Notwithstanding the day-to-day noise around stock markets, equity continues to be a favourite choice for long-term investments. Before plunging in, remember that by design, definition and style equity is a volatile asset class. However, a longer investment horizon can reduce risk substantially. For instance, the 29-year history of the Sensex shows that annual returns on the Sensex for a 1-year holding period has moved in the wild range between –52% and +265%. But with a 5-year holding period, the average annual return range is far superior, between –5% and +55%. This proves that for a short-term investor, equity is a very risky asset.
Diversified equity funds, for their inherent diversification tend to reduce your risk of losing money sharply. Simply put, these funds build a portfolio of stocks, chosen from various sectors and reduce the risk associated with a particular industry. A sector fund targeting a specific industry is susceptible to wider price-swings than its conservative counterpart - the equity diversified funds. The trade-off for balancing risk and return in a diversified portfolio is that your overall return might be lesser than what you could get in a concentrated portfolio. In the long run though a diversified portfolio helps you post steady returns and comprehensively beat the returns raked in by all other asset classes such as bonds, gold, etc. Though that diversification doesn't guarantee positive returns every year, it definitely reduces the risk on your investments. The point to remember is that risk is reduced not eliminated. The rules of sound investing are diversification, balance, and a long-term orientation. These should always be kept in mind when investing in equity funds.
Diversified equity funds will serve your purpose provided your investment span is at least 5 years and more. So, first consider your objective and the timeframe. Then evaluate the fund's return consistency and investment strategy. A look at the sector allocation will tell you about the fund's strategy. After that, decide which of the funds (in the category) will you put your money into. Pick up a truly diversified, yet actively managed equity fund. An actively managed fund will also ride the opportunities thrown up by a particular sector while being prudent with its exposure limits. And if the fund changes its investment strategy during your stay, do reconsider if the realigned strategy agrees with your comfort level. But most importantly, invest regularly.
Saturday, May 17, 2008
Saturday, April 12, 2008
WHY MUTUAL FUNDS HAVE EXIT LOADS?
Timing is the practice whereby traders try to profit from the short-term differences between daily closing prices. This is done with all types of securities. Whenever investors see the possibility of making a quick profit by buying low and selling high (or vice versa), they can do so.
Now, mutual fund timing is bad for investors in mutual funds because most often, investors are in it for the long term. But, by buying and selling the mutual fund in the short term, traders are increasing the associate costs of the mutual fund and passing these costs onto the long-term fund holders. Trading increases the costs for the long-term mutual fund investor because every time an investor buys or sells units of a mutual fund, the fund company must buy and sell the equal portion of the actual securities within the fund. With each transaction, there is a service charge (i.e. commission). These service charges eat into the returns of the people who are holding the fund for the long term.
Mutual fund companies are aware of the effects of timing and try to prevent it by adding on early-redemption penalties for those investors who redeem their investments before a minimum amount of time. These penalties transfer the costs of the transactions onto the short-term investor. These are known as exit loads.
Now, mutual fund timing is bad for investors in mutual funds because most often, investors are in it for the long term. But, by buying and selling the mutual fund in the short term, traders are increasing the associate costs of the mutual fund and passing these costs onto the long-term fund holders. Trading increases the costs for the long-term mutual fund investor because every time an investor buys or sells units of a mutual fund, the fund company must buy and sell the equal portion of the actual securities within the fund. With each transaction, there is a service charge (i.e. commission). These service charges eat into the returns of the people who are holding the fund for the long term.
Mutual fund companies are aware of the effects of timing and try to prevent it by adding on early-redemption penalties for those investors who redeem their investments before a minimum amount of time. These penalties transfer the costs of the transactions onto the short-term investor. These are known as exit loads.
Saturday, March 15, 2008
GOLD AS HEDGE AGAINST RISING INFLATION
Gold as a Hedge Against a Declining U.S. Dollar and Rising Inflation
The idea that gold preserves wealth is even more important in an economic environment where investors are faced with a declining U.S. dollar and rising inflation (due to rising commodity prices). Historically, gold has served as a hedge against both of these scenarios. With rising inflation, gold typically appreciates. When investors realize that their money is losing value, they will start positioning their investments in a hard asset that has traditionally maintained its value. The 1970s present a prime example of rising gold prices in the midst of rising inflation.
The reason gold benefits from a declining U.S. dollar are because gold is priced in U.S. dollars globally. There are two reasons for this relationship. First, investors who are looking at buying gold (like central banks) must sell their U.S. dollars to make this transaction. This ultimately drives the U.S. dollar lower as global investors seek to diversify out of the dollar. The second reason has to do with the fact that a weakening dollar makes gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the U.S. dollar.
Gold as a Safe Haven
Whether it is the tensions in the Middle East, Africa or elsewhere, it is becoming increasingly obvious that political and economic uncertainty is another reality of our modern economic environment. For this reason, investors typically look at gold as a safe haven during times of political and economic uncertainty. Why is this? Well, history is full of collapsing empires, political coups, and the collapse of currencies. During such times, investors who held onto gold were able to successfully protect their wealth and, in some cases, even use gold to escape from all of the turmoil. Consequently, whenever there are news events that hint at some type of uncertainty, investors will often buy gold as a safe haven.
Gold as a Diversifying Investment
The sum of all the above reasons to own gold is that gold is a diversifying investment. Regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth, it is clear that gold has historically served as an investment that can add a diversifying component to your portfolio. At the end of the day, if your focus is simply diversification, gold is not correlated to stocks, bonds and real estate.
Different Ways of Owning Gold
One of the main differences between investing in gold several hundred years ago and investing in gold today is that there are many more options to participating in the intrinsic qualities that gold offers. Today, investors can invest in gold by buying:
• Gold Futures
• Gold Coins
• Gold Companies
• Gold ETFs
• Gold Mutual Funds
• Gold Bullion
• Gold jewelry
Conclusion
There are advantages to every investment. If you are more concerned with holding the physical gold, buying shares in a gold mining company might not be the answer. Instead, you might want to consider investing in gold coins, gold bullion, or jewelry. If your primary interest is in using leverage to profit from rising gold prices, the futures market might be your answer.
The idea that gold preserves wealth is even more important in an economic environment where investors are faced with a declining U.S. dollar and rising inflation (due to rising commodity prices). Historically, gold has served as a hedge against both of these scenarios. With rising inflation, gold typically appreciates. When investors realize that their money is losing value, they will start positioning their investments in a hard asset that has traditionally maintained its value. The 1970s present a prime example of rising gold prices in the midst of rising inflation.
The reason gold benefits from a declining U.S. dollar are because gold is priced in U.S. dollars globally. There are two reasons for this relationship. First, investors who are looking at buying gold (like central banks) must sell their U.S. dollars to make this transaction. This ultimately drives the U.S. dollar lower as global investors seek to diversify out of the dollar. The second reason has to do with the fact that a weakening dollar makes gold cheaper for investors who hold other currencies. This results in greater demand from investors who hold currencies that have appreciated relative to the U.S. dollar.
Gold as a Safe Haven
Whether it is the tensions in the Middle East, Africa or elsewhere, it is becoming increasingly obvious that political and economic uncertainty is another reality of our modern economic environment. For this reason, investors typically look at gold as a safe haven during times of political and economic uncertainty. Why is this? Well, history is full of collapsing empires, political coups, and the collapse of currencies. During such times, investors who held onto gold were able to successfully protect their wealth and, in some cases, even use gold to escape from all of the turmoil. Consequently, whenever there are news events that hint at some type of uncertainty, investors will often buy gold as a safe haven.
Gold as a Diversifying Investment
The sum of all the above reasons to own gold is that gold is a diversifying investment. Regardless of whether you are worried about inflation, a declining U.S. dollar, or even protecting your wealth, it is clear that gold has historically served as an investment that can add a diversifying component to your portfolio. At the end of the day, if your focus is simply diversification, gold is not correlated to stocks, bonds and real estate.
Different Ways of Owning Gold
One of the main differences between investing in gold several hundred years ago and investing in gold today is that there are many more options to participating in the intrinsic qualities that gold offers. Today, investors can invest in gold by buying:
• Gold Futures
• Gold Coins
• Gold Companies
• Gold ETFs
• Gold Mutual Funds
• Gold Bullion
• Gold jewelry
Conclusion
There are advantages to every investment. If you are more concerned with holding the physical gold, buying shares in a gold mining company might not be the answer. Instead, you might want to consider investing in gold coins, gold bullion, or jewelry. If your primary interest is in using leverage to profit from rising gold prices, the futures market might be your answer.
Sunday, March 2, 2008
HOW TO EARN 9% TAX FREE RETURN
Ever since the bulls and bears began slugging it out over the past few months, equity fund managers are trying hard to make sense of the market and manage volatility. In the midst of all this humdrum, there has been one category of mutual funds that has quietly gone about its business without too much of a noise. Those are the arbitrage funds which are sometimes more lucidly referred to as equity-and-derivative funds. While these terms tend to convey a risky and aggressive investment, the reverse is actually true.
These funds are an ideal way to earn a reasonable income with a moderate amount of risk. In fact, this puts them at par with income funds on the risk-return profile. So the equity-and-derivatives funds are actually a good alternative to income funds.
The concept
All the arbitrage funds have an identical objective: to capitalise on the price difference between the spot market (cash segment) and the derivatives market (futures and options segment - F&O). So they generate income by taking advantage of the arbitrage opportunity emerging out of the mis-pricing between the spot and derivatives market.
Let’s say that the shares of company XYZ are trading at Rs 500 (cash segment). Simultaneously, they are also being traded in the derivatives market, where the stock futures is priced at Rs 510.
So what the arbitrage fund manager will do is sell a contract of XYZ stock futures at Rs 510 and buy an equivalent number of shares at Rs 500. This number of shares will be equal to the number in one contract of a stock future. The result: a risk-less profit of Rs 10 (less transaction costs like brokerage). Just by buying in the spot market and selling in the futures market, the fund manager has made a profit, irrespective of the overall market movement.
All these transactions in futures get settled on the settlement day. On this day, the price of the stocks in the spot and futures market tends to coincide. Since he already bought shares at Rs 500 and sold stock futures at Rs 510, he will just have to reverse the transaction, i.e., buy back a contract in the futures market and sell off the holding of equity shares in the spot Markets.
In this way, irrespective of which direction the market moves, the fund earns its share of profit (i.e., the spread between the initial purchase price of equity shares and sale price of futures contract).
Let’s create two scenarios to understand. Say the fund manager bought the shares of company XYZ at Rs 500 and sold stock futures at Rs 510.
Now let’s look at two different price scenarios on settlement day. Remember, on this day, the price will be the same in the cash and derivatives segment.
Situation I: He bought the shares in the cash segment at Rs 500 and now sells them at Rs 600, earning a profit of Rs 100. Now he will purchase the stock future at a loss of Rs 90 (because he had sold it at Rs 510). Both the transactions net up to a profit of Rs 10.
Situation II: The stock price plummets to Rs 400. He makes a loss of Rs 100 in the cash segment (he bought the shares at Rs 500). But he sold the futures contract at Rs 510 and now buys it at Rs 400, making a profit of Rs 110. Once again, both transactions net up to a profit of Rs 10.
So whichever way the market moves, the arbitrage has worked. The investment strategy of arbitrage funds is such that they earn moderate returns by taking low to moderate risk.
Even though the underlying securities in which they invest in are risky, since the portfolio is always completely hedged it is market neutral, i.e., the returns do not get affected by the Markets moving up or down.
The performance
The concept presents a wonderful proposition on paper. But the test lies in whether these funds have been able to translate it into substantial gains. The returns certainly suggest so.
Arbitrage funds have outperformed the major categories of debt funds across time periods. The category average returns of 8.9% over the last one year are definitely appealing when compared with the income funds’ average of 6.10%. And what adds to the glitter is the fact that the returns of an arbitrage fund become tax-free after a holding period of one year, since they are treated as equity-oriented funds from taxation point of view.
Moreover, these returns have come at a low risk. Barring one fund, none of them have delivered negative returns over any one month period.
This means that if you invested in these funds for a month, you would not have incurred a loss. Ditto is the case over three-month and one-year periods. And remember, this includes the periods of market correction (May-June 2006 and July-August 2007) as well. The market neutrality factor that we talked about earlier has ensured that wherever the Markets go, these funds remain unscathed.
