Having it all: Equity returns with capital protection :: Senior Director & Head – Products & Family Office Advisory, ASK Wealth Advisors in Business Line

The increased equity market volatility and accentuated market cycles have tested the courage and patience of equity investors many times during the last few years.

As a result over the last few years, investors have been reducing their equity allocations in favour of fixed income and hard assets such as gold and real estate.

However, in the current context of possibly lowering of interest rates and attractive equity outlook, investors are out exploring opportunities to take advantage of equity market growth but are scared to risk their capital.

In such a situation, principal protected equity linked debentures or structured products can be a good option for investors to enjoy equity upside with the comfort of principal protection.

Structured products are typically investments with tailor made returns contingent on conditionality of a market based instrument.

These products have underlying associated with Nifty, stocks, Government Securities and sometimes alternative financial assets such as gold.

A typical Nifty-linked principal protected structure product is an instrument which is a combination of a bond and derivative. Part of investment (say 70 from every 100 invested) gets invested into a bond which over the product tenor, earns and adds interest to achieve the objective of principal protection. The balance investment amount (say Rs 30) goes into a derivative, a call option on Nifty, which is like a contract providing investor right to gain from Nifty upside and with no obligation for participating in case of Nifty fall.

So in such investments an investor enjoys market appreciation when Nifty rises but gets his capital preserved in case of fall in the Nifty.

Apart from the simple example stated above, the world of structured products has seen evolution of many strategies. For example if an investor view is that over three years market will not grow beyond 70 per cent in total, he can enhance his returns through a higher participation. In such case if the higher participation is say 140 per cent, for every 1 per cent gain in the market, the investor makes 1.4 per cent (for 50 per cent market gains, this translates to 70 per cent returns).

However, in getting this boosted performance in 0-70 per cent performance band, he caps his maximum upside gains to 98 per cent (140 per cent participation to 70 per cent growth in market) and sacrifices gains from excess returns over 70 per cent. In another strategy, called binary option, an investor can get a fixed payoff, say 60 per cent, over three years provided the Nifty closes above a predefined level (say 10 per cent higher than the initial level at the time of investment). The call which an investor takes on market level is on the Nifty going up by 10 per cent and hence making much higher return than other fixed income alternative. If this views proves incorrect he gets only his capital back after three years and loses the opportunity of earning interest through FDs or other fixed income options.

WAYS TO INVEST

These structured products are manufactured/packaged together by NBFCs as equity-linked debentures and are recommended to investors through private bankers/wealth managers and advisors. Typically, the mode of investment is under a PMS for ease of management, monitoring and transaction. The minimum investment amount is typically Rs 25 lakh. Retail or small investors should not get disheartened by large minimum investment needed for these products as there are Hybrid Close Ended Debt Funds available from various MF houses to play the simplest vanilla strategy of these structures.

Such products launched by multiple AMCs from time to time are typically three year close-ended debt funds offering 80-90 per cent participation to Nifty upside with comfort of 100 per cent capital protection and has minimum investment amount limit of Rs 5,000.

What are the aspects investors should look at before investing in structured products. Lack of liquidity, credit risk of NBFC issuing the debenture, loss of opportunity to earn interest in case view is proven wrong or the impact of market going up during the term but closing below the starting level at the time of maturity are some of the risks which investors should be comfortable with.

While comparing multiple options, an investor should also take note of few parameters like: (a) tenor- a 36 or a 39 month tenor may both look alike but there is significant impact on pricing and attractiveness due to additional three months, (b) Observation dates and their frequency for conditions like callability, knockout etc and (c) Credit rating of issuer – a AAA rated issuer will be more secure and hence might be less attractive on payoff parameters than a AA- issuers which can give improved and more attractive payoffs but comes with a higher credit risk

(The author is Senior Director & Head – Products & Family Office Advisory, ASK Wealth Advisors Pvt. Ltd. The views are personal)

Hoping to do a Buffett ::Business Line

There are over 6,000 listed stocks in the Indian market. But how many of them are worth buying at any point in time? Well, a few Indian fund houses believe that 25 is a fair number.

Motilal Oswal Asset Management Company’s new fund — MOST Focussed 25 — plans to invest in not more than 25 companies at a time. Stocks will be selected for quality and business longevity, and held for long periods, in the hope that they will deliver market-beating returns.

This is Motilal Oswal’s first actively managed mutual fund. The fund house already manages five passive, index-tracking products — MOST Shares M50, MOST Midcap 100, MOST Nasdaq 100, MOST Goldshares and a 10-year gilt fund.

Features: MOST Focussed 25 is an open-end fund. It plans to hold a concentrated portfolio of 25 stocks with minimum exposure of 2.5 per cent to each. These companies will be selected for their earnings growth, free cash flows and shareholder returns; 65 per cent of the portfolio will be invested in the top 200 companies, 25 per cent in stocks above Rs 1,400-crore market cap and the rest, if necessary, in cash or debt.

Why focus on 25 stocks: Motilal Oswal argues that diversifying a portfolio beyond 25 securities produces no major benefit either in terms of reduced security risk or improving returns. It cites Warren Buffett, who believed in selecting quality companies with enduring ‘economic moats’ and sitting tight for the long term. Owning too many stocks, the fund house argues, shows lack of conviction.

The fund also provides numbers to show most Indian equity funds play it safe by holding over 50 stocks in their portfolio.

