Market Dynamics: is it the right time to buy

This information has been sourced from economictimes article,
http://economictimes.indiatimes.com/Markets/Analysis/Equity_-_Is_It_The_Right_Time_to_buy/articleshow/msid-3845314,curpg-2.cms

There are several metrics which can be observed to get a fair guesstimate about the direction market is heading towards. They are:

Earnings Approach

The current level of Sensex implies 10.0 x – 9.4 x P/E of FY09 earnings and probably around 12.5x – 11.3x of FY10 earnings.
Historically, since 1991, Sensex has traded in the range of 10-30 times one year forward earnings. So, currently the Sensex is certainly at the lower range of the historical P/E band.
Even if things are likely to be different this time due to a worldwide recession, we do not expect more than 20% downside from these levels.

Book Value Approach

The current P/BV (Price to Book Value) of Sensex is hovering around 2.3 which is in the range of historic lows of 2-2.4.
In last 18 years, whenever the P/BV ratio had drifted to around 2, it has been followed by a smart pull back. For example, in November 1998 when Sensex fell to around 2800 levels (P/BV of 2), the next six months witnessed a strong pullback rally of more than 40% pushing the index to 4000 levels.

Conversely during last 15 years, markets have fallen sharply every time the P/BV ratio has crossed 6.5. January 2008 was no exception to this rule.

Falling Yield in Equity

Historically, it has been observed that whenever Equity yield has crossed the G-Sec yield, it makes sense to invest in equities.
On the other hand, whenever G-Sec yield has reached higher than equity by 4% or more, it has been a good opportunity to sell out of equities.
In January 2008, the G-Sec yield was higher than equity by this threshold margin. Since this indicator was very accurate in predicting the peak of the bull market, it may be used as a good sign to determine the trough of this bear market. Since Equity yield has already crossed the G-Sec yield, we may conclude that we are near the bottom of the cycle as far as equity markets are concerned.

Average Quartely Balance -- How is it calculated

To understand how AQB is calculated, here are some useful links:

http://www.hdfcbank.com/personal/accounts/aqb_pop_up.htm

Futures and Options -- Let us Know

Derivatives are products that obtain their value from a spot price, called the “underlying”.In India, F&Os are the two popular derivatives instruments traded on stock exchange. While in a futures contract, you agree to buy or sell shares at a certain price in the future, the option contract gives you the right, but not an obligation, to buy (through a call option) or sell (through a put option) the underlying scrip at a specified date and at a specified price.To start trading in futures contract, you are required to place a certain percentage of the total contract as margin money.This feature of futures contract makes it a leveraged instrument since you can make a larger profit (or loss) with a comparatively small amount of capital. In India, futures contracts are available on equity stocks, indices, commodities and currency.

In options trading, you pay the premium for buying the rights to exercise your option. To take the buy or sell position on index and stock options, you are required to place a certain percentage of order value as margin money.An option can be a ‘call’ option or a ‘put’ option. A call option gives you a right to buy the asset at a given price or before a given future date. This ‘given price’ is called ‘strike price’.Similarly, a ‘put’ option gives you a right to sell the asset at the ‘strike price’ to the buyer. Thus in an options contract, the right to exercise the option is vested with the buyer and the seller has only the obligation but no rights.Since the writer of an option bears the obligation, he is paid a price known as ‘premium’.

Before venturing into unknown waters, analysts advise that you must fully understand the implications arising out of trade in F&Os. “It is trading on margin with a leverage of four-six times. You should know that in leveraged trading, the market fall is magnified to the extent of the leverage availed by you.Understanding your risk appetite and risk tolerance is important in F&Os trading,” says Sandeep Nayak, senior vice-president and head, private client dealing, Kotak Securities.The golden rule — never trade anything that you don’t understand — believe analysts, has a special significance for F&Os trading since the risk in them, with all the leverage and complexity, comes in multiple dimensions. “Unlike the cash market where your risk is limited to the amount you deploy, you can lose much more than what you’ve put in and in much more ways than a simple price move in the F&Os segment. Always think risk first and then think about returns,” cautions Nilesh Shah, CEO of Ambit Capital.

