Burgeoning inflation. A term which is now as much part of the list of concerns of the biggest corporations as it is of the list of worries of the ordinary individual. Whichever way one looks at it, the impact is clearly deep and devastating (see chart). And for those shelter-seekers of the markets who have burnt their fingers or are simply untested, it has become the biggest worry: will investment in equity be fruitful? If not, are there investment avenues where the principal amount can at least be protected in these tough times?
Amidst such pessimism and concern, it is appropriate to note what the legendary Warren Buffett, in his 1990 chairman’s letter to shareholders, had written. ?The most common cause of low prices is pessimism- sometimes pervasive, sometimes specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer,? says Buffett. And as seen in the past, it is not just the search for solace that leads one to believe in what the quote implies. The situation is not that bleak as it is seen by many to be. You can invest!
Sift and select
Considering the situation in the markets, there is a need to follow the examine- cull-and-choose format. Advises Tridib Pathak, chief investment officer, Lotus Asset Management Fund, ?Investors must look at companies which have better pricing power. Companies which, if they come under pressure, can pass it on to their consumers.? Some fast-moving consumer goods (FMCG) (see chart) are examples of companies which fall in the category of companies which have better pricing power. Also, one of the best aspects associated with such companies is that they are largely debt-free and even if their input costs rise, they can sustain margins primarily due to brand penetration.
There is also a need for digging into the past. A look at the companies, which became instant favourites in the market and lost their sheen for reasons varied and known, would serve as good indicators for the current decision-making process.
Adds Venkatesh Subramanian, an independent analyst, ?A substantial part of the rally, which continued till December 2007, was brought about by taking into account the embedded value or the sum of the parts valuation in the recommendations. One couldn’t gauge that the rally in stocks was not based on the company’s core business. There is a need to focus on those companies which have grown on their core business and you need to verify that the valuation of such companies is not inclusive of their subsidiaries? businesses (embedded value, SOTP).? He says, ?It is also advisable to look at those companies which don’t have subsidiaries. The reason being, any movement in the stock would bring in clarity as to what has been the contributory factor for the trend.?
It is also necessary to look at companies which are self-dependent in terms of funds requirement, companies which are efficient in generating funds through internal accruals, and the ones which have already put up capital for expansion purposes. And these are the companies which are different from those which are cash starved and resort to means of financing like public issue, FCCB, ADR, GDR, etc. Companies which fall in this category are those which have the ability to utilise internal accruals for expansion purposes. Some of these companies are debt-free. And hence, they can manage to fund their expansions even in tough market situations. Also, it would be prudent and diligent on the investor?s part to take exposure to sectors or companies where valuations are attractive. Explains Pathak, ?Valuations in banking, media, capital goods and engineering (on a selective basis) have corrected and have become attractive. And we believe that these sectors would stand the investors in good stead.? Even though interest rates have risen on a periodic basis, the banking sector has maintained a steady net interest margin of 3%, which is a healthy margin. Also, the media sector, due to its better pricing power, seems an attractive bet, says Pathak.
Beyond equity
Although equity as an asset class has always been the biggest hedge against inflation, given the current uncertainty, you might not have the appetite to take those risks. After all, seeing the market gyrate can be funny on the belly. Obviously, the same reasoning that was applied to equity investing applies while investing in equity mutual funds too. Selecting funds with a defensive bias would be a good idea, reckon most experts. And there have been a plethora of funds that have not fallen to the extent that the market benchmark has. There are a number of such funds and they can be located by using search engines on specialised mutual fund websites.
Here, one must add that equity linked saving schemes (ELSS) offer a good alternative. For the long-term investor, there will be returns, and these can be accentuated by the fact that ELSS schemes offer tax savings. So even if the returns fall, in a falling market, you have gains by way of tax savings. Little wonder then that ELSS schemes are now amongst the most favoured by investors. Getting into the details of ELSS, it would be worthwhile to select funds with low entry loads — they can vary between no load to 2.5%.
?Choosing an index-based ELSS would be ideal,? says a fund manager. ?We all know that the current turmoil will ease. May be not now, but at least in the next year and a half, at the most. So if you have a three-year time frame, buying into an index-based ELSS is the best option. And a systematic investment plan (SIP) is even better, since you can keep getting tax benefits every year and also have the advantage of cost averaging,? he adds. ?Plus, if one really believes in India, then the index will provide a return equal to the nominal GDP growth. So, a 15% plus, pre-tax return over three years is what one can expect from such funds,? he concludes.