The concerns
Though not the case now, a bloating asset size can be a real drag on the performance of an arbitrage fund, which will face the challenge of identifying that many more mis-pricing opportunities to keep up the performance. ICICI Prudential Equity & Derivative Income Optimiser, the biggest of the lot, manages Rs 1,400 crore and also happens to be the best performer. However, it has to be kept in mind that this fund has the option to invest up to 5% in equities without taking an off-setting position in the derivatives market. This enhances its return potential while adding slightly to its risk profile as well.
Going forward, a concern does arise on the availability of adequate arbitrage opportunities to generate reasonable amount of returns.
This category of funds is managing a modest amount of assets. But going forward, should there be a surge in the assets of such funds, they might find it difficult to identify enough arbitrage opportunities to keep up their performance records achieved thus far. Moreover, arbitrage is a self-cannibalising activity. As more and more money chases the limited amount of mis-pricing opportunities, the occurrence of such situations tends to diminish. In such a scenario, the assets can remain parked in the money market instruments for want of arbitrage opportunities, turning such a fund into nothing more than a liquid fund.
However, we seem to be far from such a situation as of now. More and more stocks are being introduced in the derivatives Markets, broadening the investment universe for these funds. For example, 14 stocks were added to the derivative segment from September 6, 2007, taking the total number of stocks traded in the F&O segment to 207. Therefore, there is little to worry about the future potential of these funds as of now.
The decision
Should you decide to opt for such a fund, there are 10 such offerings in the market, up from just one at the start of 2005. Their ability to generate reasonable returns by taking moderate risk, coupled with their tax efficiency, makes them a strong contender to be part of income fund investors’ portfolios.
These funds generally thrive on volatility. The reason being that higher the volatility in the Markets, higher the potential of mis-pricing between the spot and futures Markets which leads to arbitrage opportunities. So don’t shirk them when you find the market volatile. That’s the time you should seriously look at them.
These funds are an ideal way to earn a reasonable income with a moderate amount of risk. In fact, this puts them at par with income funds on the risk-return profile. So the equity-and-derivatives funds are actually a good alternative to income funds.
The concept
All the arbitrage funds have an identical objective: to capitalise on the price difference between the spot market (cash segment) and the derivatives market (futures and options segment - F&O). So they generate income by taking advantage of the arbitrage opportunity emerging out of the mis-pricing between the spot and derivatives market.
Let’s say that the shares of company XYZ are trading at Rs 500 (cash segment). Simultaneously, they are also being traded in the derivatives market, where the stock futures is priced at Rs 510.
So what the arbitrage fund manager will do is sell a contract of XYZ stock futures at Rs 510 and buy an equivalent number of shares at Rs 500. This number of shares will be equal to the number in one contract of a stock future. The result: a risk-less profit of Rs 10 (less transaction costs like brokerage). Just by buying in the spot market and selling in the futures market, the fund manager has made a profit, irrespective of the overall market movement.
All these transactions in futures get settled on the settlement day. On this day, the price of the stocks in the spot and futures market tends to coincide. Since he already bought shares at Rs 500 and sold stock futures at Rs 510, he will just have to reverse the transaction, i.e., buy back a contract in the futures market and sell off the holding of equity shares in the spot Markets.
In this way, irrespective of which direction the market moves, the fund earns its share of profit (i.e., the spread between the initial purchase price of equity shares and sale price of futures contract).
Let’s create two scenarios to understand. Say the fund manager bought the shares of company XYZ at Rs 500 and sold stock futures at Rs 510.
Now let’s look at two different price scenarios on settlement day. Remember, on this day, the price will be the same in the cash and derivatives segment.
Situation I: He bought the shares in the cash segment at Rs 500 and now sells them at Rs 600, earning a profit of Rs 100. Now he will purchase the stock future at a loss of Rs 90 (because he had sold it at Rs 510). Both the transactions net up to a profit of Rs 10.
Situation II: The stock price plummets to Rs 400. He makes a loss of Rs 100 in the cash segment (he bought the shares at Rs 500). But he sold the futures contract at Rs 510 and now buys it at Rs 400, making a profit of Rs 110. Once again, both transactions net up to a profit of Rs 10.
So whichever way the market moves, the arbitrage has worked. The investment strategy of arbitrage funds is such that they earn moderate returns by taking low to moderate risk.
Even though the underlying securities in which they invest in are risky, since the portfolio is always completely hedged it is market neutral, i.e., the returns do not get affected by the Markets moving up or down.
The performance
The concept presents a wonderful proposition on paper. But the test lies in whether these funds have been able to translate it into substantial gains. The returns certainly suggest so.
Arbitrage funds have outperformed the major categories of debt funds across time periods. The category average returns of 8.9% over the last one year are definitely appealing when compared with the income funds’ average of 6.10%. And what adds to the glitter is the fact that the returns of an arbitrage fund become tax-free after a holding period of one year, since they are treated as equity-oriented funds from taxation point of view.
Moreover, these returns have come at a low risk. Barring one fund, none of them have delivered negative returns over any one month period.
This means that if you invested in these funds for a month, you would not have incurred a loss. Ditto is the case over three-month and one-year periods. And remember, this includes the periods of market correction (May-June 2006 and July-August 2007) as well. The market neutrality factor that we talked about earlier has ensured that wherever the Markets go, these funds remain unscathed.
The concerns
Though not the case now, a bloating asset size can be a real drag on the performance of an arbitrage fund, which will face the challenge of identifying that many more mis-pricing opportunities to keep up the performance. ICICI Prudential Equity & Derivative Income Optimiser, the biggest of the lot, manages Rs 1,400 crore and also happens to be the best performer. However, it has to be kept in mind that this fund has the option to invest up to 5% in equities without taking an off-setting position in the derivatives market. This enhances its return potential while adding slightly to its risk profile as well.
Going forward, a concern does arise on the availability of adequate arbitrage opportunities to generate reasonable amount of returns.
This category of funds is managing a modest amount of assets. But going forward, should there be a surge in the assets of such funds, they might find it difficult to identify enough arbitrage opportunities to keep up their performance records achieved thus far. Moreover, arbitrage is a self-cannibalising activity. As more and more money chases the limited amount of mis-pricing opportunities, the occurrence of such situations tends to diminish. In such a scenario, the assets can remain parked in the money market instruments for want of arbitrage opportunities, turning such a fund into nothing more than a liquid fund.
However, we seem to be far from such a situation as of now. More and more stocks are being introduced in the derivatives Markets, broadening the investment universe for these funds. For example, 14 stocks were added to the derivative segment from September 6, 2007, taking the total number of stocks traded in the F&O segment to 207. Therefore, there is little to worry about the future potential of these funds as of now.
The decision
Should you decide to opt for such a fund, there are 10 such offerings in the market, up from just one at the start of 2005. Their ability to generate reasonable returns by taking moderate risk, coupled with their tax efficiency, makes them a strong contender to be part of income fund investors’ portfolios.
These funds generally thrive on volatility. The reason being that higher the volatility in the Markets, higher the potential of mis-pricing between the spot and futures Markets which leads to arbitrage opportunities. So don’t shirk them when you find the market volatile. That’s the time you should seriously look at them.
Saturday, February 16, 2008
MUTUAL FUND OFFER DOCUMENT
As a mutual fund investor, you've probably heard it said more than once that you should always consult a mutual fund's offer document before handing over your money. It's no secret, however, that the size of this document and the type of information inside can be hard to tackle. But don't be too overwhelmed. Here is a guide to what an offer document is, why it is important and what items should be central to your considerations.
What Is a Mutual Fund offer document?
A mutual fund offer document is a document detailing the investment objectives and strategies of a particular fund or group of funds, as well as the finer points of the fund's past performance, managers and financial information. You can obtain these documents directly from fund companies through mail, email or phone. You can also get them from a financial planner or advisor. Many fund companies also provide PDF versions of their prospectuses on their websites.
Knowing What to Look For
An offer document is a legally binding contract between the fund itself and the investor. It's easy to get lost in all the legal jargon and miss the information that matters most to you, so here is an outline of sections to which you should pay special attention. Note that the way in which a fund's offer document information is organized may vary from fund to fund; however, by law, all offer documents must contain the following important sections:
Investment Objectives
These are the fund's financial goals, which are reflected in the types of securities chosen to achieve those goals. Types of investment objectives include long-term capital growth, stable income, high total return, etc. Fund companies cannot change these objectives unless investors of the fund consent to the changes through a vote.
It is important to determine whether the fund's goals match your own investment goals. For example, a fund with an above-average capital growth objective would probably not be a good fit for an 89-year-old widow who needs regular income from investments to cover day-to-day expenses.
Investment Strategies
This part of the offer document explains the way in which a fund allocates and manages its resources to achieve its investment objectives. Aspects considered when designing such a strategy include setting goals for net asset value, determining asset allocation, investment restrictions (such as only investing in a certain industry) and deciding whether (and how) derivatives may be used.
A fund's investment strategy, like its goals, should be in sync with your investment style. For example, although a small cap fund and a large cap equity fund are both aiming for long-term capital appreciation, they are both using very different strategies to reach this goal. Before choosing one type of fund over another, make sure you consider why investing in any one of these asset types is right for you. Otherwise, you might be in for some surprises!
Risks of Investing in the Fund
Because investors have varying degrees of risk tolerance, the risk section of an offer document is very important. It details the risks associated with a particular fund, such as credit risk, interest rate risk, market risk, etc.
To get the most out of this section, you should be familiar with what distinguishes the different kinds of risk, why they are associated with particular funds, and how they fit into the balance of risk in your overall portfolio. For example, if a fund invests a large portion of its assets into foreign securities, you need to understand that this may pose significant foreign-exchange and country risk - but you also need to determine whether this kind of risk works with other types of risk in your portfolio in satisfying your tolerance.
Past Performance
This section shows you the fund's track record, but do remember the common disclaimer that "past performance is not an indication of future performance". Read the historical performance of the fund critically and make sure to take into account both long- and short-term performance. Also, make sure the benchmark chosen by the fund is appropriate. For example, using the performance of a bond market as a benchmark for an equity fund is useless. In addition, keep in mind that many of the returns presented in historical data don't account for tax, or some funds calculate an after-tax return with a rate that may be higher or lower than your own. Be sure to look at any fine print in these sections, as they should say whether or not taxes have been taken into account.
Distribution Policy
The dividends a fund pays its investors come from realized capital gains, dividends, interest or other income stemming from the securities and investing activities of the fund. The distribution policy tells you how these payments are made.
Fees and Expenses
This section is extremely important to consider because fees and expenses will eat into your total investment return from the fund. Here you will find information on any back or front-end loads and the management expense ratio. Because these compromise your return regardless of the fund's performance.
Fund Management
Here you can discover how long your fund manager has been managing your fund. Watch out for the fund that has been in operation significantly longer than the fund manager has been managing it. The performance of such a fund can be credited not to the present manager, but to the previous ones. If the current manager has been managing the fund for only a short period of time, look into his or her past performance with other funds with similar investment goals and strategies. You can then get a better gauge of his or her talent and investment style.
Conclusion
After reading the sections of the prospectus outlined above, you will have a good idea of how the fund functions and what risks it may pose. Most importantly, you'll be able to determine whether it is right for you. If you need more information beyond what the prospectus provides, you can consult the fund's annual report, which is available directly from the fund company or through a financial professional.
What Is a Mutual Fund offer document?
A mutual fund offer document is a document detailing the investment objectives and strategies of a particular fund or group of funds, as well as the finer points of the fund's past performance, managers and financial information. You can obtain these documents directly from fund companies through mail, email or phone. You can also get them from a financial planner or advisor. Many fund companies also provide PDF versions of their prospectuses on their websites.
Knowing What to Look For
An offer document is a legally binding contract between the fund itself and the investor. It's easy to get lost in all the legal jargon and miss the information that matters most to you, so here is an outline of sections to which you should pay special attention. Note that the way in which a fund's offer document information is organized may vary from fund to fund; however, by law, all offer documents must contain the following important sections:
Investment Objectives
These are the fund's financial goals, which are reflected in the types of securities chosen to achieve those goals. Types of investment objectives include long-term capital growth, stable income, high total return, etc. Fund companies cannot change these objectives unless investors of the fund consent to the changes through a vote.
It is important to determine whether the fund's goals match your own investment goals. For example, a fund with an above-average capital growth objective would probably not be a good fit for an 89-year-old widow who needs regular income from investments to cover day-to-day expenses.
Investment Strategies
This part of the offer document explains the way in which a fund allocates and manages its resources to achieve its investment objectives. Aspects considered when designing such a strategy include setting goals for net asset value, determining asset allocation, investment restrictions (such as only investing in a certain industry) and deciding whether (and how) derivatives may be used.
