The Complete Magazine for Indian Investors
JULY 2010, Rs. 25
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Volume XI-Issue(7)
This issue consists of 80 pages Including 24 pages of supplements on Mutual Fund Ready Reckoner
China Currency Reforms
With Stock Market Monitor
Plus Free Supplement
Inside Stories 10 Market Commentary 12 Cover Story 44 Mutual Fund Articles 50 Insurance Articles 52 Investors Educations
Contents
CONTENTS | JULY 2010 Head Office
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Volume: XI Issue :(7) July, 2010 Editor: Rajat Prasad Deputy Editor: Gurmeet Katar
Investment Monitor INSIDE STORIES Editor’s Desk..................................................3 News Bytes....................................................4 Review & Analysis......................................6 Global Outlook...........................................18 Indian Economy.........................................19 Industry Analysis......................................20 Stock Market Monitor...............................22 Equity Stock Ideas.....................................34 Equity Technical Analysis.......................36 Commodity Fundamentals......................38 Commodity Technicals............................40 Currency Fundamentals..........................42 Currency Technicals................................43 Derivative Articles....................................46 FD Articles.................................................48 Astro Market .............................................54 Query Time ...............................................55 Mail Box......................................................56
July, 2010
Investment Monitor 1
Editor Desk
EDITOR’S DESK Anticipation of robust corporate financial performance boosted the domestic bourses after front line companies paid higher advance taxes for the 1Q FY11 ended June 2010. Rally in world stocks aided the gains on the domestic bourses as China decided to end pegging of Yaun, euro zone debt worries eased and some positive data inflow from US. Good and timely monsoon is crucial for Indian farmers as only 40% of India’s cultivated land has adequate irrigation facilities while the rest depends on rainfall. About half of India’s farm output comes from crops sown during the June-September monsoons season. Even for crops sown later, the monsoon is important as good rains raise soil moisture, which is good for crops like wheat, the main winter-sown crop. Rising inflation is the immediate concern for the market. Inflation is being fuelled not just by food costs but also growing demand for manufactured goods. The central bank is most likely to go for rate hike in its next policy review this month. The Direct Taxes Code (DTC), which is in the proposal stages, will replace the Income Tax Act come April, 2011. We believe, foreign portfolio investors will not be materially impacted by the proposed changes in the new tax code, as long as these funds are able to claim tax credit in their home jurisdictions. India remains one of the fastest growing economies globally, and is likely to attract a sizeable chunk of the flows coming out of other troubled markets.
“ Good and timely monsoon is crucial for Indian farmers as only 40% of India’s cultivated land has adequate irrigation facilities while the rest depends on rainfall. About half of India’s farm output comes from crops sown during the JuneSeptember monsoons season. Even for crops sown later, the monsoon is important as good rains raise soil moisture, which is good for crops like wheat, the main winter-sown crop.”.
RAJAT PRASAD
China’s decided to ease controls on the yuan’s exchange-rate. In our view, China’s decision to allow its currency, yuan, to appreciate against the US dollar will not hurt the Indian economy. Yuan’s appreciation against the US dollar will increase the purchasing power of the Chinese, although it would make imports costlier for the West. On the other hand, increased consumption in China would help US and European exports. The US Federal Reserve offered a subdued assessment of the US economy in its recent meeting and affirmed that short-term interest rates would remain near zero for “an extended period”, which could mean well into 2011 and possibly into 2012. In the coming month, along with international cues, the domestic market will closely watch the corporate results for the 1Q FY11 and the progress of monsoon. With the strong fundamentals, Indian companies are expected to post good set of numbers as evident from advance tax numbers. While rains are traditionally vital for India’s agriculture, this year it is particularly important as not only will good rains have a positive impact on the economy, it would also temper inflation.
July, 2010
Investment Monitor 3
News Bytes
Corporate News
Reliance to buy Infotel for $1 bn
Reliance Industries, controlled by billionaire Mukesh Ambani, buy Infotel Broadband Services for $1 billion, marking the re-entry of India’s largest-listed firm into the booming telecom market. Unlisted Infotel Broadband Services is the only firm to win broadband spectrum in all 22 zones in India in an auction that ended on Friday. The firm is paying Rs12, 848 cr ($2.7 billion) for the spectrum, the government said. Reliance will invest about Rs4,800 crore by subscribing to fresh equity capital at par to be issued by Infotel Broadband. Reliance will own 95% of Infotel, which will function as a unit of the company.
MVL forays into telecom, forms separate entity
MVL Group, a diversified business house having interest in real estate and consumer electronics announced its foray into telecom by launching a separate company called MVL Telecom Limited on Wednesday. On the occasion, group’s chairman, Prem Adip Rishi also announced an operational investment of around Rs400 crore over after sales services and research and development activities. The company has also launched eight mobile handsets that range between Rs1,400 and Rs5,000. “The company would spend the entire Rs400 crore over the next six months. Apart from this investment, the company will also open warehouses at 27 locations apart from its master warehouse at Bhiwadi.”
Bank of India seeks mutual fund re-entry
he country’s fourth largest public sector lender, Bank of India (BoI), is planning a re-entry into the asset management business five years after scrapping its solo venture and is looking for a foreign partner this time around. The bank is ready to divest up to 49% and has identified a handful of potential partners, both existing players and new ones, according to two officials with knowledge of the development. “We want to have a good name that has proven expertise in handling this business,” said one of them, a senior official with the bank who did not want to be named.
Real estate companies plan QIPs to fund expansion
After a hiatus of some six months, real estate firms are again turning to qualified institutional placements (QIPs) to raise money, this time mainly to fund expansion. Bangalore-based Brigade Enterprise Ltd wants to raise Rs750 crore through a QIP and Mumbai’s Orbit Corp. Ltd passed an enabling resolution last week to raise Rs1,000 crore both from a QIP and an issue of non-convertible debentures. Overall, at least six realty firms are expected to raise a total of Rs5,000 crore from QIPs this fiscal year.
Last year, as the real estate sector began recovering from the slump of 2008-09, many developers including India’s top three realty firms— DLF Ltd, Unitech Ltd and Indiabulls Real Estate Ltd—resorted to QIPs, raising around Rs13,000 crore overall. But investor sentiment Morgan Stanley report ups ante for Khazanah in Parkway bid slackened again and some planned QIPs fell through. An independent adviser to Parkway Holdings said on Wednesday that Malaysian sovereign fund Khazanah’s $835 million partial take- Growth fuels M&A appetite over bid for the Singapore healthcare firm was not compelling, put- Indian companies have entered into a record number of mergers ting pressure on Khazanah to up its offer. Morgan Stanley said the and acquisitions (M&As) in 2010, striking deals worth $36 bilstate investor’s offer price of S$3.78 ($2.72) was reasonable “but not lion (around Rs1.67 trillion) until the start of June, according to compelling”, adding “there is no certainty that shareholders will re- Bloomberg data.That’s only counting the 152 transactions whose ceive the offer price.” Khazanah said in May it intended to raise its values are available publicly. The reasons for the surge in M&A acstake in Parkway, Asia’s largest healthcare operator by market capi- tivity are evident enough. talisation, to 51.5% from around 24%, pitting it against India’s Fortis, Faster growth in the world’s second fastest growing major economy which currently controls Parkway with about 25% of the shares. has improved corporate profits and cash flows. Equity markets have bounced back and access to capital, at relatively lower rates, has Emirates in record $11 bn order for A380s Dubai’s Emirates, the Arab world’s largest airline, has placed an $11 been easier. Not only are Indian companies such as Bharti Airtel, Inbillion order for 32 A380 superjumbo jets from EADS’s Airbus unit dia’s biggest mobile phone firm, buying assets abroad, foreign firms in a surprise opening to the Berlin Air Show. Airbus called the un- such as Abbott Laboratories are also acquiring local companies to expected vote of confidence the largest commercial aircraft order by tap a market of 1.2 billion people. Investment bankers and analysts dollar value ever. It came as EADS showed off the capabilities of its say this year will see more M&A deals as industries such as telecomembattled A400M military transporter plane and as it faces a dispute munications and pharmaceuticals consolidate, and the corporate with German military bosses over problems with two of its new heli- turnaround story gets stronger. copters. Emirates’ order would be worth just over $11 billion at a list price of $346.5 million per plane, though airlines typically receive discounts for large orders.
4 Investment Monitor July, 2010
News Bytes HDFC mutual fund launches HDFC gold exchange traded fund
HDFC Mutual Fund has launched a new open ended Gold Exchange Traded Fund (ETF) namely, HDFC Gold Exchange Traded Fund. The new fund offer will be available from 25th June, 2010 to 23rd July, 2010. The minimum investment amount of the scheme is Rs 5,000. The investment objective is to generate returns that are in line with the performance of gold, subject to tracking errors. The scheme will invest 90 per cent to 100 per cent in gold bullion with medium to high risk profile. The scheme may also invest up to 10 per cent in SEBI chief calls MF industry’s bluff as members pour out debt securities and money market Instruments with low risk profile. grievances The scheme will charge any entry and exit load. The scheme will be A forum by an industry body on mutual funds on Wednesday, benchmarked against price of gold. where fund houses intended to pour out their woes to the Securities and Exchange Board of India or Sebi, hardly had any effect SEBI panel recommends maintaining expense ratio at 2.25 per on the market regulator. On the contrary, Sebi chairman CB Bhave cent launched a scathing attack on the practices of the mutual fund inSEBI Mutual Fund Advisory Committee, comprising SEBI (Securities dustry. Mr Bhave was critical of the way fund houses do business and Exchange Board of India) and mutual fund industry representaand reiterated the need for them to focus on investors to grow. “If tives, in a meeting recommended retaining the expense ratio at 2.25 you (mutual funds) are producing better returns than what an averper cent; which mutual funds deduct annually from investors net asage investor investing himself in the stock market gets, then why is sets value (NAV). Currently, the expense ratio for the mutual fund it that you are unable to convince investors that you are giving them industry is capped at this level. The panel has also decided to make better returns,” said Mr Bhave, at a mutual fund summit organized disclosure norms more transparent for investment in equity options. by the Confederation of Indian Industry (CII). “I mean, are investors Equity options are derivative products where investors bet on the fuso dumb as not to understand that they are getting better returns ture value of stocks or their indices and SEBI is against mutual funds here (mutual funds) and yet would invest somewhere they would getting into the hedging business, as they could suffer losses. Hence, get lesser returns,” he said. mutual funds may also have to provide more disclosures regarding investment in equity derivatives.
Mutual Fund News
UTI mutual fund launches UTI dynamic bond fund
UTI Mutual Fund has launched a new open ended income scheme, UTI Dynamic Bond Fund. The new fund offer will be available from 16th June, 2010 to 23rd June, 2010. The minimum investment amount of the scheme is Rs 10,000. The investment objective is to generate optimal returns with adequate liquidity through active management of the portfolio, by investing in debt and money market instruments. The scheme will invest up to 99 per cent of assets in money market, debentures and securitized debt with residual maturity of less than one year with low to medium risk profile. It would further allocate 1 per cent to 100 per cent of assets in debt instruments including securitized debt with maturity of more than one year with medium risk profile. The scheme will not charge any entry load and exit load charge will be 0.50 per cent if investment redeemed between 30 days from the date of investment. The scheme will be managed by Mr. Puneet Pal and will be benchmark against CRISIL Composite Bond Fund Index.
ICICI Prudential mutual fund launches ICICI Prudential nifty junior index fund
ICICI Prudential Mutual Fund has launched a new open ended index scheme, ICICI Prudential Nifty Junior Index Fund. The new fund offer will be available from 10th June, 2010 to 21th June, 2010. The minimum investment amount under the scheme is Rs 1,000. The investment objective is to invest in companies whose securities are included in Nifty Junior Index and to endeavor to achieve the returns of the above index as closely as possible, though subject to tracking error. The scheme will allocate 90 per cent to 95 per cent of assets in equity and equity related securities of companies constituting the CNX Nifty Junior and exchange traded derivatives on the CNX Nifty Junior Index. It will further allocate 5 per cent to 10 per cent of assets in debt and money market instruments. The minimum investment amount under the scheme is Rs. 5,000. The scheme will charge 0.25 per cent exit load, if units are redeemed within 7 days from the date of allotment. The scheme will be managed by Mr. Kayzad Eghlim and Canara Robeco Mutual Fund revises key features under its will be benchmarked against CNX Nifty Junior Index.
scheme
Canara Robeco Mutual Fund has decided to revise its key features under its scheme, Canara Robeco Floating Rate Fund. The changes will be effective from 01st July, 2010. The scheme nature will be changed to open ended debt scheme from open ended cash management scheme. The revised investment objective is to generate income by investing in a portfolio comprising of short term debt instruments and money market instruments with weighted average portfolio duration of equal to or less than 1 year. The scheme will allocate 70 per cent to 100 per cent of assets in Indian Money Market Instruments. It would further allocate up to 30 per cent of assets in Indian debt securities (including securitised debt). Exposure by the fund in securitised debt shall not exceed 25 per cent of the net assets of scheme at the time of investment. Investors who do not agree to the revision, have an option to redeem or switch their units on or before 30th June, 2010 without paying any exit load.
DSP BlackRock Mutual Fund converts DSP BlackRock Micro Fund into open ended fund
DSP BlackRock Mutual Fund has announced that DSP BlackRock Fund, which is currently a close ended scheme, will be converted into an open ended scheme. The change will be effective from 15th June, 2010. The scheme will offer regular and institutional plan with growth option. The minimum application amount under regular plan is Rs. 1000 and for institutional Rs.5 crore. The scheme will be managed by Mr. Apoorva Shah and Mr. Vinit Sambre. The scheme will charge 0.25 per cent exit load, if units are redeemed within 7 days from the date of allotment. Investors, who do not agree to the revision, have an option to redeem or switch their units on or before 14th June, 2010 without paying any exit load.
July, 2010
Investment Monitor 5
Review & Analysis
Re v i e w & BSE SENSEX MOVEMENT
BSE SENSEX MOVEMENT Company
27/06/10
27/05/10
Returns (%)
M Cap (Rs Cr)
P/E Ratio (x)
ACC
861.4
817.35
5.39
16171.92
10.68
BHEL
2450.9
2298.65
6.62
119976.46
24.57
Bharti Airtel
262.95
260.6
0.9
99855.79
15.47
Cipla
346.8
317.45
9.25
27844.57
22.77
DLF
286.05
270.55
5.73
48554.13
18.68
Grasim Inds
1794.9
1869.4
-3.99
16455.64
9
HDFC
2936.65
2754.45
6.61
85330.24
29.34
HDFC Bank
1947.8
1894.95
2.79
89538.42
30.95
Hero Honda Motor
2049.95
1895.15
8.17
40937.5
17.6
Hind. Unilever
266.55
232.75
14.52
58966.19
29.26
Hindalco Inds.
148.55
148.4
0.1
28430.98
4.03
ICICI Bank
857.5
856.6
0.11
95649.84
27.51
Infosys Tech.
2777.75
2643.45
5.08
159392.84
26.98
ITC
302.15
275.15
9.81
115366.91
29.3
JP Associates
129.2
124.2
4.03
27449.83
11.3
1761.25
1629.4
8.09
106229.79
11.66
614.7
528.7
16.27
35556.71
12.52
Maruti Suzuki
1397.05
1232.7
13.33
40363.57
18.65
NTPC
196.15
197.2
-0.53
161734.7
19.29
ONGC
1264
1125.35
12.32
270353.16
11.14
Rel. Comm.
192.5
139.2
38.29
39732.39
7.55
Reliance Inds.
1063.25
1021.85
4.05
347751.88
22.12
Reliance Infra.
1168.05
1056.6
10.55
28602.04
10.46
St Bk of India
2300.8
2215.7
3.84
146073.19
14.78
Sterlite Inds.
168.25
161.2
4.37
56558.92
92.32
Tata Motors
769.45
742.9
3.57
43922.51
9.59
Tata Power Co.
1303.45
1247.35
4.5
30932.17
19.03
Tata Steel
490.05
493
-0.6
43477.73
3.09
TCS
761.55
741
2.77
149050.56
30.91
Wipro
390.55
394.23
-0.93
95661.32
12.51
Larsen & Toubro M&M
6 Investment Monitor July, 2010
Review & Analysis
Analysis INDIAN MARKET
ASIAN MARKET 2,552.0 (-3.9%)
17,574.0 (5.4%)
SHANGHAI
SHANGHAI 9,737.0 (1.0%) NIKKEI
5,269.0 (5.3%)
20,690.0 (6.5%)
CNX NIFTY
HANGSENG
5,046.0 (-0.1%)
10,143.0 (-1.1%)
FTSC
DJIA
3,519.00 (-0.2%
1,076.0 (-2.5%)
CAC
S &P 500 2,223.0 (-2.4%) NASDAQ
DAX
BANK NIFTY Gainers 27/06/2010
27/05/2010
Change(%)
Rel.Nat.Resour.
65.95
51.95
26.9%
Essar Oil
137.65
119.05
HPCL
402.2
IOCL ONGC
27/06/2010
27/05/2010
Change(%)
Canara Bank
432.9
395.5
9.5%
15.6%
IDBI Bank
117.75
109.85
7.2%
351.35
14.5%
Punjab Natl.Bank
1049.1
988
6.2%
377.95
340.25
11.1%
Union Bank
303.75
290.5
4.6%
1263.4
1123.2
12.5%
St Bk of India
2300.8
2219.4
3.7%
Company
27/06/2010
27/05/2010
Change(%)
BSE Reality Gainers
BSE Metal Gainers Company
US MARKET
6,070.00 (2.2%)
BSE OIL Gainers Company
EUROPE MARKET
27/06/2010 27/05/2010
Change(%)
Company
Jindal Saw
204.15
181.45
12.5%
HDIL
244.45
210.4
16.2%
Sesa Goa
367.4
337.3
8.9%
Parsvnath Devl.
123.8
112.35
10.2%
Welspun Corp
236.75
218.5
8.4%
Anant Raj Inds.