According to Shah, a first-time investor must not trade in F&Os due to the associated risks. Only after having invested in stocks for over three years, an investor should try to become a trader.“However, you must start with very small ticket sizes initially and only once you’ve gained confidence about the nature and working of these instruments should you look to increase your ticket size.You should try to seek expert advice at least in the initial part of your trading journey,” he feels. Nayak, too, feels that a first-time investor trading in F&Os is akin to an individual trying to swim in the deep end of the pool on day one of swimming class.

According to Shah, a first-time investor must not trade in F&Os due to the associated risks. Only after having invested in stocks for over three years, an investor should try to become a trader.“However, you must start with very small ticket sizes initially and only once you’ve gained confidence about the nature and working of these instruments should you look to increase your ticket size.You should try to seek expert advice at least in the initial part of your trading journey,” he feels. Nayak, too, feels that a first-time investor trading in F&Os is akin to an individual trying to swim in the deep end of the pool on day one of swimming class.

Example: On November 1, an investor feels the market will rise Buys one contract of November ABC Ltd futures at Rs 400 (market lot: 200) November 12 ABC Ltd futures price has increased to Rs 480 Sells off the position at Rs 480. Books a profit of Rs 16,000 (200x80).Options Example: On November 1, an investor is bearish on the market Current Nifty is 2,980. You buy one contract (lot size 50) of Nifty near month puts for Rs 20 each.The strike price is 2,940. The premium paid by you: (20x50) Rs 1,000.Your breakeven Nifty level is 2,920. If at expiration Nifty declines to 2,890, then Put Strike Price 2,940 Nifty expiration level 2,890 Option value 50 (2,940-2 ,890) Less: Purchase price 20 Profit per Nifty 30 Profit on the contract Rs 1,500.

Investment Banking - What do they do

An investment bank uses its proprietary book (own money) to lend others and invest. It started with the subprime crisis. Banks like Lehman, buy mortgage loans from other banks, and then package them to sell bonds against the loan pool. Often they add cash to make the loan pool more attractive, so that the bonds can be sold at a higher price.

Suppose mortgage was earning 6%, these bonds are sold at 4%. The difference is the spread which the investment bank earns. By selling these structured bonds, it raises money and frees capital. But when homebuyers started defaulting, these bonds lost their value. It all began like this, and then the virus spreads across markets.

Systematic Investment Plans aka SIP

Systematic Investment Plans (SIPs) are much misunderstood. For one, investors often mistake SIPs as an investment avenue rather than a mode of investing in mutual funds. Then there are investors who invest in SIPs expecting quick results without fully appreciating the need to invest via SIPs for the long-term.

In an earlier article, we discussed how SIPs are perceived incorrectly by many investors as standalone investments. This explains why one of the most common queries we receive on the website is – which is the best SIP? Unfortunately, these investors have not been educated by their investment advisors about SIPs i.e. SIPs are only a mode of investing and not an independent investment avenue.

Minimum tenure of an SIP
Another misconception investors have about SIPs is with regards to the minimum tenure. Most fund houses have a minimum SIP tenure of 6 months. This leads investors to believe that 6 months is the ideal time frame for investing via SIPs (just like a lot of investors invest Rs 5,000 in mutual funds simply because that is the minimum investment amount for several mutual fund schemes).

In our view, investors should ideally invest via SIPs over at least 2-3 years. This way they can exploit the most critical benefit of an SIP – rupee cost averaging. Let’s understand how this is possible.

For an SIP to deliver the goods, it must witness a falling market. This way the investor can average out his cost of purchase. If the investor does not witness a downturn, i.e. he is only exposed to a market rally, the average purchase cost of his SIP will rise over a period of time.

SIPs in a rising market

Month of investment	NAV (Rs)	No. of Units
January	11.00	45.45
February	12.00	41.67
March	12.50	40.00
April	12.90	38.76
May	13.25	37.74
June	13.40	37.31
Avg. purchase cost of 6 SIPs	Rs 12.45

In the above table the average purchase cost of the SIP is Rs 12.45. Clearly, the SIP has not worked in the investor’s favour. Why is that? Because if he had instead invested lumpsum in January, his purchase cost would have been Rs 11.00 as opposed to the average purchase cost of Rs 12.45 over a 6-month period.


