Wednesday, 29 February 2012
Investment Guide
Have an 'Investment Objective'
Create for yourself an objective to perform wiser investments. This objective helps you choose between schemes that satisfy different objectives.
Read carefullyRead the offer document carefully before investing. Though it may be lengthy, you must at least read the sections on risk factors, litigations, promoters, company history, project, objects of the issue and key financial data.
Don't hesitate to approach professionals.Although you may be tempted to make your own investments, it may be smarter to trust options that offer a professional management of investments, for example Mutual Funds.
Deal only with registered intermediaries.You may need a broker to invest in many financial instruments. And a good broker might be the difference between a good, safe investment and a bad, money-losing investment. That’s why, it is important to deal with brokers who are registered with the regulatory authorities.
The SEBI approvalAlways look out for those companies that have been approved by the SEBI. The regulations laid down by the SEBI make for wiser investments with an official corroboration.
Avoid volatile sectors.
There are times when a sector is performing amazingly well and times when the same sector might be in a downtrend. That's why it is best to not be influenced by such volatile investment areas. Go for safer and less risky options like investing in a Mutual Fund.
Picking the Right Mutual FundMutual Funds are a great way to invest if you do not have the time or the expertise to invest in the stock market directly. Since there are several mutual funds and schemes in the market, it is important to select the right one for you.
Conduct your own research.There are various schemes in the market which may seem lucrative or even promise guaranteed returns. But take professional help and ensure that you select a scheme that best meets your investment objective.
Beware of stock advice spread via the media.
Free advice is not always free. Many of the investors who offer free advice on specific stocks with promises of lofty returns have vested interests in suggesting so. Beware of such tips.
Beware of fixed/guaranteed returns schemes.Treat any scheme that offers higher interest rates than a bank with suspicion. Do not be lured by false promises of unachievable profits on investments. Conduct your own research to choose a scheme that best suits your future needs.
Do not be fooled.In today's world, it is very easy to get fooled by seemingly lucrative offers that invite investments. Be strong and do not be taken in by companies that up their CSR or even unethical promoters.
Redressal of GrievancesIn case of any doubts or grievances it is best advised to approach the appropriate authorities or bodies. Seek corrective action and do not take things lying down.
Be honest.Be honest to yourself as only then can you demand honesty. Be a part of investor forums and fight for your own rights.
I Don’t want to invest for 10-15 years?
I Don’t want to invest for 10-15 years?
Power of compounding is huge over long term
What will be the value of money
on 31st day?
The longer you stay, higher the returns you make
Plan your time frame in accordance with your Goals, like,
for a child of age 3 yrs, do an SIP for 15 years for education
and for 20 yrs for marriage
Power of compounding is huge over long term
A little story
If you invested Re. 1 and it keeps on
doubling daily, do you know what will - Rs. 53.7 crorebe it’s value on 30th day?
What will be the value of money
on 31st day?
Rs. 107.4 crore
The longer you stay, higher the returns you make
Plan your time frame in accordance with your Goals, like,
for a child of age 3 yrs, do an SIP for 15 years for education
and for 20 yrs for marriage
Mutual Fund and Equity Overview
• What is Mutual Fund - Overview
• Types of Mutual Fund – Structure Wise and Objective Wise
• Regular Terms used in Mutual Funds
• Conviction on Equity Mutual Funds for Long Term Wealth Creation
Concept of a Mutual Fund
A common pool of money into which
investors place their contribution
This money is to be invested
according to the pre-stated objectives of the fund
Ownership of the fund is joint or mutual amongst all investors -
equivalent to the contribution made as a proportion of the overall fund
Ownership through holding of units at NAV
Advantages of Mutual Fund
Portfolio Diversification
Reduction of Risk
Professional Management
Reduction of Transaction Costs
Access to Information
Types of Funds: As per Structure
Open-ended
Daily sale/purchase
No fixed maturity
Fund is “secondary market”
Sale during NFO
Closed-ended
Fixed Maturity
SE is secondary market
Periodic sale / purchase
No fixed maturity
Tuesday, 28 February 2012
5 pointers to measuring Mutual Fund performance
More often than not meritocracy of investments is often decided by the returns. Quite simply then a fund generating more returns than the other is considered better than the other. But this is just half the story. What most of us would appreciate is the level of risk that a fund has taken to generate this return? So what is really relevant is not just performance or returns. What matters therefore are Risk Adjusted Returns.
The only caveat whilst using any risk-adjusted performance is the fact that their clairvoyance is decided by the past. Each of these measures uses past performance data and to that extent are not accurate indicators of the future.
As an investor you just have to hope that the fund continues to be managed by the same set of principles in the future too.
Standard Deviation
The most basic of all measures- Standard Deviation allows you to evaluate the volatility of the fund. Put differently it allows you to measure the consistency of the returns.
Volatility is often a direct indicator of the risks taken by the fund. The standard deviation of a fund measures this risk by measuring the degree to which the fund fluctuates in relation to its mean return, the average return of a fund over a period of time.
A security that is volatile is also considered higher risk because its performance may change quickly in either direction at any moment.
A fund that has a consistent four-year return of 3%, for example, would have a mean, or average, of 3%. The standard deviation for this fund would then be zero because the fund's return in any given year does not differ from its four-year mean of 3%. On the other hand, a fund that in each of the last four years returned -5%, 17%, 2% and 30% will have a mean return of 11%. The fund will also exhibit a high standard deviation because each year the return of the fund differs from the mean return. This fund is therefore more risky because it fluctuates widely between negative and positive returns within a short period.
Beta
Beta indicates the level of volatility associated with the fund as compared to the benchmark. So quite naturally the success of Beta is heavily dependent on the correlation between a fund and its benchmark. Thus if the fund's portfolio doesn't have a relevant benchmark index then a beta would be grossly inadequate.
A beta that is greater than one means that the fund is more volatile than the benchmark, while a beta of less than one means that the fund is less volatile than the index. A fund with a beta very close to 1 means the fund's performance closely matches the index or benchmark.
If, for example, a fund has a beta of 1.03 in relation to the BSE Sensex, the fund has been moving 3% more than the index. Therefore, if the BSE Sensex increased 10%, the fund would be expected to increase 10.30%.
Investors expecting the market to be bullish may choose funds exhibiting high betas, which increase investors' chances of beating the market. If an investor expects the market to be bearish in the near future, the funds that have betas less than 1 are a good choice because they would be expected to decline less in value than the index.
R-squared
The success of Beta is dependent on the correlation of a fund to its benchmark or its index. Thus whilst considering the beta of any security, you should also consider another statistic- R squared that measures the Correlation. The R-squared of a fund advises investors if the beta of a mutual fund is measured against an appropriate benchmark. Measuring the correlation of a fund's movements to that of an index, R-squared describes the level of association between the fund's volatility and market risk, or more specifically, the degree to which a fund's volatility is a result of the day-to-day fluctuations experienced by the overall market.
R-squared values range between 0 and 1, where 0 represents no correlation and 1 represents full correlation. If a fund's beta has an R-squared value that is close to 1, the beta of the fund should be trusted. On the other hand, an R-squared value that is less than 0.5 indicates that the beta is not particularly useful because the fund is being compared against an inappropriate benchmark.
Alpha
Alpha = {(Fund return-Risk free return) - Funds beta *(Benchmark return- risk free return)}. Alpha is the difference between the returns one would expect from a fund, given its beta, and the return it actually produces.An alpha of 1.0 means the fund produced a return 1% higher than its beta would predict. An alpha of -1.0 means the fund produced a return 1% lower. If a fund returns more than its beta then it has a positive alpha and if it returns less then it has a negative alpha. Once the beta of a fund is known, alpha compares the fund's performance to that of the benchmark's risk-adjusted returns. It allows you to ascertain if the fund's returns outperformed the market's, given the same amount of risk.