118.4
107.5
10.1%
426
404.25
5.4%
Peninsula Land
71.55
65.05
10.0%
167.85
161.01
4.2%
Orbit Corpn.
268.1
247.9
8.1%
27/06/2010
27/05/2010
Change(%)
Natl. Aluminium Sterlite Inds.
BSE Auto Gainers
BSE Power Gainers Company
27/06/2010
27/05/2010
Change(%)
Company
JSW Energy
127.05
114.25
11.2%
Canara Bank
432.9
395.5
9.5%
Reliance Infra.
1167.2
1054.6
10.7%
IDBI Bank
117.75
109.85
7.2%
Lanco Infratech
66.95
60.45
10.8%
Punjab Natl.Bank
1049.1
988
6.2%
Neyveli Lignite
153.9
139
10.7%
Union Bank
303.75
290.5
4.6%
GVK Power Infra.
44.15
41
7.7%
St Bk of India
2300.8
2219.4
3.7%
July, 2010
Investment Monitor 7
Prime Economic Indicators
Prime Economic Indicators Gold Mumbai
Forex Reserve
Gol d ( M umbai ) ( R s) 18, 800
For ex R eser v e ( R s C r ) 1, 280, 000
18, 706 18, 700
1, 273, 921
1, 270, 000 1, 260, 000
18, 600 1, 250, 000
18, 500
18, 400
1, 240, 000 1, 231, 355
18, 388 1, 230, 000 1, 220, 000
18, 300
1, 210, 000
18, 200 27t h M ay
M ay
27t h j une
Brent Crude
Ruppe Vs Dollar
Brent Crude (Rs/Barrel)
3,700
3,651
3,650
46. 8
46. 5 46. 4 46. 3
3,477
46. 1 46
3,400
45. 9 45. 8
27t h M ay
27t h M ay
27t h j une
10Yr G-Sec (%) 7. 70%
10 Yr G- Sec ( %)
27t h j une
Call Rate (%) 7. 68%
7. 65%
Call Rate (%)
3.90% 3.80%
7. 60%
3.80%
3.70%
7. 55%
3.60% 7. 49%
3.50%
7. 45%
3.40%
7. 40%
3.30%
7. 35% 27t h M ay
27t h j une
3.20%
BSE Sensex 16,800
46. 18
46. 2
3,450
7. 50%
46. 76
46. 6
3,550
3,350
R upee Vs D ol l ar
46. 9
46. 7
3,600
3,500
J une
3.40%
27t h M ay
27t h j une
WPI Inflation (%)
Sensex
10.29%
Inf lation (%)
16,667
10.16%
10.08%
16,600 16,400
9.87%
16,200 16,022
9.66%
9.59%
16,000
9.45% 15,800 15,600
9.24% 27t h M ay
8 Investment Monitor July, 2010
27t h j une
May
June
TERMSHEET FOR NABARD (BHAVISHYA NIRMAN BOND) I. GENERAL INFORMATION i. A 10 Year Zero Coupon Bond of National Bank for Agriculture and Rural Development (NABARD) hereinafter referred to as Bhavishya Nirman Bond is being issued by way of private placement as long term investment under Sections 2 (47)& 2(48) of Income Tax Act, 1961. ii. The bonds will be made available for investment as unsecured bonds during the Financial Years 2006-07, 2007-08 and 2008-09 unless NABARD decides otherwise. iii. The bonds will be listed at BSE. Each bond has a face value of Rs. 20,000/-. i. Face value:
ii. Issue Price:
Each bond has a Issue Price of Rs. 9,500/-.
iii. Tenure of Bond: iv. Coupon Rate iv. Minimum Investment: v. Tax Liability:
The bonds will be issued for tenure of 10 years from the deemed date of allotment. 7.73% p.a compounded. 11.05% p.a. Simple Yield The minimum investment under Bhavishya Nirman Bond shall be 5 bonds and thereafter in multiples of five bonds. No tax at source wil l be deducted by NABARD in terms of Section 194 A(3) of the Income Tax Act, 1961 on the income, which is paid, or payable. The said income will be treated as capital gains and capital gains tax, if any, will be payable by the investor directly to the Income Tax Authorities. The deemed date of allotment of bonds shall be the first day of the month succeeding the month in which the duly completed application for investment is received. The instructions and other details contained in the application form will be updated from time to time. Any investment made will be governed by the terms and conditions applicable on the date of realisation of application money. NABARD reserves the right to close/revise the terms and conditions at its sole discretion without assigning any reason.
vi. Deemed Date of Allotment: vi. Right to update/revise/close the bond issue:
Market Commentary
T
Market on Fire
he domestic market shed its volatile mood to spike upward taking cues from buoyant global market. Easing of euro zone debt worries and augmented foreign fund inflow helped the overall buoyant outlook. It was the healthy monsoon progress and higher advance tax payment by some of the major index heavy weights for the first quarter of the current fiscal that was the primary mover of the domestic benchmark. Robust growth in the economy and corporate earnings should drive India’s main stock index higher over the next year but gains may be capped as euro zone worries continue to bother investors, a poll showed. Back home, investors will closely watch the progress of the monsoon rains. Annual monsoon rains were 11.1% below normal between June 1-23, the India Meteorological Department (IMD) said on 24 June 2010. The south west monsoon is important for India as about 60% of the country’s farmlands are rain-fed and more than half of the workforce is employed in the agriculture sector. The south-west monsoon usually covers the entire country by mid-July. The weather office late April 2010 said rainfall is likely to be 98% of the long-term average. Good monsoon rains would help raise farm output, boost rural incomes and lower food inflation. Global financial markets have seen wild fluctuations in the last quarter emanating from a crisis of confidence over the indebtedness of euro zone states. Foreign funds have invested a net $1 billion in Indian equities so far this month, after withdrawing $2 billion last month as euro zone jitters hit risk appetite. The government data released on 14 June 2010 showed a surge in headline inflation. Inflation based on the wholesale price index (WPI) rose an annual 10.16% in May 2010, faster than 9.59% rise in April 2010, government data showed on Monday. Meanwhile, inflation for March 2010 was revised upwards to 11.04% from a provisional rise of 9.9%. Primary market offerings are likely to absorb a part of the liquidity flow, dealers said. Indian companies have raised a total of $10.7 billion through share sales so far in 2010, compared with $2.6 billion in the same period last year and about $16 billion in 2009, according to Thomson Reuters data. Bankers have said India could see roughly $30 billion of equity issuance in 2010. The government proposed to impose capital gains tax on all stock market transactions by Indians and overseas funds as a part of changes in tax laws. As per the second draft of the direct tax code (DTC), the securities transaction tax (STT) will stay and rates will be calibrated. In its
10 Investment Monitor July, 2010
first draft DTC unveiled last year, the government had proposed to scrap the securities transaction tax. The DTC has proposed taxing gains from investments in the stock market and also equitylinked mutual fund units at the applicable rate of taxation. The DTC has also proposed some taxes on income of foreign funds, treating all incomes from their investments in the stock market in India as capital gains. The revised discussion paper on DTC has proposed computation of minimum alternate tax (MAT) on book profits. The earlier code had proposed MAT on gross assets. The revised discussion paper also makes it clear that profit-linked deductions of units already operating in special economic zones would be protected for the unexpired period. The tax proposals, which will replace the existing direct tax laws introduced decades ago, are expected to come into force in the next financial year starting 1 April 2011. Agricultural Bank of China (AgBank) and Petroleo Brasileiro may hit the market with $50 billion of shares by the end of September after state-backed sales pushed initial public offerings (IPOs) in emerging markets above developed nations for a record fifth straight quarter. IPOs in developing countries raised $29.3 billion this quarter, almost three times the amount in industrialized nations, as the European debt crisis sent stock indexes from Tokyo to Paris and New York to their lowest levels of 2010. While bears say the new sales will inundate emerging countries and choke off capital to private companies, bulls say economic growth that’s double developed nations will underpin demand. China announced that it would effectively de-peg its currency. This thus sets the tone for a fresh appreciation of the Chinese Yuan. It also provides a booster dose the global economy was so badly looking for. A rising Yuan puts more purchasing power in the hands of Chinese consumers and its firms. And this in turn leads to increased demand of goods and services for nations exporting to China. Besides, the appreciation is also positive for other Asian nations competing with China for a share of the exports pie. The decision by the Chinese government to let its currency appreciate, though gradually, against the US dollar will help Indian textile exporters, industry insiders are saying. China is the biggest competitive for Indian textile industry and has been able to rise way higher than India due to its currency policies. Chinese are willing to let the yuan appreciate; it will not only help Indian textile exporters to China, but across the globe. By making the Chinese items more costly, the appreciating yuan will help Indian textile industry automatically become
Market Commentary more competitive against their top rival. International uncertainties would have an impact on equity markets globally, including India. “The uncertainty in Europe will have an impact on the emerging markets, including India. European crisis is a cause for caution and concern and this is a lesson for India as well. Fiscal deficit should be controlled to control this situation. Commenting on Indian economy, India would not be affected by the crisis in a major way. In India, the growth story is intact and the government policies are positive for growth. Cheaper valuations in markets such as Russia and China have started to attract investors once more following a May sell-off, according to data from EPFR Global, which monitors fund flows. Fears of policy tightening and moves to curb property prices have weighed on China and Hong Kong shares. Shanghai has been one of the world’s worst-performing bourses this year, sliding more than 20%, but markets have picked up since news last week that China’s exports surged nearly 50% in May. Investors will keep a close watch on FII activity in the next week as sustained support of foreign funds will be crucial for the benchmark indices to hold on to the higher levels. Developments on monsoon front will be in focus as well. Meanwhile, the double-digit May inflation figure coupled with sustained rise in the food price inflation over sixteen percent mark in past few weeks has increased the pressure on the central bank of the country to take some corrective steps ahead of its scheduled policy meet on July 27. It is being rumoured that the Reserve Bank of India (RBI) was likely to go for a 25 basis points (bps) hike in policy rates before the next month’s monetary policy meet. Buoyed by the robust fourth-quarter growth in the last fiscal, the finance minister Pranab Mukherjee has affirmed that the Indian economy will expand by over 8.5% in the current fiscal and could ascend to the double-digit level by 2012. The domestic economy had expanded by 8.6% in Q4 of 2009-10 and consequently enabled the overall economic growth to touch 7.4% compared to government’s earlier forecast of 7.2%. While commenting on the GDP outlook for the current fiscal, Mukherjee said, ‘Of course, I explained the state of Indian economy and we are going to have more than 8.5 per cent growth.’ It is noteworthy that after several revisions, the International Monetary Fund (IMF) has projected the Indian economy to grow at 8.8% in 2010-11. Moreover, the economic survey of 2009-10 had also projected the economy to expand at 8.8%, keeping in view of the robust growth in industrial output. The 12th plan period for which the official procedure has recently been initiated, is likely to target 10% growth rate during 2012-17.
The yield on bonds had closed higher in the wake of a considerably higher-than-expected Index of Industrial Production for April 2010. Meanwhile, the Union government has decided to go ahead with the planned borrowing programme.The rupee strengthened on optimism fund inflows would increase as overseas investors step up purchases of the nation’s assets to benefit from India’s economic growth. Automobile and cement stocks will be focus as companies announce sales volume data for the month of June 2010 in early July 2010. Investors will also closely watch the progress of the monsoon rains. Global risk appetite holds key with regard to inflow of foreign funds into emerging market equities, including India. An increase in risk appetite normally triggers inflows whereas risk aversion triggers outflows. Foreign funds have made heavy purchases of Indian stocks this month. As per data from the stock exchanges, the net FII inflow totaled Rs 6900.07 crore in June 2010, compared to a massive outflow of Rs 12071.13 crore in May 2010. Domestic funds, which had absorbed some of the heavy selling from foreign funds last month, offloaded stocks worth a net Rs 3970.14 crore in June 2010. Domestic funds had mopped up equities worth a net Rs 6361.17 crore in May 2010.On the global front, Group of 20 leaders will meet in Toronto on June 26-27 to discuss policies aimed at addressing Europe’s crisis, spurring global growth and overhauling financial regulation. With the RBI planning to de-regulate savings bank deposits, banks may be forced to shell higher interest rates on these deposits. Their net interest margins (NIM) may witness pressure if they are unable to pass through the higher costs. The recent change in the mode of interest calculation on savings bank deposits and upcoming base rate calculation too are set to impose margin pressures on banks. Of the savings banks deposits, the 14-day maturity category accounts for 10 per cent and the rest are in 1-3-year category. Going by the rates offered today on the term deposits for a 1-3 year maturity (6-7.5 per cent), banks, especially the ones relying on bulk deposits, may not mind paying rates as high as 4.5-5 per cent for savings accounts. The Reserve Bank of India (RBI) may raise key repo and reverse repo rates in the first half of July to contain inflation, four of the six economists surveyed on Thursday said. The central bank might raise repo and reverse repo rates by 25 basis points each, they said. Still, RBI action would be conditional on its ensuring sufficient liquidity in the banking system. The liquidity condition remained tight and money market rates were at levels seen on Friday. The Reserve Bank of India infused Rs 41,220 crore on a net basis in the system through the Liquidity Adjustment Facility (LAF). On Friday, RBI had pumped in a net Rs 45,450 crore. The government’s latest decision to raise fuel prices will stoke inflation, maintaining pressure on the Reserve Bank of India to tighten monetary policy. The government on 25 June 2010, raised petrol price by Rs 3.50 a litre, diesel price by Rs 2 litre, kerosene by Rs 3 litre and LPG by Rs 35 per cylinder. The government has decided to decontrol petrol prices. The government will also eventually decontrol diesel prices. The government will, however, continue to subsidize kerosene and LPG.
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Cover Story
China Currency Reforms
The People’s bank of China signaled that the country is ending the 6.83 Yuan peg to the dollar which was adopted during the global crisis to protect domestic exporters. The surprise move was welcomed by investors and suggests that policy makers expect the global economic recovery to strengthen. China’s central bank ended a two-year Yuan peg to the dollar ahead of the G20 summit allowing the Yuan to appreciate 0.42% against the dollar so far, from 6.83 to 6.79 Yuan per dollar. A stronger Yuan is expected to help curb inflation in the Chinese economy and allow domestic demand for imports to expand, although the appreciation is expected to be very gradual. In the present section we are trying to understand the need of such move and its impact on China and other economies including that of India. 12 Investment Monitor July, 2010
Cover Story Chinese Currency - Yuan
The currency of China is called the Chinese Yuan or the Renminbi, which translates to “the people’s currency”. The People’s Bank of China, the monetary authority of the People’s Republic of China, issues the Renminbi. Popular press and most politicians are convinced that Yuan is undervalued which gives China an unfair competitive advantage. This initiated the need of ending the pegging of Yuan.
What currency pegging is?
Pegging a currency has both advantages and disadvantages for the country doing the pegging. Pegging a currency can be a method to control inflation if the currency being pegged to has a low inflation rate. Also pegging promotes stability for a developing country assuming that pegged currency is stable. If these advantages hold true then one of the largest disadvantage is that it prevents a country from using their own domestic monetary policy. A country can maintain a Fixed Exchange Rate or Peg by two methods. The first is to buy or sell currency on the open market so that the Inflation has picked up somewhat because of higher food prices, but pegged value is maintained on the open market. core inflation remains low: Consumer price inflation reached 3.1 percent (yoy) in May, driven mainly by higher food prices and somewhat The second is for the government to control the currency ex- by higher “residence” items (housing costs).PPI inflation rose from -8 change and make it illegal to trade currency at any other rate. percent (yoy) in mid 2009 to 7.1 percent in May. However, the sequential increase in the PPI index has declined since March as raw China operates it peg by controlling the currency exchange and commodity prices have stopped increasing (see below). Moreover, eskeeps pressure from black market or secondary trading by buying timated unit labor cost has been constant in recent quarters, consistent and selling currencies on the open exchange. with low core inflation and suggesting no wage-inflation spiral, despite the expansionary monetary stance.
Recent Economic Developments in China
China’s economic growth has remained strong: After bottoming out in early 2009 amidst the global economic crisis, sequential GDP growth was strong on the back of massive domestic policy stimulus, pushing GDP up 11.9 percent on a year ago in the first quarter of 2010. Growth has continued to be supported by an expansionary macro policy stance: Fiscal policy has not been expansionary in the first 5 months of 2010 (see below, in the policy section). However, the monetary expansion remains large and this in part reflects quasi fiscal activity, notably via lending to local government investment platforms. After the 30 percent of GDP expansion of credit in 2009, outstanding loans rose another 7.6 percent of GDP in January-May (seasonally adjusted). In the first quarter of 2010 infrastructure construction and real estate received most of the new medium and long term (MLT) loans.
China - Need of ending Pegging The currency value of a country is determined by the country’s economic growth, productivity, foreign exchange surplus, foreign investments, political stability and interest rate. Currency is expected to appreciate when there is an economic growth, rise in productivity, rise in exports, an increase in foreign direct investment inflow and building up of Central bank foreign reserves. Almost all of the above factors were positive for China, when China partially floated Yuan between July 21, 2005 and July 21, 2008, Yuan appreciated from 8.276/Dollar to 6.827/Dollar.
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Investment Monitor 13
Cover Story Owing to global recession causing fear of Yuan depreciation, from July 2008, China again pegged the Yuan to the U.S. Dollar. But all the factors that determine the value of currency show that Yuan will have continued to appreciate had Yuan not been pegged to the U.S. Dollar.China has ended its “crisis-mode” pegging of the yuan to the dollar in June, 2010 which will gradually increase the flexibility of its exchange rate. It’s a formal step towards a developed economy by making the currency floating. It was all started during the 2008 economic crisis and thus signaled that its time to move forward.
including the U.S. trade deficit. This will also help China gain control of its monetary policy again as removing the peg to the U.S. Dollar will separate China from the monetary policy of the United States. This is beneficial to China since the country’s currency value will no longer be subject to the whims of the policymakers in the United States, which recently has a loose monetary policy that could be detrimental to a growing economy such as China’s. China will also be able to rebalance its economy in that it will become less dependent on exports. Since demand from foreign consumers will drop, and the purchasing power of Chinese citizens will increase, there will be a more of a shift towards domestic consumers in China purchasing Chinese goods as well as foreign goods. This will allow China’s growth to be more sustainable and less dependent on foreign consumers and less affected by changes in demand for Chinese goods from abroad. Changing the Chinese Yuan from a peg to the U.S.