Pros and cons: The idea that a concentrated portfolio can deliver high returns is a sound one. By choosing just 25 stocks, a fund manager will be forced to seek out stock ideas on which he has high conviction. Given the dearth of quality stocks in the Indian market, this may also ensure better results for investors.

Motilal Oswal’s decision to apply Warren Buffett’s principles to this fund also makes it appropriate for a long-term investor. As a research house, Motilal Oswal also has good credentials to manage this fund, given its value/fundamentals-oriented approach.

On the flip side however, the idea of a concentrated fund isn’t new. There are already at least three diversified funds in the market — Sundaram Select Focus, ICICI Focussed Bluechip and Axis Focussed 25, which follow similar strategies.

Of these, the first two have a five-year track record, but haven’t fared significantly better than peers which follow a more diversified strategy.

Now, the key constraint to a concentrated portfolio strategy in India seems to be fund size and its impact on portfolio choices. Even equity funds which have started out with concentrated portfolios and succeeded in earning higher returns from this strategy have had to eventually diversify because of expanding asset size. The high impact costs in many of the smaller and mid-cap stocks in India make managers wary of building up very large positions in individual stocks.

MOST Focussed 25, if it succeeds may run up against this constraint too. The one key differentiator between MOST Focussed 25 and the existing focussed funds seems to be that it plans to own more mid-cap stocks, with nearly a third of the portfolio allocated to stocks smaller than the top 200. These may offer better returns, but with significant additional risk.

Overall, a concentrated portfolio strategy places great reliance on the fund manager’s skills. In short, a concentrated strategy may work quite well, provided one is a Warren Buffett.

Given that Motilal Oswal doesn’t yet manage any actively managed mutual funds, it is difficult to gauge its credentials on this score. It may be prudent for investors to bet on this fund once it demonstrates a consistent track record in beating the market.

JPMorgan, India financials FY14 - be defensive

We retain our preference for private banks in India; however, we shift our
preference to quality names with strong deposit franchises and resilient
asset quality. We see the economy in poor shape for the next six months –
and any recovery is likely to back-ended in FY14. We cut PTs on SBI,
Axis, ICICI, IDFC, Yes, PNB and BOB to reflect the near-term challenges
to the sector on asset quality. Our top picks are now HDFC, HDFC Bank
and Kotak.
 Changing drivers. We think the weak economy will be the key
overhang on the sector in the near term. There are no definitive signs of
a recovery and we see pressure on banks’ revenues and credit costs.
Asset quality is the key risk and we see some of the pain now spilling
over the private banks, via some retail stress and infra loan restructuring.
 Wholesale private banks – near term pain. We think wholesale private
banks will face some pain in FY14. Retail asset quality is likely to turn
worse, though the impact of credit bureaus should mitigate the pain
significantly. The momentum of restructuring in the wholesale space
should accelerate over the next two years – it’s hard to pinpoint exactly
when. On a longer term basis, the stocks are attractive – but the near term
pain worries us.
 PSU banks – too early to buy. While valuations are now undemanding,
we see continuing asset quality stress for PSU banks capping stock
performance. Recoveries may accelerate as the banks seem to be getting
tougher with defaulters but we think the overall asset quality stress will
get worse before it gets better. We maintain our negative stance.
 Risks to our call. The trend has already set in so we are risking a short
term reversal of the “defensives” trade. We would use any short term
rally to switch into the defensive stocks

India Equity Insights Quarterly Burden of expectations HSBC Research,

India Equity Insights Quarterly
Burden of expectations
We downgrade India to underweight from neutral. Cut our
Sensex targets to 20,700 (from 21,700) for CY13
Prefer defensive positioning; overweight private banks,
exporters, utilities and energy; underweight consumer
discretionary, materials and state-owned banks
Key stock ideas – ONGC, Colgate, Tata Power, Petronet LNG,
ICICI Bank, HDFC Bank, Sun Pharma (an Asia Super Ten
portfolio stock), Hindalco, TCS, Titan and NTPC

Don’t overdose on MNC pharma stocks ::Business Line

India Strategy To Be Part of the Family or Not : Morgan Stanley Research,

First, the Famous B C Forbes quote: “A young financial
writer once brought ridicule upon himself by stating that
a certain company had nothing to commend it except
excellent earnings. Well, there are companies whose
earnings are excellent but whose stocks I would never
recommend. In selecting investments, I attach prime
importance to the men behind them. I’d rather buy brains
and character than earnings. Earnings can be good one
year and poor the next. But, if you put your money into
securities run by men combining conspicuous brains
and unimpeachable character, the likelihood is that the
financial results will prove satisfactory”.

Angel Broking - Weekly Review

Forwarding you the Weekly Review dated 29.04.2013. Kindly click on the following link to view the Report.

 

Weekly Review

 

India Strategy The Key Call Is “Earnings” -Morgan Stanley Research,

Quick Comment – Earnings will determine market
behavior: Since the end of the previous bull market in
early 2008, the market’s direction has been determined
largely by the change in its multiple. This is not
surprising given that the starting point of valuations at
the end of 2007, when the market was trading at over
30x trailing earnings, suggest that growth expectations
were overly optimistic. Over the past five years, these
growth expectations have arguably moderated into fair
territory (implied equity risk premium is around 7%
versus 4% in Dec-07) and, hence, the key call for stock
returns going forward is what happens to earnings.
Over the medium term, as the earnings recovery gains
traction, growth expectations will rise and a multiple
increase will follow.