Dalal Street English Magazine Preview Issue 22

View Point

Are P/E Ratios Relevant? While it is liquidity that determines the force of the markets, P/E is just one among the many market indicators that provides broad guidelines as to where the market is headed

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Yamal Vyas

UPSIDE FACTORED

The improvement in stock prices on such a large scale means that the upside in earnings for the next few quarters has already been factored. LIQUIDITY MATTERS

Going by the liquidity, There seems to be good amount of steam left in the market. As in the short term it is liquidity which really matters. 8

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he manner in which the market has been moving up has raised some questions in the minds of retail as well as institutional investors. The smart run-up in the first half of FY 2010 has been historic. I have never seen any half-year so bullish on a continuous and sustained basis. We shall not go into the figure, but the broad facts are enough. The Sensex and Nifty have more than doubled from their March 9 lows, and also from the March end levels. And that is not all. Almost every portfolio must be having at least a few stocks which have quadrupled or more. So obviously this is time for introspection and for pausing to review the situation in the market. The most common and popular ratio that is used in such a situation is the Price Earnings (P/ E) ratio. This has gone up significantly to more than 19 for the Nifty and Sensex if we take the FY10 estimates. All time high P/E s for these indices have been around 23, and so one line of argument says that there is still about 20 per cent upside left before the market becomes overheated. In terms of Nifty and Sensex, this would mean levels of 6,000+ and 21,000. This sounds logical, but there is another school of thought too. The improvement in stock prices on such a large scale without any significant correction also means that the upside in earnings for the next few quarters has already been factored in the current prices. This always happens in a bullish market, as optimism and exuberance have a tendency to go out of control beyond a point. In that case, the fundamentals of the economy and corporate sector do appear stretched at the current prices. The current prices indicate that the market expects the Nifty companies to show a more than 20 per cent rise in earnings in the current year. And even that seems to be included in the current

price. So what is the logic behind investor optimism even at these prices? For one, the liquidity in the system is very high. In fact, it is so high that the success of three mega IPOs and the subdued performance of two – which means that the retail investors have had little chance of exit - have not deterred the retail investors who are imparting good liquidity in the secondary market even now. And the foreign and local institutions are also flush with funds to invest in the market. So we once again come back to the question as to what is the prime driving force behind the present boom - fundamentals or liquidity or both? In my view it is only liquidity which is driving the market today. Fundamentals do matter in the market and in the long run only fundamentals prevail as we have seen time and again. And yet the real boom always comes about when there is high liquidity in the market. We have seen this earlier in 1992 (Harshad Mehta), 2000 (Ketan Parekh) and 2007 ( FIIs). This time around too the FIIs are investing heavily in the Indian market and the retail investors are just joining the party. There seems to be good amount of steam left in the market if one goes by liquidity only. And one can do that because in the short term it is liquidity which really matters. So we are face to face with the question: Are P/E ratios relevant for the market? Well, in my view, P/E is just one among the many market indicators which provide broad guidelines as to where the market is headed, but unless the P/E ratios reach unusually high or low levels of say 8-9 or 23-24, they do not provide any guidance about share price movements in the medium term. To put it in other words, extreme P/E levels indicate that the market will change direction. Period. I do not think P/E has any other importance for DS retail investors.

(The writer is the founder of indiainvestment.com) www.DSIJ.in

[ ECONOMY ]

to have several things that we can offer to the world, especially at a time now when consumers, cutting across their status in the global economy, are seeking value in their spending. For example, the predicted trend in the global automobile sector is for consumers to move on to smaller and better fuel-economy providing vehicles for which India is fast developing into a major production hub, thanks to the domestic demand that has nurtured this sector on a constant growth path along with our human skill sets, liberalising trade trends, and a growing auto component sector. As consumers cutting across economies and their status are looking for such cars, it is manufacturers (mostly international brands) who, having set their foot strongly in India, are aiming to make the country’s production base their global hub to meet such demand. If we dig into the core of this success story, it is the well-organised and better trained labour force possessing quality skill sets, along with strong labour laws, which has supported this growth story. Compared with the Chinese scenario, what is to India’s advantage is the difference in the quality of skill sets and the strong labour laws that had started attracting the shift of some of the production bases into India. We can see that all those items of exports that had picked up following liberalisation have had a strong domestic demand base leaving them nothing to worry about except the compromise they have to make on the value proposition that their exports would otherwise have fetched. It is also a lesson for other exporters that it will not remain a viable proposition to set up 100 per cent export-oriented industries. Also, it is time for our trade policy, which focuses on 100 per cent EOUs, to be tweaked to help them tide over such crises giving them some leg room in the domestic market or make it mandatory to receive the concessions therein to make investments in such units safer. Being a nation of 1 billion-plus population, what we have as the strength to take the economy sustainably forward is our strong labour force. What would help them keep stronger and take the economy on a sustainable growth path is development of the social infrastrucwww.DSIJ.in

