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Wednesday, April 26, 2017

How to meet long term fixed income goals

For most people, investing is about identifying undervalued investments(stocks, real estate etc) and entering. The areas of position sizing, entry price, portfolio allocation and exit criteria is hardly considered. Additionally,dynamic portfolio allocation, wealth preservation and tax efficient withdrawal are essential parts of a wealth management strategy but due to behavioural finance quirks, are not optimized. Hence, one has the challenge of purchasing different products for different needs, and these products often have different providers, time horizons, design frameworks and regulators, thus leading to cognitive overload by the poor individual investor who has to juggle term plans, FDs, liquid funds, pension funds, equities and insurance. What if one could maximize post tax investment returns, without sacrificing portfolio rebalancing flexibility and liquidity needs?
Let’s consider the case of Mr Akash, aged 30 years,earning Rs 50,00,000 net salary per year, who is in the maximum tax bracket of 30%. He wishes to retire early at the age of 50, but would like to fund some commitments such as children's education, marriages etc. Considering his overall financial position and goals, his financial planner suggests an allocation of 2% of annual income, to fixed income. Now, fixed deposits would lock in the rate for maximum 5-7 years, but exposes him to reinvestment risks. Unlike institutional investors, he cannot purchase a 30 year GSec bond which would give him that locked in return. And even if he directly purchased it, his post tax returns would fall below 4%. His goal is to lock in long term interest rates, but also ensure the investment continues even in the event of death, or inability to pay the annual contributions due to accidental disability, critical illness etc.Also, having seen how some friend's dependents had not been able to effectively utilize the lump-sum maturity payouts, he wishes to stagger the maturity payouts so that in the unfortunate event of death, his family will get the money in instalments and hopefully spend the money prudently. And if he is still alive then as expected, his other investments permit him the luxury of staggering these proceeds. 
Any bank product would not give him protection against inability to pay premiums, nor does it give him any 'upside' compared to merely purchasing a long term bond fund. Hence,desiring guaranteed returns over a long horizon with tax benefits, Mr Akash decides to check the Edelweiss Tokio Life GCAP plan on the advise of his planner. 
The following table shows the IRR obtained basis quote for 30 year male who pays Rs 1lakh/ year for a 10 year premium paying term, and who gets the maturity benefit at the end of year 20.The quotation is sourced from https://www.edelweisstokio.in/product/planned-future/gcap as of 28 Mar 2017, and might be subject to change. 




Post Tax yield
5.68%
Year
Discount Factor
Cash Flows
PV
Remark

1
                       1.00
          (100,000)
        (100,000)
Premium at start of year

2
                       0.95
          (100,000)
          (94,624)


3
                       0.90
          (100,000)
          (89,538)


4
                       0.85
          (100,000)
          (84,725)


5
                       0.80
          (100,000)
          (80,170)


6
                       0.76
          (100,000)
          (75,860)


7
                       0.72
          (100,000)
          (71,782)


8
                       0.68
          (100,000)
          (67,924)


9
                       0.64
          (100,000)
          (64,272)


10
                       0.61
          (100,000)
          (60,817)


20
                       0.33
         2,384,564
          789,716
Maturity benefit at end of year



Total NPV->
                       2


Comments:




This includes insurance benefit(Since product offered by an insurance company)







Looking at the calculation, Akash's first reaction is that it is too good to be true. When a pension plan itself offers only 4%-5%(he knows this having recently taken one for his parent's EPF proceeds), how can the yield be so high? And that too post tax and with insurance? Is there some catch here? The planner tells him that in insurance, due to the persistency issue( people do not pay their premiums despite signing up for it), insurance companies give loyalty additions for just sticking to your contractual terms. Also, the high number of people who do not continue their policies, and the asset liability management of insurance companies, helps them manage the liquidity and solvency risks associated with this plan, and enables them to offer such a high guaranteed return. Since the plan  is eligible for 80C benefits on contribution, and 10(10D) benefits on maturity proceeds, Akash can be assured that his maturity proceeds are tax free(being a HNI he has long ago exhausted his 80C benefits with EPF etc), and that his wealth is enhanced equivalent to pre tax 5.68/70% or 8.061%per year, with the insurance sweetener. While he might pay some slight extra for the riders on premium waiver etc, he realizes that is well worth his piece of mind, and allowing him to solve his fixed income needs with one single product. 
. So with this, Akash decides to sign up for this. He also realizes that the financial product innovation is such that insurance companies can now often beat banks and mutual funds at their own game, and that one needs to be open to new ideas, instead of blindly abhorring all insurance companies due to their past sins.

