Simple strategies to meet your cash flow needs after retirement

India is a saver’s economy. During the working years sacrifices are made for the benefit of the  family and retirement is keenly looked forward to. Advertisements of retirement products paint a picture of a comfortable retirement by the sea and that your life could be one happy vacation. However, in our experience as and when individuals start approaching their retirement they start to dread it. Questions such as are they well prepared for retirement, have they saved enough, and biggest dilemma faced is  where to invest this large sum of money in order to get a regular cash flow to become financially independent. What do you do to actually turn your retirement into one big happy vacation?

Effective cash flow management is the key to a successful retirement. The magic lies in creating a strategy that generates a regular inflation adjusted income for you and your surviving spouse, lasts you a life time and offers liquidity.

Strategy 1: Create a regular income stream

Every individual wants to be financially self sufficient. In the absence of a joint family, being financially independent is not a desire but a must have in your golden years. If you need money for your day to day expenses, then getting a payout once in 3 or 6 months doesn’t help. A lot of retirees rely on dividend income either from stocks or their mutual funds. This is a huge mistake which becomes evident with time when the steady income from salary has stopped completely. Receiving a dividend from your investments when you have a  salary feels great because it provides an additional income. What most people don’t realize is that the dividend is actually paid out at irregular intervals and the amount is also inconsistent. Similarly, the interest payout from your corporate FD might be on a quarterly basis or twice a year and now locked in until maturity.

How to execute this strategy?

To be financially independent at all times you have to ensure you have created multiple income streams and timed the out flow to suit your requirement. If you need to pay salaries and bills towards the start of the month, then set the payout around that time. Opt for monthly interest payout from FDs and set up a Systematic Withdrawal Plan (SWP) from your Mutual Fund investments on a monthly or bimonthly basis. This way you will know exactly when your next payout will happen and manage your expenses and bill settlements better. You will also be more in control of your finances rather than being helpless because of a bad strategy which can now not be easily changed.

Strategy 2: Generate an inflation adjusted income

Thanks to the increase in programs aimed towards investor education, many individuals understand and are aware of the impact of inflation on their income and wealth. The income that you receive should be able to beat inflation and help you live your life comfortably and on your terms. The current consumer inflation rate is at 4.17% however, it is essential to consider your lifestyle inflation which rises faster than food inflation. It would be wise to adjust your income against an inflation of 7-8%. The income that would have sufficed today will not manage to cover the same expenses next year due to inflation. On a yearly basis, you will notice that your bills are rising, so will the salary of your staff.

How to execute this strategy?

The interest income coming from your Fixed Deposits will not be able to implement this strategy since the returns are fixed and the amount is locked until maturity. You would not have the option to choose a higher payout even at the cost of wealth depletion.

This strategy can only to executed through a Systematic withdrawal Plan (SWP). With an SWP you have the option to increase or decrease the amount that is withdrawn from the investment. For eg. If your cash flow requirement is Rs 25000/month for the 1^st year, then with a Systematic withdrawal Plan you have the flexibility to adjust the payout by increasing it to Rs 27000/month which would be inflation adjusted. This way you can increase the payout from your debt funds using SWP strategy.

Strategy 3: Avoid excess liquidity as a part of contingency planning

Most senior citizens seek comfort in keeping large amounts of cash lying in their bank accounts. This they say is for emergencies and contingencies in case they need a lot of cash all of a sudden. Assume you have Rs 50 lakhs for your retirement corpus out of which if  5-10 lakhs are kept in your bank account for comfort then this is a very expensive way to deal with emergencies. With high inflation and increasing life expectancy, one can not afford to keep 10-20% of their wealth idle. At your age you will need every cent and penny to work as hard as it can.

How to manage liquidity?

If you have parked a large sum in your bank account, the reason has  less to do with emergencies and more to do with liquidity. With most of your money parked in illiquid assets like bonds, fixed deposits or real estate how do you get your money if a need arises. Liquid debt mutual funds are a perfect option since they provide both higher returns and offer liquidity. Liquid funds can generate a return of up to 6.5% and are highly liquid as the name suggests. You can redeem your units from a liquid any time and encash your money. You will receive your money in your bank account the next day.

