Is this recipe for buying high and selling low?

Aug 31, 2011

In this issue:
» Will the Lokpal bill bring in better reforms?
» Banks can earn billions with cost savings
» Why the RBI should be very careful with new bank licenses...
» Are crude prices headed lower?
» ...and more!

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If you were not an investor during the dotcom bubble, your parents can tell you about the losses that the IT funds brought to them after 2001. Unlike Buffett we are not averse to investing in IT stocks or funds. But the problem with investing in sector specific stocks or funds is timing the market. Unless you have a really good understanding of the sectors' fundamental prospects, the chances of going terribly wrong are ridiculously high. Further media reports often tend to mislead investors about the near term opportunities or pitfalls in the sector. No newspaper warned investors about the impossibility of IT heavyweights retaining their astronomical P/E ratios during the dotcom bubble. Similarly real estate funds were touted as the next big money making opportunity until 2007. But investors have learnt little from these past mistakes.

Infrastructure related stocks and funds became investors' delight after the Planning Commission charted out mega outlays for the 11th plan period (2007-2012). The US$ 500 bn of investments planned for this period in sectors ranging from power to roadways to cold storages painted a rosy picture for prospective investors. However, as the plan period heads closer to conclusion; the targets are far from being met. Policy inaction, problems in land acquisition, funding constraints are amongst the many hurdles that have brought India's infrastructure dreams to a standstill. In the bargain, the investment returns in the sector have dwindled. The Planning Commission has yet again been ambitious enough in targeting GDP growth of 9% and investment outlay of US$ 1 trillion for the 2012-17 plan period. However there are no takers for these targets this time. In fact the infrastructure dedicated funds from the stable of the top mutual funds in India have lost between Rs 4 bn to Rs 9.5 bn by way of redemptions in the last 12 months. Not to mention that some infrastructure related stocks are trading close to 52 week lows. What does this trend indicate? That investors tend to buy sector specific themes at high valuations and sell them when valuations are at historical lows. Isn't this just the opposite of what an astute value investor should do?

We suggest that whether it is stocks or mutual funds investors would be better off staying away from sectoral themes. Most if these over hyped themes bring little value to the table for investors. More importantly investors tend to overlook long term fundamental strengths and weaknesses in the sector thanks to the herd mentality. The bottom up approach to picking stocks with sound fundamentals and cheap valuations is the safest bet to avoid such blunders.

Do you think sector dedicated funds create value for investors in the long term? Share your comments with us or post them on our Facebook page.

 Chart of the day
With the latest GDP growth numbers, speculations are rife about the Reserve Bank of India (RBI) taking interest rates higher. Especially since its attempts at cooling off inflation have had little impact on prices. Even though high inflation is a problem that both emerging and developed economies are currently facing, the former group has been hit harder. As today's chart shows, even amongst the BRICs India continues to struggle with the highest inflation rate in 2011. This is despite the fact that it is the only BRIC country to see lower price rises in 2011 as compared to average of 2010.

Data source: Reserve Bank of India (RBI)

Last week, India saw a lot of action. People from every wake of life joined hands to support Anna Hazare. His movement to get the anti-corruption bill passed was accepted as a personal agenda for nearly every Indian. The mass support that he received may have helped the country in more than one way. While the anti-corruption bill would definitely help improve the country's governance, at the same time the mass movement has also woken the Government up. It has driven home the point that merely coming up with populist policies is not enough. The government has to do much more. And this may also help fast track the badly needed policy reforms. The country has seen its economic growth slow down in recent times. Higher inflation rates combined with high interest rates have been blamed for this. But the root cause of inflation is the supply chain bottlenecks. Only policy reforms and government actions can help smoothen these out. But the latter has been busy trying to win votes rather than concentrating on reforms. The anti-graft movements are a symbol that the public is no longer interested in the empty promises that the politicians dish out to win votes. They want more. It is time for the government to wake up and do their job. And their job is to carry out the necessary reforms that will help the country prosper in the years to come.

How can banks earn more money and still serve public good? Well, in a five years time, banks which employ cost cutting in their structures can potentially earn up to Rs 35 bn annually. Despite having a number of banks in the country, only 47% of India's households have bank accounts. Three-fourths of this lot maintains an average quarterly balance of only Rs 5,000. So it doesn't make sense for banks to have high cost branches set up and a plethora of employees to cater to this audience. According to a report by Boston Consulting Group (BCG), Indian banks have the highest cost per employee at Rs 5.5 lakhs per annum. Business correspondents (BCs) , operate at a fraction of the cost. Thus, there is a huge need for banks to cut costs as well as serve these low-income customers. By being more productive, banks can tide short term pressures on the profitability front on account of rising interest rates, bad debts etc. Plus, they can help achieve the noble goal of financial inclusion in the country.

