“Caliberated Tightening” – RBI’s new stance

The shift in RBI’s stance came, but not in the repo rate as most people were expecting today.The Monetary Policy Committee ( MPC) decided to change the stance from neutral to “calibrated tightening” of monetary policy, which in plain English means that rate cuts are probably off the table, and RBI can decide on when to raise or not raise rates depending on how fresh data comes in.

Whilst a 0.25% hike in the repo rate was the consensus view of the expected MPC action today, with some even expecting a 0.5% hike, the policy statement surprised markets – bonds positively, equities and the rupee negatively, with RBI choosing to do nothing, as MPC members voted 5:1 in favor of an unchanged repo rate at 6.50%. This was also probably driven by the fact that there have been two consecutive rate hikes in the last two MPC meetings.

They stuck with their primary mandate i.e. controlling inflation, with the objective to achieve medium term target for CPI inflation of 4 percent within the range of +/- 2%, while supporting growth.

Since the last MPC meet in August 2018, the Indian basket of crude oil has increased sharply by US$ 13 a barrel, whilst global economic activity has been able to withstand ongoing trade tensions thus far. Food inflation has remained unusually weak, which imparts a downward bias to its trajectory in the second half of the year. The risk to the food inflation from a 9% deficit in the monsoon, is also probably mitigated by higher production of major kharif crops for 2018-19 than last year’s record. An estimate of the impact of an increase in minimum support prices (MSPs) announced in July has been factored in the baseline projections.

The projected inflation in Q2:2018-19 is at 4%, 3.9%-4.5% in the second half and 4.8% in Q1:2019-20 with risks on the upside, which were lower than earlier estimates.

With risks broadly balanced GDP growth projection for 2018-2019 was lowered at 7.4% against 7.5 % in August due to strong base effect.Private consumption has remained strong and is likely to be sustained even as the recent rise in oil prices may have a bearing on disposable incomes. However, both global and domestic financial conditions have tightened, which may dampen investment activity. Rising crude oil prices and other input costs may also drag down investment activity by denting profit margins of corporates. This adverse impact will be alleviated to the extent corporates are able to pass on increases in their input costs. Uncertainty surrounds the outlook for exports. The recent rupee depreciating could be negated by slowing down of global trade and the escalating tariff wars.

Global headwinds in the form of escalating trade tensions, volatile and rising oil prices, and tightening of global financial conditions therefore pose substantial risks to the growth and inflation outlook.

Your Investments

As we see change in stance from neutral to calibrating tightening signals that rate cuts are off the table. Concerns seem to be around crude oil prices, global interest rates and the ongoing global developments on the trade front. Equities continue to trade at a premium and whilst it may be very tempting to buy lumpsums as equities have fallen substantially, equity valuations in India continue to be elevated vis a vis long term averages. A gradual entry strategy or a continued SIP/STP strategy is most suited to the current market scenario. It may be a good idea to add fixed income exposure through a combination of largely ultra short term, short and medium term strategies focused on high credit quality portfolios, to avoid any spillover of the continuing bad loan cycle on your investments.

Your Loans

After hiking the repo rate twice in a row, the Reserve Bank of India (RBI) has kept the key policy rates unchanged. However, the central bank has changed its stance on the key policy rates to ‘calibrated tightening’. This indicates that RBI is of the view that there is upward pressure on interest rates which means your EMIs are likely to continue ti go up. Expect banks to raise rates gradually even though RBI kept rates constant today.

Way forward

The next policy is due on December 5, but don’t be surprised for mid course corrections if the data so warrants. Ultimately that’s what caliberated tightening probably alludes to.

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Twice in a row, inflationary pressures show

Today marked the 3rd Bi-Monthly policy statement by the RBI for the FY 2018-19 with members voting 5-1 in favor of a rate hike.

This was largely in line with market expectations and was already priced in, as post the release of the minutes of the monetary policy bond yields did not move much in either direction.

However, the MPC also continued to maintain a neutral stance, indicating that it is trying to play a delicate balance between inflation and growth, and decisions are being taken with the objective of achieving the medium term target for CPI at 4% within the range of +/- 2% and future data prints

The MPC mentioned that domestically various indicators suggest that economic activity has continued to be strong. Significant turn around in the production of capital goods and consumer durables, Progressive monsoon and increase in MSPs of Kharif crops are expected to boost rural demand by rising farmer’s income. Vehicle sales augur well for urban income growth.

