Elections - Buy or Sell? And some thoughts on savings & investments

BUY TODAY, SELL TOMORROW- MAKE HASTE It is that time of the year when everyone will suggest revisiting your portfolio and investment themes. However, I do not believe in this ritual that is marked by a change in the calendar. Why should it matter so long as things are going as planned? And if things are not going right, why should I wait for the year to get over or another one to begin? Investment strategies should be not change unless there is something wrong with what one is doing. Investment strategies can get aggressive (buying riskier assets like equities) or get passive (keeping money safe against erosion of nominal principal) depending on circumstances and events. If someone tells me to ‘rebalance' simply because it is that time when one throws away an old calendar and gets a new one, it does not make sense to me.

When one starts off on the journey to ‘invest’, I am sure that there is some inkling of risk and return. And I also maintain that ‘investment’ is the second stage in financial accumulation. The first stage is ‘savings’. The ‘savings’ allocation is free of risk and does not warrant any change unless there are dramatic shifts in inflation or interest rates. In this we will have several things like our provident fund and or PPF, bonds, bank deposits etc. We are simply building our first line of defence. We have kept for ourselves a fixed goal of reaching a certain corpus by a date. So this does not get disturbed.

After having crossed that, I am looking at real estate, equities etc. These are tactical allocations and whilst it is great to keep buying these as much as possible till as long as possible, economic and political events dictate higher or lower level of buying of these assets. Typically, one would have some portion of money that is waiting to find the right asset.

Buying assets for keeps necessarily means having to wait for a ‘right’ price. There is no formula for this as far as real estate is concerned. However, for equities, one can define and work out prices at which we can buy and prices at which one should sell. Neither prices last forever nor do markets generally move in a narrow range. Thus, it would be ideal if I could buy more when prices are low and less when prices are high. Alas, none of us are expert enough to forecast the market trends accurately. I generally advocate people to buy a select bunch of stocks at consistent intervals and keep accumulating them for ten to twenty years.

There are those of us who keep dabbling in equities without any specific thought. It is more of a ‘herd’ mentality. Many of us got enamoured of equities in 2008 and then swore off it in 2009. And finally exited in 2013 when the index looked very similar, without bothering about value or price.

I am sure history repeats itself. Very soon, we will see another build up in our markets as the general elections come closer. One likely scenario that is being painted by everyone is that we could see a government headed by Modi. Markets will make him out to be the panacea for all ills and everything in the stock markets will seem to get better once he takes charge. So, logically once should be expecting a new surge in the markets till the elections are over.

By that time, a lot of expectations would have been built in to the market. Next, the results will come. Results may be as per expectations. Now the markets will not run up much more. Markets will have to wait some time to see expectations being met and nothing can positively surprise. The risk of disappointment is higher. Let us call this Scenario A. There other outcome is that UPA could cobble together a third term. In which case, all the positive build up would lose steam and the markets would correct sharply and then get driven by what the UPA will do. As of now, if UPA 3 happens, the markets would be greatly disappointed. Let us call this Scenario B.

Scenario C would be a third front- Ugly from the stock market perspective and cause a huge fall.

So, in short, whatever be the scenario, it makes sense to sell off stocks on the day votes are getting counted or just a day before the polls, to cater to exit poll opinions.

This is simply a ‘trading’ idea. Markets are not predictable, but what I have outlined is my take on the probabilities. January 1st , 2014

Aam Aadmi Party- Today is an important day in India's history

Politics in India takes an interesting turn today. Aam Aadmi Party, the new hope on the horizon, takes control of the Delhi Assembly. There is a lot of hope and expectations from many. No one gave AAP a chance. The coming of age of AAP is clearly an indication of the level of frustration of the public with the corruption and mis-governance of the existing parties.

The coming to power of AAP, without a clear majority is interesting. BJP, the party with the most number of seats, is a sore loser and will be in the usual role of opposition. The Congress, with a handful of seats supports the AAP!! Interestingly, AAP is quite vocal against both Congress and BJP.

