Should you be investing in bonds?

Apr 22, 2013

In this issue:
» India Inc cutting down on dividends
» India's stellar growth was a jobless one?
» Corporate India faces water crisis
» Legendary investors turning 'bears'
» and more....

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The past year saw several events as far as the investors were concerned. Some reforms were announced. Equity markets remained volatile. The economy slowed down. One of the most notable events was the continued hawkish stance of the Reserve Bank of India (RBI). Thanks to high and sticky inflation rates, interest rates were kept high. But come 2013 and things have changed. The restrictive monetary policy has led the economy to slow down further. Investments have dried up. At the same time, inflation rates have eased up as well. As a result, the RBI did announce a rate cut earlier this year. And it is expected to continue easing the rates in the year to come. This has made one asset class ripe for investment. That is none other than bonds.

If interest rates decline, bonds become more attractive. This is because in addition to the coupon rate, the investor also benefits from the gain in bond prices. So suppose the coupon rate on the bond is 8%. And due to a cut in the interest rates, the bond price moves from Rs 100 to Rs 110. Therefore, total gain for the investor would be 8% plus 10% (110/100-1). Therefore, it would be a good idea for investors to hold bonds as a part of their portfolios.

The question then becomes which bonds to hold? Obviously, corporate debt offer higher coupon rates as compared to government debt. But these come with additional risks. Since the risks are higher, one needs to thoroughly study the fundamentals of the company before buying its debt. Just like what you would do if you were buying the company's equity. So buying bonds issued by the government would present a good investment option. You could look at investing in these either directly or through debt funds which are mutual funds investing in debt.

So far we have established that investing in debt funds that invest in government bonds is a good idea. Therefore you may think that your money would be safe if you went ahead with this option. But if you think this, you would be far from being right. As our founder Ajit Dayal had highlighted recently that debt funds are not always as safe as they may appear to be. This is because of the extra risk that is inherent with debt funds, which is not always compensated with higher returns. This extra risk is due to the maturity profile of the debt held by these funds. The maturity of the debt is typically for a period of more than 90 days. This increases the risk of repayment as well as the interest rate risk. So holding these funds may not always give better returns. Therefore, investors would do well to understand the returns being offered and compare these returns with the risk profile of the funds.

So keep these points in mind when deciding your investment portfolio. However, do not ignore equities completely. Needless to say companies with strong fundamentals and robust managements will weather the tough times when the tide turns. But it is important for investors to be cautious. During such uncertain times, the need for asset allocation becomes even more pronounced. While we are no experts when it comes to wealth management, we do believe that investors should keep some amount of cash in their portfolios as well.

Do you agree that you should include bonds in your portfolio? Please share your comments or post them on our Facebook page / Google+ page

 Chart of the day
The global macroeconomic headwinds have come as a blow to all export oriented countries. Needless to say the slump has hurt India's exports as well. But at the same time imports have been growing. This has led to an expanding trade deficit for the country. Or the gap between imports and exports has been on the rise. But in recent times, the deficit has narrowed. The biggest contributor to this was an uptick in exports in March 2013. The import bill narrowed as well thanks to the sharp decline oil prices. To narrow the gap further, India has to boost its exports. Obviously the demand for exports is out of our hands and depends largely on the global economy. But there are some things that India can do internally. Offering export sops is one way. Another way is to make the goods more competitive in the global markets through innovation, etc.

Souce: Financial Express

When you're investing in stocks, you look at two main sources of income. One is through capital gains when the stock price appreciates. The other important source is dividends. In fact, companies that pay regular dividends are often the darlings of many long term investors. A steady and rising dividend stream is the most desirable.

But dividends depend on earnings. If there is slowdown in the economy and earnings are under pressure, dividends tend to be adversely affected. Such a trend seems to be unfolding in India Inc. As per an article in the Business Standard, about 23 listed Indian companies have announced their dividend payouts for the financial year 2012-13 (FY13). The aggregate payouts by these firms have dropped by 2.4% on a year-on-year (YoY) basis. In fact, their dividend payout ratio (proportion of earnings) has fallen to the lowest level in four years. The article further notes that if adjusted for the high consumer inflation, dividends earnings for investors have actually declined in real terms.

We believe dividends may remain subdued as long as the economic slowdown persists. Many companies are choosing to keep more cash on account of the gloom and uncertainty in the global environment. However, such swings are part and parcel of stock investing. Investors must factor in these risks before investing.

India may soon have to do with another adjective - 'The land of casual labourers'! Unemployment may be a key concern for developed economies. But for India too the employment data is nothing to cheer about. Even the government cannot get away with showcasing rural employment guarantee scheme as a success. For all it has done is adding millions to the list of casual labourers. As per an employment report quoted by Economic Times, the self-employed workforce shrunk from 56.4% to 50.7% during the first term of UPA government. Note that this period (2005-2010) was one with highest GDP growth. There was just a marginal increase in the percentage of regular salaried workers (from 15.2% to 16.4%). But the section of employed that saw the maximum jump was casual labourers (from 28.3% to 33%). Now, part of this could be attributed to the National Rural Employment Guarantee Scheme (NREGS). The scheme has seen farmers and rural populace flocking to temporary jobs to avoid uncertainty in earnings. At the same time, it also shows the lack of quality in job creation and limited scope for employment of educated youth. These we believe are dangerous signs for a country like India. Not just unemployment but also under employment of educated youth can throw India's demographic dividend out of gear.

If you thought companies producing gold and oil were the best investment this side of the 21st century, it is time you correct the misconception. Bloomberg reports these companies were beaten hands down by a group of companies that are in the business of treating what could possibly the most important commodity over the next 50 years. We are referring to the life sustaining elixir called Water.

Thus, investors could do well to keep an eye out for companies that specialise in treatment of waste water. For the problem of water shortage will only get worse with time if experts are to be believed. Signs are already visible here in India. The country has committed to doubling its spending on water management, setting a new record in the process. However, this may hardly prove adequate. The fact that we have 18% of the globe's population but only 4% of its fresh water resources could mean that we would have to spend much more to secure the supply of clean water. We hope the Government is up to the task lest it becomes one more spoke in the wheel of economic growth.

The US stock markets are touching new highs almost every day. Despite the 6.5% stock market rally over the last three months, a handful of billionaires are quietly dumping their American stocks and fast. Warren Buffett, John Paulson and George Soros are dumping US shares at an alarming rate. So why are these billionaires dumping their shares of U.S. companies? After all, the stock market is still in the midst of its historic rally. Real estate prices have finally leveled off, and are rising for the first time in five years in many locations. And the unemployment rate seems to have stabilized.

There are several explanations to this. The Federal Reserve has been printing massive amount of money in an attempt to stimulate the economy. These funds haven't made it into the markets and the economy yet. But when it does, inflation will surge. Once inflation starts going up, 10-year Treasury bonds could lose their value. Interest rates will increase dramatically at this point, and that could cause real estate values to collapse. And the stock market will collapse as a consequence of these other problems. Companies will be spending more money on borrowing costs than business expansion costs. That means lower profit margins, lower dividends, and less hiring. So if that's why Buffett, Paulson, and Soros are dumping stocks, they have decided to cash out early and leave Main Street investors holding the bag.

In the meanwhile after opening the day on a positive note, Indian equity markets continued to trade above the dotted line. At the time of writing, the Sensex was up by 38 points (0.2%). The other major Asian stock markets have closed the day on a mixed note with China and Indonesia closing in the red while Japan and Korea have closed the day in the green.

 Today's investing mantra
"The single greatest edge an investor can have is a long-term orientation."- Seth Klarman

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