It’s largely a goodwill gesture, one that will likely lead to more volatility in daily trading but does not pave the way for sharp appreciation in the near term. While short-term dollar/yuan offshore forwards may overreact to the statement and price in sharp appreciation, market players may not yet realise how much Beijing could allow the yuan to rise on a six-month to two-year horizon. Spot yuan will now be more volatile, compared with movements of just one or two pips a day since July 2008 when China repegged the yuan to the dollar to soften the impact of the global financial crisis on the economy. Chinese stocks will likely gain and bond yields fall Dollar to a freely floating currency will also have the short because a shift on currency policy typically signals that the People’s Bank term effect of reducing the U.S. trade deficit (which is about USD165.8 Billion from January to September of 2009). Some of China will not immediately raise interest rates. people argue however, that this reduction in the trade deficit is overestimated, since there is some belief that as Chinese goods Expected Market Movements are still needed by American consumers, the American buyers The People Bank of China will now use the Yuan’s daily mid-point -- the will just pay more for about the same amount of goods from reference rate against which the yuan can rise or fall 0.5 percent against China. The net effect though can be seen as basically the same the dollar. Initial movements will not be big, possibly about 5-50 pips a as levying a tax on U.S. consumers in order for them to purday against the PBOC mid-point and in line with the dollar’s movements chase Chinese goods. Since removing the peg to the U.S. Dollar in global markets. In the first three months, yuan appreciation is not will cause appreciation of the Chinese Yuan, this will make U.S. likely to exceed 2 percent, to around 6.7 against the dollar from Friday’s goods easier to purchase for Chinese consumers, thus stimulatclose of 6.8262. As China is expected to enjoy robust productivity growth ing demand for U.S. goods and helping to reduce unemploycompared and maintain hefty trade surpluses with major trading partners, ment levels in the United States. the yuan will eventually appreciate against the dollar and the currencies This will also benefit the global economy. For example, this of those trade partners. will benefit the economies of many countries surrounding The middle of China’s government bond yield curve is expected to fall China that are strongly dependent on manufacturing exports several basis points as the move on yuan reform means China is unlikely because demand for their goods will increase since Chinese to raise interest rates immediately. On the money market, the benchmark goods will be perceived as relatively more expensive. The lowseven-day bond repurchase rate, should see no direct impact from the ered degree of intervention by the Chinese Central Bank will yuan announcement but will rise further, with liquidity drying up in the also cause lowered holdings of U.S. currency reserves, so China will be less susceptible to U.S. Dollar depreciation. Also, in the run-up to a major initial public offering by Agricultural Bank of China. short run, an appreciation of the value of the Chinese Yuan will cause an uptick in the amount of investment and speculation in Short-Term Effects of Removing Yuan Peg to U.S. Dollar China as the currency value is going up. Chinese Yuan were allowed to freely float, rather than being pegged to the U.S. Dollar, there will be many consequences.
Long-Run Effects of Change from Peg to Freely Floating The value of the Chinese Yuan with respect to other currencies, including Yuan the U.S. Dollar, will appreciate. Since the U.S. is a major trading partner with China, as the U.S. is a major consumer of Chinese goods, this will have the effect of reducing the purchasing power of U.S. consumers to purchase Chinese goods, thus reducing demand for Chinese goods. This will cause a significant drop in the output of goods from China to the U.S. and other countries as well. This will have severe negative consequences for China, which relies on a huge workforce and high volume of low cost production. Since output will drop, Chinese manufacturers will be forced to lower wages and/or reduce the number of workers. This will cause an elevated unemployment rate and thus harm the Chinese economy and well being of the population. Many exporters will be forced out of business almost instantly. Since the Chinese Yuan is artificially maintained at a low value due to the peg to the U.S. Dollar, as described earlier in the paper, China is able to keep exported goods “cheap” in the eyes of foreign consumers by keeping the demand and volume of production high. Reduced bubbles in shares and in property and reduced global imbalances,
14 Investment Monitor July, 2010
There will be a strong benefit to China and the global economy, largely because there will be a movement towards China becoming more of a consumer society, consuming more foreign goods and becoming more active on the global stage. This will stimulate the economies of both China and the rest of the economies of the world, with more volume of trade that is not restricted and hindered by the negative effects of an artificially valued currency. China is a very large economy with a quickly increasing economic and political presence in the world, and as such cannot afford to be attached to the policies and whims of another country. It must grow into an independent power that is not dependent so heavily on manufacturing exports. The savings rate in China is quite high, and it will benefit both China and nations across the globe if Chinese consumers had greater purchasing power.
Cover Story It will also help in increase of profit squeeze for Chinese corporations. This will reduce the savings rate in China and allow for more freely flowing currency throughout China and the rest of the globe. All of these long-term effects will help China move from a developing nation to an economic powerhouse with far-reaching positive effects throughout the world. Because the global imbalance arising from China’s trade surplus and trade deficit of U.S. is so influential, we argue that removing hard pegging to the U.S. Dollar could be beneficial to China and the remaining part of the world in the longterm to alleviate the global imbalance problem.
market.“Caterpillar is encouraged” by China’s yuan announcement, said Rich Lavin, Caterpillar Group President with responsibility for emerging markets and one of six members of the company’s executive office. “And we believe over time that a stronger Chinese currency will promote more exports from the U.S. to China.”The $119 billion U.S. precision metal forming industry, which makes metal parts and assemblies for the automotive, agriculture and off highway truck market, also could see huge benefits, both exporting to China and selling to U.S. manufacturers who need the metal parts to make a wide variety of end products.
Possible Impact in Manufacturing Sector of Chinese Econo- “An increasing number are exporting to China so the strength of the Yuan will give us a definite boost in terms of exports,” said William my It’s sometimes been assumed that a rise in China’s currency against the dollar will be inherently negative for Chinese manufacturers. In fact, the impact of a stronger yuan on China’s enormous manufacturing sector will vary significantly by sector and company.The Chinese government’s big concern has been the potential effect on producers of low-cost, low-technology products, whose often miniscule profit margins could be erased by even a small shift in the currency.Take the lighter industry in Wenzhou, an eastern Chinese city known for small, privately owned manufacturers. Huang Fajing, president of Wenzhou Rifeng Lighter Co., which exports 90% of its output, says the industry could stomach a yuan rise against the dollar of, say, 0.5%. But “if the rise is 2%, it will have a huge impact on the whole industry,” says Huang, who is also the chairman of Wenzhou lighter Industry Association. “As of now we only have very meager profits—we’re not like the IT or auto industry, which still have some profit margins.” Huang is hoping the rise will be small. “I think the government will still keep the yuan stable,” he said, adding that he believes Saturday’s announcement is largely a “publicity stunt” aimed at preventing controversy over the currency at this weekend’s Group of 20 summit in Canada.
Gaskin, president of the 1,000-member Precision Metalforming Association, based in Cleveland. “Similarly, the strength of the Yuan will make Chinese goods more expensive in the U.S. and help us compete domestically.”
Possible Impact in Energy Sector of Chinese Economy
China, the world’s second biggest oil consumer, imports about half of what is uses and that ratio is growing. The country is also a growing importer of natural gas and coal. So, broadly speaking, a stronger yuan should make energy cheaper for China, and help its energy companies. Appreciation of the yuan could trigger a rise in global oil prices, at least in the short term, based on the belief that China would buy more crude with its stronger currency. It was estimated that a yuan move could help drive oil up to $100 or more a barrel next year. Oil rose more than 2% on June 21, the first trading day after the yuan announcement, to around $79 a barrel. That could erase energy-related gains for China from a revaluation.
The impact on natural-gas imports may be clearer because some contracts are priced in dollars, Chinese buyers have signed 20-year contracts with countries like Australia with gas prices set in dollars. The companies that will suffer most from a stronger yuan are textile So in the long term the Chinese would get a bargain as the yuan and apparel makers and office equipment producers, which they es- gains against the dollar. timate will see a decline of around 1% in profits if the yuan gains 5% on the dollar.That could also mean a sting for clothing retailers such Gainers & Losers from Yuan Appreciation as Wal-Mart Stores Inc. that buy a lot from China, although Wal- Gainers Mart, along with other big retailers like Carrefour SA of France, is China Airlines: also increasingly a beneficiary of China’s consumer spending.But China’s three top carriers, Air China, China Eastern Airlines and some manufacturers in China—both domestic and foreign—could China Southern Airlines, which borrow in foreign currencies to pay benefit from yuan appreciation. Overall, Industries that benefit for their aircraft but generate revenues in yuan, could benefit the from yuan appreciation actually outnumber industries that lose. most. Airlines also use dollars to buy fuel. Deutsche Bank estimates This finding does not fit well with the conventional wisdom that that a 1 per cent appreciation of the yuan will boost Air China’s 2010 yuan appreciation is generally bad for firms in China. This is because net profit by 10.3 per cent, China Eastern Air’s by 15.0 per cent and the damaging effect on China’s exports has dominated the debate” China Southern Air’s by 20.6 per cent. while the benefits have been understated. The biggest beneficiaries within China will be importers whose costs are mainly in dollars Auto Makers: but revenues mainly in yuan. Its analysts say big winners could inForeign automakers which sell cars in the world’s largest vehicle clude paper companies Nine Dragons Paper (Holdings) and Lee & market, including BMW, Volkswagen, General Motors, PSA PeuMan Paper Manufacturing, as well as Hengan International, maker geot Citroen, the Renault-Nissan alliance and Fiat SpA should also of personal hygiene products in China, and Tingyi (Cayman Islands) gain from a yuan strengthening. Germany’s BMW could benefit the Holding, which sells noodles and other products—could experience most if the yuan continues to rise against the euro -- an outcome earnings impact of three-to-four times the amount of yuan apprethat’s far from certain -- as its auto manufacturing joint venture with ciation against the dollar (in other words, a 15% to 20% increase Brilliance China imports about half of its parts and component from in earnings from a 5% rise in the yuan).A stronger yuan could also overseas, mainly Germany. be a boon to foreign manufacturers that export to China to feed industrial demand, such as construction-equipment makers Caterpillar Inc. and Komatsu Ltd. China is a top export market for Caterpil- Consumers, Techs: lar, the world’s largest maker of construction equipment. The com- A rising yuan will boost the profits of American companies such as pany also has a significant manufacturing based there as well, with General Electric and Proctor & Gamble when their profits in China most of the machines it makes being sold into the domestic Chinese are converted into US dollars. PC maker Lenovo, which earned 47
July, 2010
Investment Monitor 15
Cover Story per cent of its sales in China in 2009, also reports its earnings in in China would help the US and European exports. It will help Indian exporters compete better with their Chinese counterparts in the globUS dollars. al market, especially in areas like textiles, leather and handicrafts.
Foreign heavy machinery makers:
The world’s largest maker of earth-moving equipment, Caterpillar Inc, could be a major winner -- the US machinery giant sells billions of dollars of earth-moving equipment and other products to China each year. Its group president said on Saturday that Beijing’s move will help lift US exports.
Luxury Firms:
If the yuan strengthens, other Asian currencies should rise, too, as a stronger yuan is seen by investors as a pledge of confidence for Asia’s growth. That should help luxury goods makers, whose imported products will be cheaper across the region. At the top of the list are the luxury goods companies for whom Asia is a key market. These include Tiffany & Co, Italy’s Bulgari SpA, France’s Hermes International SCA and LVMH Moet Henness Louis Vuitton.
Chinese Financials:
Chinese insurance companies such as China Life and Ping An Insurance also stand to benefit as a yuan revaluation is expected to boost China’s domestic A-share stocks, which account for a large chunk of their investment portfolios. Chinese insurers can put up to 25 per cent of their total investible assets into stocks, but most keep it below that level.
Impact on US Economy
The effects are more complicated than people think,a more expensive yuan would make Chinese goods more expensive on world markets and reduce the appeal of those goods to U.S. consumers. But the stronger yuan would also slow the Chinese economy and reduce Chinese demand for U.S. products. It would lead to an increase in U.S. domestic prices and eventually an increase in U.S. short-term interest rates. China’s purchasing power will rise. Commodities priced in US dollar will become cheaper for China. So oil, coal and aluminium will become cheaper for China to import. This will help big US multinational producers. Cheaper labour and production costs in the past have meant US consumers enjoyed lower prices for China-made goods. As the yuan appreciates, prices are set to increase for goods ranging from computers to clothing, but that might actually benefit the US too.
Impact on Global Economy
This development was received with enthusiasm from investors across the world as stock markets soared. The US is still struggling to recover and Europe is mired in a debt crisis. And so, China had been under increasing pressure from the developed world to do away with the artificial peg to the dollar. Chinese authorities had earlier been reluctant to bid to the wishes of the West. This is because the Chinese economy was not able to replicate the 11% plus growth that it had Losers been logging in before the crisis erupted. Meanwhile exports slowed Foreign Retailers: Big retailers that source from Asia, such as Sweden’s Hennes & down due to lack of demand from the rich world. Consequently, ChiMauritz and US-based Target andWal-Mart Stores Inc, could suffer nese growth also slowed down. Little wonder then China was not if the yuan appreciates, as their production costs will rise. Yuan ap- keen to let its currency appreciate against the dollar. preciation will also be costly for Walt Disney Co, which has signed a memorandum of understanding to build an amusement park in After all, exports would receive further beating. For the global econShanghai, as it will have to fork out more in US dollars to fund omy there could be some sort of rebalancing. Before the crisis unfolded, America and the rich world were consuming more than they investments. produced. They ran into debt troubles and deficits as a result. China meanwhile has amassed surpluses and needs to consume more for the Commodity Firms: greater health of the global economy. Since, imports for China will China’s commodity producers could be hardest hit. Companies be cheaper, the Chinese would be persuaded to consume more. This such as Aluminium Corp of China, Zijin Mining and PetroChina will however be a gradual process and it remains to be seen how the face dollar-linked prices for their output but incur China-based impact of the yuan revaluation pans out in the longer time. For the costs. If the yuan does strengthen, these firms will find that their time being, however, willingness of the authorities to take the first revenues fall while their costs remain steady. step must surely be a welcome relief to the US and Europe. It is now upto the developed world to spur their respective economies and reImpact on Indian Economy duce the high levels of debt that are choking recovery. China’s recent This will ease India’s trade deficit with China and will help Indian actions with respect to the yuan means that the US and Europe can exports of textiles, leather products, marine products, engineer- no longer blame the dragon nation for the ills afflicting them and the ing products, auto ancillaries more favorable in comparison to the global economy. Chinese exports. The trade between India and China soars closer to the US$60 billion target, India’s trade deficit with China is inConclusion creasing. In 2009, India suffered a trade deficit of US$15.8 billion China recovered at a strong pace from the slowdown thanks to a rise against China, while in 2008 the trade deficit was 11.17 billion., in consumption, increase in bank lending and investments in the thus a stronger Yuan will help in eliminating this deficit and also property market. The latter especially has raised concerns about a increase the cost of Chinese imports of electrical machinery and bubble once again forming in the dragon nation. In that sense, an other goods into India and benefit Indian manufactures.China is an appreciation in the yuan at this time is probably a good move by the export surplus economy and there is room for it to appreciate and Chinese authorities. This is because the economy has performed betget stronger. If it does get stronger it will have a positive impact for ter than what it did at the height of the crisis. But more importantly, the Indian economy.Asian currencies tend to move together in a it will rein in inflation, prevent the formation of bubbles and reduce trend. So, if the yuan appreciates, the Indian Rupee is also likely to the dependence on exports. appreciate. Yuan’s appreciation against the dollar will increase the purchasing power of the Chinese, although it would make imports from China costlier for the West. Besides, increased consumption
16 Investment Monitor July, 2010
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June, 2010 Investment Monitor 17
Global Outlook
C
Remarkable Recovery Recovered But Concern Remains
oncerns about the sustainability of Greece’s fiscal position spilled over into global financial markets in early May 2010. Although there was a sharp increase in risk premia and a steep decline in stock markets worldwide, there are only limited indications of contagion.Following the announcement of a €750 billion, or nearly $1 trillion aid package by the European Union, the International Monetary Fund, and the European Central Bank, the initial sharp uptick in the price of credit default swaps (CDSs) on the sovereign debt of European countries receded before rebounding partially in the following weeks. LIBOR-OIS spreads have increased to 32 basis points, suggesting that commercial banks are concerned that the ability of counterparties to repay even short loans might be affected by a default or restructuring of high-income sovereign debt. The credit ratings of most developing country sovereigns have not been affected by the crisis. Since the end of April, though May 24, the credit ratings of 5 countries (Azerbaijan, Bolivia, Nicaragua, Panama and Ukraine) have been upgraded, and none have been downgraded. For the year to date, there have been 22 upgrades and only 4 downgrades. Indeed, a recently developed index of the deterioration in financial conditions for a sample of 60 countries (31 high-income, 27 middle-income, and 2 low-income countries), shows that as of early June 2010, only 8 of the 23 countries displaying relative deterioration in market conditions since March 31st were developing counties. Four of the 8 countries where the deterioration in the aggregate index exceeded 0.5 were developing countries. However, in two cases, the deterioration reflected rising interest rates following a tightening of monetary policy in response to improving economic conditions, rather than a reaction to the situation in Greece.Stock markets worldwide lost between 8 and 17 percent in May, with losses generally larger in high-income Europe and developing Europe than in markets further removed from Greece. Moreover, data for May indicate a significant decline in capital inflows toward developing countries, although yearto-date flows are 90 percent higher than in 2009. Most of the decline was concentrated in bond issuance by developing countries, with more modest declines in bank-lending and equity flows. Although it is difficult to determine with precision to what extent this reflects a normal seasonal decline in flows, or a temporary reduction in issuance prompted by elevated spreads at the beginning of the month,3 these developments could signal a further tightening of capital markets.
