A re-look at Gilt funds – a guest post

Both WPI and CPI inflation rates have been moving down. However, there are questions whether inflation is low because of a higher base effect. As the base effect wears off from Jan ‘15 onwards, inflation may rise again.

Industrial growth continues to be tepid. India Inc. have been clamouring for an interest rate cut to spur growth. The RBI Governor has so far left rates unchanged till inflation gets firmly under control.

If inflation stays low during Jan-Feb ‘15, then a 25 or 50 bps rate cut in Feb ‘15 is a possibility. That should provide impetus to the stock market and gilt fund returns. In this month’s guest post, Nishit suggests a re-look at gilt funds as a safe diversification avenue for your investments.

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The 10 year Government Security yield has come down to 8.15% from a peak of about 9.10% in April. So, should one invest in Gilt funds now?

Gilt funds offer an interesting diversification from equity and Gold investments. They work best when interest rates are coming down and bond prices go up. For example, if a Rs 100 bond is yielding 9% interest and if the interest rate comes down to 8%, then the same Rs 100 bond will cost Rs 112.50 to yield 8% interest.

So, one stands to make a return of say about 12-13% if the interest rate comes down by 1% in about 6 months.

Inflation is going down and so are fuel prices. An interest rate cut by RBI is expected - if not in December ’14 then definitely in February ‘15.

The Government prefers low interest rates as industry can borrow at lower rates and make more investments leading to more employment and growth in the economy. The Finance Minister has already tried nudging the RBI Governor to reduce interest rates. The fear of inflation re-emerging is what is holding back the RBI from reducing interest rates in a hurry.

Interest rate is expected to come down to 7.75% in the next 4-6 months. Currently it is at 8%.

For those who have already invested in Gilt funds, now is the time to enjoy the profits. Those with a horizon of 6 months also can look at Gilt funds as a measure of diversification. Over the last 3 years, gilt funds have given an annual return of about 10%.

In a complete cycle of top to bottom when the interest rates start falling, they typically give about 25% returns out of which 10-12% have been realised already.

Interest rates usually bottom around 7%. Gilt funds can be used to optimise returns from fixed income instruments and one can invest about 5-10% of total allocated funds for investment.

The risk to Gilt funds arises from interest rates going up and at such times, the funds give very low returns.  For those who want to play the interest rate cycle, gilt funds offer the perfect medium.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

Why you should include gold in your investment portfolio – a guest post

For most Indians, buying gold is a no-brainer. Gold is bought for the family deity. It is bought for a daughter’s wedding and for the wife on a wedding anniversary. It is bought on Dhanteras, and on Diwali. Having significant amounts of gold in one’s possession is a sign of great wealth and status.

But is gold a good investment? Sure, the price of gold has appreciated over the years. But it doesn’t provide any regular returns. Equity shares provide dividends, rights and bonus shares. Plus, they can be redeemed quickly for cash. Redeeming gold for cash is cumbersome – though many NBFCs now offer easy gold loans.

The debate should not be about equity vs. gold. Logically, equity is far better as an inflation-beating investment. However, that does not mean one should not include gold as part of an asset allocation plan. In this month’s guest post, Nishit builds the case for including a small percentage allocation for gold as a hedge against inflation.

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Gold’s price is back where it was in July 2010 in US Dollar terms (at about 1200-1250). In July 2010, the Indian Rupee was about Rs 47 to the US Dollar and now it is around Rs 61.

While investment focus should be on equities, it is always better to have 5-10% in Gold as a hedge against inflation. People talk about Rupee going back to 47 levels but that will make exports uncompetitive and it remains to be seen if Rupee actually appreciates that much.

Historically, Rupee has always depreciated against the Dollar. With global markets showing signs of weakness, Gold can also be a hedge against equity weakness if any. While I do not believe that the Indian markets will have a drastic fall, it is always good to have a hedge.

Interest rates also show signs of weakening and Gilts are another good option at the current juncture. Gilt funds make money when interest rates drop. With weak diesel prices, inflationary pressure will lessen.

Investment in Gold can be in the form of Exchange Traded funds, physical gold or even jewellery (if one wishes to enjoy the gold while using it as a hedge). There are talks of import duty being cut on Gold in the forthcoming budget.

Asset allocation at the current juncture can be 90% Equity, 5% Gold and 5% Gilt funds. When gold was at its peak at almost US $1900, the risk-reward ratio was unfavourable for buying any gold. Now, it has corrected almost 33% from the top and almost 55% of the rise which started in 2008.

