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Posts Tagged ‘debt & bond instrument’

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.

Break your home bias-page-001

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RBI has , last night, once again introduced measures to tighten liquidity, so that the fall of the rupee can be controlled by removing liquidity for possible speculation on the rupee. Whilst this may seem like a localized response to many and unique to India, it is important to note that similar measures have been announced in Turkey, Brazil, Indonesia and China in different forms. Bond markets in India have reacted sharply to these tightening measures and are likely to do so every time these measures are announced. However, it is important to look at this from a historical perspective as the widely held view is that these measures are temporary in nature. If one looks at past measures of currency defence by the RBI, and the resultant measures and periods that it takes to reverse such measures, it provides some interesting insights. Four periods have been considered here:

1. 2011-12, when the rupee depreciated after the emergence of the Euro crisis and the US debt downgrade.

2. 2008, during the period of high oil prices and the global financial crisis.

3. 2000, post the tech bubble bursting

4. 1998, in the aftermath of the Asian financial crisis

PERIOD

DATE OF MEASURE

RBI’s ACTION

BOND YIELD IMPACT

REVERSAL DATE

PERIOD RUN

1998: Asian Financial Crisis

Jan 1998

· Increase in bank rate by 200 bps· Increase in CRR by 50 bps · Immediate increase in yields· But within 1 month yields decreased though it took a few months to fully normalize Mar 1998 · Policy: Approx. 2-3 months· Bond Market: 1 month
2000: Tech Bubble

July-Aug 2000

· Increase in bank rate by 100 bps· Increase in CRR by 50 bps, 25 bps immediately reversed · Immediate rise in yields· Yields peaked by Nov 2000

· But reached a new low within 6 months

Feb-Mar 2001 · Policy: Approx. 6 months· Bond Market: 2-3 months
2008: Global Financial Crisis

Jun-July 2008

· Increase in repo rate by 125 bps· Increase in CRR by 75 bps · Immediate rise in yields, however rates peaked before the last rate hike· Yields set a new low within 2 months of rate hike Oct 2008 · Policy & Bond Market:Approx. 1-2 months
2011-12: Aftermath of the US Debt downgrade

Sep-Dec 2011

· Increase in FCNR & NRE rates· Increase in repo rate by 100 bps · Yields peaked in Nov 2011bu reversed all losses by end Dec 2011· But reversed all losses by end of Dec 2011 · CRR cut in Jan 2012· Repo rate cut in April 2012 · Policy : Approx. 6 months· Bond Market: 2-3 months

Source: Bloomber,RBI, Axis Mutual Fund

As you will see from the data above, whilst bond markets sold off in response to RBI measures, bond yields typically peaked very soon after the policy actions and resumed the downward trend soon after. The total period of the bond market stress was 1-3 months, whilst RBI itself reversed the measures within 2-6 months. Thus, all these measures were temporary and were reversed when it became apparent that the impact on the domestic economy was worse than the marginal impact on the exchange rate.

Therefore, from an investor perspective, it is important to view your holdings in bonds and bond funds keeping this perspective in mind ie if you have a short term holding period, you need to be concerned about the volatility, but if you have a long term horizon, and are using bonds and bond funds as a part of your overall asset allocation strategy, you should look at these opportunities to buy into this volatility over the next few months.

Of course we should not forget what Warren Buffet once remarked “If past history was all there was to the game, the richest people would be librarians.”

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WHETHER YOU are an existing investor in the stock market with a substantial amount of your money invested either in stocks directly or equity mutual funds, or an investor who has been thinking about investing in stock markets but waiting for the right time, investors are looking for insights on whether it is the right time to buy or sell equities or just maintain existing portfolios as they are.

There are no easy answers to this. In fact, the answer to this question becomes even more challenging when you consider three things:

  1. Fixed income returns from bank deposits, FMPs and other debt/bond instruments are in the range of 9-10 per cent per annum. Of course, this return would be lower depending on the tax bracket in which you fall as the returns from these instruments are likely to be subject to tax, but they are nevertheless at close to the highest level that they have been for the last few years.
  2. News of a slowdown coming in from global economies like the US and Europe, as well as domestic news from India of a slow-down due to high inflation, high interest rates and slow decision making by the government are becoming a daily phenomena. As an equity investor, bad news on any of these sources, whether international or domestic, causes an impact on Indian stock markets as well.
  3. Gold has been breaching new highs regularly. With the known Indian affinity for gold and the temptation to invest in the option that is giving the highest rate of return currently or has done so in the recent past, there is a temptation to enhance gold exposure further.

Past evidence from Indian stock markets shows that returns from stock markets over short periods of time are extremely unpredictable.

In fact, the probability of getting this right is very similar to the probability of being able to call heads or tails accurately on a sustained basis when you toss a coin.

However, as you stay invested for longer periods in stock markets, the returns become far more predictable and the growth of companies and their profitability tend to have a direct correlation with the movements of the stock markets.

Therefore, if you are investing for a long term goal like an education for your child a decade away or for your retirement twenty years from now, equities continue to be one of the best options for you to consider to achieve those goals.

However, if you have a goal that is short term in nature like a marriage two years from now for a child, avoid stock markets and use the high fixed income rates that you have at the moment to secure your goal.

While it is very tempting to try to exit the stock markets at this point and re-enter at lower levels, it is critical to remember that stock market returns tend to be very lumpy, that is, most returns come from very few days.

To illustrate this point further, over the last 11 years, if you had stayed invested for the entire period, your equity returns would have been close to 16 per cent per annum, but if you missed the best 25 days in the last 11 years, your rate of return would drop to less than one per cent per annum.

As a result of this, unless you have very significantly overvalued stock markets, it may not be a good idea to exit. At this point, since Indian stock markets are trading at valuations which are in line with long term averages, it may not be prudent to try to time your exit and re-entry.

This article was written by Vishal Dhawan, CFPCM and appeared in the Asian Age on 23rd July 2011 .


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