Why You need a Long Term Investment horizon?

In today’s volatile environment which largely stems from economic uncertainties from global markets, be it the Yuan devaluation some time back or Brazil being downgraded to junk or the September Fed meet on which everyone had an eye which resulted in no rate hike at the moment. The thing which most investors lose focus on is something that is called as long term investment perspective. By investing for the long term one will not try to time the market. Nobody can. We all know the simple rule of investment – buy at low and sell at high but invariably we tend to do it the other way round.

While focusing on short term we tend to buy stocks which have all the positive news around it and little do we realize the half of the time that news has already been priced in. If we focus on the short term our investments are bound to react to events in the short term both positive and negative. Whereas if we focus on the long term the returns will be impacted less by volatility and more by the performance of the investment instrument.

As per tax laws holding stocks beyond one year is categorized as long term but when it comes to investment an investment horizon of 3 – 4 years or more can be considered as long term. On the other hand when it comes to real estate it is far beyond that. Gold is another asset class but again it depends in which form it is held, whether in physical form as ornaments or in the form of ETFs.

Historical data also shows SENSEX had jumped 250% from April 1991 to March 1992 on the back of Harshad Mehta scam. He took crores of rupees from the banking system and pumped it in the market. The scam came to light when the State Bank of India reported a shortfall in government securities. That led to an investigation which later showed that Mehta had manipulated around Rs 3,500 crore in the system. On August 6, 1992, after the scam was exposed, the markets crashed by 72 percent leading to one of the biggest fall and a bearish phase that lasted for two years.

Similarly, from April 1999 to March 2000 SENSEX rallied 35% on the back of improving macroeconomic scenario – improved GDP numbers from growth in manufacturing, infrastructure and construction sector, falling inflation, healthy forex reserves and good industrial production numbers as against the year before and also the technology bubble was engulfing the rest of the world.

Again SENSEX fell 27% in March 2001 when the Ketan Parekh scam took place. A chartered accountant by training, Parekh came from a family of brokers, which helped him create a trading ring of his own. Be it investment firms, mostly controlled by promoters of listed companies, overseas corporate bodies or cooperative banks, all were ready to hand the money to Parekh, which he used to rig up stock prices by making his interest apparent.

Again in Feb 2008 SENSEX corrected by 8% approx on the day Reliance power Ltd. got listed. It closed 17% below its cost. Sensex witnessed a fall of approx 36% from 2008 to 2009 on the back of US Subprime crisis.

Following that there was a sharp pull back in equities between March 2009 to November 2010 led by global (Quantitative Easing announcement by US) and domestic (general elections) news flow. Putting all the pieces together the message to take away is that events will keep on happening but if one keeps a long term investment horizon it will be a safer bet.

The two main factors to consider before taking an investment decision for one self are ability and willingness. It is very important to know the difference between the two. Willingness is more about the attitude towards risk irrespective of the financial ability to do so. Ability on the other hand is financial capacity to bear the risk. It depends on income of the individual, his savings and expense pattern. It depends on the amount of money which one can keep aside purely for investment and not dip into it time and again for personal needs and can hold on to it even if they are not doing good at a particular point in time.

But again the point to note here is that if a particular investment is consistently a poor performer, one should plan an exit from the same and reinvest it in another suitable option. If one is not very good at deciding which stock to invest in and what the best time to do so is, then there are professionally managed mutual funds with different investment objectives from which one can choose.

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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 December 2013

December was a month of expectations being different from reality. There was a widely held view that tapering in the US would be deferred for a while, till the new US Federal governor Janet Yellen settled down into her new role. However, after keeping investors guessing for several months on when and how much the US Federal Reserve will taper its $85-billion-a-month bond buying program, the Federal Open Market Committee ( FOMC ) finally decided to start tapering its third round of quantitative easing by $10 billion a month from January 2014 onwards. FOMC made this decision because of the reduction in unemployment since the start of QE3 (quantitative easing) and the stronger non-farm payrolls in recent months. Of course, this means that the US recovery is well on track now, and that is good news for the global economy, considering the significant size of the US economy and consumer.

In India, the widely held view was that continuing his fight against high inflation, Raghuram Rajan would increase interest rates once again to quell inflationary expectations. However, Rajan surprised the markets by maintaining status quo, though he kept his options open, including discussing the possibility of a hike between policy meetings if the data so warranted.

Domestic Equities: The Indian Equity markets saw various ups and downs in 2013 on account of FED tapering concerns and general elections.

For the year to 26th December, BSE Sensex Index gained approx.  8.50% where CNX Midcap lost close to 6 %.

Recently concluded elections of 5 states (MP, Rajasthan, Chattisgarh, Delhi, Mizoram) have seen big gains made by the BJP at the cost of Congress. This has enthused investors as it improves the odds of a likely stable government at the centre following the next general election in 2014. The surprise element of the Aam Aadmi Party (AAP) winning a disproportionate share in Delhi and thereby forming a government, augurs well for the democratic credentials of India.

