalistic economic model. For instance, if there is a high growth opportunity in an industry within an economy, it will attract new players who would invest more capital to set up new capacities. As a result, over a period of time, the industry is likely to lose its competitive edge leading to a reversal to its mean growth rate. It is important to remember that any investment strategy that is based upon buying well-run, good companies and expecting the growth in earnings in these companies to carry prices higher is risky, since it ignores the reality that the current price of the company may reflect the quality of the management and
the firm. If the current price is right (and the market is paying a premium for quality), the biggest risk is that the firm loses its lustre over time, and that the premium paid will dissipate. If the market is exaggerating the value of the firm, this strategy can lead to poor returns even if the firm delivers its expected growth.
COMMON MISCONCEPTIONS ON VALUE INVESTING
1. Value investing is investing in “cheap” shares Value investing does not mean just buying any stock with falling prices and therefore one that seems cheap. Value investors generally do their homework to be certain that they are picking a company that is undervalued in spite of its high quality. It is important to distinguish the difference between a value company and a company that simply has a declining price. Say, for the past year Company A has been trading at about Rs. 25 per share but the price suddenly drops to Rs. 15 per share. This does not automatically mean that the company is selling at a bargain and hence is a value stock. All we know is
that the company is less expensive now than it was last year. The drop in price could be a result of the market responding to a fundamental problem in the company. To be a real bargain, this company must have fundamentals healthy enough to imply it is worth more than Rs. 15. Value investing always compares current share price to intrinsic value not to historic share prices. Picking “cheap” stocks without adhering to a valuation discipline could often lead to “Value traps” where prices go on declining further and the investor is never able to recover his investment.
2. A stock with a lower valuation ratio is a better value pick Contrary to popular belief, value investing is not simply about investing in stocks with lower valuation
ratio like a P/E or P/BV. It is just that stocks which are undervalued will often reflect this undervaluation through a low valuation ratio. A low valuation does not necessarily imply that the stock is a value pick. It could be in response to a fundamental issue or weakness in the company. A value investor would try to
establish the intrinsic value of the company and compare it with the market value. The higher the difference between the market value and intrinsic value, the better is the value pick.
3. Value stocks are difficult to find in a growth/emerging market Value investing has nothing to do with a Growth economy or market. Every market, irrespective of its
nature, is likely to throw up valuation anomalies. These anomalies are more to do with market sentiment than anything else. More often than not, there are situations where the market participants take investment decisions out of either greed or fear. As a result, there are some fundamentally strong stocks which suffer from market pessimism, or the market fails to understand the structural earnings potential in an industry or the pace or extent of change is not appreciated.
4. Value investment can not work in a growth market like India A simple study shows that a notional investment of Rs. 1 lakh in the MSCI India Value Index has given about twice the returns of the same investment in the corresponding Growth Index, over a period of the
last 10 years.
5. Value investing can outperform but with a higher risk
The following table shows the compounded annualised growth of the MSCI India Core, Growth and Value indices across various time periods. It can be clearly seen that the Value index has outperformed the others significantly across time periods. At the same time, the Value Index has not added significant risk as compared to the other two indices, when measured by volatility or annualised standard deviation of monthly returns.
CONCLUSION
Value investing has outperformed other investing styles across global markets over the long term. Irrespective of market cycles and regardless of the fact that it is a high or a slow growth market, there could be valuation anomalies which would provide stock picking opportunities for the focused and disciplined value investor.
For most individual investors, it would be well near impossible to replicate this strategy to build up their own stock portfolios. They would be well-advised to look at investing in value funds offered by mutual fund companies to reap the benefits of value investing and add style diversification to their investments.
Source: Fidelity
Value Investing. This edition of the Perspective takes a look at the concept of Value Investing, its usefulness as an investment style and addresses some of the common misconceptions associated with it.
AT A GLANCE The basics of Value Investing
Value Investing has worked in markets across the world over the long term
Common misconceptions on Value Investing ZOOMING IN WHERE MARKETS REFUSE TO TREAD
"The market is not a weighing machine, on which the value of each issue is recorded by an exact and impersonal mechanism, in accordance with its specific qualities...The market is a voting machine, whereon countless individuals register choices which are the product partly of reason and partly of emotion,” said Benjamin Graham and David Dodd, professors of finance at the Columbia University in
the USA, who in the 1930s, laid out what is considered to be the framework for value investing. Their concept was actually very simple: identify and invest in companies trading below their inherent worth or intrinsic value.
THE QUEST FOR INTRINSIC VALUE
The value investor looks for stocks with inherently strong fundamentals - including earnings, dividends,book value, and cash flow - that are selling at a lower price, given their quality. The value investor tries to actively identify companies that seem to be incorrectly valued (undervalued) by the market and therefore whose share price has the potential to increase when the market corrects its anomalies in valuation. While a company’s market capitalisation reflects the value of its stock based on what investors are willing to pay for its shares, the intrinsic value seeks to identify what the company is really worth, based on the value of the underlying business. Value investment professionals use different techniques to calculate intrinsic value and there is no universally accepted measure. But, for the most part, they use criteria based on a company’s assets and earnings to evaluate its past performance and estimate its future prospects. Understanding the management, competition and the business model and fundamentals of the company, is also important
in determining the intrinsic value of a company. Then there are other variables such as brand name, trademark, and copyrights that are often difficult to calculate and sometimes not accurately reflected in the market price. Value investors would only be interested to invest in companies that are available at significant discounts
to their intrinsic values. Value investing combines the conservative analysis of determining intrinsic value with the requisite discipline and patience to buy stocks only when a sufficient discount from that value is available in the market.
Because value investing is as much an art as a science, value investors feel the need for a margin of safety to arrive at a decision to invest. A margin of safety is achieved when securities are purchased at prices sufficiently below their intrinsic values to allow for human error, bad luck, or extreme volatility in a
complex, unpredictable, and rapidly changing world.
According to Graham, "The margin of safety is always dependent on the price paid. For any security, it will be large at one price, small at some higher price, nonexistent at some still higher price."
Conventionally speaking, many of the value investors begin their search by looking for investing in stocks with low price-earnings (P/E) or low price-book value (P/BV) ratios in the tradition of Benjamin Graham. The other ratios used by Graham were Dividend Yield, Return on Equity (RoE), Return on Capital Employed (RoCE), Enterprise Value to Earnings before interest, taxes, depreciation and amortisation (EBITDA), Enterprise Value to Sales and Price to Cash Flow etc. Over time, these ratios have been used in the primary screening criteria by many value investors.
BENJAMIN GRAHAM’S VALUE INVESTING TOOLKIT
Based on years of empirical evidence, Graham developed a screening toolkit which he used extensively to identify value picks.
1. P/E of the stock has to be less than the inverse of the yield on AAA Corporate Bonds
2. P/E of the stock has to less than 40% of the average PE over the last 5 years
3. Dividend Yield > Two-thirds of the AAA Corporate Bond Yield
4. Price < Two-thirds of Book Value
5. Price < Two-thirds of Net Current Assets
6. Debt-Equity Ratio has to be less than 1.
7. Current Assets > Twice Current Liabilities
8. Debt < Twice Net Current Assets
9. Historical Growth in EPS (over last 10 years) > 7%
10. No more than two years of negative earnings over the previous 10 years.
VALUE INVESTING – THE WARREN BUFFETT WAY
Graham's most famous student, Warren Buffett, has taken value investing to another level. He chooses stocks on the basis of their overall potential as companies or businesses. Holding these stocks as longterm plays, Buffett seeks not capital gain but ownership in quality companies extremely capable of generating earnings.
WARREN BUFFETT’S TENETS FOR VALUE INVESTINGBusiness
The business the company is in should be simple and easy to understand.
The firm should have a consistent operating history, manifested in operating earnings that are stable and predictable.
The firm should be in a business with favourable long term prospects.
Management
The managers of the company should be candid. As evidenced by the way he
treated his own stockholders, Buffett put a premium on managers he trusted.
The managers of the company should be leaders and not followers.
Financial
The company should have a high return on equity. Buffett used a modified version
of what he called owner earnings:
Owner Earnings = Net income + Depreciation & Amortization – Capital Expenditures
The company should have high and stable profit margins.
Market
Use conservative estimates of earnings and appropriate discount rate.
Valuable companies can be bought at attractive prices when investors turn away
from them.
SOME OTHER SCREENERS
Here is a list of a few more thumb-rules that some value investors use as rough guides for picking stocks. Do remember that these are guidelines, not hard-and-fast rules:
1. Look at companies with P/E ratios at the lowest decile of all equity securities.
2. PEG (Price to Earnings Growth) should be less than 1.
3. Stock price should be no more than the tangible book value.
WHERE TO LOOK FOR VALUE?
Equity markets, from time to time, present situations which are called “Valuation Anomalies”, in which the market either overlooks or is ignorant of the value – either hidden or emerging out of a shift in business parameters. Value Investors wait for these situations to identify suitable investment opportunities.
There are basically three kinds of valuation anomalies that can be seen in the markets:
Over-pessimism – the entire market becomes pessimistic about something and the stocks start falling.Because the stocks are falling, no one wants to invest in them.
Under-estimated structural earnings potential – this structural change happens in an industry or a business which changes it from a fundamentally bad to a good business. And because the markets are so taken by what is happening currently, they miss the structural change.
Under-estimated change (the extent or pace) – this arises where the extent or pace of change is not properly estimated by the market.
The key point of note here is that market will always present such valuation anomalies. These anomalies in turn, are driven by risk-aversion of market players who would like to stay with the crowd and invest in stocks which are already going up no matter how expensive they are. Markets are going to be driven by greed and fear and this is what will create valuation anomalies.
THE VALUE – GROWTH CONUNDRUM
While Value Investing is focussed on valuation anomalies and buying stocks which trade at a price significantly lower than their intrinsic values, Growth Investing involves buying stocks which have a high earnings growth rate and are likely to be expensive as expectations are high. While both styles of investing have their merits as investment strategies and they come into prominence at different phases in the market cycle, empirical evidence is in favour of value investing over a sustainable period of time. This is mainly because in value investing, one buys into low expectations that are less likely to disappoint whereas investing for growth could lead to underperformance over a period of time as growth rate tends to revert to the mean in a capitalistic economic model. For instance, if there is a high growth opportunity in an industry within an economy, it will attract new players who would invest more capital to set up new capacities. As a result, over a period of time, the industry is likely to lose its competitive edge leading to a reversal to its mean growth rate. It is important to remember that any investment strategy that is based upon buying well-run, good companies and expecting the growth in earnings in these companies to carry prices higher is risky, since it ignores the reality that the current price of the company may reflect the quality of the management and
the firm. If the current price is right (and the market is paying a premium for quality), the biggest risk is that the firm loses its lustre over time, and that the premium paid will dissipate. If the market is exaggerating the value of the firm, this strategy can lead to poor returns even if the firm delivers its expected growth.
COMMON MISCONCEPTIONS ON VALUE INVESTING
1. Value investing is investing in “cheap” shares Value investing does not mean just buying any stock with falling prices and therefore one that seems cheap. Value investors generally do their homework to be certain that they are picking a company that is undervalued in spite of its high quality. It is important to distinguish the difference between a value company and a company that simply has a declining price. Say, for the past year Company A has been trading at about Rs. 25 per share but the price suddenly drops to Rs. 15 per share. This does not automatically mean that the company is selling at a bargain and hence is a value stock. All we know is
that the company is less expensive now than it was last year. The drop in price could be a result of the market responding to a fundamental problem in the company. To be a real bargain, this company must have fundamentals healthy enough to imply it is worth more than Rs. 15. Value investing always compares current share price to intrinsic value not to historic share prices. Picking “cheap” stocks without adhering to a valuation discipline could often lead to “Value traps” where prices go on declining further and the investor is never able to recover his investment.
2. A stock with a lower valuation ratio is a better value pick Contrary to popular belief, value investing is not simply about investing in stocks with lower valuation
ratio like a P/E or P/BV. It is just that stocks which are undervalued will often reflect this undervaluation through a low valuation ratio. A low valuation does not necessarily imply that the stock is a value pick. It could be in response to a fundamental issue or weakness in the company. A value investor would try to
establish the intrinsic value of the company and compare it with the market value. The higher the difference between the market value and intrinsic value, the better is the value pick.
3. Value stocks are difficult to find in a growth/emerging market Value investing has nothing to do with a Growth economy or market. Every market, irrespective of its
nature, is likely to throw up valuation anomalies. These anomalies are more to do with market sentiment than anything else. More often than not, there are situations where the market participants take investment decisions out of either greed or fear. As a result, there are some fundamentally strong stocks which suffer from market pessimism, or the market fails to understand the structural earnings potential in an industry or the pace or extent of change is not appreciated.