SIPs in a falling market

Month of investment	NAV (Rs)	No. of units
January	11.00	45.45
February	12.00	41.67
March	12.50	40.00
April	12.90	38.76
May	13.25	37.74
June	13.40	37.31
July	12.10	41.32
August	11.20	44.64
September	10.30	48.54
October	10.10	49.50
November	10.50	47.62
December	10.20	49.02
Avg. purchase cost of 12 SIPs	Rs 11.50

However, if the investor had opted for a longer investment tenure of say 12 months, he could have benefited from greater fluctuations in the mutual fund’s NAV. These fluctuations which arise over a market cycle lower the average purchase cost of the SIP over the long-term.

This is apparent from the above illustration. As is evident from the table, if the investor had taken an SIP for 12 months (instead of 6 months) his average purchase cost would have declined to Rs 11.50. Compare this with the average purchase cost of Rs 12.45 for a 6-month SIP.

It can be argued that there is no way for the investor to know when there is likely to be a turnaround in the markets (in this case a downturn). That is exactly our point. Since the investor does not know when markets will fall (and lower his average purchase cost), he must opt for a longer SIP tenure. Or at least he must manage his investments in a manner so that when his existing SIP terminates without witnessing a dip in stock markets, he can extend it further. This way should the markets fall, his SIP can benefit from a dip in the mutual fund NAV which in turn will lower his average purchase cost.

Points to remember before opting for an SIP

1) Ironically, while SIPs are meant to eliminate market-timing, investors must opt for a long-enough SIP tenure so as to ‘time’ the market downturn.

2) SIPs are equally beneficial in a falling market. Most investors believe that lumpsum investments (as opposed to SIPs) prove more beneficial in a falling market. This is only partly true. Having an SIP in operation during a falling market can ensure that investors stand to benefit should markets fall even further.

Gold ETF versus Buying Gold for Investment

While individual gold holdings are the highest in India, most of it is in the form of jewellery. But jewellery is an uneconomic method of holding gold as on selling jewellery you will lose up to 10 per cent of the gold value and also the making charges that you paid during the purchase.

“Those who want to buy gold for investment, prefer buying medallions and bars — this category has been growing in India over the past few years,” informs Mr Shah. Although coins and bars do not attract making charges, the sale discount is still there if the gold is not hallmarked. Hallmarked gold attracts the lowest discount and can be sold at 1-2 per cent lower than the market value.

Gold jewellery is not as good a investment as it is not as liquid as bars or gold funds, points out financial planner Gaurav Mashruwala. If you are saving to buy jewellery it makes sense to buy gold coins. These coins are accepted by jewellers in return for gold used in jewellery. If you intend to sell the coins, you may have to take a discount of up to 4 per cent, irrespective of how pure are the coins/bars.

But if you are holding a large quantity of gold, you will have to make provisions for storage and insurance as there is a security issue in keeping gold at home.

Gold ETFs are quite similar to mutual funds. The money you invest in gold ETFs is used to purchase physical gold of equivalent value. The advantage of ETFs are that the fund house that issues the gold ETF takes over the responsibility of storage and insurance of this gold. Gold ETFs are also tax efficient unlike physical gold. “While physical gold is considered a long-term investment, only if you hold the same for three years, gold ETFs acquire this status after one year,” says Mr Mashruwala.

In short, selling gold within three years of purchase will attract capital gains tax. Moreover , holding large quantities of physical gold can attract wealth tax, while gold in demat form does not. This apart, the spread between the buy and sell prices pertaining to gold ETFs is less than that of physical gold.

In other words, while your jeweller could sell you a gram of physical gold at Rs 105 and buy the same at Rs 95, you can buy a unit of gold ETF at Rs 101 and sell it at Rs 99. “Doing an SIP in gold would be the best option in the current scenario,” reckons Pritam Patnaik, AVP, Kotak Commodity Services.

The two gold ETFs that are more than a year old — Gold Benchmark ETF and UTI Gold ETF — have delivered more than 40 per cent returns in the last one year. In case of others too, the returns have been positive for most months, in contrast with equity and debt funds that have posted negative or mediocre returns. However, the two world gold funds, which invest in stocks of gold mining companies, have had to suffer a fate similar to other equity funds. “It is advisable that you invest in gold as a commodity. Gold funds basically invest in gold mining companies. If you buy a gold fund, you actually invest and take a risk on that company and not on gold," adds Mr Gopkumar.

