Why investors do not make good returns II

 It has been time and again established that good returns are seldom made on investments made in good times. Rather good investments are typically those that are made in adverse market conditions.

There is a fair value of companies—both for listed and non-listed. When the economy is booming companies trade above their fair value and below the fair value when the economic condition is not good just like the present times. 

Markets revert to the mean or fair value over long term. They do not sustain at either overvalued or undervalued levels.  Hence, if they do revert to fair value only then will an investment made during bad times yield good returns.  

Given below is the proof that good investments made during adverse market conditions (when P/E ratio is low):-

Table 1:

Y.E. 31ST March	Sensex	I year Forward P/E	3 year CAGR (%)	5 year CAGR (%)	EVENT	Equity MF Inflows (Rs. In cr.)
2000	5001	24.20	(-)15	5		10058
2001	3604	15.80	16	26		22161
2002	3469	12.10	23	30	Global markets meltdown in aftermath of 9/11 attacks. Unexpected NDA defeat	8763
2003	3049	9.20	55	39		118
2004	5591	12.50	33	12		7205
2005	6493	12.00	34	22		7398
2006	11280	15.90	-5	12		36155
2007	13072	15.40	10	6		29916
2008	15644	20.30	8	4		52701
2009	9709	12.10	21	NA	Sub prime crisis. Collapse of Lehman Bros	4084
2010	17528	17.70	2	NA		1456
2011	19445	17.40	NA	NA		(11795)
2012	17404	14.20	NA	NA		504
2013	18836	14.00	NA	NA	QE tapering Concerns on Indian economy High inflation Falling rupee High fiscal deficit & CAD	(14731)

(Source: - HDFC Mutual Fund)

  

Is high P/E investing the only reason why investors do not make good returns? We AT AIMS believe there are other factors that lead to low returns for investor. Some of them are as under:-

• Decision to buy based on past performance: - A majority of investors/prospects that we have met to date invariably look up past performance before taking the buy decision. If the fund has performed well during the past, then they strangely enough feel confident to invest. Disclaimer made by mutual funds that past performance may or may not be sustained in future is usually overlooked. They forget that you cannot drive a car by looking at the rear view mirror.

• Bankers are more knowledgeable compared to IFAs: - The common perception amongst the investors is that bankers are more knowledgeable than IFAs. They feel more comfortable dealing with banks rather than their friendly neighborhood advisor. There are innumerable stories of gullible investors having been mis-sold investment product by their banking RM.

• Flight to “safety” during downtrends:-  Over last 1-2 years fixed deposits and tax free bonds have witnessed record inflows, contrast this with the fact that equities has seen huge outflows and closure of folios. As a result, investors do not have liquidity to buy equities when the market is low.

• High P/E investing is good (?):-How can an Indian MF investor hope to make money when he buys high and sells low. Indian Mutual Fund industry has got record inflows only during the period P/E were at all-time high. In Indian context, a P/E ratio of up to 15 is considered to be safe zone for investing, while a P/E between 15-20 is considered to be cautious zone; and beyond that is considered to be red zone. A look at Table 1 above shows that while inflows were mere Rs. 118 crores in 2003, they rose dramatically to Rs. 52700 crores during 2008 when the P/E were 9.20 & 20.3 respectively. Inflows into equity MF again were reduced to a trickle in 2012 to mere Rs. 504 crores.

• Does FII have more faith in our economy than we do: - We always tend to blame FII when our markets go down! We still haven’t found answer to the eternal question--- what will happen to the market if FII decide to exit lock, stock & barrel? If they haven’t exited after 20 years of upheavals, then we believe chances are they are here for good!

Despite many ups and down in the Indian and world economy, FIIs have been consistent in their investments.  They have withdrew only on a few cataclysmic events like

•     2002 on the eve of global meltdown due to  9/11 attacks
•     2009 due to economic crisis in USA & collapse of Lehman Brothers.

 Looking at the FII flows in India, one can easily conclude that they are more confident of the Indian economy than us. Over less than 2 decades, they control about 20% of our equities.

Y.E. 31st. March	2002	2003	2004	2005	2006	2007	2008	2009	2010	2011	2012	2013
FII owner ship	13	13	16	17	19	20	18	15	17	18	19	21
FII flows (Billion $)	1.70	0.50	9.6	9.40	11.1	5.80	13.10	(11.00)	23.40	25.20	8.40	25.90

(FII’s were allowed to invest from September 1992 onwards; shareholding of FII not available from 1992 - 2000). Source: - HDFC Mutual Fund)

The flows may have been irregular, but they have been fairly consistent.  Even if we had just mimicked them, we would have made more money.

