Archive for December, 2006

Markets have crashed, where do we go from here?

2 comments Written on December 12th, 2006 by
Categories: Uncategorized
The Sensex is now under 13,000, with the last three days accounting for a 1000 point drop. This is a 7% drop in three days; and with heavy volumes.

Minor correction?
Markets usually take a breather every now and then. So this could be a minor correction. If this is the case, the markets will move up as suddenly as they dropped. But I do not think this is the case, simply because the immediate past does not show such a trend. Fast drops are followed by slow rises. The big factor here is that there is a lot of fear and doubt in the minds of people, and it is reflected in sentiments expressed in TV channels, and the fact that mutual funds have not been buying heavily (although they have collected tons of money).

Having said that, this may be an opportunity for them to buy. So we must get mutual fund data over the next few days to see whether they have been buying or selling, especially the "heavy cash" funds (which have lots of money but not all of it is invested in the market)

India Inc. slowing down?
The Central Statistical Organisation has reported that industrial growth in October has only seen a 6.2% rise over Oct 2005. This is a matter of concern as the growth is a lot lower than the 8-9% expected. However, the 30 November 2006 estimate still thinks India's GDP growth will be 8.9%, which is good enough.

Global cues
Other cues include the fact that the US Fed has decided to keep rates steady, meaning they are not hiking or reducing rates. This is probably temporary, as the recent rate hikes will most likely be compensated by a drop at some point.

Japan is expected to announce an interest rate change on Friday, and that may be significant as their phenomenally low interest has caused a lot of institutions to borrow from Japan and invest in emerging markets like India. If the Japanese interest rates rise, there will be another drop in India - this will largely be "perception" that FIIs will pull out. But they won't, because countries like India are the only places they will get a significantly higher return than average, therefore if anything MORE money will come in.

What should you do? For the confused investor: Hold your horses. A few days here and there will not make a difference to you. Let this week by, and if the market has recovered to 13,500 Sensex levels by next week, continue your normal investment strategy.

For a value investor: Some stocks especially midcaps are quoting at extremely low levels. Go ahead and buy them.

For a mutual fund investor: Usually crashes are accompanied by huge redemptions. Hold for a week, and then think of purchasing new funds.

Regardless of the above, if the crash takes the sensex below 12,000, sell.

Posted in Uncategorized

Tax saving schemes: Wait till March 2007

6 comments Written on December 8th, 2006 by
Categories: Commentary, IncomeTax, MutualFunds
The finance ministry is considered changing the tax benefits given to many tax saving schemes (Check: Personalfn,Economic Times and My Blog)

Next year's budget may remove some of the tax exemptions provided under 80C and reduce the personal tax rate. Moreover, some of the exemptions provided may continue, but may be taxed on exit. So if you put in Rs. 100,000 today into a tax saving fund, you will save Rs. 30,600 (highest bracket) tax; but if the ministry has its way, the entire corpus will be fully taxed when you use this money, usually unlocked three years later.

But this deal may still be worth the effort, versus "ditching" tax saving schemes completely. Here's the logic:

Assumption 1: You have 1 lakh to invest in some tax saving investment.
Assumption 2: In three years, your money grows by 70%.
Assumption 3: FM declares that 80C investments are fully taxable on exit, and tax rate is down to 25%. No change to Long Term Capital gains etc.

Scenario 1: You invest the 1 lakh in tax saving funds today.

Tax today: nil.
Net value after three years: Rs. 170,000 (70% in three years)
Tax if you exit: Rs. 42,500 (at 25%)
Real value to you : Rs. 127,500.

Scenario 2: You pay your tax today, and invest in a diversified fund instead.

Tax today: Rs. 30,600 (at 30.6%)
Net value today: Rs. 68,400.
Net value after three years: Rs. 116,280
Tax if you exit: Nil (no long term capital gains)
Real value to you: Rs. 116,280.

So there is a value is investing, providing the tax rate comes down to 25%. What if tax rate stays at 30.6%, and the FM still taxes investments on exit?

Net values after three years:

Scenario 1: Rs. 117,980
Scenario 2: Rs. 116,280 (stays the same)

The difference is only Rs. 1,600! And for that difference you have to stay invested for three years, and lock in your money. It's better then to stay away. And as seen lately, diversified funds seem to do a better job of managing money than tax saving funds, so you might just make this difference by higher returns. No lock in, same returns, a much better deal in general.

The budget is usually revealed in the last week of February. You have time till March 2007 to make your 80C investments. You may have to consider the budget proposals carefully; Calculate whether it makes sense, and only if there is a substantial saving, go on.