ture - education and health being its two key sectors. On the education front what is needed is appropriate orientation of labour force towards the needs of the industry and services’ sectors, taking into account the constant changes in the environment to help them better adapt to it. While a strong base is provided up to the secondary education stage, at a higher level, specialisation and exposure to exact environments are those which are not much prevalent in the form of technical education, though the management education industry has been quick to catch up on the best practices prevalent in the western countries. Other sectors of education at a higher level were also missing that orientation, probably being not exposed to the innovative ways it is done in the developed countries. Pending reforms in the education sector and passage of the Bill will put the sector into proper perspective so that the social sector can catch up with globalisation based out of the country itself rather than leading to extensive migration which deprives the economy of intellectual property. Secondly, the health sector will have to be reoriented looking into the western models such as making family health coverage mandatory for workers. This will service the health needs of the middle and highincome groups of population in terms of serious ailments from creeping into their work performance. The public health delivery model adopted at the state level will have to be improved towards better performance and infrastructure to help the

low-income group who otherwise cannot access the private health delivery system. A flexible policy and a competitive compensation package for medical practitioners, along with improved equipment and infrastructure for focused delivery to the low-income sector to identified beneficiaries through the proposed innovative national smart card scheme, will help serve the objective. After better education is provided and health is taken care of, employees come to the market better protected by the law. However, the same law should not be a hindrance to employers in generating better competition in the labour market, which is necessary for them to remain competitive in the globalised scenario. While it has to be partially achieved within the corporate sector through effective internally streamlined processes of performance management and role rotation, externally labour market reforms will help make wages and salaries competitive. Having lagged in our development process and averted the financial crisis (not caught up much with financial innovation that happened in the developed economies), the current efforts of the government to focus on the hard and soft infrastructure sector are a noteworthy approach to take the economy to the targeted 7 per cent growth path this year. However, reforms will have to be implemented and monitored regularly for progress to sustain the growth path banking upon the people’s power that we fundamenDS tally possess. Oct 12 - 25, 2009

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Special Report Real Estate Investment Trusts (REITs)

A New Investment Avenue REITs are a convenient investment vehicle for retail investors with limited resources to take advantage of appreciation in the real estate market without having to invest directly in real estate, says Paresh Lad

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n the last 4-5 years many Tier-I cities in India have witnessed a huge boom in the prices of real estate and now even Tier-II cities are in the race. There is an investment vehicle which uses real estate as a tool to generate decent returns for the investors called as Real Estate Investment Trusts or REITs. Real Estate Investment Trust is a collective investment vehicle which helps the investors to invest their money in real estate asset class. REIT carries out its functions through a real estate investment management company (REIMC) which can be either a privately held company or a public one whose shares are traded on a stock exchange.

History of REITs The REITs find their origin in the US way back in the 1960s when the US Congress created the REIT. Today, the US has the largest REIT market which however is facing a tough time since last couple of years more so because of the sub-prime crisis which left the mortgage markets all over the world in the doldrums. Thereafter, REITs spread their wings in Singapore as well as in Japan. They also gained popularity in Canada, where they were introduced in 1993.

How a REIT functions: The real estate is an asset class which includes, land, building and any other

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structure built on the land. For an individual investor, it’s very difficult to invest in real estate assets as the prices are too high and a long gestation period is involved. Even if you take an example of “ready to move in” properties, as the prices are too high, very few people can actually afford to think of it as an “investment option”. Here comes into play the REIT. A real estate investment management company (REIMC) pools the money from investors and in turn invests such money in real estate properties. This is just like the many mutual funds in the market which invests the money of common investors in equities. Various investment options available with a REIT are commercial establishments, shopping malls, large

residential projects, hotels etc. The income generated out of investments made in these real estate assets is distributed in the form of dividends to the REITs investors. In case of REITs whose shares are listed on a stock exchange, the investors enjoys the benefit of easy and quick liquidity as they can sell the shares of the REIT as and when they want and thus their capital is not blocked unnecessarily for a long period of time.

Graphical presentation:

Salient features: Real estate per se is a costly asset class and hence it’s difficult for a common investor to invest in it and generate returns. This is made possible by REIT. REIT provides diversification benefit within real estate as well so that investors are not exposed to www.DSIJ.in

[ GURU MANTRA ]

ended funds. In addition to this he is heading 13 overseas offices of FT.

simple: Invest for at least five years

More You Travel More You Invest

A long-term investment principle has its own perils. As Dr Mobius always insists on long-term investment, during the decade of the Nineties his emerging market investing accumulated a lot of fan following among the investors and AUM in his funds swelled manifold. Having a good sum in his kitty, he has always invested

When we started this column our perception was that the greatest investment gurus of all time may have their own principles of investing based on fundamental analysis of the information available in the public domain published in black and white. However, after having discussed the strategies of three gurus we can say that our perception was not fully correct. All these gurus have had their own beliefs and disbeliefs which may be in contrast to each other but are successful. The same is the case with Dr Mobius, whose guru mantra for investment was travel. Sounds odd but it is true. Dr Mobius spends around 300 days annually shuttling from one location to another just to get first-hand information about the investment climate of the country and the political situation. After this he makes an assessment of the factors and decides his future course of action. After spending 30 years in Asia and 40 years in the industry, this practice has certainly paid rich dividends. That’s one reason why Asia Money Magazine in 2006 incarnated him as one of the 100 most powerful and influential people. Besides, the Carson Group chose him as one of the top ten money managers of the 20th century. He has numerous other accolades under his belt which makes him one of the most powerful investment managers of all times.

