Tuesday, September 8, 2015

Even the worst ELSS outperformed PPF over 15 years

Investments in equity-linked savings schemes (ELSS) of a mutual fund’s would yield higher returns compared to other fixed income instruments like public provident funds and national savings certificates (NSCs) over the past 15 years, if invested systematically. However, in a point-to-point comparison over the past 15 years, LIC Nomura Tax Plan, the worst performing scheme, delivered a return of just 6.91% over the period from 1 March 2000 to 30 April 2015. A PPF earned an average interest rate of around 8.50% over the same period.
But when investing in an equity scheme, it is essential to invest regularly. Had you invested systematically in the LIC Nomura scheme, the yield (IRR-internal rate of return) works out to 13.49% compared to a yield of 8.31% for the PPF. Therefore, if an investor made a single one-time investment in the mutual fund scheme, he would have underperformed a PPF. Making regular investments each year would have improved his yield.
LIC Nomura Tax Plan was the worst scheme over the 15-year period. HDFC Taxsaver was the best performing scheme with a return of 16.09% on a point-to-point basis. The CNX Nifty index delivered a return of 10.86% over the period. The average return of the 12 schemes available over the period was 13.45%.
A few percentage point difference may seem small, however, over 15 years, the power of compounding and investing systematically can lead to a huge difference in the final value. Investing Rs1 lakh each year in HDFC TaxSaver would have led to a portfolio value of nearly Rs1.14 crore at the end of the period in March 2015, a yield of around 24%. Had you invested in the LIC Nomura scheme, your portfolio value would be less than half of this at Rs47.71 lakh.
Investing in schemes of Franklin Templeton, ICICI Prudential and SBI Magnum too would have led to a corpus of over Rs1 crore.

There is no doubt that PPF is among the best long-term fixed income product, but investing in equity is the key to long term wealth generation. However, when investing in equity mutual fund schemes, one not only needs choose the right scheme but also needs to invest regularly to benefit from the volatility in the market through rupee-cost averaging.

Saturday, September 5, 2015

More on bond market distortions

FT points to a BIS paper by Valentina Bruno and Hyun Shin which draws attention to the spectacular growth of the now $1.7 trillion emerging market (EM) dollar bond market, which now outstrips even the more established US high-yield debt market. It claims the motivating factor for a significant share of these issuance as simply "carry trade" (borrow in cheap dollars and invest in higher interest rate securities at home) by EM non-financial firms. The authors examined firm-level balance sheet data for 3500 non-financial companies in 47 developed and emerging countries that issued dollar bonds in 2002-14,

The dataset combines bond issuance data with firm-level financial information. We find that firms with already high cash holdings are more likely to issue US dollar-denominated bonds, and that the proceeds of the bond issue add to cash holdings. The tendency to add cash is more pronounced during periods when the dollar carry trade is more favourable and is prevalent for emerging market firms. 
They find that the issuance is more likely when the local currency is gaining in value against US dollar. They also find that a large portion of this is raised by overseas subsidiaries of the EM firm. In fact, nearly half the international debt issuance by non-bank private corporates of EM countries in the 2009-13 period were by the firm's overseas subsidiary. In other words, these EM firms were pursuing a corporate version of "carry trade", as they seek to profit from financial arbitraging, rather than using the borrowings for investment purposes or for re-balancing their debt portfolio.
Their findings carry great relevance for policy makers in EM economies.

1. The scale and pace of such debt accumulation is staggering - it is estimated that the total outstanding USD-denominated debt of non-banks located outside the US stood at $9.2 trillion in end-September 2014, against $6 trillion at the beginning of 2010. In a matter of 2-3 years, fortunes can be reversed dramatically. It is one more, and increasingly large, channel of capital inflows into EM's when credit is plentiful, with all the attendant risks when sudden-stops ensue. The attendant risks are well documented.