Retail inflation i.e. CPI grew to 5% in June from 4.9% in May, driven by an uptick in inflation in fuel. Food inflation remained muted due to lower than usual seasonal uptick in prices of fruits and vegetables in summer months. Adjusting for the estimated impact of the 7th central pay commission’s house rent allowances (HRA), headline inflation increased from 4.5 per cent in May to 4.6 per cent in June. Low inflation continued in cereals, meat, milk, oil, spices and non-alcoholic beverages, and pulses and sugar prices remained in deflation. Factors mentioned above have resulted marginally downward revision in inflation projections for Q2 vis-à-vis the June statement. However, projections for Q3 onwards remain broadly unchanged on account of uptick of 20 bps in inflation expectation for 3 months and 1 year ahead horizon survey of households by RBI’s. RBI’s industrial outlook survey also reported higher input costs and selling prices in Quarter 1 of 2018-19. Input cost of companies polled in services PMI in June also stayed elevated. Farm and non farm input costs rose significantly in June.

The central government has decided to fix the minimum support prices (MSPs) of at least 150 per cent of the cost of production for all kharif crops for the sowing season of 2018-19. This increase in MSPs for kharif crops, which is much larger than the average increase seen in the past few years, will have a direct impact on food inflation and possible secondary impacts on headline inflation. Uncertainty around the full impact of MSP on inflation will only resolve in the next several months once the price support schemes are implemented and procurement by the government is visible.

Based on an assessment of the above-mentioned factors, inflation is projected at 4.6 per cent in Q2, 4.8 per cent in H2 of 2018-19 and 5.0 per cent in Q1:2019-20, with risks evenly balanced. Excluding the HRA impact, CPI inflation is projected at 4.4 per cent in Q2, 4.7-4.8 per cent in H2 and 5.0 per cent in Q1:2019-20.

The MPC notes that domestic economic activity has continued to sustain momentum and the output gap has virtually closed. However, uncertainty around domestic inflation needs to be carefully monitored in the coming months. In addition, recent global developments raise some concerns. Rising trade protectionism poses a grave risk to near-term and long-term global growth prospects by adversely impacting investment, disrupting global supply chains and hampering productivity. Geopolitical tensions and elevated oil prices continue to be the other sources of risk to global growth. On account of these risks, RBI governor stated that by keeping the neutral stance, the Monetary Policy Committee have kept the option of further rate increase or decrease open and dependent on future data.

With an election year upon us and possible fiscal risks emanating, along with global outflows on the back of higher US interest rates and a falling rupee, this may not be the last of the rate hikes in our view.

Your Investments

Financial markets have continued to be volatile and driven mainly by monetary policy stances in advanced and emerging economies and geopolitical tensions. Globally, equity markets have been volatile on trade tensions and uncertainty around Brexit negotiations. However, it also important that public finances do not crowd out private sector investment activity at this crucial juncture.

Capital flows to Emerging Economies declined in anticipation of monetary policy tightening in Advanced Economies. Also currency of Emerging economies have depreciated against the US dollar over the last month on account of strong USD supported by strong economic data.

Equities continue to remain overpriced from a price to earnings perspective in spite of recent corrections and a better growth outlook. However, good results so far by many companies, along with good growth expectations and better capacity utilisation bode well for earnings growth going forward.

Real rates continue to remain positive.The rising G-sec yield makes dynamic bonds and long term bond funds unattractive and the exposure to the same should be minimized. Bonds with a shorter duration of 3 months to 2 years are ideal in the given scenario. We therefore, continue to believe that investors should continue to have fixed income exposure through a combination of lower duration and short term strategies.

Your Loans

With an increase of 25 basis points by the RBI, the deposit rate of the banks could further increase which would be followed by lending rate hikes. Thus we suggest looking at prepaying or raising EMI amounts on your loans to negate the interest rate hike and future hikes that could follow.

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6-0 verdict by MPC, interest rates hiked

Today marked the second and much awaited Bi-Monthly policy statement by the RBI for the new FY 2018-19.

In line with what bond markets expected, the Monetary Policy Committee (MPC) delivered a 6-0 verdict on an interest rate hike by 0.25%. The was largely in line with market expectations post the release of the minutes of the last meeting and thus the bond market had only a marginal impact of this change.