Posted in Commentary, IncomeTax, MutualFunds

LinkFest #3:Gold, and Mutual funds

No Comments » Written on December 7th, 2006 by
Categories: Gold, MutualFunds, Readings
India has 0.4% of the Worlds mutual fund assets (Economic Times) With about 3.41 lakh crore in assets, India's just about 0.4% of the world's assets. Less than 2% of our GDP is available in funds, so the opportunity to grow is tremendous! In fact, just last month, 30,000 crore was invested in mutual funds.

Buy Gold? (Value Research) What's the fuss about gold, and how to invest in it. Interestingly the author also talks about how he might earn more money if he talked more about gold investments rather than mutual funds.

Top 10 Mutual Funds (Outlook Money)
Outlook Money researches and lists the top 10 funds bases on "RaR" - Risk Adjusted Return. Some very good funds figure here.

Earlier LinkFests: 1, 2

Posted in Gold, MutualFunds, Readings

Closed ended funds: Why they are popular suddenly, and why they are not really closed ended.

3 comments Written on December 7th, 2006 by
Categories: Commentary, MutualFunds
A lot of new fund offers are appearing as "Closed Ended" because of a notification that SEBI has introduced, saying that open ended equity funds must not charge "initial expenses" over the first five years, but offset them with entry loads. (Read "Mutual Funds NFOs have hidden costs")

NFO expenses
What does this initial charge mean? You see all these ads on TV and on billboards asking you to buy NFOs - these are all paid for by what is called "initial marketing expenses". Earlier upto 6% of the funds collected could be allocated to such expenses, but then fund asset management companies (AMCs) started appearing with hundreds of new issues, just to get distributors more commissions. (which are much higher than the 2.25% they get on their existing funds)

SEBI has therefore acted like a good regulator and disallowed open ended funds from charging NFO marketing charges beyond the entry load. But if AMCs do this, and charge 6% entry load, no one will buy! If they decide to take it up as their own expense, they lose money. So what to do?

The best way out, for AMCs, was to use closed ended funds instead. Closed ended funds, going by the name, are funds that, once subscribed, are closed for fresh investments and for exits. (These kind of funds are special to India perhaps - all U.S. funds are open ended) So it's a "closed" fund. SEBI decreed that such funds could charge initial charges and amortise them over the period of the fund, meaning that you as the investor pay for those ads over the three-year period of a three year closed ended fund.

The cost of an early exit
The phrase Closed Ended is misleading. What if you invest a huge amount of money and want it back desperately? Most closed ended funds allow you to exit prematurely, somtimes at fixed days of the year like first five days of a calendar quarter etc., but that exit usually comes with an exit load.

Also, SEBI has said that apart from the exit load, if you exit early, you should pay the remaining amortised charges on the fund. Let me demonstrate with an example.

Let's say you put in Rs. 100,000 in a 3 year closed ended NFO, which collects Rs. 100 crores. They charge 6% = 6 crores as marketing expenses. You have therefore got 0.01% of the fund and therefore your share of the marketing expense is Rs. 6,000. This is amortized for three years, meaning 2,000 per year. This is adjusted, daily, in the NAV so you don't have to physically pay anyone, it is automatically reflected in the "repurchase price".

After one year, you decide to sell. Now let's say they are very nice and charge you zero load on exit. Because you were in there for a year, you have paid Rs. 2,000 of the amortised charges. But Rs. 4,000 is remaining! So when you sell, they will remove Rs. 4,000 and give you the rest back. That 4,000 is 4% of your investment! So if the fund had gone up 10%, it has now resulted in only 6% gain for you. (Note that you can get that if you put the money in a bank deposit)

Not really closed ended
So you can exit early if you want, just that you pay a charge. Which means these funds are not really closed ended. What they are really, are Closed Entry. After the NFO, for the closed period, no fresh investments are allowed in the fund.

Is "closed entry" bad for me?
What does this mean for you? Every time the market tanks or drops a lot, investors will try to take out their money, no matter what the exit load. In open ended funds that is usually balanced by some people trying to BUY the fund, because they feel it will go back up. This means that some redemptions can be met with the money coming in, so the fund manager need not sell the investments.

But in closed ended funds there is no fresh entry, so the fund manager has to sell. And therefore, when the markets recover, these funds underperform because they were not able to buy or hold when the market was low!

You will see this happening with all these funds, unfortunately, and I will show you the results after a year from today. I know there will be at least one correction before then (it has to happen) and that will put pressure on these funds.

Wait and Watch
I do not recommend these NFOs at all. But I think you may be able to get a good deal when they finish their closed ended period and become open ended instead. Let's see.

Posted in Commentary, MutualFunds

SBI One India Fund (NFO): Should you invest?