The last time around, the Fed tapering created its own challenges and volatility but India looks much better prepared now for Fed Tapering due to following factors:

1. Current account deficit for FY14 is likely to be around 2.7 percent of GDP, much lower than.
2. FII INR debt holding is lower at $20Bn v/s $37Bn than in May 13.
3. Accretion of USD 34 billion through FCNR bank deposits against a targeted USD 15 to 20 billion
4. Lower oil prices and inclusion of Indian government bonds in JP Morgan Government bond Index- Emerging Markets are other potential  positives.

Indian Rupee: The Rupee went through a sharp correction in 2013 on Fed-taper concerns. Recent months have seen much more confidence on the government’s ability to manage the funding shortfall and hence a return in stability of the rupee, as the Rupee valuation has become supportive and the Current Account Deficit (CAD) has come down sharply. Markets are expecting the Rupee to be much more stable in 2014 even as Fed carries out its tapering of QE. Inflation differentials between the US and India will continue to drive the value of the currency moving forward, even though there may be shorter term deviations using this model.

Gold:  Gold prices remain under pressure due to both fundamental factors (normalization in US interest rates) as well as technical factors (redemptions from gold ETFs). Gold continues to be an important component of an asset allocation strategy, and should be maintained at 5-10% of the overall portfolio.

On Fixed Income: Year to 26th December, 10 Year Government security yield lost close to 14 percent.

The annual consumer price inflation rose to 11.24 percent in November from 10.09 percent in October, driven by food prices. WPI Inflation rose to 7.52 percent in November from 7.00 percent in October. Hence, it was expected that the RBI may once again raise the repo rate in the monetary policy review on December 18, 2013 which is currently at 7.75 percent. But, RBIs move to keep rates unchanged surprised the markets as it came in contrary to consensus expectations of at least 25 bps hike. However, RBI has chosen to wait for more data as there are indications of vegetable prices turning down sharply as well as the weak state of the economy.

Key drivers of Improving Interest Rate Outlook:

Inflation – sharp moderation likely in Year 2014

CAD (% of GDP) – sharp improvement (2.7% in FY14E Vs 4.8% in FY13)

CAD Deterioration was led mainly due to rising gold imports (2.9% of GDP in FY13 Vs 0.5% in FY08).

Fiscal Deficit Improvement: diesel subsidy is the key.

Yield Spread between Indian 10yr G-Sec Yield and 10yr US Treasury Yield is @6% Vs long term (10yr) average of 4.1%.

Summary of Interest rate drivers – Outlook

All the above indicators point towards lower interest rates in CY14. Thus adding some component of longer term bonds and duration/income funds can be considered with a 18-24 month view.

US Equities: For the year to 26th December, Dow Jones and Nasdaq gained close to 26 percent and 41 percent respectively. Whilst it has been a spectacular year, the outlook on US equities continues to be positive. However, we are unlikely to see returns in 2014 anywhere close to what 2013 provided. Building a globally diversified portfolio across the US, Europe and Asia continues to be strongly recommended.

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History- Don’t forget the learnings from the past.

 

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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Is crashing market good to buy or sell?

AS I walked through a multi brand garments mall, I found that most shoppers had bags that were over flowing with clothes of different shapes and sizes. The salary increases and bonuses were probably being put to use. And of course, the big draw.

However, things in the financial markets seemed very different. With the sharp correction in recent weeks on the back of the concerns around the long-term sustainability of the European Union having brought the prices of a large number of stocks down significantly, there seemed to be a dearth of investors willing to buy.

Stock markets have historically been a place where the number of people buying decreases with the drop in price.

Thus, a 30 per cent sale in the stock market does not normally see investors stocking up like they do when they see the discount sign in a shopping store. Remember the sub 10,000 levels on the Sensex in the end of 2008 and early 2009. So what should one do, when stock markets are falling and doomsday scenarios are being predicted?

It actually depends on the time horizon that you have with respect to your financial goals.

For financial goals that are at least five-seven years away  stock sales should be used as buying opportunities to add to your existing portfolio.

It would be a good idea to use index funds or diversified equity funds with good track records to build this exposure. In case you already have SIPs running in quality funds, consider adding exposure to the funds to average down your purchase costs.

Remember, that despite all the trying conditions, that we have seen inIndiaover the last decade, the Sensex has delivered an annualised return in excess of 15 per cent over the last 10 years and a very large number of funds have delivered returns in excess of 20 per cent per year.

For financial goals that are less than five years away — If the goals can be compromised/moved ahead like a planned foreign holiday, any other discretionary goal— you could stay invested or even consider adding exposure to stocks as the case may be.

However, in case the time frame cannot be compromised, for example a planned education or marriage, it may be advisable to reduce equity exposure despite the fact that the equities have corrected significantly and move the monies to fixed income instruments so that the goal is not compromised.

For investors who do not wish to actively manage their portfolios, they could also consider using balanced funds or dynamically managed products for long term goals, wherein the fund manager automatically rebalances the portfolio at periodic intervals.

So the next time you see a sale in the stock market, consider loosening your purse strings.

This article was written by Vishal Dhawan, CFP^CM and appeared in the Asian Age  on  29^th May 2010 .

 

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