However, the MPC also continued to maintain a neutral stance, indicating that it is trying to play a delicate balance between inflation and growth, and decisions are being taken basis news flow and fresh data coming in.

The MPC noted that domestic economic activity has exhibited a sustained revival in recent quarters and the output gap has almost closed. Investment activity, in particular, is recovering well and could receive a further boost from swift resolution of distressed sectors of the economy under the Insolvency and Bankruptcy Code. This is in general good news for the economy.

Retail inflation i.e. CPI grew to 4.6% in April. The decision to raise rates is therefore in line with the objective of keeping the medium term inflation at 4% i.e. well within the 2-6% range.

Since the MPC’s meeting in early April, the price of Indian basket of crude surged from US$ 66 a barrel to US$ 74. This, along with an increase in other global commodity prices and recent global financial market developments, has resulted in a firming up of input cost pressure thus persisting in a high CPI inflation projection for 2018-19. On the other hand the summer momentum in vegetable prices was weaker than the usual pattern softening the food inflation in the short term, though this has been more than negated by the changes in oil prices. Household inflation expectations have also moved up sharply and  pricing power seems to be on its way up as well.

Taking these effects into account, the projected CPI inflation for 2018-19 is revised to 4.8-4.9 per cent in H1 and 4.7 per cent in H2, including the HRA impact. Excluding the impact of HRA revisions, CPI inflation is projected at 4.6 per cent in H1 and 4.7 per cent in H2.

Crude oil prices have been volatile recently and since consumption, both rural and urban, remains healthy and is expected to strengthen further, all this imparts considerable uncertainty to the inflation outlook, possibly on the upside. With an election year upon us and possible fiscal risks emanating, along with global outflows on the back of higher US interest rates and a falling rupee, this may not be the last of the rate hikes in our view.

Your Investments

Geo-political risks, global financial market volatility and the threat of trade protectionism pose headwinds to the domestic recovery. However, it also important that public finances do not crowd out private sector investment activity at this crucial juncture.

In most Emerging Market Economies (EMEs), bond yields have risen on reduced foreign appetite for their debt due to growing dollar shortage in the global market and on prospects of higher interest rates in Advanced Economies.

Equities continue to remain overpriced from a price to earnings perspective in spite of recent corrections and a better growth outlook. However, signs of improved demand and pricing power for companies, along with good growth expectations and better capacity utilisation,  bode well for earnings growth going forward. Corrections into equities could therefore be bought into.

Real rates continue to remain positive.The rising G-sec yield makes dynamic bonds and long term bond funds unattractive and the exposure to the same should be minimized. Bonds with a shorter duration of 3 months to 2 years are ideal in the given scenario. We therefore, continue to believe that investors should continue to have fixed income exposure through a combination of lower duration and short term strategies.

Your Loans

Even before the RBI meet, the banks had begun hiking both their lending and borrowing rates. This rise in lending rates was brought about by the rapid increase in bond yields and increased loan demand, especially in private banks.

With an increase of 25 basis points by the RBI, the deposit rate of the banks could further increase which would be followed by lending rate hikes. Thus look at prepaying your loans with excess liquidity.

A 6-0 verdict is therefore a clear indicator that inflation targeting continues to be the MPCs primary role, and a conservative stance will probably give foreign investors a more positive view on India.

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RBI maintains neutral stance in the midst of Volatility.

Today marked the first Bi-Monthly policy statement by the RBI for the new FY 2018-19.

The MPC notes that there has been a recovery in growth on a domestic level and various structural reforms introduced will support further long term growth. The MPC recognizes the downside risk to private financing and investments as well as growth on both a global and domestic level is brought out by deteriorating public finances and rising trade protectionism.

The MPC stated that the GDP growth is projected to strengthen from 6.6% in 2017-18 to 7.4% in 2018-19 with H1 2018-19 reflecting growth in the range of 7.3-7.4% and 7.3-7.6% in H2 2018-19 supported by revival in investment activity and global demand.

The MPC revised down the CPI for FY 2018-19 to 4.7-5.1% in H1 and 4.4% in H2 (inclusive of the HRA impact) keeping in mind that factors such as the revised formula for MSP (minimum support price), impact of HRA, further fiscal slippages, a weak monsoon and volatile crude prices could all pose upward risks to the near term inflation outlook.