Sunday, January 29, 2017

Is it fair for DCB to extend ESOP exercise period due to strategic change?

A niche private sector bank DCB(Development Credit Bank) was named by Motilal Oswal in its annual wealth creation study as a potential 100x bagger, subject to management validation :D
In Oct-15, they announced an ambitious plan(http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/22B0BC71_2E4B_42AF_8CE5_3CABA08280AE_171649.pdf)  to double their branch network in 12months. They had even stated upfront that this investment would pay back only in 3-4 years. Unsurprisingly, despite their detailed planning, the stock market punished them by hammering down the stock by ~50%. Then the management rolled back the plan and said they would consult the analysts going forward  http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/6577829A_1250_4D5C_AE43_DF6253C10D48_080642.pdf

Things settled down and the stock has nearly returned to its earlier levels. However, while reading the annual report, I came across this nugget indicating repricing of stock options 
During the year under review, the Bank has extended the exercise period from 5 years to 8 years from the date of vesting for all the unexercised options in force, as on July 1, 2015

I could not locate any specific shareholder approval for this measure, and it appears this was done to protect employees from their underwater stock options(remember the shares as at Mar 31,2016 was trading at ~Rs 70/share vs earlier levels of 140). This is quite sad that the 3yr extension was given without revising the exercise price upwards. Where is the skin in the game for the management to feel the pain like equity shareholders? Ironically, this extension happened even when the stock price was way above the weighted average exercise price of Rs 47(as at 31 Mar 2015), and hence most options would not have lapsed. 

Dr Vijay Malik has explained the volte face of the management very beautifully in his blog post
http://www.drvijaymalik.com/2016/05/steps-to-assess-management-quality-before-buying-stocks-moneylife-session-part-3.html




Tuesday, January 10, 2017

Value Investing Courses for Indians-some guides

Ok I admit it. The title is kinda clickbait to draw folks like you to this post. But having come here, why not spend 2min to decide whether it is worth while? While everyone feels their situation is different, that of the Indian markets is especially so. Like Ambit Capital opined in their Nov-16 report, while earnings yield of value stocks looks attractive, these stocks display limited potential to actually realise those earnings given their declining return ratios, excessive leverage and poor accounting practices. While the rising tide of demographics, reforms, zero interest rates driven liquidity lifts all boats, value investing is good to know to avoid being caught naked while the tides go out. For those interested in a detailed overview, read responses to the question on Quora.
https://www.quora.com/How-do-I-learn-stock-market-investing-in-India

Below are some links. Do note I do not specifically recommend any of these, so please do your due diligence

Distance Learning-Paid
http://www.safalniveshak.com/mastermind-login/

Distance Learning-Free
http://zerodha.com/varsity/module/fundamental-analysis/
https://www.sanjaybakshi.net/bfbv-v12/
https://janav.files.wordpress.com/2015/12/agentleandpracticalintroductiontovalueinvesting2.pdf

Classroom Training/Workshops
http://www.flame.edu.in/academics/executive-education/fil-with-the-masters This is invite only
http://www.safalniveshak.com/value-investing-meetups-bangalore-mumbai/
http://www.drvijaymalik.com/2016/06/pre-register-express-interest-free-for-stock-investing-workshop.html
http://www.jsalphaa.com/register.php  
http://www.bsebti.com/all_program_pages/fundamentals_analysis.html 
http://imarticus.org/certification-in-value-investing
Valuepickr forum members sometimes meet up in cities like Mumbai, Kolkata, Delhi, Pune. Try and attend these meets.