Strategy 4: Plan your cash flow to avoid wealth depletion during your lifetime

With the advancement in medical sciences the average life expectancy in India has risen to be around 85 years. There is also a risk that both you and your spouse might outlive your life expectancy and live longer than what you had accounted for. This poses a threat to your financial independence as there is a possibility of your wealth getting depleted while you both are still alive. It therefore becomes important to invest your money in such a way that your portfolio can provide a steady cash flow not just for you but for your surviving spouse too and a little over your assumed life expectancy.

How to make this strategy work without compromising on your dreams?

As a retired person wealth preservation is of utmost importance however, if inflation and longevity poses a threat to your wealth and goals then you have to go beyond your comfort zone and add more growth assets in your portfolio. However, if there is a gap between the income that your portfolio can generate and your needs, then instead of taking excess equity exposure it is advisable to taper your expenses instead.

An expert financial planner will be able to execute and implement this strategy for you by creating a realistic portfolio which meets your income expectation and risk profile. A combination of debt and equity mutual funds should do the magic.

The secret to a successful retirement is a little bit of planning which can go a long way to turn your retirement into a happy vacation.

 

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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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What are Fixed Maturity Plans (FMPs) and who should invest in them?

Fixed Maturity Plans are a category of debt mutual funds that are currently attracting the attention of Ultra HNI and retail investors alike. With the debt market looking fragile and the 10 year Gsec yield on a back breaking spree, are FMPs the next alternative investment solutions that can save the investors from interest rate risk? Are FMPs for you, read to find out.

Fixed Maturity Plan or FMPs are close ended debt mutual funds that have a fixed maturity period. The AMC launches a New Fund Offer (NFO) and inviting subscription to scheme. Unlike an open ended scheme which stays open for subscription all the time, a FMP remains open for a limited period. The NFO will have a launch date and a closing date till when an investor can subscribe to the fund and after it’s maturity the fund ceases to exist. In the interim, an investor can trade the FMP on the stock exchange.

Where do FMPs invest and what are the indicative returns?

Being a debt fund, FMPs invest in debt securities like corporate and government of India (GOI) bonds, Non Convertible Debentures (NCD), and liquid instruments like T-bills, Repo, Corporate Deposits (CD) and Commercial Papers (CP), based on the market yield and the scheme’s investment objective, an FMP could invest in AAA to A+ rated securities with varying credit risk.

With the 10 year G-sec yields having crossed 7.9% mark, the bond yields too have surged. Now a portfolio of high quality of AAA rated securities can easily give a return in the range of 7.7-8.4% thus making them very attractive.

What is the maturity of an FMP?

The maturity of an FMP is similar to the maturity of its underlying assets. Since the FMP exists for a fixed period which is defined during the subscription of the NFO, it invests in debt securities with similar maturities such that they mature on or before it’s maturity date.

Eg: If the Fund has the maturity period of 1110 days then it will pick instruments that will mature on or before 3 years.

The fund manager of a close ended FMP follows a passive investment strategy where in they buy and then hold securities until they mature. Therefore there is minimum churning unlike in a open ended fund where the fund manager churns the portfolio more regularly based on his strategy and market outlook.

This helps an FMP keep its expenses lower.

How are they taxed?

Most FMPs have a maturity of 3 or 5 years. Being a debt fund, the biggest advantage of investing in a FMP is the indexation benefit that an investor receives after completing 3 years.

Although it is similar to a Fixed Deposit, the tax benefit that an investor earns makes an FMP triumph over any FD or NCDs.

Assume you had invested Rs 10 lakhs in a FD and FMP with the maturity of 5 years. Even though return generated by an FMP is higher, to level the playing field lets consider both had generated a return of 8%.

As you can see from the table above, you can potentially save Rs 1 Lakh in taxes by investing in an FMP. Even for an investor in 20% tax bracket, the post tax corpus earned from an FD would be significantly higher than a bank FD.