In US Dollar terms gold can correct another 10% or so. One cannot catch exact levels but it is safe to start accumulating gold.

The promise of “Acche Din” is here and I see no reason why India will not see glory days ahead, but it is always good to buy insurance for a rainy day.

If interest rates go up for some reason, or if the global economy weakens further for some reason, equity and Gilt funds will go for a toss. At least gold will cover up some of the losses.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan. You can reach him at nish.stockid@gmail.com)

Look at fixed income in a choppy market – a guest post

Many investment experts, who regularly appear on business TV channels, suffer from herd mentality. When the stock market rallies, they jump on to the bull bandwagon and start predicting higher and higher index levels.

When the market corrects, the same experts suddenly turn gloom and doom mongers and predict ever lower levels. Since the stock market’s nature is to fluctuate, opposing views from the same set of experts tend to confuse small investors – who end up sitting on their hands.

In this month’s guest post, Nishit takes a look at some fixed income options that small investors can look at, without taking undue risks in a choppy stock market.

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Stock Markets are going crazy with wild swings. Government Securities funds, which trade mainly in Government 10 year paper, are swinging too. So, what are fixed income instruments one can invest in?

There are a slew of investment opportunities in fixed deposits from second tier companies like India Infoline and Muthoot. These are medium risk and high return investments. I would advise people to stay away from these, especially those who depend on fixed income for livelihood. In case of default they can lose the entire amount. For those who can afford to take the loss, a small amount can be invested.

Options are also available for Non Convertible Debenture (NCD) side of the market, which are not given much prominence but are lucrative. Older series L&T Finance NCDs are traded on the BSE. They are giving a yield of 10-10.5% (taxable) and pay interest twice a year. If one digs deeper one can find out other such investment opportunities.

There is one more lucrative option started by Government called Tax-Free bonds. These are bonds issued by PSU undertakings with tenures of 10 to 20 years. They give returns of 8.5-8.75% or so. The Interest earned from these bonds is tax free. Rs 1 lakh invested in say Hudco bonds - currently on offer - will yield you Rs 8760 tax-free every year. Now, if a bank FD at 10% gives you Rs 10000 for the same principal of Rs 1 lakh, then at highest tax bracket ( approx. tax of 30.9%), you would be left with only Rs 6910 after tax.

Effectively, if you are in the highest tax bracket, you are getting safe return equivalent to that of a 12.5% bank FD. So, what is the catch? None on the face of it. Since, the bonds are listed on the stock exchanges, one can get out whenever one wants to.

If all this doesn’t appeal to you, then you have the good old bank Fixed Deposits. Interest rates are attractive for tenures of just over a year. If one wants to invest in the market after the current volatility gets over that is another option.

Also, if one looks at Gilt funds, the 10 year yield is now at about 8.45%. If the new RBI Governor walks his talk, one can see a cooling off of interest rates after some time – which will increase 10 year yields. However, this option is only for patient investors.

Thus, even amongst market turbulence, there are investment options which are safe and low profile. Investing is all about being smart not flashy.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

RBI’s liquidity squeezing – a guest post

Vote-bank politics with schemes like NREGA, food securities bill, and hugely hiking the pay of government employees – not to speak of fertiliser subsidy, oil subsidy – has led to a bloated fiscal deficit in India.

Slowdown in global economies – including in India – and rising oil prices have added to the Current Account deficit. Instead of taking pro-active steps to curtail the twin deficits and put GDP growth back on track, the government tried to coerce RBI into reducing monetary controls to re-energise growth.

Instead of succumbing to pressure, the RBI Governor stuck to his hawkish stance against inflation. He is paying the price by not getting an extension of his term in office. His latest step to stem the fall in value of the Rupee by tightening liquidity has not been well-received by the stock market.

In this month’s guest post, Nishit discusses the likely effect of RBI’s action on Gilt Fund yields.

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Recently, the RBI indirectly raised Interest Rates by squeezing liquidity to curb the pressure on the Rupee. This led to a spike in bond yields from 7.5% to 8.1%. Many of the debt funds lost 3-4% of their NAVs. Many must have panicked, as this had never happened before and can almost be called a ‘Black Swan’ event.

So what does it mean for Gilt funds going ahead? The basic objective of Gilt funds is that they are meant for long term investors when the interest rates are coming down, to capitalize on the increase in Bond Prices when yields come down. One is supposed to exit when the trend has changed and the bond yields are going up.