The higher a funds risk level, the greater the returns it must generate in order to produce a high alpha.
Normally one would like to see a positive alpha for all of the funds you own. But a high alpha does not mean a fund is doing a bad job nor is the vice versa true. Because alpha measures the out performance relative to beta. So the limitations that apply to beta would also apply to alpha.
Alpha can be used to directly measure the value added or subtracted by a fund's manager.
The accuracy of an alpha rating depends on two factors: 1) the assumption that market risk, as measured by beta, is the only risk measure necessary; 2) the strength of fund's correlation to a chosen benchmark such as the BSE Sensex or the NIFTY.
Sharpe Ratio
Sharpe Ratio= Fund return in excess of risk free return/ Standard deviation of Fund
So what does one do for funds that have low correlation with indices or benchmarks? Use the Sharpe ratio. Since it uses only the Standard Deviation, which measures the volatility of the returns there is no problem of benchmark correlation.
The higher the Sharpe ratio, the better a funds returns relative to the amount of risk taken. Sharpe ratios are ideal for comparing funds that have a mixed asset classes. That is balanced funds that have a component of fixed income offerings.
The only caveat whilst using any risk-adjusted performance is the fact that their clairvoyance is decided by the past. Each of these measures uses past performance data and to that extent are not accurate indicators of the future.
As an investor you just have to hope that the fund continues to be managed by the same set of principles in the future too.
Standard Deviation
The most basic of all measures- Standard Deviation allows you to evaluate the volatility of the fund. Put differently it allows you to measure the consistency of the returns.
Volatility is often a direct indicator of the risks taken by the fund. The standard deviation of a fund measures this risk by measuring the degree to which the fund fluctuates in relation to its mean return, the average return of a fund over a period of time.
A security that is volatile is also considered higher risk because its performance may change quickly in either direction at any moment.
A fund that has a consistent four-year return of 3%, for example, would have a mean, or average, of 3%. The standard deviation for this fund would then be zero because the fund's return in any given year does not differ from its four-year mean of 3%. On the other hand, a fund that in each of the last four years returned -5%, 17%, 2% and 30% will have a mean return of 11%. The fund will also exhibit a high standard deviation because each year the return of the fund differs from the mean return. This fund is therefore more risky because it fluctuates widely between negative and positive returns within a short period.
Beta
Beta indicates the level of volatility associated with the fund as compared to the benchmark. So quite naturally the success of Beta is heavily dependent on the correlation between a fund and its benchmark. Thus if the fund's portfolio doesn't have a relevant benchmark index then a beta would be grossly inadequate.
A beta that is greater than one means that the fund is more volatile than the benchmark, while a beta of less than one means that the fund is less volatile than the index. A fund with a beta very close to 1 means the fund's performance closely matches the index or benchmark.
If, for example, a fund has a beta of 1.03 in relation to the BSE Sensex, the fund has been moving 3% more than the index. Therefore, if the BSE Sensex increased 10%, the fund would be expected to increase 10.30%.
Investors expecting the market to be bullish may choose funds exhibiting high betas, which increase investors' chances of beating the market. If an investor expects the market to be bearish in the near future, the funds that have betas less than 1 are a good choice because they would be expected to decline less in value than the index.
R-squared
The success of Beta is dependent on the correlation of a fund to its benchmark or its index. Thus whilst considering the beta of any security, you should also consider another statistic- R squared that measures the Correlation. The R-squared of a fund advises investors if the beta of a mutual fund is measured against an appropriate benchmark. Measuring the correlation of a fund's movements to that of an index, R-squared describes the level of association between the fund's volatility and market risk, or more specifically, the degree to which a fund's volatility is a result of the day-to-day fluctuations experienced by the overall market.
R-squared values range between 0 and 1, where 0 represents no correlation and 1 represents full correlation. If a fund's beta has an R-squared value that is close to 1, the beta of the fund should be trusted. On the other hand, an R-squared value that is less than 0.5 indicates that the beta is not particularly useful because the fund is being compared against an inappropriate benchmark.
Alpha
Alpha = {(Fund return-Risk free return) - Funds beta *(Benchmark return- risk free return)}. Alpha is the difference between the returns one would expect from a fund, given its beta, and the return it actually produces.An alpha of 1.0 means the fund produced a return 1% higher than its beta would predict. An alpha of -1.0 means the fund produced a return 1% lower. If a fund returns more than its beta then it has a positive alpha and if it returns less then it has a negative alpha. Once the beta of a fund is known, alpha compares the fund's performance to that of the benchmark's risk-adjusted returns. It allows you to ascertain if the fund's returns outperformed the market's, given the same amount of risk.
The higher a funds risk level, the greater the returns it must generate in order to produce a high alpha.
Normally one would like to see a positive alpha for all of the funds you own. But a high alpha does not mean a fund is doing a bad job nor is the vice versa true. Because alpha measures the out performance relative to beta. So the limitations that apply to beta would also apply to alpha.
Alpha can be used to directly measure the value added or subtracted by a fund's manager.
The accuracy of an alpha rating depends on two factors: 1) the assumption that market risk, as measured by beta, is the only risk measure necessary; 2) the strength of fund's correlation to a chosen benchmark such as the BSE Sensex or the NIFTY.
Sharpe Ratio
Sharpe Ratio= Fund return in excess of risk free return/ Standard deviation of Fund
So what does one do for funds that have low correlation with indices or benchmarks? Use the Sharpe ratio. Since it uses only the Standard Deviation, which measures the volatility of the returns there is no problem of benchmark correlation.
The higher the Sharpe ratio, the better a funds returns relative to the amount of risk taken. Sharpe ratios are ideal for comparing funds that have a mixed asset classes. That is balanced funds that have a component of fixed income offerings.
Understanding Debt Funds
Debt funds (or Income funds) are funds that invest strictly in debt related securities. Unlike any other asset class like equity, debt securities are characterized by the following factors
• Known maturity period
• Known coupon rate (or in common parlance known interest rate)
• Known maturity value
Examples of these instruments include Debentures issued by Corporates, State Governments and Central Government, Fixed deposits, Commercial paper, T Bills, Debentures,
WHY DON’T DEBT FUNDS ASSURE RETURNS WHEN THE UNDERLYING SECURITIES THAT THEY INVEST DO?
Debt funds invest in debt securities where the three factors that govern any investment product are known. Yet they don’t assure returns. Sounds a bit perplexing. Actually it is not. Here’s how
There are several factors that decide the coupon rate for a debt security. Chief among them being
• Prevailing interest rate scenario
• Credit worthiness of the security and
• Maturity period.
Of the above, the first factor i.e. the prevailing interest rate scenario is the most critical and most unknown among the rest.
To give you an example, if the prevailing interest rate scenario (as decided by a slew of risk- free debt securities like the Bank prime lending rate, GOI coupon rate for a similar maturity period) suggests that a risk free security maturing in one year is offering a coupon of around 6% then a similar maturing security offered by a corporate (which theoretically speaking is riskier) has to offer a slightly higher rate else buyers wont find this lucrative enough.
Interest rates are not constant at all. They in turn are dependent on a whole range of macro and micro economic factors. Tracking this is a highly complex and sophisticated exercise.
Fund managers therefore constantly track these factors and attempt to get a grip on the movements on the kind of securities that will offer the best return given the prognosis that the fund manager has arrived at.
The prices of these securities change, based on how interest rates actually unfurl. (More about this later). In a rising interest rate scenario older securities are generally offered at discount as the newer securities get issued at a higher coupon and conversely in a falling interest rate scenario older securities go at a premium as they offer a higher coupon rate than the ones that are newly issued.
