Pain of Discipline OR Pain of Disappointment : Analysis of Investment Strategies

In the past few weeks I have come across several investment strategies, hence I feel this would be the best time to put it on paper (blog) so that this information can be accessed later as well. It is amazing to realize that, as in life there is no one way to salvation, investing also follows a similar pattern. There are so many investors following diverse strategies and making tonnes of money; the most pertinent reason for this is the discipline with which they stick to their strategies. Ofcourse they did not strike gold in their first attempt but have refined their strategies over and over, by incorporating experiences from their failures. I feel that they hold valid even in this volatile and continuously evolving environment, the only caveat being that one needs to identify which strategy best suits their temperament and stick to it through thick and thin. Have listed below the ones which have appealed to me….

1.  Index Investing: Index investing is a fairly simple and straight forward strategy, especially for people who do not have the bandwidth to invest time and energy into researching stocks. It involves either buying an Index Mutual Fund or buying shares that form part of a particular index, for example buying all the 50 stocks in the same proportion as in India’s NIFTY Index, and whenever the National Stock Exchange (NSE) changes the weight of a stock or replaces a stock, then the investor needs to do the same. In short it means replicating the NIFTY.

2.  Value Investing: Value investor is one who does detailed analysis of historical financial data and buys a stock only if it offers value i.e. it is available at cheap rates as compared to peers or historical averages or book value. Ben Graham was the proponent of value investing; he has captured the essence of Value Investing in his book Security Analysis (written in 1930s).

3.  Growth Investing: Growth investing is completely opposite of value investing, as per this strategy one analyses the industry in detail to ascertain the growth potential of a company, growth stocks are usually in sunrise industries like IT, internet, robotics etc. However, they are available at expensive valuations and also are susceptible to failures, hence it is very important to study the industry in detail. Warren Buffet follows a mix of Value and Growth investment philosophy.

4.  Contrarian Investing: Contrarian investor is one who basically invests in stocks which have gone out of favor, primarily due to short term head-winds or downward pressure on earnings. So contrarian investor is one who would invest in Infra or PSU Banking stocks in the current economic environment (November 2013). This strategy is primarily used for long term investing.

5.  Momentum Investing: As the name suggests, momentum investing basically involves taking long/short positions purely based on the daily/weekly/monthly price trends. So it’s a trading strategy for short term investors.

6.  High Frequency Trading: This trading strategy basically involves developing and applying complex quant based strategies. These strategies would involve taking simultaneous positions in various asset classes across International Markets.

7.  Alternate Assets: Alternate assets would include investments in Commodities, Real Estate, Hedge Funds and Private Equity. Each of them has its own nuances, which affect their prices.

8.  Fixed Income: Fixed income basically involves investing in Debt markets i.e. government bonds & Tbills, corporate bonds and asset backed securities. The duration of investments could range from few days to 30 years.

To make money one needs to be disciplined and hence Pain of Discipline will help one avoid Pain of Disappointment.

QE Tapering and India

The most pertinent question lying in front of the financial world is life post the unprecedented Quantitative Easing (QE). Just the thought about tapering has brought about a 100 bps rise and an upheaval in the currency markets. So we would like to present our thoughts on how the economic scenario shall pan out following the complete wind down of the US QE program.

Background: The US Fed since Alan Greenspan has constantly tackled economic problems by perpetrating another one. This began with the crash of LTCM and Internet bubble when the Fed went for loose monetary policies which in turn lead to a housing boom, mainly because the benchmark interest rates fell from 6% to below 2% from 2000 to 2002.  As the housing boom attained bubble proportions along with heightened economic growth, interest rates went back to 5.5% by January 2007, following this came a crash in mid-2007 due to excessive and complex derivative built-up in the system, the Fed tried to overcome this scenario once again by reducing interest rates to near zero levels and QE. Now we are faced with another bubble being formed in the Fixed Income securities market. So by the time the QE is wound up, the US Fed might have to propagate another bubble in another asset class.

Rise in Interest rates: Interest rates will surely get firm once we see the end of the QE program, we have already seen a glimpse of this in the recent past. Another factor would be the raising of the US debt ceiling; this could also perk up the rates further. Currently US is considering increasing the debt ceiling, any increase in the debt ceiling will go towards meeting the welfare obligations like Obamacare and unemployment benefits. This will is surely contrary to Keynesian economic thinking of increasing spending to perk up employment in the economy. However, if the commercial banks in the US start begin purchasing treasury bills instead of holding cash or reserves, then interest rates could be capped.