A fund's investment strategy, like its goals, should be in sync with your investment style. For example, although a small cap fund and a large cap equity fund are both aiming for long-term capital appreciation, they are both using very different strategies to reach this goal. Before choosing one type of fund over another, make sure you consider why investing in any one of these asset types is right for you. Otherwise, you might be in for some surprises!
Risks of Investing in the Fund
Because investors have varying degrees of risk tolerance, the risk section of an offer document is very important. It details the risks associated with a particular fund, such as credit risk, interest rate risk, market risk, etc.
To get the most out of this section, you should be familiar with what distinguishes the different kinds of risk, why they are associated with particular funds, and how they fit into the balance of risk in your overall portfolio. For example, if a fund invests a large portion of its assets into foreign securities, you need to understand that this may pose significant foreign-exchange and country risk - but you also need to determine whether this kind of risk works with other types of risk in your portfolio in satisfying your tolerance.
Past Performance
This section shows you the fund's track record, but do remember the common disclaimer that "past performance is not an indication of future performance". Read the historical performance of the fund critically and make sure to take into account both long- and short-term performance. Also, make sure the benchmark chosen by the fund is appropriate. For example, using the performance of a bond market as a benchmark for an equity fund is useless. In addition, keep in mind that many of the returns presented in historical data don't account for tax, or some funds calculate an after-tax return with a rate that may be higher or lower than your own. Be sure to look at any fine print in these sections, as they should say whether or not taxes have been taken into account.
Distribution Policy
The dividends a fund pays its investors come from realized capital gains, dividends, interest or other income stemming from the securities and investing activities of the fund. The distribution policy tells you how these payments are made.
Fees and Expenses
This section is extremely important to consider because fees and expenses will eat into your total investment return from the fund. Here you will find information on any back or front-end loads and the management expense ratio. Because these compromise your return regardless of the fund's performance.
Fund Management
Here you can discover how long your fund manager has been managing your fund. Watch out for the fund that has been in operation significantly longer than the fund manager has been managing it. The performance of such a fund can be credited not to the present manager, but to the previous ones. If the current manager has been managing the fund for only a short period of time, look into his or her past performance with other funds with similar investment goals and strategies. You can then get a better gauge of his or her talent and investment style.
Conclusion
After reading the sections of the prospectus outlined above, you will have a good idea of how the fund functions and what risks it may pose. Most importantly, you'll be able to determine whether it is right for you. If you need more information beyond what the prospectus provides, you can consult the fund's annual report, which is available directly from the fund company or through a financial professional.
Monday, February 4, 2008
RISK PLANNING FOR RETIREMENT
When it comes to risk planning in investments, especially in retirement, take care not to go about it the wrong way. Don't make the mistake of establishing unrealistic return goals and forcing yourself into an asset allocation and risk profile that is inappropriate for your situation. Your assets are finite and can only provide a certain amount of money on a sustainable basis. Reaching too far for return in retirement can be a cataclysmic experience if you get your timing wrong and are unprepared for the financial consequences. As such, your risk profile is of the foremost consideration in your retirement planning. Because no advice is appropriate for all investors, this process requires both objective and subjective analysis of your own situation. Let me show you how to determine how much risk your retirement portfolio can tolerate.
Take a Look at Expenses
The first step in this process is to determine your spending rate on an annual basis. The calculation is a simple division of your annual spending needs into your total portfolio value. For example, if you have a Rs.1 crore portfolio and plan on spending 500,000 per year, you have a 5% rate of spending (500000/10000000). So what does your spending rate tell you?
One way to view your spending rate is to gauge for the lifespan of your portfolio. More specifically, the higher the spending rate is, the shorter the lifespan of your assets, and vice versa. Assuming proper portfolio diversification, a 4-5% spending rate is generally considered sustainable over the long term while still protecting, if not enhancing, your real spending power. To illustrate, consider the fact that the average spending rate is 4.6% to last your portfolio infinitely. So, if you can live on a 4-5% spending rate, then you're in pretty good shape and can sustain a moderate to high risk tolerance in your portfolio.
The problem is that most people probably haven't saved enough money to live on a 4-5% rate of spending by retirement. Still, this knowledge is a very valuable general rule in your investment planning because it allows you to use your spending rate as an easily understood guidepost for risk tolerance. For example, if you have a spending rate of 10%, you know for sure that your portfolio's lifespan could be relatively short if you hit a protracted bear market. Therefore, you would need to invest in a very conservative manner to minimize fluctuations in portfolio volatility, lest your spending rate force you to sell large positions in a down market. Conversely, if you only have a 1% spending rate, your risk tolerance would be virtually limitless, as would your potential for portfolio growth.
As such, the key point here is to understand the potential effects of normal spending on your risk tolerance, which carries over into asset allocation and diversification considerations.
A spending rate of 500000 per year during a bear market would create an unrecoverable loss in real spending power. This illustrates the need for diversification for a retiree, who will almost certainly be pulling from a portfolio on a regular basis. Again, the higher your spending rate, the more exposed you are to fluctuations in market value and the lower your risk tolerance, which is why diversification is so important in your retirement planning.
So, once you've determined your spending rate, sit down with your financial advisor and begin the process of sorting out the risk of various asset allocations while taking into consideration your spending needs. Any reputable financial services firm will have asset allocation, risk management and financial planning software that can assist you in this process. Nonetheless, there are a few key points you want to keep in mind during these sorts of discussions.
Metrics to Think About:
• What is the expected annual standard deviation of monthly returns?
Standard deviation is probably the most important statistic because it will tell you the likely fluctuations in your portfolio's market value from year to year. For example, if you have an asset allocation that will fluctuate plus/minus 15% every year and you have a 10% spending rate, then you're taking on too much risk.
• What is the probability of taking a large loss in a given year, say 10%, 15% or more?
This is another very important statistic and essentially represents your total money at risk to achieve a given rate of return. For example, if your portfolio is expected to make 10% over the long term, but is placing 25% of your assets at risk in a given year, and you have a 10% spending rate, then you're probably taking more risk than you can tolerate.
• What is the expected rate of return for a given asset allocation?
This is important to know because your asset allocation should produce a rate of return that will pay for your spending needs, protect against inflation and maybe even grow your portfolio. However, as mentioned before, don't let your return goal back you into an inappropriate risk profile. Start by discussing your spending needs and associated risk tolerance, and then try to eek out the best asset allocation given those constraints.
It is an unfortunate reality that most people don't save enough to cover their retirement needs on an indefinite basis. Furthermore, this leads a lot of people to reach for return to make up that difference, implicitly ignoring their risk profile, which is primarily driven by spending needs.
Conclusion
Keep in mind that in retirement, your risk tolerance is driven primarily by spending needs as opposed to your psychological tolerance for fluctuations in market value. Trading only according to your psychological tolerance for risk is a luxury of being young. The fact of the matter is that unless you are in a position to live on a 4-5% spending rate in retirement, your portfolio will have a finite lifespan and accepting that reality is key to your financial planning. Just remember, high spending rates mean low levels of risk tolerance and low spending rates means high levels of risk tolerance.
Take a Look at Expenses
The first step in this process is to determine your spending rate on an annual basis. The calculation is a simple division of your annual spending needs into your total portfolio value. For example, if you have a Rs.1 crore portfolio and plan on spending 500,000 per year, you have a 5% rate of spending (500000/10000000). So what does your spending rate tell you?
One way to view your spending rate is to gauge for the lifespan of your portfolio. More specifically, the higher the spending rate is, the shorter the lifespan of your assets, and vice versa. Assuming proper portfolio diversification, a 4-5% spending rate is generally considered sustainable over the long term while still protecting, if not enhancing, your real spending power. To illustrate, consider the fact that the average spending rate is 4.6% to last your portfolio infinitely. So, if you can live on a 4-5% spending rate, then you're in pretty good shape and can sustain a moderate to high risk tolerance in your portfolio.
The problem is that most people probably haven't saved enough money to live on a 4-5% rate of spending by retirement. Still, this knowledge is a very valuable general rule in your investment planning because it allows you to use your spending rate as an easily understood guidepost for risk tolerance. For example, if you have a spending rate of 10%, you know for sure that your portfolio's lifespan could be relatively short if you hit a protracted bear market. Therefore, you would need to invest in a very conservative manner to minimize fluctuations in portfolio volatility, lest your spending rate force you to sell large positions in a down market. Conversely, if you only have a 1% spending rate, your risk tolerance would be virtually limitless, as would your potential for portfolio growth.
As such, the key point here is to understand the potential effects of normal spending on your risk tolerance, which carries over into asset allocation and diversification considerations.
A spending rate of 500000 per year during a bear market would create an unrecoverable loss in real spending power. This illustrates the need for diversification for a retiree, who will almost certainly be pulling from a portfolio on a regular basis. Again, the higher your spending rate, the more exposed you are to fluctuations in market value and the lower your risk tolerance, which is why diversification is so important in your retirement planning.
So, once you've determined your spending rate, sit down with your financial advisor and begin the process of sorting out the risk of various asset allocations while taking into consideration your spending needs. Any reputable financial services firm will have asset allocation, risk management and financial planning software that can assist you in this process. Nonetheless, there are a few key points you want to keep in mind during these sorts of discussions.
Metrics to Think About:
• What is the expected annual standard deviation of monthly returns?
Standard deviation is probably the most important statistic because it will tell you the likely fluctuations in your portfolio's market value from year to year. For example, if you have an asset allocation that will fluctuate plus/minus 15% every year and you have a 10% spending rate, then you're taking on too much risk.
• What is the probability of taking a large loss in a given year, say 10%, 15% or more?
This is another very important statistic and essentially represents your total money at risk to achieve a given rate of return. For example, if your portfolio is expected to make 10% over the long term, but is placing 25% of your assets at risk in a given year, and you have a 10% spending rate, then you're probably taking more risk than you can tolerate.
• What is the expected rate of return for a given asset allocation?
This is important to know because your asset allocation should produce a rate of return that will pay for your spending needs, protect against inflation and maybe even grow your portfolio. However, as mentioned before, don't let your return goal back you into an inappropriate risk profile. Start by discussing your spending needs and associated risk tolerance, and then try to eek out the best asset allocation given those constraints.
It is an unfortunate reality that most people don't save enough to cover their retirement needs on an indefinite basis. Furthermore, this leads a lot of people to reach for return to make up that difference, implicitly ignoring their risk profile, which is primarily driven by spending needs.
Conclusion
Keep in mind that in retirement, your risk tolerance is driven primarily by spending needs as opposed to your psychological tolerance for fluctuations in market value. Trading only according to your psychological tolerance for risk is a luxury of being young. The fact of the matter is that unless you are in a position to live on a 4-5% spending rate in retirement, your portfolio will have a finite lifespan and accepting that reality is key to your financial planning. Just remember, high spending rates mean low levels of risk tolerance and low spending rates means high levels of risk tolerance.
Friday, February 1, 2008
HOME BUILDERS STOCKS ARE ON THE MOVE
As the ice begins to break up, investors may be tempted to dip a toe into the frigid sector - just to test if the worst is over and there is finally profit to be made again. In this article we'll explore signals that capitulation is in full swing and examine if now is the time for contrarian investors to dive in.
Since the low in the fourth trading week of January, the Dow Jones U.S. Home Construction Index (DJUSHB) rallied 40%, as of the close on Thursday. Technical analysts know the recent pop means descending resistance of the relevant downtrend has been breached. However, technicals are lagging indicators and are simply a visual map of market action, based on underlying fundamentals. While the chart of the DJUSHB shows a breach of the relevant downtrend, what's really happening is a fundamentals-related shift within the sector.
It's Darkest Before the Dawn
Last Thursday, the Associated Press reported that existing home sales fell by 13% for the year, according to the National Association of Realtors. Talk about dismal. If that‘s not enough, total U.S. median home prices dropped on an annual basis for the first time since the 1968.
Here's the rub, when there's no end in sight and the whole market starts abandoning the sector, it's usually the time to start buying. Then again, those who've been on board with homebuilder stocks over the past few days already know this.
Stimulus Plan Good For Homebuilders Too
President Bush is attempting to implement an economic stimulus plan in which subprime mortgage rates will be frozen for five years. What this means is that those who are in way over their heads can relax a little…at least for a moment. At the end of the day, the government is doing everything possible to dig out subprime borrowers. And housing stocks are benefiting…at least the ones with solid fundamentals.
There was a rumor that Warren Buffett was thinking about buying Pulte Homes (NYSE:PHM), though not much has surfaced in the way of real news. However, the company is trading with an ungodly low price-to-sales of about 0.30 and a laughingly cheap price-to-book of 0.65. The fact is, the company has taken so many charges over the past year that its freefall has driven the stock into fundamental attractiveness.