Also as a thumb rule, the longer the maturity period, riskier it is and therefore the most volatile.
• Known maturity period
• Known coupon rate (or in common parlance known interest rate)
• Known maturity value
Examples of these instruments include Debentures issued by Corporates, State Governments and Central Government, Fixed deposits, Commercial paper, T Bills, Debentures,
WHY DON’T DEBT FUNDS ASSURE RETURNS WHEN THE UNDERLYING SECURITIES THAT THEY INVEST DO?
Debt funds invest in debt securities where the three factors that govern any investment product are known. Yet they don’t assure returns. Sounds a bit perplexing. Actually it is not. Here’s how
There are several factors that decide the coupon rate for a debt security. Chief among them being
• Prevailing interest rate scenario
• Credit worthiness of the security and
• Maturity period.
Of the above, the first factor i.e. the prevailing interest rate scenario is the most critical and most unknown among the rest.
To give you an example, if the prevailing interest rate scenario (as decided by a slew of risk- free debt securities like the Bank prime lending rate, GOI coupon rate for a similar maturity period) suggests that a risk free security maturing in one year is offering a coupon of around 6% then a similar maturing security offered by a corporate (which theoretically speaking is riskier) has to offer a slightly higher rate else buyers wont find this lucrative enough.
Interest rates are not constant at all. They in turn are dependent on a whole range of macro and micro economic factors. Tracking this is a highly complex and sophisticated exercise.
Fund managers therefore constantly track these factors and attempt to get a grip on the movements on the kind of securities that will offer the best return given the prognosis that the fund manager has arrived at.
The prices of these securities change, based on how interest rates actually unfurl. (More about this later). In a rising interest rate scenario older securities are generally offered at discount as the newer securities get issued at a higher coupon and conversely in a falling interest rate scenario older securities go at a premium as they offer a higher coupon rate than the ones that are newly issued.
Also as a thumb rule, the longer the maturity period, riskier it is and therefore the most volatile.
How does money in a Debt Fund appreciate?
| There are two independent sources of revenue that a debt fund earns : a) Interest Income b) Mark to market | |||||||||||||||||||||||
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| a) Understanding Interest Income When you invest in a Bank/Company deposit it offers you a fixed rate of interest with the principal being returned on maturity. Similarly when a debt fund invests in various debt securities the issuers of these securities offer a rate of interest and the principal on maturity. The issuers of these securities could either be various corporates like Reliance, Hindalco, ICICI, Bharat Petroleum or the Government of India. Understanding Interest Income Say a debt fund with a starting NAV of Rs 100.00 buys a Rs 100 GoI security paying 8.5% interest semi-annually with a maturity of 5 years. • The debt fund would earn Rs 8.50 annually and get back the principal of Rs 100 at the end of 5 years. • The debt fund spreads the Rs 8.50 of interest it earns annually over 365 days of the year i.e. it earns Rs. 0.0233 per day. | |||||||||||||||||||||||
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| b) Mark to Market Gain/Loss As interest rates on Bank Fixed Deposits change frequently so do interest rates on debt securities. Interest rates and debt security prices are in fact the two sides in a See-saw. In general, prices fall when interest rates rise and rise when interest rates fall. If interest rates were to decline then newer bonds would be issued at lower interest rates than existing bonds. Consequently old bonds would be dearer and hence prices of these older bonds would rise. Similarly if interest rates were to rise then the value of old bonds would fall as newer bonds would bear higher interest rates. The traded price of a bond may thus differ from its face value. The longer a bond's period to maturity, the more its prices tend to fluctuate as market interest rates change Understanding Mark to Market If interest rates decline and the GoI issues new 5 year bonds at an interest rate of 7.5% it leads to an increase in the value of the old bonds of 8.5%. The price of the old bonds will move from Rs 100 to Rs 105. If the old bonds are now sold the new buyer will receive Rs 8.50 per year for 5 years but will make a loss of Rs 5 on redemption of the principal at the end of 5 years. The investor over 5 years therefore earns Rs 42.50 by way of interest and loses Rs 5 on the principal amount invested giving a return of Rs 37.50 over 5 years which is equal to the new bond's.
On the day the old bond price is marked up to Rs 105 the NAV of the fund will increase by Rs 5.00 but from that day onwards the daily interest income will decrease from 8.5% p.a. to 7.5% p.a. |
Understanding floating rate funds
| The interest rate yo-yo The interest rate yo-yo has impacted most of us. Interest rates have been volatile in the past few years. Riding this Interest rate roller-coaster can be a nerve-racking experience. At times enjoyable and at times distressing. In times when interest rates were going down, one benefited from cheaper loans but lost out on lower returns on investments. Conversely when interest rates stiffened, one benefited from higher rates on fixed rate investments but lost out on dearer loans. Understanding Fixed Rate Loans and Floating Rate Loans Before actually trying to unravel Floating Rate Instruments, let us get a grip on a situation we are familiar with - Floating rate and Fixed rate loans. A fixed interest rate loan has the advantage of clearly defining the total loan obligation, but in case of a fall in interest rates, a fixed rate loan may result in a higher debt service obligation. On the other hand, a floating rate loan allows you to take advantage of interest rate movements. The interest rate in such loans is linked to a benchmark generally the internal prime- lending rate. This is adjusted periodically in relation to market movements. Thus a floating rate loan denies you the knowledge of the total loan obligation but ensures that you reap benefits in case of fall in interest rates. So quite clearly floating rate loans work best to your advantage at time when interest rates are falling. Quite similarly a Floating Rate instrument is a debt instrument whose interest rate (coupon) is not fixed and is linked to a benchmark rate and is adjusted periodically. What is a benchmark rate? A benchmark or a reference rate is a rate that is an accurate measure of the market price. In the fixed income market, it is an interest rate that the market respects and closely watches. A benchmark rate should be from an unbiased source, be representative of the market, transparent, reliable and continuously available and most importantly be widely acceptable to the market as the benchmark rate Such benchmark rates issued by unbiased sources are the Treasury Bill T-Bill) rate issued by the Government of India, the bank rate as decided by the Reserve Bank of India, the Mumbai Interbank Offering Rate (MIBOR) released by the National Stock Exchange of India and GOI Securities. A company issues debentures at 1 year GOI Security yield +100 basis points (simply 1%) with a tenor of 5 years, periodically reset every six months. If the1 year GOI security is currently ruling at 5.75%, the interest rate that is fixed for the first six months is 5.75% +1%=6.75%. What are Floating Rate funds? A floating rate fund is a fund that by its investments in floating rate instruments seeks to provide stable returns with low level of interest rate risk and volatility. For example the UBS Floating Rate Fund invests primarily in Floating rate debentures and bonds Short tenor fixed rate instruments Long tenor fixed rate instrument swapped to floating rate (Interest Rate Swaps) Why Floating Rate Funds? Floating Rate funds are protective funds and shield your investments from interest rate fluctuations. In a declining interest rate scenario older securities issued at higher coupon rates (interest paid on the face value of a debt instrument) appear much more attractive than the ones that are currently issued. Consequently older higher interest bearing securities would go at a premium. Thus long term income funds by virtue of their investments in longer maturing securities would see a rise in their Net Asset Values. However, when interest rates are on the rise newer securities appear more attractive than the ones that were issued earlier, as they offer higher coupons than their predecessors. The lesser paying older securities therefore will be sold at a discount. So the same income fund with a majority of investment in longer maturing securities, now start earning you lesser as newer securities continue to earn higher returns than the ones in the portfolio. This bearish scenario lasts as long as interest rates continue to show an upward trend. It is during these times that floating rate funds offer the best utility. In a rising interest rate scenario, the interest rate on a Floating Rate instrument is periodically reset to a higher level due to the fact that accompanying benchmark rate is anyway at a higher level. On account of this periodic reset the difference in returns between a floating rate fund and a security