What makes Ajit Dayal a buyer of Indian stocks are a few fairly simple assumptions and facts:

The Indian stock market has done well over the past six years. After some semblance of control over the outbreak of SARS, global investors began looking to invest in more “risky” places. In the past 6 years, the BSE-30 Index has given a +228% return in US Dollars - with dividends reinvested back in the market (see Graph 1). In comparison, China has given a return of +109% and the MSCI Emerging Markets Index has given a return of +137%. The Indian economy is more balanced than some of the larger emerging market economies. China is very reliant on exports; Russia is dependent on oil exports; and Brazil is dependent on a few commodities and China’s ability to export these processed commodities to the developed world.

India does better than China and emerging markets index
Source: Bloomberg

The Indian economy has been affected by the global slowdown. Some Indian companies had planned their businesses around a booming global environment. That has disappeared. And these companies will have a few tough years as they navigate themselves out of the excess capacity and international adventurism. But there are other companies that are still focusing on the Indian consumer. And their growing needs. The level of the BSE-30 Index in relation to the historical earnings of the BSE 30 Index is now 14x, and the all-time low was 10x in 1998. This compares with the Price-to-Earnings Ratio of 21x. This is the average over a 20 year time period (see Graph 2). Profit margins of companies have been under pressure for the past few months but - given the inherent growth in the Indian economy - revenues will resume their growth again as will profits. Stock markets move on anticipated profits, and this should cause the markets to rise.

Indian stocks are cheap
Source: Bloomberg

But will the market rise immediately? Will it continue its recent rally? In the near term, a lot of this depends on what the foreign investors do. And it also depends on the election results which will not be known till June 3rd. the markets have regained the 10,000 level - its fourth attempt to stay above this level since last November, 2008

Are the charts pointing up?
Source: Bloomberg

A lot of short term concerns are in conflict with long term trends. In the short term, the gloom and doom will win but in the long run, the markets will give patient investors sensible returns.

Gold ETFs hit a new high on Indian bourses on Tuesday even as the equity markets slid further, on lingering disappointment over the Interim Budget.

Even as stocks were deluged with sell orders, the one class of securities that saw buying was the listed gold exchange traded funds (ETFs). While Sensex and Nifty lost 3 per cent, gold ETFs gained over 3.5 per cent in value.

GoldBEES, Benchmark Mutual Fund’s gold ETF touched its life time high of Rs 1,504 on the National Stock Exchange and closed at Rs 1,503 per unit. Relgold (Reliance’s Gold ETF) and Goldshare (UTI MF) too touched new highs at Rs 1,466 and Rs 1,498.50 respectively.

Volumes too were higher on all gold ETF counters. The number of units traded (Gold Benchmark ETF, Kotak Gold ETF, Quantum Gold, UTI Gold ETF and Reliance Gold ETF) were at twice the average volumes recorded last week. Volume in GoldBEES, the most popular of the lot, surged to 52,280 units when the average volume last week was just 24,000 units.

Rupee effect

Higher buying interest in gold ETFs came on the back of spot prices of domestic gold going above Rs15,000/gm. International prices hover at $961 per ounce (a 7-month high). Higher global gold prices, combined with the rupee traversing below the 49 mark to a dollar, helped the surge in domestic gold prices and ETFs.

Higher returns

Incidentally, gold ETFs have been the best performing category of funds over a one year as well as one-month period.

Gold ETFs have delivered a handsome 25 per cent return in one year whereas in the same period, diversified equity funds as a category have seen a value erosion of 49 per cent. Had one invested in Gold ETFs just a month back, they would have got a 14-per cent return; an investment in equity funds during the same period, however, would have delivered a negative return of 1 per cent.

THE Securities and Exchange Board of India (Sebi) has finally made changes in the characteristics of liquid funds that caused considerable heartburn and churn in the October market crash. Sebi has now mandated that liquid fund schemes and plans will, with effect from February 1, 2009, make investment in debt and money market securities with maturity of up to182 days only instead of the current level of one year. With effect from May 01, 2009, securities with maturity of up to 91 days only should be purchased.

The regulator has further said that the nomenclature ‘liquid plus scheme’ should be discontinued since it gives a wrong impression of added liquidity. In another order, Sebi has barred fund houses from offering indicative portfolios and indicative yields in their fixed income (debt) products.

