Two big things to keep in mind while investing in company fixed deposits

by Manshu on May 17, 2012

in Investments

Rakesh had a comment on what parameters should be checked before investing in a company’s fixed deposit, and when investing in fixed income there are two big things that you should keep in mind, and I’m going to talk about them first before getting down to specific parameters in a subsequent post.

Investing too much money in just one instrument brings risk without reward

Unlike equity, there is no disproportionate reward for concentrating all your fixed income investments in one instrument.

What this means is that if you had Rs. 1 lakh today, and you invested all of that in a stock with the hopes that the stock triples in a year you could go broke but you could also get rich because there is no limit to how high a stock can go.

But the same thing doesn’t apply to fixed deposits. If a smaller, riskier company is offering you 13% per year, and a bigger more stable company is offering you 10%, when you put all your money at 13%, your upside is just that 3% extra and your potential downside is simply too much because if the company goes bust then you stand to lose not only the extra interest but the principal as well.

I first came across this idea in 2009 when GM defaulted and a lot of its bondholders who had invested their life savings in GM bonds were left holding worthless paper.

I think this is a very important thing to keep in mind while investing in any fixed income instrument whether a company fixed deposit or otherwise.

You don’t know what you don’t know

Manappuram is one company that recently came out with NCDs and their stock along with Muthoot’s stock (which also issued NCDs) recently tumbled when news broke out that RBI was putting some restrictions on gold loans.

This news itself doesn’t threaten the NCDs issued by these companies but it’s impossible for a retail investor to know about these kind of things before they happen and take precautionary measure. There are simply far too many things that you don’t know and only when the event occurs you realize that such a risk even existed.

This is just one example, but this can happen to any company, and just last week news broke out that TV-18′s losses widened which is another company that issued NCDs recently.  While that was not as out of the blue as the RBI announcement, I think a lot of retail investors would have been surprised by it.

The two things I wrote about above are nothing new and I’ve written about them earlier as well in different contexts but if you think about them specifically with respect to investing in company fixed deposits, the big lesson to me is that you should always be humble about what you don’t know and appreciate that there is a big risk lurking somewhere and the best way to deal with that risk is to play it safe and spread your money around so that if something does go wrong it doesn’t wipe you off completely for what will be a few extra percentage points of interest.

In a following post I will write about the specific parameters that can help you build a negative list of NCDs that you shouldn’t invest in.


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How can the government carry out disinvestment through ETFs?

by Manshu on May 16, 2012

in Economy

I read an interesting article about the possibility of the government taking the ETF route to carry out disinvestment, and that can be a novel way to carry out disinvestment because the government did pathetically last year as far as disinvestment is concerned and things haven’t improved much since that time so it won’t be surprising if they aren’t able to do much with disinvestment this year as well.

A bit of creative thinking will help in these times and an ETF to disinvest stocks could prove very helpful in meeting the disinvestment target. This idea is based on Tracker Fund of Hong Kong fund  and they have already shown that the model works.

The way this will work is that the government will take a bunch of its listed stocks, and create a basket of shares which they will then sell to other ETF sponsors like Goldman Sachs.

They need to take companies that are already listed like Coal India because if those companies are to be part of an ETF then people need to see what the value of one unit of that ETF will be and that’s only possible if you have some frame of reference which in this case will be a listed stock.

The sponsor will then take those shares and create smaller units with them which can be bought and sold by Authorized Participants, and those APs will in turn buy and sell those shares to the general public.

People will then be able to trade the ETFs in the market and instead of buying a single stock, they can get an ETF with a bunch of PSUs.

The utility of the ETF will depend on the constituents and how low cost it can be and I’m skeptical that this will really be useful to an investor in the sense that it helps them fill a gap in their portfolio that they otherwise would have had.

Having said that, I’m fairly certain that this will do better than individual PSU stock sales because of the marketing muscle of the fund company that will combine with the buzz that’s always created when a PSU is disinvested and the novelty of this method. That alone should be enough to give enough legs to this scheme to succeed and that will be good for our cash strapped government.


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Part 4: How should beginners approach investing in the stock market?

by Manshu on May 15, 2012

in Investments

In part 1 of this series I wrote about the evolution of an investor to either a trader or a long term investor, and said that I favor long term investing to short term trading.

Then in the second part I wrote about the implicit assumption that a long term investor makes which is over a very long period of time the market will move upwards, and then also spoke about the nature of a share or stock. That nature I said was that a stock is a representation of the earnings of a company, and looking at it that way helps you stomach the volatility that exists in the market and deal with the daily ups and downs.

In the third part I wrote about regular investing, calibrating those investments and three big ideas that drive that type of investment. First one was my expectation that markets will edge higher over a time period of 3 – 5 years, second one was that markets don’t move in a linear fashion and a lot of the gains that have come in the past have come from small time periods that have surprised a lot of people so you don’t want to get out of markets completely, and finally I said that while timing is not be possible, you can vary how much money you put in the market and take advantage of falls.

I ended that post saying that I’ll deal with what are some of the instruments that you can use to execute this strategy, and that’s what I’m going to write about in this post.