What are the drawbacks of an FMP?

Being a close ended fund an investor can’t redeem the units until the FMP matures. However, the investor does have an option of early exit through a stock exchange. For this the SEBI has mandated the FMPs to be listed on the stock exchange. The problem is that there is little demand for them in the secondary market and even when there is a buyer the price offered is lower than its NAV.

So an investor must subscribe to an FMP with an intention to keep their money locked-in for the duration of the fund and with the knowledge that this money would not be needed in the interim.

Also the indexation benefit can be enjoyed only if the debt fund investment has been held for 3 years, so it would be ideal to pick FMP with a maturity of at least 1100 days which is just a few days over 3 years.

 

Who should invest in a FMP?

Unlike a debt fund, an FMP is insulated from the interest rate volatility since the fund manager buys and holds the securities until maturity. Thus the returns of the FMP are less impacted by the price fluctuations triggered by the swinging interest rates of the market.

Therefore, HNI, ultra HNI in the highest tax bracket, retail investors and even senior citizens can benefit from investing in an FMP as the yields offered are competitive and the capital gains are taxed with indexation benefit making FMPs a very attractive investment solution in the tumultuous and uncertain interest rate scenario.

 

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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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Rexit + Brexit & its impact your investment portfolio

Over the weekend there was news that RBI Governor Raghuram Rajan’s term is ending on 4th September 2016. The market clearly does not like surprises, and therefore the impact could be short term volatility in currency,equity  and bond markets. Thus, whilst this is clearly a short term impact to India’s image in the international community and financial investors, we believe there is a list of very eligible candidates who can be appointed. In fact, the events over the weekend are likely to get the government to move much faster on finding an approprite replacement, and thus we believer there is no need of changes in your investment portfolio as a result of this. Ultimately, we believe that institutions are typically bigger than their chief executive.

The event which is likely to have a much bigger impact is the probability of Britain moving out of the European Union.  Over the last couple of weeks, there has been significantly higher newsflow around Brexit and the importance of 23^rd and 24th June for world markets, due to the Brexit. Let’s understand the possible impacts of Brexit on your personal finances.

What is Brexit?

The European Union has 28 countries as its members. European policies currently aim to ensure free movement of people, goods, services and capital amongst its member states. Out of these, 19 members use Euro as its currency. Britain which is one of its members is evaluting whether it needs to stay in the EU or exit. That’s why it is termed as Brexit – ‘ Britain Exit’.

Bexit and your investments

There is a possibility of largely two scenarios in the referendum on the Brexit, that is,  either a leave or a stay. Let’s examine the impact of each of these on your investments separately. As indicated, this will be decided on the basis of a referendum which is going to be held on 23 June – a final decision will be taken on the basis of the votes.

Scenario 1– Leave

• Depreciating Pound and Euro / Strengthening Dollar and Yen– Thus, if you have kids studying in the UK or planning to study there, you couldend up paying lesser.

• Strengthening Dollar

The US dollar could then be expected to strengthen in the short term as investors will rush to Dollar as a safe investment vehicle. If you have any dollar denominated investments then those will increase in value.

• Sell off in the emerging markets

In the short term emerging markets including India , as well as UK and European markets, could experience volatility due to flight of capital to safety . However, the expectation is that impact on India will be lesser compared to the other emerging markets due to its realtively stronger fundamentals. Thus, if you have investments in emerging markets then those might see temporary fall in returns. Do not panic and sell. Over the longer term, the performance of your emerging market funds will depend on the economic scenarios of the individual countries to which your fund is exposed to, apart from the temporary brexit effect.

• Gold could become attractive

Gold is gaining importance as an  investment vehicle with rising global uncertainties. Therefore, Gold Exchange Traded funds, Gold funds and sovereign gold bonds could benefit from this price rise of gold, as well as strength of the US dollar.

Scenario 2- Stay

• Equity markets could react positively

This will ideally mean increase in the value of your equity investments since world markets could do well, as the overhang of the Brexit has led to signficant market volatility over the last few weeks. A relief rally could follow, especially as multiple other EU countries are also at this point looking to see what the UK does with the Brexit.

