Does sector investing fit into asset allocation? How?

The short answer is that it does, if you have time and energy to devote to personal finance. But if you are like the majority of people who do not have time for finance, and are minimalist and ad-hoc in their efforts, you would be better off without sector investing.

There are two reasons we say this:

1. Sector investing calls for deeper research than investing in diversified or index funds. After all, if you note the five-year performance of most diversified funds, they will differ from each other by only a few percentage points. This would not be the case with sector investing - you can get it spot on, or go very wrong.

2. Sector outlook can change more quickly than the view on Indian markets as a whole. For instance, you can continue investing in an index fund for decades, without worrying about ups and downs of the markets. But it is rare that a single sector will outperform for longer than 2-3 years. Therefore you need to have consistency of monitoring, to be able to enter and exit in time.

Before you continue, decide for yourself whether or not sector investing is for you. There is nothing intrinsically inferior about sticking to index investing - an ``invest it, shut it, forget it`` philosophy. Read on only if you have the commitment to do more.

Sectors in the equity asset class

Equity as an asset class is particularly interesting, in that it gives you a lot of choice within. This can also ruin you - for example by encouraging trading (i.e. frequent churning that enriches only the broker). But if used well, it can give you the thrill of market ups and downs, and of getting your analysis and foresight proved right.

Sector investing may be one such interesting offshoot of equity. It should never exceed about 30% of your equity portfolio (the rest being in diversified stocks or funds). You don`t want to have too many sector calls at once - since that is same as diversified investing! Two or three well researched calls at any point of time should do.

A time horizon of 1-3 years should be your target. Less than a year and you are getting into trading territory, not into strategic sector investing. Greater than three years, and it is likely that your calls haven`t really gone right - other sectors may have outperformed in the interim.

The approach

While we cannot reduce the art of investing into a step-by-step algorithm, we can lay down some principles and best practices based on experience, to aid your approach. Some of the best practices are:

> Unless you have some very specific and deep information, avoid sectors that have already outperformed the index in the last couple of years. An encore is unlikely.

> Avoid the dual risk of identifying a sector and a stock within it. One way to start is to only choose a sector, and invest in a sector mutual fund. That way, you are spared of individual stock research.

> If a sector is already hot news in the media and among `experts`, it is probably best to avoid it. Such sectors may have already run up in anticipation, so future potential may be limited.

> Ideally, derive your sector view from reading a general sector report from somewhere other than an equity research firm. Such reports tend to be more balanced, have long-term views, and are free of sensationalism. That is, you are keeping your sector view based on macro-trends and economic fundamentals.

> Measure your performance once a year, always comparing your sector with the Nifty index. Only an outperformance here means that you have got it right; not just a positive return.

> As mentioned above, make not more than 2-3 picks; each with a 1-3 year horizon. Keep this within about 30% of your allocation to equity. In each pick, be clear what the drivers of value for the sectors are (e.g. more foreign investment, greater consumer demand, government support, cheaper raw materials, etc). This way, you can monitor and decide whether things are going the way you anticipated.

With some effort and experience, you should find this an interesting experience. And make some useful above-normal returns too!

Missed the rally? Best to do nothing! Source: BUSINESS LINE (28-SEP-10)

What should retail investors do now, if they have completely missed out on this bull market? ? Nothing?, said a fund manager with a leading mutual fund when we posed this question to him. Though that answer may have us gnashing our teeth a bit, it is actually not a bad one, under the circum- stances.

Lured back to IPOs?

However, evidence from various segments of the equity market today suggest that some sections of retail investors aren`t heeding this advice. For one, from the way the retail response to initial public offers (IPOs) has shot up, retail investors seem to be succumbing to the lure of listing gains once again.

After a series of IPOs that scrounged for retail money, recent ones such as Microsec Financial (retail portion subscribed 11 times), Eros International Media (26 times) and Career Point Infosystems (32 times) met with runaway retail response. This is vaguely reminiscent of the frenzied market of 2007, when IPO allotments were seen as prizes to be secured and every IPO was thought to be a sure-fire listing bet.