4. Value investment can not work in a growth market like India A simple study shows that a notional investment of Rs. 1 lakh in the MSCI India Value Index has given about twice the returns of the same investment in the corresponding Growth Index, over a period of the
last 10 years.
5. Value investing can outperform but with a higher risk
The following table shows the compounded annualised growth of the MSCI India Core, Growth and Value indices across various time periods. It can be clearly seen that the Value index has outperformed the others significantly across time periods. At the same time, the Value Index has not added significant risk as compared to the other two indices, when measured by volatility or annualised standard deviation of monthly returns.
CONCLUSION
Value investing has outperformed other investing styles across global markets over the long term. Irrespective of market cycles and regardless of the fact that it is a high or a slow growth market, there could be valuation anomalies which would provide stock picking opportunities for the focused and disciplined value investor.
For most individual investors, it would be well near impossible to replicate this strategy to build up their own stock portfolios. They would be well-advised to look at investing in value funds offered by mutual fund companies to reap the benefits of value investing and add style diversification to their investments.
Source: Fidelity
Thursday, November 19, 2009
DSP BlackRock World Mining Fund
DSP BlackRock Investment Managers announces the launch of DSP BlackRock World Mining Fund. The scheme is a fund of funds Scheme investing into the BlackRock Global Funds (BGF) – World Mining Fund (WMF) which invests in equity securities of mining companies globally. These companies generally operate across various geographies and enjoy considerable pricing flexibility. The New Fund Offer (NFO) will commence on November 23, 2009 and close on December 18, 2009.
Unique Features
DSP BlackRock World Mining Fund provides Indian investors with a unique investment opportunity to benefit from potential growth prospects in the mining sector by investing into mining companies globally. The unique features of this product are:
§ Provides access to BGF–WMF, one of the largest funds in its category in the world, with a long term performance track record
§BGF World Mining Fund is highly regarded and rated by independent agencies.
§The scheme provides investors the opportunity for global diversification combined with access to fundamentals of the mining sector and the growth potential of equities
§The team responsible for BGF-WMF is one of the strongest Natural Resources Teams in the industry, managing around US$ 31.9 billion in assets as on Oct 30, 2009. Four of the team’s five portfolio managers are geologists/geophysicists – a definite advantage for successful investing in this sector. The core of the team has worked together for over ten years, which has enabled them to build up invaluable experience with regards to the gold, mining and mining resources industry.
Areas into which this scheme invests
DSP BlackRock World Mining Fund will invest into the BGF-WMF and other similar Mutual Fund schemes, and will provide investors with access to the fundamentals of the mining sector. BGF - World Mining Fund invests mostly in the equity securities of mining and metals companies whose predominant economic activity is the production of base metals and industrial minerals such as iron ore and coal. The scheme may also hold the equity securities of companies whose predominant economic activity is in gold or other precious metals or mineral mining.
Key drivers in the Mining sector
The global mining and metals sector is faced with the challenge of responding to the rising demand for resources. While deposits are becoming scarcer and harder to locate, new production is being limited by supply chain bottlenecks and skills shortages.
Current outlook on the Mining Sector
The first half of 2009 saw China aggressively restocking. This drove up the demand for commodities in the first half of the year and caused commodity prices to rise significantly from the lows seen in late 2008. For example, by the end of June 2009, copper had risen 92% from its lows. We are yet to see evidence of a material restocking cycle in the US or Europe but once signs of sustainable economic recovery emerge, restocking in these regions should also be supportive for commodity prices. Despite a supposed slowdown in industrial demand, there were record levels of imports for copper, iron ore and coking into China during the first half of 2009. We have also seen signs of economic recovery in the Western World with some restocking seen in selected areas e.g. steel, but the full effect is yet to be felt, in our opinion.
As we look forward to 2010, it is likely that the impact of stimulus spending on infrastructure projects should begin to come through into the market, as well as a potential recovery in private sector demand. If demand does recover then the supply side is unlikely to be able to respond to the same extent.
The credit crisis has resulted in widespread production cutbacks across most metals. Some of this capacity has been taken offline permanently and the remainder will not be able to be brought back online instantaneously. In addition, a large number of planned expansion projects have been shelved as appetite for taking on development risk has diminished and the ability to finance the projects has reduced. Such constraints on the supply side lead us to believe that a demand recovery could provide a constructive environment for commodity prices, which are the key earnings driver for mining companies.
Why Invest DSP BlackRock World Mining Fund?
As mentioned earlier, DSP BlackRock World Mining Fund will invest into the BGF-WMF (Fund).
·This Fund has a strong long-term performance track record – The Fund is ranked no. 1 in its sector over 5 years, 10 years and since launch and has produced impressive cumulative returns ahead of benchmark over the long term.
·The Fund offers Regional and sub-sector diversification – By investing in DSP BlackRock World Mining Fund, which will invest into the BGF-WMF, Indian investors will have the opportunity to diversify investments away from country based asset allocation strategies and gain exposure to sectors of the market which tend to outperform at various phases of the business cycle.
·The Fund is managed by an Expert, Experienced Team – The Team is one of the industry’s acknowledged specialists, with extensive industry contacts and significant research capabilities, managing US$31.9 bn (As on Oct 30, 2009)* in assets on behalf of clients. The latest August 2009 Standard & Poor’s report refers to the Fund as being “Managed by BlackRock’s expert natural resources team”.
·The Fund benefits from an In-depth research process – the managers really apply a kick-the-tyres approach to the companies in which they invest. It is only by meeting with company management, attendance at industry events and research trips to company assets, as well as extensive commodity and equity analysis that the stock-specific risks within the portfolio can be evaluated fully.
·The Fund has been awarded the maximum AAA ratings from both Standard & Poor’s and OBSR. The Fund was also awarded an “ELITE” Morningstar Rating in July 2009. The fund achieved “Twenty four 1st place awards” for performance excellence worldwide in 2008 from a number of recognised ratings agencies and publications.
The Fund strategy
The Fund endeavors to incorporate the ‘best ideas’ in the portfolio instead of just following a benchmark driven approach. The wide experience of the portfolio managers as well as their sector perspective of companies across the globe helps them ensure that the best global ideas are reflected in the portfolio. The Fund focuses on a bottom-up approach to portfolio construction coupled with a top-down sub-sector overlay.
Unique Features
DSP BlackRock World Mining Fund provides Indian investors with a unique investment opportunity to benefit from potential growth prospects in the mining sector by investing into mining companies globally. The unique features of this product are:
§ Provides access to BGF–WMF, one of the largest funds in its category in the world, with a long term performance track record
§BGF World Mining Fund is highly regarded and rated by independent agencies.
§The scheme provides investors the opportunity for global diversification combined with access to fundamentals of the mining sector and the growth potential of equities
§The team responsible for BGF-WMF is one of the strongest Natural Resources Teams in the industry, managing around US$ 31.9 billion in assets as on Oct 30, 2009. Four of the team’s five portfolio managers are geologists/geophysicists – a definite advantage for successful investing in this sector. The core of the team has worked together for over ten years, which has enabled them to build up invaluable experience with regards to the gold, mining and mining resources industry.
Areas into which this scheme invests
DSP BlackRock World Mining Fund will invest into the BGF-WMF and other similar Mutual Fund schemes, and will provide investors with access to the fundamentals of the mining sector. BGF - World Mining Fund invests mostly in the equity securities of mining and metals companies whose predominant economic activity is the production of base metals and industrial minerals such as iron ore and coal. The scheme may also hold the equity securities of companies whose predominant economic activity is in gold or other precious metals or mineral mining.
Key drivers in the Mining sector
The global mining and metals sector is faced with the challenge of responding to the rising demand for resources. While deposits are becoming scarcer and harder to locate, new production is being limited by supply chain bottlenecks and skills shortages.
Current outlook on the Mining Sector
The first half of 2009 saw China aggressively restocking. This drove up the demand for commodities in the first half of the year and caused commodity prices to rise significantly from the lows seen in late 2008. For example, by the end of June 2009, copper had risen 92% from its lows. We are yet to see evidence of a material restocking cycle in the US or Europe but once signs of sustainable economic recovery emerge, restocking in these regions should also be supportive for commodity prices. Despite a supposed slowdown in industrial demand, there were record levels of imports for copper, iron ore and coking into China during the first half of 2009. We have also seen signs of economic recovery in the Western World with some restocking seen in selected areas e.g. steel, but the full effect is yet to be felt, in our opinion.
As we look forward to 2010, it is likely that the impact of stimulus spending on infrastructure projects should begin to come through into the market, as well as a potential recovery in private sector demand. If demand does recover then the supply side is unlikely to be able to respond to the same extent.
The credit crisis has resulted in widespread production cutbacks across most metals. Some of this capacity has been taken offline permanently and the remainder will not be able to be brought back online instantaneously. In addition, a large number of planned expansion projects have been shelved as appetite for taking on development risk has diminished and the ability to finance the projects has reduced. Such constraints on the supply side lead us to believe that a demand recovery could provide a constructive environment for commodity prices, which are the key earnings driver for mining companies.
Why Invest DSP BlackRock World Mining Fund?
As mentioned earlier, DSP BlackRock World Mining Fund will invest into the BGF-WMF (Fund).
·This Fund has a strong long-term performance track record – The Fund is ranked no. 1 in its sector over 5 years, 10 years and since launch and has produced impressive cumulative returns ahead of benchmark over the long term.
·The Fund offers Regional and sub-sector diversification – By investing in DSP BlackRock World Mining Fund, which will invest into the BGF-WMF, Indian investors will have the opportunity to diversify investments away from country based asset allocation strategies and gain exposure to sectors of the market which tend to outperform at various phases of the business cycle.
·The Fund is managed by an Expert, Experienced Team – The Team is one of the industry’s acknowledged specialists, with extensive industry contacts and significant research capabilities, managing US$31.9 bn (As on Oct 30, 2009)* in assets on behalf of clients. The latest August 2009 Standard & Poor’s report refers to the Fund as being “Managed by BlackRock’s expert natural resources team”.
·The Fund benefits from an In-depth research process – the managers really apply a kick-the-tyres approach to the companies in which they invest. It is only by meeting with company management, attendance at industry events and research trips to company assets, as well as extensive commodity and equity analysis that the stock-specific risks within the portfolio can be evaluated fully.
·The Fund has been awarded the maximum AAA ratings from both Standard & Poor’s and OBSR. The Fund was also awarded an “ELITE” Morningstar Rating in July 2009. The fund achieved “Twenty four 1st place awards” for performance excellence worldwide in 2008 from a number of recognised ratings agencies and publications.
The Fund strategy
The Fund endeavors to incorporate the ‘best ideas’ in the portfolio instead of just following a benchmark driven approach. The wide experience of the portfolio managers as well as their sector perspective of companies across the globe helps them ensure that the best global ideas are reflected in the portfolio. The Fund focuses on a bottom-up approach to portfolio construction coupled with a top-down sub-sector overlay.
RELIANCE MIP
Fund Manager View
Globally, the monetary policy reversal has begun, with Reserve Bank of Australia becoming second central bank to raise the key policy rate after Israel. Taking cues from global developments, RBI raised SLR in the policy meeting. Robust IIP numbers, rising food inflation, anaemic credit growth, appreciating rupee were the other key highlights of the month. In the quarterly monetary policy review, RBI left the key policy rates unchanged (Repo Rate: 4.75%, Reverse Repo Rate: 3.25%, CRR: 5.00%). However, RBI increased the statutory liquidity ratio (SLR) to former level of 25% from 24%, giving clear indication that the monetary policy reversal has already began as it announced the closure of some of the unconventional liquidity support measures provided earlier. WPI and IIP numbers continue to show an upward trend. After remaining in negative zone for three consecutive months, WPI inflation rate grew at 0.51% in September and stood at 1.51% for week ending October17. For last couple of months, food prices have been driving up the inflation rate on account of erratic monsoon. Similar concerns are reflected in Consumer price index (CPI) inflation for industrial workers (with higher weightage of food). CPI-IW continues to be in doubledigit (Aug’09: 11.7%) for third month in row. On currency front, the rupee appreciated sharply by 4% against US dollar in October (after marginally depreciating in September). The appreciation was mainly driven by dollar weakness and foreign inflows on back of economic turnaround. Indian industrial production (IIP) continued to grow robustly for third month in row. It grew at
10.4% in August driven mainly by favourable base effect. Broad-based recovery across the sectors suggests that the economic activities have certainly picked up. On a cumulative basis, IIP growth during April-August was up 5.8% as against 4.8% in same period last year. Credit offtake continued to post dismal performance, with credit growth coming down to 10.8% by Oct 9 as against 13% in Sept, 14.5% in Aug and 15% in July. This was primarily due to base effect and still low non-food credit offtake. However, this has been to a large extent made up by more inflows from other domestic sources (in form of public issues and private placements) and external sources (like FDI, ECBs, GDR, ADRs). Corporate bonds witnessed a lack-luster month with longer end yields moving in a band of 10-15 bps. 10 year AAA was range-bound and moved in band of 8.75%-8.85%. Good support was Reliance Monthly Income Plan (An open ended fund. Monthly Income is not assured and is subject to availability of distributable surplus) witnessed in 2 & 3 year bucket on account of comfortable liquidity. Yields in 2 & 3 year bucket were quoted around 6.90%-7% and 7.80%-7.95% respectively throughout the month. The liquidity conditions continued to be comfortable with the average LAF balances above Rs.1,02,500 crore during the month. The overnight call rates hovered in the range of 2.00% to 4.10% levels during the month. The CD levels were range-bound, with CDs trading in the range of 3.25%-5.60% as against the previous month’s level of 3.00%-6.25%.
