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.

The Draft Report of the Committee on Financial Sector Reforms headed by Professor Raghuram Rajan was issued for comment in April 2008. Among the proposals that the high-level committee made was the introduction of domestic hedge funds. The committee feels that, “The presence of hedge funds would induce greater competitive pressure for other regulated fund management channels such as mutual funds.”

This week’s article discusses the benefits of introducing hedge funds in the Indian market. It shows how hedge funds could improve asset price efficiency. Besides, such funds, by virtue of their diverse investment styles, could provide investors an opportunity to enhance their risk-adjusted portfolio returns.

Of different genreSuppose a long-only (mutual fund) manager and a hedge fund manager both have a negative view on SBI, a positive view on HDFC Bank and a neutral view on ITC.

Long-only active managers will buy ITC in the same weight as their benchmark index, may overweight HDFC Bank and may not take any exposure in SBI. There is a reason for such a strategy. Active managers strive to beat their benchmark index. But they do not take too many active bets, lest their bets go wrong. Often, active funds tail the benchmark index with few active bets. Importantly, such managers cannot short-sell to take advantage of their negative view on a stock.

Hedge fund managers’ do not suffer from such constraint. In the above example, the hedge fund manager may overweight HDFC Bank, short-sell SBI and not take any exposure in ITC.

Better still, to neutralise any market risk, the hedge fund manager may buy HDFC Bank and short-sell SBI in such a way that the market risk in HDFC Bank is offset by short-selling SBI. Often, neutralising market risk on a portfolio would mean short-selling Nifty futures.

Exploiting price inefficiency

Hedge funds identify mispriced assets and exploit any price inefficiency. One way to do this is to employ statistical arbitrage.

Suppose a hedge fund manager finds that combination of one share of HDFC Bank and two short shares of SBI (1HDFC – 2SBI) has a stable statistical distribution. If the “spread” wanders far away from its mean, a hedge fund manager would set-up this strategy with a view that the “spread” will tighten. Such relative-value strategies can help arbitrate away asset price inefficiencies in a “normal” market.

Besides, hedge funds employ strategies to arbitrage price differentials between the derivatives and the spot market. Suppose a stock is trading at Rs 1,480 in the spot market. Assume that the hedge fund manager, based on her proprietary model, believes that the futures price should be only Rs 1,470 against its current market price of Rs 1,510.

The fund manager will short the futures contract and simultaneously buy the stock in the spot market. The trade will be profitable as long as difference between the spot price and the futures price is less than Rs 40.

As more hedge funds exploit such price differentials, disconnect between the spot and derivative markets could gradually reduce. And that could attract long-term hedgers to the market.

Higher risk-adjusted returns

Hedge funds create value for investors through their diverse investment styles. Here are some examples.

Relative-value strategies such as fixed-income arbitrage and market-neutral style strive to back-out beta exposure and provide alpha returns. Such strategies typically carry lower volatility than government bonds but generate higher returns. They, hence, act as returns-enhancers when combined with a bond portfolio.

The long-short investment style (such as 130 per cent long position and 30 per cent short position in equity) is a high-risk high-return strategy. The volatility of this strategy is lower than that of the traditional equity strategy. This strategy, hence, acts as return-enhancers when combined with equity portfolios.

The managed-futures investment style primarily takes exposure in commodity futures. This style acts as a risk-diversifier for an equity portfolio.

Of course, there are risks with such investments. Hedge funds typically employ high leverage. This causes a systemic risk in the event a fund folds because of high drawdowns. Besides, monitoring such managers is important because many of them may charge alpha fees for beta exposure.

It is not surprising that the committee has recommended that hedge fund investments be offered only to those who can invest Rs 1 and above. A similar such rule exists in the US.

Conclusion

It is important to understand that arbitraging price inefficiencies does not mean that hedge funds will prevent formation of market crashes or asset price bubbles. Hedge fund managers can be as irrational as the professional long-only managers and investors.

Yet, the introduction of hedge funds will be a welcome move to the Indian markets for two reasons — such funds can provide higher risk-adjusted returns for investors and can facilitate better asset price efficiency.

(The author is an investment strategist. He can be reached at enhancek@gmail.com)

With equity markets descending from their record highs, several investors want to know if this is the right time to invest in equities. More importantly, they would like to know if markets have bottomed out.

As regards the former, it can be safely stated that the markets are attractively poised in terms of valuations. So does that mean investors across the board should get invested in equities? Not really. Only investors who can take on the risk associated with an equity investment should consider getting invested. Also, investors should be willing to stay invested for the long haul (at least 3-5 years).