• Bond markets could be stable

If the brexit does not take place there may not be any selloff in the bond markets which means the yields could remain as is. The higher inflation ovehang on domestic bonds is likely to be the driver of bond prices going forward in that case.

• Euro/Pound sterling could strengthen

There will be increased confidence in European markets and Euro could appreciate. Your Euro denominated investments could do well in this case.

All in all,

Since the outcome is hard to call currently, one may need to track this event carefully, and decide you investment strategy carefully basis the outcome of the referendum. In the short term volatility may be expected to be higher than normal, but do not take panic calls and stick to your asset allocationand overall financial goals and plans.

 

 

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Break your home bias; go global for diversification – article by Vishal Dhawan in Mint

Asset Allocation should also include global stocks and mutual funds as a diversification strategy is always better. Its always good to get the best of all global markets.

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Returning Indians should plan finances meticulously

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Our Market Mantra for December 2014

The year 2014 was mostly a year full of positive events for Indian financial markets which caused the equity markets (BSE Sensex) gaining close to 30% in 2014 . Some of the major events that took place are as follows and our outlook in 2015:

1. Historical electoral results – A strong, pro- growth oriented and business friendly government looks good for economic growth and for businesses. This promise has to translate into big reforms on the ground as most of the early work has been focused on getting the bureaucracy and decisions that were deferred forward.
2. The GDP growth for Q3 2014 expanded to 5.3% from 5.7% in Q2. It is expected to pick up further to 6-6.5% YOY in FY16 with growth over other parts of the world remaining subdued and hence the gap of India GDP Growth with Global GDP growth is expected to widen as seen from the data below:

Source:  IMF, credit Suisse Research, Dec 2014

3. Current Account Deficit (CAD) widened in 2Q FY15 due to widening of trade deficit. However, it is expected to be in a comfort zone in FY16 with falling crude oil prices offsetting high import growth of non-oil and gold.

Source:  RBI, Citi Research, Dec’14

4. Fiscal Deficit for the first 8 months of FY15 (Apr-Nov) came in at 99% of the budget estimate of 4.1% for the full fiscal year. Whilst it is still possible that the government could achieve the target by controlling spending for this year, the fiscal deficit target of 3.6% of GDP in FY16 could be difficult to meet.

Source:  Budget Documents, Citi Research, Nov’14, BE=Budgeted Estimate

5. Earnings Growth: The private sector in India remains in a deleveraging cycle, saddled with excess debt. However, Corporate Earnings should be better than estimates as corporate margins are significantly below the long term averages and should improve gradually as capacity utilization and business conditions improve in the next 2-3 years which is when the full impact of lower interest costs and softer commodity prices will show up in corporate profits.

Source: Motilal Oswal Research, November 2014

The outlook for equities in 2015 could be challenging, but things look promising from a longer term perspective and there is merit in increasing allocation to equities in a phased manner and staying invested. However, every investor should look at their own specific asset allocations rather than specific asset class performances.

6. Inflation declined to a series low due to lower commodity prices, slowdown in consumer demand, low growth in MSPs and falling oil prices. CPI inflation eased to a series-low 4.4% in November 2014 from 5.5% in October 2014 in year-on-year (y-o-y) terms. This primarily reflected a sharp decline in food inflation to 3.6% in November 2014 from 5.7% in October 2014, as well as a fall in core-CPI to 5.5% from 5.9%. In fact, WPI inflation declined to 0% in November 2014.

Source: CSO, ICRA Research

In the December Policy review, RBI kept the rates unchanged and revised the CPI target to 6% for March 2015 and also as per RBI, the risks to the Jan 2016 CPI target of 6% looks balanced. There could be concerns during the first quarter of 2015 as RBI waits for certainty with regards to lower/stable inflation, and fiscal adjustments during the budget before commencing any monetary easing and interest rate cuts. Global concerns over interest rate hike in US and movement of global crude oil prices will also keep investors guessing on the direction of interest rates in India.