Recovery is moving into more mature phase
In June, Financial markets in developing and high-income countries have staged a remarkable recovery from the worst of the crisis. Notwithstanding recent turmoil, interbank lending rates and developing country bond spreads have returned to close-to-normal levels; stock markets in high-income and emerging economies have recovered much of the value they lost, and most developing-country currencies have regained their pre-crisis levels against the dollar, with some having appreciated.The real-side of the global economy is also recovering. In the first quarter of 2010, global industrial production was expanding at an 11 percent annualized pace, while merchandise trade, was growing even more briskly (20 percent annualized pace). Still the level of industrial production remains 10 percent or more below potential in many developing countries and unemployment is high.
18 Investment Monitor July, 2010
Bounce-back factors (including the deep inventory cycle, and the growth impetus from fiscal and monetary stimulus) that contributed to very rapid quarterly growth rates are fading. Increasingly, the pace of the recovery at the national and regional level will depend on the extent to which private-sector activity recovers, and measures taken to address longer-term structural factors (including fiscal sustainability, banking-sector restructuring, and underlying productivity).Medium-term prospects for both high-income and developing countries face serious headwinds. High-income countries will continue to be plagued by weak financial sectors, waning growth effects from fiscal and monetary stimulus, and an increasingly pressing need to set public finances on a sustainable path.The need to tighten fiscal policy extends well beyond those countries most in the headlines, and the immediate challenge of unwinding the crisis-related stimulus measures that were put into place. This is a problem for many high-income countries, where fiscal deficits and debt to GDP ratios have reached unsustainable levels. The G-7’s debt is expected by the IMF to reach more than 113 percent of the group’s GDP in 2010, a level not seen since 1950. Bringing debt levels down will be more challenging now than earlier because, in contrast with the war-related debt of the 1950s, today’s debt reflects ongoing demands on government coffers that are likely to grow as pension and health liabilities expand with aging populations. The IMF (2010) estimates that high-income countries will need to cut government spending (or raise revenues) by 8.8 percent of GDP for a 20 year period in order to bring debt levels down to 60 percent of GDP by 2030.The need to unwind stimulus measures among developing countries is generally less pressing; because both fiscal deficits and debt-to-GDP ratios are much lower. Overall, general government deficits as a percent of GDP in developing countries have increased by 4.5 percentage points between 2007 (before the crisis) and 2009. Due to binding financing constraints facing low-income countries, their deficits increased by only 1.3 percentage points of GDP.Several developing countries do face fiscal challenges, including India whose fiscal deficit is estimated to have reached 9.5 percent of GDP in 2009/10, and whose debt represents 77 percent of its GDP. Recognizing the challenge, the government has announced a medium-term adjustment path, which is expected to reduce India’s debt-to-GDP ratio to at most 68 percent of GDP by FY2014/15. China also put in place a large stimulus package, but its finances are on a firmer footing, so there is less urgency to unwinding stimulus (although overheating could be a strong macroeconomic argument for doing so). Recently, a number of central banks have started to tighten interest rates in the face of strengthening economic activity and rising inflation expectations. But as for all developing-and high-income countries, adjustment of fiscal balances in the post-crisis era will present a challenge for policymakers and play a large role in shaping the outlook to 2012.
Indian Economy
I
India Shining
ndia’s economic performance in 2009-10shows that the recovery from the slowdown during the global financial crisis is well underway. India’s GDP growth in 2009-2010has beaten expectations by reaching 7.4 percent compared with 6.7 percent in the previous year. In particular, agricultural sector growth was better than feared with a slightly positive growth rate despite the worst monsoon shortfall in three decades. The manufacturing and mining sectors were the main engines of growth, while services sector growth was lower than in FY2008/09, when it was buoyed by fiscal stimulus spending. In particular in the fourth quarter of 2009-10, GDP growth reached 8.6 percent on the basis of a resurgent industrial sector. On the demand side, much higher investments replaced government stimulus.At this point, growth is expected to return to 8-9 percent in the next two years, with a shift from fiscal stimulus to manufacturing and, possibly, agriculture. Agricultural growth is likely to be high if the monsoon returns to normal in 2010 given the low production base of the 2009 kharif (summer) season. Signs of a recovery in investment demand bode well for broad based manufacturing growth. Services sector growth, on the other hand, was maintained at a high level during the downturn by fiscal stimulus spending. Growth rates going forward may be somewhat lower, given the plans for fiscal consolidation. India’s food inflation accelerated in mid-June, maintaining pressure on the Reserve Bank of India (RBI) to tighten monetary policy at a faster pace. India’s food price index rose 16.90% in the year to 12 June, higher than the previous week’s annual reading of 16.12%. The fuel price index remained unchanged at 13.18% in the year to 12 June. May’s inflation of 10.16%, driven by higher food and fuel prices, was the seventh straight monthly reading over 5%, the central bank’s perceived comfort level. The RBI expects it to come down to 5.5% by end-March 2011.The Indian Rupee exchange rate (USDINR) appreciated 2.14 percent during the last four weeks. During the last 12 months, the USDINR declined 3.01 percent. Industrial growth has displayed a strong growth once again with 17.6 percent growth in general IIP numbers for April 2010. What is significant is that the manufacturing sector and within the manufacturing sector, the capital goods sector has shown a high increase.India’s merchandise exports shown improved figures during March 2010 at US$ 19.9 billion recorded a growth of as much as 54.1 per cent as compared with a decline of 25.1 per cent registered in March 2009. After a decline for twelve consecutive months, exports turned around in October 2009. India’s merchandise imports during March 2010 at US$ 27.7 billion showed a high growth of 67.1 per cent as against a decline of 29.6 per cent recorded in March 2009. This was due to growth in both petroleum, oil and lubricants (POL) and non-POL imports. After a continuous decline for eleven months, imports turned around in November 2009 by exhibiting an increase of 2.7 per cent.Trade deficit during 2009-10 amounted to US$ 102.1 bil-
lion, thereby showing a decline of US$16.3 billion (13.8 per cent) over US$ 118.4 billion during 2008-09, primarily due to decline in both oil and non-oil imports.In FY2009/10, net portfolio investment inflows amounted to US$32.3 billion, compared to a net outflow of US$13.8 billion in the previous year. By contrast, direct investment inflows have been flat, even registering a marginal decline over the same period, to US$34.2 billion in 2009-2010from US$35.2 billion in FY2008/09. The rupee strengthened by 15.1 percent against the U.S. dollar between March 2009 and April 2010. The real effective exchange rate appreciated by 11.2 percent over this period. The Greek debt crisis and associated fall in the euro has led to a sharp appreciation of the rupee against the currency of India’s most important trading partner. M3 growth languished at 14.7 percent (y-o-y) in April 2010, the same as the growth of deposits. Non-food credit growth revived to 17 percent in March 2010, which represents a significant improvement from a nine-year low of 10.3 percent in October 2009 (y-o-y). The series of auctions during May and June 2010 resulted in revenue of Rs. 677 billion for 3G licenses, and another Rs. 385 billion for broadband wireless access spectrum, or about US$20 billion together. This is about twice the amount targeted in the budget.The Reserve Bank raised the repo and reverse repo rates by 25 basis points each on March 19, 2010 to anchor inflation expectations. The latest available data on the monthly indices of stock market delivered an optimistic scenario of Indian stock market. As revealed in the following table, the BSE sensex rose marginally from 16356 points in February to 17600 points in June 2010. Similarly the NSE nifty swelled to 5300 points in March 2010 with an increase of 5 percent over the previous month During the year 2009-10, the total government expenditure has been robust at Rs 858305 crores securing an increase of almost 14.7 percent from Rs 748324 crores during the same month of last fiscal year. On the revenue receipt side, the total receipt has gone up by of Rs 21335 crores in 2010 from Rs 437397 crore in February 2009 to Rs 458732 crores during February 2010. In 2009-10, India’s foreign exchange reserves increased by $US 27.1 billion over the previous year to reach $US 279.1 billion. Foreign currency assets (FCAs) increased by $ US 13.3 billion during the year. The rise in the foreign exchange reserves from $US 250 bn recorded in the previous year to $ US 280 bn was due to higher capital inflows in the form of portfolio investments during the year.
Outlook
With the past robust figures on economy growth indicators, it is expected to be positive on GDP growth, inflation, export, import and fiscal deficit. Going forward, the rise in industrial activities, improved sales and fiscal allocation to infrastructure sector development will lead to India as a emerging market to attract foreign investments at a fast pace.
July, 2010
Investment Monitor 19
Industry Analysis
A
Fuel Deregulation
government panel decided to free petroleum prices from government control, meaning gasoline and diesel prices will move in response to global fuel prices rather than government fiat. The panel didn’t reveal any details about how this will work. However, the panel hasn’t freed some fuels like subsidies for cooking gas and cheaper kerosene, vital to low-income households.
The government’s decision to hike fuel prices follows a recommendation to that effect by the Kirit Parekh committee appointed by the government earlier this year. The committee had recommended linking the prices of petrol and diesel to market rates. It had also recommended a partial increase in the price of kerosene to Rs 6 and Rs 100 per LPG cylinder.
Impact on Economy
Diesel and petrol consumption has been growing at 10-15% per year even during the global economic turmoil. Around 92% of the market is with state-
owned companies, which are bedevilled with issues such as corruption, bloated infrastructure and adulteration of their products by their agents.
To describe the government’s decision to deregulate petroleum and diesel as an act of raising prices is to get it completely wrong. It is one of the most major reforms of recent times and should have beneficial effects on the entire economy. What is being done is to put both diesel and prices on a float. Prices will rise The petrol price hike will cause an in- petrol and fall in step with the international crease of 100bps in the monthly WPI in- prices. For diesel, there will still be per-litre subsidy from the governflation. But since these changes will cause ament, to keep the domestic retail price the fiscal and revenue deficits to decline, below market level. But what is imis that it will no longer be a they will exert a downward pressure on portant fixed price.
prices. Hence, though the immediate impact of this policy will be to increase inflation, in six to nine months will have lower prices than what would have happened in the absence of this much needed reform.
The fiscal deficit definitely is going to look down now from the current levels. At $75 per barrel kind of a crude oil price at which government would have ended spending full year about 75,000 crores just to fill this particular deficit part for the under recoveries. Now, in a given situation it will be down anywhere between 53000 crores to 47,000 crores that means what we are talking off is close to about 25,000 crores worth of saving in the fiscal deficit situation and the most important part is that going forward in subsequent years now onwards this worry would be kept aside because these prices are driven by the market factor and if it is going to be linked to the market that means government will not had to bear that particular cost. The petrol price hike will cause an increase of 100bps in the monthly WPI inflation. But since these changes will cause the fiscal and revenue deficits to decline, they will exert a downward pressure on prices. Hence, though the immediate impact of this policy will be to increase inflation, in six to nine months will have lower prices than what would have happened in the absence of this much-needed reform. Kerosene and LPG would continue to drag government into this particular game to a certain extent but by going forward it will also find its way into partial deregulation. So from a view point government has gathered the courage to bring down the fiscal deficit, it would
20 Investment Monitor July, 2010
Industry Analysis get a thumbs up in form of winning the confidence of the investors including global investors.
Impact on Industry
Market determined pricing is expected to attract higher investments in the fuel retail sector, and by spurring market competition, encourage OMCs to reduce costs, improve efficiency and service standards. Market determined pricing will also incentivise fuel conservation and encourage the consumer to adopt fuel efficiency practices. The move would save around Rs 6,500 crore on petrol under-recoveries for government and around Rs 15,000 crore on diesel underrecoveries. Once the diesel is fully deregulated, it will further lead to a Rs 9,000 crore saving Till last year, 31% of the under-recoveries were borne by the upstream companies, about 12% by the downstream companies and the rest by the government. Extrapolating the numbers based on last year’s formula, upstream companies like ONGC, GAIL and Oil India would save Rs 4,000 crore, Rs 600 crore and Rs 700 crore, respectively, leading to a 10-13% increase in earnings per share. Similarly, among OMCs, BPCL, HPCL and IOC would see 23%, 15% and 7% addition to their bottomline. Total under-recoveries in the system will come down substantially. Though the earnings would significantly improve for all the oil companies, the exact extent would depend on the final subsidy sharing formula, which the government has not come out with till now.
In a decontrolled environment, private retailers may be able to offer cheaper rates since they do not have historical baggage of location or manpower and enjoy the advantages of new technology, more efficient operation and competitive sourcing of crude. They are able to keep their crude costs down through hedging and highsea trading, which state-run entities are not allowed. The private refineries also have the latest technology that allows them to extract more high-value products from inferior crude varieties that come cheaper and maximise returns on refining. The move has opened up one of the world’s fastest growing hydrocarbon markets to private sector players like Reliance Industries, Essar Oil and Shell, three years after they were virtually forced out of the market. These private players, who entered the Indian retail market in 2003 when the government scrapped the controlled prices policy the first time, had been forced to shut down most of their outlets three years ago due to spiralling prices of crude oil. The price of crude oil, which was around $25 per barrel when the administered pricing formula was abandoned in 2002-03, reached levels of up to $147 by early 2008, forcing the government to bring back price controls on petrol and diesel and pushing private players out of business.
Impact on State Run OMCs
Public sector oil marketing companies are expected to be major beneficiaries from the government’s decision to free petrol prices. The companies were expected to lose a whopping Rs 1,10,000 crore this year, The re-entry of private retailers is expected to ease off the pressure on resources of the public sector oil marketers and will allow them to redeploy manpower and operate infrastructure such as terminals, depots and pipelines more efficiently. The re-entry of private firms will also bring back to life their idle infrastructure, built at huge investments. This will take off pressure on state facilities, though they are sure to lose market share. However, even at a lower market share returns on their investments will be much better if they did not have to stretch manpower, finances or infrastructure to unviable options. They may now also take a rationalise their outlets. The government compensates the state-owned oil marketing companies for some of their losses. It was on track to spend $17.7 billion on subsidies for such firms this year, but with the move means the total will likely drop to $13.5 billion
Impact on Private Players
Deregulation of petrol prices has cleared the way for private fuel retailers to reopen petrol pumps that had become unviable owing to government cap on prices and could eventually lead to a price war between them and the state-run oil marketing firms. The Centre provided subsidy to its own companies, no such comfort was available for private firms. While Essar has continued to operate its 1,342 outlets throught the control era, Reliance Industries and Shell had shut down most of their petrol pumps some years back when they could not compete against the government-capped price being offered by the public sector firms.
The state-run companies will also benefit as their cash flows will improve and revitalise financial health. Though the petrol volumes, at 5-6 million tonnes a year, are half of the diesel or kerosene, profitability in the motor fuel and reduced losses in kitchen fuels will certainly shore up their financial muscle and may resurrect many expansion projects.
Impact on End Users
This move will benefit the consumer in the long run through competitive pricing of fuel and an offering of better services across outlets. The move will also rationalise the way end user spend money, the kinds and amount of energy end user use. It is an important step in making India a more efficient, global player.
July, 2010
Investment Monitor 21
Stock Market Monitor
STOCK MARKET MONITOR In Stock Market Monitor we have covered over 1200 companies appropriately classified into various sectors (109 in numbers). Each sector is given an unique code. The data aims to provide an insight into the financial health of the companies. The data of each sector is divided into 3 portions - Full year, Latest Quarter and Current data. This database is packed with powerful features necessary for fundament research on any company.
LEGEND
The fields that we have covered are explained below: Year End • • • • • • • • • •
Year End - The first two digits show the year while the last 2 digits show the calendar month. E.g. 0903 show March 2009 results. Equity - The latest fully paid equity capital of the company. Net Sales - Net revenue earned by the company during the year. Net sales growth – YoY Sales growth reported by the company during the year. EBITDA - Operating profit earned during the year. EBITDA % - Operating profit margin. PAT - Net Profit reported by the company. EPS - Earning per share during the year. RONW (%) - Return on net worth. ROCE (%) - Return on Capital Employed
Quarter End • • • • • •
Qtr End - The first two digits show the year while the last 2 digits show the calendar month. E.g. 0903 show March 2009 results. Net Sales - Net revenue earned by the company during the quarter. Net sales growth - YoY Sales growth reported by the company during the quarter. EBITDA % - Operating profit margin. PAT % Profit after tax margin. EPS Un-annualised earning per share during the quarter.
Current Data • • • • •
CMP - Current market price is the closing price as on the particular day. 52 W H - 52 high price of the stock on BSE. 52W L - 52 low price of the stock on BSE. Market Cap. - Market Capitalization is calculated by multiplying the number of equity shares outstanding by the current market price. Promoters Holding Latest Promoter’s holding
22 Investment Monitor July, 2010
Stock Market Monitor Company
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The Complete Magazine for the Indian Investor When you think about investment
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Investment Monitor Personal Finance and much more Mutual Fund Research July, 2010 Investment Monitor 33
Equity Stock Ideas Diversified Revenue Stream
KSB Pumps Limited
KSB earns 30% of its revenues by way of sales of standard products, 65% through project based (made to order) revenues and the remaining by way of after sales services.
Investment Rationale
Catering to Diversified Set of Industries
The company is the only player that manufactures pumps and valves to support functions of agricultural sector and water and sewage management systems apart from industrial applications such as power, petrochemicals, etc. The growth of the pump and valves sector is driven by the growth and increased investments in power and energy sectors apart from the agricultural sector. Pumps and valves form part of large projects across the aforesaid industries. KSB manufactures various pumps and valves of various specifications to enable fluid transportation. The company also takes up project execution on turnkey basis and caters to niche industrial as well as highly competitive low margin agricultural and domestic (residential/commercial buildings) segments. On industrial front the company caters to diverse industries such as chemicals, petrochemicals/ refiners, breweries/distilleries etc and power generation (both thermal and nuclear for feeding water to boilers).
