Sublime Consulting

It has taken a while for me to compile this concluding part.. while the Sensex is almost blasting its way to 19K!..

After culling through lot of data and research reports..its pretty clear that our markets are probably going to scale newer heights in the next 12-18 months or so..

‘Liquidity’ is the buzzword going around the markets..
Will the Fed cut rates again [on Oct 30, 2007] which would lead to more fund flows into emerging markets?

Meanwhile..some interesting theories have started floating around in the last 3 weeks:
1. Decoupling of Emerging Markets..
2. Low Correlation levels of India with other markets..
3. Is History repeating itself and will the next bubble be in emerging markets?
4. Will the central bankers get autonomy to take decisions without being influenced by the government?

On the home front the political fiasco has been merely postponed..
If one were to go by the latest news, there probably wouldn’t be a mid term polls after all..
this will further get ratified on 22nd October 2007 when the UPA meets once again..The stability factor could be decisive in bringing more fund flows into the country for the next 12-18 months..

The earnings season have kick started on a good note [In line results for Infosys and HDFC bank beating the street expectations] and it does look like there will be some decent number of positive surprises rather than negatives..

What is worrisome with ‘liquidity’ in the Indian context is.. the companies seem to be getting into unrelated diversifications[eg constructions cos getting into telecom, almost all large business houses getting into retail]..
One wishes its not the repeat of the 1990s..

What should you and I do as a long term investor in the next 12-18 months? Like I said before in the previous post [Sensex at 20K].. Re-balance/Churn selectively equity portfolios by booking significant profits at higher levels, buy Gold [ a very interesting piece followed by advice at the end of the article by the noted columnist Anantha Nageswaran]and buy/accumulate into businesses[at dips] that one belives strongly will deliver decent returns over a period of time.. One should also look at diversifying into international asset classes after due dilligence and research..now that the RBI has increased the investment cap to $ 200,000 per individual..
For first time investors in equity markets.. its better to participate in the equity markets through the systematic plan route in equity diversified/index/etf mutual funds..
For those who want to ride the momentum and make a killing on their short term portfolio allocation..may god bless!!

While we are contemplating on getting on to the bandwagon of the great chase ..I am reminded of Charles Mackay’s ” Men, it has been well said, think in herds ; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one!”

Kiran from India wanted to know if its a good idea now to invest in DSP ML T.I.G.E.R Equity Diversified Fund..

Kiran..before I answer to your question on whether to invest in this fund or not, would like to give a little background about the fund..

Background :
Tiger in short for The Infrastructure , Growth and Economic Reforms Fund was launched with much fan fare in June 2004, by DSP Merrill Lynch just ahead of the General Elections of 2004, when the markets were shining and NDA launched the India Shining Campaign.
The fund bets and believes on the growth oriented infrastructure and economic reforms story.
Even though the NPA government was defeated and UPA came to power, it believed the reforms are here to stay.

Tiger Fund pre-dominantly focuses on infrastructure related stories where it has the maximum exposure..
It continues to believe that the potential for growth is enormous in that sector in the coming years..
Tiger Fund is one of the best performing funds in the equity diversified fund category with CPR1 ratings by CRISIL. Value Research Online has voted it as a 5 star fund category. The fund is well diversified and has a portfolio of 64 stocks and 2 derivative positions.
One of the interesting fact is that it has almost 12.5% in cash and cash equivalents which would come in handy during market downturns to capitalize on buying opportunities. This is the portfolio update as on 31 Aug 2007. The AUM of the fund stands at on Aug 31 2007 is Rs.2241 crores.

The fund has consistently out- performed the benchmark category of BSE 100 by more than 10% year on year.
Infact, it has exceptionally done well in the last one year where its returns are 52% and the BSE 100 gave returns of 32.42%..

Observations : As you might know, mutual funds are long term wealth creators. It is advisable to stay put in these funds for atleast 3 years if not 5 years.
With India story intact, foreign and domestic fund flows rushing in, thanks to the FED funds rate cut and the rupee appreciation, the market trends are extremely bullish.
In the short to medium term, the volatility in the markets will be very ferocious.. Factors like high oil prices, political crisis could play spoil sport in the short to medium term..

While at the same time, the global trends do point to an impending financial crisis, we seem to be fairly protected from the US recessionary trends/slowdown due to our domestic consumption story and demographic dividend which plays to our advantage. Of course, we have to address two key bigger issues like infrastructure and employability issues , but the process of reforms/development is irreversible…

We still need to wait and watch as to whether Asia, specifically India will de-couple from U.S. It does look like it will happen sooner or later..

Factoring all these, my recommendation for Kiran would be to invest in the fund, provided he has a clear time horizon of minimum 3-5 years and opts to go for systematic investment plan, which would ensure that the rupee cost averaging and power of compounding would generate extra kicker to his returns.