Fall in inflation and slow economic growth would lead to cut in interest rates in future. As seen from the chart below, bond yields have moved sooner than policy rates more often. Currently also, the yields have fallen in anticipation of a rate cut.

Source: RBI, Bloomberg

RBI is also targeting a real positive return on interest rates to potentially move savings from physical assets to financial assets. This could mean that a 6% CPI inflation would synchronize with a 7% repo rate – which means a 100 bps cut in repo rate over the next 18 months.

Investors will need to have a sufficiently long time horizon ( 12-24  months) when investing in duration strategies now, especially given that the first 25 bps of the expected cuts are perhaps already in the price.

Thus, we would recommend continuing to stay invested in a portfolio with a mix of longer maturities and accrual funds, which are likely to benefit as interest rates are expected come down in the next 18-24 months.

7. The global equity markets also continue to perform well with US markets reaching new highs. Crude oil prices corrected to a 5.5 year low due to significant new supply of shale gas from U.S., slowdown in global demand, and a reduction in per unit consumption in automobiles due to better and efficient technology. So, there’s enough reason to believe that oil prices will remain favourably low. Obviously, a sharp drop in oil prices can potentially create some pressures in oil exporting countries like Russia and in market players who were perhaps overextended in trading.

Also, lower oil prices reduce inflationary pressures and current account deficits allowing emerging market central banks greater freedom to stimulate domestic economies.

We think 2015 is going to be a year of divergence in economic growth and central bank policy. While the US is leading developed markets growth, Europe and Japan are struggling for growth at this point of time and China is still in search of its sustainable growth formula. So we could have central banks across the globe moving in a de-synchronized manner where US is looking to normalize its interest rate structure, while Japan and Europe will still continue to adopt loose monetary policy conditions to fight deflation in their economy. This divergence in policy action will increase market volatility and require investors to pay more attention to risk management.

8. Currency: Dollar strength and one of the drivers of this trend is the shale gas revolution which US is experiencing and its impact on shrinking the US economy’s current account deficit. This could pose some challenges for emerging markets but stronger fundamentals should limit the financial risks for those emerging market which have already gone through a course correction over the last 18 to 24 months.

Hence, we continue to reiterate to build a well diversified portfolio with having exposure of between 10-15% into international investments to hedge against currency risk.

9. Gold prices could continue to remain under pressure in the short term due to the fear of interest rate hike in US. Whilst the INR currently looks a little overvalued and is expected to depreciate, Gold as an asset class could gain value as it has an inverse relationship with the Indian currency traditionally.

Hence, we continue to believe to have gold as small part of the portfolio for the purpose of diversification and hedge currency risk.

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Market Mantra November 2014

Indian Equity markets once again touched all time highs by crossing the 28500 level on the BSE SENSEX due to various reasons like structural reforms made by strong government, weak commodity and oil prices, inflation easing further, improvement in macros and continued foreign flows on the back of strong  liquidity conditions overseas

Equities:  The CNX Nifty and CNX Midcap increased by approx. 6% in the last one month. The local market sentiment has remained buoyant through the last few quarters as the market anticipates a strong domestic recovery and lower interest rates in an improving policy environment. Various macro factors like GDP growth, Current Account Deficit (CAD), Fiscal deficit (FD), IIP, WPI and CPI are showing an encouraging trend in FY 2014-15, compared to last year FY 2013.

Source:  Citi Research, HDFC MF, Colored rows refer to yearly data; other represent quarterly data

Corporate margins are currently at cyclical lows, and though earnings are still to significantly pick up and may take a few more quarters, better managed companies are starting to show some traction. As corporate margins normalize from depressed levels and as interest rates move lower, current P/Es that look expensive could start to look much more justifiable.

However, it is critical to have a long term horizon for investors buying into equities as always, as there could be volatility in the short term, especially with a consensus positive view on India. A consensus positive view tends to be a good contrarian indicator very often, so having a long term view and holding some cash to buy on corrections could be a good idea.