Outlook
In coming months, we expect G-secs yields to be range-bound. The market will take cues from RBI policy reversal, GDP and IIP numbers, inflation numbers, announcement related to Government borrowing and actions from global central banks. G-Sec market will take further cues from various events like auction outcomes, credit-deposit growth data and fiscal measures to fight drought conditions. In Q4 FY10, the yields might come under pressure on expectations of RBI raising the policy rates. Going forward, the corporate bond yields are likely to follow G-Sec movement and corporate bond issuance.
About Monthly Income Plan Category
Hybrid Funds seek to benefit by investing in both worlds of fixed income and equity
instruments.
MIPs are hybrid investment avenues that invest a minor portion of their portfolio (around 15 per cent-30 per cent) in equities and the balance in debt and money market instruments (i.e.bonds, certificates, G Secs etc).
The asset allocation pattern is designed in such a way that there is a cap of 10%-30% on the equity exposure in the portfolio which during a bear market phase helps in minimizing risk because of limited downside seen during bad times and also aims to generate above average returns in a good equity market phase. Therefore, the equity component provides MIPs with just the edge it needs to outperform conventional debt funds.
MIPs provide income to investors, but the periodicity depends upon the option chosen(Monthly/Quarterly) and the distributable surplus available in the fund. Growth Option provides income in the form of capital gains/appreciation. Case for Investment in the Fund
With the current levels of market volatility, MIPs can be a good option considering their exposure to debt instruments. This helps in maintaining a comparatively low-risk portfolio and generates regular and stable returns. Stability, rather than quick and high returns, is usually the priority for a typical MIP investor.
The equity exposure in the portfolio during a bear market phase helps in minimizing risk because of limited downside seen during bad times and also aims to generate above average returns in a good equity market phase. Therefore, the equity component provides MIPs with just the edge it needs to outperform conventional debt funds.
Investor Profile
Investors who are conservative in their investment approach but still want to earn marginally better returns than a debt-only portfolio then MIP is definitely a fund category to be considered.
Portfolio Analysis and Strategy
Debt Portfolio Analysis
Emphasis is more on accrual-based returns than on active trading. MIP portfolio reflects an optimum blend of both fixed and floating rate instruments comprising of Certificate of Deposits to take care of liquidity needs and plain vanilla bond specially to take care of yield enhancement, Government Securities enhance the credit quality and shall enable in benefiting from the bond market play.
Equity Portfolio Analysis
Though investment into equity and equity linked securities forms a minor part (maximum 20%) of the portfolio, right timing and selection of stocks has been able to generate the alpha returns, thus resulting in the growth of capital.
From January 2008 till date, financial markets have witnessed its peak of volatility due to various global and domestic factors. Both, Nifty and Sensex has seen its highs and lows. During this period, the equity exposure in Reliance MIP has been roughly between 10%-20%, depending upon the market opportunities.
During the above mentioned period, the fund had taken equity exposure across all market caps in various sectors like Banking, Auto, Finance, Petroleum Products, Software etc.
However, the entry and exit to and from particular stock or sector has been done according tothe market timing and opportunities in a particular sector/company.
Fund Strategy
Reliance Monthly Income Fund seeks to generate moderate level of returns for its investors by taking advantage of almost every opportunity available in the fixed income market space.
An active duration management strategy is followed along with a close monitoring of the portfolio on a regular basis. The fund is suitable for investors with 1.5 – 3 years investment horizon and a low to moderate appetite for risk.
We will have a bottom up approach of stock selection in our equity portfolio consisting of a mix of mid cap and large cap stocks. The equity investment philosophy will tend to be more aggressive with the idea of generating an alpha to the portfolio.
1] Point to Point ReturnsNAV Performance report as on 31/10/2009
Compound Annualized
1 Year 3 Years 5 Years Since Inception
Reliance MIP - Growth 33.88 12.58 13.42 11.96
Crisil MIP Blended Index 18.84 7.35 8.52 6.92
*Past Performance may or may not be sustained in the future.
Compounded annualized returns of Growth Option. (Inception Date: 13th Jan 2004)
Calculations assume that all payouts during the period have been reinvested in the units of the
scheme at the then prevailing NAV.
2] Quartile Analysis
Quartile Analysis of the "Hybrid Monthly Income" which consists of 39 MIP schemes was done for
the 1 month, 6 month, 1 year, 3 year and 5 year period as on 12.11.09. The peer group consists’ of 39 schemes uptil 6 months time period 37 schemes uptil 3 year tenure and 36 schemes for 5 year tenure.RMIP has found a place in 1st quartile across all the above mentioned tenors. Reliance MIP has also been rated as a Five Star Fund by Value Research Online. Source: www.valueresearchonline.com
Product Features
Investment Objective:
The primary investment objective of the Scheme is to generate regular income in order to make regular dividend payments to unit holders and the secondary objective is growth of capital.
Choice of Plans/Option
Growth Plan
Dividend Plan
Monthly Dividend Plan (Payout & Reinvestment)
Quarterly Dividend Plan (Payout & Reinvestment
Minimum Application Amount
For Resident and Non Resident Investors
In Monthly Dividend Plan: 25,000 *
In Quarterly Dividend Plan: Rs. 10,000*
In Growth Plan: Rs.10,000 *
*Any purchases thereafter can be made in multiples of Re.1. The minimum amount is specified
above.
Portfolio Features as on 31.10.09
Weighted Average Maturity: 2.21 years
Weighted Average Yield: 5.40 % p.a
Scheme Details
Date of Inception: 13th Jan 2004
Fund Size : Rs.1414.48 crore (as on 31.10.09)
Load Structure
Entry Load: Nil
In terms of SEBI circular no. SEBI/IMD/CIR No.4/ 168230/09 dated June 30, 2009, no entry load will be charged by the Scheme to the investor effective August 1, 2009. Upfront commission shall be paid directly by the investor to the AMFI registered Distributors based on the investors' assessment of various factors including the service rendered by the distributor
Exit load: 1% if the units are redeemed/switched out on or before completion of 1year from the date of allotment of units. There shall be no exit load after completion 1year from the date of allotment of units.
Source: Reliance Mutual Fund
Globally, the monetary policy reversal has begun, with Reserve Bank of Australia becoming second central bank to raise the key policy rate after Israel. Taking cues from global developments, RBI raised SLR in the policy meeting. Robust IIP numbers, rising food inflation, anaemic credit growth, appreciating rupee were the other key highlights of the month. In the quarterly monetary policy review, RBI left the key policy rates unchanged (Repo Rate: 4.75%, Reverse Repo Rate: 3.25%, CRR: 5.00%). However, RBI increased the statutory liquidity ratio (SLR) to former level of 25% from 24%, giving clear indication that the monetary policy reversal has already began as it announced the closure of some of the unconventional liquidity support measures provided earlier. WPI and IIP numbers continue to show an upward trend. After remaining in negative zone for three consecutive months, WPI inflation rate grew at 0.51% in September and stood at 1.51% for week ending October17. For last couple of months, food prices have been driving up the inflation rate on account of erratic monsoon. Similar concerns are reflected in Consumer price index (CPI) inflation for industrial workers (with higher weightage of food). CPI-IW continues to be in doubledigit (Aug’09: 11.7%) for third month in row. On currency front, the rupee appreciated sharply by 4% against US dollar in October (after marginally depreciating in September). The appreciation was mainly driven by dollar weakness and foreign inflows on back of economic turnaround. Indian industrial production (IIP) continued to grow robustly for third month in row. It grew at
10.4% in August driven mainly by favourable base effect. Broad-based recovery across the sectors suggests that the economic activities have certainly picked up. On a cumulative basis, IIP growth during April-August was up 5.8% as against 4.8% in same period last year. Credit offtake continued to post dismal performance, with credit growth coming down to 10.8% by Oct 9 as against 13% in Sept, 14.5% in Aug and 15% in July. This was primarily due to base effect and still low non-food credit offtake. However, this has been to a large extent made up by more inflows from other domestic sources (in form of public issues and private placements) and external sources (like FDI, ECBs, GDR, ADRs). Corporate bonds witnessed a lack-luster month with longer end yields moving in a band of 10-15 bps. 10 year AAA was range-bound and moved in band of 8.75%-8.85%. Good support was Reliance Monthly Income Plan (An open ended fund. Monthly Income is not assured and is subject to availability of distributable surplus) witnessed in 2 & 3 year bucket on account of comfortable liquidity. Yields in 2 & 3 year bucket were quoted around 6.90%-7% and 7.80%-7.95% respectively throughout the month. The liquidity conditions continued to be comfortable with the average LAF balances above Rs.1,02,500 crore during the month. The overnight call rates hovered in the range of 2.00% to 4.10% levels during the month. The CD levels were range-bound, with CDs trading in the range of 3.25%-5.60% as against the previous month’s level of 3.00%-6.25%.
Outlook
In coming months, we expect G-secs yields to be range-bound. The market will take cues from RBI policy reversal, GDP and IIP numbers, inflation numbers, announcement related to Government borrowing and actions from global central banks. G-Sec market will take further cues from various events like auction outcomes, credit-deposit growth data and fiscal measures to fight drought conditions. In Q4 FY10, the yields might come under pressure on expectations of RBI raising the policy rates. Going forward, the corporate bond yields are likely to follow G-Sec movement and corporate bond issuance.
About Monthly Income Plan Category
Hybrid Funds seek to benefit by investing in both worlds of fixed income and equity
instruments.
MIPs are hybrid investment avenues that invest a minor portion of their portfolio (around 15 per cent-30 per cent) in equities and the balance in debt and money market instruments (i.e.bonds, certificates, G Secs etc).
The asset allocation pattern is designed in such a way that there is a cap of 10%-30% on the equity exposure in the portfolio which during a bear market phase helps in minimizing risk because of limited downside seen during bad times and also aims to generate above average returns in a good equity market phase. Therefore, the equity component provides MIPs with just the edge it needs to outperform conventional debt funds.
MIPs provide income to investors, but the periodicity depends upon the option chosen(Monthly/Quarterly) and the distributable surplus available in the fund. Growth Option provides income in the form of capital gains/appreciation. Case for Investment in the Fund
With the current levels of market volatility, MIPs can be a good option considering their exposure to debt instruments. This helps in maintaining a comparatively low-risk portfolio and generates regular and stable returns. Stability, rather than quick and high returns, is usually the priority for a typical MIP investor.
The equity exposure in the portfolio during a bear market phase helps in minimizing risk because of limited downside seen during bad times and also aims to generate above average returns in a good equity market phase. Therefore, the equity component provides MIPs with just the edge it needs to outperform conventional debt funds.
Investor Profile
Investors who are conservative in their investment approach but still want to earn marginally better returns than a debt-only portfolio then MIP is definitely a fund category to be considered.
Portfolio Analysis and Strategy
Debt Portfolio Analysis
Emphasis is more on accrual-based returns than on active trading. MIP portfolio reflects an optimum blend of both fixed and floating rate instruments comprising of Certificate of Deposits to take care of liquidity needs and plain vanilla bond specially to take care of yield enhancement, Government Securities enhance the credit quality and shall enable in benefiting from the bond market play.
Equity Portfolio Analysis
Though investment into equity and equity linked securities forms a minor part (maximum 20%) of the portfolio, right timing and selection of stocks has been able to generate the alpha returns, thus resulting in the growth of capital.
From January 2008 till date, financial markets have witnessed its peak of volatility due to various global and domestic factors. Both, Nifty and Sensex has seen its highs and lows. During this period, the equity exposure in Reliance MIP has been roughly between 10%-20%, depending upon the market opportunities.