Competitive Edge
Within the KSB Group globally, KSB India has relatively the highest range of pumps and valves to offer. Even among its competitors in India, KSB India has a large range of pumps to offer under one roof. Both these give the company the required competitive edge over its peers.
Strategically Located Plants
The company has 5 plants in India, two in Pune that cater to the requirements of irrigation and power projects, one in Nashik that manufactures multistage pumps, water and submersible motor pumps, a valve manufacturing plant in Coimbatore and a foundry in Ahmednagar to support captive consumption of castings.
Growing Order Book, but with Low Margins
The company doesn’t sharing its current order book, however hinted that the order book is up on YOY basis. The company is expected to further bag some more projects in coming months. At the time of revival in economy in 2009, the competition increased as everybody wanted to grab whatever orders came even at lower margins. So, the company also bags certain orders at low margin as compared to its normal run rate impacting the overall profitability in CY09. This pressure on margins is also expected to continue in CY10 also.
Key Financials Particulars (in millions)
CY’08
CY’09
Q1 CY09
Q1 CY10
Net Revenue
6022.1
5689.7
1348
1384.9
Sales Growth
N/A
-5.5%
N/A
2.7%
EBIDTA
1095
1166
231.4
215.5
EBIDTA Margins
18.2%
20.5%
17.20%
15.60%
Depreciation
130
203
39.9
48.5
Other Income
55
47.7
17.4
13.7
EBIT
965.7
962.7
191.5
167
EBIT Margins
16%
16.9%
14.20%
12.10%
Interest
22.5
18.3
6.6
1.8
PAT
715.6
708.8
135.2
117.6
PAT Margins
11.9%
12.5%
10%
8.5%
Shares 17.4 Outstanding (mn)
17.4
17.4
17.4
EPS (Rs)
40.74
7.8
6.8
41.13
34 Investment Monitor July, 2010
Financial Performance Q1 FY ‘10
• Net sale increased by 3% to Rs 138.49 crore on the back of pump sales growth of 7% to Rs 115.78 crore. Pump segment witnessed a spurt in demand on the back of revival in user industries. However the sales of valves were lower by 16% to Rs 21.60 crore moderating the overall revenue growth. The revenue of others was higher by 9% to Rs 8.06 crore. • EBITDA margins witnessed a decline of 160 bps to 15.6%, largely on account of higher material and staff cost which as a proportion to sales net of stocks was higher by 200 bps (to 50.5%) and 20 bps (to 14.5%) respectively. However, other expenses were lower by 70 bps to 20.1%. Consequently, EBITDA stood at Rs 21.55 crore, lower by 7%. • Other income was lower by 21% to Rs 1.37 crore. The interest cost was lower by 73% to Rs 0.18 crore and the depreciation was higher by 22% to Rs 4.85 crore. Thus the PBT was lower by 12% to Rs 17.89 crore. • Taxation was lower by 9% to Rs 6.13 crore but the tax incidence was at 34.3% compared to 33.2% in the corresponding previous period. Thus strained further the net profit was finally lower by 13% to Rs 11.76 crore.
Valuations
At the current market price of Rs. 463, stock is available at a PE multiple of 68x to its annualized (Q4 FY10) EPS of Rs 6.8.However, at the same price, the stock is trading at a PE multiple of 11.36x to annual EPS of Rs.40.
Recommendations
Owing to diversified business model, the company is well set to explore opportunities in various industries. However, the current order book is not so encouraging. At the current valuations, the stock looks worth buying for a handsome appreciation in medium to long term horizon.
Company’s Background
The company was incorporated in 1960 by KSB AG, Germany, one of the largest pump and valve manufacturers in the world. While the foreign promoter controlled around 40.54% stake in the company, the Indian promoters owned 25.95%, taking the total promoter holding to 66.49%. The company has grown geographically and owns plants at Pune, Sinnar and Nashik in Maharashtra and Coimbatore in Tamilnadu. The company has its own foundry plant is at Ahmednagar in Maharashtra, which caters to most of its in-house needs. KSB Pumps also manufactures castings, mainly for captive consumption. Apart from the power and energy sectors, the areas of application of KSB Pumps’ products range from building services to industrial processes, water engineering, mining and energy technology. The company also provides solutions for heating and air-conditioning problems. KSB Pumps products are used in chemical, petrochemical and other industries to transport aggressive, corrosive, explosive, solids-laden and viscous liquids. They are also used to carry industrial and municipal waste water.
Equity Stock Ideas
Deccan Chronicle Holdings Ltd Investment Rationale
Industry Revival
Financial Performance Q4 FY ‘10
Quarterly
For the quarter ended March 2010, the company reported 6.3% rise in the net sales at Rs 191.65 crore mainly on the back of higher sales volume. On the back of lower newsprint prices and other cost cutting initiatives, the company has shown 1900bps improvement in EBITDA at 42.4% for the quarter ended March 2010. As a % of net sales, raw material cost decreased 2750bps at 39% on the back of fall in newsprint prices whereas staff cost increased 250bps at 9.4% and other expenditure increased 610bps at 9.2%. The resultant operating profit surged 93% at Rs 81.29 crore.
Media companies were one among the biggest victims of the global financial crisis as their ad revenues fall sharply during 2008. Things have now looking up and media companies have made a smart recovery in the past two quarters. Much can be attributed to the softening of newsprint prices, overall improvement in advertisement situation and a perk-up in circulation aided by cut in cover prices. Other income was down 5% at Rs 7.34 crore. Interest cost decreased 5% at Rs 11.64 crore and depreciation charge was up 33% at Rs 12.60 crore. The Synergies with Merged Subsidiaries resultant PBT surged 128% at Rs 64.39 crore. The tax incidence of the comRecently, the company merged its subsidiaries Sieger Solutions, Asianage pany was up 189% at Rs 57.89 crore on the back of year end adjustments. The Holdings and Deccan Chronicle Bangalore with itself. Sieger Solutions is resultant PAT was down 21% at Rs 8.50 crore. the only merged entity which has significant revenues and profits. For the FY’09, the Sieger reported revenue of Rs 44 crore and a PAT of Rs 10.3 Annual (Standalone) crore. Asianage reported a net profit was just Rs 1.6 crore on a sale of Rs 9 For the year ended March 2010, the net sales of the company increased 10% crore. It would take a few quarters for the company to secure a steady flow at Rs 892.49 crore driven by growth in advertising revenues, however, cirof revenues from these subsidiaries then the long-term benefits involved culation revenues remained flat. EBITDA margins witnessed an increase of in the merger will become visible. 1780bps to 50.7% up from 32.9%, mainly on the back of decline in raw material cost. As a % of net sales, the raw material cost decreased 1880bps at 35.5% and that of the other expenditure decreased 30bps at 6.4%, whereas, The company has reported outstanding performance during the Q4 FY’10. staff cost increased 130bps at 7.3%. The resultant EBITDA increased by 69% The EBITDA margins of the company increase by 1920bps to 42.4% driven at Rs 452.54 crore. by rise in cover prices and ad tariffs, cut in pagination and fall in newsprint prices. Other Income decreased 31% at Rs 29.43 crore, interest cost was down 36% at Rs 45.13 crore and the depreciation charge increased 34% at Rs 42.86 crore. The resultant PBT grew 89% at Rs 393.98 crore. Tax incidence increased 96% Advertisement Tariff to Derive Margins The company increased its Advertisement Tariff by 30% and 50% wef at Rs 132.89 crore with effective tax rate at 33.7% and the resultant PAT of April, 2008 and October, 2008 respectively. The company further in- the company surged 86% at Rs 261.09 crore. creased the adv. Rates by 20% w.e.f. October, 2010. Going forward, when the increased tariffs come into play, are expected to drive the profitability Note: The Quarterly financials of the company are not strictly comparable as they include the financials of Asianage Holdings, Deccan Chronicle Bangaof the company. lore and Sieger Solutions w.e.f. April 1, 2009. The company is trading at a significant discount to its peers. Competitively Posited As per the ABC, readership of the company is 13.5 lakh per day. The Company is second in Bangalore with 2.45 lakh, Chennai - 3.03 lakh, HyderaValuations bad - 5.56 lakh and rest of Andhra Pradesh – 2.46 lakh. At the current market price of Rs. 128, stock is available at a PE of 11.5x to its Financial Performance Q4 FY ‘10 annualized FY10 EPS of Rs 10.79.
Strong Quarterly Performance
Key Financials Particulars (in millions)
Recommendations FY’09
FY’10
Q4’09
Q4’10
Net Revenue
8149.30
8924.9
1802.60
1916
Sales Growth
N/A
9.5%
N/A
6.3%
EBIDTA
2682.40
4525.40
422.10
812.40
EBIDTA Margins
32.9%
50.7%
23.4%
42.4%
Depreciation
320.60
428.60
94.80
126
Other Income
426.80
294.30
77.10
73.40
EBIT
2361.80
4096.80 327.30
686.40
EBIT Margins
29%
45.9%
18.2%
35.8%
Interest
709.30
451.30
122.60
116.40
PAT
1400.70
2610.9
81.50
64.50
PAT Margins
17.2%
29.3%
4.5%
3.4%
Shares Outstanding (mn)
249
242
249
242
EPS (Rs)
5.63
10.79
0.33
0.27
The company has taken various initiatives like merger of subsidiaries with itself, Advertisement tariff. This coupled with revival in industry scenario, are expected to impact positively on the financials of the company. At the current price of 128, the stock can be BUY for a handsome gain in medium to long term prospective.
Company’s Background
Deccan Chronicle Holdings Ltd. owned ‘The Deccan Chronicle’ is one of the largest English language publications in the South with a total circulation of around one million copies, 70% of which comes from AP and rest is from Tamil Nadu. It recently entered the Bangalore. In addition, the company now also owns Asian Age, an international newspaper based in Delhi, Financial Chronicle, a financial daily, and AndhraBhoomi, a telegu language newspaper. In the past few years, the company has been expanding its portfolio to become a multi-region player from being a South India focussed publisher. It also owns Deccan Chargers, one of the most prolific team in IPL. Bulk of the company’s revenues and profits are generated from Deccan Chronicle franchisee. However, most of its recent forays holds good longterm potential.
July, 2010
Investment Monitor 35
Equity Technical Analysis
MCLEOD RUSSEL CMP TARGET OUTLOOK
200.65 230/250 BULLISH
On the daily chart we can see Mcleod Russel has bounced from the level of 170 and has broken its resistance of 170. In technical indicator MACD is supporting it rise. Volume is also supporting its rise. Mcleod Russel has resistance around 230. We are expecting this stock will retrace around 230 levels if it will break that level then its next target around 250.
Mcleod Russel is the largest tea plantation company in the world. It prides itself on running a successful business that directly employs over 80,000. People and has an excellent reputation around the world.
HIND OIL EXPLORA
first private company in India to enter into field of oil and gas exploration. HOEC’s operational activities commenced in 1991 with the Government of India announcing the fourth round of CMP 202 exploration bidding for private sector participation. TARGET 230/250 On the daily chart we can see Hind Oil Explora has bounced OUTLOOK BEARISH back and break its resistance of 206. In Technical indicator MACD supporting it’s rise. Hind Oil Explora has resistance HOEC was incorporated in 1983 for taking up Exploration and Produc- around 230. Investor can buy it for the target of 230 and if it tion (E&P) activities inter-alia by Late Shri. H T Parekh. HOEC was the will break this level then it can touch the level of 250.
36 Investment Monitor July, 2010
Equity Technical Analysis
ABAN OFFSHORE CMP TARGET OUTLOOK
741.25 800 BULLISH
The ABAN Group was born as a small engineering firm in Chennai, Aban Constructions, established by late Mr. M. A. Abraham in 1986. A visionary, Mr. M. A. Abraham began his career as an engineering professional in the Construction Industry with illus
VOLTAS LTD CMP TARGET OUTLOOK
200.95 220/230 BULLISH
Voltas is one of the world’s premier engineering solutions providers and project specialists. Founded in India in 1954, Voltas Lim-
trious names like the Tata Group and Saipem. The Group took giant strides into newer arenas of operation like the execution of high-pressure systems and cross-country pipelines for refineries and fertilizer and petrochemical industries. Inevitably, Aban ventured into the high-powered domains of drilling, power generation and IT Enabled Services (ITES). On the daily chart we can see Aban Offshore has broken its resistance of 723. In technical indicator RSI we can see bullish divergence and MACD also supporting its rise. Investor can buy it for the target of 800.
for a wide spectrum of industries in areas such as heating, ventilation and air conditioning, refrigeration, electro-mechanical projects, textile machinery, mining and construction equipment, materials handling equipment, water management & treatment, cold chain solutions, building management systems, and indoor air quality. On the daily chart we can see voltas have given breakout with heavy volume. And technical indicator MACD also supporting its rise. Investor can buy it with the target price of 220/230.
July, 2010
Investment Monitor 37
Commodity Fundamentals
Silver Highlight • Silver consider as a bullion but mostly used as an industrial metal. • More demand of the metal as compared to gold. • In the recent past silver has provided better returns than gold. • Mines produce around 72% of the world’s silver. • Though demand from non-digital photography went down, the total demand of silver is going up. • Silver’s unique properties make it a very useful ‘Industrial Com modity’, despite it being classed as a precious metal. • Demand for silver is built on three main pillars; industrial uses, photography and Jewellery & silverware. • Just over half of mined silver comes from Mexico, Peru and United States, respectively, the first, second and fourth largest producing countries. The third largest is Australia. • Primary mines produce about 27 percent of world silver, while around 73 percent comes as a by-product of gold, copper, lead, and zinc mining. • The price of silver is not only a function of its primary output but more a function of the price of other metals also, as world mine production is more a function of the prices of other metals. • The tie between silver and economic activity is strong, given that around two-thirds of total silver fabrication is in the industrial and photographic sectors. • Often a faster growth in demand against supply leads to drop in stocks with government and investors. • Economically viable primary silver mine is a function of the world silver price level. • By contrast with United States and Japan, Indian industrial offtake for fabrication in hardcore industrial applications like electronics and brazing alloys accounts for only 15 % and the rest being for foils for use in the decorative covering of food, plating of Jewellery and silverware and jari.
Silver – As an investment Silver is soft, white, lustrous transition metal, it has the highest electrical conductivity of any element and the highest thermal conductivity of any metal. It occurs as a pure free metal (native silver) and alloyed with gold, as well as in various minerals, such as argentite and chlorargyrite. Most silver is produced as a by-product of copper, gold, lead, and zinc mining. Silver has been known since ancient times, and it is used as a bonus metal. It has long been valued as a precious metal used to make ornaments, jewellery and high-value tableware and utensils (hence the term “silverware”). Today, silver metal is used in electrical contacts and conductors, in mirrors and in catalysis of chemical reactions. Silver is found in native form, alloyed with gold or combined with sulfur, arsenic, antimony or chlorine in ores such as argentite (Ag2S), horn silver (AgCl), and pyrargyrite (Ag3SbS3). The principal sources of silver are the ores of copper, copper-nickel, lead, and lead-zinc obtained from Peru, Mexico, China, and Australia. Peru and Mexico have been mining silver since 1546 and are still
38 Investment Monitor July, 2010
major world producers. A major use of silver is as a precious metal and it has long been used for making high-value objects reflecting the wealth and status of the owner. Jewellery and silverware are traditionally made from sterling silver. Silver- which is often quoted as the poor cousin of gold is the cheapest among the precious metals. Historically too, gold had been preferred investment tool for the investors compared to silver. In the recent rally experienced in the precious metals both- gold & silver had given descent returns but silver’s return on investment had been better than gold.
Commodity Fundamentals
The main demand of silver comes from mainly three sectors viz: Industrial applications, Jewellery and silverware and non digital photography. Total fabrication of silver in 2009 reached 940.5 Million oz..
Outlook 2010-
Historically too silver had provided better returns than gold. In the bull run of 1970-80 silver touched the high of $ 50/ounce from the base price of $1.39/ounce, a return of mind blowing 3600% whereas gold in the same period touched $875/ounce from the base price of $40.80/ounce a return of 2100%. So we can see that even though gold may be costlier than silver but it is a better investment avenue for the investor compared to gold- silver’s wealthier cousin. If history is any indication of the future we can say that silver would continue to out play gold in providing returns to its investors.
Supply- Demand Like all metals silver cannot be artificially created and occurs naturally. The main source of silver are the mines but we may consider the central banks (who have huge reserves of the metal) as another source which is also termed as above ground supply. Mines had been the major source of the metal, almost producing 72% of the total silver. But in the recent past other sources such as silver scraps and govt. sales are also becoming good sources of silver in order to meet the ever increasing demand of silver .Govt. sells its silver in order to stabilize the market price of silver or to suck extra liquidity in the economy.
“Silver could get a boost if the European sovereign debt issues leach into U.S. investments but the nagging possibility of a double-dip recession could dampen the metal’s prospects, according to Philip Newman, research director of GFMS in London. The 2010 outlook for silver, however, is a bit cloudy, despite a good start. This year has started “quite positively,, but noted the large pick-up was in part due to the re-stocking of the pipeline, which had become quite depleted last year”.
Rising Silver Investments
While gold has traditionally performed better than silver as a commodity, many predict silver investments will continue to rise in price, attaining heights never before reached by this precious metal. Silver is used to manufacture all kinds of electronics, from computer chips to cell phone parts. It’s also a highly effective bactericide and is used in medicines and disinfectants – it’s even used for water purification. For this reason, silver is now scarce – unlike gold, a precious metal of which we have no short supply of; a material that’s primarily held onto and hoarded indefinitely. With increasing demand and scarce supply, silver investments will continue their growth as a primary financial venture, and many analysts believe Prices will continue to appreciate over the next ten years. There’s no better time to consider silver investments. Whether you like to dip your feet in investing or you’re a hardcore portfolio player, save a space for silver - the time is now, while prices are still low.