Let’s try to reason why FIIs are so bullish on India

• India offers significantly higher growth than world growth.
• Favorable demographics, rising affordability, low penetration of consumer goods, rich natural resources, large size are some of them.
• By 2020, India is expected to be 6^th or 7^th. Largest economy in the world.

 They have personified the quote “time in the market is more important than timing the market”.

It’s time we accept the fact that there’s certainty of returns from equities. The timing of return is however uncertain.

Peter Lynch had said –“I've found that when market’s going down and you buy funds wisely, at some point in the future, you will be happy. You won’t get there by reading “Now is the time to buy”. These things never go off that way”.

Compelling case for investment in bond funds

10 Year Benchmark has been trending higher after the credit policy announcement of 29^th October 2013.

Key factors that drove the benchmark yield to 9% levels:

• Indian rupee has been under performing against the US dollar in the first half of November’13.
• Rs. 75,000 crores of bond supply in November
• Continued FII selling of Indian debt securities.
• Switching to new 10 year benchmark. Market participant have been switching out of current 10YR benchmark (7.16% 2023) and into new 8.83% 2023. This has resulted in narrowing spreads between them from around 30 bps to near parity presently.

We believe the above factors caused the benchmark yield to rise to 9%.

What’s next?

The chart given here below of benchmark 10Yr G-Sec (from Nov 2003 to November 2013) makes a compelling case for investing in bond funds when the yields are hovering above 9%.(9.05% as on 12/11/2013)

Consider the following data points:-

Period of observations		From 29/11/2003 to 19/11/2013
Total No. of observations		2512
No. of days when 10Yr yield closed above 9%		37
Average YTM in last 10 years		7.48%
Mean YTM in last 10 years		7.74%

(Source: - DSP Blackrock Mutual Fund)

It is worth noting that the benchmark closed above 9% only 1.47% of the time i.e. on 37 days out of total 2512 trading days during the last 10 years.

Another perspective of the rare opportunity:-

Last 10 yr. G Sec yield Range		% of occurrence
5-6%		9.47%
6-7%		12.35%
7-8%		44.85%
8-9%		32.16%
9-10%		1.40%	A rare opportunity

          (Source: - IDFC Mutual Fund)

So when  would you invest in bond fund—at a level when there is maximum occurrence of attractive yields with less scope for making returns. Or when the occurrence is just 1.40% of the time in last 10 years—thus presenting good scope for discerning investors to make good returns.

An over view of the 1 year return generated by bond funds (from say IDFC MF stable when the yield touched/crossed 9%

From	15/07/2008	01/08/2008	14/11/2011
To	14/07/2009	31/07/2009	13/11/2012
10 Yr. G Sec yield on from date	9.47%	9.26%	8.97%
Returns generated by
IDFC Dynamic Bond Fund	19.12%	18.33%	11.99%
IDFC SSIF—IP	13.48%	13.16%	10.71%

(www.valueresearchonline.com)

The current yield of 9% is like an index level of 15000 on Sensex. What should be the correct strategy at such levels---redeem or invest more?

Conclusion:-

Risk reward ratio is in favour of investors who invest in bond funds at present yield levels. A limited period discount offer is presently open.

Recommendation:-

We strongly recommend investments in bond funds at the current 9% YTM of benchmark 10Yr. G Sec. Following are our recommendations:-

·         IDFC Dynamic Bond Fund

·         IDFC SSIF—MT

Opportunity favours the prepared mind. We are prepared. Are you? 

Is your income Tax return complete?

Let us assume for a moment that today is 31/07/2013—the last date for salaried employees like Mr. Sinha to file their income tax returns.

Mr. Sinha is a typical salaried employee in a senior position with an Indian conglomerate. He diligently files his returns and pays income tax due on his income.

Mr. Sinha is relaxed and satisfied that today he has fulfilled his duty of duly filing his income tax return having submitted the Form 16 to the agency appointed by his employer for bulk filing of tax returns. He is not averse to paying the tax on his income (from salary) and believes that since the tax due on his salary is being deducted by way of TDS, filing the return is just a formality.  

Mr. Sinha was surprised to receive a demand notice from the income tax department. There was a difference in the total income as disclosed in the return and Form 26 AS (Annual statement of TDS) as compiled by the income tax department.