During the above mentioned period, the fund had taken equity exposure across all market caps in various sectors like Banking, Auto, Finance, Petroleum Products, Software etc.
However, the entry and exit to and from particular stock or sector has been done according tothe market timing and opportunities in a particular sector/company.
Fund Strategy
Reliance Monthly Income Fund seeks to generate moderate level of returns for its investors by taking advantage of almost every opportunity available in the fixed income market space.
An active duration management strategy is followed along with a close monitoring of the portfolio on a regular basis. The fund is suitable for investors with 1.5 – 3 years investment horizon and a low to moderate appetite for risk.
We will have a bottom up approach of stock selection in our equity portfolio consisting of a mix of mid cap and large cap stocks. The equity investment philosophy will tend to be more aggressive with the idea of generating an alpha to the portfolio.
1] Point to Point ReturnsNAV Performance report as on 31/10/2009
Compound Annualized
1 Year 3 Years 5 Years Since Inception
Reliance MIP - Growth 33.88 12.58 13.42 11.96
Crisil MIP Blended Index 18.84 7.35 8.52 6.92
*Past Performance may or may not be sustained in the future.
Compounded annualized returns of Growth Option. (Inception Date: 13th Jan 2004)
Calculations assume that all payouts during the period have been reinvested in the units of the
scheme at the then prevailing NAV.
2] Quartile Analysis
Quartile Analysis of the "Hybrid Monthly Income" which consists of 39 MIP schemes was done for
the 1 month, 6 month, 1 year, 3 year and 5 year period as on 12.11.09. The peer group consists’ of 39 schemes uptil 6 months time period 37 schemes uptil 3 year tenure and 36 schemes for 5 year tenure.RMIP has found a place in 1st quartile across all the above mentioned tenors. Reliance MIP has also been rated as a Five Star Fund by Value Research Online. Source: www.valueresearchonline.com
Product Features
Investment Objective:
The primary investment objective of the Scheme is to generate regular income in order to make regular dividend payments to unit holders and the secondary objective is growth of capital.
Choice of Plans/Option
Growth Plan
Dividend Plan
Monthly Dividend Plan (Payout & Reinvestment)
Quarterly Dividend Plan (Payout & Reinvestment
Minimum Application Amount
For Resident and Non Resident Investors
In Monthly Dividend Plan: 25,000 *
In Quarterly Dividend Plan: Rs. 10,000*
In Growth Plan: Rs.10,000 *
*Any purchases thereafter can be made in multiples of Re.1. The minimum amount is specified
above.
Portfolio Features as on 31.10.09
Weighted Average Maturity: 2.21 years
Weighted Average Yield: 5.40 % p.a
Scheme Details
Date of Inception: 13th Jan 2004
Fund Size : Rs.1414.48 crore (as on 31.10.09)
Load Structure
Entry Load: Nil
In terms of SEBI circular no. SEBI/IMD/CIR No.4/ 168230/09 dated June 30, 2009, no entry load will be charged by the Scheme to the investor effective August 1, 2009. Upfront commission shall be paid directly by the investor to the AMFI registered Distributors based on the investors' assessment of various factors including the service rendered by the distributor
Exit load: 1% if the units are redeemed/switched out on or before completion of 1year from the date of allotment of units. There shall be no exit load after completion 1year from the date of allotment of units.
Source: Reliance Mutual Fund
Wednesday, November 18, 2009
Can NRIs Invest in India?
Investments by NRI’s in Mutual Funds can be made on a repatriable or on a non-repatriable basis, as preferred by the investor
Repatriable Basis
To invest on a repatriable basis, you must have an NRE or FCNR Bank Account in India. The Reserve Bank of India (RBI) has granted a general permission to Mutual
Funds to offer mutual fund schemes on repatriation basis, subject to the following conditions:
1.The mutual fund should comply with the terms and conditions stipulated by SEBI.
2.The amount representing investment should be received by inward remittance through normal banking channels, or by debit to an NRE / FCNR account of the non-resident investor.
3.The net amount representing the dividend / interest and maturity proceeds of units may be remitted through normal banking channels or credited to NRE / FCNR account of the investor, as desired by him subject to payment of applicable tax.
Non-Repatriable Basis
The Reserve Bank of India (RBI) has granted a general permission to Mutual Funds to offer mutual fund schemes on non-repatriation basis, subject to the following conditions:
1.Funds for investment should be provided by debit to NRO account of the NRI investor. Alternatively, funds may be invested by inward remittance or by debit to NRE / FCNR Account.
2.The current income in the form of dividends is allowed to be repatriated.
No permission of Reserve Bank either by the Mutual Fund or the NRI investor is necessary.
Which schemes of Mutual Fund can NRI does invest in?
NRI’s can invest in all schemes of AMC Mutual Fund. In particular, the funds contained herein have not been and will not be registered under the United States Securities Act of 1933 (the "Securities Act") or under the securities laws of any state and the funds have not been and will not be registered under the Investment Company Act of 1940 (the "Investment Company Act").
Units in the funds may not be offered or sold within the United States or to United States Persons, except in a transaction not subject to, or pursuant to an exemption from, the registration requirements of the Securities Act and any applicable state securities laws and which would not require the funds to register under the Investment Company Act. The term "United States Person" shall have the meaning ascribed to such term in Regulations under the Securities Act.
Does an NRI need any approvals from the Reserve Bank of India to invest in mutual fund schemes?
No. As an NRI one does not need any specific approval from the RBI for investing or redeeming from Mutual Funds. Only OCBs and FIIs require prior approvals before investing in Mutual Funds.
Repatriable Basis
To invest on a repatriable basis, you must have an NRE or FCNR Bank Account in India. The Reserve Bank of India (RBI) has granted a general permission to Mutual
Funds to offer mutual fund schemes on repatriation basis, subject to the following conditions:
1.The mutual fund should comply with the terms and conditions stipulated by SEBI.
2.The amount representing investment should be received by inward remittance through normal banking channels, or by debit to an NRE / FCNR account of the non-resident investor.
3.The net amount representing the dividend / interest and maturity proceeds of units may be remitted through normal banking channels or credited to NRE / FCNR account of the investor, as desired by him subject to payment of applicable tax.
Non-Repatriable Basis
The Reserve Bank of India (RBI) has granted a general permission to Mutual Funds to offer mutual fund schemes on non-repatriation basis, subject to the following conditions:
1.Funds for investment should be provided by debit to NRO account of the NRI investor. Alternatively, funds may be invested by inward remittance or by debit to NRE / FCNR Account.
2.The current income in the form of dividends is allowed to be repatriated.
No permission of Reserve Bank either by the Mutual Fund or the NRI investor is necessary.
Which schemes of Mutual Fund can NRI does invest in?
NRI’s can invest in all schemes of AMC Mutual Fund. In particular, the funds contained herein have not been and will not be registered under the United States Securities Act of 1933 (the "Securities Act") or under the securities laws of any state and the funds have not been and will not be registered under the Investment Company Act of 1940 (the "Investment Company Act").
Units in the funds may not be offered or sold within the United States or to United States Persons, except in a transaction not subject to, or pursuant to an exemption from, the registration requirements of the Securities Act and any applicable state securities laws and which would not require the funds to register under the Investment Company Act. The term "United States Person" shall have the meaning ascribed to such term in Regulations under the Securities Act.
Does an NRI need any approvals from the Reserve Bank of India to invest in mutual fund schemes?
No. As an NRI one does not need any specific approval from the RBI for investing or redeeming from Mutual Funds. Only OCBs and FIIs require prior approvals before investing in Mutual Funds.
Glossary - CBLO/CBO/CDO/CMO
What Does Collateralized Borrowing And Lending Obligation - CBLO Mean?
A money market instrument that represents an obligation between a borrower and a lender as to the terms and conditions of the loan. Collateralized borrowing and lending obligations (CBLOs) are used by those who have been phased out of or heavily restricted in the interbank call money market. Collateralized Borrowing and Lending Obligation (CBLO)", a money market instrument as approved by RBI, is for the benefit of the entities who have either been phased out from inter bank call money market or have been given restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market. CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety Days.
What Does Collateralized Bond Obligation - CBO Mean?
An investment-grade bond backed by a pool of junk bonds. Junk bonds are typically not investment grade, but because they pool several types of credit quality bonds together, they offer enough diversification to be "investment grade."
What Does Collateralized Debt Obligation - CDO Mean?
An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds.
What Does Collateralized Mortgage Obligation - CMO Mean?
A type of mortgage-backed security that creates separate pools of pass-through rates for different classes of bondholders with varying maturities, called trenches. The repayments from the pool of pass-through securities are used to retire the bonds in the order specified by the bonds' prospectus.
A money market instrument that represents an obligation between a borrower and a lender as to the terms and conditions of the loan. Collateralized borrowing and lending obligations (CBLOs) are used by those who have been phased out of or heavily restricted in the interbank call money market. Collateralized Borrowing and Lending Obligation (CBLO)", a money market instrument as approved by RBI, is for the benefit of the entities who have either been phased out from inter bank call money market or have been given restricted participation in terms of ceiling on call borrowing and lending transactions and who do not have access to the call money market. CBLO is a discounted instrument available in electronic book entry form for the maturity period ranging from one day to ninety Days.
What Does Collateralized Bond Obligation - CBO Mean?
An investment-grade bond backed by a pool of junk bonds. Junk bonds are typically not investment grade, but because they pool several types of credit quality bonds together, they offer enough diversification to be "investment grade."
What Does Collateralized Debt Obligation - CDO Mean?
An investment-grade security backed by a pool of bonds, loans and other assets. CDOs do not specialize in one type of debt but are often non-mortgage loans or bonds.
What Does Collateralized Mortgage Obligation - CMO Mean?
A type of mortgage-backed security that creates separate pools of pass-through rates for different classes of bondholders with varying maturities, called trenches. The repayments from the pool of pass-through securities are used to retire the bonds in the order specified by the bonds' prospectus.
All you need to know about ETFs
Thanks to the launch of a number of gold ETFs (exchange traded funds) in the recent past, ETFs as investment avenues have gained a fair bit of popularity as well. Increasingly, ETFs are finding themselves on the investor’s ‘to invest’ list. Having said that, ETFs still have a lot of catching up to do, before they can compete with conventional mutual funds, in terms of popularity among investors. One of the primary reasons for this is lack of knowledge and objective understanding about ETFs among investors. In this article, we present a primer on ETFs and discuss their investment proposition.
What are ETFs?
ETFs are a basket of securities that are listed and traded on a recognized stock exchange. Simply put, they are mutual funds, whose units can be bought and sold on the stock exchange. ETFs can be either passively managed or actively managed.
A passively managed ETF attempts to replicate the performance of its underlying benchmark index (like the S&P CNX Nifty, for instance). It invests in the same stocks as the index and in the same weightage as well. The intention is to track the index as closely as possible (i.e. with least deviation).
On the contrary, an actively managed ETF can freely invest in stocks/securities, within the guidelines laid down by its investment mandate. In other words, the fund has no obligation to invest in the same stocks/securities as its benchmark index. The intention is to outperform the benchmark index.
However, it must be noted that the defining feature of ETFs is not whether they are passively or actively managed, but that they are traded on the stock exchange.
ETFs in India
ETFs first made their presence felt in India in the year 1994 with the launch of Morgan Stanley Growth Fund, a close-ended, actively managed, diversified equity fund. However, the dismal track record of the fund combined with a price history that was trading perpetually at discount to the NAV, gave investors the wrong signal as far as ETFs were concerned. Investors began perceiving ETFs as poorly managed and felt short-changed when they sold their units at a steep discount to the NAV.
Things changed after the launch of Nifty Benchmark Exchange Traded Scheme-Nifty BeES (launched in December 2001), an open-ended, passively managed fund. It would be fair to say that the fund set the records straight for ETFs in the country. Since then, the ETF segment has grown slowly but steadily. Recently, the launch of gold ETFs has provided the much needed zing to the segment, thus attracting many investors.
ETFs at present have a fair variety to offer. For example, among others, there are ETFs like Quantum Index Fund and ICICI SPIcE Fund that track broad indices such as the S&P CNX Nifty and the BSE Sensex respectively. Then there is Bank BeES (from Benchmark Mutual Fund), an ETF that tracks CNX Bank Index. On the debt side, there is Liquid BeES that invests in a basket of call money, short-term government securities and money market instruments. And there are several gold ETFs to choose from. Going forward, investors can only expect the bouquet of ETF offerings to grow.
Advantages of ETFs
1. ETFs tend to be more cost-effective vis-à-vis comparable mutual funds. For instance, while the expense ratio of a passively managed ETF (tracking a benchmark index) would normally be in the range of 0.50%-1.00%; for an index fund, it can be as high as 1.50%.