No Comments » Written on December 5th, 2006 by
Categories: MutualFunds
SBI MF has an new fund offer (NFO) called : SBI One India Fund.[Offer Document]

Issue Price: Rs. 10
Minimum: Rs. 5,000 per investor.
SIP option: Not available
Entry Load: Nil at NFO, 2.25% after three years.
Exit Load: Nil. (Amortised initial expenses will be charged)
Initial expenses: 5% expected (upto 6% allowed)

The idea is that they "focus on all four regions of the country". They also invest in ADR/GDRs and foreign securities.

I find it weird. It invests equally among Indian "regions". Meaning what? Many big companies have a pan-India presence, but are headquartered in Mumbai or Delhi. Are they all western companies? And what's the point of investing in a region specific companies? Is the region a factor in performance at all? I don't think so. Plus, what do you consider the "region" of a company that is across India? The headquarters, perhaps?

Lets see the top companies in India and see where they are headquartered: 

1. ONGC : Delhi
2. Reliance : Mumbai
3. NTPC : Delhi
4. Infosys: Bangalore
5. Bharti : Delhi
6. TCS: Mumbai
7. Reliance Comm: Mumbai
8. Wipro: Bangalore
9. ICICI Bank: Vadodara, Gujarat
10. ITC: Kolkata
11. SBI: Mumbai
12. BHEL: Delhi
In this set, 4 are in the north, 5 in the west, 2 in the south and 1 in the east. If you take even the top 100, there will be a very uneven trend towards the north and west. But most of these companies are pan-India companies!

The offer document says that:
Definition of Regions:
Companies of a region will be defined as those having their:

  • Registered office; or
  • Head Quarters; or
  • Major manufacturing facility; or
  • Major Revenue generating activity
In the region defined as a group of states and union territories.

This means Tata Steel can be both in Western region (since HQ is Mumbai) or in Eastern region (Jamshedpur unit). That confuses the definition and objective of the fund, which I think makes it exactly equal to a diversified fund. Honestly, attempting to invest equally among regions is a ridiculous idea.

This fund is a lousy diversification concept. I'm not at all impressed, and I will track the performance of this fund after six months to see if a) they are really following their strategy and b) is it making better returns.

Also the fund wants to invest in ADRs, GDRs and foreign securities. Why is a "One India" fund investing in foreign securities?

Fund structure: This is a three year closed end, and initial expenses of 6% are amortised over the period. There is no additional entry load. You can exit earlier than three years, but you must pay the remaining amortised value of the initial expenses. You can't buy after the NFO for three years - I think this is not a closed "end" fund, but a closed "entry" fund.

Benchmark: The fund benchmarks itself against the BSE 200. This is a fairly lousy benchmark, because it has underperformed every other benchmark in existence (BSE 100, Sensex, Nifty, NSE Junior Midcap etc.) I would request that they compare this fund to the BSE 100 or the NSE 100 instead.

The fund house is good: SBI. But this fund adds very little value, really. Their other funds have done very well- Magnum Global, Magnum Contra, Magnum TaxGain - but I think they have pressure from fund management and distributors to introduce new funds, since the new fund commissions are much more. (nearly 6% vs. 2.25%) But why should you and I pay for that?

Overall I don't see much difference in this fund from their Magnum Global Fund. Invest in that instead.

Recommendation: Do not subscribe. After three years, you can gauge the performance and enter when it becomes an open ended fund.

Posted in MutualFunds

HDFC 1 year 15 day deposit at 8%

No Comments » Written on December 4th, 2006 by
Categories: Commentary
I've just noticed that HDFC's Interest rates have changed recently. They offer 7% for a one year deposit, but a special rate applies for a deposit of 1 year and 15 days: 8% per year compounded quarterly.

This seems to apply only for deposits from 1 year 15 days to 1 year 16 days. If you take a deposit of lesser days or more days (1 year 14 days or 1 year 17 days you get only 7%!)

Posted in Commentary

Your savings may be taxed next year

No Comments » Written on December 4th, 2006 by
Categories: Commentary
An Economic Times article states that some of the 80C deductions, those that helped you make 1 lakh of your income off the taxman's list, may now be removed as part of the next year's budget.
...[Being reviewed] are a whole lot of tax breaks – bonus from life insurance policies; payments from a provident fund, other statutory funds, superannuation funds; medical insurance premia, interest on home loans; capital gains on property transfers invested in bonds, gratuity benefits, pension benefits and so on. Sops to software developers, incentives for backward area development are also in this hit list, though experts reckon that their phase out is next to impossible.
The government's reasoning is simple: Make taxation more transparent and simple, but do not affect collection of tax. This year, a huge amount of taxes have been collected, which means more people are complying with the taxation laws. Going forward, the government might want to cut down on the (high) tax rates, and even bring down the highest rates from 30% down to a more affordable rate.