An interesting strategy from the Congress. Maybe they want to show how 'responsible' they are and how they are willing to listen to the people. In all probability, the Congress support may last till the outcome of the general elections. And if they do badly and BJP does well, they may continue the support. If they do better than is commonly expected, they could pull out.

BJP has ended up as the biggest loser in the Delhi game. First they wanted power. Upset at AAP being the reason for their not getting a clear majority in Delhi, they now look at AAP as a bigger enemy than Congress!!

For citizens across the country, AAP brings forth new hopes.

AAP, however, is perhaps surprised by its own success. A few slogans against corruption and the involvement of citizenry has left them without a proper workable manifesto. The manifesto they now have is quite lame- slashing power bill etc. They need to articulate some economics quite soon. And realise that governance is more important than merely talking about governance.

Everyone will be keenly watching this experiment. And has given a new hope to hardened sceptics like me, that we could have a government that does not include the congress and the BJP. Both parties are virtually the same, though the BJP states that the Congress had a longer tenure to ruin the nation.

Unfortunately, in the last five years, BJP has done absolutely nothing. Just boycotted parliament. Nothing remedial has been suggested. The campaign speeches of their leaders, including Mr Modi, have merely been anti-Congress, anti-dynasty lectures. Nothing about what they intend to do has been spelt out. And the infighting at the top is not over at all.

I write this, presuming that Aam Aadmi Party is accepting the proposal to rule Delhi.

The way AAP has gone about consulting people at this stage, perhaps is an indication that they will do so when it comes to any big issue. That is welcome and refreshing.

2014- Some thoughts on preserving money

2014- HOLD YOUR HORSES

2014 does not look very exciting, from an investment perspective. The focus of the world seems to be more on what is referred to as ‘tapering’ and what the implications are. In India, the tempo will build up to the coming general elections in the middle of the year. The global economy looks as shaky as before, except for the surge in liquidity everywhere.

2013 is ending with our stock market indices at near all time highs. However, the indices hide the fact that the markets have become extremely polarised. High quality has become unaffordable from an investment perspective and poor quality stocks are now catching up. The mid caps are still way behind their highs. Banks are sitting on record levels of doubtful credit and ways will be found to change the label.

PSU stocks seem to have found more scepticism as the government seems to be helplessly torn between populism and inactivity on the economic reform front.

Politics has become very predictable. Irrespective of what happens at the centre, there is unlikely to be any big change in the economic outlook or policies. If the UPA goes and NDA comes, we can expect no better. Every reform measure has been opposed by the NDA in the current term and should they come to power, do not expect anything different. It is only the ‘expectation’ of change that could provide some altitude to the markets.

As 2013 draws to an end, the inflation linked bonds are being launched. A welcome initiative, but with a lot of ifs and buts about the tax implications a full throated endorsement to invest is not possible. It may be good for those in the non tax-paying bracket. The moot point is whether they have money enough to invest. A small asset allocation to the bonds would be useful, should there be an undesirable coalition that will push inflation through the roof. Should a third front take charge at the centre, expect mayhem on the financial markets.

I would keep my liquidity intact. I do not see many great investment opportunities in equities at the present juncture. I would keep my eyes peeled for any event based price action that could bring some good stocks to a buying level. The stock markets did not do much, if we measure point to point. However, the volatility threw up a lot of opportunities. If one had discipline to have a laundry list of stocks to buy, at prices that provided some safety, 2013 provided many opportunities in quality stocks and some select mid caps.

Gold had a terrible year, though Indian investors were cushioned to a large extent by one of the sharpest annual depreciation in the rupee.

2014 is going to be interesting. The Chinese New Year in 2014 will herald the beginning of the “Year of the Horse”. The stock markets clearly personify that. We all know that one horse will win, but no one knows at the start about which one it is going to be. If we look at corporate earnings, the first two quarters of 2013-14 have been the worst in over a decade. One way to look at it is that things can only get better from here.