Fixed income option
At the moment, placing your funds in a fixed deposit is a clear invitation to wealth erosion. Even though rates have been raised recently, with 11%-plus inflation and taxation, this avenue is clearly not worth it. However, it is not that you don?t have a choice.
Says Devendra Nevgi, head, fixed income, Quantum Mutual Fund, ?In mutual funds, one can take exposure in floating rate instruments or fixed maturity plans (FMPs)(see chart for performance). FMPs can be taken for a lock-in period of one to one-and-half years. However, one must closely assess the portfolio before investing in FMPs. One should avoid the funds that had taken exposure in real estate and broking companies.?
And in terms of gross pre-tax returns for FMPs, you can expect 10-10.5% and also can get double taxation benefit. In case of floating rate instruments (bonds), you can take advantage of the higher interest rates, which in the short-term are relatively high due to the liquidity tightening measures taken by the RBI. It must be noted that lower the tenure of the instrument, higher is the possibility of not losing out on the yield. Also, because of uncertainty in the trend of interest rates, it is sensible to remain invested in a short-term bond. The reason being, once invested in a long-term bond, you get locked-in and wouldn?t able to take advantage of the rise in interest rates. It is estimated that in these instruments you can expect a return of 8-8.5%.
Dedicating a portion of your investments to gold would be lucrative. Gold has always been stated as the best inflation buster for investors the world over. The market can meet the demand for gold as it is virtually indestructible and hence all the gold which has been mined till date still exists.
Says Dharmesh Shah, a bullion trader, ?It is always recommended that at least 5% of your portfolio must be invested in gold in the form of government certified gold coins or gold bars.? Gold exchange traded funds (ETF) is another good investment avenue. Gold ETFs are fairly new in India, with the first gold ETF launched in February 2007. And, since then, they have been providing stellar returns.
The top schemes have clocked 6% plus returns in the past month. (the Sensex has given ?13%). In this market, they are the ones that beat all numbers hands down. And the best part is that returns for these schemes tend to be very close, so investors should look for funds with low loads.
Although equities and equity-linked investments are the only investment vehicles able to beat inflation, concentrating your allocation in dire times to one investment avenue is certainly not advisable. It would look tempting to cash out of equities and have an 80% gold portfolio, or simply buy out a lot of real estate. But hold on. The characteristic of uncertain times is that they are uncertain and therefore the need for diversification in assets that have the fundamental characteristic of beating inflation is paramount.
More important is the need to remain alert, as these times do offer bargains like never before. The wise words of Baron Philippe Rothschild comes to the fore, when this wealthy banker once exclaimed that the time to buy was ?when there is blood in the streets.? And there is blood on the streets now.
Rajesh Naidu of The Financial Express gives you the perspective of market veterans on where to invest given inflationary conditions
Bharat Shah
CEO & managing partner, ASK Investment Managers
Where would you ask investors to invest right now to save their wealth from erosion due to various factors like inflation, interest rates, etc?
I would recommend greater allocation to equity at this juncture. You need to take into account the fact that share prices have become cheaper, attractive in the current markets situation. An important point I would like to draw the investors? attention to is the conspicuous presence of sentiments, which are pessimistic and alluringly cheaper price. And this high pessimism and cheap prices is one of the best combinations that one could aim at for this kind of situation in the markets. As regards inflation, a paramount strategy, which investors need to follow, is investing in equity, which for a long period in the markets has proven to be the best hedge against inflation.
Also, investors need to comprehend the basic difference between investing in equity and other investment avenues. Firstly, equity as an asset class is ?growth-driven?, while other assets are ?yield-driven.? I would also recommend an exposure to real estate, which provides a proper insulation against inflation. In fact, the combination of ?equity? and ?real estate? is the one that investors need to aim for, considering the current markets situation. In sum, I must say that investors need to consider growth assets, which provide good returns. I would remain positive on equity and real estate and more precisely in that order.
Which are the sectors you recommend to investors?
I should like to say investors must keep their focus on those sectors, which have suffered immense destruction. These are the sectors, which would emerge as good investment options. Sectors like banking, capital goods, fast moving consumer goods (FMCG), among others. These are the sectors, which have suffered hugely in the plunge of the markets. Investors should also need to take into account of those sectors, which are sensitive to interest rates.
Parag Parikh
Parag Parikh Financial Advisory Services
Where would you ask investors to invest right now to save their wealth from erosion due to various factors like inflation, interest rates?
It is a phenomenon, which is accepted universally that the best hedge against inflation is equity investment. Even though it is widely known, investors must note that it is a crystal clear strategy. Investors don?t need to worry about the situation in the markets. It is a blunder to look at the movements of the markets and invest on hearsay and the movements of the markets. An important thing I would recommend to investors is to remain invested in their stocks. I don?t want to look at the movements of the markets. As regards my preferences in investments, I would say any stock, which is beaten down and has good, attractive valuations, would be a good investment option for me.