India will be placed in a precarious situation in case of withdrawal of QE as one of the foremost beneficiaries of QE, with Foreign Institutional Investors (FII) pumping in a lot of money in the Equity and Debt market. India has in the recent past relaxed FII investment norms for Indian debt, and due to capitalize on the high interest rates as compared to the US, we have seen good inflows. However, with the rising interest rates in the US, risk premiums for holding Indian debt would also rise and hence we saw a concomitant rise in the interest rates and the dollar. India will have to change its strategy of attracting FIIs from interest rate arbitrage to better growth potential opportunities.

With flawed economic policies being followed in the US and India; greater risks lie ahead for the Indian economy as the US will manage to float as its status not only as the reserve currency of the world but also a huge consumer of products. But India will have to put its house in order to raise the living standards and the per capita income; with elections looming ahead and chances of another weak coalition government prospects look extremely dim.

India Vs England :2nd Test, Day 2 at Wankhede

For me it was the first day of watching a Test from the stands. Hopefully many more such days are there around the corner. Being a keen follower of Test Cricket, I was really looking forward to watch the Mumbai Test match between India and England. Mumbai Test pitches have been good sporting tracks (in my memory), which are predominantly spin friendly. Usually most of the pitches in India are run riots and these produce really boring cricket. For me Test Cricket represents a keen contest between bat and ball, aggressive or contemporary stratagems and loads of patience. 

The Session 1, Day 2 the Indian batting folded up at 327, with major contributions coming from Pujara (have huge expectations from him) and Ashwin. England started their 1st innings very cautiously with Dhoni using the spinners Ashwin and Ojha to open the bowling. The pitch was assisting the spinners and looking at the performance of the English spinners there were great expectations from the 3 Indian spinners. The English openers very reserved and cautious in their opening stance, they made sure that the team didn't lose early wickets. 

Over 30, Session 2, Day 2 provided the initial breakthrough for India. England lost 2 wickets within a span of a few overs and in walked in Kevin Pietersen (KP), who was expected to make a huge difference to the England batting line up. After failing in the 1st Test KP had a point to prove to his critics. KP too started cautiously but started capitalising on the weak line and length of the Indian spinners. It was a treat to watch KP and Cook bat, both have contrasting batting styles; Cook is an orthodox player who scores at a leisurely pace and KP who likes to stamp his authority on the opposition bowlers.

England did look vulnerable at the fall of the 2 quick wickets but after KP had settled down, the game was evenly balanced at the end of Day 2, with a slight advantage to England. The moment of the day was KP's back foot cover drive, it was simply awesome.  

PSU Banks - Rich Dividends

Public Sector Unit (PSU) Banks have recently undergone around 25% - 30% correction. Prior to this steep correction PSU Banks were already trading at cheap valuations compared to Private Sector Banks, the current prices have lead to further attractive valuations and dividend yields for several scripts in this sector. The below table provides ten year growth trajectory of 5 PSU Banks.  

Particulars	2003	2005	2007	2009	2012
Corporation Bank - Dividend Yield	2.78%	1.91%	3.01%	3.78%	5.06%
Dividend Declared	45%	65%	90%	125%	205%
Market Price	162	340	299	331	405
NPAT (Rs. In Crores)	416	402	536	893	1,506
Advances (Rs. In Crores)	12,029	18,546	29,950	48,512	1,00,469
Indian Overseas Bank - Dividend Yield	6.13%	3.11%	2.70%	5.23%	5.84%
Dividend Declared	16%	24%	30%	45%	45%
Market Price	26	77	111	86	77
NPAT (Rs. In Crores)	416	651	1,008	1,325	1,050
Advances (Rs. In Crores)	17,447	25,205	47,060	74,885	1,40,724
Oriental Bank of Commerce - Dividend Yield	3.60%	1.18%	2.00%	4.08%	2.79%
Dividend Declared	45%	30%	47%	73%	79%
Market Price	125	254	235	179	283
NPAT (Rs. In Crores)	458	727	581	905	1,142
Advances (Rs. In Crores)	15,677	25,299	44,138	68,500	1,11,977
IDBI Bank - Dividend Yield	3.13%	1.61%	2.28%	2.03%	5.58%
Dividend Declared	15%	8%	15%	25%	55%
Market Price	48	50	66	123	99
NPAT (Rs. In Crores)	474	415	630	858	2,031
Advances (Rs. In Crores)	46,385	45,413	62,470	1,03,428	1,81,158
Union Bank of India - Divid Yield	6.33%	3.21%	2.79%	2.30%	3.92%
Dividend Declared	21.00%	35.00%	35.00%	50.00%	80.00%
Market Price	33	109	125	217	204
NPAT (Rs. In Crores)	314	712	675	1,387	2,081
Advances (Rs. In Crores)	21,383	29,425	53,379	74,348	1,50,986