Internship
https://www.linkedin.com/pulse/value-investing-internship-2016-ankur-jain  Might be one-off but for those serious, worth a try

Wednesday, November 2, 2016

Dynamic Asset Allocation-a genuine way to get outperformance in sideways market

If I had a rupee for each time I got a SMS/email/report guaranteeing me a multi bagger, I’d be a millionaire by now. Naturally, I am skeptical when someone claims the magic sauce of superior returns. But when that person has achieved it over a 13 year period across multiple market cycles, one would tend to sit up and pay attention. The below post outlines the dynamic asset allocation approach.
Volatility is the friend of value investors since it is at periods of extreme volatility that Mr Market offers bargains to buy, or premium prices to sell. However, most often, volatility is not a part of time  ‘Buy and hold’ is a cliché which fails in ‘sideways markets’. As Howard Marks puts it, markets are like pendulums which spend maximum time in the middle, and very little in extremes. So while equity returns do compound over time balancing out the periods of zero returns/negative returns, one wonders whether one can avoid even these periods of low returns. In theory, one can monitor market valuations levels and change the asset mix between debt, equity and cash. In practice however, this needs expertise and transaction costs, taxes and emotions reduce the odds of making alpha. Given the necessity of active management to spot and manage such potential periods of low returns, one could consider professional fund managers to do the same via specialized products/strategies which use dynamic asset allocation.
Being a member of the ICICI family be it savings account, home loan etc, I decided to see how ICICI performs in this. They have a fund called ICICI Prudential Balanced Advantage fund. http://www.icicipruamc.com/icici-prudential-balanced-advantage-fund
The fund benchmarks itself against the CRISIL Balanced Fund-Aggressive Index and has outperformed its benchmark over the last 3 yrs ending June 30, 2016. The equity benchmarks are Nifty 50 and debt benchmark is 1 yr Tbill. While one might question the relevance of the indices(since many investments are outside the benchmarks), the fact is that the fund’s returns exceeds the total of its benchmark returns. For example, in the year ended June 30,2016, the fund returned 6.7% while Nifty 50 and 1yr Tbill returned (0.96%) and 7.67%. The benchmarks returned totaled 6.71%, and averaged 3.36%(which was coincidentally the CRISIL index return, implying a possible 50:50 split. With the benefit of hindsight, someone investing in Tbills over Nifty 50 would have earned 7.67%, but lost only 1% return by choosing ICICI Prudential balanced fund, thereby achieving investment goals with much less risk. The picture is even more stark for inception to date returns, where the scheme CAGR of 14.62% outperforms the Nifty CAGR of 11.62%. The balance 3% yield is due to asset allocation to debt in times of flat markets. They have on average 70% equity exposure.
Also, one can withdraw upto 20% of the units till 18 months from investment, without an exit load(otherwise 1%). Post 18 months, exit load is NIL.
In short, it is apt for all investors-experts or otherwise-and this appears a superior substitute to debt or NCDs, in the Indian context.
Do note as always that this blog is not a substitute for professional investment advice. Further, mutual funds are subject to market risks, and the scheme related SID/other documents should be read carefully
 

Tuesday, October 25, 2016

Draft GST Formats-Some Observations

As professionals, part of the public service obligation in my view, is to go through draft proposals and try to refine/improve it. In that light, I decided to read the 70pg GST forms/rules, and find out any issues. Below are my observations.

Form/Rule
Observation
Suggestion
FORM REG GST-1- Application for Registration under Section 19(1) of Goods and Services Tax Act, 20
Trade name is asked also as an optional field. Address contains latitude/longitude which might be used for apps/mapping. Reason for registration is sought including merger etc
Nature of premises ownership is asked including shared/Consent-this might be a risk mapping factor
DIN/Aadhar/PAN/Passport Number is asked for details of KMP, besides citizenship-helps cross matching
Name of Father/Mother instead of Name of Father
FORM GST REG 26-Form for Field Visit Report
Physical verification report has photograph of place with person present at verification time as also details of open, covered and, floor on which business done.
It ensures the person has visited the place, and gives details of the person interacted with. If only there is a similar facility for Swatch Bharat Abhiyan, things would be much better
Rule 1[e]Tax Invoice
name and address of the recipient and the address of delivery, along with the name of State and its code, if such recipient is unregistered and where the taxable value of supply is fifty thousand rupees or more-This provision will help curb URD menace and the bill to/ship to scam
The invoice should also include the PAN number of the unregistered recipient, so that it is easier for the government to track. Name/Address alone with end up in a physical/manual reconciliation

Sharekhan Ignite Trading Guarantee-the caveats render it usless

I got an email from Sharekhan offering a 1yr trading education program, with the claim that they are so confident in it, they will absorb the losses on your first 40 trades! However, while reading the full offer, I saw the below fineprint. Lesson learnt-ALWAYS read the fineprint