Experts say the changes might bring cheers to savvy investors who park their extra cash in liquid fund schemes. The October 2008 turbulence had caused huge redemptions as a large number of corporates, faced with a credit crunch and in need of working capital, exited fixed maturity plans, liquid and liquid-plus funds. “Fund houses were rolling over their payment obligations to corporate houses. In some cases, some schemes which were supposed to mature in 180 days rolled over for 200 or 250 days, which isn’t the best thing to happen,” said Value Research CEO Dhirendra Kumar.

In another order, Sebi said that the indicative portfolio and yield might be misleading to the investors. “No communication regarding the same in any manner whatsoever, shall be issued by any mutual fund or distributors of its products,” said Sebi. “It is an obvious move as it is against the spirit of law for a MF house to provide indicative portfolio in conjunction to the yield. How can a fund house talk about its portfolio even before raising the sum?” said Kumar.

Sebi further said inter-scheme transfers of securities having maturity up to 365 days and held in other schemes as on February 01, 2009 will be permitted till October 31, 2009.

At the end of 2008, it isn’t an easy task to look ahead and see what stockinvestors should do.

However, there is a simple way to choose one’s investment strategy. I have always firmly believed that the only approach to investing that could possibly be of any use to the retail, non-professional investor would be one that doesn’t have to be fine-tuned according to market conditions.

If you needed to have even a vaguely correct idea of what lies ahead for the financial markets in order to decide which mutual fund to buy, then you’ve failed before you’ve even begun. So here’s a general outline of the investment strategy you should be following in 2009, and indeed in any other year, along with a list of five income and five growth funds with which to implement the strategy.

The first step is not to look at investments but instead at your own life and try and make a liberal estimate of how much of your savings you would need to tap into over the next five to seven years. This would include some sort of an emergency amount, plus predictable big-ticket expenses such as weddings, education, the down payment on a house and such things.

This is the amount you should hold in debt investments which could be anything from PPF to short-term debt mutual funds.

The rest should be in diversified equity mutual funds with a good long-term track record.

Any fresh investments into equity funds should be done gradually and continuously regardless of the state of the markets. Don’t invest in too many funds—four or five is enough diversification.

You’ll have to do a little bit of home work to find funds with a good long-term track record but it’s not difficult. Of course, investments can improve or degrade so these would have to monitored, perhaps, a couple of times a year.

As for insurance, make a liberal estimate of the amount of money your dependents will need if you die soon.

A portfolio is a combination of products and themes. Investors should plan and build the portfolio over a period of time, considering all options.

Over the last few days, there has been a growing consensus on the fact that asset classes are set for a free fall. While equity has been showing intermittent strengths at lower levels, it has been more on account of trading support than investment buying with long-term investors preferring cash or debt. In fact, in the last few months, the fund flow from the high net worth individual community to debt has been on the rise and besides bank deposits, income funds and gold have been the preferred bets.

In such a scenario, investors have to rely on a de-risking model to build a portfolio and reliance on a single instrument or option may not provide the comfort. Investors who prefer mutual funds can look at a combination of products to minimise risk. While the percentage of allocation for each scheme differs based on individual risk-taking ability and tenure of the investment, these options can be considered by a larger segment as portfolio components.

Here are some of those options:

Debt allocation

This has been the preferred option in recent times due to the economic environment. While fixed deposit is a product with assured returns, mutual funds (MFs) don’t offer the comfort of assured returns. However, MFs have a wide range of products ranging from income funds, liquid funds to ultra short-term bond funds for investors looking for a debt option. As they are more tax-efficient and also offer the flexibility of partial withdrawal, these products can be your option besides fixed deposits.
Allocate around 50 percent of your corpus towards these in the current market environment, while your short-term fund needs should be completely in debt.

Balance with risk

An ideal MF portfolio should reflect the risk-taking abilities of the investor and should have a mix of debt, equity, gold and other options that come up from time to time. For instance, the real estate portfolio management service (PMS) or equity PMS are some options that have been launched by mutual fund companies in recent times. As a result, investors should be aware of the changing market needs and should also have the liquidity to take advantage of such opportunities. For instance, while everyone expects the equity markets to test new or October lows in 2009, a smart investor would brace himself for such an event by building his liquid portfolio.