Foreign exchange earners are going to be the preferred choice for 2014. IT for sure looks good. Avoid the trap of falling in to commodity exporters or rice, jewellery etc. Capital goods are best avoided, though there could be a selling opportunity once the new government comes in to power. I clearly do not see government finances being able to afford populism and development expenditure out of its budget. Our fiscal position is not all that great and the impact of government freebies is going to be severe in the years to come.

Look for companies with no debt, steady domestic market and reasonably clean management. Do not increase allocation to equities or re balance etc simply because the year is changing. Asset allocation should also be a function of relative price to value of assets. Do not spend time worrying about ‘tapering’. It is more important to see whether the company we choose will make more money or less money and with what level of certainty.

MUTUAL FUND ROUTE TO EQUITIES- DO NOT IGNORE SIP ROUTE

Investing in equities has always been a matter of considerable debate. We look at the indices and draw quick conclusions. For instance, we saw the BSE Sensex at 20,000 in 2008 and in 2013 we are still there. So we conclude that equities did not give us returns. This happens to us because this is a measure from one fixed point in time to another. It also assumes that we simply put money in to equities in one go and wait. This means that we are being subjected to the vagaries of market timing. If we were great at market timing, we would have bought at 8,000 index and sold at 20,000. Alas, we are not blessed with this as foresight. It is only in hindsight that we can draw these conclusions.

There are two methods of investing that I like. One is to keep target prices for buying my stocks and buy when the stock hits that price. It may happen or it may not. Also, it is possible that the stock may still seek lower levels.

Given that markets keep fluctuating, the much talked about SIP or “Systemic Investment Plan” is probably a good way to invest in to the markets. Let me take two of the oldest equity schemes that I think are well run and see. One is Franklin Blue Chip Fund and the other is the HDFC Top 200.

Let me give below some numbers;

.......................... 1 year ..... 3 years ...... 5 years ....... 10 years ..........

Point to point return

HDFC Top 200 3.01......... 0.88 ......... 21.30 ........ 20.76 ...........

Franklin Blue Chip 3.14......... 2.74 ......... 20.53 ........ 18.68 ............

BSE Sensex 7.51 ........ 2.12 ......... 17.97 -------- 15.20 ............

(These are annualised returns, in percentages. I have taken 1st December 2003 as start date)

It does look like the last three years, we have not got much return and that both the funds could not match the index returns in the last one year. So, can we say that mutual fund investing is pointless or equity investing is not all that hot?

Now for the same periods, let us look at what SIP (monthly on the 1st of each month, we invest equal amounts) would have delivered:

SIP Returns

For the latest ----------- 1year ....... 3yrs --------- 5yrs --------- 10yrs ............

HDFC Top 200 13.34 ------- 7.28 --------- 10.78 --------- 15.74 ............

Franklin Blue Chip 14.16 ------- 8.63 --------- 11.55 --------- 14.27 ............

NIFTY ETF(Benchmark) 17.57 ------- 9.42 --------- 10.03 --------- 11.30 ............

(Annualised percentage returns for equal amount SIPs starting December 1st )

Does this not change the perspective radically? The main problem has been our paying too much attention to the noise and trying to put money in to the market when everyone is buying? We tend to just put money once or twice when the noise is the highest and then suffer because our timing was wrong?

Whilst this strategy cannot deliver big returns, it also prevents big losses. The important thing is to have the discipline to keep on going at it. Treat the SIP amount as expenditure rather than a decision point each time. And I would urge long time frames- ten years or longer. As I keep saying often, investing in equities should be with money that you do not need in a hurry.

Whilst opting for an SIP, I would prefer to keep away from thematic funds or sector funds. I would rather focus on diversified equities. There is also an option to pick on the Exchange Traded Funds on the Nifty or the BSE Sensex. The advantage of the ETF is the fact that it is an automated process and does not have a fund manager bias in stock picking. Also, as the size of each fund grows larger and larger, beating the index gets harder.

The other obvious advantage of the mutual fund return is the tax break on the returns. So whilst comparing it with bank deposits or fixed income, keep this in mind.