He approached us with all the relevant papers and requested us to reconcile the difference.

Upon scrutinizing the papers furnished to us, we discovered that the difference in income was on account of

·         Interest earned on bank fixed deposits; and

·         Capital gains on mutual fund investments and dealing in shares

The interest income along with capital gains(long term or short term) should have been separately reflected in the return and gross taxable income been calculated thereafter.

Since, Mr. Sinha travels extensively on office work; he chose to file his income tax returns through the agency appointed by his office which was convenient--and not through a personal financial and/or tax advisor for his taxation matters.

Mr. Sinha argued that bank had deducted TDS @10% just like his employer. We pointed out that since Mr. Sinha was subject to 30% tax bracket, the tax department was well within its right to send a demand notice.

We would like to point out here the penal provisions under the Income Tax Act. The income tax officer is empowered to levy a penalty of a minimum of 100% of the tax sought to be evaded and it can go as high as 300%. Mr. Sinha is not only liable to pay tax on income which was not reported—even though inadvertently—but also pays an equivalent amount more as penalties.

The penalty provisions can however only be invoked if the ITO is of the opinion that the assessee had furnished inaccurate particulars or concealed details of other income in his returns.

It is the duty of the assessee to record all transactions during a financial year so that true income can be declared in the returns every year. In absence of this, the income tax department is well within its right to levy such penalties as it deems fit. 

What can make or break your retirement planning---YOU

 With present high inflation and low business environment, everybody is talking or thinking about their likely retirement picture.

Retirement planning, supposedly, is a road map that helps you understand, visualize and work towards a financially independent post retirement life. Theoretically speaking that is.

A plan template assumes certain factors which are common. However, just like fingerprints, retirement planning roadmap is different for every person. Past experience and current environment can certainly be of some help in devising a strategy which is based on certain guiding principles and lots of commonsense.

Laying down the guidelines—rather than be of help-- may themselves impede the retirement planning process. One of the biggest roadblocks to setting up a workable retirement planning strategy is—YOU.

For instance:-

• You may have assumed average inflation to be 8%, while actual inflation can be and is actually higher than the assumed rate.
• Working with an average rate of return on equity component.
• Visualizing a non-volatile & rather linear debt fund returns.
• Assuming that the PPF and LTCG (Equity) will be tax free forever.
• Ignoring tax on annuity/pension.

And the list goes on and on and on………

None of that is said above will affect your plan as much as you will.

Yes. You and me---we.

It is you and me that can and will make or break the retirement plan-- 

•  Pre-eminence of real estate in the total portfolio 

Indians have been traditionally inclined towards gold and real estate as fail safe investments. You just cannot go wrong with them in your portfolio. 

As if one house used for self-occupation is not enough, people buy a 2^nd.  or even a 3^rd. house for investment. Most people do not realize that many so-called one-time purchases come with regular expenses tagged!  One common example is maintenance charges and other expenses associated with a bigger house.

Nothing wrong with this, everyone wants to enjoy the pleasure of life as they earn more.  However (there is always a however!), any increase in annual expenses (other than that caused by inflation), must be immediately taken into in the retirement plan-something that is given a pass by.

Of course, an increase in annual expenses obviously means we need to invest more each month for building a bigger retirement corpus to account for our present lifestyle.

•  Zero tolerance to compromising present lifestyle 

One of the basic tenets of retirement planning is that you will maintain your present lifestyle into retirement. Calculations for retirement corpus are based on current expenditures and hence, present lifestyle. The idea is to arrive at a retirement corpus that will at least live till you do.

A good figure to compute in spread sheet. What most people fail to realize is that the key requirements of a retirement corpus intended for a future lifestyle, imposes constraints on the individuals present lifestyle.

It is quite common for us to regularly upgrade our car, televisions, mobiles etc. in tune with changes with our incomes. Nothing wrong in that except that it is quite likely that our incremental annual expenses increase at a rate much greater than assumed inflation.  Unfortunately, these additional expenses would increase with inflation too!

It would be prudent to recognize that most lifestyle changes are difficult to reverse and hence must be factored in while planning for retirement. In absence whereof rest assured that your life style in your twilight years will not be as comfortable as your present one.

Hence, beware of yourself. The choices that you make today can impact your future in more ways than you can possibly imagine.

• Pre-eminence of real estate in the total portfolio; and
• Zero tolerance to present lifestyle

are not the only factors that influence your retirement plan.

Watch this space for more as picture abhi baki hai.