All About Trust If you don’t trust the Indian stock market and its growth story, learn from Dr Mobius who thinks that emerging markets are the best place to invest. In respect to Asian markets he once quoted that it is a “once in a generation bargains”. Even after the south Asian crisis he moved back to Thailand, Malaysia and Hong Kong - a move that paid off magnificently in the last decade. At that time he was of the opinion that in emerging markets opportunities are there and these opportunities are amazing and incredible as also beyond anyone’s reckoning. But his principle was straight and www.DSIJ.in

Success Has Its Own Failure

on the Asian markets and was recently quoted saying that the bull rally has already started in many Asian countries. As far as Indian, Russia and Chinese markets are concerned, though he is not very keen in investing in these traditional emerging markets, yet he is confident that the booming commodity prices wouldn’t be hampered in their growth. In 2008, he was of the opinion that countries cannot subsidize prices and so price rise is

All Asian countries borrowed heavily in US dollars and when their local currencies fell, they could not pay back the loans. Central banks and governments have certainly learned their lessons DR MARK MOBIUS, In Investors Chronicle in blue-chip companies of Asia, an example being HSBC Holding. Due to this inclination his funds usually ignored the hidden values in small and mid-cap stocks. This practice of Dr Mobius greatly affected the chances of Templeton’s offshore China’s funds, which lost 25 per cent in 1994, the year in which the Asian flu hit Asia. In the same way many critics have questioned his aggressive bottom-up approach in the debacle of FT funds during the South Asian crisis and it was touted that Dr Mobius had lost his touch. What was interesting is that he opened offshore Thai fund just 12 days before the devaluation of the currency which triggered a financial crisis in the region. At the end of the fiscal 1997-98, this fund was at 53 per cent. On the other hand, his India and Japanese offshore funds lost 27 per cent and the Korean fund fell 67 per cent during the six months.

Being Bullish On Asian Markets Dr Mobius is again very bullish

inevitable which proved true in that year. As far as growth is concerned he predicted that due to the slowdown growth will be moderate but wouldn’t go into reverse direction, which was again proved correct. As far as his understanding of Asian markets goes he is quite confident about the appetite of these markets. Due to this he is not at all concerned about the risk of capital flight. He is of the view that though fund redemption is a risk and FIIs’ selling is putting pressure on these markets, the local markets are deep enough to take the strain. He has clearly pointed out in many of his interviews that cheap money has its own perils but Asian countries learnt their lessons 10 years ago so that they now know how to tackle this kind of capital influx. “All these countries borrowed heavily in US dollars and when their local currencies fell, they could not pay back the loans,” he says. “Central banks and governments have certainly learned their lessons,” is what DS he said to Investors Chronicle. Oct 12 - 25, 2009

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Special Feature: Infra investors (both equity and debt). To spur increased investor participatation in India’s roads sector, the minister has indicated that he is in favour of reforms, such as revisiting the exit clause of the project. The government is looking at various innovative financing instruments to fund road projects and attract both domestic and foreign investors. It is also planning to involve pension funds, sovereign wealth funds, equity funds, besides other available investment channels like banks for the purpose. Chanda Kochhar, Managing Director and Chief Executive Officer, ICICI Bank, says, “The investment period in road projects is long. So there is a need for innovative financing which will cover both equity and debt markets.”

Opportunities Galore The government’s ambitious plan for the roads sector has already got the sectoral players like L&T, Soma, Nagarjuna, JMC Projects, Unity, Supreme Infrastructure, Gammon Infrastructure, Afcons, DS Constructions, Reliance, and IRB excited. Says A M Naik, CMD, L&T, “There has been a very visible change in the roads sector in the last couple of years but now with the government linking economic growth with the development of the roads sector the pace of work will accelerate. The various sectoral players will stand to benefit.” With an eye on the main chance Reliance Infrastructure (R-Infra), for instance, plans to grow its roads portfolio five times to Rs 220 billion by 2012 from the Rs 46 billion currently.