We can understand if a small financial services firm somewhere or a tiny co-operative bank comes under the scrutiny of RBI due to irregularities in its functioning. But for a firm, which in 2008 had close to 40 m depositors, to be accused of the same thing really underlines the risk that investors face in investing their hard earned money. We were really surprised when we came across a newspaper advertisement from the company claiming to pay back all investor money! As per a leading daily, Sahara India Financial Corp, India's largest residuary non-banking company, has decided to wind up its deposits and pay all its customers by December this year, a full four year ahead of the timeline stipulated by RBI. The money to be paid out by the non-banking firm could turn out to be in the region of Rs 90 bn. The company had accepted deposits to the tune of Rs 730 bn till June 2011. Important to add that in 2008, the banking regulator had asked the company to not accept fresh deposits and wind up the Rs 200 bn public deposits it had in seven years. However, what is not known is the way in which the company plans to raise funds for the advance payment. While there is no harm in undertaking such an exercise, the non-transparent manner in which it is being done is not a good sign we believe. Let's just hope the RBI is doubly vigilant now especially since it is also likely to give out banking licences

Some positive parallel outcomes of the US debt downgrade are being felt in the oil market now. Crude oil prices have headed for biggest monthly drop since May on concerns of rising inventories. The slide comes along with the fall in US and Europe consumer confidence which is at its lowest level since April 2009. Does the recent trend indicate lower oil prices in the short term? We doubt it. Oil demand may not go in line with global economic slowdown. On the contrary prices may harden on account of weakening US dollar and geopolitical concerns in the Red Sea.

There are increasing predictions that China's Yuan could overtake the US dollar as the world's principal reserve currency as soon as the next decade. Already the dragon nation has been promoting the use of the yuan beyond its borders since 2009 to settle trade transactions. However, can the yuan truly become a world currency? At present, the government has been heavily intervening in the currency market and has not allowed the yuan to appreciate too much against the dollar. Also, Chinese economy is still dependent on exports which may make the government vary before it completely allows the yuan to trade freely. However, on the other hand, a Washington think tank opines that China is already on the cusp of overtaking the US as the world's leading economy which will raise the status of the yuan. Indeed, one would recall that that the dollar displaced sterling as the main global currency within about 10 years of the US surpassing Britain as the world's dominant economic power. Thus, while possibilities abound, whether the yuan emerges as the dominant currency remains to be seen.

The Indian stock markets were shut today on account of Ramzan Eid. Most other Asian markets closed higher with the Seoul Composite leading the pack of gainers. Europe has also opened on a positive note.

 Today's investing mantra
"Investors repeatedly jump ship on a good strategy just because it hasn't worked so well lately, and, almost invariably, abandon it at precisely the wrong time." - David Dreman

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6 Responses to "Is this recipe for buying high and selling low?"

Mohd Azizullah Ahrari

Sep 5, 2011

A very educative wrap-up.Thank you for putting us wise.Aziz



Sep 4, 2011

Investing through sector specific funds is a surefire recipe for disaster. As Mr. Ganapathy stated above, the sector specific fund starts exactly when the stocks start getting overvalued. The example given by Mr. Sunilkumar above is impractical since no sector specific fund bought Unitech in 2004, and absolutely no Infra/Realty fund sold Unitech in 2007 at 545. You could have made money in Unitech only if you were a privileged insider. Hence, if you are looking at Mutual funds as a mechanism to invest into markets choose only large-cap well-diversified funds and maybe 10-20% of portfolio allocation to diversified mid-cap funds.


shome suvra

Sep 1, 2011

In India due to the fact that the different sectors are positively correlated owing to macroeconomic influence bottom up approach is the suitable one. Taking the infrastructure sector separately, public private partnership is one of the suitable ways though foreign borrowings may not be found cheaper due to huge capital requirements in the western economies.


sunilkumar tejwani

Sep 1, 2011

Sector specific funds can create value, provided the investment is done at a nascent stage, for example Uni tech (a real estate company) in 2004 was quoting around rupees 1.50 -2 (ex-bonus & ex-split basis) in 2007 went up to 545, gave multifold returns. Moral of the story, one should identify investment themes at a nascent stage & exit when every body is trying to get in to it.
Otherwise for a lay investor it is better to invest in diversified blue chip stocks without running behind sector specific themes.


Ranjith Menon

Aug 31, 2011

The best time to invest in a sector fund is when the whole sector is in deep trouble as mean reversion will ensure better times ahead.

By the above logic, the sector funds to buy now will be banking and infrastructure!


Ganapathy Sastri

Aug 31, 2011

Just watch for Mutual Funds coming in large numbers to start a sector specific fund. That is an indication of the likely collapse of the sector. In 2000 MF after MF started Technology Fund. One ( Chola) converted a diversified fund to a Tech Fund. In 2007 fund after fund started Realty or Infra Fund. In 2011 every one of them is starting GOLD FUND. Is it time to bail out of gold?
As for investors just entrust your money to a DIVERSIFIED FUND.

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