that is issued currently is marginal. So the price difference is marginal leading to a marginal impact on the NAV. Interest Rate Swaps Most floating rate funds also invest in something referred to as 'Long tenor fixed rate instrument' swapped to floating rates. These kinds of instruments are commonly referred to as an Interest Rate Swaps. By definition an interest rate swap is a contractual agreement entered into between two counter parties under which each agrees to make periodic payment to the other for an agreed period of time based upon a notional amount of principal. The principal amount is notional because there is no need to exchange actual amounts of principal. A fixed for floating interest rate swap is an exchange of a series of fixed interest payments for a series of floating interest payments, fluctuating with the benchmark. Example Fund A and Bank B enter into an IRS agreement where in Fund A pays Bank B a fixed rate of 7.25%p.a. for three months and receives NSE MIBOR (benchmark floating rate) from Bank A for the next 3 months on a notional principal of Rs. 10 Cr. Scenario I After 3 months let us assume the average MIBOR compounded daily turns to be 7.05% p.a. Fund A would pay = 10,00,00,000 x (7.25/100) x (90/365) = 17,87,671 Bank B would pay = 10,00,00,000 x (7.05/100) x (90/365) = 17,38,356 Net Pay from Fund A to Bank B = Rs. 49,315 At the end of 3 months SCMF would pay Bank A Rs. 49,315. Please note that the notional principal is not exchanged. Scenario II After 3 months let us assume the average MIBOR compounded daily turns to be 7.45% p.a. Fund A would pay = 10,00,00,000 x (7.25/100) x (90/365) = 17,87,671 Bank B would pay = 10,00,00,000 x (7.45/100) x (90/365) = 18,36,986 Net Pay from Fund A to Bank B = Rs. 49,315 After 3 months had the MIBOR compounded daily turned out to be 7.45% then Bank B would have to pay Rs.49,315. Fund A thus benefits if interest rates rise. Bank B benefits if interest rates fall |
Measuring bond price volatility
Bond Price Volatility refers to the fluctuations in the price of a bond due to changes in various underlying factors. An optimal bond portfolio should be able to effectively factor in such volatilities and keep resulting price risk to a minimal. However, estimation of such volatilities in the bond price is not easy. Moreover, volatility in the prices of different securities varies with the yield, maturity and the duration of these respective securities. Thus to effectively estimate volatility of a portfolio, various measures of such estimation need to be resorted to. Some of these are discussed here.
Price Value of a Basis Point
Price Value of a Basis Point refers to the change in the price of a bond if the yield changes by 1 basis point (0.01%). If the price of Security A falls by 20 paise when the yield rises by 0.01% and the price of Security B falls by 25 paise for the same rise in the yield, then Security B would be said to be more volatile than Security A. This volatility, of course, holds good even on the positive side; that is when price of Security B rises more than that of Security A for the same fall in yield. Therefore, a portfolio manager's job is to optimize positive volatility while minimizing downside volatility.
Yield Value of a Price change
Yield Value of a Price change refers to the change in the yield of a security for a specified change in the price of the security. The smaller the yield value, the price volatility would be greater since even a small change in the yield would change the price considerably.
Duration of the Bond
Duration of the bond, in simple terms, is the measure of time to its maturity. It is a measure of the bond's price risk. Higher the duration of the bond, higher is the bond's sensitivity to market interest rate movements. The concept is of extreme importance in the context of bond volatility. In case of a bond having fixed term to maturity with no intermittent coupon payments, the duration of the bond is simply its tenor to maturity. However in case of coupon paying bonds, the investor receives interest payments before the maturity date and hence the duration of the bond is lower than its tenor. The present values of the cash flows are taken as the weights for calculating the duration of the bond.Generally, bonds with longer terms to maturity have higher durations than bonds with shorter maturities. Bonds with lower coupons have higher durations than bonds with higher coupons.
Modified Duration
Modified Duration establishes a direct mathematical relationship between bond price and interest rate changes. It is a direct measure of the interest rate sensitivity of the bond.Mathematically, percentage change in bond price is the product of Modified Duration of the bond and the change in its yield. The concept can be used effectively to manage portfolio volatility since the modified duration of a bond and the sensitivity of its price to interest rate movements are inversely related.
Convexity
Duration and Modified Duration of the bond assume a linear relationship between price and yield. However, since the actual yield curve is usually convex, measurement of the bond risk using its duration may not give a perfect picture. Convexity takes into account the shape of the Price yield relationship when making price sensitivity calculations. It is the rate of change of duration with a change in the yield.
Price Value of a Basis Point
Price Value of a Basis Point refers to the change in the price of a bond if the yield changes by 1 basis point (0.01%). If the price of Security A falls by 20 paise when the yield rises by 0.01% and the price of Security B falls by 25 paise for the same rise in the yield, then Security B would be said to be more volatile than Security A. This volatility, of course, holds good even on the positive side; that is when price of Security B rises more than that of Security A for the same fall in yield. Therefore, a portfolio manager's job is to optimize positive volatility while minimizing downside volatility.
Yield Value of a Price change
Yield Value of a Price change refers to the change in the yield of a security for a specified change in the price of the security. The smaller the yield value, the price volatility would be greater since even a small change in the yield would change the price considerably.
Duration of the Bond
Duration of the bond, in simple terms, is the measure of time to its maturity. It is a measure of the bond's price risk. Higher the duration of the bond, higher is the bond's sensitivity to market interest rate movements. The concept is of extreme importance in the context of bond volatility. In case of a bond having fixed term to maturity with no intermittent coupon payments, the duration of the bond is simply its tenor to maturity. However in case of coupon paying bonds, the investor receives interest payments before the maturity date and hence the duration of the bond is lower than its tenor. The present values of the cash flows are taken as the weights for calculating the duration of the bond.Generally, bonds with longer terms to maturity have higher durations than bonds with shorter maturities. Bonds with lower coupons have higher durations than bonds with higher coupons.
Modified Duration
Modified Duration establishes a direct mathematical relationship between bond price and interest rate changes. It is a direct measure of the interest rate sensitivity of the bond.Mathematically, percentage change in bond price is the product of Modified Duration of the bond and the change in its yield. The concept can be used effectively to manage portfolio volatility since the modified duration of a bond and the sensitivity of its price to interest rate movements are inversely related.
Convexity
Duration and Modified Duration of the bond assume a linear relationship between price and yield. However, since the actual yield curve is usually convex, measurement of the bond risk using its duration may not give a perfect picture. Convexity takes into account the shape of the Price yield relationship when making price sensitivity calculations. It is the rate of change of duration with a change in the yield.
Watch your portfolio and not market levels
Rajiv Anand, Head Investments
Reincarnation is in vogue these days. And in true Indian style I must have done something good in my past to be witnessing times like these. The last 6-8 years have been perhaps the most defining years for the country in general and for the markets in particular. And I intend sharing with you what I have collected in the recent past by being a very involved participant in this match.
But I wouldn’t want to insult the intelligence of even the novice investor by expounding on evergreen cliches like Magic of compounding, the best time to invest is now etc.. Not that I am saying that these truths are no longer true. They are and will be the foundation. And the longevity and solidity of your investment structure will depend on the strength of your foundation.
With each new level of the Sensex it gets increasingly difficult to evaluate and exercise judgment for each new level brings a sense of excessiveness. Consider this though, when you travel in a plane and as it goes higher you see more only of the forest. Quite naturally from that height the tall trees make up the forest. However if you pull the plug of the parachute and glide down ever so slowly and delve deeper into the forest you are sure to find a few tall trees have masked a lot of small trees. The point therefore is focus on stocks in your portfolio rather than on the “market levels”.