One interesting data thrown out from the table above is that the ETF in the Nifty ( the only index based ETF with a ten year history) seems to have done better in the recent period, besting the mutual funds in the three years and lesser time frame. Whilst it is too early to conclude, it could be because in the earlier days, it was easier to beat the index with a smaller corpus and now with the two funds having grown very large, the impact of small winners is not high. So, going forward, maybe the passive ETFs on the broad indices may be the best option.

Unbankable- The lure of banking business

The Tata Group finally seems to have got something right. They have withdrawn their application for a banking license. It is perhaps the induction of the new Chairman, who must have had a hardnosed look at it. Tatas had made a hash of Tata Finance with scandals galore. The problem was / is that at the Tata group, some professional managers used to treat companies and businesses like personal fiefs. Maybe the airline business investment is just to humour the outgoing Chairman. I cannot understand why a business house should get in to poor businesses using public money. Personal passions should be explored by using personal money.

What is driving 25 others to remain in the fray is simple regulatory arbitrage. Get a license, tell a story, sell stakes at a fancy price to someone stupid and have a ball. The other way is to inflate all capital costs (real estate to technology) and skim it off. There is no advantage a bank gives as opposed to a NBFC. If you own a bank, you cannot lend to your own group. So what is the lure? Obviously, dreams of a capital market play and/or a continuous siphoning off of money. Give loans, take a bribe. Everything is possible.

When we invest in stocks, we are betting on the premise that we will be able to sell it to someone else at a price. This is the liquidity that stock exchanges provide. We make many assumptions in arriving at what price we are willing to pay. All of these basically boil down to what money (earnings) the company will make from its business. The other big investor (the promoter) also theoretically gets the same benefits, apart from other non financial benefits that may come his way. I am not talking about any money he may make other than the legitimate dividends and the management compensation he gets. His wealth is represented by his share in the market capitalization of the company.

For the promoter, the company is a real asset and he is at full liberty to deal with the profits of the company. He can pay dividends, buy assets or simply keep cash. He can use funds from one company to promote another. In short, he is the absolute master of all the assets of the company. He has a high level of motivation in keeping the company as profitable as he can. The promoter also wants to own as much of the company as he can and he also has the freedom to take the company private by buying out all the shareholders.

Other investors have the confidence that whatever happens to the shares held by the owner, the same fate awaits them. The promoter, within the framework of law, is the absolute master of the company.

I wonder whether this premise can be applied to someone who sets up a commercial bank. A bank is not at all like other industries in respect of ownership. In fact, being an owner of a bank is very demanding and legally complex. Firstly, the Central Bank (RBI) puts a limit on the ownership in a Bank. The main promoter cannot have a clear majority. The day to day functioning, the deployment of the bank’s assets etc all are subjected to guidelines laid down by law. If the promoter has other industries, a bank owned by him cannot lend monies to it.

The profits that a bank makes cannot be disposed at will. Dividend payments have to be approved by the regulator. The regulations cover virtually every aspect, including the remuneration that a CEO can draw. The promoter cannot use the bank’s money to do any single act that is not permitted by the regulator. And there are not many things that are permitted. A bank cannot promote a company n another industry. A banker cannot promote a car manufacturing business.

Of course, instances abound of shady promoters who have bent the law to have higher ownership apart from diverting loans to friends and family. But these cannot be a goal on which one would like to buy shares in a bank as an investor. And of course, we have businessmen who have ‘used’ a bank to push business in other financial services like mutual funds, stock broking or wealth management. They have used banking clout to build and strengthen other businesses. However, in this, the bank shareholders may not be participants.

A bank takes money from various people and lends it to different people for a fixed return. There is no upside on what it lends. If it lends a rupee, it will not get back anything more than a rupee. The book value of the share of a bank represents the value of all its assets (loans) less its liabilities (deposits, borrowings etc). The only difference between a mutual fund and the bank is the fact that a bank has ‘capital’ that is provided by the shareholders is leveraged by some borrowings. The only way to look at a bank is how much does it add to its book value each year, after dividends etc.