Technical Risk Ratios for Portfolio Planning

There are five ratios referred to while creating and maintaining efficient portfolios.

1. Alpha,
2. Beta,
3. Standard deviation,
   
4. R-squared, and
   
5. The Sharpe ratio.

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Alpha
A measure of performance on a risk-adjusted basis. Alpha takes the volatility (price risk) of a mutual fund and compares its risk-adjusted performance to a benchmark index. The excess return of the fund relative to the return of the benchmark index is a fund's alpha.

A positive alpha of 1.0 means the fund has outperformed its benchmark index by 1%. Correspondingly, a similar negative alpha would indicate an underperformance of 1%.

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Beta
A measure of the volatility, or systematic risk, of a security or a portfolio in comparison to the market as a whole.

Beta is calculated using regression analysis, and you can think of beta as the tendency of a security's returns to respond to swings in the market. A beta of 1 indicates that the security's price will move with the market. A beta of less than 1 means that the security will be less volatile than the market. A beta of greater than 1 indicates that the security's price will be more volatile than the market. For example, if a stock's beta is 1.2, it's theoretically 20% more volatile than the market.

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Standard Deviation

Standard deviation is a statistical measurement that sheds light on historical volatility. For example, a volatile stock will have a high standard deviation while the deviation of a stable blue chip stock will be lower. A large dispersion tells us how much the return on the fund is deviating from the expected normal returns.

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R-squared

R-squared values range from 0 to 100. An R-squared of 100 means that all movements of a security are completely explained by movements in the index. A high R-squared (between 85 and 100) indicates the fund's performance patterns have been in line with the index. A fund with a low R-squared (70 or less) doesn't act much like the index.

A higher R-squared value will indicate a more useful beta figure. For example, if a fund has an R-squared value of close to 100 but has a beta below 1, it is most likely offering higher risk-adjusted returns. A low R-squared means you should ignore the beta.

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Sharpe Ratio

The Sharpe ratio tells us whether a portfolio's returns are due to smart investment decisions or a result of excess risk. This measurement is very useful because although one portfolio or fund can reap higher returns than its peers, it is only a good investment if those higher returns do not come with too much additional risk. The greater a portfolio's Sharpe ratio, the better its risk-adjusted performance has been.

A variation of the Sharpe ratio is the Sortino ratio, which removes the effects of upward price movements on standard deviation to measure only return against downward price volatility.

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Financial health of a company: some tips

We started off by eliminating all those companies that had recorded less than 15% growth in net sales and PAT in any of the past three years.

Further, we filtered companies on the basis of debt-to-equity ratio and return on capital employed (RoCE). While a high debt-to-equity ratio indicates that a company may not be able to generate enough cash to satisfy its debt obligations, a low leverage ratio increases a company’s potential to raise funds.

Hence, we selected companies which had a debtto-equity ratio of less than 1.5. In order to carry sustainable operations, it is necessary for a company to operate at an RoCE which is well above its cost of capital. Only those companies with an RoCE of more than 15% could make it to the next stage.

The final criterion was to do away with all companies whose three-year average net cash flows from operating activities was less than 50% of their reported cash profit.

SIP + Insurance but Not ULIP

A number of mutual fund companies have tied up with insurance companies to offer long-term investment plans that offer you an insurance cover for the residual part of your entire investment plan. If you die part of the way through the plan, then your survivors will get not just the principal and returns of the amount that you have invested, but also the amount that you had not yet invested, but intended to.

Because this product is so unusual, it's probably not quite clear how this works, so let me explain through a detailed example. Let's say that a forty-year old person decides to invest Rs 20,000 a month till he is fifty-five years old. This amounts to investing Rs 2.4 lakh a year, or Rs 36 lakh over the entire fifteen year period. He decides to invest this money in a Systematic Investment Plan of an equity fund. Based on past experience, he expects to earn an average of perhaps 15 per cent a year on the investments he makes.