2. Another important advantage with ETFs is that they provide more flexibility to investors than regular mutual funds. Since they are traded on the stock exchange, they are available to investors any time during the trading hours. So investors can buy and sell units of an ETF on a real time basis, unlike regular mutual funds, which can be transacted only at end-of-day NAV.
3. Since ETFs witness most of the buying/selling on the exchange, the interests of the long-term investor are not compromised. Take a regular equity fund where units are bought and sold at the AMCs end – when a significant amount of money enters and exits the fund rather quickly, the long-term investor could suffer as a result of the costs (trading costs, registrar costs and opportunity loss, if the fund manager is forced to sell his best stocks) associated with this quick inflow/outflow.
With an ETF, since the trading investor does not approach the AMC at all and only interacts with other investors over the exchange; his quick entry/exit does not compromise the interests of the long-term investor.
Disadvantages of ETF
1. Investors need to have a demat and a trading account, with a SEBI registered stockbroker, for investing in ETFs. For investors, who do not trade in stocks, this could be a bit of a deterrent. Also, maintaining a demat account entails paying annual fees (approximately Rs 500); however the same varies across stockbrokers. For investors, who invest in stocks, this will not pinch as the maintenance charge of the demat account will be spread across the stock and ETF investments.
2. While investors have to incur entry/exit loads at the time of making/redeeming investments in mutual funds, for ETFs they have to pay a brokerage (usually around 0.50%) to the stockbroker, along with other applicable charges (STT for instance), every time ETF units are bought or sold. For a trader who frequently trades, this can have a significant impact on the net returns. But for long-term investors, these expenses hold little relevance.
What investors must do
It is evident that ETFs offer a different investment proposition vis-à-vis conventional mutual funds. ETFs may appeal to investors who want to track the performance of a particular benchmark index (such as S&P CNX Nifty or BSE Sensex); similarly, the ETF route can also appeal to investors who are desirous of investing in asset classes such as gold. The allure of ETFs will only grow given the expanding bouquet of offerings.
Investors on their part would do well to thoroughly understand the pros and cons of ETFs; this will help them make informed investment decisions. Also, investors must consult their investment advisors/financial planners to determine the suitability of an ETF in their investment portfolios.
What are ETFs?
ETFs are a basket of securities that are listed and traded on a recognized stock exchange. Simply put, they are mutual funds, whose units can be bought and sold on the stock exchange. ETFs can be either passively managed or actively managed.
A passively managed ETF attempts to replicate the performance of its underlying benchmark index (like the S&P CNX Nifty, for instance). It invests in the same stocks as the index and in the same weightage as well. The intention is to track the index as closely as possible (i.e. with least deviation).
On the contrary, an actively managed ETF can freely invest in stocks/securities, within the guidelines laid down by its investment mandate. In other words, the fund has no obligation to invest in the same stocks/securities as its benchmark index. The intention is to outperform the benchmark index.
However, it must be noted that the defining feature of ETFs is not whether they are passively or actively managed, but that they are traded on the stock exchange.
ETFs in India
ETFs first made their presence felt in India in the year 1994 with the launch of Morgan Stanley Growth Fund, a close-ended, actively managed, diversified equity fund. However, the dismal track record of the fund combined with a price history that was trading perpetually at discount to the NAV, gave investors the wrong signal as far as ETFs were concerned. Investors began perceiving ETFs as poorly managed and felt short-changed when they sold their units at a steep discount to the NAV.
Things changed after the launch of Nifty Benchmark Exchange Traded Scheme-Nifty BeES (launched in December 2001), an open-ended, passively managed fund. It would be fair to say that the fund set the records straight for ETFs in the country. Since then, the ETF segment has grown slowly but steadily. Recently, the launch of gold ETFs has provided the much needed zing to the segment, thus attracting many investors.
ETFs at present have a fair variety to offer. For example, among others, there are ETFs like Quantum Index Fund and ICICI SPIcE Fund that track broad indices such as the S&P CNX Nifty and the BSE Sensex respectively. Then there is Bank BeES (from Benchmark Mutual Fund), an ETF that tracks CNX Bank Index. On the debt side, there is Liquid BeES that invests in a basket of call money, short-term government securities and money market instruments. And there are several gold ETFs to choose from. Going forward, investors can only expect the bouquet of ETF offerings to grow.
Advantages of ETFs
1. ETFs tend to be more cost-effective vis-à-vis comparable mutual funds. For instance, while the expense ratio of a passively managed ETF (tracking a benchmark index) would normally be in the range of 0.50%-1.00%; for an index fund, it can be as high as 1.50%.
2. Another important advantage with ETFs is that they provide more flexibility to investors than regular mutual funds. Since they are traded on the stock exchange, they are available to investors any time during the trading hours. So investors can buy and sell units of an ETF on a real time basis, unlike regular mutual funds, which can be transacted only at end-of-day NAV.
3. Since ETFs witness most of the buying/selling on the exchange, the interests of the long-term investor are not compromised. Take a regular equity fund where units are bought and sold at the AMCs end – when a significant amount of money enters and exits the fund rather quickly, the long-term investor could suffer as a result of the costs (trading costs, registrar costs and opportunity loss, if the fund manager is forced to sell his best stocks) associated with this quick inflow/outflow.
With an ETF, since the trading investor does not approach the AMC at all and only interacts with other investors over the exchange; his quick entry/exit does not compromise the interests of the long-term investor.
Disadvantages of ETF
1. Investors need to have a demat and a trading account, with a SEBI registered stockbroker, for investing in ETFs. For investors, who do not trade in stocks, this could be a bit of a deterrent. Also, maintaining a demat account entails paying annual fees (approximately Rs 500); however the same varies across stockbrokers. For investors, who invest in stocks, this will not pinch as the maintenance charge of the demat account will be spread across the stock and ETF investments.
2. While investors have to incur entry/exit loads at the time of making/redeeming investments in mutual funds, for ETFs they have to pay a brokerage (usually around 0.50%) to the stockbroker, along with other applicable charges (STT for instance), every time ETF units are bought or sold. For a trader who frequently trades, this can have a significant impact on the net returns. But for long-term investors, these expenses hold little relevance.
What investors must do
It is evident that ETFs offer a different investment proposition vis-à-vis conventional mutual funds. ETFs may appeal to investors who want to track the performance of a particular benchmark index (such as S&P CNX Nifty or BSE Sensex); similarly, the ETF route can also appeal to investors who are desirous of investing in asset classes such as gold. The allure of ETFs will only grow given the expanding bouquet of offerings.
Investors on their part would do well to thoroughly understand the pros and cons of ETFs; this will help them make informed investment decisions. Also, investors must consult their investment advisors/financial planners to determine the suitability of an ETF in their investment portfolios.
Pass-Through Certificates - A Primer
What are Pass Through Certificates (PTCs)?
They are high quality debt instruments that represent ownership in a pool of assets and derive monthly principal and interest payments from those assets. PTCs are nothing but securitization (part of structured finance), which has evolved over the past few decades, across the globe. Securitization in India largely adopts a trust structure and the underlying assets are transferred through a sale to the trustee company (special purpose vehicle/SPV).The SPV issues PTCs and investors in PTCs are entitled to a beneficial interest in the underlying assets held by the trustee.
What is Securitization?
Simply put, securitization transforms illiquid assets into liquid assets, thereby expanding the investment universe and typically has the following characteristics –
• Pooling of assets such as receivables from auto/student/equipment/house loans, credit cards, trade,leases..etc . An asset-backed security (ABS) can be created on the basis of many forms of receivables -music royalties, movie revenues,mutual fund fees, and tobacco settlement fees…etc. Housing loan backed securities are known as Residential Mortgage Backed Securities (RMBS).
• The monthly payments from the underlying assets would consist of principal and interest. Cash flows can be directly given to the investors as per pre-determined rules (pass-through structured security).
• Insulating the investors from the credit risk of the originating financial institution, through the creation of a special purpose vehicle. In other words, possibility of a higher credit rating than the originator.
• Because rating is based on the cash flows (principal/monthly interest) and not on the originators’ credit worthiness, one can cherry-pick and create a higher quality asset pool.
What is the size of securitization market and the key trends in India ?
Securitization is estimated to account for around 43% of the global debt issuance ($6.63 trillion) in the year 2007. US accounts for over 74% of the global securitization transactions, Europe contributing 23% while the rest is contributed by Australia and Asia. In India, the structured finance market consists mainly of retail asset securitization (mainly ABS) along with securitization of single corporate loans (CDOs) – ABS accounted for 53% of market volumes in 2007 and the latter accounted for 43%.The Indian securitization market size was at around Rs.550billion in 2007(Rs.215 billion in 2006).
What are the advantages to the originator?
The key advantages are –
• Monetization: Helps in monetizing intangible and illiquid assets into cash.
• Financial health: Depending on the accounting practices and the structure, securitisation can help
improve the debt-equity ratio of the firm.
• Asset-Liability Management: Given the flexibility in structuring and timing cash flows to each tranche, one can match the tenure of the liabilities and assets.
What are the risks inherent in PTCs ?
The key risks are –
• Interest Rate Risk : Like all fixed income securities, the prices of fixed rate PTCs move in response to changes in interest rates. Also interest rate changes may affect the prepayment rates, impacting yields.
• Default Risk : Default risk is the borrowers’ inability to meet interest payment obligations on time and the credit rating reflects a particular security’s default risk. However, given that we invest mostly in investment grade, this is minimized.
How do the ratings of these securities differ ?
CRISIL uses "SO" to indicate a structured obligation [AAA (SO)] and defines investment grade as AAA
(SO) to BBB (SO).Ratings of these PTCs are mainly based on credit enhancement/structured payment mechanisms, which enable a higher rating than the issuer’s stand-alone rating.The credit enhancements could be in different forms –
• Cash Collateral : Cash deposited by the originator in an account operated by the Trustee and any
short fall in collections can be met by drawing from this account.
• Corporate Undertaking : Similar to CC and short falls are met by invoking the undertaking.This
reduces cost of carry to originator.
• Apart from these two, we also have over collateral (subordinate) and excess interest spread
Do the investment and risk management process differ in the case of securitized
debt ?
The overall investment philosophy remains the same i.e., to minimize both liquidity and credit risk.We look to arrive at a general maturity/duration range for a fund’s portfolio in line with its objective and based on our interest rate outlook.The shifts within this range are then determined by short-term cyclical trends in the economy.The team looks to manage interest rate risk across different asset class and duration buckets, in order to optimize risk-adjusted returns. All the investment options are thoroughly analyzed to ensure that credit risk is kept at the minimum level. In case of securitized debt,we adopt the same rigorous investment processes and look to diversify the PTC exposure for ABS across different asset classes.We look at factors such as – historical performances of similar pools and credit collateral utilization. Pool performance indicators include ageing profiles, collection efficiency ratios and delinquency levels.
What is the nature of FT’s exposure to securitized debt at this stage?
Majority of our securitized debt exposure is currently towards single loan PTCs and the PTC exposure in ABS is towards auto pools. In the case of single loan PTCs, our investment universe is same as that considered for our corporate bond investments and in that sense, our investments are only in those companies that have been vetted using our investment process. In the case of short term funds,we have adopted a step up maturity strategy to ensure that liquidity requirements can be met in all types of market conditions.
What is the impact of the changes in macro economic conditions and rising interest
rates on PTCs (ABS)?
Typically in a rising interest rate scenario, the delinquency rates are bound to increase and we have seen this impact pools of recent vintage. Rating agencies factor this in their rating process by proactively seeking credit enhancements and ensuring adequate coverage levels.The below table clearly indicates that majority
of the pools have witnessed credit collateral utilization of less than 30%.
They are high quality debt instruments that represent ownership in a pool of assets and derive monthly principal and interest payments from those assets. PTCs are nothing but securitization (part of structured finance), which has evolved over the past few decades, across the globe. Securitization in India largely adopts a trust structure and the underlying assets are transferred through a sale to the trustee company (special purpose vehicle/SPV).The SPV issues PTCs and investors in PTCs are entitled to a beneficial interest in the underlying assets held by the trustee.
What is Securitization?
Simply put, securitization transforms illiquid assets into liquid assets, thereby expanding the investment universe and typically has the following characteristics –
• Pooling of assets such as receivables from auto/student/equipment/house loans, credit cards, trade,leases..etc . An asset-backed security (ABS) can be created on the basis of many forms of receivables -music royalties, movie revenues,mutual fund fees, and tobacco settlement fees…etc. Housing loan backed securities are known as Residential Mortgage Backed Securities (RMBS).