Amongst the midst of global and local market volatility in both the equity and bond markets, the monetary policy committee maintained their neutral stance and kept the policy repo rate and the reverse repo rate unchanged at 6 percent and 5.75 percent respectively.

5 out of 6 members voted in favor of the policy while one member voted for raise in rates by 25 basis points.

The 10 year G-Sec fell sharply from 7.3% levels to 7.12-7.13% indicating that the market is putting to rest any near term rate hikes.

Your Investments

While the RBI does talk about economic recovery as well as a possible sustained long term recovery one can not ignore the volatility brought about by the juxtaposition between global recovery and the possible trade war between the United states of America and China.

Equities continue to remain overpriced from a price to earnings perspective in spite of recent corrections. Real rates continue to remain positive and interest rates (benchmarked by the 10 year G-sec) have cooled down from their high ranges of 7.7-7.8%.

We continue to believe that investors should continue to have fixed income exposure through a combination of accrual, short to medium and hold strategies. Considering a large state loan calendar interest rates could revert back to an upward movement scenario and thus we recommend maintaining only a 10% exposure to dynamic bond fund that have the flexibility to move across bond maturities.

Your Loans

For the first time in 2 years banks started increasing interest rates indicating a change in rate cycle. This rise in lending rates was brought about by the rapid increase in bond yields.

The RBI has maintained status quo on rates and has allowed banks to spread their bond losses over 4 quarters. This action by the RBI could cause lending rates to stabilize.

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New Mutual Fund Classifications – What you should know

The universe of mutual funds within the Indian space is quite big; as per latest data on AMFI, to be precise. So it’s not particularly easy for an investor, especially a first time investor, to navigate through it to identify the right kind of mutual fund for his/her requirements.

In response to fund houses launching multiple schemes in one category, which confused investors, market regulator SEBI has come up with a new system for fund classification. The new system aims to bring uniformity to the schemes launched by different fund houses, thus facilitating scheme comparison across fund houses.

Based on the categories, mutual funds will be forced to either merge, wind down or change the fundamental characteristics of a particular scheme. This move could also have short term impacts on the portfolio on any investor depending on the schemes they have currently invested into.

As per the new classification, all open-ended mutual fund schemes will be placed under the following categories:

• Equity
• Debt
• Hybrid
• Solution-oriented
• Others (index funds/ETFs/fund of funds)

Only one scheme per category would be permitted except index funds/ETFs, fund of funds and sectoral/thematic funds.

However, each of these categories will have sub categories:

• Equity will have 10 sub classifications
• Debt will have 16
• Hybrid will have 6
• Solution Oriented will have 2
• Other will have 2 sub classifications.

That is a grand total of 36 classifications an investor can choose from.

As such, these new classifications will have varying impact on existing funds and consecutively on an investor’s portfolio. Such impacts could include:

• Schemes will be forced to stick to their mandate:Funds often change their investing style based on market conditions. For example, a large cap fund may have sizeable mid cap exposure because its chasing higher alpha. But now, any drastic change will force the scheme to change its characteristics resulting in the same being communicated to the investors. So now the investor will not have to worry about the fund becoming something it originally was not set out to do.
• Like for Like Comparison:As AMCs will have one scheme per category, it will be easier for the investor to compare the options available. All schemes of different AMCs of a category will have similar styles and characteristics, which will result in a “apples to apples” comparison.
• Better choice by fewer options:With AMCs forced to ensure one scheme per category and fund labeling to be made in line with investment strategy, options will become lesser which should result in investors being more aware of their choice.
• Need for review in the short term:With the latest mandates, one can expect a short period of fund houses realigning their products. As such, many schemes may end up being quite different they what they originally were. Therefore, investors may need to keep a thorough eye on their funds to watch out for any changes that may occur and act accordingly.
• Possibility of reduction in performance:Like mentioned above, funds often change their investing styles to generate significant alpha. But after these regulations, alpha creation may be more difficult as the universe of stocks will be same for all schemes in a category. Furthermore, as per the latest mandate, if a fund wants to be categorized say as a large cap, it will have to invest only stocks defined as large cap as per regulations. So in the short term it may have to sell or buy some stocks which could have an impact on cost that would be borne by the investor. Also, as regulations would demand funds to rebalance their stocks as per the semi – annual publications of AMFI which enlist large, mid and small cap stocks, it may result in forced selling to accommodate any change in status of a stock, resulting in a possible negative impact on the performance of the fund.