Yet, experience tells us that chasing IPOs may be the most risky way to play a bull market that has already run on for some time. While the Sensex has almost made it back to its January 2008 highs, nearly 40% of the 2007 IPO stocks are still in the red for their original investors, with some even trading at less than half their offer price. The reason for this poor show from IPOs is fairly simple. Not only do a majority of issuers time their IPOs to market highs, they usually demand a very stiff price that cannot be sustained under more sober market conditions.

Playing small-caps

Then there is the persisting fancy for small and mid-cap stocks in recent months. From the shareholding patterns, there is evidence that retail investors have been steadily adding to their holdings in the galloping small cap stocks, even as the FIIs have been cashing out. In every bull market, after frontline stocks have become quite expensive, it is usual for experts to predict a `catch-up rally` based on the discounted valuations of mid- and small-cap stocks.

While this may work in the initial stages of a rally, this bull market has gone on for long enough to make even small and mid-cap stocks look quite expensive. The fact that the BSE-500 today sports a PE of 24 - a marginal premium to the Sensex - and the BSE Smallcap Index trades at a stiff 18 PE, suggests that there isn`t much margin of safety here. Small- and mid-cap stocks are not `value` picks simply because their PEs look low relative to index stocks. Their inherently riskier business means they deserve to trade at a discount.

In contrast to all this, one section of investors that has been playing it extremely safe are the ones in mutual funds. Even as the market (and with it equity fund NAVs) have climbed higher, equity funds have seen outflows shoot up and inflows dwindle. Now, given that mutual funds did see a deluge of inflows at the peak of the previous bull market (October 2007 to January 2008), it is certainly understandable that investors who got in then would want to cash out with a profit.

However, for retail investors, diversified equity funds are certainly a far safer option than IPOs or small and mid-cap stocks. Yes, fund NAVs would suffer damage if the stock market were to correct sharply from current levels. But the damage is likely to be much less than that to individual stock portfolios, given the diversification.

For investors with a more than five-year perspective (which is what equity investing is all about), the Sensex hitting 20,000 should not be cue to move entirely out of equities, stop systematic investing or switch frenetically into those segments of the market that they think are `undervalued`.

Yes, the vertical climb in the markets so far, current valuations and the recent sluggishness in corporate earnings, all suggest that this is the time to be cautious.

However, if you have a long investment horizon and haven`t taken undue risks in the stock market, the best answer, really, is to continue with ‘business as usual.`

Stick to the equity allocations that you are comfortable with (don`t increase or reduce them sharply), stay with index stocks or good diversified equity funds through systematic investing.

Resist the temptation to `make up` for the lost time by taking large impulsive bets. The formula should be no different for first time equity investors.

If you have a long horizon and haven`t taken undue risks, the best bet is to stick to the equity allocations that you are comfortable with and stay with index stocks or good diversified equity funds through systematic investing.

Why individual investors should seriously consider debt MF schemes

The investment choices of the majority of Indian investors have continued to remain conservative and conventional, to say the least. This tendency has resulted in notional sense of investment protection and growth, albeit, in reality, the inflation leaves very little by way of `real income` for the investor. Given this behavioral proclivity, the inclination to discover, discern and drive fresh investments requires conscious effort to change this habit. This, especially given the scale of opportunities available alternately in the debt mutual funds segment. And, that too without any meaningful compromise of the associated risk-return tradeoff.

The debt and money market mutual funds present themselves as a lucrative alternative (and an increasingly popular one) to the customary retail investment avenue. The underlying asset base of both the categories is by and large the same. Therefore, there is no significant diversion between the earnings potential of the debt market mutual funds or any other debt oriented investment avenue. In fact, from time to time, given the appropriateness of the interest rate cycle, the investor may choose options like the duration funds or accrual funds, as the case may be.