1
Total 40 trades to be taken under “controlled trades” in Ignite TradeTiger.
2
All trades will be intra-day (compulsory square off by 3.15pm).
3
Trades to be taken in cash segment only and in BigTrade scrips only. They are not confident enough to extent the offer to F&O/Commodity segment, or even to smaller scrips. Just shows their faith.
4
Order entry by bracket order only, i.e. entry, target and stop loss to be entered initially.
5
Maximum loss per trade will be Rs125. Position size will be decided accordingly by the system. For eg. if long entry is at Rs100 per share and stop loss is Rs99, then risk per share is Rs1. Position size in this case would be Rs125/Rs1 i e 125 shares. That means even if ALL 40 trades end in loss, their max risk is Rs 125*40 or Rs 5000. Do remember they would earn a minimum of 25-50 Rs in brokerage itself, so their risk is much less
6
At the end of all 40 trades, cumulative profit / loss will be calculated. If there is a net loss at the end of 40 trades, Sharekhan.com India Pvt. Ltd. will reimburse the loss to you. SO there is a setoff but no capping/retention of profit to you
7
For the purpose of profit/loss calculation, only market price of entry and exit shall be considered, i e other trading costs such as brokerage, STT etc will not be included. For small positions with max loss of Rs 125, these costs often equal the profit
8
To get the reimbursement, you will have to take all 40 trades in your account. The time limit for taking these 40 controlled trades is the end of the calendar month following your Certified Trading Professional course, i e if you have enrolled for the Certified Trading Professional course in September 2013, then the time limit for doing the 40 controlled trades will be till October 2013.
9
All the trades have to be as per Online Trading Academy’s core trading strategy that will be taught in the Certified Trading Professional course.
10
At least half of these trades must be as per trading calls given by the Ignite research team. The remaining trades can be based on your own analysis (using Online Trading Academy’s core trading strategy).


Monday, September 12, 2016

How to gauge management quality and integrity in India


There is a lot of articles on this but mostly in the western context. I thought to write a brief note on what I do to evaluate Indian companies
  1. What they say about themselves
    1. MD&A: There will obviously be puffery and exaggeration but do they take a balanced view and try to highlight risks/issues? Or do they just take credit in the good years and blame external factors in the bad years 
    2. AGM Q&A: Do they address all questions including critical questions?
    3. Conference Calls: How is the behaviour and confidence on the con-calls?
    4. Investor Presentations: Is the presentation balanced?
  2. What others say about them
    1. Scuttlebutt What do competitions,employees, channel partners, suppliers and regulators say about them? Are there serious quality or safety concerns? 
    2. Media(Incl interviews): What does the media say? Does this seem paid media/hagiography or an objective look?
  3. Public records
    1. Are they listed as defaulters or have criminal cases been filed? Have they/related entities defaulted on debt to banks, or has case been filed against them in personal capacity(eg murder-this is a real case against the MD of a listed infra co in maharashtra)
  4. How did they behave during adverse times
    1. Did they convert preferential issue warrants at above market prices? Or did they allow it to lapse: Before SEBI made it mandatory for preferential allotment to require a minimum 25% upfront non refundable advance, promoters used the warrants as a free 18month call option! While 25% is low, it is still enough of a deterrent for opportunistic investors. When the regulations were lax, did the promoters allow the warrant to lapse
    2. Did the company cease all non mandatory investor relations activity: Some companies in 'bad times'(when they make losses/stock price collapses) stop updating IR presentations or maintaining the site. If possible, ask a veteran investor in the stock if the company did like this. 
  5. Ownership/Shareholding pattern
    1. How much is purchased vs acquired via mergers into listed company, ESOPs etc: Have the ownership stake increased via merger of unlisted entities into the listed companies at valuations blessed by a pet merchant banker, in the era before this required majority votes from non interested shareholders
    2. How much is insider trading-and is this buy/sell? Do the promoters trade frequently in their sales? How much pledged and do they usually buy or sell>  
  6. How are their incentives aligned with yours
    1. Management compensation linkage with company profit: Do the promoters primarily link remuneration to profit or clearly defined KPIs
    2. Do the management take a pay cut/NIL pay when company starts defaulting/making losses?
    3. Related party transactions- red flags: Is a high extent of expense/sales from related parties? 
    4. Other related entities/business group: If having outside business interests or part of vertically integrated group, how aligned are the interests of the listed and non listed entities
    5. Minority shareholders Squeezeout: Have they squeezed out minority shareholders ever earlier(supposedly this was done by Godrej also one).
  7. Professional Management
    1. How much are the KMPs paid? Are the KMPs paid at the maximum possible limit? How reasonable is the compensation given industry salary levels?
    2. How much is the compensation growth of promoters vs others? Do promoters take a hike when everyone else is flat
    3. Are the 2nd generation promoters catapulted into high levels at remunerations greater than market levels? Is the 'usually foreign educated' son/daughter made a VP/AVP at levels greater than IIM/HBS alumni? This indicates undue favouritism. 