2. A large part of the overseas issuance by subsidiaries come back to the firm headquarters as borrowings from the subsidiary. Such flows apart from increasing firm and country vulnerability to exogenous shocks, also raises a host of regulatory concerns. For a start, discriminating such flows from plain tax avoidance or even money laundering is very difficult. It creates a financial flows channel within each firm which facilitates transfer pricing and other similar policies aimed at avoiding taxes and evading various regulatory requirements.

3. The subsidiary which transfers money to the parent firm acts as a "shadow bank" or a "surrogate intermediary". Given that a significant share of these issuances were done by firms with strong balance sheets and deployed for financial investments, and held as cash, rather than capital investments, its effects on the domestic credit markets can be uncertain. The graphic below shows the increasing share of non-residential EM non-bank issuances.
4. The traditional measures of a firm's external indebtedness may no longer be a reliable estimation of the firm's true external debt exposure. It may be necessary to take into account, off-shore borrowings by subsidiaries, thought accurate information on this may not be very easy to get.
5. This is a powerful example of the distortions engendered by the extraordinary monetary accommodation in developed economies. As the authors show, it has distorted the incentives of yield-hungry fixed income investors in developed economies and non-financial corporates in EM countries, leaving both parties vulnerable when the tide turns. 

6. The carry trade by non-bank corporates in EMs is yet another reiteration of arguably the biggest failure of financial markets, its characteristic disciplining powers break down when credit is plentiful,
The size and maturity of issuance follow the pattern of risk-taking in financial markets, with periods of easy financing conditions being associated with larger issuance as well as longer maturities.
7. There exists wide heterogeneity among countries in issuances. India has among the lowest USD non-bank bond issuance of any large country.
However, this can change dramatically once the regulations are relaxed. Reversing the course or managing such issuances are virtually impossible. 

Where is India's middle class?

Where is India's middle class?

Livemint points to a Pew research work which highlights that while the global middle class (with per capita incomes more than $10 per day) has grown from 7% to 13% of total population in the 2001-11 period, nearly two-thirds continue to remain poor (less than $2 per day) or low-income. 
The income distribution barely shifted at the top half of the income ladder.
In India, while the share of poor declined from 35% to 20%, the middle income hardly changed, inching up from 1.4% to 2.6% in the same period. In fact, among all its major peers whose middle class share is more than 20% of the population, India is easily a disconcerting outlier in its middle-class share. 
This raises several disturbing questions about the country's long-term growth prospects. At 3%, those with middle class incomes and above constitute just 37 million, and is clearly not growing at a satisfactory enough rate to sustain very high economic growth rates. Simply put there aren't enough Indians around who can afford refrigerators and cars, shop at the malls, buy a house in a metropolis, send their children for management education or get treatment at Apollo hospitals, or take-off for annual vacations within the country. Further, since the stock of middle class is growing ever so slowly, the boost from the pent-up demand may be tapering off. Even doubling this estimate, assuming the Pew study is off the mark (which is unlikely given that the recently released Socio-Economic Survey of Indiapoints to similar trends), does little to minimize the concern.

Being smart with your fund picks

When making a buy or sell decision on a fund, it is essential to look beyond returns.

When it comes to fund managers and market strategists, this year's hero usually turns into next year's zero.