Problem Areas Funds may not be a major issue but land acquisition continues to be the major ogre. A study of projects cutting across sectors such as railways, roads and power has revealed that the main obstacle is difficulty in acquiring land. The responsibility for acquiring land is vested with the National Highway Authority of India under the federal roads ministry. The current practice is for the centre to approach state governments to identify land parcels and negotiates the purchase price with the owners, who are usually far flung rural land owners. Unfortunately unclear land titles, absent or incomplete revenue records in villages and the frag-

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mented nature of rural land holdings have complicated the sale process with a large number of families having to be compensated for their land. The Centre which has sought increased spending on infrastructure projects in a bid to counter the slowdown found that up to 70 per cent of 190 projects were stalled on account of land issues. The projects viability has suffered thanks to the rising costs thus forcing to embark on a mission to identify the delayed projects and expedite their completion in association with the state governments. According to the survey Bihar tops the list of states with delayed highway projects. The government is yet to pay compensation for land acquired for eight projects. The problem is also seen in Uttar Pradesh for the last four years where the NHAI has been unable to obtain land for projects because the state government has stipulated development of a 10m-wide strip of plantation along either side of the roads if it involves felling of existing trees. The cap on bids and limiting of players resorting to JVs from the bidding process and short supply of contractors also led to a slowing down of the roads programme.

The Solutions The National Highways Authority of India (NHAI), in a bid to keep up to its promise of delivering 20 km a day of road construction, has contemplated the opening of 150 Special Land Acquisition Units (SLUs) and 10 regional offices across the country – these will have the mandate to remove hurdles of land acquisition for road projects. Under the new dispensation with a view to facilitate speedy construction of roads projects will have to acquire 80 per cent of the required land before bids are allotted. The state governments have been told to assume the role of stakeholders in the projects. In the event of unsatisfactory participation the projects will be in danger of being abandoned. A proposal to set up a dispute resolution mechanism on the lines of the Lok Adalat is also currently under examination. SS Kohli, CMD, India Infrastructure Finance Company, is of the opinion that the government must share risks and NHAI should try out alternative models while awarding road projects. Currently the highways

body awards projects on either BOT or annuity basis. He has also recommended a subtraction in the period of achieving financial closure in the case of highway projects from six to three months and the reduction in the bunching of projects for bidding to four or five instead of 20-30 at a time. Meanwhile the highways authority as part of its aggressive designs in the roads sector is looking to address its manpower problems. Says NHAI Chairman Brijeshwar Singh: “At the administrative level we are trying to introduce a structure which will cater to the needs of our road development plan. We are restructuring and decentralising our field organisation. We will recruit 400 people in the next 12-18 months to deal with the manpower shortage. Our emphasis is also on the quality of construction.” Will the established players be able to deliver the mammoth task at hand? The issue crying for an answer now is of new qualification norms which bar smaller road sector entities from the bidding process on the plea of not meeting required financial and technical standards. The new system has doubled the financial exposure in terms of projects executed by a developer in the past five years to Rs 200 crore. It is obvious that very few players who have executed projects worth the prescribed limits will make it to qualification stage for every project. Developers allege that the new condition will also prevent the government from getting competitive bids at lower price quotations. “These conditions will reduce the number of suitors for a project from 15-20, which is required for competitive bid, to about six,” laments National Highways Builders Federation (NHBF) Director General M Murali. The developers have said: “By making the pre-qualification criteria more stringent the government is restricting the competition by denying the competent, experienced and serious bidders from participating in the bidding process for the forthcoming highway projects under PPP (public private partnership) model.” Political grandstanding aside, it is only solutions that enable a level playing field for all which will allow a smooth road ahead. The targets set by the Ministry will by DS no means be a cakewalk. www.DSIJ.in

[ SPOTLIGHT ]

feet in the near future. Although the market value of its land bank is Rs 2,100 crore, the book value of land in company’s balance sheet is just Rs 250 crore, indicating that the company has acquired the land quite cheap. Due to the low cost of land, the company would be looking at developing its properties as and when demand revives. A revival in the real estate market would give a better valuation of the land bank of the company going forward. Some of the company’s commercial real estate projects on the anvil are as follows: Patel Corporate Park, Mumbai: Patel Corporate Park is a commercial office development admeasuring 80,000 sq.ft. The project is located at Jogeshwari in Mumbai and is ready for lease. Patel Estate, Mumbai: Patel Estate is an office complex comprising one million sq.ft located at Jogeshwari in Mumbai. The company has already commenced work on this project and is expected to complete it in the next few years. Patel Eco-City, Bangalore: Located at Electronics City in Bangalore and spread over 120 acres of land, Patel Eco City will be an integrated Land Bank Details Location Acres MUMBAI

Jogeshwari Panvel

27.1

7.1 20.0

HYDERABAD

Gachibowli Shamshabad Maheshwaran Mominpet Sadashivpet Chewella Yadaram Kollur Vattinagulapally

811.3

11.4 82.1 16.2 460.0 120.0 26.4 60.1 17.6 17.5

BANGALORE

Electronics City Whitefield Devenhalli CHENNAI Total Land Bank (Source: Company Data) www.DSIJ.in

89.3

64.3 18.0 7.0 200.0 1127.6

township comprising of residential and commercial developments, two Special Economic Zones (SEZs) and an Information Technology (IT) Park. Approval for SEZ has been obtained from Ministry of Commerce. However, due to the economic slowdown last year, the company has not pursued the project aggressively, but since the scenario is improving, it is expected to do so going forward.