July, 2010
Investment Monitor 39
Commodity Technical
Crude Oil CMP 3526 Target – 3480 Outlook- Bearish Technical Analysis-
Nymex Crude-
July crude oil closed near $76.90 a barrel last Week. Prices closed near mid-range and were pressured by some weak U.S. L data and some profit taking from recent gains. The bulls still have the slight MCX Crude oil futures for June, which are about to expire on 21st overall near term technical advantage. June, slid lower to Rs 3526 per barrel last week and witnessed a massive unwinding in the open interest, which fell by around 34%. My bias is that a market low is in place and that it’s likely price acThe counter is expected to witness similar moves last week with tion will remain choppy and in a trading range between the May low the break under Rs 3500 proving further impetus to sell for the of $67.15 and psychological resistance at $80.00. The next near-term bears. Watch out for supports to emerge around Rs 3482-90 and upside price objective for the bulls is producing a close above solid 3470. Oil fell notwithstanding the persistent weakness in the US technical resistance at $80.00 a barrel. The next near-term downside dollar, which hovered around 1.2400 in the Asian trades. Crude oil price objective for the crude oil bears is to produce a close below for July delivery fell as much 48 cents, or 0.6 percent, to $76.31 a solid technical support at $74.00. First resistance is seen at $77.50 barrel on the New York Mercantile Exchange. The prices were last and then at this week’s high of $78.13. First support is seen at $76.00 seen quoting at 76.52, down 27 cents from the previous close. The and then at $75.00. contract lost 88 cents to settle at $76.79 yesterday, after hitting sixweek highs above $77 per barrel.
( Weekly Chart- Crude)
40 Investment Monitor July, 2010
Commodity Technical
Gold CMP-18700 Target -19000 Outlook-bullish
However, decisive break of the trend line support will argue that gold has reversed in medium term and will turn focus to 1166 support for confirmation.
MCX Gold
At this point, gold’s long term up trend is still in progress and should be targeting 100% projection of 931.3 to 1227.5 from 1044.5 at 1340 next.
At MCX, gold August futures fell sharply after failing to breach the crucial resistance at 18850 and fell below both 10 and 20 day EMA and tested support at 18500 levels. Next support is at 18460, break of same can test 18430 then 18380.
However, considering bearish divergence condition in daily MACD, break of 1166 support will argue that an important top is formed and will turn outlook bearish for a major correction.
Gold prices at global market fell sharply from new high of $1265 and ended at $1232, recording biggest daily fall in recent weeks. It tested trend line support at $1230. Immediate support is at $1230, break of the same can test $1226, which is 20 day EMA. Resistance is at $1242 then $1248. RSI is reading at 0.58.
July, 2010
Investment Monitor 41
Currency Fundamental
EURO/INR Facts The euro is the official currency of the Eurozone: 16 of the 27 Member States of the European Union (EU) and is the currency used by the EU institutions. The eurozone consists of Austria, Belgium, Cyprus, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia and Spain. The currency is also used in a further five European countries, with and without formal agreements, and is consequently used daily by some 327 million Europeans. Over 175 million people worldwide use currencies which are pegged to the euro, including more than 150 million people in Africa.
debts and how to balance reducing state debts and economic stimulus.The euro’s level is in line with the region’s economic condition and European sovereign risk will have a limited impact on the global economy. The current level of the euro isn’t largely apart from the economy’s medium-term fundamentals. The euro region’s problems will unlikely have an extremely adverse impact on the global economy partly because emerging economies such as China, India and Brazil are robust enough to cushion any impact.
Historical Patterns Over 3 Months
The euro is the second largest reserve currency (a status it inherited from the German mark) as well as the second most traded currency in the world after the U.S. dollar. As of June 2010, with more than €800 billion in circulation, the euro is the currency with the highest combined value of banknotes and coins in circulation in the world, having surpassed the U.S. dollar. Based on IMF estimates of 2008 GDP and purchasing power parity among the various currencies, the eurozone is the second largest economy in the world. The name euro was officially adopted on 16 December 1995.The euro was introduced to world financial markets as an accounting currency on 1 January 1999, replacing the former European Currency Unit (ECU) at a ratio of 1:1. Euro coins and banknotes entered circulation on 1 January 2002.
Effect on Inflation The introduction of the euro has led to extensive discussion about its possible effect on inflation. In the short term, there was a widespread impression in the population of the eurozone that the introduction of the euro had led to an increase in prices. Paradoxically, this impression has not been supported by general indices of inflation, showing no major effect of the introduction of the euro. A study of this paradox has found that it is due to an asymmetric effect of the introduction of the euro on prices: while it had no effect on most goods, it had an effect on cheap goods which have seen their price round up after the introduction of the euro. The study found that consumers based their beliefs on inflation of those cheap goods which are frequently purchased. It has also been suggested that the jump in small prices may be due to the fact that prior to the introduction, retailers made fewer upward adjustments and waited for the introduction of the euro to do so.
Fundamental Outlook: Impact The euro was under pressure against other major currencies in Asia as risk aversion grew on falling stock prices ahead of a G20 meeting. The euro also faced selling ahead of weekend meetings of the Group of Eight and Group of 20, which are to discuss reform plans for the financial industry. Investors are not willing to hold long euro positions as the fundamentals of the European economies are not firm as pressure continues from the debt crisis. The euro-area recovery remains on track although the renewed market turbulence seen over the past two months shows that uncertainty and downside risks remain high. Euro-area exports will be further stimulated by the recent depreciation of the euro. The euro has declined 14% against the dollar this year. China’s central bank set the strongest Yuan exchange rate in years as international pressure builds for a stronger currency ahead of the G20. The main topics of the gathering will likely be reforms of the financial industry, fiscal
42 Investment Monitor July, 2010
Over 12 months
Currency Technical
USD/INR
S
trength in equity market and net portfolio inflows from foreign institutional investors helped rupee appreciate towards 46.4 against the dollar. But with Moody’s Investors Service cutting Greece’ credit rating to junk, financial markets have turned turbulent again, pulling the rupee lower .Foreign institutional investors have been net buyers to the tune of Rs 325 crore in June so far after pulling out Rs 12,000 crore in May.
STRATEGY : Sell USDINR Near 46.50 SL 46.75 Target 45.90 Support Levels
Resistance Levels
45.90
46.52
45.50
47
Remarks Short-term outlook remains bullish for Rupee below 46.50
USD/INR Technical Analysis The rupee appreciated to the high of 46.3 against the dollar but it could not move beyond that level. This confirms our view that the Indian currency could remain choppy between 45.90 and 46.50 for few more sessions. A symmetric triangle pattern is apparent in the daily chart. This is a continuation pattern that implies that the down-move could resume to take the currency to 48.4 or 49.9 over the medium-term. A close above 45.5 is required to mitigate the negative outlook for the near-term. If we consider Fibonacci retracement levels of the down-move istrough, the medium-term supports for the rupee are at 48.1 and 49. Short-term traders should close their long positions on a decline below 46.4. Subsequent supports are 45.92 and 45.5. The contract will face resistance at 46.9 and 47.2 in the days ahead. Fresh long positions are advised only on a close above 47.2. Subsequent targets are 47.6 and 47.8.
July, 2010
Investment Monitor 43
Mutual fund Article
Does Size Really Matter ?
O
pen-ended mutual funds have a great track record of expanding to mammoth sizes quickly as investors flock to these growing funds. But it is possible for funds to get too large and cause problems for fund managers and investors. In this article we’ll show you how to handle the rapid growth of these funds and how to determine whether these funds are a good fit for your investing strategy.
cap growth fund in which asset size grows from Rs.100 million to Rs.1 billion is simply not as effective in its initial strategy. Most small cap fund managers have more of a “stock-picker” mentality, which may be what attracts certain investors to this kind of fund
How Do Mutual Funds Grow?
When we talk about size, we are referring to the total asset base or total amount of money that a mutual fund manager must oversee and invest.
Open-ended mutual funds grow their asset size in two ways:
• Strong performance of stocks and/or bonds in the fund’s portfolio. When the underlying assets in a portfolio increase in value, the fund’s asset size increases. • The inflow of investors’ money. This is why a fund’s asset size will continue to grow even if it has a negative return.
When Size Begins to Hinder Performance
As more and more investors are attracted to a specific mutual fund, the manager is presented with a significantly large amount of cash. The risk that arises in this situation is that to put the cash to work as soon as possible, some managers may purchase additional instruments that are not optimal for the fund’s investors. To determine when size begins to hinder performance, we need to ask at what point the positive relationship between fund size and management efficiency becomes negative - that is, the point at which the negative effects of the size of a fund cancels out the positive effects of a fund’s total return performance. It is difficult to determine exactly at what point this occurs, but in general, when the fund manager is unable to maintain the fund’s investment strategy and produce returns comparable to fund’s historical record, the fund has become too large. It should be noted that with index funds and bond funds, size is not a problem. In both these cases, bigger is definitely better. Portfolio management is easily handled and the funds’ operating expenses are spread over a larger asset base, thus reducing a fund’s expense ratio.
Growing Out of Investment Strategies
In the mutual fund industry, the size of a fund must be looked at in relation to the context of its investment style. Some funds suffer when the fund outgrows its investment style. For example, a small
44 Investment Monitor July, 2010
in the first place. Small cap funds usually have stock that is thinly traded and tend to concentrate on a smaller number of stocks. If the small cap manager is successful and the fund attracts new investors (and money), the fund manager may have trouble purchasing additional large blocks of the thinly traded shares without driving up the share price and making it more expensive. Performance may slip as the fund manager attempts to find new investments with the new influx of cash.
Combating Fund Size Difficulties
When a fund’s size compromises management’s ability to maintain the same investment approach, the mutual fund has three choices: 1. Continue to manage the larger fund with the same strategy that was effective when the fund was half the size. 2. Change the investment approach of the fund, which may undermine the motivation of the investors who bought into the fund because of the fund’s stated investment strategy. 3. Close the fund to new investors. 4. Convert the open-end fund into a closed-end fund. In this way, the fund will no longer increase as a result of investors making ad-
Mutual fund Article ditional cash payments into the fund.
When Large Equity Funds Become Generic
Another problem large funds encounter is that, because these funds are more difficult to actively manage, they tend to become what the industry calls “closet index funds”. In other words, their portfolios begin to resemble an index fund. As assets become larger, mutual fund managers need to spread the assets over a larger number of stocks because investing large amounts in one particular stock, as we mentioned earlier, may affect the share price. As a result, the individual investor, while paying extra fees for “active” management, ends up receiving a performance similar to that of the S&P 500 index.
So Is Smaller Better?
Some investment managers prefer a smaller fund because it allows them to move quickly in and out of stocks. Compare, for example, a small mutual fund that might invest Rs.1 million in a stock to a large one that might invest Rs.30 million. As you can imagine, it’s much easier to try to get out of (or into) a stock with Rs.1 million than with Rs.30 million. Selling Rs.30 million in stock could take several days, and the selling would put downward pressure on the price of the stock. At the same time, smaller funds can also be too small. First of all,
Not All Large Funds Are Bad
For some segments, market size simply doesn’t matter. For example, a fixed-income (bond) fund should produce consistent returns, regardless of its size. The market for bonds is far larger than the stock market, so price is less sensitive to high-volume trades. As a result, bond fund managers oversee assets with higher liquidity. In addition, not all large funds are notorious for underperforming. For example, people began to criticize Peter Lynch in the early 1980s when his Fidelity Magellan Fund surpassed Rs.1 billion in assets. The fund, however, rose to Rs.13 billion in less than seven years - this increase in assets came from the performance of the underlying assets and the large inflow of funds attracted by Peter Lynch’s superior stock-picking talents. Under his management, the Magellan Fund outperformed the S&P 500 index by 13% per year from 1977 to 1990. Had you, as an investor, passed on it once it reached Rs.13 billion, you would have missed out on one of great investment opportunities of recent times. In the years following Lynch’s managerial leadership, the Magellan Fund continued to grow in size, reaching Rs.137 billion in 1999. However, its total return performance declined over the next four years - it underperformed and/or generated returns barely comparable to the S&P 500 Index and was saddled with the “closet index fund” label.
Finding the Funds that Are “Just Right”
Just as Goldilocks found the bowl of porridge that was “not too hot and not too cold, but just right”, you too can find a fund that is not too small or too big, but just right. The following general rules may help you determine whether a mutual fund’s size is a hindrance or benefit to the fund’s returns: • Consider the size in relation to the investment approach: While Peter Lynch may have been able to handle the size of his blend fund, you can bet that a small cap growth fund with an asset value of Rs.1 billion dollars wouldn’t fare as well. • Funds in which asset base is shrinking should raise a red flag: Be sure to review and compare past cash holdings of the fund you are considering. A shrinking asset base means the fund is losing money because investors are withdrawing their investments or the performance of the assets in the portfolio have greatly depreciated in value.
new smaller funds can exhibit excellent short-term performance, which can be misleading because a few successful stocks in the portfolio could have a large impact on the fund’s performance. Because these new funds do not have as long of a track record, some investors could be enticed to purchase a fund managed by an inexperienced manager. Secondly, since because funds are less diversified, the poor performance of one stock will have a large negative impact on the overall portfolio. Lastly, operating expenses tend to be higher for smaller funds because of the lower opportunity to take advantage of economies of scale.
• Beware of funds with large cash holdings: Compare the total cash holdings of the fund in the current year to its holdings in previous years. Although mutual funds are required to maintain a small portion of the portfolio in cash to satisfy any investor requests for redemption, a fund with a large portion of its portfolio in cash (greater than 15%) can indicate that the manager is having difficulty allocating the fund’s assets to various securities. There are exceptions to this rule, as some fund managers habitually use large cash holdings to anticipate a market decline, thereby having the cash ready to quickly pick up bargain investments.
Conclusion
Mutual funds grow, and their growth may affect their performance, so it’s up to you to make sure their strategies match their goals, or take your money elsewhere. To have a large growth fund that you are truly happy about is one thing - to stick with it because you don’t know better is another.
July, 2010
Investment Monitor 45
Derivative Article
A
Are Derivatives Safe For Retail Investors?
re derivatives even appropriate for the average retail investor? One aspect of derivatives is certain - they have an image problem.
The Problem with Derivatives
There are four fundamental problems that contribute to derivatives’ negative image: □□ Bad press. If it isn’t bad news, it isn’t news. Stories in the press tend to focus on the illegitimate abuse of derivatives rather than how they are used legitimately. □□ Investors’ misinformed perceptions and uninformed opinions □□ Improper suitability given an investor’s resources and temperament □□ Lack of investor education The retail public reads these disaster stories and form opinions based on nothing else but what they read in the paper or see on television. The consequence of this is that they tend to follow only the headline news and focus on the illegitimate abuse of derivatives rather than on their legitimate ones.
Who Uses Them?
Data from Greenwich Associates’ research of institutional investors and hedge funds indicates a clear preference: 80% of institutional investors use single-stock, listed and over-the-counter options, as do 96% of hedge funds. About 74% of institutional investors and 77% of hedge funds use index options. Index futures are used by two-thirds of institutional investors and half of hedge funds. Exchange-traded funds are used by 70% of institutional investors and 84% of hedge funds. All other strategies pale in comparison. The average daily trading volume in that contract has reached more than one million contracts per day. In all equity products, that volume has reached 1.6 million contracts per day. Year-overyear growth from 2005 to 2006 has risen 30% in e-mini futures and a whopping 134% in the option contracts on those futures.
Investor Perceptions
There are four fundamental perceptions or opinions the public has about derivatives: • It’s an institutional market: Yes, it is. According to research conducted by the consulting firm Greenwich Associates, notional volume in interest rate derivatives for 2005 was nearly $1.5 trillion, 85% of which came from 260 institutions trading more than $1 billion each. Derivatives are a global marketplace - 27% originates in the United States and Canada, 63% in the U.K. and Europe, and the rest in Asia and the Pacific Rim.
46 Investment Monitor July, 2010
• Derivatives are too complicated: Yes, some of them are. Think of the last time listed equity options were explained to you, even for something as simple as covered writing. Then you heard about puts and calls. Next comes bull spreads, bear spreads, calendar spreads, butterfly spreads, strips, straps, straddles and strangles. Have your eyes glazed over yet? • Derivatives are expensive: Everyone deserves to get paid and this is not a public service. The products have become commoditized but the service and advice has not. How expensive would it be if you lost a large portion of market value because your portfolio was not hedged or you were over-exposed to a single issue? Potentially, the cost would be a great deal more expensive than the fee your firm charges on a derivatives transaction. • Derivatives are purely speculative and highly leveraged: This objection relates directly to the use vs. abuse problem. When hedge vehicles are used as a primary investment, they become extremely risky business. The problem is that much of the investing public does not appreciate that when properly used, derivatives can actually mitigate risk, rather than exacerbate it. Many retail investors equate risk in terms of leverage and market risk and hesitate to appreciate that leverage works both ways. It is commonplace for the public to not consider systemic risk, single stock ownership risk, event risk, or credit risk. They also may not understand that some derivatives, such as futures and options, by definition, are contract markets. When used as an investment instead of a hedge vehicle, it’s a zero-sum game. The fact is, when used properly, derivatives tend to be no riskier than the underlying asset from which they are derived. When you use a hedge vehicle as an investment by itself, the risks grow exponentially. The major caveat is suitability for the investor; one size does not fit all.
Decreasing Vs. Increasing Risk
Does all this mean you can’t or shouldn’t get involved? No, of course it doesn’t. The whole idea behind many derivative or alternative products is a non-correlated return. When used as a hedge vehicle, derivatives can enhance returns and reduce risk.Years ago, there were futures contracts on agricultural commodities - this was the original derivative. These gave farmers the ability to lock in a price in a forward market and hedge their profits while speculators provided the liquidity to the market.
