Saturday, June 18, 2011


( This appeared in a recent issue of Moneylife)

Our stock markets seem to have stuck in a range. It neither breaches the 20 thousand mark on the BSE Sensex convincingly nor falls low enough to make buying attractive. Corporate results being announced for the full year ended March 2011 seem to be in line with market expectations. Negative voices, expressing concern on the valuations as well as the possibility of more attractive opportunities elsewhere, do not seem to have dampened the cash coming in to our markets.
Valuations are rich, pricing in growth in earnings of over twenty-five percent year after year. Inflation is sticky and refuses to come down. Gold, silver, crude and global stocks are all moving up. Some metals have lost lustre, but overall, the mood is without any caution.
As I write this, there is news out that Mr KV Kamath is taking over as Chairman of Infosys. This company deserves a relook for reasons other than valuation. This decade would perhaps see the exit of its original team of founders and no dominant shareholder. Someone large enough could perhaps make a takeover attempt on it. I would like to keep an eye out for companies where families are likely to sell out. Mergers and takeovers are not possible in the Indian context unless there is a willing seller. Or else look for companies like an Infosys or a L&T where there is no dominant ownership.
The other thing that is likely to keep valuations in check is the Central Bank’s actions that would make borrowing unreasonably expensive. Instead of attacking inflation from the supply side (a long term solution rather than a quick fix one) the Central Bank is trying to make borrowing more expensive. This is precisely the wrong thing to do. This will make capital spending more expensive and lead to postponement of projects. Sectors like construction will get hit badly. So, the Central Bank will contribute its bit in keeping profit growth down for many Indian companies.
FMCG and MNC companies continue to do exceedingly well. They are likely to do better, but stocks in this pack are not exactly cheap. Capital goods and labour intensive sectors are seeing pressure on their operating margins as increasing wage costs become a concern. Service sectors like banking and IT are facing a shortage of competent people and are managing to add headcount by compromising on quality of people.
All in all, there is reason to believe that things look ok, but no runaway upside is visible.
So, what can cause a downslide in our markets? Clearly fundamentals do not matter, given the fact that our markets are driven by the inflow / outflow of FII money. Political crises and corruption clearly do not worry the institutional investor. Otherwise how else does one explain the fact that stocks of companies, whose key executives have been put behind bars, continue to trade at not so cheap valuations? It is clearly an indicator that the market participants do not think much of governance issues.
Gold and silver continue to defy gravity and head in to bubble territories. The excess currency supply in the world and the weakness in the global economy are making people run away to gold and silver. The global economy seems to show some signs of recovery, but the withdrawal of stimuli would surely dent global growth. On top of that, the rating agencies are threatening to downgrade US and Japan. Food inflation is clearly a global concern. US is facing the twin issues of jobless growth and a declining currency.
In all these worries, the global stock markets are strong. Clearly a case of excess money in the world that is trying to find havens of safety and some money chasing higher returns from riskier markets like India or Brazil.
So, logic and reason seem to be clearly not a driving factor for the global equity markets. It seems more like a case of too much money going around and no one wanting to miss a party if it happens. Everyone is willing to pitch tent and wait it out.
In such a context, where global money flows in to our markets are robust, a significant downside may not happen. Many investors seem to be wanting a significant downside, so that it becomes a buying opportunity. The markets seem to be testing them. The BSE Sensex seems to get stuck in a groove, refusing to decisively cross 20 thousand. At the same time, it falls by a couple of thousand points in a couple of weeks, then recovers back to the 19 thousand plus level! This market is surely not good for domestic mutual funds, which would underperform in this kind of a market, due to sitting on cash and not having conviction to be fully invested at these valuations. Mid cap funds have had their own roller coaster ride, with steep falls followed by sharp recoveries.
In this market, the best is to keep new money away from the equity markets. Fixed income still offers around nine to nine and a half percent yield. That takes care of a near 2000 point rise in the BSE Sensex over one year. Sure, does not satisfy greed and perhaps may not beat inflation, but could help to save on any significant downside if the FII’s ( some of it could be Indian money illegally routed through the FII route) decide to take a powder.