Overall, while there may be short term practical hurdles for both investors and fund houses alike while adjusting to the new mandates, the general consensus has been that this move is a positive step taken by the regulators in the right direction as it will bring reliability and simplicity to investors. For any investor, it would be prudent now to get professional advice on how such changes may impact their own portfolios.

 

 

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Benefits from Geographical Allocation

According to Investopedia, “Geographical Diversification” is the practice of diversifying an investment portfolio across different geographic regions so as to reduce the overall risk and improve returns on the portfolio.

As with diversification in general, geographical diversification is based on the premise that financial markets in different parts of the world may not be highly correlated with one another. For example, if the US and European stock markets are declining because their economies are in a recession, an investor may choose to allocate part of his portfolio to emerging economies with higher growth rates such as China, Brazil and India.

There are two major advantages in diversifying one’s investment portfolio based on geography:

• Taking Advantage of Opportunities in other Strong Economies:

A significant benefit to a geographic diversification of assets has to do with the way it allows you to mitigate risk by taking advantage of stable economies elsewhere in the world. It’s no secret that some economies are struggling to recover from the trying economic times of the last few years. Other countries, however, have seen higher growth rates due to a variety of factors. International portfolios have been shown, in general, to outperform domestic ones, this is because when there are so many markets to choose from, it is unlikely that the same country will ever repeatedly achieve the highest level of growth. With improved access to international markets and investment instruments such as mutual funds bringing down the costs, an additional option to further diversify has been to buy in international markets.

(Source: Bloomberg, Kotak MF. As of 31^st Jan, 2018)

The above returns data chart clearly shows that while the Indian Equity Markets have performed significantly in the last year, there were opportunities elsewhere which proved even better. Diversification into such economies can therefore result in better yielding portfolios.

• Balancing out the risks:

While chasing better returns might definitely be one aspect of any investment portfolio, it is also crucial to understand how any strategy helps in mitigating the associated risks that are part of every investment decision. Geographic diversification provides a much needed balance that all investors strive for. If one of your assets is located in a part of the world that is or could be vulnerable, the investments in other geographies could compensate or buffer any unexpected losses. This is because despite the impact of globalisation, geographies and economies can still have limited correlation between them, and over time international markets could perform very differently to domestic markets. Following is a chart that shows how various sectors form part of some regions around the world, in % of total market capitalization:

(Source: credit suisse global investment returns yearbook 2015)

As you may notice, different regions give different weightages to every sector. Thus by accessing these regions, you can in essence, reduce investment risks in individual sectors and therefore your entire portfolio as a whole.

Since the cycles that drive business and investment are experienced at different times in different countries, foreign markets seldom move in perfect tandem with each other. Losses in one market may be offset by gains in another. Geographical diversification significantly reduces the overall level of volatility and exposure to external factors. For an investor, theoretically this would mean that the more diversified your assets, the safer is your money. However it is true that a significant black swan event, such as the financial crisis of 2008, will likely deplete any such benefits, especially in the short term immediately after such an event. What is rather important to keep in perspective is (a) your investment horizon and (b) your risk taking capability to diversify into foreign markets.

 

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The Best Financial Resolutions for 2018

 

The New Year is a great time to overhaul your life for the better. And what better way to do it is make those kind of resolutions that will act as a constant guide in that endeavor. For this, Resolutions, like goals, are best when they’re specific.

Financial resolutions made during beginning of the New Year can determine the shape of your short and long term financial objectives whether is it increasing your savings for retirement or putting aside a little extra for this year’s down payment of that property.

If getting your financial life in order is a resolution for you this year, here are some ideas that may help you get there faster:

1. Save Smartly!:It is common knowledge that

• Income -Expenses = Savings

We suggest change that equation from this year, make it

• Income – Savings = Expenses

This new equation will help create an automatic budget, and will ensure you only spend after saving.

Use automatic investment ideas like SIPs and STPs to transfer your monthly savings to dedicated investments for your goals.

 2. Have Contingencies, for everything!:

Dangers and risks are ever present. They can have sudden and significant impact on your finances if they are realized. So it’s better to be safe that sorry.