Then again, investors must honestly evaluate if they are competent enough to directly invest in equities. If not, they would be better off opting for the mutual funds route and thus bank on the expertise of the fund manager and the fund house. As for the question about markets having bottomed out, to be honest, we are not equipped to predict when that will happen.

However, for serious long-term investors, we believe that is an irrelevant parameter.

Some equity investors may think it is wise to follow investment patterns of expert fund managers. But there are many reasons why this may turn out to be a bad idea, says Nikhil Walavalkar

THOSE who invest in shares use different methods to pick stocks. These methods vary greatly. A large number of investors rely on tips from friends and insiders, some pore over balance sheets of companies, while others scrutinise share price charts for a ‘head and shoulder’ pattern.

But there is yet another category of investors who try to be clever and mirror the investment actions of mutual funds. After all, mutual funds have all the expertise, they have access to extensive research and they hold discussions with senior management of companies.

Hitching a free ride like this may provide the investor with a feeling that he is saving time, money and resources. But there are many reasons why this may turn out to be a bad idea. There is no guarantee that a scheme that has beaten all equity indices may show the same results in the future.

Stock picking involves subjectivity. Investors have to track the fund management team of the fund house at a time when fund managers change jobs with a regularity. Though, it is easy to track the moves of fund managers, it is difficult to track research professionals sitting at various fund houses that serve as the backbone of the stock picking process.

The monthly fund factsheet does not tell investors at what price a particular stock was bought and the price target for the stock. There are instances of stocks running up 25-30% in a matter of days as the news of a fund manager buying a counter enters the market. This is especially true in the case of mid- and small-cap stocks where there is a possibility of higher returns compared to broad markets. In such circumstances, there is a risk of buying at a higher price.

Though, fund houses are not involved in heavy trading and quick profit booking, there are cases where the price move makes it a case for profit booking. This is a normal phenomenon that holds good in the case of schemes that are actively managed for high returns.

Exit cannot be timed by an individual investor as the scheme’s sale details come out only by the end of the month. In the mean time, insiders would have exited bringing the stock under pressure. In the mid-cap and small-cap space, there are cases when investors have bought stocks at a higher price and sold at a lower price while tracking mutual funds. Mirroring the portfolio of a mutual fund scheme is something that leaves the investors with significantly h i g h e r costs compared to the costs incurred by the fund.

Given the comparatively small corpus that an average individual investor has and the average fund holding of more than 30 stocks, the costs do not justify the activity. Instead it makes sense to invest the money in a mutual fund. If you already are a mutual fund investor, there is no point investing in the stocks that are there in the scheme portfolio. It rather makes sense to pick up stocks that are not picked by a mutual fund scheme. Investors would be better off picking such stocks that are typically expected to get supernormal returns but are high-risk small-cap or where there is low floating stock and a fund house cannot find a suitable entry and exit.

Source: Economic Times

In the last fortnight we witnessed the RBI increase the Repo Rate by 50 basis points to 9.0 per cent and the Cash Reserve Ratio (CRR) by 25 basis points which also now stand at 9.0 per cent. Although the market was expecting a rate hike, the magnitude of the hike was greater than anticipated. 

Inflation continued to surge; it touched a 13 year high of 12.01 per cent for the week ended 26^th July. The RBI governor, YV Reddy, stated that inflation might continue to be firm until the end of the current calendar year. It is expected that inflation would peak at the level of 13 – 13.25 per cent. 

Crude oil prices have come down significantly from the peak level of USD 147 per barrel to the current USD 120 per barrel. Prices have come down due to reduction in global consumption and a conscious attack on speculation. 

The result season (Q1FY09) has come to an end with numbers of most of the companies being released. Overall, margins have been mildly impacted due to an increase in the cost of raw materials and higher cost of capital. 

There has been an intermediate rally in stocks recently which has been triggered by factors such as a stable political scenario and a fall in crude oil prices. In the near term, crude oil prices will play an important role in determining market direction. If they range between USD 100 – 120 per barrel then we could see the Sensex touching 16,000 levels. However, if crude starts climbing once again towards the USD 150 per barrel mark, then the Sensex could test 13,000.

In their recent meetings, central banks, including the Federal Reserve, the European Central Bank and the Bank of England, have maintained interest rates steady in an attempt to fine balance inflation and economic growth. On the domestic front too, we might see the rates getting steady; there could just be one last rate hike in the near term. The Indian economy can possibly deliver an economic growth rate of 7.5 – 8 per cent in FY09. 