While the U.S. continues to normalize its monetary policies, the same does not apply elsewhere. To overcome weakness in Europe, China and Japan, the respective central banks are taking steps towards more monetary easing to stimulate growth in their economies.

Emerging Markets like India and China have adopted a more flexible exchange rate system, increased Foreign Exchange reserves and managed their external debt in an efficient way thus far.

Source: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Investors should remain disciplined in maintaining a well-diversified portfolio by investing across domestic and international equities. A global economic recovery should favour equities, especially emerging markets like India and China that are likely to benefit from a global recovery.  Both emerging markets and developed markets should benefit as a result.

Over the long term, the INR should continue to depreciate vs. the USD at nearly the rate of inflation differential between India and US (last 30 years CAGR of INR depreciation vs USD is 5.5 %; inflation differential between India and US is 4.8%). Therefore, we continue to recommend building international exposure in the portfolio for the purpose of diversification and act as a hedge against currency risk.

Fixed Income: While the equity market is on a high, there are good investment opportunities that we foresee in the fixed income market. There are various factors that impact inflation and the table below shows that they are moderating:

Investors should start looking at bonds and bond funds (a combination of short, medium and long term options would be recommended, depending upon investment objectives and risk appetite) as a means of hedging their future reinvestment risks.

Globally the gap between US &Indian interest rates is currently high, yet, a sharper than expected reversal in US interest rates could lead to volatility / challenges for the Indian fixed income markets as well. Foreign portfolio flows into debt have also been at a high for many months now, as can be seen from the graph below, and thus investors need to be cautious about any reversal in fund flows. Thus maintaining a long term view on fixed income investments (18-36 months) wouldalso be crucial.

CPI inflation eased to a series-low 5.5% in October 2014 from 6.5% in September 2014 in year-on-year (y-o-y) terms.  This primarily reflected a sharp decline in food inflation to 5.8% in October 2014 from 7.6% in September 2014, even as core inflation was unchanged at 5.9%.

Source: CSLO, ICRA Research

However, RBI may not cut the rates in the upcoming monetary policy in December unless they are very sure of achieving CPI inflation target of 6% by January’2016. In addition, it may want to reward investors with continued positive real returns of between 1%-1.5% p.a. over and above inflation, which should help monies move from physical assets like real estate and gold to fixed income instruments as well.

Gold: Gold may continue to see downward pressure globally, with weak commodity prices, and less fear amongst global investors. The government has removed gold import restrictions in spite of the fact that gold imports went up significantly in the last festive month to $3.75 billion. Hence, allocating only a small portion of your investments into this asset class continues to be a good strategy in our view.

We came across a very interesting table recently showing the returns on CAGR basis and the risk measured by standard deviation over 1, 3 and 5 years holding periods of the BSE SENSEX, 1 year SBI Fixed deposit (FD) and Gold in INR terms for the last 30 years:

Source: Bloomberg, HDFC MF

As you can see from the above data that:

FDs vs Gold: Fixed deposit returns are very close to the Gold returns in the last 30 years; however the volatility or risk in gold is much higher compared to the risk in FD. Hence, Gold is not a superior option compared to FDs to invest in from a risk perspective.

Equities vs Gold:  Long term returns on equities are much higher than returns on gold (appreciation in Sensex was 5x of gold*). Volatility of equity returns is high but to a lesser extent (3x over 3 year holding periods and 2x over 5 year holding periods). Equities are therefore a superior asset class compared to gold for long term investments and for those with tolerance to volatility.

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Market Mantra October 2014

India equity markets celebrated Diwali in style, with the Nifty regaining the 8,000 mark and the Sensex moving above 27000.

There was plenty of positive news flow from India like the Government announcing a series of policy reforms including diesel deregulation, gas price hikes and e-auction of the cancelled coal blocks. The victory of the BJP in the Assembly elections in Maharashtra and Haryana too buoyed sentiments.

Equity:

Nifty increased by 1.02% whereas CNX Midcap increased by 1.44% during the month.