We live in a complex world and every purchase decision involves wading through has a plethora of choices and views. Gone are the days when there was one car- one phone provider (In fact these companies have either closed down or are rapidly decaying). 10 years ago the market was about “Khabbar” and access to information was with a limited few. Today we have moved to the other extreme. We are bombarded with information from all sides; minute by minute update on stock prices, daily sound bytes from “experts”, regular analysis of daily/weekly/monthly movements of the markets of all types. And it doesn’t help when you live in a country where everyone has “thodu advise”. Even my maid now talks intelligently about yen carry trade! Fine I am exaggerating a bit here. But the point is that for the aam investor, making an informed decision is much easier. If he is willing to make the effort, that is. The effort involved in deciding what to use and what to discard. Remember each set of new information sounds appealing but can be completely useless or maybe even incorrect. If you find that difficult, leave it to the fund managers. The role of the fund managers has now evolved to collecting and gleaning the right kind of information.
We live an age of heightened impatience. We want everything now (yet I notice fewer people are making it on time for appointments). The focus therefore is greater on “instant gratification” or “love at first sight”. Be it products or relationships one needs a quick high. If it ain’t working replace it. And this way of life has in some way crept into the investment behavior as well. Investors want quick fixes on their portfolios as well. However some things never change; the only way to create wealth in the equity markets is through diligence, conviction and patience, in that order.
In a bull market fuelled with high degrees of liquidity, it is easy to collect quick wins (trading gains) but unfortunately these wins are just that. But a quick win is a like an energy drink. Take a swipe and then you feel great but you soon require higher degrees of the same to satiate. But each excess tends to loosen your control. And very few know when to stop. Losses too are quick. It is not uncommon to hear people talk about their last stock pick and how it has gone up manifold. But when was the last time you heard someone tell about the losses on his portfolio. Keeping up with the Patels next door is a dangerous thing to do in investing.
And in the end my advice (like any die-hard Indian) would be the next time some one asks you market kya lagta hai? Just say Kuch khatta, Kuch meetha par long term main zaroor meetha.
Reincarnation is in vogue these days. And in true Indian style I must have done something good in my past to be witnessing times like these. The last 6-8 years have been perhaps the most defining years for the country in general and for the markets in particular. And I intend sharing with you what I have collected in the recent past by being a very involved participant in this match.
But I wouldn’t want to insult the intelligence of even the novice investor by expounding on evergreen cliches like Magic of compounding, the best time to invest is now etc.. Not that I am saying that these truths are no longer true. They are and will be the foundation. And the longevity and solidity of your investment structure will depend on the strength of your foundation.
With each new level of the Sensex it gets increasingly difficult to evaluate and exercise judgment for each new level brings a sense of excessiveness. Consider this though, when you travel in a plane and as it goes higher you see more only of the forest. Quite naturally from that height the tall trees make up the forest. However if you pull the plug of the parachute and glide down ever so slowly and delve deeper into the forest you are sure to find a few tall trees have masked a lot of small trees. The point therefore is focus on stocks in your portfolio rather than on the “market levels”.
We live in a complex world and every purchase decision involves wading through has a plethora of choices and views. Gone are the days when there was one car- one phone provider (In fact these companies have either closed down or are rapidly decaying). 10 years ago the market was about “Khabbar” and access to information was with a limited few. Today we have moved to the other extreme. We are bombarded with information from all sides; minute by minute update on stock prices, daily sound bytes from “experts”, regular analysis of daily/weekly/monthly movements of the markets of all types. And it doesn’t help when you live in a country where everyone has “thodu advise”. Even my maid now talks intelligently about yen carry trade! Fine I am exaggerating a bit here. But the point is that for the aam investor, making an informed decision is much easier. If he is willing to make the effort, that is. The effort involved in deciding what to use and what to discard. Remember each set of new information sounds appealing but can be completely useless or maybe even incorrect. If you find that difficult, leave it to the fund managers. The role of the fund managers has now evolved to collecting and gleaning the right kind of information.
We live an age of heightened impatience. We want everything now (yet I notice fewer people are making it on time for appointments). The focus therefore is greater on “instant gratification” or “love at first sight”. Be it products or relationships one needs a quick high. If it ain’t working replace it. And this way of life has in some way crept into the investment behavior as well. Investors want quick fixes on their portfolios as well. However some things never change; the only way to create wealth in the equity markets is through diligence, conviction and patience, in that order.
In a bull market fuelled with high degrees of liquidity, it is easy to collect quick wins (trading gains) but unfortunately these wins are just that. But a quick win is a like an energy drink. Take a swipe and then you feel great but you soon require higher degrees of the same to satiate. But each excess tends to loosen your control. And very few know when to stop. Losses too are quick. It is not uncommon to hear people talk about their last stock pick and how it has gone up manifold. But when was the last time you heard someone tell about the losses on his portfolio. Keeping up with the Patels next door is a dangerous thing to do in investing.
And in the end my advice (like any die-hard Indian) would be the next time some one asks you market kya lagta hai? Just say Kuch khatta, Kuch meetha par long term main zaroor meetha.
What are Fixed Maturity Plan?
Understanding Fixed Maturity Plans (FMPs)
I. | What are Fixed Maturity plans? |
II. | FMPs do not guarantee returns but their returns are fairly predictable |
III. | What are FMP maturity periods? |
IV. | Can I withdraw before maturity? |
V. | What to look out for? |
VI. | FMPs are less taxing |
VII. | Risk Factors |
I. What are Fixed Maturity plans?
A Fixed Maturity Plan (FMP) is a fixed income scheme and generally is 100% equity free. FMPs have a fixed life and a definite maturity date i.e. they are closed ended schemes and hence the name Fixed Maturity. Post the maturity date the fund ceases to exist and your investment along with the appreciation is automatically returned back to you.
II. FMPs do not guarantee returns but their returns are fairly predictable
Though Fixed Maturity plans do not guarantee returns they are relatively more predictable in their returns. Here’s how.
As investments generally do not flow in or out during the tenure of the scheme it allows the Fund manager of the FMP to lock into a pre-decided fixed instrument (could be debentures, Commercial Paper, Certificate of Deposit, Gilts i.e. securities issued by the Government of India.) and hold on to it till the expiry of the instrument. Quite naturally the maturity profile of this fixed income instrument would be similar to the maturity profile of the scheme thus lending FMPs their relative predictability. Thus unlike an open ended fixed income fund, the fund manager here generally does not trade.
Though Fixed Maturity plans do not guarantee returns they are relatively more predictable in their returns. Here’s how.
As investments generally do not flow in or out during the tenure of the scheme it allows the Fund manager of the FMP to lock into a pre-decided fixed instrument (could be debentures, Commercial Paper, Certificate of Deposit, Gilts i.e. securities issued by the Government of India.) and hold on to it till the expiry of the instrument. Quite naturally the maturity profile of this fixed income instrument would be similar to the maturity profile of the scheme thus lending FMPs their relative predictability. Thus unlike an open ended fixed income fund, the fund manager here generally does not trade.
III. What are FMP maturity periods?
FMPs come in various maturities. Typical maturity periods are 90 day, 180 days, yearly (though the maturity tends to be slightly more than a year to avail of double indexation benefits), 3 years etc. A 90 day FMP simply means a FMP with a maturity of 90 days.
IV. Can I withdraw before maturity?
FMPs that have a maturity of more than 90 days, have to provide investors specific exit dates where investors can withdraw. But this comes at a price. These exit dates are pre-decided and known beforehand.
You can withdraw only after paying an exit load i.e. a penalty for early withdrawal as the fund manager may have to break the scheme’s investment in an otherwise locked-in instrument thus entailing transaction costs and in an extreme scenario even a decline in returns of the portfolio as new instruments may or may not yield the earlier yields.