At this juncture in the markets which is the one development that you would say investors should be wary of? Do you see the situation improving?
An important thing to I have been observing in the markets is the recommendation, which are given in the markets and the adoption of an exactly opposite position of the professionals, entities who made the recommendation. It is like one professional recommending a ?buy? on a stock and that professional taking a ?sell?? position. This practice is really bad for the markets and Sebi and investors alike should take note of such recommendations. A crucial thing that investors need to be aware of is the trust in their appropriately-researched stocks. With regard to situation in the markets, it is like knowing the fact that you are going to die but you don?t know when. I would say that prediction about market movements cannot be done and those who claim to do so feign it.
Bharat Dalal
Fund manager, Dawnay Day AV Financial Services
Where would you ask investors to invest right now to save their wealth from erosion due to various factors like inflation, interest rates?
I would like investors to focus on these avenues:
Mutual funds ? It would be prudent to stay away from instruments which are rate sensitive. Thus debt funds like gilt funds, income funds are to be avoided. Small allocation to short term FMPs and large allocation to liquid funds can be made. Small allocation to fixed deposits (around 24 months) can be made after the credit policy is announced. This strategy would ensure liquidity and also give reasonable earnings.
Some allocation can be made to defensive sector funds and SIP for 3-5 years can be done. Some allocation can also be done for international theme funds whose country?s currency is relatively stronger
Gold ? Increased allocation can be considered in the form of Pure Gold and / or Gold Traded Funds. Gold is good hedge against inflation, credit and financial risks and also against currency devaluation.
Equities ? Inflation is inversely related to equities. When inflation goes beyond a level it results in equity value erosion. Hence, equities in general can be trimmed considerably. Sector-wise, defensive ones like FMCG, IT and pharma should be given more weightage and interest rate sensitive ones like auto, banking, and real estate must be avoided.
Real estate- Presently, this asset class is one of the least favoured. But allocation can be considered when a bargain opportunity knocks after sometime. In such an event, factors like location, development, etc would be key for decision making
Rahul Jain of The Financial Express, in an interaction with fixed income heads, discusses the options available in the debt market in a high interest rate environment
Devendra Nevgi
Head Fixed income, Quantum Mutual Fund
Considering high interest rates and inflation, how should one go about investing fixed income?
One can prefer the shorter end of the yield curve with duration of one to two years. Short term interest rates are ideally controlled by RBI. We see interest rates continue to tighten in the short-term due to high inflation. So lower the duration lower would be the risk of interest rise in the shorter term and vice versa.
In mutual funds one can take exposure in floating rate instruments or fixed maturity plans (FMPs). FMPs can be taken for a lock-in period of one to one and half year. However, one must closely assess the portfolio before investing in FMPs.
One should avoid the funds that had taken exposure in real estate and broking companies. In terms of gross pre-tax returns, investors can expect 10-10.5% and also can get double taxation benefit. In case of floating rate instruments, one can take the benefit of higher interest rates in the short-term due to liquidity tightening.
Returns of 8-8.5% in liquid instruments can be expected.
In general what would you advice investors?
Investors should stick to traditional instruments like equity and fixed income. Now gold has become a good option. Gold has given the highest return in the asset class. Gold is closely linked with the dollar and oil. With rise in oil, gold is seeing a simultaneous rise. It also acts as a natural hedge. Investment for a period of two years can be taken in gold.
When do you see the situation improving in the market?
Inflation would be on the higher side due to a higher base effect. In October 2007 the average inflation was around 4%. And this year due to the base effect, the inflation will remain at and in double-digit for the next two to three months. From equity market perspective the sentiment is bad due to reasons like higher inflation, interest rates, and global issues. Currently however, valuations are reasonably attractive. In this situation systematic investment plan is the best route for investment.
Amitabh Mohanty
Head Fixed Income, Reliance AMC
Considering high inflation and interest rates, tell us your views on investing in fixed income?
The next three to six months would be tough as far as high interest rates are concerned. The increasing rates are due to ballooning inflation. Further, interest rate should peak out in the next three to six months and would come down thereafter. The opportunity for investors is in investing FMPs for a lock-in period of one, two or three years. It would give good returns of around 10% annually. It is a very good level to lock in the returns over a period. As the inflation would cool off after six months, the real interest would become favourable, considering inflation-adjusted returns. Other options investors can look at in fixed income are income funds and government securities after three months.