Derivative Article That same principle hasn’t changed. Given the number of derivative and alternative products available since that time, perhaps it’s easy to understand why retail investors might find them confusing, if not intimidating. However, considering the growth and use by institutional and hedge fund investors, something must be going right. Think about some of the investment strategies available in alternative investments. These would include such strategies as deltaneutral option trading, value-driven long vs. short portfolios, volatility dispersion trading, capital-structured arbitrage and so forth. For a typical retail investor to even attempt to accomplish some of these strategies is unrealistic; they are so sophisticated, technology-driven and time-intensive that they require a fulltime professional. Perhaps this is why managed money has seen the growth it has.
General Strategies
There are, however, some popular strategies for high net-worth investors that are worth considering: For the high level executive with an over abundance of his or her own company’s stock, there are strategies to pursue. The first would be access to exchange funds (not exchange- traded funds). These funds allow an executive to exchange restricted or controlled shares for a portfolio of other stocks. The second would be to employ certain options strategies within the context of governmental guidelines. The third options strategy would be to analyze strategic selling programs, again within governmental rules and guidelines.Another strategy for high networth investors is managed futures funds and/or hedge funds. Either of these asset categories also have a fund-of-funds approach. Remember, a non-correlated return is an important theme in many asset allocation models. Many major broker/dealer investment models call for a 4% allocation to managed futures and a 7-11% allocation for hedge funds, depending on the investor’s education, financial resources and temperament. One strategy for investors over age 50 is to use options strategies to produce income and protect principal, such as covered call writing with long puts. Another strategy is to replicate a stock portfolio with long-term equity options known as long-term equity anticipation securities (LEAPS). In this strategy, investors put 80% to 90% of a portfolio in fixedincome securities and the remaining balance in LEAPS for equity exposure. Please be mindful of any tax implications when using options.
Long Put Strategy
Buying a Put is the opposite of buying a Call. When you buy a Call you are bullish about the stock / index. When an investor is bearish, he can buy a Put option. A Put Option gives the buyer of the Put a right to sell the stock (to the Put seller) at a prespecified price and thereby limit his risk.
When to use: Investor is bearish about the stock / index. Risk / Reward
Break-even Point: Stock Price – Premium Example:
Mr. XYZ is bearish on Nifty on 24th June, when the Nifty is at 4694. He buys a Put option with a strike price Rs. 4600 at a premium of Rs. 52, expiring on 31st July. If the Nifty goes below 4548, Mr. XYZ will make a profit on exercising the option. In case the Nifty rises above 4600, he can forego the option (it will expire worthless) with a maximum loss of the premium. Break Even Point (Rs.) (Strike Price - Premium) =4548
Payoff Table:
On expiry Nifty Close
Net Payoff
4300
248
4400
148
4500
48
4548
0
4600
-52
4700
-52
4800
-52
4900
-52
A bearish investor can profit from declining stock price by buying Puts. He limits his risk to the amount of premium paid but his profit potential remains unlimited. This is one of the widely used strategy when an investor is bearish.
Oversight
Most broker/dealers have clear-cut suitability standards for retail investors, not only in terms of financial resources but in terms of education and temperament as well. There may also be suitability standards for the individual advisor in terms of tenure, background and experience. In addition, most firms will have progressively higher levels of supervision on client accounts involved in advanced strategies. While the CME responds to clearing members’ interests on the part of its clients, such as equity contracts, foreign exchange and, most recently, energy, it recognizes that other contracts such as eurodollars and interest rate swaps are clearly an institutional market and are not promoted to retail customers. The CME also considers options a step up from futures in the level of sophistication required for suitability. Its bottom line is that the level of sophistication is paramount to educational suitability. There is certainly a need for advisory and broker/dealer firms to get involved in client education, much as the various exchanges have.
Conclusion
whether derivatives and alternative investments have a place in your portfolio is a question only you can answer. It all comes down to suitability. The guiding principle in the financial community is supposed to be “Know your customer.” This principle isn’t optional, so if you decide to jump into derivatives, be sure that you’re the right kind of investor for this market.
Maximum Loss: Limited to the net premium paid for the option. Maximum Gain: Unlimited as the market sells off.
July, 2010
Investment Monitor 47
Fixed Deposit
FD Schemes Unfold
Fixed Deposit – Company Fixed deposits earn a fixed rate of return over a period of time. Financial institutions and Non-Banking Finance Companies (NBFCs) also accept such deposits. Deposits thus mobilised are governed by the Companies Act under Section 58A. TDS is deducted if the interest on fixed deposit exceeds Rs.5000/in a financial year.At the end of deposit period, the principal is returned to the deposit holder. Company Fixed Deposits can be accepted by a Manufacturing Company having duration from 6 months to 3 years. Non-Banking Finance Companies can accept deposit from 1 year to 5 years period. A Housing Finance Company can accept deposit from 1 year to 7 years. Company Fixed Deposits are adequate for regular income with the option to receive monthly, quarterly, half-yearly, and annual interest income. Moreover, the interest rates offered are higher than banks.
CUMULATIVE SCHEME <Rs.25 lac Int. Rate in % Deposit
Rs.25 lac & above
Annual Yield in %
Int. Rate in % Deposit
Annual yield in %
12
9.00
9.20
9.25
9.45
24
9.10
9.75
9.35
10.03
36
9.25
10.38
9.50
10.70
48
9.25
10.89
9.50
11.24
60
9.25
11.43
9.50
11.81
72
9.25
12.01
9.50
12.42
84
9.25
12.62
9.50
13.07
Performance of the companies should be reviewed at maturity .This helps in deciding whether the deposit should be renewed or Minimum deposit Rs. 2000/not. One should also keep track of these companies by checking Additional deposit in multiple of Rs. 1000/their Balance Sheet, Share prices. There are some of our recommended FD schemes (a) DHFL-AASHRAY DEPOSIT PLUS SCHEME DHFL offers a range of home loan products, which include home loans for purchase or construction of house/flat; home improvement and extension loans, home loans for women, non-resident home loans, mortgage loans, plot loans, lease rental financing, project loans and reverse mortgage loan. The company has a robust growth plan in terms of improving its network through its own branches and alliances across the country and has set a target of achieving an asset base of Rs. 25, 000 crore in the next four years . DHFL is listed on BSE & NSE and has been rated AA+ (CARE), FAAA (BWR) & P1+ (CRISIL) indicating high standards of business management. The schemes under this are as follows For non cumulative scheme - If the investment is less than Rs 25 Lacs , then the rate of interest will vary from 9.20% - 9.46 % annually. If the investment is more than Rs 25 Lacs , then the rate of interest will vary from 9.45 % – 9.71 % . The rate of interest is depend upon the period of investment chosen by the investor .
Minimium deposit for monthly interest plan is Rs 20,000 Deposit for others Rs 10,000 .
48 Investment Monitor July, 2010
SMALL SAVINGS SCHEME Monthly Deposit Rs.
Period of Months
Rate of Interest %
500
Upto 36 Months
9.25
500
Above 36 upto to 84 Months
9.00
Recurring Deposit Amount per month can be flexible subject to a minimum of Rs.500/- and in multiple of Rs.100/-. Without any ceiling monthly installment can be stepped up in multiple of Rs.100/- above the chosen installment. It can also be stepped down steeped down but not below the chosen installment.
(b) Unitech – Unitech has the most diversified product mix comprising Residential, Commercial/ IT Parks, Retail, Hotels, Amusement parks and SEZ. Unitech’s Fixed Deposit Scheme is the fastest growing mobilizer in the segment with approximate 75000 investors in just 1 year of its launch. With a market capitalization of approx Rs. 27000 Crores (as of 30th Sept 2009), Unitech is the 2nd largest among the listed Real Estate Developers.
Fixed Deposit Fixed Deposits Schemes:
taking NBFC with Reserve Bank of India under Section 45IA of the Reserve Bank of India Act, 1934.
SMALL SAVINGS SCHEME Period
Minimum Amount
Rate of Interest(% p.a)
1 Year
25,000
11.00%
2 Years
25,000
11.50%
3Years
25,000
12.00%
Scheme A- Non Cumulative*:
Minimum Rate of Amount Interest(% p.a)
Payable on Maturity (Rs.)
Months
Rate of Interest
12
8.75
24
9.50
36
10.00
Scheme B
Interest would be paid on quarterly basis Additional Amounts in Multiples of Rs1, 000/Minimum Amount: Rs.25000/Period
Scheme A
Yield (% p.a)
6 Months 25,000
11.00%
26,375
11.00%
1 Year
10,000
11.00%
11,157
11.57%
2 Years
10,000
11.50%
12,572
12.86%
3Years
10,000
12.00%
14,308
14.36%
Scheme B- Cumulative**:
Period
Minimum Amount
Rate of Interest(% p.a)
1 Year
10,000
10.50%
2 Years
10,000
11.00%
3Years
10,000
11.50%
Minimum Rs.25000 & in multiples of 1000 thereafter * Compounded Monthly Fitch has assigned tAA (investment grade) credit rating for the fixed deposit scheme of STFC which denotes low credit risk.
Latest Scheme By STFC – SHRIRAM UNNATI – Fixed Deposit Scheme
** Interest Compounded Monthly on Deposits of 1Year or more and Payable on Maturity •The company aims to mobilize Rs. 400 Crores in this Scheme. **Additional Amounts in Multiples of Rs1,000/•The scheme is for limited period – July - August, 2010. •RATING FAA+/STABLE FROM CRISIL
(c ) Shriram Transport Finance Company –
It is one of the largest asset financing NBFCs in India with a niche presence in financing pre-owned trucks and Small Truck Owners (STOs). STFC is the flagship company of the Shriram Group which has significant presence in Chit Funds, Consumer Durable Finance, Life Insurance, General Insurance, Stock Broking, Property Development, Project Engineering, Wind Energy among others. Company was incorporated in the year 1979 and is registered as a Deposit Period
It was the first Company to manufacture portable generators in India in 1986. The Company has the expertise of manufacturing 2 stroke as well as 4 stroke engines. BPSL is committed to provide total Power Solution depending upon customer needs by manufacturing Portable Generators, Inverters, and Home UPS. To provide complete Power Solution to its esteemed customers under one roof. Company has recently started opening POWER SHOPPEE across the country. Birla
Minimum Deposits
1 Year
25000
2 Year
25000
3 Year
25000
4 Year
25000
5 Year
25000
Period
(d) Birla Power Solutions Ltd –
Minimum Deposits
Effective yield
1 Year
25000
8.24
2 Year
25000
9.16
3 Year
25000
10.2
4 Year
25000
10.69
5 Year
25000
11.21
Period
Minimum Amount
Rate of Interest (% p.a)
Yield (% p.a)
1 Year
10,000
10.50%
10.78%
2 Years
10,000
11.00%
11.94%
3Years
10,000
11.50%
13.29%
Power Solutions Ltd., (BPSL), is a Rs.2500 Crore Yash Birla Group Company which was established in April 1984 in collaboration with globally renowned Yamaha Motor Co. JAPAN .
FIXED DEPOSIT SCHEME:
Scheme A- Non Cumulative*: Scheme B- Cumulative – (0.50% extra only for share holders) •In a single deposit of 1, 00,000 and above additional interest of 0.25% will be paid irrespective of the period of deposit. •Interest compounding half yearly
July, 2010
Investment Monitor 49
Insurance Article
Five Life Insurance Questions and Policies
I
f you’re in the market for life insurance, you might have been tempted by those ads claiming that “for just a few dollars a day, you can protect your family with Rs.1 Cr. in life insurance!” It sounds like a great deal, doesn’t it? These ads typically refer to term life insurance. As its name implies, term life insurance provides protection for a limited amount of time - or a specific “term” of years, such as 10, 20 or even 30 years It’s fairly simple; if you die while your policy is active, your family will receive a death benefit, but the many types of term insurance and options can be confusing. Is term life insurance likely to pay off for you? Start by asking yourself the following five questions.
1. What am I trying to accomplish?
• Individual - As its name implies, an individual policy is one in which you apply for coverage on your own. You - or typically a family member - will own the actual policy. In order to obtain an individual policy, you’ll probably have to undergo a medical exam of some sort, provide a detailed medical history, and give the insurance company permission to look into your medical records and perform a background check on any driving offenses and criminal activities. This might sound a little invasive, but there are some great benefits to owning an individual life insurance policy. It’s portable - If you take a new job at a different company, you don’t have to worry about losing your life insurance protection.
Before you buy any kind of life insurance, think about why you’re Level premiums - Generally, individual policies can be structured buying it. Are you protecting your family in case of an early death? to have level premiums for the duration of the policy; typically this Have you taken on additional debt that requires you to provide cover- is a 10-, 20- or 30-year period. age? Are you looking to leave an inheritance to a charity? Flexibility - If you ever want to upgrade or convert your term polUnderstand that in most cases, term insurance policies do not pay a icy to a permanent policy, you might have more options available claim - most people who buy term insurance “outlive” their policy’s with an individual policy than you would with a group plan. term. As a result, if you’re shopping for insurance to protect financial obligations you may have for a very long time - possibly for the rest of 3. What if I don’t die? your life - consider exploring another type of policy, called permanent Ironically, some people who buy term life insurance get upset when insurance. they find out that if they don’t die, they don’t get anything back. If this is a concern for you, it’s If you’re in a cash crunch and have immediate obligations to your important to get an understanding of what will happen to your family, business partners, or lenders, term insurance can provide you policy as you near the end of the term. with a quick, simple, short-term solution. Premiums go up - Many term policies offer level premiums for several years (10, 20 and even 30 years, for example). As you approach 2. What’s available? Most people will have access to at least one of the two types of term the end of that term, you may have the option of keeping your policy. If you do, you can expect a hefty jump in your premium. insurance policies: group or individual. • Group - Most companies offer their employees some form of term Might need a new policy - If you are still healthy at this time in life insurance as an employee benefit. This is called group term in- your life and you want to keep the coverage, it may be best to apply surance, because you’re getting protection as part of a larger group. for a new policy. Usually it’s deducted right from your paycheck and the only requirement for coverage is to complete a brief questionnaire with details of Drop in coverage - Perhaps you only wanted your policy to cover your health history. Here are some of the advantages of group term you as long as you had a mortgage, or until your children’s college education was paid for. If that’s the case and you have no other obinsurance: ligations to protect, you might want to let the coverage expire. It’s easy - You can usually sign up for a policy when you take a new job and enroll in your company’s benefits program. You may also have Upgrade the policy - Most term policies come with a “conversion an opportunity to sign up during the annual enrollment period at your privilege”. This allows you to essentially trade in your old term company; when you may sign up for other benefits, such as medical, policy for a new permanent policy. dental, or an employer-sponsored retirement plan.
4. How can I upgrade this policy?
No medical - Most group plans don’t require a physical exam. A state- As mentioned previously, most term policies allow you to convert ment of good health, along with a medical history, is usually all that’s from a term policy to a permanent one. This is a great feature that provides future flexibility but because some policies have limitarequired to secure coverage. tions, you should familiarize yourself with the conversion rules of Automatic payments - Through payroll deduction, you’ll hardly feel any policy you’re considering. the financial hit of paying premiums every month.
50 Investment Monitor July, 2010
Insurance Article When can I convert?
will happen to me,” relying on hope to protect your future earning The conversion privilege might have a time limitation on it, to age 70, power is simply not a good idea. Instead, choose a disability policy for example. Some policies allow conversion during the entire term that provides enough coverage to enable you to continue your current lifestyle even if you can no longer continue working. of the policy.
What can I convert to?
2. Life Insurance
Life insurance protects the people that are financially dependent on you. If your parents, spouse, children or other loved ones would face financial hardship if you died, life insurance should be high on your list of required insurance policies. Think about how much you earn each year (and the number of years you plan to remain employed) and purchase a policy that will replace that income in the event of your untimely demise. Factor in the cost of burial too, 5. Where do I buy a policy? Chances are you’ll probably hit the major internet search engines as the unexpected cost is a burden for many families. first when looking for information about buying a policy. A number of online distributors can provide you with a term insurance policy. 3. Health Insurance These distributors typically focus on finding the lowest cost policy, The soaring cost of medical care is reason enough to make health given the personal information you provide.For a more personalized insurance a necessity. Even a simple visit to the family doctor can experience, you might consider finding a professional. An insurance result in a hefty bill. More serious injuries that result in a hospital agent will help you understand all the different variations of insur- stay can generate a bill that tops the price of a one-week stay at ance - both term and permanent - and should be able to answer any a luxury resort. Injuries that require surgery can quickly rack up questions you might have. You can find one by visiting any of the five-figure costs. Although the ever-increasing cost of health insurmajor company websites or combing through your local phone books, ance is a financial burden for just about everyone, the potential cost but probably the best way to find a representative is to ask around for of not having coverage is much higher. a referral from a friend or business associate.Finally, for group coverage, you can check with your employer. If you’re self-employed, you 4. Home Insurance may have access to a group plan through a professional association, Replacing your home is an expensive proposition. Having the right or you may even be able to put a group plan in place for yourself and home insurance can make the process less difficult. When shopyour employees. ping for a policy, look for one that covers replacement of the structure and contents in addition to the cost of living somewhere else Million-Dollar Dreams while your home is repaired. After going through these five questions, you will be able to decide for yourself if that million-dollar coverage ad is really what you need Keep in mind that the cost of rebuilding doesn’t need to include to provide for you and your family. If it’s not, don’t be afraid to pass the cost of the land, since you already own it. Depending on the it by - there are hundreds of policies waiting to provide you with the age of your home and the amenities that it contains, the cost to repeace of mind you’re looking for. place it could be more or less than the price you paid for it. To get an accurate estimate, find out how much local builders charge per square foot and multiply that number by the amount of space you INSURANCE POLICIES will need to replace. Don’t forget to factor in the cost of upgrades and special features. Also, be sure the policy provides adequate 1. Long-Term Disability Insurance The prospect of long-term disability is so frightening that some coverage for the cost of any liability for injuries that occur on your people simply choose to ignore it. While we all hope that, “Nothing property. The most generous term policies allow you to convert to any type of permanent policy available, such as whole life, universal life, or variable universal life. Some term policies may force you to convert specifically to just one type, and some companies may not offer all types, which can also limit your options down the road.