He starts investing and for five years, everything is fine. His has invested Rs 20,000 a month for five years, which comes to a total of Rs 12 lakh. His investments have yielded an average of about 15 per cent a year and are now worth a total of Rs 17 lakh. At this point, an unfortunate mishap occurs and he passes away. Normally, that would be the end of the investment plan. Of the Rs 36 lakh he originally intended to invest, he could invest only Rs 12 lakh before he died.

However, if this person had invested in the insured investment products that I'm talking about, then this would not be the end of the story. The 24 lakh that he couldn't invest because he died will be paid to his family by the insurance company. So his family gets the Rs 41 lakh which is Rs 17 lakh (the current value of the 12 lakh that he was able to invest), plus the 24 lakh that he intended to invest but couldn't because he died. His family could then invest the money and thus make sure that the financial plan is not disrupted. This isn't like a normal insurance where the amount you are insured for stays constant. Instead, the amount insured keeps decreasing. At any point, this amount is equal to what remains out of the original investment plan that the investor signed up for.

The obvious question is who pays for the insurance. After all, if the insurance company is covering the risk of the investor's death, then the investor must be paying the premium somehow. The answer is that this premium is paid in the form of an extra one per cent load that is deducted out of the money that is invested. Normally, fund companies charge a load of 2.25 per cent out of the investment you make. In the case of this product, this load is one per cent more. For Rs 20,000 a month, that comes to an extra Rs 200, which would strike most of us as a fair price to pay for the peace of mind that this product offers.

What is interesting is that there is no lock-in and there's no obligation. If you want to pull out of the scheme at any point then you can just stop investing and withdraw your money. Such product, with minor variations, are offered by a number of fund companies including Kotak, DSPML and Reliance.

The obvious downside is that this product ties one to a particular fund company for a long period of time. I think that's where one should spread the risk a bit by splitting one's investment across funds from different companies.

Few things to know before you decide your SIP + Insure

1. Is there a minimum amount that has to be invested in the SIP?

2. Must the SIP be of a certain tenure?

3. Are all equity schemes of AMC, eligible or is it offered only on certain schemes?

4. Will the insured amount be given to the nominee or be used to continue with the SIP so that the investment plan continues?

5. Will all the insurance expenses be borne by the AMC?

6. Is there any age limit to avail of this scheme?

Things to look when buying house

But when it comes to your home, be sure to ask plenty of questions.

1. How big a house do I need?
It depends on your individual needs. If you are a family of five seeking more room, choose your second home with space and additional rooms.

If you are a young couple buying your first nest, settle for a cosy place for two. That is, if you are not planning a family soon.

Once you have figured out your needs, translate them in terms of built-up, carpet area and the new concept of super built-up areas. Carpet area is simply 75 per cent to 85 per cent of super built-up area. That means if the super built-up area is 1,000 square feet, the carpet area would be around 750 square feet to 850 square feet.

The ratio for built-up can be as low as 15 per cent for an old construction and as high as 28 per cent for new constructions. Super built up is at a phenomenal 40 per cent!

Make a note of the budget you will need for the same.

2. Which is the right area for me?
Ask yourself, do I want to spend half my life commuting? Or live in townships or residential complexes far from the dust, grime and noise of the city?

Or are the happening suburbs with their attractions -- malls, multiplexes, luxurious homes -- more my style?

Keep the investment point of view in mind. Suburbs offer value for money and investment appreciation.

3. What do I look for in a neighbourhood?
Once you have the area, narrow it a step further to a neighbourhood. Your immediate neighbourhood will decide how hassle-free your existence will be.

Look for proximity to doctors and clinics, shopping, transport connectivity, schools and hospitals.

Today, people also check out entertainment and recreational options, which could include bowling alleys, game centres, sports facilities, shopping malls, food courts and restaurants.

4. How much importance do I give amenities?
As dull as they sound, these things can be major reasons of concern if they are absent or insufficient.

Starting with water and power supply, look into access roads, parking space, safety and security and perks such as children's play areas, gardens, etc.

Verify the construction quality carefully. Compare a new construction with other existing projects by the same builder. This way, you can be sure that what you get will be the same as what you see in the sample flats.