The argument is that a bank’s profits grow. So does the NAV of a mutual fund (the debt part surely). A bank has to provide for assets that are stressed. A mutual fund NAV rises or dips as per the market prices. So, if we are paying three times or five times the book value of a share of a bank, is it solely on account of the incremental profits that we expect the bank to show? And these profits are not available for disposal, except in liquidation. No bank will voluntarily liquidate when the going is good. When it liquidates, it is generally because it has blown away all the money in poor lending.

An owner of any business can sell off the business to anyone at any point in time. A bank cannot do that. It can at best merge or sell itself to another bank. Again, we come to who can take the call. Typically, someone with no personal stake in the bank will take the call if it is ‘professionally’ managed or a PSU. Or someone who takes a decision would have reasons beyond the balance sheet to make the corporate event happen. All in all, buying or selling a bank is a cumbersome process and not very exciting.

Thus it does not make any economic sense to either promote a bank or invest in shares of one. What is keeping the happy circle going is a combination of reckless optimism, misguided valuation and benign regulators.

I AM NOT A SECULAR PERSON- ATHEIST? PERHAPS- LAICISM

Secularism. A word wrongly introduced in to our constitution that is breaking the nation today. Secularism according to Nehru and his descendants has become a tool to divide and remind people constantly through the tool of reservation.

I always believe that religion is a personal business and should not come out in to the open. Pray at home. Keep your gods at home. Break down temples, churches, mosques. Maybe make them in to public conveniences. If you believe in your gods, they should be all over. Why go to one place and pray? And why use loudspeakers in this modern era? Why have public festivals that are nuisances to those who give a damn for those dunkings and processions?

The word that should have enshrined in our constitution is "LAICITE" and not secular.This is a word used by the French to define secularity.IT DENOTES THE ABSENCE OF RELIGIOUS AFFAIRS IN GOVERNMENT BUSINESS AND ALSO THE ABSENCE OF GOVERNMENT INVOLVEMENT IN RELIGIOUS AFFAIRS. This would surely have been a far nobler goal to reach than the appeasement tools used by different parties to whip up sentiments.

In the west, progress happened only after the separation of the Church and the State.History is evidence.

It is high time that we ban ALL religious outfits. And this will make people focus on economy. A sad case where the head of a scientific outfit goes to a stone idol with a plastic model to seek divine assistance. How terrible.

Bank Stocks- which to buy- New incumbents or existing ones

Tough Going for New Banks? (This appears in the latest issue of Moneylife)

If you have to buy a banking stock, the odds are in favour of buying an existing one rather than a new one because banking is a tough business

There are as many as 26 aspirants for the business of banking and the Reserve Bank of India (RBI) is supposed to grant licences to seven of them? At least, that seems to be the message of the finance minister P Chidambaram to RBI. Why seven? Why not five or why not 12 or why not all 26, if they meet the criteria laid down by RBI? Well, one day, we will find out. Hopefully, the new governor will make it an ongoing process rather than an occasional one. I fail to understand why there should be some special time windows for selling or issuing these licences. The bureaucrats and the politicians conspire to keep things complex and mysterious. That is the way we work. Transparency is for speeches. There is no good governance practised by the government or the regulators.

Let us look at the few private licences that were issued the last time: Times Bank, Centurion Bank, Bank of Punjab, Global Trust Bank are four names that come to mind, which folded up and were sold. If they had done well, they would surely have been around. The ones that survived are HDFC Bank and Kotak Bank. Axis Bank is a strange animal, having been promoted by Unit Trust of India and was lucky to have been led by the hard-nosed Dr PJ Naik. ICICI and IDBI were forced transitions of elephantine institutions and not greenfield ventures. And Kotak is known more for its capital market business than for banking. In my book, it leaves HDFC Bank and Axis Bank as the sole winners in the banking space since financial liberalisation started in 1992.

Among the new applicants, there are a few who have had problems in running non-banking finance companies (NBFCs). Will they be excluded by the government? The mutual fund arm of one of the aspirants ran afoul of the Securities and Exchange Board of India (SEBI) in the past but SEBI has been very generous in giving it a new mutual fund licence after having shut down the old one. So regulators are very indulgent and, unless the Supreme Court intervenes, past conviction on offences is no bar to entering the business where, once upon a time, trust was the key word.