PELÊs Order Book (Rs/Crore)

Overseas Presence

Good Prospects

The company has subsidiaries in the USA and has carried out extensive projects in the US, Arabian Gulf, Sri Lanka, Nepal and Bhutan. PEL acquired a controlling stake in Michigan Engineers Pvt Ltd (MEPL), a specialty infrastructure construction company specializing in underground works and foundations, atypical dredging, bridges, specialized sewer rehabilitation works and other heavy civil works. Furthermore the company acquired ASI RCC a US based engineering company having expertise in the roller compacted concrete technology which is used in construction of dams in 1997. PEL also acquired another US based engineering company Westcon Microtunneling Inc. Through the acquisition of Westcon the company got access to the Micro tunneling technology. PEL was the first company in India to have used the micro tunneling technology. This technology is used for constructing small tunnels.

The Eleventh 5-Year Plan has envisaged an investment of US$ 514 bn in infrastructure, which would be shared between the Centre, states and the private sector. Going forward, the shares of Centre and states is proposed to be brought down by about 9 per cent and 1.5 per cent respectively, while the share of the private sector is expected to register a quantum jump from 20 per cent to 30 per cent. The increasing thrust on infrastructure and the Public Private Partnership (PPP) model would lead to several new opportunities for established players such as PEL. Out of the proposed investment in infrastructure in the Eleventh Plan, power, roads, bridges and water and irrigation are likely to account for large chunk of the outlay. In the power segment, the hydropower and thermal power projects present huge opportunities for players such as PEL. Hence, it is evident that Patel Engineering has excellent growth prospects and a DS bright future. Oct 12 - 25, 2009

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Special Feature: Infra

West Bengal – Powering Ahead From a power-deficit state to a power surplus one, West Bengal has come a long way by investing in power projects in a big way

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est Bengal, as the gateway to south-east Asia, is on the threshold of an industrial resurrection. Revamping the existing infrastructure while building up new vestiges has become one of the top priorities of the State Government. Sponsorship of this development is jointly borne by public and private investments, which has well surpassed the amount of Rs. 85,000 crore so far. Power plays the major infrastructural key in the economic synthesizer. It exercises a direct control over many faces of development, i.e., agriculture, industry, employment etc. The demand for power is increasing at the rate of 9% per annum in the state and the capital investment in the sector amounts to Rs. 10,500 crore so far, which is a record in capital procurement in a state-owned organization. It is not only power production that is benefited financially, transmission and distribution of power are equally on the gaining side. West Bengal was a power-deficit state when the Left Front Government took over the reins. It has now turned into a power-surplus one. Thermal power has been the key area in the state owing to geographical reasons. Quite a few organizations belonging to the State Government, the Union Government and private houses have been at work in unison to lend the power structure of the state a different composition. Generation of electricity in the state is carried out by the thermal and hydel power plants under the West Bengal Power Development Corporation and some other agencies. The central sector power allocations come from

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National Thermal Power Corporation, National Hydel Power Corporation and Damodar Valley Corporation. Apart from all these, captive generation units and the solar, wind, hydro and biomass-based power plants have been set up and looked after by the West Bengal Renewable Energy Development Agency. The total installed capacity in the state including captive generators and non-conventional energy sources is around 10,125 MW. Incidentally, the number of consumers of electricity in the state (excluding central sector power utilities) up to November 2006 stands at 82,85,025 households. However, the demand for electricity is shooting up. The combined power production capacity of all the thermal power projects of the state taken together is 7256.20 MW while the same of all the hydro-power projects is 229.255 MW. Power stations with the generation capacity of 2470 MW of electricity during the Tenth Plan period and 3550 MW during the Eleventh are on the cards. An amount of Rs. 5000 crore is being injected into diversified thermal power projects at Bakreswar, Santaldih, Sagardighi and DPL, which would yield not less them 1570 MW of electricity collectively. As one of the oldest power generating units of the state, the Dishergarh Power Supply Corporation, established in the year 1911, used to supply power to the collieries at the Asansol-Ranigunj belt. In 1932, the company, on obtaining a 50-year licence, began to grow into the life of the belt by illuminating them with power supply, projecting upon the path of industrial development. In 1990, in a bid for stabilization

in supply in the area, the company installed a 20 MW captive power plant for the Eastern Coalfields at Chinakuri. At present, the generating capacity of DPSC stands at 9-10 MW, which is supplied to keep the production floating on viability. It has also ensured uninterrupted power supply to ECL during emergency such as landslide, fire etc. Decisions have also been taken to enhance production and utilization of power tapped from unconventional sources during the Tenth Plan period. The 320 KW Biomass Hybrid Power Centre at the Sunderbans, three biodiesel generators with the total production capacity of 55 KW, wind power generator with the capacity of 40 MW at Purba Medinipur are some of the showcase examples to cite. All these projects await completion shortly. West Bengal Renewable Energy Development Agency has exemplified glowing resourcefulness in identifying areas of rural needs for energy and their renewable solutions. This autonomous agency, which is now acclaimed worldwide, was formed under the Department of Science and Technology in 1993. It is crowned with the credit of many firsts and foremosts, which, to name a few, are Energy Park designated to create awareness regarding power and its proper uses, Rabi-Rashmi, a housing project with 25 buildings at Rajarhat energised with solar power exclusively. Each of the buildings have solar panels (2 KW) on roof top, capable of supplying 100 litres of hot water, among others. In short, West Bengal is all set to power ahead on the path of development in years to come. www.DSIJ.in