But a more distinguishing element in favor of the debt market mutual funds is the relatively lower tax incidence (for individuals falling under the highest tax bracket). For eg, such an investor with a less than 1year investment horizon can invest in the dividend option and attract only 14.16% dividend distribution tax on the interest accrued. This is in contrast to the 33.99% income tax incidence which a conventional debt investment accrual may attract.

Additionally, for an investor with greater than 1 yr investment horizon, the investor can avail the growth option of a long-term debt MF scheme and attract a tax incidence of only 10.30% on the gains. Alternately, the investor can also use the indexation method to discount the inflation in the accrued interest amount and save an even larger proportion.

So depending on the investment horizon, an investor can invest in scheme categories like Liquid, or Ultra short term, which cater to the investment horizons ranging from 1-day to 3-months. Or, if an investor carries a longer investment horizon, the scheme categories like `Short term debt`, `Short term gilt`, `long term bond` and `long term gilt` can be considered (in the given chronology of the time horizon). Also, the fixed time scale plans, like the fixed maturity plans too can be utilized to invest according to the desired time horizon.

Also, given the strength of the inverse-relationship which the inflation and the interest rates in the economy have with the performance of the debt funds, some recent insights may be of assistance to the investors. For instance, the RBI hiked the reverse repos by 50 bps to 5% and repos rate by 25 bps to 6% in yesterday`s policy action. With this, the RBI has hike repos and reverse-repos by 125 bps and 175 bps respectively ever since they embarked on the hiking campaign in the present phase. Having said that, it is evident from the stance of the monetary policy that future rate hikes may not be guided with the objective of `normalization`. It would be more a function of evolving situations on the global front and inflation on the domestic front. Incremental rate hikes going forward are likely to be data driven.
The article is contributed by Lakshmi Iyer - Head (Fixed Income and Product), Kotak Asset Management Company 

Need quick money? Go for a gold loan

Often in life, sudden money crunch situations occur, which require quick remedial action. During such situations, when you need to source a significant sum of money at short notice and that too at a low interest rate, so that the debt does not overwhelm you, gold loan is one of the first options you should consider.

Indians consider gold an auspicious metal and love to accumulate it - in the form of ornaments, gold coins or bars -  and make it a part of their wealth accumulation. Some prefer to invest in paper gold, that is, gold ETFs.

To obtain gold loans however, you need to use the gold which generally lies idle at home or in the bank locker. You can make this asset liquid without selling it, that is, by taking a loan on it in times of need. A loan will be sanctioned on completion of some minimal paperwork and satisfactory assessment of gold ornaments by the lender. Generally, the lender will give you a loan that is 60-80% of the value of the security, namely, the gold you have provided.

The lender retains the exposure to the market risk arising from movements in the market price of gold. Some banks claim to process gold loans in three minutes, while most banks hand you the money within an hour.

A gold loan can be especially useful when you need quick money for a short term as this loan is for a short tenure of one year and can also be foreclosed at any point of time. The rate of interest is much lower than a personal loan because of the security provided. Also, there is generally no prepayment penalty levied.

Interest rate - 10 -12%; loan tenure - one year; processing charge - 1-2% of the loan amount; and loan value - 60-80% of the evaluated gold value.

You can choose to pay interest on a monthly or quarterly basis - no EMIs to pay or worry over.

When the total loan amount is repaid to the bank, the gold held as security is released and given back to you. You can opt to foreclose the loan anytime during the tenure.

Only during instances where the interest has not been paid on time, an additional penal interest rate of 1-2% maybe charged by the bank.

A significant aspect for a gold loan is that you do not require a source of income to benefit from the loan.

Approach the loan desk of the bank of your choice and state your intent to purchase a gold loan. A simple form will be required to be duly filled and the bank will proceed to evaluate your gold, the charge for this is usually borne by the loan applicant and can be anywhere between Rs 100 and Rs 250.

