Investing in Various Asset Classes of Mutual Funds
Is the party in Debt Funds over ? What kind of returns should we expect in Debt Schemes ? Should we stay invested in Asset Classes like G Sec Funds, Dynamic Funds ? When should we exit from Income/G Sec/Dynamic Funds ? And finally what is the alternative to investing in Income Funds for a conservative Corporate Investor ?
These are some of the querries that are being raised on daily basis. Debt markets have given very poor returns for those who invested in or around October’2003 when 10 year had touched a low of 4.94%. Today the benchmark 10 year has gradually risen to 5.13%-5.15%. Are expecting any further easing of rates or firming up of rates ?
Let us analyse two or three basic inputs which determine the interest rate scenario & its impact thereon:
- LIQUIDITY:
Yes, market is still flushed with liquidity. However, we are foreseeing that slowly & steadily liquidity will be sucked out of the system due to following reasons:
- There are many Equity IPOs to the tune of almost Rs.20,000 crs slated to open in the months of February & March 2004. With the kind of overwhelming response some of the IPOs have seen in the recent past, we expect the same story to repeat itself; thereby sucking out more than Rs.20,000 crs liquidity ( with oversupscriptions amounts).
- Advance tax outflows in the month of March 2004.
- Due to the IPOs of PSU companies like ONGC etc. Central Governemnet might go easy on their borrowing programme ( which was already reduced by Rs.35000 crs for the second half of the year); but due to the election year & likely sops & doles that the Government is likely to announce will have adverse impact on the liquidity front.
- Credit offtake figures show a sharp increase of almost 40-45% in the months of September-December’03 over similar period in the year 2002. With corporates doing exceedingly well & & not able to cope with demand situation; strain on liquidity is a real danger. This will have an adverse impact on the interest rate scenario.
- INFLATION:
- Though inflation has gradually increased from a low of 4% to 4.5% to the current levels of 6.09%; we forsee that the same has peaked & will ease before the end of current Financial Year.
- Though RBI had estimated inflation to be around 4-4.5% in their November Credit Policy, with the rising fuel prices, commodity prices & subsequently manufactureres resorting to price hikes; we do not forsee the inflation to ease very rapidly. If however, inflation does settle down at the levels mentioned by RBI, we may see the benchmark settling at 5.05% levels.
- INTERNATIONAL SCENARIO:
- Worldwide interest rates are firming up. Australian & European Central Banks have already hiked their interest rates from their historical lows.
- With the improvement in the US economy, we expect that there will be a Federal Rate hike in the near future. If this happens, India with its current GDP growth estimates at above 7% can not remain insulated from the pressures on liquidity & corresponding impact on the interest rate scenario.
All the above factors point towards tightening of liquidity & a cirresponding rise in the interest rate scenario. We expect the markets to be range bound from now to say Mid February & thereafter to start hardening. In any case we do not forsee the interest rates to breach the 5% mark that it had touched in Mid October’2003.
IF THIS BE THE CASE, WHAT SHOULD ONE DO ?
- We are recommending booking of profits from Income/G Sec/Dynamic Funds at or around 5.10% levels ( which we had recommended in our letter dated December 29’03 – a copy is enclosed) & switch the same to either Short Term or Floating Funds. This is for those investments which you would not like to carry forward in your Balance Sheet beyond March 31’2004 .
- For the time being we are recommending to get out out of asset classes like G Sec & Dynamic Bond Funds & switch the same to either Floating/Short Term or MIPs depending your investment horizon.
- Peg your expectations at realistic levels of 6-7% in Income Funds & 4-5% in Short Term Funds.
- Have some flavour of equity added to your portfolio by investing in conservative Monthly Income Plans with 10-15% allocation to equities.
- Incremental investments for with short maturity horizons can either be invested in Flaoting Funds or Liquid Funds.
ARE WE STILL BULLISH ON THE EQUITY MARKETS & CORRESPONDINGLY IN MIP SCHEMES ?
Though markets have run up substantially from a low of 2900 in March ’03 to its current levels of 6000 in a very short span, India still looks to be an attractive story for the following reasons. Though the bull run was very steep & sudden , the market at the present moment is taking a breather & has corrected by at least 300 points in the past few days. This is healthy for the equity markets.
- Inflation is under control
- There is too much of liquidity chasing very few investment avenues
- Corporate results are very encouraging & we estimate that FY 2004 will see corporate results improving by at least 25% on a conservative note.
- There is huge FII inflows in the country. Almost Rs.150 crs to Rs.200 crs on a daily basis is being invested by FIIs in the Indian Equity markets.
- Historically also, inspite of the current rally in the market, PE are at a low of around 15.5 ( It started with a PE of 10 when the Sensex was at around 3000-3300 levels). With improved corporate results we expect that fair valuation of PE will be at or around 19-20 levels.
- Technically from Jan to April’2003 there was an inflow of Rs.2400 crs in the equity markets against which domestic Mutual fund industry (mainly UTI) was a net seller to the tune of Rs.2000 crs. After the UTI bailout package, we do not forsee UTI coming to market to sell in a major way for another 5 years. Hence, realistically, market base should have been around 4000-4300 levels if UTI was not a seller during this period. From that base to the current levels the markets have only discounted FY 2004 results & not FY 2005.