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IN FOCUS You can win over inflation with judicious investments ...84

FUND OF THE FORTNIGHT Reliance NRI Fund is a winner all the way ...85

FINANCIAL GUIDANCE Investing funda for the beginners ...90

INSURANCE Insure online, but watch the web ...92

Email your queries on financial planning, taxation, mutual funds, insurance and banking products to [email protected] and we will get experts to provide solutions to your queries www.DSIJ.in

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IN FOCUS

You Can Win Over

Inflation This Diwali, as we celebrate the triumph of good over evil, sit down and work out a strategy to help you cut through the impact of inflation on your savings and investments

Hemant Rustagi CEO, Wiseinvest Advisors

KEY POINTS • One of the asset classes that have the potential to beat inflation over the longer term is equities. • It is important to evaluate your investment options carefully and select those you will be comfortable owning for years.

he Diwali festival is around the corner and everyone is gearing up to celebrate the victory of good over evil. One such evil is inflation that erodes our purchasing power. In other words, it can damage the value of our hard-earned money year after year. Let us take an example of someone who is 30 years away from retirement. If we assume a 5 per cent inflation rate for 30 years and that his current annual expenditure is Rs 1,00,000, it will increase to over Rs 4,35,000 by the time he retires. Therefore, if he plans for Rs 1,00,000 per annum for his retirement, he would be having less than 25 per cent of what he would really require. We all need to recognise the importance of defeating this evil called inflation. Once we do that, all our dreams of leading a comfortable retired life, providing the best education to our children, owning a comfortable house and having a few other things that could facilitate a particular lifestyle can become a reality. Needless to say, winning over this dangerous evil is not an easy task. However, if we plan our investment, invest in instruments that have the potential to beat inflation, and are willing to make a few sacrifices today to have a better tomorrow, it can be defeated. Remember, achieving this victory would require years of patience, planning and discipline. Here is what you need to do:

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Plan Your Investments: The first step towards achieving the positive real rate of returns i.e returns minus inflation is to have an investment plan in place. Though it can be quite challenging to develop a strategy that not only withstands the turmoil in different markets but also helps in achieving short-term as well as long-term investment objectives, one can achieve it by focusing on the correct asset allocation. The principles behind asset allocation are simple and they can help you control the risk, match your portfolio with specific financial goals and increase the predictability of returns. The asset allocation strategy can help you achieve realistic financial

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goals within the defined time frame and that too without losing sleep. Besides, one has to continuously work towards curbing one’s expenditure. By doing so, more money will be available for investments every month.

Make Equities An Integral Part Of Your Portfolio: While commodities like gold provide an excellent hedge against inflation, one has to aim to beat inflation over the years. One of the asset classes that have the potential to beat inflation over the longer term is equities. However, investing in equities would mean taking higher risk as compared to some of the instruments that give pre-determined or stable returns. However, one can minimise the risk by investing only long-term funds in equities as well as by following a disciplined approach. For example, a disciplined approach can go a long way in building the retirement kitty large enough to have freedom from the retirement blues.

Invest In Tax Efficient Options To Beat Inflation: Considering that inflation eats into a substantial part of returns over the years, tax efficiency of the investment options plays a crucial role in improving the real rate of return in the long run. While tax efficiency alone should not drive the investment strategy, it can make a substantial difference to your portfolio’s ultimate size. In other words, tax efficiency has to be an essential element of any investment plan along with portfolio mix, investment philosophy and management. While paying taxes when necessary is understandable, paying more taxes than necessary is not. The ultimate objective of investing should be to fund your current and future requirements by maximising your returns in a manner consistent with your means, future needs and risk tolerance. The tax efficiency becomes even more important when one plans to achieve medium to long-term investment objectives like children’s education, buying a house and retirement planning. Mutual funds are one of the most tax-efficient investment vehicles. Some of the strategies to ensure that your investments remain tax efficient are to minimize portfolio turnover and to analyse the tax consequences before rebalancing your portfolio. In other words, it is important to evaluate your investment options carefully and select those you will be comfortable owning for years. Remember, taking the time in the beginning would mean that you have more to keep in the end. www.DSIJ.in