A stamp paper needs to be provided to the bank post evaluation for pledging the gold as security in exchange for a loan.

Once this is done, the loan amount is credited to your bank account, which you can withdraw for your use.

In case of an emergency fund requirement, rather than look at personal loan as the only option, one should exhaust the possibilities of securtised loans such as gold loans as these work out to be less expensive with comparatively lower interest rates.

Active funds: Strong relationship with custom-tailored benchmarks better Source: Business Line (19-SEP-10)

B. Venkatesh

In this column dated September 5, we discussed why active funds with high R 2 are not optimal for individual investors and how such investors can create their own active portfolio at low cost, separating benchmark returns and excess returns. In response to the article, one reader eloquently argued that a fund having strong relationship with its benchmark is desirable, as it carries low active risk, and high risk-adjusted return.

We thought the argument deserved a discussion in this column. Accordingly, this article explains the relevance of active risk and policy risk to individual investors. It then discusses when high R2 is good in the context of such risks.

Buying an active fund exposes an investor to both policy risk and active risk.

Policy risk is the risk that the investor assumes by choosing a benchmark index, say, the Nifty Index. Active risk is the risk of deviating from that benchmark.

The investor is inherently rewarded for the policy risk. That is, if an investor assumes policy risk, she can expect to receive market returns.

Active risk is not inherently rewarded; buying active funds does not necessarily mean an investor can expect to generate excess returns, as alpha is a zero-sum game.

This separation of policy risk and active risk clearly allocates investment responsibility in the portfolio management process. The investor is responsible for the policy risk - the risk of, say, the Nifty Index underperforming the broad market. This is because the investor chose to invest in the large-cap style over broad-cap index or other style benchmarks. The portfolio manager, on the other hand, is responsible if the active fund underperforms the Nifty Index - its style benchmark.

Suppose the S&P CNX 500 returns 15% in one year and the Nifty Index, 12%. If an active fund benchmarked to the Nifty Index generates 13% risk-adjusted return, the portfolio manager can be said to have delivered excess returns. The underperformance of the large-cap style is the investor`s responsibility.

Normal portfolio:

The R2 captures the relationship that a fund has with its benchmark index. An R 2 of 0.95, for instance, means that 95 per cent of the changes in fund returns can be explained by the changes in benchmark returns. This means that the fund is closely tracking its benchmark.

Is higher R2 good? The answer depends on the fund`s benchmark. Suppose an asset management firm decides to offer a fund that invests in stocks of companies having high growth and low financial leverage. Such a fund may be overweight on technology sector but may carry zero exposure to the power sector. It would be inappropriate for the fund to have a market benchmark.

The portfolio manager has to instead create a custom-tailored benchmark that captures the underlying investment process.

The fund would be expected to have a high R2 with its custom-tailored benchmark. Why? High R 2 means that the fund manager is closely following the style mandate. This enables the fund to generate higher excess returns with lower active risk.

The case is different for funds benchmarked to a market index, say, Nifty. A high R 2 (0.95 or above) means that the active fund has close relationship with the Nifty. And unlike in the case of funds with custom-tailored benchmark, the investor can buy a Nifty Index fund at a lower cost.

The R2 is relevant only if the benchmark correctly captures the portfolio`s underlying investment process. Among other factors, the portfolio should, on average, have a beta of one with its style benchmark. Inappropriate benchmarks means that the investor is not, on average, assuming policy risk associated with that benchmark. Higher R2 is desirable for active funds that have custom-tailored benchmark. It may be optimal for investors to buy index funds when active funds with market benchmark have higher R2.

It`s not a market level but your risk appetite that matters!

The markets have breached 19,000 levels. Some experts say that a correction around the corner whereas others are fairly bullish about India`s prospects. In this article, we look at how different fund categories have performed across market cycles and understand the importance of risk profiling!