These scripts definitely come under my purchase radar for the reasons mentioned as under...
1) 3 of the above mentioned banks have a dividend yield of over 5%, this dividend is tax-free in the hands of the investor. And they have consistently provided above average dividend yield throughout the ten year period.  
2) NPAT or Advances have grown by atleast 2 times their 2002-2003 levels. And with their branch strength and growth of the Indian economy, these banks will continue to grow.

If these scripts make for such great cases then what is the reason for the sharp fall in their prices. The fall mainly be attributed to the markets expectation that Non Performing Advances will increase, which in turn will lead to higher NPA provisions and lower profits. I would recommend Corporation Bank, IOB and Union Bank of India as good long term bets as they are available at P/B of 0.70 and PE of 0.60. Such cheap valuations coupled with great dividend yields provide ample margin of safety for future asset slippages.
 

Diesel Prices : To Raise or not to Raise

The Indian government was planning to increase the prices of diesel several times in the last 6 months. And as the cookie crumbles in India, it has remained an illusion for all Indians. The question arises that why has the government thought about increasing diesel prices so often ? The answer 1) Fuel prices are dependent on  International Benchmarks and 2) Our currency has depreciated.

In India the prices of diesel are subsidised by the government and this subsidy bill comes to around Rs. 1 lakh crore. We can't increase the prices because we are a poor country and an increase would increase our already high inflation (currently at 10%, as per official estimates). The main reason that we need to raise the prices is because this subsidy burden is increasing the deficit i.e. the government's income is less than its expenditure, which leaves no surplus to invest in infrastructure and poverty reduction measures. And as we import more than 80% of our fuel our Balance of Payment also gets skewed, this further weakens the rupee.

As our deficit increases the government will have to borrow to pay not only for the subsidy but also for other expenditures, this in turn raises the cost of borrowing for the government. The high deficit rate also dissuades foreign investors from investing further money in a country which cannot balance its books. The low prices create high demand for diesel fuel, as petrol prices have been increased and anything which is not fairly priced will not be used efficiently ( economic basics ). Low diesel prices have also attracted people towards buying diesel cars, hence the government's rationale for subsidising the fuel for the poor doesn't stand.

Any measure such as differential pricing for disparate customers will lead to corrupt practices and also increasing tax on diesel cars will lead to lower demand which will further hurt the fragile economy. So if the government wants to subsidise diesel so that it doesn't create inflation as most of the goods in India are transported via road transport which primarily uses diesel. 

I propose we have dual pricing for diesel not between customers but for large cities and the rest of India. So that we can reduce the burden on the government and the affluent section of society pays the true price of fuel. This duality won't have a major impact on prices of essential commodities but it will curb indiscriminate use of diesel in cities. Those who want to use economical means of travelling in cities can opt for CNG cars or public transport (just hope it gets better).

Part III - The Solution

What's the use of discussing the problem if one doesn't provide the solution. So this it then, let us read my version of the solution to this issue.

As the boom began from 2003 and lasted till 2007, the fall will also last till 2013 or 2014. Most of the solutions require a long term approach to resolving our current conundrum. I feel we should stop the austerity measures as they aren't producing the desired results. On the contrary austerity has led to reduced consumption, lower tax collections, high unemployment and a feeling of helplessness among the masses. We need to complement the Monetary Stimulus i.e. the Quantitative Easing by USA and England and Long Term Refinance Operations (LTRO) i.e. lending by the European Commercial Bank at 0% for 3 years with Fiscal Stimulus as the money supply has not met with money demand which has led to inflation as the system if flush with liquidity and there are no other options but to speculate.