Was RBI’s intervention a signal that Interest Rates may be going up? I do not think so. The economy is in shambles and to simulate the economy, rates have to come down. RBI’s action was just a one-off blip as a desperate government tried to stop the Rupee from devaluing further.

Bond Yields, which had spiked to 8.1% towards the end of the week, came down to 7.9%. If there are no more unpleasant surprises, then the yields could touch the record low of 7.1% by December. The spike in yield was a buying opportunity for the long term investor.

The very fact that the yield rose from 7.56% to 8.10% and back to 7.94% means that the market had over-reacted and yields are coming down.

The RBI policy on the 30^th of July ‘13 will give further guidance on what the RBI intends to do. As I see it, they will maintain a status quo and will neither raise nor cut Interest Rates.

In real terms, home loan rates will not come down. The Auto or the Realty sectors’ hopes of a stimulus will have to keep waiting.

Long-term investors do not need to worry. Only short-term traders, and Banks who conduct treasury operations, will take a hit. Till the economy turns around, I do not see Interest rates rising.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

A re-look at Gilt funds – a guest post

After a decent rally during 2012, backed by strong FII inflows in 2012, the stock market touched 2 year highs. A correction has ensued since then. Slow down in economic growth has forced the RBI’s hand in lowering repo and reverse repo rates, though inflation remains high.

In this month’s guest post, Nishit argues in favour of an investment in Gilt funds – since repo and reverse repo rates have started on their way down.

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We had last reviewed Gilt funds in the month of August ‘11. A lot has changed since then. Let us take a look at where we stand now.

The 10 year bond was trading at 8.2% approx. In a period of 6 months, the rate has come down to 7.9% approx. A period of 6 moths and a rate drop of 0.3% - how does it translate into real returns for an investor?

The Birla Sun Life Government Securities fund, which is a blue chip fund with a 5 star rating from Valueresearcholine.com, has provided an absolute return of 6.61%. When annualized, it becomes 13.22%.

In the next 6 months, Interest Rates should fall by about another 0.5%. Typically in this Interest Rate cycle the peak and the bottom is usually 300 basis points minimum. The peak was about 9%, so the rates should bottom around 6 to 6.5% in the next 2 years.

Now is the time to invest in Government Securities funds, as the Interest rate cycle has clearly started its way down.

Government Securities are the highest rated securities. A default on them is almost impossible, as it would amount to a sovereign default of the Indian state.

If we look at other funds like Income funds, the rate of return has already declined. The trick to make profits from Gilt funds is to ride out the bottoming out of Interest Rate cycle and then move the money back to equity. Typically when the Interest Rate cycle bottoms, it is time to move back into equity.

This happened during October 2008 to March 2009. It happens because rate cuts stimulate the economy - which also means the economy is doing pretty badly. Stock markets are usually 6 months ahead of the economy. When the rate cuts stop and the yield bottoms out, it is also time to invest in equity.

The chart below illustrates how the cycle works. One can compare it with the equity cycle. The rate cuts bottomed out in Dec 2008 and equity markets bottomed in March 2009.

The idea of investing is to safely make a compounded return of around 15-16% every year. When the equity markets are headed downwards, it is time to make money in Gilts and when Gilts are headed down, it is time to make money in Equity Markets.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

What to do when the stock market is bearish and volatile?

When stock markets are bearish and volatile, small investors feel anxious and unsure of what to do. Activity, innovation and endeavour are useful in business and employment – but they detract from wealth building. One has to be passive, dispassionate and patient to be able to make correct investment decisions when there is chaos and bad news flying around.

Having a financial plan with clear goals, and an asset allocation plan to meet those goals, helps investors to remain calm and resolute under adverse conditions. A proper asset allocation plan should include an equity component, a fixed income/debt component, a small allocation to gold and some cash. If you don’t have a plan yet, the time to start is now.

The equity component can comprise equity funds, balanced funds, index funds, sectoral funds, company stocks or any combination of these – depending on an investors risk tolerance and investing skills. The debt component can comprise PPF, Post Office MIS and other small savings schemes, bank fixed deposits, debt funds or any combination of these – depending on an investor’s risk tolerance and tax bracket.