``Equity is for long-term!`` is the most commonly given advice to anyone wishing to take an exposure to stock markets. True, then how does one determine when to enter or exit from the markets? While we may attempt to time the market but can never be 100% accurate with the predictions. Due to lack of guarantee, retail investors prefer to put their hard-earned money in fixed deposits. Though an allocation to capital protected products is must, certain portion of the investible surplus can be allocated to different asset classes and products but after knowing the level of loss acceptable to them on that investment. In the mutual fund space, there are several fund categories within each asset class. Broadly speaking, equity and fixed income are two major asset classes. Several fund houses offer gold ETFs and fund of funds which invest in gold mining companies. Each of these fund categories have a specific time horizon and risk rating. In this article, we look at how different fund categories have performed across market cycles and understand the importance of risk profiling!

Within Equity, the main fund categories include -

> Diversified
> Index
> Style based
       o Contra/Value
       o Dividend Yield
       o Large-cap
       o Mid-cap/ Small-cap
> Thematic
       o Banking
       o FMCG
       o Infrastructure
       o Pharmaceuticals
> ELSS or Tax Saver funds

In equity fund, the risk rating goes up for thematic funds (risk rating =10) as they depend on performance of a particular sector or industry. Likewise, the mid- and small-cap (risk rating =9) offer higher returns than large-caps but at higher risk whilst the Index funds (risk rating = 5) and Dividend Yield (risk rating = 6) are relatively conservative equity class. Index funds follow the broad-based index such as S&P CNX Nifty or BSE Sensex and Dividend Yield Funds invest in companies that offer high dividend yield. Contra/Value funds (risk rating = 7) require patience on part of investors to hold the fund till the contrarian calls in the fund portfolio work.

Similarly, Debt categories offer fixed income funds as per expected period of holding an investment in the portfolio and risk appetite. 

Fund Category	Time Horizon	Risk Rating (Highest =10, Lowest =0)
Liquid	0-3 months	1
Ultra-Short Term	3-6 months	1
Short-Term	6-12 months	2
Income	Greater than 1-5 years	3
GILT	Greater than 1-5 years	3
FMPs	Depends	-
Floating Rate/Floater	<1-3 years	2

Besides these two fund categories, there are Balanced Funds (risk rating = 5) which have 60-80% allocation to equity and rest to debt and Monthly Income Plans (risk rating = 6) which have 15-20% exposure to equity and remaining in fixed income. There are dynamic asset allocation funds which may invest in equity, debt or gold in a specific pattern as given in the investment objective in the fund factsheet.
Risk Return Trade-off 
We analyze the returns generated by different fund categories each calendar year. For this review, we have considered Recommended Funds as they are already filtered by Fundsupermart.com Research team on parameters of performance, volatility, resilience and expenses. We have classified the funds as per their asset class exposure. The funds are listed in the ascending order of their risk rating so the Recommended Fund from Ultra Short-Term category, Reliance Money Manager is at the top with the lowest rating and the thematic funds with the highest risk rating of 10, belonging to Banking, Infrastructure and Pharma are shown at the bottom (in alphabetical order).

The three year annualized volatility represents deviation in the past returns over a period of three years and is expressed annually. As the risk rating goes up, the volatility in historical performance also goes up.

Clearly, the equity funds have generated superior returns albeit with high volatility. During 2008, the year of global financial crisis, most funds on equity side were hit badly. Although majority of equity funds in India invest in local companies and domestic markets, the fluctuations in the stock indices around the world have a cascading effect on funds. Then again, 8% GDP growth rate coupled with consumption story seem to build a strong case for a robust economy and hence, a subsequent revival as seen in 2009 and 2010. On the contrary, the fixed income funds have consistently given returns in the last five years though on the lower side and at lower risk.