• The monthly payments from the underlying assets would consist of principal and interest. Cash flows can be directly given to the investors as per pre-determined rules (pass-through structured security).
• Insulating the investors from the credit risk of the originating financial institution, through the creation of a special purpose vehicle. In other words, possibility of a higher credit rating than the originator.
• Because rating is based on the cash flows (principal/monthly interest) and not on the originators’ credit worthiness, one can cherry-pick and create a higher quality asset pool.
What is the size of securitization market and the key trends in India ?
Securitization is estimated to account for around 43% of the global debt issuance ($6.63 trillion) in the year 2007. US accounts for over 74% of the global securitization transactions, Europe contributing 23% while the rest is contributed by Australia and Asia. In India, the structured finance market consists mainly of retail asset securitization (mainly ABS) along with securitization of single corporate loans (CDOs) – ABS accounted for 53% of market volumes in 2007 and the latter accounted for 43%.The Indian securitization market size was at around Rs.550billion in 2007(Rs.215 billion in 2006).
What are the advantages to the originator?
The key advantages are –
• Monetization: Helps in monetizing intangible and illiquid assets into cash.
• Financial health: Depending on the accounting practices and the structure, securitisation can help
improve the debt-equity ratio of the firm.
• Asset-Liability Management: Given the flexibility in structuring and timing cash flows to each tranche, one can match the tenure of the liabilities and assets.
What are the risks inherent in PTCs ?
The key risks are –
• Interest Rate Risk : Like all fixed income securities, the prices of fixed rate PTCs move in response to changes in interest rates. Also interest rate changes may affect the prepayment rates, impacting yields.
• Default Risk : Default risk is the borrowers’ inability to meet interest payment obligations on time and the credit rating reflects a particular security’s default risk. However, given that we invest mostly in investment grade, this is minimized.
How do the ratings of these securities differ ?
CRISIL uses "SO" to indicate a structured obligation [AAA (SO)] and defines investment grade as AAA
(SO) to BBB (SO).Ratings of these PTCs are mainly based on credit enhancement/structured payment mechanisms, which enable a higher rating than the issuer’s stand-alone rating.The credit enhancements could be in different forms –
• Cash Collateral : Cash deposited by the originator in an account operated by the Trustee and any
short fall in collections can be met by drawing from this account.
• Corporate Undertaking : Similar to CC and short falls are met by invoking the undertaking.This
reduces cost of carry to originator.
• Apart from these two, we also have over collateral (subordinate) and excess interest spread
Do the investment and risk management process differ in the case of securitized
debt ?
The overall investment philosophy remains the same i.e., to minimize both liquidity and credit risk.We look to arrive at a general maturity/duration range for a fund’s portfolio in line with its objective and based on our interest rate outlook.The shifts within this range are then determined by short-term cyclical trends in the economy.The team looks to manage interest rate risk across different asset class and duration buckets, in order to optimize risk-adjusted returns. All the investment options are thoroughly analyzed to ensure that credit risk is kept at the minimum level. In case of securitized debt,we adopt the same rigorous investment processes and look to diversify the PTC exposure for ABS across different asset classes.We look at factors such as – historical performances of similar pools and credit collateral utilization. Pool performance indicators include ageing profiles, collection efficiency ratios and delinquency levels.
What is the nature of FT’s exposure to securitized debt at this stage?
Majority of our securitized debt exposure is currently towards single loan PTCs and the PTC exposure in ABS is towards auto pools. In the case of single loan PTCs, our investment universe is same as that considered for our corporate bond investments and in that sense, our investments are only in those companies that have been vetted using our investment process. In the case of short term funds,we have adopted a step up maturity strategy to ensure that liquidity requirements can be met in all types of market conditions.
What is the impact of the changes in macro economic conditions and rising interest
rates on PTCs (ABS)?
Typically in a rising interest rate scenario, the delinquency rates are bound to increase and we have seen this impact pools of recent vintage. Rating agencies factor this in their rating process by proactively seeking credit enhancements and ensuring adequate coverage levels.The below table clearly indicates that majority
of the pools have witnessed credit collateral utilization of less than 30%.
Gilt Funds
Over the last few years, when equity markets were on an ascent, equity funds were favorites with investors. On the other hand, debt funds were considered unnecessary as they dragged down the portfolio’s performance. Even risk averse investors didn’t want to miss the boat by being invested in debt instruments. However, the investment scenario has now changed radically. Investors are increasingly shunning equity funds in favor of debt funds.
Within the debt funds segment, there’s a lot of buzz around gilt funds at the moment. Newspapers and magazines are carrying articles eulogizing their performance. Fund houses and investment advisors are busy promoting the cause of gilt funds. Clearly, gilt funds have emerged as the season’s flavor.
What are gilt funds?
Simply put, gilt funds are mutual funds that predominantly invest in government securities (G-Secs). Unlike conventional debt funds that invest in debt instruments across the board, gilt funds target just a given category of debt instruments i.e. G-Secs. The latter are securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India. Being sovereign paper, they do not expose investors to credit risk. Since the market for G-Secs (as is the case with most debt instruments) is largely dominated by institutional investors, gilt funds offer retail investors a convenient means to invest in G-Secs. Depending on their investment horizon, investors can choose between short-term and long-term gilt funds.
Why are gilt funds in the news?
First, let’s understand the relationship between bond prices and the interest rates. The two are inversely related. Hence a fall in interest rates, leads to a rise in bond prices. In recent times, the RBI has undertaken a series of rate cuts to infuse liquidity into the system. The falling interest rates have translated into an appreciation in prices of long-term bonds and G-Secs alike. Expectedly, funds that are invested in such securities have benefited.
Are gilt funds really risk free?
Increasingly, gilt funds are being promoted by fund houses and investment advisors, by emphasizing on their risk free nature. That isn’t entirely correct. We have already discussed how the underlying instruments i.e. G-Secs do not expose investors to any credit risk. However, that doesn’t make gilt funds, risk free investment avenues in the conventional sense. Unlike small savings schemes wherein investors enjoy both safety of capital and assured returns, gilt funds are not equipped to offer assured returns.
For instance, investments in gilt funds are vulnerable to interest rate risks. When interest rates rise, prices of government securities fall; this in turn has an adverse impact on the performance of gilt funds. Typically, higher the fund’s average maturity, more it is prone to volatility. In the table above, several funds have languished in negative territory over the 1-Mth period.
A security is termed as liquid, if it can be easily bought and sold. It can be broadly stated that higher the liquidity, lower is the risk. A gilt fund can be invested in a G-Sec paper which isn’t actively traded i.e. it is illiquid. Now consider a scenario wherein to meet redemption pressure, the fund manager is forced to make a distress sale i.e. incur a loss. This in turn will adversely affect the fund’s performance.
When should one invest in gilt funds?
Investors would do well to keep an eye on indicators that can be precursors to a fall in interest rates. A slowdown in GDP growth, rising inflation, a decline in IIP (Index of Industrial Production) and expectations of a fall in corporate earnings, to name a few. Broadly speaking, a situation when interest rates have peaked and a downturn seems imminent would be an opportune time to invest in gilt funds. Of course, investors must understand that to make the most of their gilt fund investments, being invested for the long haul (to cover an interest rate cycle) is important.
Within the debt funds segment, there’s a lot of buzz around gilt funds at the moment. Newspapers and magazines are carrying articles eulogizing their performance. Fund houses and investment advisors are busy promoting the cause of gilt funds. Clearly, gilt funds have emerged as the season’s flavor.
What are gilt funds?
Simply put, gilt funds are mutual funds that predominantly invest in government securities (G-Secs). Unlike conventional debt funds that invest in debt instruments across the board, gilt funds target just a given category of debt instruments i.e. G-Secs. The latter are securities issued by the Reserve Bank of India (RBI) on behalf of the Government of India. Being sovereign paper, they do not expose investors to credit risk. Since the market for G-Secs (as is the case with most debt instruments) is largely dominated by institutional investors, gilt funds offer retail investors a convenient means to invest in G-Secs. Depending on their investment horizon, investors can choose between short-term and long-term gilt funds.
Why are gilt funds in the news?
First, let’s understand the relationship between bond prices and the interest rates. The two are inversely related. Hence a fall in interest rates, leads to a rise in bond prices. In recent times, the RBI has undertaken a series of rate cuts to infuse liquidity into the system. The falling interest rates have translated into an appreciation in prices of long-term bonds and G-Secs alike. Expectedly, funds that are invested in such securities have benefited.
Are gilt funds really risk free?
Increasingly, gilt funds are being promoted by fund houses and investment advisors, by emphasizing on their risk free nature. That isn’t entirely correct. We have already discussed how the underlying instruments i.e. G-Secs do not expose investors to any credit risk. However, that doesn’t make gilt funds, risk free investment avenues in the conventional sense. Unlike small savings schemes wherein investors enjoy both safety of capital and assured returns, gilt funds are not equipped to offer assured returns.
For instance, investments in gilt funds are vulnerable to interest rate risks. When interest rates rise, prices of government securities fall; this in turn has an adverse impact on the performance of gilt funds. Typically, higher the fund’s average maturity, more it is prone to volatility. In the table above, several funds have languished in negative territory over the 1-Mth period.
A security is termed as liquid, if it can be easily bought and sold. It can be broadly stated that higher the liquidity, lower is the risk. A gilt fund can be invested in a G-Sec paper which isn’t actively traded i.e. it is illiquid. Now consider a scenario wherein to meet redemption pressure, the fund manager is forced to make a distress sale i.e. incur a loss. This in turn will adversely affect the fund’s performance.
When should one invest in gilt funds?
Investors would do well to keep an eye on indicators that can be precursors to a fall in interest rates. A slowdown in GDP growth, rising inflation, a decline in IIP (Index of Industrial Production) and expectations of a fall in corporate earnings, to name a few. Broadly speaking, a situation when interest rates have peaked and a downturn seems imminent would be an opportune time to invest in gilt funds. Of course, investors must understand that to make the most of their gilt fund investments, being invested for the long haul (to cover an interest rate cycle) is important.
Beta
Beta is a measure of a stock's volatility in relation to the market. By definition, the market has a beta of 1.0, and individual stocks are ranked according to how much they deviate from the market. A stock that swings more than the market over time has a beta above 1.0. If a stock moves less than the market, the stock's beta is less than 1.0. High-beta stocks are supposed to be riskier but provide a potential for higher returns; low-beta stocks pose less risk but also lower returns.
Beta is a statistical term. It measures the volatility of a stock (or fund) relative to the market (or the benchmark). The value of beta of a stock or fund is always stated against its benchmark, which is always equal to 1.
The measure of an asset's risk in relation to the market (for example, the S&P500) or to an alternative benchmark or factors. Roughly speaking, a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [More precisely, that stock's excess return (over and above a short-term money market rate) is expected to move 1.5 times the market excess return).] According to asset pricing theory, beta represents the type of risk, systematic risk that cannot be diversified away. When using beta, there are a number of issues that you need to be aware of:
(1) Betas may change through time;
(2) Betas may be different depending on the direction of the market (i.e. betas may be greater for down moves in the market rather than up moves);
(3) Estimated beta will be biased if the security does not frequently trade;
(4) Beta is not necessarily a complete measure of risk (you may need multiple betas).
Also, note that the beta is a measure of co movement, not volatility. It is possible for a security to have a zero beta and higher volatility than the market.
If a stock is benchmarked against Sensex and has a beta value, that is, greater than 1 (say 1.5), this indicates that the stock is 50 per cent more volatile than the market as the beta of the Sensex is 1. The stated stock will deliver 15 per cent return if the market has delivered a 10 per cent return in the same period. This implies in a falling market too. If the Sensex delivers 10 per cent negative returns, then the stated stock will fall by 15 per cent in the same period. A beta of less than 1 implies lesser volatility.
The desirable value of beta depends upon the individual risk-bearing capacity. So, while you can expect a high return from a stock that has a beta of 2, you will have to expect it to drop much more when the market falls.
It's important for investors to make the distinction between short-term risk--where beta and price volatility are useful--and longer-term, fundamental risk, where big-picture risk factors are more telling. High betas may mean price volatility over the near term, but they don't always rule out long-term opportunities
Beta is a statistical term. It measures the volatility of a stock (or fund) relative to the market (or the benchmark). The value of beta of a stock or fund is always stated against its benchmark, which is always equal to 1.