The importance of the tax bracket should be remembered in choosing the constituents of the debt component. PPF (Public Provident Fund) scheme is available at post offices and banks. It allows an investment of a minimum of Rs 500 upto a maximum of Rs 1 Lakh per year. The entire investment is tax free under Section 80(C) of the Income Tax act. The dividends (around 8.5% per annum) are also tax free. For small investors, it makes sense to utilise the PPF avenue to the limit. The holding period is 15 years – which allows compound interest to work its miracle. Part withdrawals are permitted after 5 years. Investment can be extended beyond 15 years.

Interest on Post Office small savings schemes (7-8% per annum) and bank fixed deposits (8-9% per annum) are taxable. The tax will depend on an individual’s tax bracket. Rs 9000 earned on a Rs 1 Lakh bank fixed deposit will entail a tax of Rs 900/1800/2700 for tax bracket of 10/20/30%. So, the effective return will be 8.1/7.2/6.3% after tax instead of 9%.

For those in the highest tax bracket, and even for others, investment in debt funds – particularly gilt funds – is advisable. Gilt funds mainly invest in government securities, so there is negligible chance of shrinkage in the principle amount invested. Dividends are not taxable in the hands of investors, but the funds pay a dividend tax. Tax is payable at the time of withdrawal and is treated as short-term (for holdings of 1 year or less) or long-term (for holdings beyond 1 year) capital gains tax. Indexation is allowed for long-term capital gains, which can be a great advantage for long period of holding.

Another benefit of a gilt fund over a Post Office/bank fixed deposit is that you can add to or withdraw from your holdings at any time. A couple of gilt funds – IDFC GSF PF regular and Kotak Gilt Investment regular, which gave 12.5% and 14.2% returns over the past 12 months – beat fixed deposit returns comfortably. They may not do so in future, but the Kotak fund has given 10.35% returns since its launch in Dec 1998.

The importance of an asset allocation plan can’t be emphasised more. The most common query received from investors is: “Is this a good time to start buying?” The answer should be provided by the individual investor’s asset allocation plan – not by me!

Investment options in a bear market – a guest post

Both Sensex and Nifty indices have been sliding down in bear markets for the past 13 months. There doesn’t seem to be any signs of a recovery. In fact, the economic situation – both in India and abroad – seem to be heading from bad to worse. This is not the best time for investing in the stock market, because the market can fall much further.

What should investors do? Where can they park their savings and hope to get reasonable returns without undue risk? In this month’s guest post, Nishit discusses a few investment options that can provide decent returns without taking on too much risk.

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With the markets falling continuously, the question uppermost in people’s minds is where to invest their hard earned money? Let us explore a few options.

PPF investment limits have been increased from Rs 70,000 to Rs 1 lakh, and the interest rate has been increased to 8.6%. This is one of the safest options for investors and should be used first before looking at anything else. Next it is tax saving time and IDFC has come with Infrastructure bonds which provide tax saving on an additional Rs 20,000 over and above the 1 lakh cap under Section 80C. These bonds have an interest yield of 9%. If you are in the highest tax bracket you will save additional tax of Rs 6,000. Thus, in the month of December itself, additional avenues to invest Rs 50,000 are possible.

Gilt funds are a good place to be in. In the past 1 month, bond yields have fallen from 8.97% to 8.4%. Bond funds have given a return of 4.5%. Now, this performance will not be repeated every month but one may get an annualized return of about 15% in the next 2 years in gilt funds.

A slightly more sophisticated way of generating money in a falling market is writing call options of the Nifty against your portfolio. For example, Jan 5200 Nifty call is trading at Rs 32. The margin for writing 1 lot is around Rs 20,000. So, for 5 lots one would get an inflow of Rs 7,500 and the margin of 1 lakh would be blocked till Jan 25^th 2012. This is another safe way of generating steady returns in a bear market.

HDFC Top 200 is a very good equity fund where one can continue to do a SIP every month. This fund has yielded a return of 22% over the last 15 years. During this time, several bear and bull markets have come and gone.

The above mentioned are just a few avenues for putting in one’s money as per his or her risk appetite. Also, there is the safe bank fixed deposit giving very good returns for risk-averse investors. My advice for those not needing that cash in a hurry is to lock in the money for next 5 years for returns between 9-10%, depending on the bank.

Also, there is the L&T NCD trading on the NSE which has an expiry of about 7.5 years still and yield is about 10%. The benefit is one gets the interest credited twice to the bank account.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

Investing strategies in inflationary times – a guest post

The business channels and pink papers have been obsessive about high inflation in the Indian economy and the consequent rise in interest rates – and well they should be. The government doesn’t seem too perturbed about the deleterious effect that high inflation causes – not just to GDP growth, but also to the wallets of common citizens.