William Bernstien makes that statement in his book titled The Investor’s Manifesto. Bernstein is an American financial author, theorist and neurologist. His words are worth noting.
Irrespective of whether the decision is to invest or to liquidate, performance often becomes the sole deciding factor – an error that many investors commit unknowingly. While we vociferously advocate that returns remain an important indicator of how a fund has been able to deliver historically across varied market cycles, it is not the only factor. A more holistic approach is needed when evaluating a mutual fund from an investment perspective.
Top performing fund? Don’t live in the past!
Historical returns do provide an insight into what the fund has done in the past, but its predictive powers are definitely limited. A fund’s impressive performance is not guaranteed to be repeated in the future.
It is not without reason that the regulator, the Securities and Exchange Board of India, insists on the disclosure along the lines of: Past performance of the Sponsor/ Mutual Fund/ Investment Manager is not indicative of the future performance of the Scheme(s).
For one, performance could change if there is a change in the fund manager. It could change for better or for worse. Having said that, in most cases, it is not the issue of a fund manager change. It could simply be plain market dynamics; the stock bets that worked in the past may not work going forward. For instance, if the fund manager was stocking up on value stocks and the market favoured them, it would have worked to his benefit. If growth stocks were on a roll and value stocks were being punished, he would suffer. The stock bets that worked in the past need not work going forward.
Companies that were part of the portfolio and propelled the fund’s overall returns in the past may have either changed significantly in terms of their structure and/or their and ability to generate similar levels of return. In contrast, the constituents of the fund itself could have changed affecting the return profile of the fund.
Hence, while returns can be used as a starting or reference point, taking investment decision solely based on them could lead to financial disaster.
Top performing manager? But for whom?
Fund managers tend to have different styles, investment horizons and philosophies. Investors on the other hand tend to have varying investment goals and risk appetites. Since there is no concept of ‘assured returns’ or a ‘one size fits all’ solution in the mutual funds industry, evaluating a manager’s style and comparing the best ‘fit’ with individual investing preferences becomes essential.
A so-called top performing fund manager may be a disastrous fit for your portfolio. Let’s say he manages his fund in a volatile fashion, and while he delivers admirably, the highs and lows could churn your stomach. In that case, you should be avoiding his fund.
Understanding the styles and the differences across the investing patterns of different fund managers helps gauge the suitability of funds managed by them and prevents investors taking on additional unwarranted risks as part of their portfolio. It also encourages a higher level of investment discipline. Not all strategies are suitable for all investors. For example, large cap funds are typically considered as being lower risk as compared to a mid or small cap fund. You need to check whether the fund falls in the large-cap category, flexi-cap category, or mid-and-small cap category. You would also need to look at other parameters such as concentrated portfolios against highly diversified ones.
Investors need to first assess their requirement and then the fund’s suitability to meet their individual goals.
Don’t ignore costs.
Additional costs and increased fund expenses can eat into the income that an investor really makes. In John Bogle’s words, “The miracle of compounding returns is overwhelmed by the tyranny of compounding costs.” A higher expense ratio will tend to lower investment gains thus nullifying and/or lowering actual earnings. Bogle is an author and founder of the Vanguard Group.
Furthermore, the tax structure in India can have an impact on fixed income funds that are redeemed before the 3-year period, thus making the income from such funds taxable.
An exit load as defined by the fund documents is another factor to consider while redeeming investments. With all these different facets of costs come into play, it becomes important to take into account the actual income vs. the percentage returns that a fund is able to deliver.
In conclusion….
Investors often exit a fund due to its under performance just in time to see its returns take a 360 degree turn. While maintaining a long-term view is important, it is important to understand the reasons for short term aberrations and their possible impact over the long term.
Investment decisions should be based on a combination of fundamental strength backed by quantitative support. Look for consistency of returns and whether or not the fund manager’s style is in sync with the fund’s mandate. And don’t expect a blockbuster performance every year. William Bernstien’s words yet again: Mutual fund manager performance does not persist.

Source: Morningstar india  By Kavitha Krishnan |  02-09-15

Friday, September 4, 2015

Bond market distortions amplify capital flows volatility

Bond market distortions amplify capital flows volatility

One of the defining features of the post-Lehman cross-border capital flows has been the dominant role played by bond market investors. Whereas in the earlier periods, large commercial lenders were the primary overseas lenders, the onset of stricter regulations shifted the onus to shadow banks, asset managers. A BIS study has shown that overseas lending from the US banks and bond mutual funds (BlackRock, Franklin Templeton, Pimco etc) to emerging market non-financial issuers, companies and countries, has doubled since the crisis to $9 trillion. The extraordinary monetary easing in the US, accompanied by rock-bottom yields, left these fund managers with little choice but to search for yields in emerging markets (EM).