• Having a highly liquid corpus (available to you in 48 hrs or less) is one way of doing it.
• Another useful and highly critical step is getting adequately insured. While a variety of insurances are up for grab, focus on the basics first. Sufficient health cover for your family and yourself should top the list.
• Followed by insurance for specific risks such as critical illnesses, accidents and even insurance for your home.
• Another smart thing you should do is take a insurance for any big ticket loan you may be servicing, such as a home loan. You do not want to burden your dependents in the event of you passing away, do you? 

3. Have a Strong Debt Strategy:

• Home Loans / Education Loans

Not all debts/loans are equal. It is essential for you to know which loan is drawing the most interest from you. Also some loans are useful, such as home loan as you have access to an appreciating physical asset or a educational loan from which you stand to appreciate the biggest asset of them all, yourself! Plus it does not hurt that they have tax deduction benefits.

• Personal / Credit Card Loans

Personal/Credit Card loans should be ticked off at the first available opportunity, simply because they have high interest rates. If you had to choose between investing into a fixed income product or pay off a high interest loan, you should ideally opt for repayment. Interest saved is interest earned after all! 

4. Know what you want:

It is said “If you don’t know where you are going, well then, any road will take you there”. It is better to have well defined goals. A goal helps you focus because the end objective is clear. For example, it is probably not enough to say, “I will save some money for that amazing Europe vacation that I always dreamed of.” It needs a lot of planning and finances. You not only need to know the destinations you will visit, you also need to the travel routes you will need to take, how much funds you will need, where all do you intend to spend and so on so forth. The more crisp your goal is, the better actionables you will be able to achieve.

 

5. Invest in yourself:

In today’s highly dynamic world, the word of the day is “reskilling”. As a professional, now more than ever, you have to stay on top in your industry by constantly upgrading your skill sets. Therefore always ensure you have enough kitty set aside so that you can opt for those special courses which will give you that edge in your profession.

While not all resolutions can be worked on simultaneously, it is important that you start with some and even more importantly that you stick to them. Give your resolutions time lines so you know what to prioritize. And work towards strong finances and a worry free New Year 2018!

 

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Are ETFs a worthy investment option

With the recent launch of the ICICI Bharat 22 ETF, a lot of buzz around Exchange Traded Funds or ETF’s has been doing the rounds. Most investors may be wondering whether it is worth investing in ETF’s?

So what is an Exchange Traded Fund?

An ETF is a passive investment instrument whose value is based on a particular index and such a scheme mirrors the index and invests in securities in the same proportion as the underlying index. For example, a Nifty ETF will invest in the 50 stocks compromising the Nifty index. ETF’s are freely marketable securities which are traded on the stock exchange.

Since ETF’s trade on the exchange, their value fluctuates all the time during the market trading hours. This is different from the working of a mutual fund scheme which has a single Net Asset Value (NAV) per day that is determined after the trading hours are over.

Theoretically, ETF’s are structured to provide a variety of advantages to investors. The most prominent among them are as follows:

• Diversification: ETF’s can provide a variety of diversification based on following themes:

1. Asset classes such as equities, gold, fixed income
2. Sectors such as financial services, consumption, infrastructure
3. Based on market cap i.e. large, mid and small cap

• Low Cost: One of the biggest attraction of ETF’s has been it’s very low cost structure, especially in comparison to Indian mutual funds. The low costs is primarily due to the fact that an ETF is a passive investment i.e. there is no active intervention in stock selection, re balancing based on a certain view. Therefore the costs associated with hiring professionals and the required infrastructure is avoided, resulting in a significantly cheaper product. Furthermore, most ETF’s have kept the expense ratios low to induce significant inflows from institutional investors. Following are examples of some commonly known ETF’s and their respective Expense Ratios

ETF	Expense Ratio
CPSE ETF	0.07%
Motilat Oswal MOSt Shares M100 ETF	1.50%
Kotak Banking ETF	0.20%
ICICI Prudential Nifty iWIN ETF Fund	0.05%
SBI – ETF Nifty 50	0.07%
Average	0.38%

(Source: Value Research, mutual fund websites)

• Suited to Efficient Markets: it is a global observation that passively managed funds have performed significantly better over actively managed funds where markets are more efficient. This is because in developed markets, all related information that should be priced into the equity market already happens, leaving very little space for the fund managers to beat their respective benchmarks.
• Reduced Risks: Due to its passive structure, the risk arising due to stock selections by a fund manager are reduced. Furthermore, as an ETF comprises the same stocks in the same allocation as in the underlying index, tracking error is significantly reduced to the point of it being almost negligible. Tracking Error is the standard deviation between the returns of the fund and the underlying index. A lower tracking error indicates the fund is that the ETF will mirror the index more closely and therefore its performance will be more consistent with the same index.