5. Does it live up to my lifestyle requirements?
Your house is your refuge from the world and speaks volumes about you. Flooring, tiling, classy fittings and fixtures, fancy lighting, French windows can all make your nest a beautiful place to relax in.

Features offered by your building -- jacuzzi, swimming pool, gymnasiums, clubhouses, jogging tracks -- will all enhance your lifestyle.

A major element in your lifestyle will be the profile of people living nextdoor. If you have like-minded people in the neighbourhood, it puts your social calendar in place too.

6. What if I want more?
Above and beyond these, if you are looking at the best, most elite complexes, you are likely to be offered wide open spaces with lush, landscaped gardens and tree-lined roads.

This gives the complex an elegant feel, besides keeping the air fresh. Other green ideas that builders incorporate are rainwater harvesting and sewage treatment plants.

But like all good things in life, this comes with a price tag which you should be able to afford.

7. What if all this is there but the flat size is small?
Small flat sizes are a fact in a city like Mumbai. But there are myriad ways to maximise space with clever interior design. Traditional layouts have fast been abandoned in favour of specialty rooms or areas within the home.

Thus, larger rooms can be segregated into various areas of utility with the help of furniture, screens, dividers and so forth. Balconies can provide both leisure and storage space, even a computer room.

8. What about resale value?
The most important aspect in resale is the view. Naturally, all the amenities will be factored in, but houses with a great view normally sell for premium prices.

So if view is what pleases you, it may be worth that extra chunk of cash. Only people who can afford to pay a premium for a view will be your buyers so you may have to wait longer or drop your asking price substantially and match the general rate of the neighbourhood.

Excellent construction quality and good infrastructure in your area could give your property graph an upward slant.

SideCar Investment

What Does it Mean?

An investment strategy in which one investor allows a second investor to control where and how to invest the capital. The sidecar investment will usually be used when one of the parties lacks the ability or confidence to invest for themselves. The strategy will place trust in someone else's ability to gain profits.

Investopedia Says...

The word "sidecar" refers to a motorcycle sidecar; the person riding in the sidecar must place his or her trust in the driver's skills. This differs from coattail investing, where one investor mimics the moves of another. For example, suppose there are two individuals - Fred, who is experienced in trading stock, and Barney, who has a background in real estate. They decide to work together in a sidecar investing strategy. In this case, Fred would give Barney money to invest in real estate on his behalf and Barney would give Fred money to invest in stocks. This setup allows both Fred and Barney to diversify their portfolios and benefit from one another's expertise.

Floating Rate Funds

Floating rate fundsFloating rate funds (or floaters as they are called) are just as critical in an uncertain interest rate scenario. These funds invest in floating rate debt instruments wherein the coupon rate is revised at regular intervals. Uncertainty in interest rates does not significantly impact the prices of floating rate instruments, because the coupon rate is adjusted (either lower or higher depending on the interest rate scenario) in response to the market rates. Again, given that portfolios of floaters are largely comparable, lower expenses are crucial in clocking a competitive return. While floaters come in both variants (short-term and long-term), opt for short-term floaters, which allow investors to redeem any time without paying an exit load (long-term floaters usually have an exit load on premature redemptions).

FMP Simplified

FMP's are investment instruments that are to be bought in the month of march. Since banks invite funds for investment for a very short duration of time, say a week or even less than that, in case you are interested in investing in FMP's, keep your eyes and ears open when March starts :)

Following piece of text would give some insight to what's and how's of Fixed Maturity Plans.

Fixed maturity plans (FMPs) have become popular amongst investors mainly as a foil for uncertain interest rates. FMPs by staying invested in a portfolio of bonds/government securities till maturity offer a relatively certain return despite their market-linked nature. During periods of uncertainty, the certain return offered by FMPs assumes even more significance. While FMPs are launched with varying tenures, go for the short-term FMPs (less than a year). If the interest rate scenario appears uncertain even after the FMP matures, you can consider rolling over to the next issue (provided the fund house is offering another FMP with a similar tenure).

Risks involved in FMP's: Visit this link :- http://www.personalfn.com/detail.asp?date=3/27/2008&story=2

Compare FD with FMP :-
http://personalfn.com/detail.asp?date=4/29/2008&story=1

Happy Investing.