The Fed has once again [50:50 Fed Funds rate cut and Discount Rate cut] unleashed the animal frenzy in the markets..
The rupee closed yesterday at 39.88 per dollar..
The currency has risen 11% since January 2007!

Indian markets are going to witness a never before fund flows from multiple segments..
In the last two days, FII inflows into the equity market stood at $608 million. Till date the FII inflows for this calendar year have already crossed $ 10 billion..
Raining wealth?!

Let me try and list out broadly the segments who could possibly contribute to the stratospheric highs of Sensex reaching 20k :
1. The existing ‘waiting on the side lines’ money from FIIs, Domestic Institutions and Retail/HNI segments.
2. The first time retail house hold investors who would enter the market through direct/Mutual Funds/ULIPS. The retail participation by house holds for FY 06-07 was a mere 6% of their savings into equity markets. This pie could significantly go up at the cost of the most dominant savings mode - Bank Fixed Deposits which is currently at 47%.
2. More and more hedge funds will enter the ‘arbitrage game play’ due to the return of the yen carry trade in a bigger manner [since BOJ went on the ‘hold’ mode with respect to interest rates]..
3. Newer Private Equity funds will find its way into the domestic markets..
4. The latest animal to the party, ‘Sovereign Wealth Funds’ would also try to wriggle its way into the market.
5. New Retail Investors from U.S. and other the developed world will join the bandwagon via India focused oversees Mutual Funds .
6. Last but not the least.. the NRIs pre-dominantly from the Middle East and other parts of the world will rush in as well..

In retrospect, at the start of the year 2007, I came across a very interesting column by a Neo Wave Technical Analyst who goes by the name Milind Karandikar whose column appeared on January 8, 2007 in the Business Standard’s ‘Smart Investor’ section.

According to Karandikar, “We are in the 5th wave as per the New Wave Theory.Wave 5 usually covers 100 % to 161.8% of the price action of Waves 1 and 3 combined. On a logarithmic scale this calculation sets a target of 20,000 plus for the Sensex. And that could happen in the year 2007 itself. Those who cannot over come the general feeling of nervousness would miss a life time investment opportunity, that the year 2007 presents. My advice to small investors is to over come this fear of heights and invest. They should take this opportunity; else the other wise men will take it away”.

Well.. there definitely seems to be a case for the build-up for the Sensex to hit 20,000 soon..

Hey..Should you and I join this party at all?
I am thinking..
Wait till I re-visit this subject[in the next few days] with more data and research and pen down my thoughts again ..
Meanwhile.. If you can’t wait to call your broker now, remember Jim Rogers latest quote ” Every time the Fed turns around to save its Wall Street friends it makes the situation worse. The dollar’s going to collapse, the bond market’s going to collapse, there will be a lot of problems in the U.S.”

Yes! Recent data released by Life Insurance Council clearly indicates that the 16 Life Insurance companies in India are moving the Indian Equity market. Literally.
While the FIIs pumped in around $ 8 billion in Indian equities in FY 2006, the Life Insurance companies invested around $ 35 billion worth of equities in FY 06-07.
What is interesting in this finding is that the domestic equity mutual funds chipped in with just about $ 2 billion.
Bulk of the contribution[to the tune of 75%] in the life insurance segment was thanks to the behemoth, Life Insurance Corporation of India.The $ 26 billion investments by LIC indicates that no longer the FIIs flows could have significant impact in the domestic equities market.
Case in point - FII outflows in August 2007 was approximately to the tune of $ 2 billion. But sensex and nifty still ended the month positive with almost 3% returns.
Next to Hang Seng we have been better performers in the last two months in comparison with other emerging markets and developed markets.
The increasing participation by retail investors in equity market through Unit Linked Products or ULIPS floated by the Life Insurance Companies could have helped stemmed the tide in the domestic equity markets while FIIs were pulling out funds, specifically hedge funds due to redemption pressures.

This sure is a tipping point for our Indian Markets and reversal of roles as to who supersedes the equity market flows in the Country.
Of course, one needs to watch whether this is sustainable, because if and when our markets do get bearish[due to global factors and political factors] in the near term, our retail investors again could develop cold feet to equity investing.
The last time around we saw huge participation of domestic house holds investing in capital markets, was when Harshad Mehta moved the market in 1990s!
And the rest is history…

We hope this time around its different..
May we raise a toast to the coming of age of the Indian Investor!

Just a few minutes ago, the Central Bank of U.S.A or Fed cut the Fed Funds rate by 50 basis points. Yes. 5.25 to 4.75. Lo behold! It cut the discount rate too by 50 basis points. From 5.75% to 5.25%.