Despite many advantages that ETF’s can bring to the table, in India they so far have been primarily avoided for the following reasons:

• Liquidity: One of the major disadvantages plaguing ETF’s currently is liquidity. As ETF’s are traded on the exchange like any stock, its not always you will have to opportunity to either buy or sell at the desired quantity or price, depending on the type of ETF involved. However an alternative to this problem is the use of a market maker. A market maker is appointed by fund houses. They, on behalf of fund houses, provide quotes for buying or selling an ETF based on the current NAV of that ETF. This helps ensure liquidity for investors. Any investor can approach a market maker for transaction. The difference in their quote and the NAV of the ETF is called “spread”, is the cost for the services. –
• Lack of awareness: Distributors receive negligible commission for recommending and executing an investment into an ETF. Because of these low margins not much efforts have gone into promoting ETF’s. Thus, most investors are unaware of what an ETF is and how it can add value to their portfolio.
• Relative Underperformance over long term: While in theory ETF’s should out perform active managed funds in an efficient market, the point to note is that India is still some time from achieving that status. Hence actively managed equity funds, especially in the top quartile, are able to beat the underlying index, and ETF’s over long term horizons. This currently results in alpha creation which ETF’s may take time to match up to. The following table is a comparison between a random mix of actively managed equity funds and equity oriented ETF’s:

	1yr	3yr	5yr	10yr
Aditya Birla Sun Life Frontline Equity	26.62	10.21	16.89	10.61
Franklin Templeton Franklin India Prima Plus	24.86	11.17	18.22	10.87
HDFC Top 200	28.42	8.39	14.99	10.65
IDFC Premier Equity	30.35	11.72	18.68	14.08
ICICI Prudential Nifty 100 iWIN ETF	27.54	8.44
Kotak Sensex ETF	23.88	5.36	10.7
Reliance ETF Nifty BeES	26.78	6.7	11.91	5.75
S&P BSE Sensex	25.58	5.01	11.15	5.14
NSE Nifty 100	26.97	7.55	12.71	6.08
source: value express , date (07 Dec 17), returns data CAGR

As in the Indian economy continues its march towards being recognized as a developed nation, there is fair certainty that ETF’s will have a far larger role to play. However in current scenarios, practical hurdles continue to keep them out of favor among investors. We believe that assigning a small allocation towards ETF’s, after due diligence, is sufficient basis investor’s risk appetite and investment horizon. As Indian Equity markets evolve, so will the ETF space and this will increase investors interest towards them.

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RBI sticks to the script

Inflation concerns mean rates stay as is…

As was broadly expected, The Monetary Policy Committee (MPC) on Wednesday left the policy repo rate and reverse repo rate unchanged at 6 percent and 5.75 percent, respectively. Out of six members, five members voted for no rate cut and one member voted for 25 bps rate cut. RBI continued to maintain its view that the 4% target on inflation remains its focus. Retail inflation measured by year-on-year change in the consumer price index (CPI) had recorded a seven-month high in October, and with an indicated range of 4.3% to 4.7% for the next two quarters, along with higher inflationary expectations getting built in through the possibility of higher oil prices and some possible fiscal pressure, this was very much in line with expectations. Surplus liquidity in the system has also continued to decline, reducing chances of rate cuts going forward.

Focus on the real rate of return

With the RBI referring to possible green shoots on growth starting to appear in the economy, it does seem that whilst they will continue to track data closely, strategies that are focussed on interest rates getting reduced are likely to face pressure. However, considering that real rates of return (returns from fixed income investments less inflation) continue to be significantly positive, we continue to believe that investing in fixed income is attractive.