ELSS Tax Saving Mutual Fund

If you want to invest in equities then ELSS funds are a great way to get started. They are one of the best options in the 80C limit since they have the lowest lock in period, and by investing the equity portion of your portfolio in ELSS, you ensure that you get some tax benefit right away which can be pretty significant if you are in the 30% bracket and the advent of some great tax free listed bonds also means that even if you don’t invest in bonds with 80C tax benefits you can still get good yields so you can keep 80C for equities.

Here is a list of good ELSS tax saving mutual funds that I updated late last year and this gives some good options that you can select one or two from.

I think ELSS funds should be on top of your list if you’re looking to get started with investing in shares.

Balanced Mutual Funds

Balanced funds may appear an odd selection when you first think about them because most of them invest about 35% of their assets in debt products, but past performance has shown that balanced funds have given returns comparable to good diversified equity funds, and that stems from the fact that the debt portion of it protects you from the sharp downturns that Indian investors have had to face many times during the last two decades, and there’s hardly any reason why that would stop from happening in the future.

Here is a list of some good balanced funds that you can choose from.

Good Diversified Funds

Hemant has a great article on some of the best diversified funds with some great comments that can be used to select a couple of diversified mutual funds to add to the balanced funds in the list above.

Nifty Index Funds

Internationally, index funds have done a lot better than active funds, I believe this is not true for India, and I’ve highlighted the reasons in this post (also read instructive disagreeing comments from Nitin).

Having said that, I feel if you are going to construct an equity portfolio, at least a small part of that should be a low cost index fund based on a large cap index like the Nifty or Sensex. I say that because costs eat into returns and index funds are lower cost (thought not as low as American funds) when compared with active funds, and have also performed decently in the past and give you the peace of mind that the fund manager won’t be screwing around with your money. The reason to stick to the big indices is that the Indian market is not very deep and volatility becomes quite high when you start moving towards the smaller caps.

These are some options from which you can consider choosing from, and as to the question of how much money you should invest – I think a little less than you are comfortable with is a good way to start.

I say that because it is hard for people to come to terms with how violently and quickly the market can fall, and how difficult it is to not panic and sell when you own funds that have gone down 15% or 20% in a month or two. Getting into the market with lower amounts will ensure that you’re able to deal with this volatility and get a grasp on how you feel about the market and feel more confident going in with bigger sums later on.

If you’re starting off then it is likely that you are in your twenties and still have a good 30 – 40 years of investing ahead of you, don’t rush to put all in and then later find out that you weren’t ready to risk that much money. More than losing the money, it will turn you away from the market completely and that means you lose out on what is potentially a great opportunity to steadily grow your money in years to come.

This is the last post of this series, and I must admit this was a lot harder than I thought it will be and took a lot longer than I thought it would take, so if you found it useful please do forward the links to your friends, and as always, all comments are welcome!

 


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GS Nifty Junior BeES Review

by Manshu on May 14, 2012

in Investments

The Goldman Sachs Nifty Junior BeES is an index ETF that aims to track the CNX Nifty Junior Index.

The CNX Nifty Junior Index is an index that comprises of the 50 most liquid stocks after the Nifty, and as a result is a mid cap index.

The GS Nifty Junior BeES is an index ETF and you normally associate low costs with index ETFs because there is no active management involved, however at a 1% annualized expense ratio – this ETF is not low cost and I’m not sure why they charge 1% because they charge just half of that for their Nifty ETF and this product is no different from that.

With just over Rs. 85 crores in assets, this fund is not very big either and given that it’s been around since 2003, it shows that it hasn’t been able to attract the attention of investors quite like the other funds.

Deepika, who originally commented about this ETF wrote that this gives a feeler of safe and attractive returns, and if you look at the chart below which shows the returns of the Nifty BeES along with Junior BeES you will see why she says that.

Nifty BeES versus Junior Nifty BeES

Nifty BeES versus Junior Nifty BeES

The Junior index has run up quite a bit this year and that’s probably the reason behind the interest in the index. A few months ago I did a post on the leading Indian indices and their performance details, and that post has 10 year returns data as well which shows that the Junior index did better than the Nifty in the 10 year period but the Sensex did better than both in the 10 year period so you can’t really conclusively say that the mid caps are better than large caps.

As far as returns are concerned you see that the Nifty and Nifty Junior are quite close and it’s impossible to say which will do better in the next 5 or 10 year period.

As far as safety is concerned, I think the calendar year returns chart for both the funds tells a great story. Here is the chart with data from Moneycontrol.

Calendar Year Returns Nifty BeEs and Junior BeES

Calendar Year Returns Nifty BeEs and Junior BeES

As you can see, Junior BeES fell a lot more than Nifty BeES during bad years, and rose a lot more than it during the good years.

This is what you’d expect of an ETF comprised of relatively smaller cap stocks and it paints an instructive picture.

While the returns in the past may be similar or even better, they came with a higher volatility and you must have been willing and able to stomach that.

Personally, I’d favor the Nifty ETF instead of the Nifty Junior ETF because of the lower cost, lower volatility and higher assets under management.

This post is from the Suggest a Topic page.


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