What's vital to know right now, though, is that even though the company looks quite appetizing at current levels, there really isn't any evidence that consumers are sure to begin borrowing again. It's hard not to think that new homeowners won't resurface, especially with the recent economic stimulus freezing ARMs, providing tax rebates…and of course the Fed's recent rate cut. But the market is good a bucking trends, and therefore if a total rebound is expected too early in the game, investors could find themselves pounded again.
The Bottom Line
What it comes down to is common sense. While fundamentals of several homebuilders, including Ryland Homes (NYSE:RYL) and Tol Brothers (NYSE:TOL) seem enticing, those seeking to establish positions based on the recent turnaround may want to ease in ever so slightly, because we may end up finding these homebuilders' foundations to be in even worse shape than expected.
Since the low in the fourth trading week of January, the Dow Jones U.S. Home Construction Index (DJUSHB) rallied 40%, as of the close on Thursday. Technical analysts know the recent pop means descending resistance of the relevant downtrend has been breached. However, technicals are lagging indicators and are simply a visual map of market action, based on underlying fundamentals. While the chart of the DJUSHB shows a breach of the relevant downtrend, what's really happening is a fundamentals-related shift within the sector.
It's Darkest Before the Dawn
Last Thursday, the Associated Press reported that existing home sales fell by 13% for the year, according to the National Association of Realtors. Talk about dismal. If that‘s not enough, total U.S. median home prices dropped on an annual basis for the first time since the 1968.
Here's the rub, when there's no end in sight and the whole market starts abandoning the sector, it's usually the time to start buying. Then again, those who've been on board with homebuilder stocks over the past few days already know this.
Stimulus Plan Good For Homebuilders Too
President Bush is attempting to implement an economic stimulus plan in which subprime mortgage rates will be frozen for five years. What this means is that those who are in way over their heads can relax a little…at least for a moment. At the end of the day, the government is doing everything possible to dig out subprime borrowers. And housing stocks are benefiting…at least the ones with solid fundamentals.
There was a rumor that Warren Buffett was thinking about buying Pulte Homes (NYSE:PHM), though not much has surfaced in the way of real news. However, the company is trading with an ungodly low price-to-sales of about 0.30 and a laughingly cheap price-to-book of 0.65. The fact is, the company has taken so many charges over the past year that its freefall has driven the stock into fundamental attractiveness.
What's vital to know right now, though, is that even though the company looks quite appetizing at current levels, there really isn't any evidence that consumers are sure to begin borrowing again. It's hard not to think that new homeowners won't resurface, especially with the recent economic stimulus freezing ARMs, providing tax rebates…and of course the Fed's recent rate cut. But the market is good a bucking trends, and therefore if a total rebound is expected too early in the game, investors could find themselves pounded again.
The Bottom Line
What it comes down to is common sense. While fundamentals of several homebuilders, including Ryland Homes (NYSE:RYL) and Tol Brothers (NYSE:TOL) seem enticing, those seeking to establish positions based on the recent turnaround may want to ease in ever so slightly, because we may end up finding these homebuilders' foundations to be in even worse shape than expected.
Monday, January 21, 2008
MUTUAL FUND GLOSSARY
Dear fellow investors,
This should help in clearing some of the jargon you come across in the world of investments.
Active Portfolio Management
Is a systematic and proactive approach to investment with the goal of beating the market. This strategy is based on the premise that markets are not efficient and that there is scope to earn abnormal profits through an active investment strategy.
Annualized Return
The return a fund would have generated over a year on a compounded basis. This method is the best indicator to measure the performance of a fund.
Asset Management Company (AMC)
A Company registered with SEBI, which takes investment/ divestment decisions for the mutual fund, and manages the assets of the mutual fund. e.g. for Sun F&C mutual fund , the AMC is Sun F&C Asset Management (India) Pvt. Ltd.
Asset Allocation
It is the process of allocating the overall corpus to different assets like equities, bonds, real estate, derivatives etc.
Back-end Load
A kind of redemption charge that an investor has to pay for withdrawing his money from the mutual fund. It is basically imposed to discourage investors from exiting the fund. It is also popularly referred to as an Exit Load.
Balanced fund
A fund that invests substantially both in debt and equity.
Bottom-up Investing
It is a strategy of selecting the company for investment first and then cross checking it by evaluating factors pertaining to the industry and the economy. It is the opposite of the top-down approach to investing.
Closed-ended fund
A fund where investors have to commit their money for a particular period. In India these closed-ended funds have to necessarily be listed on recognized stock exchanges which provides an exit route.
Contingent deferred sales charge (CDSC)
An exit charge permitted under the regulations for a no-load scheme
Continuous Offer Period
Is the date from which the units are available for sale and repurchase at a price linked to NAV of the scheme.
Corpus
The total investable funds available with a mutual fund scheme at any point of time.
Credit Risk
It is the risk that the issuer of a fixed income security may default on payment of interest and repayment of principal. It is also referred to as default risk.
Dated Security
A debt instrument that is long term in nature and has a fixed date of redemption.
Debt fund
A fund that invests in debt securities like Government securities, Treasury Bills, corporate Bonds etc. These funds are generally preferred by investors wanting steady income and not willing to take higher risks.
Dematerialization
The process of converting the physical /paper shares in Electronic form. SEBI had made it compulsory to get the shares of some companies dematerialized. In this process the investor opens an account with a Depository Participant (DP) and the number of shares the investor holds is shown in this account.
Depository Participant
An authorized body who is involved in dematerialization of shares and maintaining of the investors accounts.
Discount/Premium to (Net Asset Value) NAV
It is the difference between the unit price and NAV. If the price is higher than the NAV, the units are trading at premium: if the price is lower, the units are trading at a discount.
Diversification
It is the investment strategy of not putting all one’s eggs in one basket. By diversifying a portfolio across different industries, overall risk of the portfolio is reduced.
Dollar Cost Averaging
The strategy of dividing the investible amount into a number of equal parts and buying at regular intervals to take advantage of lower prices. This strategy is more beneficial in a bear phase.
Efficient Portfolio
A portfolio which ensures maximum return for a given level of risk or a minimum level of risk for an expected return.
Factor Fund
It is a mutual fund that has a core philosophy of investing in a particular factor or style in the market. They are also referred to as Style Funds. Examples of factor funds are Mid-cap funds, Low P/E funds, Growth funds etc.
Financial Pyramid
An investment plan in the shape of a pyramid structure where the safest investments are at the base and the riskiest investments at the peak.
Fixed Income Security
A type of security that pays fixed interest at regular intervals. These comprise gilt-edged securities, bonds (taxable and tax-free), preference shares and debentures. Less risky than equity shares and have little scope for capital appreciation.
Front-End Load
An initial amount charged by a fund for its administrative expenses or for paying commissions to brokers. If the charge is made at the termination or redemption, it becomes a back-end load.
Gilt-edged Security
Government securities and bonds, usually with a low interest rate. Considered safest investments, as the government security is free from default risk. Originally such certificates were edged with gold and hence the name.
Gilt fund
Funds that invest predominantly in government securities and treasury bills. It is good for investors who desire safety of principal and adequate liquidity.
Go-Go Fund
A mutual fund which invests in highly risky but potentially profitable investments. Such a fund usually has a short life.
Equity/Growth fund
A fund that invest primarily in equities and has capital appreciation as its investment objective
Fund Manager
A professional manager appointed by the Asset Management Company to invest money in accordance with the objects of the scheme.
Fundamental Analysis
A method of investment analysis based on the fundamentals like turnover, net profit, growth, and vision of a company. The boom or depression of the stock markets are not considered in this analysis.
Income Fund
A fund that usually invests in debentures, bonds, and high dividend shares. Preferred by investors who wants regular income. It pays dividends to the investors out of its earnings.
TOP
Index Fund
A fund whose portfolio is benchmarked against a popular index like the BSE Sensex or the BSE Natex. Such an investment philosophy reflects the belief that the market is efficient and trying to beat the market over the long term is futile
TOP
Initial Offer Period
The dates on which the initial subscription to the units of the scheme can be made. It is similar to the IPO of an equity issue. This initial offer period is followed by a continuous offer period.
Interest Rate Risk
The change in the price of a debt security due to changes in the market interest rates is the interest rate risk. For debt oriented mutual fund schemes, this interest rate risk affects the NAV of the fund. A rise in the interest rates leads to a fall in the price of a fixed income security.
Interim Dividend
An advance installment of the dividend finally declared. More often one, but sometimes two such payments are made. The final dividend is often at least equal, and sometimes more. The interim dividend is a fair indication of a company's profitability, during the working year.
Liquid Fund
A fund that invests its corpus in short term instruments like call markets, treasury bills, Commercial Paper (CP), Certificate of Deposit (CD).
Liquidity Risk
It is the risk in a fixed income security as well as in equities that these securities may not be sold in the market at close to their value. Liquidity risk is characteristic of narrow markets like India.
Load
A charge by the fund when an investor buys (entry load) or sells (exit load) units in the fund.
Market Capitalization
Represents the market value of the company. It is a product of the current market price and the number of shares outstanding.
Market Instrument
A fully negotiable instrument for short-term debt.
Market Lot
A fixed minimum number of shares, in which or in multiples of which, shares are bought and sold on the stock exchange. The advent of dematerialization of shares will do away the significance of market lot.
Net Asset Value (NAV)
This is calculated as total assets minus all expenses and divided by the number of outstanding units. This is the main performance indicator for a mutual fund, especially when viewed in terms of appreciation over time.
No-Load Fund
Shares of an open-ended fund, which can be bought directly from the fund without any sales charge or brokerage. US-64 is an example of a no-load fund.
Offer Price
The price at which units can be bought from a fund.
Offshore Fund
A fund domiciled outside the country where investments are made. It is often a tax haven, not subject to the tax laws of the holder's country.
Pari Passu
Ranking equally. After conversion of debentures into shares, the new shares created carry the same rights as the existing shares of the company to receive dividends, rights and bonus shares, and to participate in the company's profit and loss.
Passive portfolio management
Exactly the reverse of active portfolio management. The portfolio manager assumes that markets are efficient and all information is already analyzed and reflected in the prices of shares. This strategy is based on the premise that it is impossible to consistently beat the market.
Rating
Evaluation of credit risk in fixed income securities. This evaluation is specific to the security rated and is done in India by Crisil, Icra, Care and Duff & Phelps.
Record Date
It is the date announced by the company/mutual fund, which is a cut-off date for corporate benefits like dividends, rights, bonus etc. Only investors whose names appear in the company’s registers on that date are eligible for the said benefits.
Reinvestment Plan
It is a plan where the earnings of a mutual fund scheme are reinvested back in the fund.
Reinvestment Risk
It is the risk that the interest on fixed income instruments cannot be reinvested at the same rate. This problem becomes pronounced in a falling interest rate scenario.
Sector fund
Such funds invest only in stocks belonging to a specific industry usually aimed at growth. For e.g. Kothari Pioneer Infotech Fund. Sector funds are generally considered to be risky in nature.
Securities
Financial documents which give the owner specific rights of ownership; these include: equity and preference shares, debentures, treasury bills, government bonds, units of mutual fund, and any other marketable documents.
Sinking Fund
Money regularly set aside in a separate fund and invested by a company for the repayment of debt instruments (fixed deposits, debentures, other loans) or the redemption of preference shares, or for replacement of assets.
Sponsor
Sponsor is the parent organization that contributes the initial capital of the asset management company (AMC). e.g. Kotak Mahindra Finance is the sponsor for Kotak Mahindra Mutual Fund.
Switching
Transferring from one scheme to another in a group of schemes operated by a Mutual Fund, where the rules so permit. A switching fee may or may not be charged.
SWOT Analysis
A type of fundamental analysis of the health of a company by examining its strengths(S), weakness (W), business opportunity (O), and any threat (T) or dangers it might be exposed to.
Systematic Risk
This is the market risk that a security faces and is essentially non-diversifiable in nature. This risk is caused by macro level factors like changes in inflation, interest rates, budget announcements etc.
Tax saving fund
Such funds allow the income tax payees to claim a rebate under the Income Tax Act.
Technical Analysis
A method of prediction of share price movements based on a study of price graphs or charts on the assumption that share price trends are repetitive. Since investor psychology follows a certain pattern, what is seen to have happened before is likely to be repeated. The technical analyst is not concerned with the fundamental strength or weakness of a company or an industry; he only studies price and volume behavior.