Next Topic How are the mutual funds regulated? Mutual Funds are regulated by SEBI guidelines except for UTI, which is governed by the UTI Act. It is expected that the law will be amended to bring UTI under the purview of SEBI. How safe is the investment in mutual funds? Since mutual funds invest in both risk free and risky asset classes (e.g., shares), there is always a market risk. But, the risk is low for which the return generated also is not high. What are your recommendations for investment in mutual funds? a. If you are a small investor, mutual fund is your best bet. b. Mutual funds always have a risk. But due to diversification, the risk factor is very low. c. Even if large public sector banks like SBI launch some mutual funds, Canbank etc. these funds are in no way connected with these banks. Hence do not assume that in the event of any default by the SBI Mutual Fund, the State Bank of India can be held responsible. d. Do not go in for a private mutual fund started by promoters with no record. e. Opt for a scheme, which is quoted in the market, rather than an unlisted scheme. f. Read NAV of mutual funds to find out the performance of your mutual fund scheme. UTI is still one of the best mutual funds with a solid track record, though a track record cannot assure good future performance. g. Do not put all your investment in the same mutual fund. Diversify in a number of them. How good is investment in new issues as a portfolio strategy? Investment in new issues generally gives the highest return. A good Rs.10 share is often listed at more than Rs.20 giving a 100 per cent return. But getting allotment is difficult because most often these issues are excessively oversubscribed. You can allocate a part of your funds for the “new issue lottery” provided you are ready to sacrifice the liquidity in return of “something or nothing”. Can an investor reduce all his risks through portfolio management? Diversifying the portfolio can eliminate the stock specific risks called systematic risks. If you have about 12 shares in your portfolio, generally the strength of one share will obliterate the weakness of another. However, another element of risk is the unsystematic risk, which affects the entire market equally badly. For instance, the Ayodhya issue. No matter how much you diversify your portfolio, such unsystematic risk cannot be reduced below a certain point. Incidentally, this element of risk, below which unsystematic risk cannot be reduced, is measured by a mathematical concept called “Beta” (B) in a portfolio

management theory.

Investor’s enemies: Greed and Panic

Can you tell me what is Beta (B)? To put it briefly, the Beta (B) of a share is a measure, which reflects the sensitivity of the return on the security vis-à-vis the market return. The market return is the return you get by investing in the 30 shares, which constitute the BSE index. Now suppose, there is a share whose Beta are 3. It means that if the market returns increases by say 10%, then return from that share will increase by 3 times i.e. 30%. So the share outperforms the 30 BSE shares in the rising market. But what if the market falls? If the market return falls by 10%, this scrip’s fall will also be 3 times sharp i.e. 30%. Can you assess that high Beta means that the share is very volatile, i.e. more risky? If, during the bull phase of the market you come across an analysis in an investment magazine where they have given the beta value of a share; you may invest in that share only if the beta value is high. But do not buy that share if the overall market sentiment is low. If the beta value is less then 1, such shares cannot give high return in a rising market but will add to your confidence in a falling market. Can you summarize your advice on portfolio management? Finally, our suggestions to all investors would be: a. Define you own investment objective. b. Develop your portfolio of financial assets depending on your specific need of return, safety and liquidity. c. Do not speculate. d. Read about companies and industries before investment in stocks. e. Follow the fundamental and/or technical analysis (explained in this book) and analyze before you invest. f. Timing and strategy for acquiring and selling assets are important and apply the guidelines given in this book. g. Rely on your own analysis. Do not ignore your instinct or recommended tips but do heed to them only after reading, understanding and getting convinced of their analysis. h. Monitor your portfolio from time to time. Add or divest whenever necessary.

This is an excerpt from the Stock Market Book. If you wish to buy this book, please send a cheque for Rs 399 in favour of DSIJ Ltd and send to DSIJ Ltd, 101 A, 1st Floor, Uttam House, 69, P. D'Mello Road, Near Carnac Bridge, Mumbai-400009. Or call us on 022-40629500 (100 Lines) www.DSIJ.in

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FINANCIAL GUIDANCE Government of India bonds. Here are my recommendations for your SIP. Choose the profile that you think fits you best. The best book for you to read and pick up on equity investing is ‘Buffetology’ by Mary Buffet, the daughter-in-law of the legendary investor Warren Buffet. It is simple in its explanation and conveys the essence of equity investing. Conservative Equity Bonds

Moderate

Aggressive

30%

50%

80%

Franklin India PE Ratio FoF

DSP Blackrock Top 100

HDFC Equity Fund

70%

50%

20%

Templeton India Short Term Plan

Birla Sun Life Dynamic Bond Fund

ICICI Prudential Income Opportunities Fund

Restructuring The Portfolio

Q

T Srikanth Bhagavat Managing Director Hexagon Capital Advisors www.hexagononline.com