The growth in dollar-credit from the US investors to non-banks outside the US till June 2014 is shown below. The declining share of bank loans mirrors the sharp rise in bond market investments, especially to EMs.

The World Bank has estimated that corporates and sovereigns in emerging economies sold $1.5 trillion in debt in the five years to 2014, about three times that in the 2002-07 period. China, Brazil, and India were the largest recipients. India's off-shore issuance (to skirt around the domestic capital flows management regime) has risen significantly since 2009. 

The Times writes about the distortions engendered by these flows,
EPFR Global, a fund-tracking company, calculates that global bond funds have allocated 16 percent of their holdings to emerging-market bonds. Relative to the 2.5 percent recommended benchmark for these securities suggested by the Barclays aggregate bond index, that is a very aggressive bet... Among the many beneficiaries of this largess were commodity-driven borrowers such as the state-owned oil companies Petrobras in Brazil and Pemex in Mexico, the Russian state-owned natural gas exporter Gazprom, and real estate developers in China.
One of the more extreme cases of this bond market frenzy was Mongolia. In 2012, with expectations high that the relatively tiny economy would reap the benefits from China’s ceaseless appetite for raw materials, the government sold $1.5 billion worth of bonds, with demand from investors reaching $10 billion. That meant, in effect, that the country was in a position to borrow an amount twice the size of its $4 billion gross domestic product. Three years later, the International Monetary Fund is warning that Mongolia may not be able to make good on these loans... and the yields have shot up to about 9 percent from 4 percent...
Russian train companies easily sold dollar bonds, despite the fact that their revenues were earned in rubles. Even Ecuador, a country that defaulted in 2008, was able to raise $2 billion last year. Brazil, China, Malaysia, Russia, Turkey and others have sold more than $2 trillion in bonds, mostly to American mutual fund companies, since 2009. As this money flowed into their countries, financing skyscrapers in Istanbul and oil exploration in Brazil, economies and currencies strengthened. Now the reverse is occurring, led by a slowing Chinese economy, and as that money heads for safety, local currencies are plunging.
This highlights an inter-temporal asset-liability mismatch in the books of these asset managers. Their assets (bond mutual funds and exchange traded funds) are often in illiquid or hard-to-sell investments, whereas their investors are free to withdraw anytime. Since bond investors typically rush to redeem their positions when faced with such turmoil, especially in the currency markets, any panic-sale has the potential to trigger a forced-sale of infrequently traded assets, thereby unraveling the bond markets. On the debtor's side, the sharp devaluation of their currency that invariably follows such episodes adds to their debt burden.

This game of massive inflows where private corporations (and governments) leverage-up on plentiful external credit, followed by sudden-stops in response to shocks and panic flight to the exit gates has been replayed too many times to be kept track. A large share of such inflows end up financing hubris-driven projects with limited social value and/or doubtful commercial viability. The capital flights leaves in its wake the ruins of incomplete or failed projects with massive debts, battered corporate balance sheets, vulnerable banks (exposed to these corporations), and economies on the brink.

Countries like India which have been aggressively courting capital from asset managers like pension funds to finance their infrastructure investment requirements would do well to keep these lessons in mind as they go about this. Most infrastructure investments have their revenue streams in local currency. Financing such investments with foreign currency denominated liabilities is fraught with considerable risks. This is all the more so since the volatility engendered by cross-border capital flows, which has become all too frequent, does not discriminate between prudent and reckless borrowers. In any case, given the scale of the country's infrastructure financing requirements, foreign capital can at best be small change.

All this assumes even greater significance given that economic fundamentals are no insurance against the volatility induced by bouts of global financial market turmoil and that markets react excessively when faced with such uncertainty.