What does it mean to you and me in India?
Well for starters..the Dow Jones has already rallied by 260 points to 13663.
Tomorrow the Asian markets and India will follow the rally..

While the Fed’s aggressive move of cutting 50 basis points in both fed funds rate and discount rate may stem the recession in the short term, what we need to watch is whether the American consumer is going to be wise enough this time or not..
It is interesting to note that equity markets across the world surge for a very short period and then decline considerably with interest rates climbing up again.

Meanwhile oil climbed above $ 82 per barrel!

All this leads us to Hyman Minsky’s ‘The Financial Instability Hypothesis’
At its core, the Minsky view was straightforward: When times are good, investors take on risk; the longer times stay good, the more risk they take on, until they’ve taken on too much. Eventually, they reach a point where the cash generated by their assets no longer is sufficient to pay off the mountains of debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. “This is likely to lead to a collapse of asset values,” Mr. Minsky wrote.
When investors are forced to sell even their less-speculative positions to make good on their loans, markets spiral lower and create a severe demand for cash. At that point, the Minsky moment has arrived.
Another famous Bond Fund Manager Paul McCulley’s ‘Plankton theory meets Minsky’ is one of the widely read and appreciated report on the current financial crisis thats roiling the markets.

From an India perspective, we are fairly insulated thanks to our domestic demand and the pro-active RBI being ahead of the curve. The RBI’S focus of reducing inflation and inflationary expectations, bringing price stability and managing the rupee has been very well appreciated by most of the economists in the world. It went ahead with tightening credit through various measures when other central banks were groping in the dark, followed by stricter regulations in specific sectors like the banking sector[in terms of change in accounting system with respect to securitization activities], realty sector[curtailing ECB inflows to $20 million and higher risk weight for banks lending to realty sector] and allowing the rupee to appreciate have till date ensured that we are insular from many of the major global crisis in financial markets.
Thus be it the recent Sub Prime Crisis or Credit market bubble[the contagion though has not reached our shores, thanks to our corporates being lesser leveraged and the debt market in the country is literally non-existent] or Asian Crisis in 1997, we have been fairly insulated from the turmoil that affected other markets.
Further, unlike our wester counter parts our regulations do not allow mutual fund managers to invest junk bonds in money market funds. Neither does the Government’s Sovereign funds invests in risky investments or Private Equity Funds like some of those whose values have gone down significantly post the credit bubble.
India’s resilience has been well documented very recently by Jim Walker of CLSA in his report on Apocalypse Now! But India is a Safe Bet.

On this momentous day will leave you with two quotes that sum the current global crisis in financial markets:
Jeremy Grantham, Chairman of GMO LLC which manages $ 150 billion in assets, once ended one of his notes to clients in early 2006 with, “Guinea pigs of the world unite. We have nothing to lose but our shirts.”

“We are in the midst of a Minsky moment, bordering on a Minsky meltdown,” says Paul McCulley, an economist and fund manager at Pacific Investment Management Co., the world’s biggest Bond Fund Managers.

To sum up..what should you and I as an Investor do now in the next 6 months?
Book Significant Profits, buy Gold, stay in Cash , wait for correction and buy during the lows.

Jennifer from Canada asked a very interesting question in one of the websites I frequently visit.
She wanted to know if one were to get Inheritance Money, where and what should one invest in.

Jennifer needs to ask 3 questions to herself before investing .. why would she want to invest? What for? How Long?
By asking these questions :
1. She would get clarity on her goal or goals for investing
2. She would get to know the time horizon for investing in each of her goals.

The next step forward for Jennifer would be to look at her risk profile and accordingly plan her asset allocation. That is, how much of her investments should be in equity, debt, realty and cash. Once the asset allocation is through, she could get down to security selection. That is what product mix or portfolio to be constructed for each of her goal. Say for example, if she is planning to buy a house in the next 1 year or so..its better to put all of her allocated money for the goal into debt product which invests in treasury bills or government securities. Because she needs the money back to buy that house..

If you have questions like Jennifer has, please feel free to write in to me.. I would be happy to answer your questions..

Note : I had recommended Treasury Bills or Government Securities for the example we had taken, based on the context of the Country, Jennifer lives in - Canada and also factoring in the current global financial crisis that has roiled the markets, specifically the corporate debt market and money market funds[thanks to sub prime market crisis and CDO blow ups]. Case in point is couple of BNP Paribas Funds which went bust [funds that invested in the short term corporate debt] recently in U.S. and also the run on Northern Rock of U.K. [ last week depositors withdrew more than $ 3 Billion of deposits from the Morgage Lender]

India-focused hedge funds delivered a yearly return of 53% as on July 2007 while the sensex returns was 44%.According to Hedge Funds Net which tracks the hedge fund flows across the world, the current assets of hedge funds investing in India are to the tune of approximately $14 billion. In just 2 years the assets have multiplied 5 fold from $2.8 billion to $ 14 billion.