Top-Down Investment
An approach to stock selection which evaluates the prospects of the economy first, then the prospects of the industry and then finally the prospects of a particular company to take an investment decision. It is the opposite of a bottom-up approach to investing.
Transfer Agents
Professional firms, now mostly computerized, which maintain the records of shareholders of their client companies.
Treasury Bills
These are bills of exchange, i.e., IOUs, issued by the Reserve Bank of India for short-term loans, 91 days to 364 days.
Trustee
The trustee is the legal owner of the mutual fund. The trustee takes into custody or under its control all the capital and property of every scheme of the mutual fund and hold it in trust for the unitholders of the scheme.
Unsystematic Risk
This is the proportion of risk that is specific to a particular company. This diversifiable risk could arise due to company specific factors like operational factors, financial factors, labor unrest etc.
Value Investment
Investment in shares whose intrinsic value is above their market price. Fundamental analysts often make recommendations of value investment, as they can spot undervalued shares.
Vulture Fund
It is a fund that takes over the non-performing assets of bank or financial institution at a discount and issues pass-through units to the investors.
Venture Capital Fund
A limited company formed to provide venture or risk capital to new industries.
Zero Coupon Bond
A coupon is an interest warrant attached to a debt instrument, and the coupon rate is the rate of interest. A zero-coupon bond carries no interest, but is sold at a discount to its face value, which is the maturity value. The difference between the discounted price and the maturity value represents the interest on the bond.
This should help in clearing some of the jargon you come across in the world of investments.
Active Portfolio Management
Is a systematic and proactive approach to investment with the goal of beating the market. This strategy is based on the premise that markets are not efficient and that there is scope to earn abnormal profits through an active investment strategy.
Annualized Return
The return a fund would have generated over a year on a compounded basis. This method is the best indicator to measure the performance of a fund.
Asset Management Company (AMC)
A Company registered with SEBI, which takes investment/ divestment decisions for the mutual fund, and manages the assets of the mutual fund. e.g. for Sun F&C mutual fund , the AMC is Sun F&C Asset Management (India) Pvt. Ltd.
Asset Allocation
It is the process of allocating the overall corpus to different assets like equities, bonds, real estate, derivatives etc.
Back-end Load
A kind of redemption charge that an investor has to pay for withdrawing his money from the mutual fund. It is basically imposed to discourage investors from exiting the fund. It is also popularly referred to as an Exit Load.
Balanced fund
A fund that invests substantially both in debt and equity.
Bottom-up Investing
It is a strategy of selecting the company for investment first and then cross checking it by evaluating factors pertaining to the industry and the economy. It is the opposite of the top-down approach to investing.
Closed-ended fund
A fund where investors have to commit their money for a particular period. In India these closed-ended funds have to necessarily be listed on recognized stock exchanges which provides an exit route.
Contingent deferred sales charge (CDSC)
An exit charge permitted under the regulations for a no-load scheme
Continuous Offer Period
Is the date from which the units are available for sale and repurchase at a price linked to NAV of the scheme.
Corpus
The total investable funds available with a mutual fund scheme at any point of time.
Credit Risk
It is the risk that the issuer of a fixed income security may default on payment of interest and repayment of principal. It is also referred to as default risk.
Dated Security
A debt instrument that is long term in nature and has a fixed date of redemption.
Debt fund
A fund that invests in debt securities like Government securities, Treasury Bills, corporate Bonds etc. These funds are generally preferred by investors wanting steady income and not willing to take higher risks.
Dematerialization
The process of converting the physical /paper shares in Electronic form. SEBI had made it compulsory to get the shares of some companies dematerialized. In this process the investor opens an account with a Depository Participant (DP) and the number of shares the investor holds is shown in this account.
Depository Participant
An authorized body who is involved in dematerialization of shares and maintaining of the investors accounts.
Discount/Premium to (Net Asset Value) NAV
It is the difference between the unit price and NAV. If the price is higher than the NAV, the units are trading at premium: if the price is lower, the units are trading at a discount.
Diversification
It is the investment strategy of not putting all one’s eggs in one basket. By diversifying a portfolio across different industries, overall risk of the portfolio is reduced.
Dollar Cost Averaging
The strategy of dividing the investible amount into a number of equal parts and buying at regular intervals to take advantage of lower prices. This strategy is more beneficial in a bear phase.
Efficient Portfolio
A portfolio which ensures maximum return for a given level of risk or a minimum level of risk for an expected return.
Factor Fund
It is a mutual fund that has a core philosophy of investing in a particular factor or style in the market. They are also referred to as Style Funds. Examples of factor funds are Mid-cap funds, Low P/E funds, Growth funds etc.
Financial Pyramid
An investment plan in the shape of a pyramid structure where the safest investments are at the base and the riskiest investments at the peak.
Fixed Income Security
A type of security that pays fixed interest at regular intervals. These comprise gilt-edged securities, bonds (taxable and tax-free), preference shares and debentures. Less risky than equity shares and have little scope for capital appreciation.
Front-End Load
An initial amount charged by a fund for its administrative expenses or for paying commissions to brokers. If the charge is made at the termination or redemption, it becomes a back-end load.
Gilt-edged Security
Government securities and bonds, usually with a low interest rate. Considered safest investments, as the government security is free from default risk. Originally such certificates were edged with gold and hence the name.
Gilt fund
Funds that invest predominantly in government securities and treasury bills. It is good for investors who desire safety of principal and adequate liquidity.
Go-Go Fund
A mutual fund which invests in highly risky but potentially profitable investments. Such a fund usually has a short life.
Equity/Growth fund
A fund that invest primarily in equities and has capital appreciation as its investment objective
Fund Manager
A professional manager appointed by the Asset Management Company to invest money in accordance with the objects of the scheme.
Fundamental Analysis
A method of investment analysis based on the fundamentals like turnover, net profit, growth, and vision of a company. The boom or depression of the stock markets are not considered in this analysis.
Income Fund
A fund that usually invests in debentures, bonds, and high dividend shares. Preferred by investors who wants regular income. It pays dividends to the investors out of its earnings.
TOP
Index Fund
A fund whose portfolio is benchmarked against a popular index like the BSE Sensex or the BSE Natex. Such an investment philosophy reflects the belief that the market is efficient and trying to beat the market over the long term is futile
TOP
Initial Offer Period
The dates on which the initial subscription to the units of the scheme can be made. It is similar to the IPO of an equity issue. This initial offer period is followed by a continuous offer period.
Interest Rate Risk
The change in the price of a debt security due to changes in the market interest rates is the interest rate risk. For debt oriented mutual fund schemes, this interest rate risk affects the NAV of the fund. A rise in the interest rates leads to a fall in the price of a fixed income security.
Interim Dividend
An advance installment of the dividend finally declared. More often one, but sometimes two such payments are made. The final dividend is often at least equal, and sometimes more. The interim dividend is a fair indication of a company's profitability, during the working year.
Liquid Fund
A fund that invests its corpus in short term instruments like call markets, treasury bills, Commercial Paper (CP), Certificate of Deposit (CD).
Liquidity Risk
It is the risk in a fixed income security as well as in equities that these securities may not be sold in the market at close to their value. Liquidity risk is characteristic of narrow markets like India.
Load
A charge by the fund when an investor buys (entry load) or sells (exit load) units in the fund.
Market Capitalization
Represents the market value of the company. It is a product of the current market price and the number of shares outstanding.
Market Instrument
A fully negotiable instrument for short-term debt.
Market Lot
A fixed minimum number of shares, in which or in multiples of which, shares are bought and sold on the stock exchange. The advent of dematerialization of shares will do away the significance of market lot.
Net Asset Value (NAV)
This is calculated as total assets minus all expenses and divided by the number of outstanding units. This is the main performance indicator for a mutual fund, especially when viewed in terms of appreciation over time.
No-Load Fund
Shares of an open-ended fund, which can be bought directly from the fund without any sales charge or brokerage. US-64 is an example of a no-load fund.
Offer Price
The price at which units can be bought from a fund.
Offshore Fund
A fund domiciled outside the country where investments are made. It is often a tax haven, not subject to the tax laws of the holder's country.
Pari Passu
Ranking equally. After conversion of debentures into shares, the new shares created carry the same rights as the existing shares of the company to receive dividends, rights and bonus shares, and to participate in the company's profit and loss.
Passive portfolio management
Exactly the reverse of active portfolio management. The portfolio manager assumes that markets are efficient and all information is already analyzed and reflected in the prices of shares. This strategy is based on the premise that it is impossible to consistently beat the market.
Rating
Evaluation of credit risk in fixed income securities. This evaluation is specific to the security rated and is done in India by Crisil, Icra, Care and Duff & Phelps.
Record Date
It is the date announced by the company/mutual fund, which is a cut-off date for corporate benefits like dividends, rights, bonus etc. Only investors whose names appear in the company’s registers on that date are eligible for the said benefits.
Reinvestment Plan
It is a plan where the earnings of a mutual fund scheme are reinvested back in the fund.
Reinvestment Risk
It is the risk that the interest on fixed income instruments cannot be reinvested at the same rate. This problem becomes pronounced in a falling interest rate scenario.
Sector fund
Such funds invest only in stocks belonging to a specific industry usually aimed at growth. For e.g. Kothari Pioneer Infotech Fund. Sector funds are generally considered to be risky in nature.
Securities
Financial documents which give the owner specific rights of ownership; these include: equity and preference shares, debentures, treasury bills, government bonds, units of mutual fund, and any other marketable documents.
Sinking Fund
Money regularly set aside in a separate fund and invested by a company for the repayment of debt instruments (fixed deposits, debentures, other loans) or the redemption of preference shares, or for replacement of assets.
Sponsor
Sponsor is the parent organization that contributes the initial capital of the asset management company (AMC). e.g. Kotak Mahindra Finance is the sponsor for Kotak Mahindra Mutual Fund.
Switching
Transferring from one scheme to another in a group of schemes operated by a Mutual Fund, where the rules so permit. A switching fee may or may not be charged.
SWOT Analysis
A type of fundamental analysis of the health of a company by examining its strengths(S), weakness (W), business opportunity (O), and any threat (T) or dangers it might be exposed to.
Systematic Risk
This is the market risk that a security faces and is essentially non-diversifiable in nature. This risk is caused by macro level factors like changes in inflation, interest rates, budget announcements etc.
Tax saving fund
Such funds allow the income tax payees to claim a rebate under the Income Tax Act.
Technical Analysis
A method of prediction of share price movements based on a study of price graphs or charts on the assumption that share price trends are repetitive. Since investor psychology follows a certain pattern, what is seen to have happened before is likely to be repeated. The technical analyst is not concerned with the fundamental strength or weakness of a company or an industry; he only studies price and volume behavior.
Top-Down Investment
An approach to stock selection which evaluates the prospects of the economy first, then the prospects of the industry and then finally the prospects of a particular company to take an investment decision. It is the opposite of a bottom-up approach to investing.
Transfer Agents
Professional firms, now mostly computerized, which maintain the records of shareholders of their client companies.
Treasury Bills
These are bills of exchange, i.e., IOUs, issued by the Reserve Bank of India for short-term loans, 91 days to 364 days.
Trustee
The trustee is the legal owner of the mutual fund. The trustee takes into custody or under its control all the capital and property of every scheme of the mutual fund and hold it in trust for the unitholders of the scheme.
Unsystematic Risk
This is the proportion of risk that is specific to a particular company. This diversifiable risk could arise due to company specific factors like operational factors, financial factors, labor unrest etc.
Value Investment
Investment in shares whose intrinsic value is above their market price. Fundamental analysts often make recommendations of value investment, as they can spot undervalued shares.
Vulture Fund
It is a fund that takes over the non-performing assets of bank or financial institution at a discount and issues pass-through units to the investors.
Venture Capital Fund
A limited company formed to provide venture or risk capital to new industries.
Zero Coupon Bond
A coupon is an interest warrant attached to a debt instrument, and the coupon rate is the rate of interest. A zero-coupon bond carries no interest, but is sold at a discount to its face value, which is the maturity value. The difference between the discounted price and the maturity value represents the interest on the bond.
Saturday, January 19, 2008
US Headed for a Recession. Do We Have to Worry?
Is the United States headed for a recession? Yale professor Robert Shiller certainly thinks so. In a recent interview, Shiller told The Times that the American real estate sector has "trillions of dollars' worth of losses" yet to come, and it could plunge the U.S. into a "Japan-style slump."
But don't tell that to U.S. Treasury Secretary Henry Paulson, who said that "the economy and the markets are strong enough to absorb" rising credit losses. He remains confident that the country will not slide into recession.