Your Investments

Considering positive real interest rates, and equities continuing to trade at significant premiums to long term price to earnings ratios,  it may be a good idea to continue to have fixed income exposure through a combination of largely accrual, short to medium term, and hold to maturity strategies. For investors willing to continue to look at interest rates heading downwards, dynamic bond funds that have flexibility to move across bond maturities, can be explored for a small portion of the fixed income portfolio.

Your Loans

The RBI’s decision to hold rate cuts could indicate that there is unlikely to be any impact on existing lending rates, especially home and car loans by banks. Whilst the transmission of the rate cuts for bank loans over the last couple of years has only been partial, we believe that interest rates may not head down much more going forward.

Way Forward

Considering that the next policy meeting on Feb 6 and 7 is likely to be post the Union Budget, one will need to track how the government manages its fiscal policy and its focus on growth going forward. Global interest rates headed upwards, will also continue to drive RBI’s decisions on interest rates.

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Mr. Pilot – Are you prepared in case of rough weather ?

This 7^th of December is the International Civil Aviation Day and marks the 50^th Anniversary of the signing of the Convention on International Civil Aviation.The purpose of this day, as pilots all over might be well aware of, is to recognize the importance of aviation to the overall development of the world.

And while pilots draw great confidence from being able to manage the process of reaching passengers to their destinations safely and comfortably, a more pressing question can be that are they confident when it comes to management of their finances?

The profession of a pilot demands almost all their time all year round. Hence they are left with limited personal time which they wish to live to the fullest. And like most busy professionals,more often than not money management seems to come at the end of this wish list. Pilots go through meticulous preparation and planning for their flights daily but sometimes are unable to do so for their finances.

While money is not the end, it is definitely a means to achieve certain objectives. Proper planning and structure to a pilot’s personal finances can result in he/she being prepared for all kinds of life events and responsibilities. Events such as:

1. Sudden Illness:The requirement for pilots to be medically fit is of prime importance as they are responsible for the lives of hundreds of passengers daily. Every pilot needs to ensure a good health cover to cover sudden illness and hospitalisation. A pilot may wonder why would he need insurance when he is already covered. But if one actually things about, it might be prudent to have a separate health insurance cover for times when you may not be employed or between jobs or in cases where employer insurance is inadequate.
2. Need for upgradation of Skill Sets:Like all professions, skill updation is a critical requirement that must be met by all pilots on periodic basis. But these do not come at a cheap cost. Ensuring enough provision and funds are kept aside and is available at the time of requirement can go a long way in avoiding last minute stress.
3. Contingency Needs: A major issue plaguing the aviation industry is the availability of opportunities. The last few years have clearly demonstrated that problems are plenty in the Indian aviation sectors. For eg. Airlines have closed down, pay cuts are becoming common, or there have been significant delays in salary payments. Such events can have huge financial implications on pilots and their families. Having contingency funds parked in highly liquid assets can help bring some normalcy in such difficult times.
4. Retirement and Sunset Years:Insufficient planning for your golden years i.e. Retirement can cause stress. In case of pilots, who are among the top earners amongst professionals, this only magnifies the problem. Why so? Pilots more often than not tend to have busy lifestyles with high discretionary expenses. As such they are accustomed to a lifestyle that will only get more and more expensive as years pass This year on year rise in prices is called Inflation and it is an important factor that more often that not, is grossly underestimated. Furthermore, like any other busy professional, even pilots like to keep themselves occupied during retirement years. The interests or activities that they might pursue would also usually have financial implications. Activities such as investing into various ventures, pursuing hobbies or dream goals, continuing leisure flying by enrolling in the local flying club can be just some of the examples. To be able to fund these without affecting retirement corpus requires careful planning early on.

Take the case of pilot Mr. Sharma. Currently aged 30, the household expenses for him and his family is Rs. 12 lakhs per annum. Even if we assume a general inflation of 8%, the same Rs. 12 lakh will become Rs. 1.75 crores at the age of retirement at 65. ( Rules permit pilots to fly till the age of 65 ). In other words, Mr. Sharma would need to have a big enough corpus at retirement that will provide them atleast Rs 1.75 crores every year that will help them maintain current lifestyles.

Pilots are aware of the importance of planning. Each flight requires hours of pre flight preparation which means going through weather reports, system checks among other items to ensure that the flight goes by without any hitch. Similarly having a strategic plan in place for one’s finances can also help prepare for any “rough weather” that could come along in a pilot’s financial life.

 

 

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