The measure of an asset's risk in relation to the market (for example, the S&P500) or to an alternative benchmark or factors. Roughly speaking, a security with a beta of 1.5, will have move, on average, 1.5 times the market return. [More precisely, that stock's excess return (over and above a short-term money market rate) is expected to move 1.5 times the market excess return).] According to asset pricing theory, beta represents the type of risk, systematic risk that cannot be diversified away. When using beta, there are a number of issues that you need to be aware of:
(1) Betas may change through time;
(2) Betas may be different depending on the direction of the market (i.e. betas may be greater for down moves in the market rather than up moves);
(3) Estimated beta will be biased if the security does not frequently trade;
(4) Beta is not necessarily a complete measure of risk (you may need multiple betas).
Also, note that the beta is a measure of co movement, not volatility. It is possible for a security to have a zero beta and higher volatility than the market.
If a stock is benchmarked against Sensex and has a beta value, that is, greater than 1 (say 1.5), this indicates that the stock is 50 per cent more volatile than the market as the beta of the Sensex is 1. The stated stock will deliver 15 per cent return if the market has delivered a 10 per cent return in the same period. This implies in a falling market too. If the Sensex delivers 10 per cent negative returns, then the stated stock will fall by 15 per cent in the same period. A beta of less than 1 implies lesser volatility.
The desirable value of beta depends upon the individual risk-bearing capacity. So, while you can expect a high return from a stock that has a beta of 2, you will have to expect it to drop much more when the market falls.
It's important for investors to make the distinction between short-term risk--where beta and price volatility are useful--and longer-term, fundamental risk, where big-picture risk factors are more telling. High betas may mean price volatility over the near term, but they don't always rule out long-term opportunities
Portfolio Rebalancing Rules
It's vital to revisit and monitor your portfolio at least annually to check on the status of your allocations and make sure your investment funds are performing as expected. Why?
Depending upon your stage in life and your financial plan, this happy development may mean it is time to rebalance.
When is it time to rebalance your portfolio?
Long-term investors should only rebalance when truly necessary, for example
-When significant gains (such as those from the bull market) or major losses have skewed your intended allocations;
-When your investment objectives change;
-When you need to shift your portfolio into more fixed income vehicles (bonds) as you enter retirement or plan to invest part of your savings for a shorter-term need;
-When stock or fund seems to be consistently and continually slipping compared with the benchmarks; or
-In the case of a mutual fund, when a proven manager leaves a fund and you are unsure about the replacement.
-Research shows us that rebalancing too often accomplishes very little, except in extreme cases. In other words, take the time to choose your allocations correctly and stick with them: Rebalance annually and sell only the bottom quartile of your holdings based on performance.
Monitoring your investments is an important part of portfolio maintenance, but remembers that buy-and-hold investors are long-term strategists. Life has a strange and unpredictable habit of forcing us to rebalance our lives as well as our portfolios unexpectedly. Rebalancing is as natural as replacing an automobile or anything else that wears out or just falls apart.
Always remember that the object of rebalancing your investments is to focus first on your overall portfolio, not so much on individual stocks, funds or fixed income securities.
6 portfolio rebalancing rules:
1)Annual rebalancing: "Remember that rebalancing does not need to be frequent - annually is sufficient. However, your actual portfolio allocations will be constantly changing due to varying performances and as you withdraw funds."
2) Don't stray too much: "Don't worry about straying from your desired allocation by a few percentage points, but straying by 5 per cent should start to become a concern, and straying 10 per cent will have a major impact on your portfolio's return. In between that range - it's a tough decision and will likely be dictated by your personal tax situation and personal preferences."
3)Minimum commitments: "At least 10 per cent of a portfolio must be committed to a market segment to have a meaningful impact" on your portfolio. "If your desired allocation to a particular asset class is only 10 percent, you would not want to stray below that amount by very much; in contrast, falling a few percentage points below a 30 percent desired level would be less of a concern."
4)Discipline: "Rebalancing provides a discipline: it forces you to sell high and buy low." In other words, when making specific rebalancing decisions, a savvy investor will take profits in the sales, while seeking value in the replacements.
5)Don't get greedy: If you have a portfolio of mutual funds that have been very successful, "consider selective pruning of individual holdings that have done well." In short, stay focused on your overall portfolio, without failing in love with any particularly hot funds.
6)Focus on the long term: "Enjoy the bull market while it lasts, but don't let several terrific years deflect you from a long-term strategy." In short, remember: The market does advance, but in cycles that go down as well as up. Plan your asset allocations for the long term through both phases.
Depending upon your stage in life and your financial plan, this happy development may mean it is time to rebalance.
When is it time to rebalance your portfolio?
Long-term investors should only rebalance when truly necessary, for example
-When significant gains (such as those from the bull market) or major losses have skewed your intended allocations;
-When your investment objectives change;
-When you need to shift your portfolio into more fixed income vehicles (bonds) as you enter retirement or plan to invest part of your savings for a shorter-term need;
-When stock or fund seems to be consistently and continually slipping compared with the benchmarks; or
-In the case of a mutual fund, when a proven manager leaves a fund and you are unsure about the replacement.
-Research shows us that rebalancing too often accomplishes very little, except in extreme cases. In other words, take the time to choose your allocations correctly and stick with them: Rebalance annually and sell only the bottom quartile of your holdings based on performance.
Monitoring your investments is an important part of portfolio maintenance, but remembers that buy-and-hold investors are long-term strategists. Life has a strange and unpredictable habit of forcing us to rebalance our lives as well as our portfolios unexpectedly. Rebalancing is as natural as replacing an automobile or anything else that wears out or just falls apart.
Always remember that the object of rebalancing your investments is to focus first on your overall portfolio, not so much on individual stocks, funds or fixed income securities.
6 portfolio rebalancing rules:
1)Annual rebalancing: "Remember that rebalancing does not need to be frequent - annually is sufficient. However, your actual portfolio allocations will be constantly changing due to varying performances and as you withdraw funds."
2) Don't stray too much: "Don't worry about straying from your desired allocation by a few percentage points, but straying by 5 per cent should start to become a concern, and straying 10 per cent will have a major impact on your portfolio's return. In between that range - it's a tough decision and will likely be dictated by your personal tax situation and personal preferences."
3)Minimum commitments: "At least 10 per cent of a portfolio must be committed to a market segment to have a meaningful impact" on your portfolio. "If your desired allocation to a particular asset class is only 10 percent, you would not want to stray below that amount by very much; in contrast, falling a few percentage points below a 30 percent desired level would be less of a concern."
4)Discipline: "Rebalancing provides a discipline: it forces you to sell high and buy low." In other words, when making specific rebalancing decisions, a savvy investor will take profits in the sales, while seeking value in the replacements.
5)Don't get greedy: If you have a portfolio of mutual funds that have been very successful, "consider selective pruning of individual holdings that have done well." In short, stay focused on your overall portfolio, without failing in love with any particularly hot funds.
6)Focus on the long term: "Enjoy the bull market while it lasts, but don't let several terrific years deflect you from a long-term strategy." In short, remember: The market does advance, but in cycles that go down as well as up. Plan your asset allocations for the long term through both phases.
Types of Risks...
What are the types of risks?
Risk is an inherent aspect of every form of investment. For mutual fund investments, risks would include variability, or period-by-period fluctuations in total return. The value of the scheme's investments may be affected by factors affecting capital markets such as price and volume volatility in the stock markets, interest rates, currency exchange rates, foreign investment, changes in government policy, political, economic or other developments.
·Market Risk: At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk".
·Inflation Risk: Sometimes referred to as "loss of purchasing power." Whenever the rate of inflation exceeds the earnings on your investment, you run the risk that you'll actually be able to buy less, not more.
·Credit Risk: In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?
·Interest Rate Risk: Changing interest rates affect both equities and bonds in many ways. Bond prices are influenced by movements in the interest rates in the financial system. Generally, when interest rates rise, prices of the securities fall and when interest rates drop, the prices increase. Interest rate movements in the Indian debt markets can be volatile leading to the possibility of large price movements up or down in debt and money market securities and thereby to possibly large movements in the NAV.
·Investment Risks: In the sectoral fund schemes, investments will be predominantly in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of equities.
·Liquidity Risk: Thinly traded securities carry the danger of not being easily saleable at or near their real values. The fund manager may therefore be unable to quickly sell an illiquid bond and this might affect the price of the fund unfavorably. Liquidity risk is characteristic of the Indian fixed income market.
·Changes in the Government Policy: Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund.
Risk is an inherent aspect of every form of investment. For mutual fund investments, risks would include variability, or period-by-period fluctuations in total return. The value of the scheme's investments may be affected by factors affecting capital markets such as price and volume volatility in the stock markets, interest rates, currency exchange rates, foreign investment, changes in government policy, political, economic or other developments.
·Market Risk: At times the prices or yields of all the securities in a particular market rise or fall due to broad outside influences. When this happens, the stock prices of both an outstanding, highly profitable company and a fledgling corporation may be affected. This change in price is due to "market risk".
·Inflation Risk: Sometimes referred to as "loss of purchasing power." Whenever the rate of inflation exceeds the earnings on your investment, you run the risk that you'll actually be able to buy less, not more.
·Credit Risk: In short, how stable is the company or entity to which you lend your money when you invest? How certain are you that it will be able to pay the interest you are promised, or repay your principal when the investment matures?
·Interest Rate Risk: Changing interest rates affect both equities and bonds in many ways. Bond prices are influenced by movements in the interest rates in the financial system. Generally, when interest rates rise, prices of the securities fall and when interest rates drop, the prices increase. Interest rate movements in the Indian debt markets can be volatile leading to the possibility of large price movements up or down in debt and money market securities and thereby to possibly large movements in the NAV.
·Investment Risks: In the sectoral fund schemes, investments will be predominantly in equities of select companies in the particular sectors. Accordingly, the NAV of the schemes are linked to the equity performance of such companies and may be more volatile than a more diversified portfolio of equities.
·Liquidity Risk: Thinly traded securities carry the danger of not being easily saleable at or near their real values. The fund manager may therefore be unable to quickly sell an illiquid bond and this might affect the price of the fund unfavorably. Liquidity risk is characteristic of the Indian fixed income market.
·Changes in the Government Policy: Changes in Government policy especially in regard to the tax benefits may impact the business prospects of the companies leading to an impact on the investments made by the fund.
Tuesday, November 17, 2009
14 Commandments of investments
Benjamin Graham is regarded as the father of value investing and his
books are investment classics. Securities Analysis (first published in
1934) and The Intelligent Investor (first published in 1949) continue
to sell steadily. In addition to this legacy, he has permanently
influenced many successful investors, including Warren Buffett, the
wealthiest man in America; William Ruane, founder of the
super-successful Sequoia Fund; and well-known investor Walter Schloss.
Ben was a prophet in a very specialised but important realm of life.
He preached commandments that any investor can use as stars when
navigating the vast and mysterious seas of the investment world. An
individual investor, who is not under pressure to shoot comets across
the heavens but would like to earn a smart and substantial return,
especially can benefit from Ben's guidance. In greatly simplified
terms, here are the 14 points Graham most consistently delivered in
his writing and speaking. Some of the counsel is technical, but much
of it is aimed at adopting the right attitude:
1. Be an investor, not a speculator
"Let us define the speculator as one who seeks to profit from market
movements, without primary regard to intrinsic values; the prudent
stock investor is one who (a) buys only at prices amply supported by
underlying value and (b) determinedly reduces his stock holdings when
the market enters the speculative phase of a sustained advance."
Speculation, Ben insisted, had its place in the securities markets,
but a speculator must do more research and tracking of investments and
be prepared for losses if they come.
2. Know the asking price
Multiply the company's share price by the number of company total
shares (undiluted) outstanding. Ask yourself, if I bought the whole
company would it be worth this much money?
3. Rake the market for bargains
Graham is best known for using his "net current asset value" (NCAV)
rule to decide if the company was worth its market price.
To get the NCAV of a company, subtract all liabilities, including
short-term debt and preferred stock, from current assets. By
purchasing stocks below the NCAV, the investor buys a bargain because
nothing at all is paid for the fixed assets of the company. The 1988
research of Professor Joseph D. Vu shows that buying stocks
immediately after their price drop below the NCAV per share and
selling two years afterward provides an excess return of more than 24
per cent.
Yet even Ben recognized that NCAV stocks are increasingly difficult to
find, and when one is located, this measure is only a starting point
in the evaluation. "If the investor has occasion to be fearful of the
future of such a company," he explained, "it is perfectly logical for
him to obey his fears and pass on from that enterprise to some other
security about which he is not so fearful."
Modern disciples of Graham look for hidden value in additional ways,
but still probe the question, "What is this company actually worth?"
Buffett modifies the Graham formula by looking at the quality of the
business itself. Other apostles use the amount of cash flow generated
by the company, the reliability and quality of dividends and other
factors.
4. Buy the formula
Ben devised another simple formula to tell if a stock is underpriced.