IDR- An idea too soon for India

Standard Chartered Bank had issued the first 'Indian Depository Receipts'. Given the capital controls, it is clearly too soon. Typically, arbitrageurs got in and tried to bully the regulator. A debate on both sides was published by Business Standard, a bus newspaper. For once, I was happy to take the side of the regulator.
Here it is

Saturday, June 11, 2011

Investors prefer Bonds

(This appeared in the recent issue of Moneylife)

Investors are facing a dilemma. The capital markets are perhaps going through a kind of ennui. Perhaps Rip Van Winkle will go to sleep, wake up, find the markets at the same level and carry on without even realising that a couple of decades have gone missing.
Investment in equities, according to all experts, would give an annualised fifteen percent return over the long term. This is on the premise that our economy would sustain a growth rate of eight to ten percent year on year and inflation would be under around five to six percent per annum. The unfortunate aspect of this is that timing matters. For each investor, what matters is the time he puts his money and the time he cashes in his chips. This can take your returns from zero to fifty, depending on your luck, and the timing of your investments. Of course, one can theoretically smoothen it out with regular investments etc., The fact of the matter is that each one of us wakes up at different times in our lives and money for investment gets ear marked, at different stages in each one’s lives. Someone may start at thirty and someone at fifty. And many never start.
Inflation continues to be a bugbear and will likely stay at near double digits in the foreseeable future. Much as our RBI tries, its policies make no dent in inflation. Perhaps RBI actions are adding to inflation. Whatever be the case, the fact is that inflation with economic growth is better than no inflation and no growth.
These monetary policy measures have thrown up an investment opportunity. We are bombarded with SMS and mails about bank FD’s that are offering ten to eleven percent annual interest. Most offer these for a year or two. The hope is that interest rates at some point would start cooling off. If they don’t then we are headed towards very interesting times (also called as ‘stagflation’ or stagnating growth with rising prices). I would like to believe the former.
In these times, we are seeing some companies raise money through long term bonds (five to ten years or more duration) and some very aggressive instruments. For instance, Tata Steel raised nearly Rs.1500 cr by way of ‘perpetual’ bonds. In essence, it means no repayment ever, unless the company is wound up. The bonds carry a ‘coupon’ interest rate of 11.80% p.a, payable every six months. Tata Steel has also put in a clause ( a ‘call’ option) which enables them to repay (at their instance alone) at the end of ten years the principal in full. In case they choose not to repay at the end of ten years, the interest rate gets automatically revised to 14.80% p.a!!
Alas, the company did not make a retail issue. It placed all the bonds with insurance companies, funds, banks and other wholesale merchants. The bond is listed on the exchanges and is ‘traded’ on the exchanges (BSE, I think). So, now one has to pay a price of anything between Rs.107 or thereabouts (a premium of Rs.7/-) to buy it. Even after paying this premium, it works out to a yield of 11% p.a. if one assumes a ten year repayment. If there is no repayment, the simple yield would be 11.80 on every 107 (or whatever price one pays) .
This compares very well with FD’s or FMP’s. In fact, if I am bullish on India, surely interest rates would come off. So, I am getting a great opportunity to lock in to a high yield for ten years! And I would sincerely pray that at the end of the tenth year, the company gets in to some problems which would make repayment impossible and the bond gets in to the 14.80% percent interest. Today, when I put money in FD or FMP, the duration is short (one to three years) and after that the returns may not be so attractive. Currently, the FMP enjoys a tax arbitrage, which would vanish post end June 2011.
I have give the example of Tata Steel bonds due to its attractive features. There are other instruments with varying yields available. The sad thing about these bonds are its lack of pricing transparency. Stocks have abandoned the concept of ‘market lots’, but bonds continue to have ‘minimum’ trade sizes. The Tata Steel bonds are traded in single deal sizes of five lakh rupee face value of bonds.
It is imperative that the regulators remove these stupid ‘ticket’ size considerations for the debt instruments. Only then will the debt markets expand. So would awareness. Today, the entire debt market is like a ‘black’ box.
The other interesting thing is that there is no TDS on the interest that would come to the investor in bonds. These are in demat form, so easier to manage also.
Once interest rates start to move up, the prices of these bonds would go up. So, after a year, if the interest rates go down by half a percent, the price of the bond would go up by nearly three rupees (in the Tata Steel example). So over a one year period, you would have got a return of nearly fourteen to fifteen percent! Of course, the risk is that the prices can go down further if the interest rates keep rising. In which case, one continues to enjoy the interest rate on the instrument.
The instrument like that of a Tata Steel would be a bad one if at the end of ten year (at the tenth anniversary of the bonds) the economy is in such a bad shape that interest rates go up to 18 or 20 percent per annum. So, best not to put everything in these kind of instruments, but a fair part of one’s portfolio that is earmarked for low risk, predictable return portfolio.