Whatever happens, there are some consequential investment decisions to be taken. Most of the promoters would be listed companies. And their main purpose for opting for a bank licence is to play the valuation game in the capital market and access to low-cost funds (as deposits) rather than any fascination for banking per se.

Banking does not give the promoter any control over the cash flow. It cannot lend to group companies, cannot declare dividend without RBI approval and cannot appoint a director without RBI approval. So, obviously, the licence is a play on valuation that the analysts will give for owning a bank. A well-run bank, like HDFC Bank, can fetch a fancy four times the book value; even if you do a bad job, it still could be twice the book value! And if it ends up with a fraud, some bank will be forced to take it over as allowing a bank to fail can have negative political repercussions. In any case, it will be a few years before a fraud comes to light.

These new banks will compete in the same main cities, I guess. Unless, of course, RBI turns very radical and says that they cannot open in metro cities until they have opened a minimum number of rural branches, in the name of financial inclusion. Operating rural branches in the private sector is an unviable and losing proposition and no one will do it by choice. If there is sufficient money in any town or village, you can be sure that banks will reach there. Many NBFCs are already out there and one can be sure the public sector banks are already have a presence.

And these new banks, if they are going to be in the metro cities, are all going to drive up rentals and salaries for the top and middle level bankers. Stock options for a lucky few will be large drivers. A director in a bank has to have his salary approved by someone sitting inside RBI who is on a government salary. There is one NBFC where the CEO earns more money in a year than he earned in his entire lifetime of service with the promoter company. Should the NBFC get its banking licence? Forget the obscene salary he is getting, he may not even get approval as a director for the bank.

It is going to be an interesting race. Should the licence go to one of the NBFCs that already have a few hundred to a thousand-odd branches, they will simply seek conversion of their branches into banks. They are clearly at an advantage. Even if one of the licensees were not to have any branch, it might be very tempting for it to acquire the branches of an NBFC that has been denied the licence. Most large NBFCs are keeping small branches alive only in the hope of getting a bank licence. If they are denied the licence, selling those branches to a new kid on the block should surely fetch them a good price. If this were to happen, it would be interesting to see what the mandarins at RBI would do.

Whilst a few new private banks would come up, there is also an old generation of private sector banks that seem to have forgotten to grow or are simply content with what they are. These include Lakshmi Vilas Bank, South Indian Bank, Karur Vysya Bank, etc, although some others, like Federal Bank, are trying to grow fast. In the meanwhile, two private sector banks that seemed to have run into rough patches are trying to put their house in order, namely, DCB and Dhanalakshmi Bank.

Against this backdrop, one wonders what any new entrant would do. I also recall that a couple of applicants had failed NBFC businesses. To be a relevant player, what these private sector banks will need to build is trust which a bank like HDFC has built up. Winning big business and staying profitable is not going to be an easy task. The new entrants are going to be faced with higher costs compared to those of the existing players.

Technology is going to be the single biggest investment these new banks will have to make and it is very expensive, especially if it is imported.

To be quick off the block, they will need experienced people. So, they will have to have a mix of senior retired people from the public sector to run their operations and snatch some stars to run their IT and credit. Sound lending holds the key and there is not much talent around to ensure a correct mix of risk and return. Bankers who mistake sound credit decision-making with fancy terms like ‘risk management’ are going to pay a price.

I would be betting more on banks promoted by industrial houses (if they are licensed) rather than standalone players. They would be the ones with ability to bring in large amounts of capital. The NBFCs that have applied for licences, to my mind, do not have what it takes to run a bank over the long term. They are perhaps more interested in starting and then make an exit by selling out to a foreign or a domestic player. The NBFCs that have applied are already leveraged and pumping meaningful sums of equity into banks is going to be tough.

For investors, picking and choosing is not going to be easy. Further, it is unlikely that anyone will offer equity at a fair or reasonable price like HDFC Bank did when it got listed. So if you have to buy a banking stock, the odds are in favour of buying an existing one rather than a new one.