The Price to Equity ratios continues to show that equity market valuations are above 20 Year average and it is therefore critical to see earnings pick up to justify current valuations . Early signs show that it is starting to happen as you can from the chart below on both PAT and EBITDA margins for Nifty companies:

Source: Motilal Oswal Research, 2014

In the graph below it is very clear that investment growth has picked up recently in India compared to some of the other emerging markets (like Brazil, Russia and Mexico), but needs to rise further for economic growth to improve structurally.

Source: Morgan Stanley Research, October 2014

Global economic growth woes continued – the IMF downgraded its economic outlook on the globe due to weaker than expected global activity in the first half of 2014, along with ongoing Middle East tensions, the Ukrainian and Russian standoff, along with the Hong kong political unrest. The new epidemic disease Ebola is also a big concern in U.S, African and European countries. News from Europe also continues to be challenging. The US ended its bond buying program but maintained its stances on keeping interest rates low for a considerable period, in line with market expectations. Whilst it is very tempting to move to a 100% domestic portfolio in this environment, we continue to recommend to have at least 10% of the portfolio invested globally for the purpose of global diversification, as well as act as a hedge against currency risk.

With projections of GDP growth of 5.5 percent in FY 2014–15 and 6.5 percent in the following year, Q2 2014 GDP growth came at 5.7%, above the consensus expectations. We believe that the Indian economy is on the cusp of a growth uptrend and this will contribute to growth in corporate earnings as we have shown in our charts above in this article and hence will justify strong performance of Indian equities, especially with oil and commodity prices coming off. However, it is critical to keep you asset allocation intact.

Source: MSCI, Credit Suisse, I/B/E/S, FactSet, J.P. Morgan Economics, J.P. Morgan Asset Management “Guide to the Markets – Asia.”

Fixed Income

CPI inflation eased to a series-low 6.5% in September 2014 from  7.8% in August 2014 in year-on-year (y-o-y) terms and Core-CPI inflation (excluding food, beverages & tobacco and fuel & light) declined significantly to a series-low of 5.9% in September 2014 from 6.9% in August 2014 (refer chart below)

Source: CSO, ICRA Research

Inflation related to fuel & light moderated to 3.5% in September 2014 from 4.2% in August 2014 in y-o-y terms. Softening of prices of various commodities including crude oil and domestic fuel prices would benefit the CPI trajectory in the near term and hence we continue to expect the Reserve Bank of India’s (RBI) January 2015 target of restricting CPI inflation below 8.0% to be achieved.

Nevertheless, the probability of a Repo rate cut in 2014-15 remains low, as the RBI is likely to continue to focus on containing inflationary expectations to improve the likelihood of restricting CPI inflation below the January 2016 target of 6.0%.

The below chart shows the Interest rate differentials between US and India:

Source: Axis Mutual Fund

There is a fear that higher US rates will draw FII money away from India. This is not borne out by history. During 2004-06 even with rate hikes money continued to flow into India from FIIs. Secondly, back in 2004 at the start of the cycle, US rates were at 1% and Indian rates were at 4.5% implying a 350 bps differential. By the end of the Fed rate hikes, the rates were respectively 5.25% and 6.50% implying a differential of just 125 bps. In contrast currently the US is close to zero (officially the overnight target is 0 to 0.25%), while RBI is at 8%, a differential of nearly 800 bps.

Hence, we recommend having the fixed income portion of the portfolio comprising of both accrual and duration strategies where accrual strategies will lock into current high interest rates and duration strategies will start benefitting once the interest rates start coming off over the next 12-24 months.

Gold:

Demand for Gold has seen a rebound in recent days in India and China. India celebrated Diwali, the biggest gold buying festival  which boosted physical demand for the yellow metal on support of low prices. Meanwhile, a surge in Gold imports pushed up the India’s trade deficit for September to $14.25 billion of which Gold imports accounts for $3.75 billion. This raises questions on whether there can be some quantitative restrictions or higher import duties put on gold , to bring down the demand. Hence, allocating only a smaller portion of your portfolio in Gold continues to be a prudent strategy.

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