A guide to industry analysis for fundamental investors in India

·          Some points which struck me recently while listening to a friend: 

Regulation
o    Industry Specific: Wherever there are specific statutes or regulators for an industry, understanding this is essential as also the dynamics. Some regulators are even handed(eg telecom, natural gas) while others leave much to be desired. Is there any possibility that your industry will be on the wrong side of these rulings Foreign regulation also matters as in FDA inspection of factories
o    Competition Law: Some industries like cement, tyres, shipping etc are perceived to be cartelistic, and therefore at risk of penalties from the Competition Commission.
o    Export/Import related-There have been export bans and/or pricing floors imposed on various commodities such as basmati rice, onions, sugar, iron ore.  Similarly, import tariffs have been raised on commodities supposedly dumped from China such as tiles, steel. Having an idea of the trade policy and the lobbying power of the industries(suppliers vs importers)
·          Banking/Finance regulations:
o    Foreign investment: Wherever there are foreign investments limits on shareholding and sectors and these are eased, the demand pool goes up therefore helping the stock price. Examples are industries where FDI limit raised from 49% to 75% or even to 100%-the stock prices goes up anticipating higher demand from FIIs/FPIs
o    Prudential Norm/Banking Regulation: When it becomes difficult for certain industries to raise more funds(say real estate, gems) from banks, they need to tap the bond market or expensive sources, and hence the stock price might fall. Same holds for regulations affecting troubled loan resolution(eg CDR, SARFAESI).
·          Taxation          
o    Indirect- some industries face ‘sin taxes’ such as tobacco, alcohol. This is a real risk for those companies
o    Direct-some benefit from tax holidays or weighted deductions on research, while some are tax free(eg SEZs, agriculture).
·          Customers
o    Pull vs Push: Is there a lockin of revenues or orders as evident via customer contracts and cash/carry, or is it a push driven credit dependent business
o    B2B or B2C: Is the company largely in B2B or B2C? If B2B, expect the margins to be lower unless it is a hidden champion. Just ask insurers who suffer from losses in group health insurance but who still continue it for revenues
o    ‘Sophistication’: Are the customers aware or do they think they are aware of the business? People may not understand paints or hardware (one reason why hardware shops mint money), but they ‘get’ FMCG and hence may not continue brands.
o    Value Migration: Is there a demographic migration from basic to luxury? Or do people migrate from products(eg scooters to bikes)? Implications
·          Competition/Industry
o    Market share of top few players: If the HHI index is below 50 or if the top few players do not exceed 50%, there is a sign of unorganized sector
o    Profit pool of industry and trends: Is the industry overall profitable or loss making(like airlines, ecommerce)? How has this trend changed in the last few periods?
o    Ecommerce/Online Impact: Is ecommerce favourable(say +ve for logistics, packaging, impulse purchases, advertising but –ve for brick and mortar)? Is there any industry where competitive advantage is negated via ecommerce distribution network access(eg ability to launch smartphones without dealer network, this has hit Samsung/Nokia/Apple)
o    Growth and import competition:  Is there a China threat? Are they getting bulk of the incremental demand(eg replacement tyres growth eaten up by China market)
o    Demand supply gap-presently and 5yrs: Do you have visibility on new capacities? Can  there be a scenario where the industry becomes surplus in capacity domestically or globally due to undergoing investments?
·          Suppliers:
o    Where the key suppliers are organized or have pricing power, expect your profits to be squeezed. Ask any customer of petrochemical firms in India
o    Statutory regulation on terms of trade-Whether it be quantity allocation(like natural gas priority allocation to power and fertilizers), price controls(coal, railway) or any statutory restriction on terms of trade, this has an impact.