Then there's financial newsletter tracker Mark Hulbert, who concluded that "the odds had increased that we were already in a recession" -- and he wrote that in September!
The three wise men
When three experts offer three different opinions, it's difficult to know whom to trust. So here's my advice: Ignore them all.
Seriously, ignore them all
Suppose Shiller's correct, and the U.S. is headed for a recession. Or maybe Hulbert has it right, and we've been in a recession for months. Does it ultimately matter? Should you alter your stock selection process? Should you sell off your stock holdings in favor of fixed income?
Just what the heck is a recession, and what does it mean for stocks? The answers may surprise you.
What goes up must come down
A recession is the period between a peak of economic activity and a trough. Recessions typically last between six and 18 months, and they're a perfectly natural part of the business cycle. A recession does not mean that economic growth has stopped; it merely means that it has slowed down.
To determine whether the economy is in recession, the National Bureau of Economic Research (NBER) analyzes changes in factors such as gross domestic product, personal income, employment, industrial production, and retail sales volume. There is no fixed rule for how the different indicators are weighed.
But there is a significant delay
It takes time for the NBER to collect and analyze this economic data. By the time it's determined that the country is in a recession, odds are that the economy is already close to recovering. For example, the last trough in economic activity occurred in November 2001 -- but the NBER didn't make that determination until July 2003. By that time, the economy had been improving for over a year and a half!
Wait, stocks can go up in a recession?
Since 1945, there have been 11 recessions lasting an average of 10 months each. But according to a recent article from Hulbert, during these recessions, the stock market actually rose seven times -- and the average market return during all 11 recessions was 3%!
Those who ignore the past ...
During the 2001 recession, the S&P 500 fell about 12%. However, this was largely due to the abysmal performance of a few technology companies:
Meanwhile, quality companies with strong balance sheets, solid free cash flow, and shareholder-friendly management actually prospered during this period:
Heads you win, tails you still win
Here's how to silence the noise: Concentrate on finding the types of stocks that will perform well in any economic environment. I advise investors not to try to time the market or forecast the next recession. Rather, I advise that you only invest in quality companies with strong balance sheets, solid free cash flow, and shareholder-friendly management.
And fortunately, thanks to fears of an impending economic slowdown, many quality companies are available on the cheap.
Consider this as an example.
FedEx (NYSE: FDX), currently trading at the lowest price-to-earnings multiple the company has seen in a decade. FedEx has an extensive ground and air transportation network, strong balance sheet, great brand, and significant international presence. And as global commerce grows and the middle class expands, demand for FedEx's express transportation services will only increase.
A temporary slowdown in the U.S. economy would likely affect FedEx's earnings to some degree, but this is a company that generated $9 billion in international sales last year. If the U.S. economy does enter a recession, chances are pretty good that FedEx will survive. However, thanks to the market's irrational fear, today you can scoop up shares of this quality company at a discount to intrinsic value.
The above applies to even Indian companies and with BSE Sensex at 19000 now, many are available at reasonable valuations.
But don't tell that to U.S. Treasury Secretary Henry Paulson, who said that "the economy and the markets are strong enough to absorb" rising credit losses. He remains confident that the country will not slide into recession.
Then there's financial newsletter tracker Mark Hulbert, who concluded that "the odds had increased that we were already in a recession" -- and he wrote that in September!
The three wise men
When three experts offer three different opinions, it's difficult to know whom to trust. So here's my advice: Ignore them all.
Seriously, ignore them all
Suppose Shiller's correct, and the U.S. is headed for a recession. Or maybe Hulbert has it right, and we've been in a recession for months. Does it ultimately matter? Should you alter your stock selection process? Should you sell off your stock holdings in favor of fixed income?
Just what the heck is a recession, and what does it mean for stocks? The answers may surprise you.
What goes up must come down
A recession is the period between a peak of economic activity and a trough. Recessions typically last between six and 18 months, and they're a perfectly natural part of the business cycle. A recession does not mean that economic growth has stopped; it merely means that it has slowed down.
To determine whether the economy is in recession, the National Bureau of Economic Research (NBER) analyzes changes in factors such as gross domestic product, personal income, employment, industrial production, and retail sales volume. There is no fixed rule for how the different indicators are weighed.
But there is a significant delay
It takes time for the NBER to collect and analyze this economic data. By the time it's determined that the country is in a recession, odds are that the economy is already close to recovering. For example, the last trough in economic activity occurred in November 2001 -- but the NBER didn't make that determination until July 2003. By that time, the economy had been improving for over a year and a half!
Wait, stocks can go up in a recession?
Since 1945, there have been 11 recessions lasting an average of 10 months each. But according to a recent article from Hulbert, during these recessions, the stock market actually rose seven times -- and the average market return during all 11 recessions was 3%!
Those who ignore the past ...
During the 2001 recession, the S&P 500 fell about 12%. However, this was largely due to the abysmal performance of a few technology companies:
Meanwhile, quality companies with strong balance sheets, solid free cash flow, and shareholder-friendly management actually prospered during this period:
Heads you win, tails you still win
Here's how to silence the noise: Concentrate on finding the types of stocks that will perform well in any economic environment. I advise investors not to try to time the market or forecast the next recession. Rather, I advise that you only invest in quality companies with strong balance sheets, solid free cash flow, and shareholder-friendly management.
And fortunately, thanks to fears of an impending economic slowdown, many quality companies are available on the cheap.
Consider this as an example.
FedEx (NYSE: FDX), currently trading at the lowest price-to-earnings multiple the company has seen in a decade. FedEx has an extensive ground and air transportation network, strong balance sheet, great brand, and significant international presence. And as global commerce grows and the middle class expands, demand for FedEx's express transportation services will only increase.
A temporary slowdown in the U.S. economy would likely affect FedEx's earnings to some degree, but this is a company that generated $9 billion in international sales last year. If the U.S. economy does enter a recession, chances are pretty good that FedEx will survive. However, thanks to the market's irrational fear, today you can scoop up shares of this quality company at a discount to intrinsic value.
The above applies to even Indian companies and with BSE Sensex at 19000 now, many are available at reasonable valuations.
Monday, January 14, 2008
Insurance & Investment
On the last day of 2007, SEBI brought in new regulations that forbade mutual fund companies from charging load from investors in cases where investments were made directly to the fund company. And on the first day of 2008, another financial services regulator, the Insurance Regulatory and Development Authority (IRDA), also brought in a new regulation that has the potential to bring benefit to the public. However, the IRDA's action has brought almost no media attention, perhaps because its positive effects will be indirect and are thus not clearly understood. The change is very simple. From February 1, insurance companies will have to inform policyholders buying Unit Linked Insurance Plans (ULIPs) exactly how much of their money is being invested and how much is being consumed by other charges that the insurance company is deducting. The IRDA's circular specifies the exact format in which these charges will be documented, and this document, which will be signed by the ULIP buyer and the insurance seller will become part of the policy document.
Why is this important and why does it potentially have the power to change the way ULIPs are bought? Simply because ULIPs are being mis-sold (mis-sold being a polite way of saying con job) like no financial product has ever been mis-sold in this country. In India, ULIPs are a product which have been cynically designed to maximise profits to insurance agents (or 'advisors' as they are supposed to be called now) and insurance companies while hiding the true numbers from investors. Nominally, a ULIP is a product that combines insurance and investment characteristics. In reality, they combine an extraordinarily high cost structure (meant primarily to feed agent commissions) with a non-standardised revelation of expense so that any meaningful comparison of investment performance between different ULIPs or between ULIPs and mutual funds is impossible. In other investment products, either there are no agent commissions (as in bank FDs) or agent commissions range from 0.25 per cent to 2 or 3 per cent. In ULIPs however, commissions range from 15 per cent to (hold your breath) around 70 per cent and are typically 25 per cent. And for some bizarre reason, this is considered acceptable by everyone concerned. On 31st December, one financial regulator (SEBI) moved to push commissions down from 2.25 per cent to zero while another (IRDA) is OK with 25 per cent for what is essentially a competing product!
Basically, ULIPs are expensive and opaque mutual funds disguised as insurance. This permits the so-called insurance companies to circumvent the strict transparency, expense, and commission-related laws that govern mutual funds. It also enables them to escape the scrutiny of SEBI, which has historically been a tougher regulator than IRDA. Will the new regulations stop these abuses? No way. All I'm hopeful of is that a handful of alert and aware investors will read this new document and ask some tough questions. Anyhow, the realistic situation is that there's almost no chance that anyone will step forward and fix things. As someone responsible for your money, you need to be sensible yourself. Insurance is a great idea and most of us need it. But we need real insurance, which is to say term insurance. Here's what you should do. Make a liberal estimate of how much money your family will need if you die suddenly. Shop around and buy the cheapest term insurance you can find. You'll be stunned at how cheap term insurance is and also at how difficult it is to buy (The quickest way to get rid of an insurance agent is to say that you're interested only in term insurance). You probably won't be able to think logically about insurance as long as you don't realise that it's an expense. It's a necessary expense, like buying a helmet or going to a doctor, but it's not an investment. You need both insurance and investment. To get the best deal in both, don't mix them up.
Why is this important and why does it potentially have the power to change the way ULIPs are bought? Simply because ULIPs are being mis-sold (mis-sold being a polite way of saying con job) like no financial product has ever been mis-sold in this country. In India, ULIPs are a product which have been cynically designed to maximise profits to insurance agents (or 'advisors' as they are supposed to be called now) and insurance companies while hiding the true numbers from investors. Nominally, a ULIP is a product that combines insurance and investment characteristics. In reality, they combine an extraordinarily high cost structure (meant primarily to feed agent commissions) with a non-standardised revelation of expense so that any meaningful comparison of investment performance between different ULIPs or between ULIPs and mutual funds is impossible. In other investment products, either there are no agent commissions (as in bank FDs) or agent commissions range from 0.25 per cent to 2 or 3 per cent. In ULIPs however, commissions range from 15 per cent to (hold your breath) around 70 per cent and are typically 25 per cent. And for some bizarre reason, this is considered acceptable by everyone concerned. On 31st December, one financial regulator (SEBI) moved to push commissions down from 2.25 per cent to zero while another (IRDA) is OK with 25 per cent for what is essentially a competing product!
Basically, ULIPs are expensive and opaque mutual funds disguised as insurance. This permits the so-called insurance companies to circumvent the strict transparency, expense, and commission-related laws that govern mutual funds. It also enables them to escape the scrutiny of SEBI, which has historically been a tougher regulator than IRDA. Will the new regulations stop these abuses? No way. All I'm hopeful of is that a handful of alert and aware investors will read this new document and ask some tough questions. Anyhow, the realistic situation is that there's almost no chance that anyone will step forward and fix things. As someone responsible for your money, you need to be sensible yourself. Insurance is a great idea and most of us need it. But we need real insurance, which is to say term insurance. Here's what you should do. Make a liberal estimate of how much money your family will need if you die suddenly. Shop around and buy the cheapest term insurance you can find. You'll be stunned at how cheap term insurance is and also at how difficult it is to buy (The quickest way to get rid of an insurance agent is to say that you're interested only in term insurance). You probably won't be able to think logically about insurance as long as you don't realise that it's an expense. It's a necessary expense, like buying a helmet or going to a doctor, but it's not an investment. You need both insurance and investment. To get the best deal in both, don't mix them up.
Monday, January 7, 2008
What the charts foretell
What do technical analysts feel about the market in 2008? Renowned chartist Milind Karandikar shares his views.
Year 2007 really turned out to be “The Year of the Bull” as I had mentioned in my last article on January 8, 2007 in The Smart Investor. I received numerous mails following the article stating that I am trying to fool investors by giving some unrealistic projections of the BSE Sensex (20,000 by December 2007).
But, the Sensex did hit the target and fooled all those who did not trust my Neowave analysis. The stock markets would go where they would like to irrespective of what you and me wish. I am just an interpreter of the patterns they form.
No doubt that my analysis goes wrong on a number of occasions, especially in the short term, but on the longer term charts, the patterns look less confusing and future projections become more reliable.
Right now, the pattern formed is suggesting that another huge bull run is impending. The technical analysis of this pattern has been discussed in the Technical outlook paragraph.
Even though year 2007 closed with a bang with the Sensex closing above the 20,000 mark, it was a rollercoaster ride for the indices over the year. The Sensex survived two major falls of over 2,000 points in February and July 2007 and managed to close near the all-time high.