The market is expected to be range bound in the short term. The Sensex could oscillate in the range of 14,500 – 15,500.

Even as foreign institutional investors reduced their stake in some of the leading companies during the quarter ended June 30, mutual funds were seen buying those stocks and increasing their stake. According to the shareholding pattern declared by the companies for the June quarter, foreign funds opted to sell shares in as many as eight companies, which are part of the Sensex. The shares were later bought by mutual funds.

It is perhaps the first time when foreign and domestic funds took a divergent view of the market in the case of so many leading companies.

Take the case of Reliance Industries. While the foreign institutional investors (FIIs) reduced their stake to 17.11 per cent as of June 30 against 17.83 per cent (March 30), mutual funds increased their stake from 2.72 per cent to 2.83 per cent during the same period. In Bharti Airtel, FIIs reduced their stake to 23.63 per cent in June 30 from 24.99 per cent in March.

But mutual funds raised their stake in the company from 2.14 per cent to 2.89 per cent in the same period.

It was ditto in HDFC where FII holding went down from 60.62 per cent in March to 59.09 per cent in June. Mutual funds have managed to raise their holding in the company from 3.61 per cent to 4.33 per cent.

This post links to a treasure trove of information on personal finance. Actually, April was National Financial Literacy Month in the US and JDR (GetRichSlowly) has the ultimate collection of posts covering everything on Personal Finance.

Other than the 20 posts linking to the literacy drive, he also links to his popular articles and the websites which provide such information. Maybe it’s all dry information, but you can do well to bookmark that post and keep coming back to it. It’s dry, but important for you. Why? Look at the following questions and then decide.

How much do you know about money? Have you learned about the power of compounding? Do you know how the stock market works? What is a bond? Can you tell the difference between an Income Statement, a Balance Sheet, and a Cash Flow Statement? Do you even know why you would want to?

Do you know how to keep a budget? Do you understand how your taxes are used and why we pay them? Do you know what it takes to purchase a house? How much insurance do you need?

Head on to this treasure trove. Even though some posts are US specific, the concepts are useful and important to learn.

Nine months ago I did not know what a blog is? Stuck up at home due to a back injury, I was casually chatting up with a geeky friend asking him about how to create a website, purely in jest. “Why don’t you begin with a blog and then see if you can make it bigger”, he said and gave me a link of Blogger.

300 posts later, the dream of translating it into a website seems plausible. Just take a look at what I’ve created without knowing html code! (Well, I can figure out the a href link code, but just!!) Now you know why there’s no post here. I have exported these posts to my website blog

RSS readers are requested to take this feed please: http://feeds.feedburner.com/personalfinanceforeveryone

Personal Finance 2.01: It’s a one stop personal finance website and I urge you to take a test drive. Feedback will be of immense help.

Discussion Forum: It’s a forum where you can discuss all your doubts and questions about personal finance, planning and various products like insurance, stocks, mutual funds, etc.

PF 2.01 Blog: I have started a blog focussed on personal finance and I would invite you to share your thoughts. Let’s have a real conversation of PF going on here.

Weblinks: I am regularly out on the web. When I find a great site I list it here for you to enjoy. From the list choose one of my weblink topics, then select a URL to visit.

NewsFeeds: We have some great news feeds to take a look at. Suggestions are welcome.

Financial Advisors Directory: We invite professional and net savvy advisors to register and provide the information needs. This one is a first in India to the best of my knowledge.

The design stage will take another two months after which I’ll be ready to go live. The real action begins only after then. Wish me luck.

Open letter to SEBI by Personalfn.com, a financial planning initiative. It can be reached at info@personalfn.com. I have their permission to reproduce the article.

Dear Mr. Chairman:

The fact sheet of a mutual fund scheme that is released by its Asset Management Company (AMC) is a vital source of information for investors. However, in our view, the information provided by AMCs in these fact sheets is often inadequate and/or incoherent.

At Personalfn, we have always championed the cause of investors. To that end, we present a wish list for disclosure of information in mutual fund fact sheets.

1. Expense ratio The ratio represents the expenses charged by the AMC to the mutual fund for various purposes like investment fees, marketing and selling expenses including agents’ commission and transaction costs among others. These expenses eat into the returns clocked by the investor; expenses in fact have a very significant impact on long-term returns of the scheme. Given its importance, the expense ratio should be published in the fact sheet every month. At present only a handful of AMCs follow such a disclosure policy.