But doing so means losing revenue, and money is required by the government to build infrastructure. So a lower tax rate may mean that income tax will apply to a lot of things that are currently out of the tax bracket. Let us see what may face the axe, and reasoning.

Insurance premia: The reason this used to be exempt was to promote insurance. But today most of the insurance premiums paid are for investment. Again, the government wants to promote long term investment as well, so tax benefits were provided if money was locked in for three years. At this point, the government might decide to remove the investment from the tax benefit, and only provide this for the mortality charge premiums. There may be a push to move the investment to the EET regime (explained later).

ELSS Funds: To encourage long term equity investing and therefore build the capital markets, tax sops are given to ELSS fund investments under 80C. Given that there is no shortage of liquidity in either diversified or tax saving funds, or in the market, the government might remove the ELSS scheme from 80C or make it EET based.

Housing loan interest or principal: Interest may still be out of the taxation bracket (it's separate from 80C) but the principal repayment is an 80C saving. That might have to go, meaning you save tax on the interest paid but not on the principal. This might ease the huge investments in the real estate industry, though I don't believe tax-on-principal a big factor at the moment.

PPF and Pension plan investments: Chances are that these will stay, since they are retirement benefits and honestly the government has done nothing to keep you going after retirement, and has no plans to. That's why it incentivises you to save for your own retirement, and I don't believe that should be changed.

EET means Exempt-Exempt-Taxed. This means that your investment is exempt from tax at the point of buying in, exempt at accrual, but taxed at exit. In simple terms it's like this. If you invest Rs. 10,000 in an 80C investment like ELSS or Insurance, it is taken of your taxable income in the year you invest (Exempt at Entry). Then, in the next three years, say it grows to 15,000. The 5,000 Rs. growth is not taxed. (Exempt at Accrual). Then, if you sell the fund at say Rs. 20,000, then what is taxed is the amount of tax you saved. (Taxed at Exit)

Let's see how it goes. The EET regime was supposed to come in 2006, it's not in. With 2007 being right in the middle of the Parliament tenure, there may be some changes without feeling that they will lose a lot of votes (which is what drives most policy anyhow). I do believe in the rationalisation of tax, and I hope that the finance ministry will show the courage to reduce tax rates. If in the process we have to lose out on some confusing tax saving schemes, so be it.

Posted in Commentary

LinkFest #2: Keeping it Simple, NFOs, Gold.

No Comments » Written on December 1st, 2006 by
Categories: MutualFunds, Readings
The Simple Life
(Dhirendra Kumar,Value Research Online)
Investments are about simplicity; the simpler the concept, the better it is for investors. The author talks you through the simplest investments ("piggy banks") and tells you why it's necessary and preferable to keep things as clear as possible. Insurance is therefore, he says, an "unhealthy mix of insurance and investment" - two concepts he advises you to keep separate. I cannot agree more.

Closed Ended Funds Galore! (Economic Times)
Ever since SEBI has disallowed amortisation of initial expenses by open ended mutual funds, AMCs have introduced (largely) only closed ended funds. Initial expenses are chargeable by AMCs upto 6% of assets, now applicable only to closed ended funds. AMCs are taking the opportunity to take this money investors and hide it in smoke and mirrors; amortisation allows you to slowly take money out in a trickle every month, and as an investor you realise only when it's too late! Luckily SEBI says it's looking into this.

Case in point: Reliance Equity Opportunity fund had 1700+ crores subscribed in its NFO in March 2005. Current portfolio is 1200 crores. That means 6% initial expenses (105 cr) are now being paid by a smaller asset base, a hit of nearly 9% at this point. No wonder the fund's not performed as well as it's peers.

Is "NEW" fashionable? (Personalfn)
The author is perplexed by the attraction to something "new" in one's portfolio. There are good reasons why one should invest in a new fund, but a low NAV is not one of them - in fact, the unit price should be completely ignored. It reiterates the problem we see today; of too many similar NFOs and irrational exuberance in purchasing them.

Should you buy Gold from your bank? (Personalfn)
Some banks seem to be overcharging for gold, and justifying it saying that they give you a certificate for the purity of gold. But they don't seem to like their own certificate, for they won't buy back the gold from you at all. Jewellers, branded and unbranded, will do so and usually charge much lesser charges for the gold itself.

New funds launched: SBI One India Fund, Reliance LT Equity Fund (review), HSBC TaxSaver (review). Previous Linkfests: 1.

Posted in MutualFunds, Readings

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