Fundamental issues like crude oil prices, US sub-prime crisis, kept on producing ripples in global markets. Many analysts were worried about overstretched valuations at 14,000 level of the Sensex and continue to be worried at 20,000 level. Some are afraid of a bubble forming but, the markets are not ready to listen. If a bubble is going to form, you and me cannot stop it.
On the contrary, majority would not agree to the existence of such a bubble. The reason being a bubble is called a bubble only after it bursts. Everyone wants the bull markets to prevail for ever. But, since every bull phase is succeeded by a bear phase, one has to be very alert about exiting the market.
Technical outlook
The weekly chart of the Sensex shows that after a huge consolidation period (1992-2003) we are in a big bull run for almost last five years now. This rally is a large X-wave, which I had mentioned in my earlier articles also. A zigzag (A) – (B) – (C) pattern is the first part of this up move followed by a connecting pattern (X-wave).
This connecting wave is in the form of a running triangle that began in May 2006 and ended in August 2007. The presence of such a running triangle indicates tremendous upside potential for the Sensex. The calculations based on Neowave theory (By Glenn Neely) suggest that the breakout from such a triangle should be at least 1.618 times the largest leg of the triangle.
This puts the Sensex target at around 27,000 mark. The breakout could be as big as 2.618 times the largest leg, leading to a mind boggling figure of 39,000. Even if we keep aside this over-optimistic view, the target of 27,000 could be achieved and that too most probably in the first half of 2008.
The daily chart shows one directional wave (A) followed by wave (B), which seems to be a diametric pattern. This pattern has seven legs and has a bow-tie shape.
This pattern seems to be almost over and the next wave (C) has began. I expect this wave to be again a directional move. Right now one cannot predict which pattern will finally evolve in the entire rally from the bottom of August 2007.
Investment perspective
The diametric formation mentioned in the last paragraph has appeared on most of the indices viz. Sensex, Nifty, BSE-500, S&P CNX 500, etc. Structurally, the patterns in broader market indices like BSE-500 suggest much stronger up move. It means that the chances are high for mid caps and small caps to outperform large caps in this rally.
But, one should choose fundamentally sound stocks from these sectors that have not somehow participated in the earlier rallies of the Sensex. There are always a lot of manipulated stocks from these sectors, which attract public attention and become good traps to lose money.
The sectors that are looking good right now are banking, steel and power generation. But, I personally feel that finally it would turn out to be a broad based rally in which most of the sectors would participate.
Finally, those who are investing fresh money have to be very cautious in selecting the stocks. And for those who are already holding good stocks for long time, my advice is Lage Raho Munnabhai!
Year 2007 really turned out to be “The Year of the Bull” as I had mentioned in my last article on January 8, 2007 in The Smart Investor. I received numerous mails following the article stating that I am trying to fool investors by giving some unrealistic projections of the BSE Sensex (20,000 by December 2007).
But, the Sensex did hit the target and fooled all those who did not trust my Neowave analysis. The stock markets would go where they would like to irrespective of what you and me wish. I am just an interpreter of the patterns they form.
No doubt that my analysis goes wrong on a number of occasions, especially in the short term, but on the longer term charts, the patterns look less confusing and future projections become more reliable.
Right now, the pattern formed is suggesting that another huge bull run is impending. The technical analysis of this pattern has been discussed in the Technical outlook paragraph.
Even though year 2007 closed with a bang with the Sensex closing above the 20,000 mark, it was a rollercoaster ride for the indices over the year. The Sensex survived two major falls of over 2,000 points in February and July 2007 and managed to close near the all-time high.
Fundamental issues like crude oil prices, US sub-prime crisis, kept on producing ripples in global markets. Many analysts were worried about overstretched valuations at 14,000 level of the Sensex and continue to be worried at 20,000 level. Some are afraid of a bubble forming but, the markets are not ready to listen. If a bubble is going to form, you and me cannot stop it.
On the contrary, majority would not agree to the existence of such a bubble. The reason being a bubble is called a bubble only after it bursts. Everyone wants the bull markets to prevail for ever. But, since every bull phase is succeeded by a bear phase, one has to be very alert about exiting the market.
Technical outlook
The weekly chart of the Sensex shows that after a huge consolidation period (1992-2003) we are in a big bull run for almost last five years now. This rally is a large X-wave, which I had mentioned in my earlier articles also. A zigzag (A) – (B) – (C) pattern is the first part of this up move followed by a connecting pattern (X-wave).
This connecting wave is in the form of a running triangle that began in May 2006 and ended in August 2007. The presence of such a running triangle indicates tremendous upside potential for the Sensex. The calculations based on Neowave theory (By Glenn Neely) suggest that the breakout from such a triangle should be at least 1.618 times the largest leg of the triangle.
This puts the Sensex target at around 27,000 mark. The breakout could be as big as 2.618 times the largest leg, leading to a mind boggling figure of 39,000. Even if we keep aside this over-optimistic view, the target of 27,000 could be achieved and that too most probably in the first half of 2008.
The daily chart shows one directional wave (A) followed by wave (B), which seems to be a diametric pattern. This pattern has seven legs and has a bow-tie shape.
This pattern seems to be almost over and the next wave (C) has began. I expect this wave to be again a directional move. Right now one cannot predict which pattern will finally evolve in the entire rally from the bottom of August 2007.
Investment perspective
The diametric formation mentioned in the last paragraph has appeared on most of the indices viz. Sensex, Nifty, BSE-500, S&P CNX 500, etc. Structurally, the patterns in broader market indices like BSE-500 suggest much stronger up move. It means that the chances are high for mid caps and small caps to outperform large caps in this rally.
But, one should choose fundamentally sound stocks from these sectors that have not somehow participated in the earlier rallies of the Sensex. There are always a lot of manipulated stocks from these sectors, which attract public attention and become good traps to lose money.
The sectors that are looking good right now are banking, steel and power generation. But, I personally feel that finally it would turn out to be a broad based rally in which most of the sectors would participate.
Finally, those who are investing fresh money have to be very cautious in selecting the stocks. And for those who are already holding good stocks for long time, my advice is Lage Raho Munnabhai!
Thursday, January 3, 2008
Will mid-cap funds be the flavour of 2008?
With each passing year, it is increasingly difficult to pin-point an asset class that will outperform. A common investor runs into a complex set of variables that need to be factored in while making an informed investment decision.
However, let us restrict ourselves to a relatively less complex opportunity of investing in domestic mutual funds schemes that could be the best option available which could out perform(of course equity based) in the year 2008.
The consensus of majority of analyst is that the domestic infrastructure spending would continue through 2008 and beyond.
The huge gap between what India needs and the existing infrastructure is enough to put conviction behind the theory that power, ports, roads, airports and along with these the equipment manufacturing companies would be clear beneficiaries.
Exchange rate sensitive sectors like IT and Textiles would continue to suffer.
Interest rate sensitive sectors like banking and real estate sectors are likely to out perform as interest rates have picked and are likely to come down from here.
Keeping in mind the above reasoning the mutual fund schemes one would expect to do reasonably well during 2008 include:
1. ICICI Prudential Infrastructure Fund, a thematic fund that benefit out of infrastructure themes, where five top sectors are oil and gas, power & transmission, steel, securities and banks.
2. Reliance Diversified Power Fund, a sector fund investing only in power and energy related companies.
3. Sundaram BNP Paribas Capex Opportunity Fund, which has a significant exposure to mid-cap plays and would benefit from capex spending.
4. Sundaram BNP Paribas select focus, a large cap play with focused approach to few selected companies.
5. SBI magnum Global fund, a mid-cap fund with higher exposure to housing and construction, metals, engineering, electrical equipment and software.
It must be noted that some of these schemes can be highly volatile due to their inherent portfolios.
Considering the valuations of some of the large caps and to sustain the pace of growth, I believe, make 2008 the year of mid-caps.
Don’t miss out on them
Happy mid-cap investing in 2008
However, let us restrict ourselves to a relatively less complex opportunity of investing in domestic mutual funds schemes that could be the best option available which could out perform(of course equity based) in the year 2008.
The consensus of majority of analyst is that the domestic infrastructure spending would continue through 2008 and beyond.
The huge gap between what India needs and the existing infrastructure is enough to put conviction behind the theory that power, ports, roads, airports and along with these the equipment manufacturing companies would be clear beneficiaries.
Exchange rate sensitive sectors like IT and Textiles would continue to suffer.
Interest rate sensitive sectors like banking and real estate sectors are likely to out perform as interest rates have picked and are likely to come down from here.
Keeping in mind the above reasoning the mutual fund schemes one would expect to do reasonably well during 2008 include:
1. ICICI Prudential Infrastructure Fund, a thematic fund that benefit out of infrastructure themes, where five top sectors are oil and gas, power & transmission, steel, securities and banks.
2. Reliance Diversified Power Fund, a sector fund investing only in power and energy related companies.
3. Sundaram BNP Paribas Capex Opportunity Fund, which has a significant exposure to mid-cap plays and would benefit from capex spending.
4. Sundaram BNP Paribas select focus, a large cap play with focused approach to few selected companies.
5. SBI magnum Global fund, a mid-cap fund with higher exposure to housing and construction, metals, engineering, electrical equipment and software.
It must be noted that some of these schemes can be highly volatile due to their inherent portfolios.
Considering the valuations of some of the large caps and to sustain the pace of growth, I believe, make 2008 the year of mid-caps.
Don’t miss out on them
Happy mid-cap investing in 2008
Monday, December 31, 2007
SEBI's New Year Gift to Investors
At last it has happened. 3 cheers for SEBI and Mr. Damodaran.
We have tried to make 2008 happier for mutual fund investors,” is what SEBI chairman M Damodaran had to say on the last day of 2007. Beginning January 4, 2008, mutual funds investors will not have to pay entry load if they buy funds directly from mutual fund companies. Such purchases can be made either through the internet, or through applications submitted directly to the AMCs or their investor service centres.
The load waiver would also be applicable to additional purchases done directly by the investor under the same folio and switch-ins to a scheme from other schemes.
A majority of mutual funds charge 2.25 per cent entry load for their equity schemes, which is used to pay for the commission of the agents and distributors and meet other marketing and distribution expenses.
These changes were first proposed by SEBI back in August 2007.
Wishing all a very happy and prosperous new year.
Wadiaz
We have tried to make 2008 happier for mutual fund investors,” is what SEBI chairman M Damodaran had to say on the last day of 2007. Beginning January 4, 2008, mutual funds investors will not have to pay entry load if they buy funds directly from mutual fund companies. Such purchases can be made either through the internet, or through applications submitted directly to the AMCs or their investor service centres.
The load waiver would also be applicable to additional purchases done directly by the investor under the same folio and switch-ins to a scheme from other schemes.
A majority of mutual funds charge 2.25 per cent entry load for their equity schemes, which is used to pay for the commission of the agents and distributors and meet other marketing and distribution expenses.
These changes were first proposed by SEBI back in August 2007.
Wishing all a very happy and prosperous new year.
Wadiaz
Saturday, December 29, 2007
DO NOT FORGET ASSET ALLOCATION
Rising equity markets can have a strange impact on investors. They become overconfident as far as their investment abilities are concerned. As a result, they often end up getting invested in avenues that they should avoid and end up taking on more risk than they should. Another impact of rising markets is that investors develop a myopic vision. For example at present, most investors refuse to touch a non-equity product even with a barge pole.
Let’s travel back in time to the year 2003 when monthly income plans (MIPs) were the season’s flavour. While the reasons for the popularity enjoyed by MIPs then are debatable, their utility isn’t, especially in a scenario like the present one. For a moderate risk-taking investor who is willing to take on marginally higher risk, MIPs offer the opportunity to clock higher returns vis-à-vis debt fund investments. Conversely, for a high risk-taking investor, MIPs offer the opportunity to incorporate a degree of stability in an equity portfolio. Sadly, a product that can value to the portfolio has been pushed to the sidelines.
This brings us to a more serious topic. By investing only in equity-oriented products, many investors have landed up with lop-sided portfolios. As a result, their asset allocation has been compromised with. And over longer time frames, it is asset allocation which can help investors not just safeguard their portfolios on the downside, but also create wealth.
By diversifying across assets, investors give their portfolios the flexibility to counter market uncertainties. Sadly, it is rather difficult to appreciate the importance of asset allocation in times like now, when equity markets have surged northwards almost consistently. In fact, asset allocation might be seen as a hindrance, since being fully invested in equities seems like a surefire method to clock impressive growth. However, it takes adversity (in this case, a sharp fall in equity markets) to fully appreciate the benefit of holding a portfolio populated by several assets.