2. Portfolio turnover ratio The portfolio turnover ratio is a measure of how frequently stocks have been bought and sold by the fund manager. The same can offer investors an insight into the fund manager’s investment style. Of course, a higher ‘churn’ also has an implication on the expense ratio. There is a need to ensure that AMCs disclose portfolio turnover ratios in the monthly fact sheet. More importantly, the same needs to be computed in a standard manner. Among the AMCs that choose to reveal portfolio turnover ratios, some make use of a rolling 12-Mth period for the computation, while others consider the financial year as the starting point.

3. Average portfolio maturity It is common to find debt fund fact sheets mentioning the portfolio’s average maturity. As the name suggests, the figure denotes the time to maturity for all the debt instruments in the fund’s portfolio expressed as an average. Conversely, there are others which simply mention the duration (the unit for which is a time period i.e. days/months as well). However, duration (albeit vital) is a distinct measure from the average portfolio maturity. Duration is the tenure for which a portfolio of bonds or a bond must be held, for the investor to be immune to interest rate changes. There is a need to ensure that all debt funds disclose both their average maturities and durations in their fact sheets. Also a standard computation method must be followed so that investors can conduct a meaningful comparison between like schemes across fund houses.

4. Fund manager profile The fact sheets should unambiguously declare the fund manager responsible for every mutual fund scheme along with his profile. Similarly, the period for which he has been managing the given scheme should be mentioned as well. This will prove particularly relevant in situations wherein a successful fund manager, who was responsible for an impressive performance, has been replaced by another fund manager. Investors who are about to get invested in the scheme based on its track record, should be made aware that a new fund manager is now in charge.

5. Is the fund manager invested in the scheme? It is always comforting for consumers to know that the “cook eats his own cooking”. Similarly, a fund manager investing in a fund managed by him can be source of confidence for investors. The monthly fact sheet should have a disclosure in terms of whether or not the fund manager is invested in the scheme.

6. Unambiguous investment objectives Investment objectives like “to achieve log-term capital appreciation” are commonplace in the mutual funds segment. Such objectives are inconclusive and offer no aid to a prospective investor who is contemplating investing in the fund. An ideal investment objective must be unambiguous and comprehensive.
For example, the objective could read, “a growth-styled fund, the fund aims to achieve long-term capital appreciation by investing predominantly (at least 70% of assets) in stocks from the large cap segment. Long-term being defined as at least 5 years and companies with a market capitalisation of over Rs 50 bn (Rs 5,000 crores) at the time of investment qualifying as the large cap segment. The fund can also invest upto 30% of its assets in debt/money market instruments for defensive considerations”.

A rigidly defined investment objective ensures that the investor is decidedly aware of the investment proposition offered by the fund and can make an informed investment decision. The regulator should make this mandatory. Furthermore, the Board of Trustees can at preset time intervals (say semi-annually) offer their comments on the AMC’s adherence/success in achieving the stated investment objective.

7. Portfolio disclosure AMCs have increasingly stopped disclosing entire portfolios in their fact sheets (the printed versions, which are sent to investors). For example, in the case of equity funds most fact sheets simply reveal the top 10 stock holdings. So the fact sheet for an equity fund which holds say 50% of net assets in the top 10 stock holdings doesn’t reveal half the portfolio. Similarly there is also a case for more meaningful disclosure. Related sector holdings can be clubbed to reveal the true diversification levels in the fund’s portfolio. For example, holdings in related sectors like Auto and Auto Ancillaries can be clubbed and shown under a common heading i.e. Auto.

The regulator should make it mandatory for schemes to disclose their complete portfolios and also to follow a standardised classification of companies into sectors.

We believe that the inclusion of the aforementioned disclosure norms will go a long way in furthering the cause of investor empowerment.

This post links to a treasure trove of information on personal finance. Actually, April was National Financial Literacy Month in the US and JDR (GetRichSlowly) has the ultimate collection of posts covering everything on Personal Finance.

Other than the 20 posts linking to the literacy drive, he also links to his popular articles and the websites which provide such information. Maybe it’s all dry information, but you can do well to bookmark that post and keep coming back to it. It’s dry, but important for you. Why? Look at the following questions and then decide.

How much do you know about money? Have you learned about the power of compounding? Do you know how the stock market works? What is a bond? Can you tell the difference between an Income Statement, a Balance Sheet, and a Cash Flow Statement? Do you even know why you would want to?

Do you know how to keep a budget? Do you understand how your taxes are used and why we pay them? Do you know what it takes to purchase a house? How much insurance do you need?

Head on to this treasure trove. Even though some posts are US specific, the concepts are useful and important to learn.