(A piece I had written for an investor magazine)

The economic outlook seems cloudy. Not so cloudy that we are in the dumps, but just the fact that double digit growth in GDP now looks like a tough ask. Everyone seems to be now on a seven to eight percent band for the immediate couple of years. What this means is that our equity markets are likely to remain range-bound for longer than we think. Whilst we could see some extreme volatility in the near term based on funds flows from the FII universe, the upside seems to be kind of capped.
Of the many worries, interest rate worry seems to be one that is dampening corporate profit growth. We are seeing a large number of companies offering rates in excess of eleven percent per annum for long dated borrowings. To me, this is perhaps a good opportunity. I look at it this way. The corporate is raising money at over eleven percent for ten years. In essence, it gives me a great opportunity to lock in some money at this kind of a rate. Of course, I will go wrong if inflation and interest rates keep rising significantly. Is that likely? Perhaps there would be one more round of misguided interest rate hike by the Reserve Bank of India. After that there has to be a lull and hopefully a decline in interest rates. This lowering or falling in interest rates will not happen only if we see economic growth of India slipping dramatically over the next few years. I think that India will grow at over seven percent, irrespective of politics. About double digits, I am not sure. If this has to happen, we need lower interest rates.
So, coming back to these bonds and other long dated debt instruments, it is great to put in some money at this juncture. There is a twofold gain here:

i) If interest rates remain high, equity is going to be in the dumps. We lock in a sure and reasonably attractive yield on the debt instrument (above 11% p.a. for ten years or so, without any re-investment risk);
ii) If interest rates fall, then the values of the papers we buy now increase. For instance, in a ten year bond, a quarter percent decline in interest rates would mean a capital appreciation of over one rupee in the debt paper that we buy today. (When interest rates fall, the price of bonds go up and vice versa)
I think debt may be the best place over the next six months to a year, for investors.
Bonds are better in one another way. Many of us are used to the Fixed Maturity Plans (FMP) of the mutual funds. Post June 30th, the change in the tax regime will rob the tax attractiveness of FMP. Bonds would be better. The other thing is that in most of the bonds, there is no tax deducted at source (TDS), which helps with a better cash flow.
Bank deposits are also attractive, but give a lower return than bonds. Another thing is that we cannot get to lock in the rate of interest for ten years in bank deposits.
Whilst talking about bonds, many people will tell you that it is ‘secured’. This means absolutely nothing so far as timely repayment is concerned. We have hardly seen a company having any assets left, when it comes to a stage of default. Rather, let us remain focused on the quality of paper we buy. Good names and a high credit rating are important whilst buying bonds, unless one is comfortable with a higher risk. The key is to be focused on risk, since a bond could be for ten years, and in ten years, a lot can happen.
The bonds can be held in demat form, which makes it easier to handle. Interest is generally payable at half yearly intervals.
Bonds are generally listed and tradable. There is a secondary market for this. In an emergency, one can always sell it through the secondary market. And unlike equity, the price changes in the bonds are not extreme. A full one percentage change in interest rate would equate to a change of around five rupees, on a ten year bond with a coupon of eleven percent. So, the risk to capital is modest, should one have to exit before maturity.
There will be many papers available and it would be good to pick up some in the next two to three months. For, when the interest rates start moving down, the yields on these bonds will start to fall, correspondingly.