During such times, savings and investments may be farthest from people’s minds as they struggle to make both ends meet. However, there are some comparatively less risky investment opportunities that smart investors can avail of – and Nishit discusses them in this month’s guest post.

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Inflation is rising, cost of loan repayments (EMIs) is going up and jobs are getting lost. How does a common man deal with such a situation?

Government bond yields have almost reached 9%. This means interest rates may rise further in the times to come. EMIs may go up if the RBI hikes the Repo rate, which is currently at 8.5%. In the case of loans, it is best to pre-pay some amount rather than letting the tenure increase. Many people will not get a tenure extension if their tenure has reached the maximum limit of about 25 years.

This is a good time to lock in your savings in high yield fixed investments. Non Convertible Debentures of L&T Finance gives an yield of about 10%. Other fixed income investments like Bank FDs should be utilized to avail of high interest rates. A SIP can be started in a Gilt fund. The interest rate cycle is about to peak soon and Gilt funds are likely to give good returns.

The recently increased limit in PPF investments from Rs 70,000 to Rs 1 lakh, and the higher rate of PPF return of 8.6% is a wonderful opportunity and should be made use of by small investors.

The markets are headed downwards. This scenario is likely to remain till interest rates start moving down. At every decline to key support levels, one can add blue chip shares to the portfolio keeping a 5 years horizon in mind. Supports for the Nifty are at 4700, 4300 and 3700.

Gold as an investment can be looked at only when the previous high of US $1900 per oz is taken out, or near the support level of US $1600 per oz.

For astute investors, cash is king. In a slow GDP growth environment, if one is willing to put down cash then real estate as well as automobiles may be available at good discounts. Plummeting car sales indicate that good cars may soon get sold at discounts just to clear off the inventory and keep the assembly lines working.

This is a great time for an investor to build an entire new portfolio. The portfolio should comprise of fixed income instruments, stocks, commodities and real estate. A proper balance of allocation to these assets will generate wealth going forward.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

A good time to feel ‘Gilt’y – a guest post

The stock market is in a strong bear grip. Even blue-chip stocks are feeling the heat and sliding down at the first hint of trouble. Mid-cap and small-cap stocks have been hit hard.

What can small investors do to protect their capital and get decent returns? In this month’s guest post, Nishit suggests that investors take a look at Gilt funds.

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Last month, the RBI hiked interest rates for the 11^th time since March 2010. The Repo Rate is now 8%. When will the RBI signal a pause?

The Repo rate is the rate at which the RBI provides short-term loans to banks. At 8%, it is about 1% below the peak which it achieved three years back. The hike in interest rates by about 3.25% has put pressure on interest rate sensitive sectors like Banks, Automobiles and Real Estate.

It’s a classical economist’s dilemma. If you hike interest rates you lower inflation but sacrifice growth. So, do you want high GDP figures or lower inflation? There is no correct answer. It has to be a mix of both.

The IIP numbers are high and so are the inflation figures. The latest Inflation number was a bit lower than the previous month, but continues to be high. Expect one more round of rate hike in September. The 1 year T-Bill is already quoting at 8.47%.

How do we play this rate hike in our favour? It is time to buy some Government Security (Gilt) funds. This is a time to very easily lock in about 20-25% returns over the next 12-18 months. This is based on the following factors: a) The government will eventually end the rate hike cycle starting with a period of pause and then a gradual reduction in interest rates; b) The 10 year bond yield will drop by about 200-300 basis points (2-3%) over a period of time.

Government Securities are freely traded in the Debt Market. A 10 year G-Sec having a face value of Rs 100 gives a yield of about 9%. After, say 12 months, the yield goes to 6%. The traded price of each bond goes up from Rs 100 to Rs 150, an increase of 50%. This is the optimistic best price scenario. Looking at entry and exit it is safe to expect about a 25% gain.

If we visit www.valueresearcholine.com, and do a search for Birla Sunlife Government Securities Fund, its best annual performance was from May 2008 to May 2009 when its yield was almost 26%. If we co-relate with the chart above, in June 2006, the Repo rate was 8% which went up to 9% before being brought down to 4.75% in April 2009. So, a net reduction of 3.25 % in the Repo rate was good enough to give the above returns.

Strategy:

Should we wait for further rate hikes before investing? It is not possible to always time the markets, so allocating about 50% of the investible funds now and rest after the September RBI policy announcement may be a prudent course of action.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)