- Last year the FIIs have pumped in more than $7 bn in the equity markets as they find India as the fastest growing economy with GDP growth of upwards of 7%.
- Globally also markets have rallied.
- Currently the markets are only discounting FY 2004 results. On a conservative note if the Corporate results grow by 20-25% in FY 2005, the same will start getting discounted by beginning of the next year.
- With ONGC public issue of 10%, the floating stock of the Company will rise to 15%. This will make it part of the MSCI Emerging Markets Index. With ONGC becoming part of the said Index , India allocation is likely to go up by approx. 0.4% which will correspond to another $ 4 bn allocation by FIIs to Indian stocks.
- Indian companies are becoming globally competitive with major thrust on exports, infrastructure, ports, roads, airports etc. India is on the same thresh hold of growth which China was 6 years ago.
- Historically, average PE for last 10 years was at 17 compared to the current PE of 15.5.
- There is an inverse relation to the interest rate to PE. We are at historical lows as far as interest rate scenario is concerned with rising PE.
- Asian fund Managers are betting on Taiwan , South Korea & India to outperform other regional markets in the short run. These are the top 3 regional investment destinations for the period for the period September to November with each taking 25% of votes in the latest survey of Reuters/Benchmark.
All the above factors point towards a very buoyant equity markets. Yes, there will be blips in the market during election time & Vote on Account time, but we do not forsee a reversal in the trend. Also with a host of good IPOs slated for the months of February & March’04, we expect the markets to continue its current momentum.
WHY MONTHLY INCOME PLANS ?
“Debt with a slight flavour of equity “is what Monthly Income Plans have to offer. This translates into steady returns from a fixed income portfolio with the possibility of higher returns through the equity component. With the decline in interest rates over the past few years, long term debt funds have given significant returns on account of strong capital gains from bonds. However, such high returns may not be possible in the future. Interest rates in traditional savings instruments have declined significantly. Therefore, MIPs can be viewed as an attractive option, which aims at achieving slightly higher returns through investing a small portion in equities.
WHICH MIPs SHOULD BE LOOKED AT AS AN ASSET CLASS FOR A CONSERVATIVE INVESTORS WHO ARE INVESTING IN EQUITIES FOR THE FIRST TIME?
Most of the MIPs have a break up between debt & equity like 85:15, 80:20, 75:25 & 90:10 in favour of debt. What this means is that ( assuming a 80:20 scheme), the Mutual Fund can invest between 80% in debt going upto 100% in debt & can invest from 0-20% in equities. 20% limit includes any appreciation on the equity portfolio as well & hence, they will not invest the entire amount of 20% in equities. It will either be 15-17% in equity, keeping a cushion of 2-3% for any appreciation in equities so that it does not breach the 20% limit in equities.
Going by this standard practice, we recommend you to look at those schemes which have a break up of 90:10 in favour of debt. What this means is that generally the Scheme will invest upto 92-93% in debt & only 7-8% in equity. Going forward if we assume a return of 7% in debt schemes; the scheme will generate 6.5% on an investment of Rs.93/- in debt. Hence, at the end of the year your investment in debt will appreciate to Rs.99.50 to Rs.100/- ( giving you an asset protection by safeguarding your principal amount) & generating better returns from the 7-8% investments in the equities.
Assuming on a worst case scenario, equity markets fall by 50% from current levels in one year’s time; value of your investments in equities will become Rs.4/- from Rs.8/-. Hence, at the end of the year your investment in debt would have gone upto Rs.99.50 to Rs.100 ( from Rs.92 to Rs.93) & investment equity in this worst case scenario would have gone down to Rs.4. Nevertheless, you will still have a positive return of 4% in one years time.
STRATEGY OF FUND MANAGERS FOR MIP SCHEMES:
The strategy of Equity Fund Managers in the MIP plans is to give absolute returns with a view to conserve the capital rather than hold the investments for long periods & take undue risks attached to the said asset class. They also allocate a lot of IPO equities to such MIP schemes to enhance returns. Also, the debt portion of such MIP schemes has more of a flavour of Short to Medium Term Income schemes rather than an aggressive Income schemes. Hence, as we have pointed out earlier as we expect the interest rates to firm up in Mid February, debt portion of such MIPs will not bear that brunt as they will be more in the nature of Short to Medium Term Plans.
We therefore recommend investments in fresh IPOs of the MIP schemes, which will give the flexibility to the Fund Managers to create new portfolio depending on the market conditions:
Debt: Equity Options Approx. Date Closing Date
1.Birla MIP 95:05 and 75:25 First week of February
2.Deutsche MIP 90:10 and 80:20 15-01-2004 29-01-2004
3.HSBC MIP 85:15 and 75:25 20-01-2004 13-02-2004
4.Tata MIP Plus 80:20 27-01-2004 27-02-2004
5.ING MIP 80:20* and 100:00 12-01-2004 06-02-2004
- 20% of the Equity portion will be invested in their own Fund called NIFTY PLUS. Nifty Plus will invest 70% in Indexed stocks & 30% in actively traded stocks.
Kindly restructure your portfolio based on our above recommendations to safeguard principal & optimise returns. If you need any further clarification, please feel free to contact us.
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