The concept has been tested in many different markets and still works.
It takes into account the company's earnings per share (E), its
expected earnings growth rate (R) and the current yield on AAA rated
corporate bonds (Y).
The intrinsic value of a stock equals:
E(2R + 8.5) x Y/4
The number 8.5, Ben believed, was the appropriate price-to-earnings
multiple for a company with static growth. P/E ratios have risen, but
a conservative investor still will use a low multiplier. At the time
this formula was printed, 4.4 per cent was the average bond yield, or
the Y factor.
5. Regard corporate figures with suspicion
It is a company's future earnings that will drive its share price
higher, but estimates are based on current numbers, of which an
investor must be wary. Even with more stringent rules, current
earnings can be manipulated by creative accountancy. An investor is
urged to pay special attention to reserves, accounting changes and
footnotes when reading company documents. As for estimates of future
earnings, anything from false expectations to unexpected world events
can repaint the picture. Nevertheless, an investor has to do the best
evaluation possible and then go with the results.
6. Don't stress out
Realise that you are unlikely to hit the precise "intrinsic value" of
a stock or a stock market right on the mark. A margin of safety
provides peace of mind. "Use an old Graham and Dodd guideline that you
can't be that precise about a simple value," suggested Professor Roger
Murray. "Give yourself a band of 20 per cent above or below, and say,
"that is the range of fair value."
7. Don't sweat the math
Ben, who loved mathematics, said so himself: "In 44 years of Wall
Street experience and study, I have never seen dependable calculations
made about common stock values, or related investment policies, that
went beyond simple arithmetic or the most elementary algebra. Whenever
calculus is brought in, or higher algebra, you could take it as a
warning signal that the operator was trying to substitute theory for
experience, and usually also to give speculation the deceptive guise
of investment."
8. Diversify, rule #1
"My basic rule," Graham said, "is that the investor should always have
a minimum of 25 per cent in bonds or bond equivalents, and another
minimum of 25 per cent in common stocks. He can divide the other 50
per cent between the two, according to the varying stock and bond
prices." This is ho-hum advice to anyone in a hurry to get rich, but
it helps preserve capital. Remember, earnings cannot compound on money
that has evaporated.
Using this rule, an investor would sell stocks when stock prices are
high and buy bonds. When the stock market declines, the investor would
sell bonds and buy bargain stocks. At all times, however, he or she
would hold the minimum 25 per cent of the assets either in stocks or
bonds — retaining particularly those that offer some contrarian
advantage.
As a rule of thumb, an investor should back away from the stock market
when the earnings per share on leading indices (such as the Dow Jones
Industrial Average or the Standard & Poor's composite index) is less
than the yield on high-quality bonds. When the reverse is true, lean
toward bonds.
9. Diversify, rule #2
An investor should have a large number of securities in his or her
portfolio, if necessary, with a relatively small number of shares of
each stock. While investors such as Buffett may have fewer than a
dozen or so carefully chosen companies, Graham usually held 75 or more
stocks at any given time. Ben suggested that individual investors try
to have at least 30 different holdings.
10. When in doubt, stick to quality
Companies with good earnings, solid dividend histories, low debts and
reasonable price/to/earnings ratios serve best. "Investors do not make
mistakes, or bad mistakes, in buying good stocks at fair prices," Ben
said. "They make their serious mistakes by buying poor stocks,
particularly the ones that are pushed for various reasons. And
sometimes — in fact, very frequently — they make mistakes by buying
good stocks in the upper reaches of bull markets."
11. Dividends as a clue
A long record of paying dividends, as long as 20 years, shows that a
company has substance and is a limited risk. Chancy growth stocks
seldom pay dividends. Furthermore, Ben contended that no dividends or
a niggardly dividend policy harms investors in two ways. Not only are
shareholders deprived of income from their investment, but when
comparable companies are studied, the one with the lower dividend
consistently sells for a lower share price. "I believe that Wall
Street experience shows clearly that the best treatment for
stockholders," Ben said, "is the payment to them of fair and
reasonable dividends in relation to the company's earnings and in
relation to the true value of the security, as measured by any
ordinary tests based on earning power or assets."
12. Defend your shareholder rights
"I want to say a word about disgruntled shareholders," Ben said. "In
my humble opinion, not enough of them are disgruntled. And one of the
great troubles with Wall Street is that it cannot distinguish between
a mere troublemaker or "strike suitor" in corporate affairs and a
stockholder with a legitimate complaint that deserves attention from
his management and from his fellow stockholders." If you object to a
dividend policy, executive compensation package or golden parachutes,
organize a sharcholder's offensive.
13. Be Patient
". . . every investor should be prepared financially and
psychologically for the possibility of poor short-term results. For
example, in the 1973-1974 decline the investor would have lost money
on paper, but if he'd held on and stuck with the approach, he would
have recouped in 1975-1976 and gotten his 15 per cent average return
for the five-year period."
14. Think for yourself
Don't follow the crowd. "There are two requirements for success in
Wall Street," Ben once said. "One, you have to think correctly; and
secondly, you have to think independently."
Finally, continue to search for better ways to ensure safety and
maximise growth. Do not ever stop thinking.
books are investment classics. Securities Analysis (first published in
1934) and The Intelligent Investor (first published in 1949) continue
to sell steadily. In addition to this legacy, he has permanently
influenced many successful investors, including Warren Buffett, the
wealthiest man in America; William Ruane, founder of the
super-successful Sequoia Fund; and well-known investor Walter Schloss.
Ben was a prophet in a very specialised but important realm of life.
He preached commandments that any investor can use as stars when
navigating the vast and mysterious seas of the investment world. An
individual investor, who is not under pressure to shoot comets across
the heavens but would like to earn a smart and substantial return,
especially can benefit from Ben's guidance. In greatly simplified
terms, here are the 14 points Graham most consistently delivered in
his writing and speaking. Some of the counsel is technical, but much
of it is aimed at adopting the right attitude:
1. Be an investor, not a speculator
"Let us define the speculator as one who seeks to profit from market
movements, without primary regard to intrinsic values; the prudent
stock investor is one who (a) buys only at prices amply supported by
underlying value and (b) determinedly reduces his stock holdings when
the market enters the speculative phase of a sustained advance."
Speculation, Ben insisted, had its place in the securities markets,
but a speculator must do more research and tracking of investments and
be prepared for losses if they come.
2. Know the asking price
Multiply the company's share price by the number of company total
shares (undiluted) outstanding. Ask yourself, if I bought the whole
company would it be worth this much money?
3. Rake the market for bargains
Graham is best known for using his "net current asset value" (NCAV)
rule to decide if the company was worth its market price.
To get the NCAV of a company, subtract all liabilities, including
short-term debt and preferred stock, from current assets. By
purchasing stocks below the NCAV, the investor buys a bargain because
nothing at all is paid for the fixed assets of the company. The 1988
research of Professor Joseph D. Vu shows that buying stocks
immediately after their price drop below the NCAV per share and
selling two years afterward provides an excess return of more than 24
per cent.
Yet even Ben recognized that NCAV stocks are increasingly difficult to
find, and when one is located, this measure is only a starting point
in the evaluation. "If the investor has occasion to be fearful of the
future of such a company," he explained, "it is perfectly logical for
him to obey his fears and pass on from that enterprise to some other
security about which he is not so fearful."
Modern disciples of Graham look for hidden value in additional ways,
but still probe the question, "What is this company actually worth?"
Buffett modifies the Graham formula by looking at the quality of the
business itself. Other apostles use the amount of cash flow generated
by the company, the reliability and quality of dividends and other
factors.
4. Buy the formula
Ben devised another simple formula to tell if a stock is underpriced.
The concept has been tested in many different markets and still works.
It takes into account the company's earnings per share (E), its
expected earnings growth rate (R) and the current yield on AAA rated
corporate bonds (Y).
The intrinsic value of a stock equals:
E(2R + 8.5) x Y/4
The number 8.5, Ben believed, was the appropriate price-to-earnings
multiple for a company with static growth. P/E ratios have risen, but
a conservative investor still will use a low multiplier. At the time
this formula was printed, 4.4 per cent was the average bond yield, or
the Y factor.
5. Regard corporate figures with suspicion
It is a company's future earnings that will drive its share price
higher, but estimates are based on current numbers, of which an
investor must be wary. Even with more stringent rules, current
earnings can be manipulated by creative accountancy. An investor is
urged to pay special attention to reserves, accounting changes and
footnotes when reading company documents. As for estimates of future
earnings, anything from false expectations to unexpected world events
can repaint the picture. Nevertheless, an investor has to do the best
evaluation possible and then go with the results.
6. Don't stress out
Realise that you are unlikely to hit the precise "intrinsic value" of
a stock or a stock market right on the mark. A margin of safety
provides peace of mind. "Use an old Graham and Dodd guideline that you
can't be that precise about a simple value," suggested Professor Roger
Murray. "Give yourself a band of 20 per cent above or below, and say,
"that is the range of fair value."
7. Don't sweat the math
Ben, who loved mathematics, said so himself: "In 44 years of Wall
Street experience and study, I have never seen dependable calculations
made about common stock values, or related investment policies, that
went beyond simple arithmetic or the most elementary algebra. Whenever
calculus is brought in, or higher algebra, you could take it as a
warning signal that the operator was trying to substitute theory for
experience, and usually also to give speculation the deceptive guise
of investment."
8. Diversify, rule #1
"My basic rule," Graham said, "is that the investor should always have
a minimum of 25 per cent in bonds or bond equivalents, and another
minimum of 25 per cent in common stocks. He can divide the other 50
per cent between the two, according to the varying stock and bond
prices." This is ho-hum advice to anyone in a hurry to get rich, but
it helps preserve capital. Remember, earnings cannot compound on money
that has evaporated.
Using this rule, an investor would sell stocks when stock prices are
high and buy bonds. When the stock market declines, the investor would
sell bonds and buy bargain stocks. At all times, however, he or she
would hold the minimum 25 per cent of the assets either in stocks or
bonds — retaining particularly those that offer some contrarian
advantage.
As a rule of thumb, an investor should back away from the stock market
when the earnings per share on leading indices (such as the Dow Jones
Industrial Average or the Standard & Poor's composite index) is less
than the yield on high-quality bonds. When the reverse is true, lean
toward bonds.
9. Diversify, rule #2
An investor should have a large number of securities in his or her
portfolio, if necessary, with a relatively small number of shares of
each stock. While investors such as Buffett may have fewer than a
dozen or so carefully chosen companies, Graham usually held 75 or more
stocks at any given time. Ben suggested that individual investors try
to have at least 30 different holdings.
10. When in doubt, stick to quality
Companies with good earnings, solid dividend histories, low debts and
reasonable price/to/earnings ratios serve best. "Investors do not make
mistakes, or bad mistakes, in buying good stocks at fair prices," Ben
said. "They make their serious mistakes by buying poor stocks,
particularly the ones that are pushed for various reasons. And
sometimes — in fact, very frequently — they make mistakes by buying
good stocks in the upper reaches of bull markets."
11. Dividends as a clue
A long record of paying dividends, as long as 20 years, shows that a
company has substance and is a limited risk. Chancy growth stocks
seldom pay dividends. Furthermore, Ben contended that no dividends or
a niggardly dividend policy harms investors in two ways. Not only are
shareholders deprived of income from their investment, but when
comparable companies are studied, the one with the lower dividend
consistently sells for a lower share price. "I believe that Wall
Street experience shows clearly that the best treatment for
stockholders," Ben said, "is the payment to them of fair and
reasonable dividends in relation to the company's earnings and in
relation to the true value of the security, as measured by any
ordinary tests based on earning power or assets."
12. Defend your shareholder rights
"I want to say a word about disgruntled shareholders," Ben said. "In
my humble opinion, not enough of them are disgruntled. And one of the
great troubles with Wall Street is that it cannot distinguish between
a mere troublemaker or "strike suitor" in corporate affairs and a
stockholder with a legitimate complaint that deserves attention from
his management and from his fellow stockholders." If you object to a
dividend policy, executive compensation package or golden parachutes,
organize a sharcholder's offensive.
13. Be Patient
". . . every investor should be prepared financially and
psychologically for the possibility of poor short-term results. For
example, in the 1973-1974 decline the investor would have lost money
on paper, but if he'd held on and stuck with the approach, he would
have recouped in 1975-1976 and gotten his 15 per cent average return
for the five-year period."
14. Think for yourself
Don't follow the crowd. "There are two requirements for success in
Wall Street," Ben once said. "One, you have to think correctly; and
secondly, you have to think independently."
Finally, continue to search for better ways to ensure safety and
maximise growth. Do not ever stop thinking.
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