FMPs that have a maturity of more than 90 days, have to provide investors specific exit dates where investors can withdraw. But this comes at a price. These exit dates are pre-decided and known beforehand.
You can withdraw only after paying an exit load i.e. a penalty for early withdrawal as the fund manager may have to break the scheme’s investment in an otherwise locked-in instrument thus entailing transaction costs and in an extreme scenario even a decline in returns of the portfolio as new instruments may or may not yield the earlier yields.
V. What to look out for?
Though FMPs have a definite maturity, the credit quality of the portfolio is crucial. Credit quality simply means if the issuer of the fixed instrument that the fund manager chooses to invest in is reputable or not. AAA is the rating that is issued to a reputed borrower. Logically a better quality portfolio should yield you less than a portfolio which compromises on portfolio for returns.
VI. FMPs are less taxing
Dividends declared in FMPs are completely tax-free in your hands though the fund deducts a Dividend distribution tax of 14.1625% at source.
VII. Risk Factors
Mutual Funds and securities investments are subject to market risks, reinvestment risk, changes in political, economic environment and government policy and there is no assurance or guarantee that the objectives of the Scheme(s) will be achieved. The NAV of the Scheme(s) can go up or down depending on factors and forces affecting the Securities Market including fluctuation in interest rates, trading volumes and reinvestment risk. Past performance of the Sponsor/AMC/Mutual Fund is not necessarily indicative of the future performance of the Scheme(s) and may not necessarily provide a basis for comparison with other investments. The name(s) of the scheme(s) (including Fixed Maturity Plans) not in any manner indicate either the quality of the scheme(s), their future prospects or returns. The Sponsor or any of its associates is not responsible or liable for any loss resulting from the operation of the Scheme(s) beyond the corpus of the Trust of Rs. 30,000/-. Please read Offer Document(s) before investing.
5 easy steps to investing in Mutual Funds
Step 1: Search: Where to look for if you want to begin saving in mutual funds
Mutual funds are much like any other product, in that there are manufacturers who provide the product and there are dealers who sell them. Large banks to organized brokerage houses to Individual Financial agents get empanelled with Mutual Funds to provide advice and assistance to customers who want to buy units. Mutual funds units can now also be bought over the Internet.
Contacting an Investment advisor in a bank or a brokerage house or an Independent Financial Advisor is the first step to gathering information.
Step 2: Evaluation: choosing the right mutual fund for you
Each Mutual fund offers a variety of schemes to suit differing needs of investors. The Bank / Brokerage house / Individual Financial Advisor helps you make the choice based on your needs
As an investor one may
a) want to invest for the short term or long term want to invest
b) want regular income or growth
c) want to target lower risk or higher returns
d) be convinced of a particular sector and want to invest in it
Remember, just like a salesman in a gift shop, your investment advisor can help you the most if he knows what you are looking for.
Step 3: Purchase
After you have decided to save, you may have to decide among the various investment and withdrawal options that any fund offers to its investors. Most of these schemes also offer various options to customize your operation of the fund to your needs:
Systematic Investment Plan (SIP)
Allows you to save a part of your income regularly. Also used to reduce risk when investing in schemes targeting aggressive growth.
Systematic Withdrawal Plan (SWP)
Allows you to withdraw a part of your investment regularly. Used when you want to withdraw your investment for a specific regular payment, like insurance premium payments of monthly/quarterly frequency
Direct debit
Saves the hassle of writing a cheque when making an investment. Your account is debited automatically for the amount invested.
Direct credit
The reverse of Direct Debit. It saves the hassle of enchasing a cheque when withdrawing an investment. Your account is credited automatically with the amount withdrawn.
Dividend plan
Allows you to get Tax-free dividends from your investment. (As per current tax laws).
Growth plan
Allows the income generated from investment to be ploughed back into the scheme. Used by investor targeting growth in their investment.
Some funds carry an entry load, which is a percentage fee deducted from the amount invested before investment. Thus a 2.5% entry load will mean that if you invest Rs. 1 lakh in a Rs. 10 per unit IPO, instead of getting 10,000 units, you will be allotted 9,750 units. Check for presence of such loads and other conditions before investing.
After deciding the choice of mutual fund, investment and withdrawal, you are ready to begin your savings. You need to now fill up an application form and attach a cheque of the value of your investment or mention your account number to have it automatically debited from your account.
Step 4: Post Purchase Monitoring
Once you have invested in an ongoing fund, expect a period of two to three days before you receive an account statement on the address mentioned by you in your application form.
The Account Statement
Your account statement indicates your current holding in the scheme that you have invested. Please ensure that all your details have been correctly captured in account statement. Please point out any discrepancies to your nearest CAMS investor Service Centre or the Mutual Fund office. You can request an account statement any time by calling up your nearest CAMS / Mutual fund offices usually mentioned on the back of the account statement.
The transaction slip at the end of the account statement can be used for additional purchases, redemptions or to intimate the mutual fund on any change in bank mandates/address.
The NAVs of all the open-ended schemes are published at the fund's website, financial newspapers and AMFI (Association of Mutual Funds) web-site www.amfiindia.com.
Step 5: Exit
While you should periodically monitor the performance of your investments, we recommend you do not get swayed by short term considerations in deciding your exit. If you have invested in a long term fund, you can spare yourself undue worries by not monitoring the NAV every day or week. Checking the performance once in a while along with your advisor should be fine. Most mutual funds will provide you with a toll free number that works from 9 am to 5 am and a website. For specific assistance you can also use your financial advisors help.
Redemption/ Withdrawal
Just submit your completed transaction within the transacted time for the scheme that you are invested in and deposit the same at the nearest CAMS Investor Service Centre or the office of the fund. You can either get a direct credit to your bank account or you can generally collect the cheque at the CAMS Investor Service Centre/ AMC offices. If you fail to do so then the cheque is couriered to the address mentioned in your account statement. Most funds take 1-3 days to credit your account with your redemption proceeds.
In case an exit load is applicable to your withdrawal and you have redeemed a fixed amount, an additional number of units equivalent to the exit load amount will be liquidated from your investment. You can check this amount with the mentioned exit load when you get the account statement using a simple calculator.
Mutual funds are much like any other product, in that there are manufacturers who provide the product and there are dealers who sell them. Large banks to organized brokerage houses to Individual Financial agents get empanelled with Mutual Funds to provide advice and assistance to customers who want to buy units. Mutual funds units can now also be bought over the Internet.
Contacting an Investment advisor in a bank or a brokerage house or an Independent Financial Advisor is the first step to gathering information.
Step 2: Evaluation: choosing the right mutual fund for you
Each Mutual fund offers a variety of schemes to suit differing needs of investors. The Bank / Brokerage house / Individual Financial Advisor helps you make the choice based on your needs
As an investor one may
a) want to invest for the short term or long term want to invest
b) want regular income or growth
c) want to target lower risk or higher returns
d) be convinced of a particular sector and want to invest in it
Remember, just like a salesman in a gift shop, your investment advisor can help you the most if he knows what you are looking for.
Step 3: Purchase
After you have decided to save, you may have to decide among the various investment and withdrawal options that any fund offers to its investors. Most of these schemes also offer various options to customize your operation of the fund to your needs:
Systematic Investment Plan (SIP)
Allows you to save a part of your income regularly. Also used to reduce risk when investing in schemes targeting aggressive growth.
Systematic Withdrawal Plan (SWP)
Allows you to withdraw a part of your investment regularly. Used when you want to withdraw your investment for a specific regular payment, like insurance premium payments of monthly/quarterly frequency
Direct debit
Saves the hassle of writing a cheque when making an investment. Your account is debited automatically for the amount invested.