The management of risk is a key component of an ideal portfolio and that could be achieved through a single product or a combination of products, the latter is a better option though. For instance, balanced funds do take care of risk management but to a limited extent and would be an option for small sums. A senior citizen can allocate his corpus between fixed return products and balanced funds for his postretirement fund needs in the early stages of his retirement life. For him, such a combination can fulfil the needs of balancing with a couple of products. It may not be the case for a young investor who has different fund needs with different tenures.

Finally, portfolio creation is a long-term exercise and with respect to equity portfolio, the task extends over a longer period of time. In the case of equity, the approach has to be long-term and has to be a continuous process. For MF investors, there are plenty of products for such an exercise in the form of systematic investment plans (SIPs) and systematic transfer plans (STPs), and such investments can be through a combination of products across sectors.

It goes without saying that the Satyam affair has deepened the pall of gloom over equity mutual funds. Being a leading star of the country’s business firmament, Satyam has been a fixture in many mutual fund portfolios, and justifiably so. In mid-December, when the first inkling of problems at Satyam appeared, the company’s stock price fell sharply. At the time, a number of mutual funds reduced their holdings in Satyam. However, some funds also increased their holdings.

Although this looks like the wrong thing to have done now, that’s just in hindsight. At that time, it was a perfectly legitimate investment decisions either by a mutual fund or by an individual investor. The logic was that Raju’s attempt to take out cash for the Maytas acquisitions had been stymied. The shareholders’ revolt that Raju faced would discourage him from attempting anything similar in the future. The company’s business was intact, its massive cash bank-balance was intact, but its stock price had fallen. That added up to a reasonable case for buying the stock, which a number of mutual funds appeared to have done.

Some days later, it came out that members of Raju family had lost a large chunk of their stake in the company because they had taken loans by mortgaging their shares. As the price had fallen, they had been unable to redeem the mortgage and the lenders had sold off some of the shares. Most investors saw this as positive news. If Rajus were on their way out, then surely this was good news for Satyam. The case for investing in Satyam was actually strong at that point.

It was only on the morning of January 7, when Raju dropped the bombshell, did it become clear that Satyam’s fundamental numbers were cooked-up and no one could really guess how much the shares would worth. On that day, many mutual funds (and other institutional investors) sold their entire Satyam stake. Depending on the price they got, different funds’ NAV took a hit of different magnitude. Since funds’ declare their portfolio only at month end, we don’t know the precise magnitude of the loss.

However, the highest exposure that any diversified fund had to Satyam on December 31 was about 8 per cent. However, the average was just 1.5 per cent. For the entire mutual fund industry, December 31 holdings in Satyam Computers add up to around Rs 670 crore, which is by any estimate an extremely small part of MF investors’ equity holdings.

There’s no way that any investment manager or investment analyst can be blamed for not foreseeing the Satyam debacle. Everything boiled down to trusting Satyam’s accounts. Sure, there are companies in which investors expect such manipulations and those companies are treated accordingly. Mutual funds ignore them and the markets punish them with lower valuations than their published profits suggest. However, if the gap between expectation and reality is as wide as it was in the Satyam’s case, then nothing can be done.

However, as mentioned earlier, mutual fund investors’ losses in Satyam have been quite small. This demonstrates the value of diversification. If you are in non-specific funds that are diversified across sectors, then there are very little chance of serious damage to your portfolio.

It is learnt that Hindalco Industries, the flagship company of the Aditya Birla group, are on the right path even during the time of economic meltdown, all their projects are on track and they are not postponing any of their plans.

It is learnt that Power Grid Corporation of India (PGCIL) is all geared up to get a part of the supplementary USD 3-billion loan the World Bank (WB) will provide to India by July 2009.

Unitech, the realty major, in order to better manage telecom business has decided to merge all of its eight telecom subsidiaries. Each of these subsidiaries has licenses for three to four circles and together they cover all 22 telecom circles in the country.

Reliance Petroleum (RPL) announced on December 25, the commissioning of its refinery in a Special Economic Zone (SEZ) at Jamnagar, Gujarat in India, commencing its crude processing. The secondary processing units are now under synchronization and commissioning. The entire refinery complex is expected to attain full capacity shortly. _ In order to ensure uninterrupted supply of fuel for its safeguarded nuclear power plants, India will acquire up to 50% ownership in uranium mines in Russia, Kazakhstan and a few other countries. Certain new uranium mines are explored in these countries and India is ready to invest in order to acquire ownership in these mines.