5. Automobile Insurance
Some level of automobile liability insurance is required by law in most localities. Even if you are not required to have it and you are driving an old junker that has been paid off for years, automobile liability insurance is something you shouldn’t skip. If you are involved in an accident and someone is injured or their property is damaged, you could be subject to a lawsuit that could cost you everything you own. Accidents happen quickly and the results are often tragic - having no automobile liability insurance or purchasing only the minimum required coverage saves you only a tiny amount of money and puts everything else that you own at risk.
Shop Carefully
Insurance policies come in a wide variety of shapes and sizes and boast many different features, benefits and prices. Shop carefully, read the policies and talk to the salesperson to be certain that you understand the coverage and the cost. Make sure the policies that you purchase are adequate for your needs, and don’t sign on the dotted line until you are happy with the purchase.
July, 2010
Investment Monitor 51
Investor Education
Avoid-Ways to Lose Money on Bonds
M
ost investors are familiar with the most common ways of losing money in the fixed-income market, but there are other, lesser known - and equally effective - ways to drive yourself to the poorhouse using fixed-income securities. Below we attempt to survey them all, so that you can learn to avoid potential problems and better prepare for inevitable ones.
tion could return you less cash on maturity than you originally invested. Your purchasing power might be intact, but you would emerge with less than a regular bond would have paid you.
• Consumer Price Index
Changes in the calculation of the Consumer Price Index (CPI) could also bring losses. Again, not a daily occurrence, but it has 1. Trading Losses been done and new methods of calculation are regularly being Losing money is easy if you’re buying and selling bonds as a trader. tested and promoted to result in a reduction in your TIPS’ value. Here are the principal methods to bleed cash. • Taxation • Interest Rate Moves Finally, TIPS are taxed on both the yield and capital-appreciation As all bond traders know, when rates go up, bond prices fall. If you (CPI-linked) portions of the bond. It’s quite possible that high bouts haven’t read the rate climate effectively, you’re going to get hurt. of inflation would trigger significant tax bills that would render This is probably the single greatest source of trading losses in the the bond’s real yield lower than the rate of inflation. Tax-sheltered accounts are therefore best for holding these instruments. market. 4. Bond And Money Market Funds • Credit Downgrades A couple of bad quarters, or a punishing one-time event can force There are two distinct ways to lose on funds. rating agencies to reconsider the creditworthiness of a borrower. • Redemptions Should even a single notch be chipped from an issuer, its bonds will Should there be a large call to redeem from the fund (on a popular take a significant hit. manager’s departure, suspicion of corruption, etc.), management might be forced to sell off significant holdings to pay out. Should • Restructurings/Corporate Events When companies are merged or bought out, go private - or public - these issues be illiquid, both the fund and investors would realize the entire capital structure of the former corporate entity can also losses. In some instances, redemption fees might also add significhange overnight. Changes in corporate structure could leave bond- cantly to losses. holders facing everything from a steep loss in bond value to a big, fat • Poor management nothing on their investment. Keep an eye on the following factors: Losses in funds are more commonly the result of overly aggressive managers chasing after yield from lower-quality issues - which 1. The reasons for the restructuring then default. 2. What sort of financial shape the companies are in 3. What the prospectus of the former bond stipulated 4. What the new agreement mandate is 5. Foreign Bonds • Liquidity-related losses (wide trading spreads) Here are four exciting ways to lose your hard-earned income using For the most part, fixed-income products trade over the counter, the foreign-bond desk. meaning there’s not always a lot of visibility in certain issues. You •Exchange controls will not have access to all the relevant pricing information - spe- Your friendly, foreign-bond-issuing nation decides to impose excifically, information about the all-important bid/ask spread. If the change controls. No money can leave the country. Too bad, forspread is particularly wide, you could run into trouble. To take an eigner. extreme example, you might buy ABC Company’s bond for 96 when •Rate fluctuation its bid/ask spread was 88/96 and then sell it a month later when it The exchange rate between your foreign bond issuing nation and had appreciated and the bid/ask was 95/103 - but your sell price at 95 your own takes a turn for the worse. You will very quickly lose is still a point less than your purchase price. Illiquidity means your (a lot) of money. Same goes for rising interest rates in that forcall was right, but you lost where it counted. eign country. Bond laws are universal: the price of your bond will drop as rates rise. Free floating exchange rate increases foreign ex2. Inflation change volatility. There are economists who think that this could Your next opportunity to lose money comes from inflation. Very cause serious problems, especially in emerging economies. These briefly, if you’re earning 5% per year in your fixed-income portfolio, economies have a financial sector with one or more of following and inflation is running at 6%, you’re losing money. It’s as simple as conditions: that. • High liability dollarization • Financial fragility 3. Inflation-Indexed Bonds Or TIPS • Strong balance sheet effects Here’s one that not so many investors are familiar with. Treasury When liabilities are denominated in foreign currencies while asInflation Protected Securities (TIPS) (called “real return bonds” for sets are in the local currency, unexpected depreciations of the Canadian investors) are supposed to be the answer to that inflation exchange rate deteriorate bank and corporate balance sheets and issue. Unfortunately, there are still three distinct ways to lose mon- threaten the stability of the domestic financial system. ey on these investments. For this reason emerging countries appear to face greater fear of • Deflation Not an everyday occurrence but certainly a possibility. Because of floating, as they have much smaller variations of the nominal exthe way values on TIPS are calculated, an extended period of defla- change rate, yet face bigger shocks and interest rate and reserve
52 Investment Monitor July, 2010
Investor Education movements. This is the consequence of frequent free floating under the name of the municipality in which they operate (ex. an aircountries’ reaction to exchange rate movements with monetary line selling a municipal bond to build a new airport terminal). Not policy and/or intervention in the foreign exchange market. a few of these companies have gone on to default - even though the bonds received AAA municipal ratings, the guarantors were private • Taxation Some friendly foreign-bond-issuing nations have not-so-friendly companies. tax regimes. You may end up with a lot less once the local (foreign) tax man bites. If you come away with lower yields than 8. CDs inflation, again, you lose. Cashing in your certificate of deposit (CD) early (where permitted) may trigger a penalty. When this penalty is netted out against accrued • Nationalization If you’re searching for yield in far-off lands, chances are you’ll interest and inflation, chances are pretty good you’ll lose money. encounter some with cultures that are unlike our own. In some • Interest rate risk: of them, the government legally takes over businesses by decree. I referred to this when writing above about call risk. If interest rates When this happens, you will realize you’re not in Kansas any- go up, you’re stuck with the rate of interest the certificate of deposit more - and you will experience firsthand how rating agencies pays. Until the maturity date, unless you accept paying the early withfeel about the issue. drawal penalty. The way to avoid these two risks is to not take out certificates of deposit with a maturity date of more than one year.
6. Mortgage-Backed Securities
Mortgage-backed securities are an undiscovered gem. While these securities are primarily used to provide safe income, there is also the opportunity to get some capital appreciation as interest rates fall. Another advantage to MBSs is that they are very suitable for most tax-deferred savings accounts. Generally, MBSs are traded actively, much like bonds are, so there is very little liquidity risk. Furthermore, they are considered an extremely safe investment, often said to have the same credit worthiness as treasuries but with a return that is 1-2% greater. Monthly income from MBSs can vary as interest rates change because mortgages can be prepaid, and when interest rates are falling, prepayments tend to rise. Prepayments only shorten the life of the MBS and are passed directly to the investors. This investment offers a rather uncomplicated way to separate you from your money.
• Call risk:
This is a big one if you have a callable certificate of deposit. You take out a long term certificate of deposit for $1000 at 8% interest for 20 years. You want to earn that 8% interest for 20 years no matter how interest rates fluctuate in the future. If they go up to 10% in 5 years, you’re stuck -- you cannot withdraw the money without paying the penalty. But what if it goes down to 5%? The bank decides they don’t want to pay you 8% any longer since they can pay new certificate of deposit holders a mere 5%. So they call the CD. Yes, you get the principal of your certificate of deposit back, but now you have to reinvest it for 5%. With callable certificates of deposits, the bank has no risk. They don’t pay a penalty for “early withdrawal” of the savings certificate from YOU. You locked in your money. If interest rates go higher, you lose and the bank wins (since they’re collecting the higher rates on their loans). If interest rates go lower, you lose and the bank wins (since they call the savings certificates so they no longer have to pay Mortgage-backed securities (MBS) are collateralized by the you the higher rate of interest.) So frankly, I don’t see any good reason monthly mortgage payments of John Q. Householder. When he for putting money into a long term callable certificate of deposit. runs into personal financial problems, or when the value of his • Inflation risk: house depreciates significantly, he may default on his mortgage. This is the biggest risk of placing your money in savings certificates. If enough neighbors join him, your MBS will lose a great deal of They do pay a higher rate of interest than ordinary savings accounts, value and will likely trade without liquidity. When you finally but they generally do not keep up with inflation. Therefore, the purdecide to sell it, you will lose money. chasing power of the interest they pay will go down as time goes by. And so will the purchasing power of the savings certificate principal. 7. Municipal Bonds The dollar amount is very safe. Place $1000 in a certificate of deposit Here are three ways to lose with “munis”. today for 20 years. In 20 years, you’ll almost certainly get your $1,000 back to the penny. But it will buy a lot less. And the interest payments • Tax decreases Yes, that’s right, decreases. Municipal bonds are generally valued sent to you will not have been high enough to keep up with the loss for being exempt from federal taxation - and often from state and of purchasing power. So that even if you reinvest the interest earned local taxes. So long as those taxes are significant, there’s an ad- from savings certificates, you cannot keep up with inflation. vantage to buying munis. But when tax rates decline, so too does •Liquidity risk: the value of holding municipals - along with their prices. The liquidity of CDs is very limited. You cannot withdraw your money from CDs prematurely without incurring some sort of penalty. In • Changing regulations In order to maintain their tax-exempt status, securities like mu- some cases, banks will not allow you to withdraw your money at all. nicipal bonds also have to adhere to demanding legal require- If the economy of the nation becomes inflationary, investments in CDs ments. But laws change regularly, and so, too, does the status of will suffer a loss in purchasing power. Also, CDs will not yield you the municipal-bond issuers. Should this occur, your muni will be highest possible yield as opposed to other investments, but the risk is repriced against similar, higher-yielding (and lower-priced) is- also less in CDs sues.For example, municipalities sometimes (though not often) have their credit ratings downgraded after agencies decide that Conclusion a recent budget contains imprudent spending or an investment There you have it: from the day-to-day to the not-very-likely, there are portfolio has suffered significant losses. A downgrade might also far more ways to lose money in the bond market than people imagine. occur if the company that is insuring the bond loses it AAA rat- The good news is that, armed with this knowledge, you will be better ing. able to avoid these financial misfortunes before they occur.
• Private issuers
Finally, beware private companies that issue municipal bonds
July, 2010
Investment Monitor 53
Astro Market
Market
Planetary Movement this Month Sun will remain in Gemini till 17th July and then enter into Cancer and remained there for rest of the month. New Moon will occur on 11th July while Full Moon will occur on 26th July. Mars is in the sign of Sun i.e. Leo and will enter into Virgo on 20th July and remain there for rest of the month.
Jupiter is in Pisces and get retrograde on 23rd July. Venus will remain in Cancer till 5th July and then enter into Leo on 5th and remained there for rest of the month. Saturn will remain in Virgo during the whole month. Rahu & Ketu will remain in Sagittarius & Gemini respectively, during the whole month.
Mercury will enter into Cancer from Gemini on 8th July. Mercury will leave Cancer and enter Leo on 23rd July.
Chart during New Moon â&#x20AC;&#x201C; Sunrise 11 July 2010
Chart during Full Moon â&#x20AC;&#x201C; Sunrise 26 July 2010
Sectorwise Outlook Auto: The sector is expected to remain in demand during the first Power: The sector is expected to remain in demand during the first fortnight. Profit booking is expected during the second fortnight. fortnight. Profit booking is expected during the second fortnight. Bank: The sector is expected to sideways to negative during the month. FMCG: The sector is likely to remain sideways with positive bias. Metal: The sector is likely to remain sideway during the first Pharma: The sector is likely to remain sideways with positive bias. fortnight. Buying is likely to emerge during second fortnight.
IT: The sector is likely to remain in demand durOil & Gas: The sector is likely to remain sideways with negative bias. ing the first fortnight of the month and some sellReality: The sector is likely to remain sideways with negative bias.
54 Investment Monitor July, 2010
ing
pressure
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Query Time
Query Time
Q. I am a conservative investor want to invest Rs.2 lakh. Please suggest me which asset class should I go for? Anupam, Kanpur
Q. I am holding 50 shares of Sun Pharma at an average price of Rs.1650. I am a long term investor willing to hold the stock for more than one year. What is your advice about future prospects of the company? Rahul, Delhi A. The stock currently trading at Rs. 1800 with major support at Rs.1710 level. Technically stock trading at year high level but now the long term prospects are good because of rising demand in pharmaceutical sector and out performance in the time of uncertainty. We expect the stock to touch Rs.2000 level with in one year so hold the stock. Manoj Rathi, Mumbai Q. I am regular reader of this magazine. It really helps me a lot in investing my money in such a volatile market. I would like you to please advice me which is the best sector for the investment purpose? Yukti, Jaipur A. As per market movement infrastructure is quite good to invest for short term. Infrastructure companies have good growth in recent past and uploaded with development projects. If you really wants to invest in promising sectors go for FMCG and pharma sectors. Sandeep Aggrawal, Pune Q. Dear Sir, I am a new investor in stock market. I want to invest Rs.5 lakh for more than one year. Currently I am considering buying shares of SAIL and Reliance Power. Should I go for it, please advice? Praveen Ramnani, Surat A. As this is the right time to invest in stock market, but according to our expectations the stocks you have chosen are bearish in short term. Both metal and power sector are exposed to global exposure and domestic demand is declining. If you can hold the stock for more than six months than go for it. For short term purpose you can go for Ranbaxy, Yes bank and Educomp. Ashok Goyal, Ahamdabad
A. Best choice to invest with out exposure of risk, mutual fund is the best class. As mutual funds are managed by highly qualified finance professionals and they are well diversified into different sectors and asset classes. If you want to invest for long term go for Equity diversified schemes. Q. Hi sir, what is your advice on Hindalco Ltd? Can I invest in this stock? Shishir Sharma, Kolkata A. Hindalco has very good future prospects because of its expansion plans and running projects. Currently, Hindalco is trading at 150 level with a support at 140 level in short term. If you want to hold the stock for more than six months, go for it with the target of Rs.200. Abhinav Singh, Indore Q. I am 24, good in health and have no dependents. Is there any advantage in buying insurance now? Abhinav Singh, Indore A. Yes, there are lot of advantages in buying a life insurance policy at early stage of life. The premium you pay depends mainly on two factors –your age and policy tenor. The younger you are, the lower your premium because you would be physically sound and not likely to suffer from illnesses. So it is advisable to go for insurance policy at early stage of life. Abhinav Singh, Indore Q. I am a client of RR Commodities since two year, I have read the article on Gold in last issue. The way it has defined was amazing and really i enjoyed a lot by the article, further I bought gold in exchange the level around 18700. Should I hold or book profit in gold? Shashank – Delhi A. Since you are one of more valuable client and subscriber of our magazine, we thank you first, further I must tell you that you have bought gold at right time, as of now it is trading at 17750, you partially book profit around 17900, and can hold rest for maximum gain. Gold demand in peak month Jume to July will surely spark the shinning metal.Gold price will be higher amid renewed worries over European deficits problems and the impacts on economic growth. Readers are requested to send one query at a time so that more number of investors can be given a chance. ______________________ Send in your queries RR Information & Investment Research (P) Ltd. 47, Rani Jhansi Marg, New Delhi -110055 Email: monitor@rrfcl.com
July, 2010
Investment Monitor 55
Mailbox Mutual Fund Analysis. I am a regular reader of the magazine and I like the article on Mutual fund and mutual fund watch. The article is complete in itself as it is provides information on the Mutual fund with its background. Funds suggested in June addition, was really very good in respect to returns and risks. The idea provide in Mutual fund article is very helpful. It helped me in making good investment decisions. The information is provided with the growth, returns and price of funds is really helpful to chose best out of many. Suresh, Gurgaon
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The cover story - Greek Crisis A Paraphrase of Economic Turbulence”. I am a regular reader of your magazine. I like the information and insightful articles that you provide in the magazine. In July issue I particularly liked the cover story “Greek Crisis a Paraphrase of Economic Turbulence”. It keeps informative about global events which directly or indirectly impact on other economies of the world. Euro crisis was one of the biggest events which lead to meltdown of stocks and companies. I am looking forward for more such investment tools to maximize my benefit in future.
56 Investment Monitor July, 2010
I am a regular subscriber of investment monitor and information provided is very specific, precise and useful for retail investors. I eagerly wait for next issue to have a snapshot of market via this section. It contains all the information about market movements, economic changes, mutual fund and FII activity, global scenario and debt market. Any investor can easily get all the information about the actions that have taken place during last months and their effect on stocks, industry etc. This section gives me insight to formulate strategy to invest in the coming month. Rakesh , Delhi
Commodity Technical Analysis. I am a commodity trader having exposure in commodity market more than equity market. I really like the commodity section carried in your magazine. The articles cover all the fundamental and technical information with recommendations are very useful to play in commodity market. The section provides a information and ideas on metals and agri commodity both. I would also suggest you to bring out an article on features of various commodities and use of stop loss while trading so that one may take better decision. Suresh , Mathura
Data Monitor I am a regular reader of your magazine. The news byte section is useful as it updates up with the latest happening in the business world like takeovers, new expansion plans, new deals etc. I must appreciate the data give in data monitor as this database gives the insight in to the company information. Review and analysis section is very helpful to get an idea of stock performance and index movements. Its keep us updated about the company financial status on monthly basis. It helps in selecting the best investment stock out of the same group of companies. I have invested in some value stocks after reading this data Rakesh Verma ,Raipur
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