Direct credit
The reverse of Direct Debit. It saves the hassle of enchasing a cheque when withdrawing an investment. Your account is credited automatically with the amount withdrawn.
Dividend plan
Allows you to get Tax-free dividends from your investment. (As per current tax laws).
Growth plan
Allows the income generated from investment to be ploughed back into the scheme. Used by investor targeting growth in their investment.
Some funds carry an entry load, which is a percentage fee deducted from the amount invested before investment. Thus a 2.5% entry load will mean that if you invest Rs. 1 lakh in a Rs. 10 per unit IPO, instead of getting 10,000 units, you will be allotted 9,750 units. Check for presence of such loads and other conditions before investing.
After deciding the choice of mutual fund, investment and withdrawal, you are ready to begin your savings. You need to now fill up an application form and attach a cheque of the value of your investment or mention your account number to have it automatically debited from your account.
Step 4: Post Purchase Monitoring
Once you have invested in an ongoing fund, expect a period of two to three days before you receive an account statement on the address mentioned by you in your application form.
The Account Statement
Your account statement indicates your current holding in the scheme that you have invested. Please ensure that all your details have been correctly captured in account statement. Please point out any discrepancies to your nearest CAMS investor Service Centre or the Mutual Fund office. You can request an account statement any time by calling up your nearest CAMS / Mutual fund offices usually mentioned on the back of the account statement.
The transaction slip at the end of the account statement can be used for additional purchases, redemptions or to intimate the mutual fund on any change in bank mandates/address.
The NAVs of all the open-ended schemes are published at the fund's website, financial newspapers and AMFI (Association of Mutual Funds) web-site www.amfiindia.com.
Step 5: Exit
While you should periodically monitor the performance of your investments, we recommend you do not get swayed by short term considerations in deciding your exit. If you have invested in a long term fund, you can spare yourself undue worries by not monitoring the NAV every day or week. Checking the performance once in a while along with your advisor should be fine. Most mutual funds will provide you with a toll free number that works from 9 am to 5 am and a website. For specific assistance you can also use your financial advisors help.
Redemption/ Withdrawal
Just submit your completed transaction within the transacted time for the scheme that you are invested in and deposit the same at the nearest CAMS Investor Service Centre or the office of the fund. You can either get a direct credit to your bank account or you can generally collect the cheque at the CAMS Investor Service Centre/ AMC offices. If you fail to do so then the cheque is couriered to the address mentioned in your account statement. Most funds take 1-3 days to credit your account with your redemption proceeds.
In case an exit load is applicable to your withdrawal and you have redeemed a fixed amount, an additional number of units equivalent to the exit load amount will be liquidated from your investment. You can check this amount with the mentioned exit load when you get the account statement using a simple calculator.
Monday, 27 February 2012
THE INTELLIGENT INVESTOR -HOW TO AT LEAST SOUND LIKE ONE
The Intelligent Investor (or How to at least sound like one !)
The road to upward mobility is best traveled by name-droppers. While Page Three parties might be the epitome of air-kissing and social name dropping, the corporate world has its own special version. It's called Jargon Spewing. The more jargon you throw at colleagues, bosses, vendors, the more likely people will regard you as intelligent and well read and in-the-know.
So if you want to impress that snooty colleague in the next cubicle with a few well-chosen technical terms, make sense of all the jargon splashed across the pink papers, or most importantly, avoid having the blank I'm-too-dumb-to-write-my-own name kind of stare on your face when people around make complex-sounding statements at you, here's a primer:
The road to upward mobility is best traveled by name-droppers. While Page Three parties might be the epitome of air-kissing and social name dropping, the corporate world has its own special version. It's called Jargon Spewing. The more jargon you throw at colleagues, bosses, vendors, the more likely people will regard you as intelligent and well read and in-the-know.
So if you want to impress that snooty colleague in the next cubicle with a few well-chosen technical terms, make sense of all the jargon splashed across the pink papers, or most importantly, avoid having the blank I'm-too-dumb-to-write-my-own name kind of stare on your face when people around make complex-sounding statements at you, here's a primer:
I. | |
II. | |
III. | |
IV. | |
V. | |
VI. | |
VII. | |
VIII. |
That's a fair bit of jargon for anyone wanting to impress others. However if you are surrounded by the not-easy-to-impress types, you can atleast console yourself that reading the business papers now seems a far less formidable task than before. Happy reading.
I. India is expensive; Investors reconsider fresh investments; Valuations look attractive
Lesson 101 of Valuation comprises 4 words really - Buy Low, Sell High. Words we hear often and from people who seem unconnected to the stock markets - your grandma, the local grocer or even your family jeweler. Yet, behind this seemingly simple line, resides a very complex world. How do we know what is low, what is high and how do we measure it? The terms 'Low' and 'High' are relative terms - which means that for their value to be understood they need to be compared to something. But for that we need a common parameter of comparison. This is where P/E comes into the picture.
P/E ratios are typically used as a first-cut measure by investors to determine if a stock is overvalued or underpriced and whether it makes sense to invest in it. The P/E ratio or Price Earnings Multiple is calculated by dividing the price (of a share) by its earnings (EPS or earnings per share). It means that for a given level of performance by the company - EPS, the market has priced the stock at a particular level - P.
Take for instance a company, Xlerate, in the biotech space. Say, the company's stock price is Rs 240 and its EPS forecast for the year is Rs 8, then the PE for Xlerate is 30. However 30 per se means nothing; it doesn't signify if the P/E is high or low and whether one should buy Xlerate stock.
To take that decision, one needs to compare the P/E to other stocks in a comparable category or industry. So if most other stocks in the biotech industry have P/Es of around 40, then Xlerate could be undervalued - given its P/E is 30 and lower than the industry average, and hence its 'valuation seems attractive'
However there could be two reasons why the market has priced it lower than the rest of the companies in its category: Either the major local and global investors are unaware of the company and its performance and hence haven't been able to value it correctly, or they think the stock purposely ought to be priced lower than competitors due to reasons like bad management, expected slowdown in performance, inadequate ability to deal with future/competition, etc.
Similar to a stock, foreign institutional investors who have allocations for various countries also compare India (the major indices - Sensex and Nifty) to that of other emerging markets.
If most of the other emerging market indices P/E s are at around 12 and India's P/E is at 17, then India is considered 'expensive'
Hence P/Es of companies or countries should be compared to their industry/category average to understand if they are cheap and hence attractive, or overvalued and hence expensive.
II. Inflation figures spook market
When it comes to complaining about rising vegetable prices, we are in good company - even the Prime Minister's wife does it. That is not however the reason why the Reserve Bank of India aggressively monitors inflation. Inflation is basically a measure of prices in the country. It is measured by something called the WPI - wholesale price index, which factors in prices of basic goods and commodities in India. It is usually indicated in percentage terms. So if the WPI is 5.6%, then it means that wholesale prices have risen by 5.6% over the same date last year. But even if inflation sounds like yet another burden that common people have to deal with, for the banking and financial system players, inflation is the centre of their universe. The reason: inflation erodes the value of money and hence the return on investment. If inflation is 4%, it means that a lunch costing Rs 100 last year will cost your Rs 104 today. Hence your Rs 100 should have grown by Rs 4 in one year for you to enjoy the same standard of living. Hence for you to have a 'real' return on your investment of Rs 100, the interest rate should be more than 4%.
Hence when inflation rises, interest rates need to rise to ensure that investors get 'real returns'.