My advice to investors – don’t get caught on the wrong foot by being invested in only one asset class (read equities) and ignoring asset allocation. Hold a portfolio comprised of various assets like fixed income instruments, real estate and gold, alongside equities. Obviously the allocation to each asset will depend on your risk profile and investment objectives. This is where a competent investment advisor will have an important role to play.
Let’s travel back in time to the year 2003 when monthly income plans (MIPs) were the season’s flavour. While the reasons for the popularity enjoyed by MIPs then are debatable, their utility isn’t, especially in a scenario like the present one. For a moderate risk-taking investor who is willing to take on marginally higher risk, MIPs offer the opportunity to clock higher returns vis-à-vis debt fund investments. Conversely, for a high risk-taking investor, MIPs offer the opportunity to incorporate a degree of stability in an equity portfolio. Sadly, a product that can value to the portfolio has been pushed to the sidelines.
This brings us to a more serious topic. By investing only in equity-oriented products, many investors have landed up with lop-sided portfolios. As a result, their asset allocation has been compromised with. And over longer time frames, it is asset allocation which can help investors not just safeguard their portfolios on the downside, but also create wealth.
By diversifying across assets, investors give their portfolios the flexibility to counter market uncertainties. Sadly, it is rather difficult to appreciate the importance of asset allocation in times like now, when equity markets have surged northwards almost consistently. In fact, asset allocation might be seen as a hindrance, since being fully invested in equities seems like a surefire method to clock impressive growth. However, it takes adversity (in this case, a sharp fall in equity markets) to fully appreciate the benefit of holding a portfolio populated by several assets.
My advice to investors – don’t get caught on the wrong foot by being invested in only one asset class (read equities) and ignoring asset allocation. Hold a portfolio comprised of various assets like fixed income instruments, real estate and gold, alongside equities. Obviously the allocation to each asset will depend on your risk profile and investment objectives. This is where a competent investment advisor will have an important role to play.
Thursday, December 27, 2007
Real Estate Investment Trusts (REIT)
“Real estate is an asset class that has grown rapidly. Why keep the small man out because he does not have money to buy land?” Said SEBI chief Mr. Damodaran.
The decks have been cleared for the launch of the real estate investment products in the market.
The last hurdle had been cleared with the Association of Mutual Fund Industry and the Institute of Chartered Accountants of India having firmed up the valuation norms for these products, he said. “We should be able to clear the guidelines soon. Our expectation is that in the next couple of months, we should be able to streamline it.”
Explaining the process, he said that these two bodies looked at whether it was possible at all to accord a valuation and the frequency with which one needed to do it. Valuation, almost on a continuing basis, is needed as people enter and exit schemes on a regular basis.
However, the ultimate test for whether ‘REITs’ will succeed will be the taxation treatment. Those markets that have not given favourable tax treatment to REITs, the product hasn’t taken off because you need to see the capital gains angle, he said. In some jurisdictions that have welcomed this product, notably the US to begin with and later the Asian markets, the product has taken off as the tax treatment was favourable.
So, while the product will be available, the additional attractiveness of the product by way of appropriate tax treatment is something that the Ministry of Finance will have to decide, he said.
“Should that happen, I think the way the real estate is growing in this country, this is going to be not just an attractive product, but I think it will bring some discipline into this (real estate) industry.
The decks have been cleared for the launch of the real estate investment products in the market.
The last hurdle had been cleared with the Association of Mutual Fund Industry and the Institute of Chartered Accountants of India having firmed up the valuation norms for these products, he said. “We should be able to clear the guidelines soon. Our expectation is that in the next couple of months, we should be able to streamline it.”
Explaining the process, he said that these two bodies looked at whether it was possible at all to accord a valuation and the frequency with which one needed to do it. Valuation, almost on a continuing basis, is needed as people enter and exit schemes on a regular basis.
However, the ultimate test for whether ‘REITs’ will succeed will be the taxation treatment. Those markets that have not given favourable tax treatment to REITs, the product hasn’t taken off because you need to see the capital gains angle, he said. In some jurisdictions that have welcomed this product, notably the US to begin with and later the Asian markets, the product has taken off as the tax treatment was favourable.
So, while the product will be available, the additional attractiveness of the product by way of appropriate tax treatment is something that the Ministry of Finance will have to decide, he said.
“Should that happen, I think the way the real estate is growing in this country, this is going to be not just an attractive product, but I think it will bring some discipline into this (real estate) industry.
Tuesday, December 25, 2007
Can I still make money
There is never a good time to enter the market. Neither is there a bad time. One just has to be consistent and disciplined.
It is the discipline that pays off in the long run, not timing. ‘Buy low, sell high’ sounds great on paper but is rarely successful in reality because investors want to ‘buy lowest and sell highest’. And that is virtually impossible. Do not invest in stocks, sectors and funds you do not understand. And if you do not have the time or inclination to get educated on your investments, stick to handful of equity diversified or balanced funds.
Invest regularly via systematic investment plan (SIP) of a mutual fund. An SIP is best for a period of at least 3 years and not just one year, as most investors tend to opt for. The longer the time frame over which you distribute your investment, the better it is for you. During this time ignore all the ups and downs and corrections and invest consistently. Equity was, is and always will be long-term game. One needs to stay put and ride the ups and downs of the market. Don’t let the market frenzy lure you in to irrational decisions. When the frenzy dies down, you will be much better off by having kept your cool and sticking with your investments.
My advice: Be an India bull.
Now I would like to share with you my real experience on the ‘irrational behavior’.
In the month of December 2004, I invested in UTI infrastructure fund dividend payout (it was known then as basic industries fund) after analyzing the infrastructure boom that was likely to happen in India. The fund corpus at that time was somewhere around 60 crores and NAV 13 or there about. As the time went by, the fund was doing quite well and had given me dividend too. Then one day I read an article about thematic funds and whether one should invest in such schemes or not. This created a doubt in my mind (My analysis of Infrastructure boom in India went out of the window) whether I had taken a correct decision or not? The doubt started growing in my mind as I read more of such stories. Then came the crash of May 2006 and just before that I redeemed the whole holding of this fund. I still do not know for sure why I did that and the rest is history. If I had stayed invested in this fund, today I would have reaped rich dividends by sticking with my convictions.Moral of the story: Be long term greedy and go with your convictions
It is the discipline that pays off in the long run, not timing. ‘Buy low, sell high’ sounds great on paper but is rarely successful in reality because investors want to ‘buy lowest and sell highest’. And that is virtually impossible. Do not invest in stocks, sectors and funds you do not understand. And if you do not have the time or inclination to get educated on your investments, stick to handful of equity diversified or balanced funds.
Invest regularly via systematic investment plan (SIP) of a mutual fund. An SIP is best for a period of at least 3 years and not just one year, as most investors tend to opt for. The longer the time frame over which you distribute your investment, the better it is for you. During this time ignore all the ups and downs and corrections and invest consistently. Equity was, is and always will be long-term game. One needs to stay put and ride the ups and downs of the market. Don’t let the market frenzy lure you in to irrational decisions. When the frenzy dies down, you will be much better off by having kept your cool and sticking with your investments.
My advice: Be an India bull.
Now I would like to share with you my real experience on the ‘irrational behavior’.
In the month of December 2004, I invested in UTI infrastructure fund dividend payout (it was known then as basic industries fund) after analyzing the infrastructure boom that was likely to happen in India. The fund corpus at that time was somewhere around 60 crores and NAV 13 or there about. As the time went by, the fund was doing quite well and had given me dividend too. Then one day I read an article about thematic funds and whether one should invest in such schemes or not. This created a doubt in my mind (My analysis of Infrastructure boom in India went out of the window) whether I had taken a correct decision or not? The doubt started growing in my mind as I read more of such stories. Then came the crash of May 2006 and just before that I redeemed the whole holding of this fund. I still do not know for sure why I did that and the rest is history. If I had stayed invested in this fund, today I would have reaped rich dividends by sticking with my convictions.Moral of the story: Be long term greedy and go with your convictions
Friday, November 23, 2007
Building your own portfolio
While mutual funds are popular and attractive investments because they provide exposure to a number of stocks in a single investment vehicle, too much of a good thing can be a bad idea.
The addition of an increasing number of funds simply creates an expensive index fund. This notion is based on the fact that having too many funds negates the impact that any single fund can have on performance, while the expense ratios of multiple funds generally add up to a number that is greater than average. The end result is that expense ratios rise while performance is often mediocre.
Although there are hundreds of mutual fund offering in Indian mutual fund industry, there's no magic number for the "right" number of mutual funds in a portfolio. Despite the lack of agreement among the professionals regarding how many funds are enough, nearly everyone agrees that there is no need for dozens of holdings. In fact, even many mutual fund houses are now promoting life-cycle funds, which consist of a mutual fund that invests in multiple underlying funds The concept is simple: pick one life-cycle fund, put all of your money into it, and forget about it until you reach retirement age. These funds, also referred to as "age-based funds"(Fund of funds20-30-40-50) have an intrinsic appeal that's hard to beat.
If you prefer to build your own portfolio, there are simple steps you can take to limit the number of funds in your portfolio while still feeling comfortable with your holdings. It begins by considering your objectives. If income is your primary goal, that international fund may not be necessary. If capital preservation is your objective, a mid-cap fund may not be needed either.
Once you've determined the mix of funds that you wish to consider, compare their underlying holdings. If two or more funds have significant overlap in holdings, some of those funds can be eliminated. There's simply no point in having multiple funds that hold the same underlying stocks.
Next, look at the expense ratios. When two funds have similar holdings, go with the less expensive choice and eliminate the other fund. Every rupee saved on fees is one more rupee working for you. If you are working with an existing portfolio rather than building one from scratch, eliminate funds that have balances that are too small to make an impact on overall portfolio performance. If you've got four large-cap funds, move the money to a two best performing funds. The amount spent on management-related expenses is likely to decrease and your level of diversification will remain the same.
Happy Investing.
The addition of an increasing number of funds simply creates an expensive index fund. This notion is based on the fact that having too many funds negates the impact that any single fund can have on performance, while the expense ratios of multiple funds generally add up to a number that is greater than average. The end result is that expense ratios rise while performance is often mediocre.
Although there are hundreds of mutual fund offering in Indian mutual fund industry, there's no magic number for the "right" number of mutual funds in a portfolio. Despite the lack of agreement among the professionals regarding how many funds are enough, nearly everyone agrees that there is no need for dozens of holdings. In fact, even many mutual fund houses are now promoting life-cycle funds, which consist of a mutual fund that invests in multiple underlying funds The concept is simple: pick one life-cycle fund, put all of your money into it, and forget about it until you reach retirement age. These funds, also referred to as "age-based funds"(Fund of funds20-30-40-50) have an intrinsic appeal that's hard to beat.
If you prefer to build your own portfolio, there are simple steps you can take to limit the number of funds in your portfolio while still feeling comfortable with your holdings. It begins by considering your objectives. If income is your primary goal, that international fund may not be necessary. If capital preservation is your objective, a mid-cap fund may not be needed either.
Once you've determined the mix of funds that you wish to consider, compare their underlying holdings. If two or more funds have significant overlap in holdings, some of those funds can be eliminated. There's simply no point in having multiple funds that hold the same underlying stocks.
Next, look at the expense ratios. When two funds have similar holdings, go with the less expensive choice and eliminate the other fund. Every rupee saved on fees is one more rupee working for you. If you are working with an existing portfolio rather than building one from scratch, eliminate funds that have balances that are too small to make an impact on overall portfolio performance. If you've got four large-cap funds, move the money to a two best performing funds. The amount spent on management-related expenses is likely to decrease and your level of diversification will remain the same.
Happy Investing.
Sunday, November 4, 2007
Wealth Management for NRI's
Hi, all bloggers out there.
I have just created my blog to help and create steady wealth by introducing you to the India growth story and be a part of it. Do not feel left behind and enjoy the rich benefits India is offering to all of us. I can be your unbiased financial advisor with a small price, but rest assured by the time the whole portfolio building is over, one can see the fabulous above inflation returns it will generate.
if confused and want to enhance your returns, please contact me through this blog or call 0507886539
Happy Investing.
Wadia
I have just created my blog to help and create steady wealth by introducing you to the India growth story and be a part of it. Do not feel left behind and enjoy the rich benefits India is offering to all of us. I can be your unbiased financial advisor with a small price, but rest assured by the time the whole portfolio building is over, one can see the fabulous above inflation returns it will generate.
if confused and want to enhance your returns, please contact me through this blog or call 0507886539
Happy Investing.
Wadia
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