Country’s largest public sector trading agency MMTC is entering into partnership with 4th currency futures exchange to pick up to 15% equity in the exchange at an investment of Rs 225 million.

The government has decided to review the PSU`s projects on fortnightly basis as SAIL`s capacity expansion plan to reach 26 million tons steel production by 2010 seems to be a dream due to its slow progress. The Department of Industrial Policy and Promotion (DIPP) in the commerce ministry suggested that the foreign direct investment (FDI) ceiling for the tobacco industry should be reduced from 100 to 74%.

Jaypee Hotels announced that it has received approval from its board of directors for the merger of the company with parent firm Jaiprakash Associates. 

Nava Bharat Ventures plans to buyback a minimum of 735,295 shares of face value Rs 2 each, for an aggregate amount not exceeding Rs 500 million. The buyback will be made at Rs 170 a share, which represents a premium of 42.44% and 42.02% to the closing price on BSE and NSE, respectively, on Dec. 11, 2008.

Mauritius-based Swiss Finance Corporation has increased its stake in Amtek Auto to over 8% following acquisition of shares from the open market. 

Life Insurance Corporation of India (LIC) has increased its stake in HDFC Bank to over 5% following acquisition of shares from the open market. LIC purchased 158,519 shares from the open market hiking its stake in the company to 5.01%.

US-based Zydus Pharmaceuticals, a subsidiary of Cadila Healthcare, has received final approval from the US Food and Drug Administration (USFDA) to market Acetazolamide capsules, in the strength of 500 mg.

Vardhman Textiles on Wednesday, December 24 said its board approved buyback of foreign currency convertible bonds (FCCBs) that were issued in 2006, subject to the approval of the Reserve Bank of India (RBI) and other terms and conditions governing the buy-back of FCCBs.

GVK Oil & Gas, a wholly owned subsidiary of GVK Power & Infrastructure, has signed a production sharing contract with the ministry of petroleum and natural gas, government of India on Dec. 22, 2008. 

Deciding to invest in a sector may not be challenging but choosing the sector definitely is.

One of the ways to pick a sector is to look at its medium-term prospects. Though sector funds are riskier than diversified funds, invest in a sector which has a good potential in the near term. Hence, the investment tenure too should be a minimum of 2-3 years like diversified funds.

While choosing a sector, avoid investing into a sector which has seen a sharp rise in a short span of time. Though retail investors always tend to chase sectors which are in the news or companies which have seen a sharp upside, such a strategy will only increase the waiting period for investors.

For instance, the flood of IPOs from the construction sector had taken the share prices of many construction and realty sector stocks to dizzying heights, a year ago. Now the sector heads the list of non-performance ones and those who didn’t book profits earlier, have seen huge erosion in value. As a result, investors who made their investment at higher levels will have to wait for a good 3-5 years to see good returns. In fact, one of the big risks associated with a sector is that the performance tends to get cyclical and the investor should have the ability to hold on to his investment.

Besides keeping away from hot sectors, investors would also be better off if they choose sectors which are more dependent on domestic consumers. For instance, sectors like FMCG, retail, services, infrastructure and media are a reflection of the economy though policy changes relating to the sector could have some short-term implications. Infrastructure, for instance, is a typical example which offers good growth potential in the long term.

If there ever was a time when the government needed to overreact to a situation, it is now. The drying up of global liquidity after the bankruptcy of Lehman Brothers has hit financial markets across the board in India with astounding ferocity and speed.

And with that, market uncertainty has spiked to unprecedented levels; rarely have we seen the stock market change direction by 500 points or more in a day, these many number of times, in this short a time. In this environment of hyper-uncertainty, traders, investors and businesses are likely to have overreacted and prices of equity, bonds, foreign exchange have probably overshot their fair valuations.

To increase rupee liquidity cutting CRR to 5 per cent and SLR to 20 per cent, making oil and fertiliser bonds SLR-eligible, increasing the range of repo-eligible assets and even providing insurance against counterparty risk in interbank transactions is the key. To raise dollar liquidity in a predictable manner, setting up a weekly dollar-swap facility against rupee-denominated assets and investing part of the foreign exchange reserves in one-year deposits in foreign branches of Indian banks is the way to go.

Rajiv Mundra has a keen eye for the markets and he has the following post on his Google Group.

Details here Buy & go to sleep for 4-5 years!