Investing Funda for Beginners I am an IT professional working in Bangalore. I have started reading your magazine Dalal Street and it’s very good. Basically, I am a beginner in investment markets. After reading the magazine I feel it’s very interesting, impressive and encouraging to start investing at the right time. So I would like to know what are the best options for me for investing. Let me give my options: I want to allocate Rs 10,000 every month for my investment purpose. I have already invested in LIC policy and ULIP. Request you to suggest me some good MFs/SIPs wherein I can get a good returns either in short/long term. What should I need to have in my portfolio? Also, it would be great if you can suggest me some books where I could learn more about the shares, investments, etc.. - Shoba Jeevanram, Bangalore, on email

Q

Ah! I finally have a query from Bangalore. You see, Ms Shobha, In my experience, Bangalore has a very good proportion of educated, stable investors (and another one is getting added, now!) What does one need to have in their portfolio of investments? For a youngster to middle age, one should endeavour to have a good proportion of equities in their savings. Along with equities should be some bonds. The proportion of bonds varies with the desire of the investor for safety. And to this potent mixture, there must be a desire and a clear plan to add property. And why are these three so important? Equities are like the hero Indiana Jones – he takes the viewer through a lot of excitement, action and tension before finally winning at the end. In our story too, equities are required to fight inflation and deliver higher returns over time. And just like one has to give Indiana Jones his 120 minutes to fight impossible odds before winning, an equity investor has to allow about five years at least to see worthwhile gains. Bonds are required to lend stability to your portfolio. Though they yield less than equity, they need to be there to lend that quality of stability, safety and liquidity. In the category of bonds are fixed deposits, corporate bonds, and

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I am a regular reader of your column in Dalal Street Journal. I am 35-year-old in central government service. My monthly earning is Rs 28,000 (approx.) I can invest Rs 1,000 more per month in addition to my existing investments. I want to invest for the long term for my children’s education. I am a bit confused about whether to go for term insurance policy of LIC or mutual fund. I have heard about Century SIP from Birla Sun Life Mutual Fund which also gives insurance cover on mutual fund. If MF is worth purchasing, please suggest me a fund name. My investment portfolio is as mentioned below. Please suggest if I need any restructuring in my existing mutual fund selection. (a) Provident Fund: Rs 10,000 p.m. (b) PLI: Rs 635 p.m. (c) GIC: Rs 900 p.m. (d) LIC (term insurance): Rs 2,500 (yearly) (e) LIC Money Plus: Rs 10,000 (yearly) (f) ICICI Pru Invest Shield Cash Back: Rs 10,000 (yearly) Mutual Funds (SIP): (a) ICICI PRU INFRASTRUCTURE FUND (Dividend): Rs 1,000 p.m. (b) HDFC TOP 200 (Growth): Rs 1,500 p.m. (c) BIRLA SUNLIFE FRONTLINE EQUITY FUND (Growth): Rs 1000 p.m. - Ezhar Haq, on email

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Term insurance cannot be considered as investment at all, though it is the ideal insurance product. That is because the sum assured is paid only on death happening during the term of the policy. If the risk does not happen in the period then there is no benefit to the insured. So if you are planning on saving for your children’s education, make an estimate of what it might cost to educate them 10 years down the line. For instance, if cost of education is presently Rs 5 lakh, the same would cost about Rs 13 lakh due to inflation. Hence your savings target must be to accumulate Rs 13 lakh which can be more or less accomplished if you saved Rs 5,400 per month in a portfolio of 70 per cent equity and 30 per cent bond for the next 10 years. To match this, you must have a term policy for Rs 5 lakh today. In the unfortunate event that risk happened immediately, then the Rs 5 lakh insurance proceeds invested in a similar portfolio will still pay for the goals you had set for your family. Your mutual fund portfolio is all equity and looks reasonable for a long term objective. You could very well add to it. (Email your queries on financial planning, mutual funds, insurance, etc. to [email protected])

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TAX QUERIES

Failure to file

Sales Tax Return Failure to carry out tax audit under Section 44AB attracts penalty My sales turnover is more than Rs. 40 lakh. I am required to conduct tax audit under Income Tax Act, 1961 in respect of my annual accounts relevant to financial year ended March 31, 2009. However I have not been able to file my return on or before September 30, 2009. What are the implications under the Income Tax Act, 1961? - Sundeep S., Pune

Q

Failure to carry out the tax audit u/s 44AB invites penalty under Section 271B @ half per cent of the total sales turnover in business or Rs 100,000, whichever is less. However, no penalty is imposable on the person/assessee, if he proves that there was reasonable cause for the default.

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Abhay Vasant Arolkar B Com (Hons), LLB, ACS, FCA KEY POINTS • Failure to conduct tax audit invites penalty @ half per cent of total turnover or Rs 1 lakh.

Thus, you will be given an opportunity by the assessing officer before levying the penalty. Besides, if the tax is payable on the due date of filing the return of income, an additional interest at one per cent per month or part thereof is chargeable on the outstanding tax liability u/s 234A of the said Act. If the return is not filed on or before March 31, 2010, penalty of Rs 5,000 will also be imposed u/s 271F. (Email your queries on taxation to [email protected])

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