	Calendar Year Performance (%)					3 yr Annualised Volatility
Fund Name  (Ascending order of Risk Rating)	2009	2008	2007	2006	2005
Fixed Income
RELIANCE MONEY MANAGER FUND- GROWTH	5.8	9.09	-	-	-	0.55
BSL FLOATING RATE FUND LONG TERM PLAN- GROWTH	8.17	9.27	8.74	5.98	5.38	0.42
RELIANCE SHORT TERM FUND- GROWTH	8.85	12.14	9.8	6.98		2.56
BSL DYNAMIC BOND FUND- GROWTH	7.45	14.96	9.16	6.01	5.39	2.1
HDFC HIGH INTEREST FUND SHORT TERM PLAN- GROWTH	9.35	12.54	9.89	6.53	5.04	2.15
Monthly Income Plans (Debt with Equity Exposure)
HDFC MULTIPLE YIELD FUND PLAN 2005- GROWTH	21.84	-2.41	12.5	5.74		5.05
RELIANCE MONTHLY INCOME PLAN- GROWTH	21.17	9.57	8.48	14.98	14.88	8.29
Balanced (Equity with Debt Exposure)
DSP BLACKROCK BALANCED FUND- GROWTH	64.98	-37.97	51.26	32.7	31.16	23.61
HDFC PRUDENCE FUND- GROWTH	84.84	-42.11	43.16	33.32	47.74	27.8
Equity
DSP BLACKROCK TOP 100 EQUITY FUND- GROWTH	77.13	-45.54	64.93	46.6	42.9	30.43
HDFC TOP 200 FUND- GROWTH	94.46	-45.35	54.46	37.44	55.25	33.62
HDFC EQUITY FUND- GROWTH	105.57	-49.68	53.61	35.86	62.7	35.77
HDFC INDEX FUND SENSEX PLUS PLAN- GROWTH	80.6	-47.08	46.59	45.54	41.44	33.24
UTI DIVIDEND YIELD FUND- GROWTH	85.78	-44.44	70.56	20.65	-	28.92
ICICI PRUDENTIAL DISCOVERY FUND- GROWTH	134.32	-54.56	39.65	28.69	63.74	37.8
UTI MASTER VALUE FUND- GROWTH	117.35	-58.05	58.7	11.26	-	37.41
RELIANCE GROWTH FUND- GROWTH	97.4	-54.11	76.85	41	68.73	35.61
RELIANCE BANKING FUND- GROWTH	82.89	-37.84	76.95	18.63	29.19	37.18
DSP BLACKROCK INDIA T.I.G.E.R. FUND- GROWTH	75.99	-58.19	82.85	52.43	53.57	38.2
ICICI PRUDENTIAL INFRASTRUCTURE FUND- GROWTH	68.31	-51.64	92.92	58.53	-	34.98
RELIANCE PHARMA FUND- GROWTH	118.6	-34	49.8	16.73	29.4	31.42

Know Your Risk and Allocate Assets
Before deciding to invest in different funds, investors should answer few questions on the Risk Profiler tool on Fundsupermart.com and understand their capacity to fathom a loss on investments.

Additionally, investors should familiarize self with different fund categories. For example, a sector fund may be performing remarkably well over one year period but not necessarily, the fund will continue the upside. Even though debt funds are for conservative investors, these funds are also subject to interest rate movements and macro-economic climate.

Therefore, one should take into account the nature of the industry, the business environment of the sector and the state of the overall economy. Thereafter, one has to choose of investible surplus can be allocated to a fund.

Conclusion
As the markets have breached 19000 levels, retail investors have become wary and are wondering if a 2008 like scenario would emerge again. Investors should keep in mind that markets undergo cycles of upside and downside. More importantly, they should be aware of their risk appetite and work towards fulfilling their financial goals with careful asset allocation and timely portfolio review. A systematic way of investing will help override the fluctuations. Plus, the compounding effect of disciplined and regular investing (even Rs. 100 every month) will reap more gains. Secondly, mutual funds offer variety of options to invest in different asset classes, instruments and industries. Apart from fixed deposits, investors can look at fixed income funds to ensure reasonable diversification.