Rising interest rates means:
• the cost of loans for both companies and individuals increase
• falling asset prices thereby reducing the value of individual and corporate assets - be it land, homes, shares,
bonds, gold - almost immediately Hence rising inflation numbers tend to scare off investors in bonds and shares
since the value of their portfolio declines
III. Advance tax numbers indicate robust quarterly corporate earnings
Think of it as the old gypsy woman reading tea leaves to predict your future except that advance tax payments are a far more reliable tool of estimating the state of the country's corporate performance. Companies pay tax in four installments during the year. The four deadlines are the 15th of June, September, December and March. The tax paid in the first three installments is referred to as advance tax. Since companies pay tax on the profits they make, higher tax payments indicate that the company is performing well and on its way to recording higher profits. Hence advance tax payments indicate all is well with the corporate world. Typically market observers track advance tax payment this year vis-a-vis the last and if it registers a rise, it indicates that companies are going to post better results this year.
IV. Liquidity is tight
A favourite of the pink papers, this phrase is used generously by journalists across the stock, debt and commodities markets. Liquidity refers to amount of money floating in the system and which is available to corporates, government and individuals. The country's central bank, the Reserve Bank of India creates money in the system. It also reduces the amount of money in circulation by sucking up money from the system either by buying rupees from banks and selling them foreign currency, or by issuing government securities which banks and institutions subscribe to. The RBI is therefore the controller of liquidity. Liquidity can become 'tight' when there the demand for funds far exceeds the supply. This could happen due to a variety of reasons:
Corporates are borrowing more to fund their business growth and for capital investments
The Government of India is borrowing more to cover the gap between its expenses and income
The value of the rupee is depreciating faster that the RBI would like and hence the RBI is 'buying rupees' to increase its value versus the dollar.
And the usual repercussion of tight liquidity is increasing interest rates
V. Market is currently overbought
How many times have we read the business papers and thought: Did all the players in the stock markets bunk English classes in school? Why else would they use words like overbought or oversold? Then it dawns on us; these are technical terms and we don't really understand them. It's not their English; it's our financial market knowledge that's at fault.
Simply put, the market being overbought means that the market has risen too much or too fast and is 'expensive' (refer issue #5 for understanding valuations). Likewise, oversold means that the prices have fallen too sharply.
The terms per se are used by technical analysts - analysts who chart price movements to predict what the future price of the stock is likely to be. Usually there is a fair degree of balance between buyers and sellers in the market. However sometimes certain imbalances are triggered and there might be too much buying or too much selling. These are unnatural conditions and often an indicator that one must take the contrary action. Hence if the market is considered overbought, the technical analyst will sell, and if the market is considered oversold, she will buy.
VI. Risk weight age on these assets is 150per cent
Risk is key to all investments. Banks are required by law to maintain a particular level of capital to ensure that if the bank's assets or loans go sour, there is enough capital to back it up and depositors' monies are protected. This level is called the Capital Adequacy Ratio (CAR) and the Reserve Bank of India (RBI) has set it currently at nine per cent of risk weighted assets for all commercial banks; which means that if the bank lends Rs 100, it has to maintain Rs 9 as capital.
Apparently, one jargon leads us to another. It definitely is the maze we've all come to expect of the world of investments and finance. First it was CAR and now Risk Weightage. So what does risk weightage mean?
The loans or investments a bank makes all carry a particular level of risk - the risk of default. RBI requires that banks classify their assets (loans and investments) according to the risk they carry.
So typically government securities carry zero default risk since they are backed by the government. Hence the risk weightage assigned them is zero. So technically if a bank had invested all its money in government bonds, it would not be required to maintain any capital since there is no risk. If a bank lends to corporates, then those loans need to carry 100 per cent weightage. So the bank will maintain 9 per cent of the value of the loan as capital. If risk weightage on assets is 150 per cent, then banks are required to maintain Rs 13.5 of the value of the loan/investment - calculated as 150 per cent of 9.
Banks which have low capital (equity and reserves) prefer to invest a significant portion of their money in gilts since any investments in risk weighted assets means that they would have to raise more money as capital to back up those assets.
Risk is key to all investments. Banks are required by law to maintain a particular level of capital to ensure that if the bank's assets or loans go sour, there is enough capital to back it up and depositors' monies are protected. This level is called the Capital Adequacy Ratio (CAR) and the Reserve Bank of India (RBI) has set it currently at nine per cent of risk weighted assets for all commercial banks; which means that if the bank lends Rs 100, it has to maintain Rs 9 as capital.
Apparently, one jargon leads us to another. It definitely is the maze we've all come to expect of the world of investments and finance. First it was CAR and now Risk Weightage. So what does risk weightage mean?
The loans or investments a bank makes all carry a particular level of risk - the risk of default. RBI requires that banks classify their assets (loans and investments) according to the risk they carry.
So typically government securities carry zero default risk since they are backed by the government. Hence the risk weightage assigned them is zero. So technically if a bank had invested all its money in government bonds, it would not be required to maintain any capital since there is no risk. If a bank lends to corporates, then those loans need to carry 100 per cent weightage. So the bank will maintain 9 per cent of the value of the loan as capital. If risk weightage on assets is 150 per cent, then banks are required to maintain Rs 13.5 of the value of the loan/investment - calculated as 150 per cent of 9.
Banks which have low capital (equity and reserves) prefer to invest a significant portion of their money in gilts since any investments in risk weighted assets means that they would have to raise more money as capital to back up those assets.
VII. Market in a bear hug
Bears represent market players who keep prices down while a bullish market represents rising prices. This is easier to visualise and understand from a popular myth which says that the terms are derived from the way the animals attack a foe - bears attack by swiping their paws downward and bulls toss their horns upward. Though the imagery helps in understanding the terms, it is but mere myth.
According to the The Wall Street Journal Guide to Understanding Money and Markets, the story behind the terminology of Bears and Bulls is as follows:
'Bear skin jobbers' were known for selling bear skins that they did not own; i.e., the bears had not yet been caught. This was the original source of the term "bear." This term eventually was used to describe short sellers, speculators who sold shares that they did not own, bought after a price drop, and then delivered the shares. Because bull and bear baiting were once popular sports, "bulls" was understood as the opposite of "bears." i.e., the bulls were those people who bought in the expectation that a stock price would rise, not fall.
Hence if you read the markets are in a bear hug, you can be sure that your stocks are not going to be moving up in a hurry.
VIII. There was some unwinding of long positions in the futures market....
This statement contains far too much jargon for even us those of us with above average IQ, but no one said that the world of investment was anywhere close to being easy. It's probably easier to learn two foreign languages simultaneously than decipher finance's complexity. So baby steps on this one:
Futures market
This market refers to contracts where the buyer and seller agree to transact at a future date; the price and quantity for that future transaction is however fixed in the present. Think of a futures contract as an understanding you would get into with your local raddiwallah. You promise the raddiwallah that you will give him 5 kilos of newspapers every month over the next six months. The raddiwallah in turn promises to pay you Rs 5 per kilo. So basically the two of you'll have entered into a futures contract where the price and quantity has been pre-fixed regardless of what the price of second-hand newspapers will be in the coming months. Both the parties benefit: The raddiwallah is locking in a guaranteed supply of newspapers, whereas you are guaranteed you will get a good price for the next 6 months.
Similar such transactions take place in the stocks and commodities markets. People tend to enter into futures contracts if they think the markets will be volatile in the future. By agreeing to price and quantity now, they can control their risk.
Long positions: When an investor holds a long position, it means that he actually holds the share and intends to hold it for a while because he thinks prices will go up on the share. If prices go down, then the investor loses money. Similarly, a long position in a futures contract, means the person is required to buy the share at the future date. She will make money if the share price goes up at a later date.
Unwinding: This refers to the process of selling to liquidate long positions
Hence this apparently Greek sounding line 'There was some unwinding of long positions in the futures market' basically means that investors think the market is likely to go down in the future and hence are selling their underlying shares and offloading their long positions.
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