Anectodal evidence points to the fact that during 2005 and 2006 these funds trailed behind the sensex returns while the trend has reversed this year thanks largely to rupee appreciation to the tune of 8%..

While the debate on hedge funds investing through P -Notes rages, there is a new breed of funds that is all set to reach our shores - Yes ..the Soverign Wealth Funds or Government owned Reserve Funds.. Some of the well known investments of Soverign Wealth Funds are China’s investments in BlackStone Group LP - one of the largest private equity firms in the world , Qatar Royal Family’s Investment in J Sainsbury of U.K.

The total assets managed by all hedge funds put together is estimated to be in the region of $1.3trillion while the Soverign Wealth Funds currently manage in excess of $ 3 trillion!

Customers of Northern Rock Plc withdrew $2 Billion yesterday after the stock went down by 26% ..
Northern Rock is one the biggest mortgage lender in U.K.
The sub prime contagion is now spreading across the world and I don’t think its ‘contained’ as it was believed to be..

One is reminded of the famous words of J P Morgan on Lending - ‘character, credibility and collateral’
Nowadays the banks would want to first see your collateral [the housing documents] and as far as credibility is concerned..forget it..there are enough players in the market who don’t need your income proof to lend you the loans..
Finally..character..who has time to see you, talk to your references and process the loan documents!
In these days of ‘NINJA’ [no income, no job and no assets] loans for customers..God Save America and the rest of the world hell bent on following American financial systems!

In the last few weeks we have been witness to one of the most interesting times in the global financial markets!

First it was the ’sub-prime exposure’ contagion from U.S. Housing Markets spreading like wild fire across continents.

Second was the ‘Leverarged Buy out’ market that went into a coma [and sealed the M & A story aided by cheap financing]

Third was the ‘Collateralized Debt Obligations’ market or the packaged financial weapons of mass destruction thats blowing up financial markets into pieces..

Fourth was ‘yen carry trade’ unwinding..

Ah..we are pretty much familiar with fourth one.. ‘Remember May 2006′!

what about the first three?
The answer is simple ..
‘When the lender becomes the borrower!’

Let me explain in simple terms .
Traditionally the lender used to be banker or a financial institution and the borrower used to be a corporate or an individiual like you and me.
Lets start with the first instance of ’sub prime woes’..
It was the traditional banker or financial institution which lend to individuals[American Citizens] to buy homes in the U.S.
Except that they lend to people who are so poor that they cannot afford to even pay interest leave alone the principal.
The bankers were under the notion that since property prices are bullish and it has only one way to go..yes..up..
Based on this notion..they securitised the assets and sold commercial papers to some hedge funds and other financial institutions promising higher yields.
The deliquencies went up to as high as 25% in some places in a very short time period that the banks were forced to seize the mortgaged property and sell it..Alas..if only they had buyers!..Yes..The property prices were heading south..
Few of the Bear Sterns and BNP Paribas hedge funds that were exposed to these ‘junk bonds’ lost all or most of its value creating a massive sell off in the global financial markets.

While this story was unfolding.. the M & A activity through leveraged buy outs [that was the toast through out this year for the equity markets being bullish] turned soar with banks not being able to raise funds for Chrysler and Alliance Boots deals. Well.. overnight.. the cheap financing tap [for leveraged buy outs] dries up!..

By the end of the week..The Fed says that the sub-prime contagion is contained!
Hell it was.. The CDOs made sure that it wasn’t..

You might wonder..All these still doesn’t answer the question of ‘how a lender becomes a borrower?’ Right..
Here we go ..
Now we all know a little bit of sub prime and leveraged buy outs ..

The CDOs are structured products created by banks as a result of debt financing for Mergers and Acquisitions of companies. As protection from a probable default from the borrower, the banks structure the loan product with the collateral being the assets of the borrower by providing higher yields and sell the product now to other banks and investors. This process is known as credit derivatives in the financial markets. By doing so, the first step to lender becoming a borrower has been put in place! In a similiar fashion the other banks re-package along with few more assets[like asset backed securities or sub prime loans] of different rating profile and maturity and tranches and sell further to some more banks and so on.. By doing so..the entire banking system has not only become highly leveraged to each other but also lost track of real assets and their value[thanks to the mark to model system!].. Financial engineering at its best or shall we say worst..
Statistics tell us that today the organisations that borrow money from the banks are less leveraged than the banks themselves..
So..when the lender becomes the borrower..thanks to the CDOs..the volatility is bound to go further up [with more and more banks and financial institutions going belly up] and this in effect brings down further the equity and other markets..
Like they say, this time around its different..
We sure are living in interesting times!!