EU nations should revert to pay-cuts, pension and labour reforms to make their more productive and reduce taxes to fuel consumption. People will need to accept the fact that the days of superb social security web are over. In the USA banks should be made to realise that the funds that have been provided to them are for lending to the people and not for prop trading. The US government should come up with large scale infrastructure spending measures and alternate fiscal stimulus measures to create employment. We need to emancipate people from their current state of mind. 

EU will need to work together for a solution for the debt-ridden countries, they should be provided with more liquidity and a long term aid package should be finalised without penal austerity and fiscal goals. This will help to remove the insecurity and provide a definite road map for the revival of their Economy and re-entry into the Debt Markets. The current indecisiveness and disparate solutions by different countries needs to go, the stronger countries like Germany, Finland, the Netherlands and Norway need to sacrifice for the long term survival of the Euro. 

For India these measures will lead to higher prices and even higher inflation. If we exclude fuel price inflation from the indices we will see that the other components like agricultural and manufacturing prices can be tackled my taking prudential steps like de-bottlenecking the infrastructure and providing impetus to agricultural reforms. I feel the major beneficiaries of subsidies have been the rich farmers and the middle class, we need to provide them on a need basis and to the deserving. And we need to start making tough decisions pretty soon or the situation will be such that decisions will be made for us. I feel that the latter situation will prevail. It's human tendency to procrastinate and we are seeing this all over the globe.

Let us see what the future beholds.    

The Current State of the Global Economy - Part II

The bail-out funds came with many covenants, fiscal consolidation being the major one. Fiscal consolidation aims to reduce the fiscal deficit i.e. reduce government spending on social security measures like pensions, healthcare education and unemployment benefits. Hence these countries had to cut down on jobs in government departments, increase the retirement age from 55 years to somewhere near 60 years, wage cuts and tax increases to augment government finances. The caveat for receiving further funds was on reducing the fiscal deficit. Subsequently these measures led to large scale protests and resentment among the general public. 

e) USA - Post 2008 USA bailed out its ailing financial sector which included housing finance companies, banks, insurance companies and investment banks. Under Federal Reserve's (Fed) ( USA's Reserve Bank) blessings also several financial institutions were merged with their stronger counterparts. To spur up the economy the Fed came up with a monetary stimulus package called Quantitative Easing (QE) of about $600 billion and reduced the borrowing rate to Zero, this money was used to buy US Government Bonds which was used to bail out the financial companies and help the US Government to meet social security benefits , in layman terms the Fed printed $'s and gave them to the Government to splurge. This infusion of money didn't have the desired effect of increasing the growth rate or creating job opportunities. So in 2010-11 the Fed announced QE II of another $600 billion, this additional funds were used by banks to hoard or increase their cash reserves and speculate in commodity and forex markets, which led to increase in commodity prices without any tangible increase neither the growth rate nor the employment figures. This wasn't the last step which the Fed took, another measure called operation Twist i.e. replacing short term bonds with long term bonds in the Fed's Balance Sheet, this measure was introduced to reduce long term borrowing rates and propel infrastructure spending. But in 2012 the unemployment rate continues to remain above 8% and the number of people receiving unemployment benefits have remained the same. 

f) China - China's biggest trading partner is the US, hence it was thought that post the QE measures the consumer spending in the US would increase on the contrary it has remained at 2007-08 levels and is slowing moving lower and with very little employment growth the signs look bad. So to prop-up domestic consumption to sustain its manufacturing base, China also undertook a monetary stimulus which led to a property bubble and the inflation rate inched above 5%. Mid 2011 China's Reserve Bank increased the borrowing rate and put curbs on real estate lending, this tightening coupled with the slowdown in exports has also slowed down the Chinese growth rate to mid 8% level.

g) India - Recent economic surveys and reports haven't been kind to India. We all know the story by now, policy paralysis, high inflation, huge subsidies, fiscal deficit, current account deficit, crippling infrastructure etc. Last year inflation was the major issue in India which was caused to rise in agricultural commodities, dairy and poultry products and supply chain constraints in manufacturing products. Few of our problems can be because of international issues but the majority have been our doing.

My last part of this series will be about how we can tackle this mess.