MFs are moving to cash, should you? - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

MFs are moving to cash, should you? 

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In this issue:
» Is the worst for the CV sector over?
» CCEA clears stake sales for three major PSUs
» Does India have higher credit risk as compared to peers?
» Krugman believes interest rates in the US are still very high!
» ...and more!

We came across an interesting article in today's Economic Times. It discusses about certain mutual funds lowering their exposure to equities. And instead, they have been increasing their exposure to bonds.

Why have they been doing so? Because of the higher valuations!

As per the ET Intelligence Group database, the CNX Nifty is currently trading at a multiple of 21.68 times. A year ago, the same stood at 17.14 times. This is a rise of about 26.5%. The index has moved up by about 38% in the year gone by, thereby giving an indication of what has been driving the market rise.

It may however be noted that this move is being done based on historical valuations, and is a strategy that these mutual funds tend to follow. As such, one of the key decisions of the fund managers of these funds would be to decide whether to increase exposure to stocks or bonds, depending on the valuations - the lower the valuations, the higher the exposure to stocks; and vice versa.

Readers of the Daily Reckoning would relate this to the strategy that Bill Bonner has been discussing in the past few editions of the newsletter. As per him, the simplified trading strategy of increasing exposure to stocks when the index is trading at low double digit valuations and selling them when it crosses 20 times is a one that would work very well.

In fact, we at Equitymaster also recently introduced a service called 'Microcap Millionaires' that is based on this very strategy - one that was expounded by the father of value investing Benjamin Graham. This is a service which identifies the strategy that an investor could take - and one that also helps investors pick out stocks based on the principles of value investing - during various market scenarios. Depending on the same, the ratio of exposure to equities and fixed income instruments shifts towards the more lucrative investment opportunity. In other words, when the market is attractive, we would recommend investors have 75% exposure to stocks (balance in fixed income instruments) and when the market becomes too pricey we would recommend 75% exposure to fixed income instruments (and balance in stocks).

Having said that, when applying this strategy, there would be some periods when one may find it difficult to stay out of the market. But then if one has a formal approach in place, it would be best to stick to it; especially when such an approach - as the one mentioned above - has worked well in the past.

All one needs to essentially do is make the right broader decisions and be patient when the market scenario looks too good or too messy.

As for our take on the exposure that one should have towards stocks at the moment? You guessed it. Not to increase exposure would be our call; except for good quality names available at reasonable valuations. In fact, we would like to add that investors could make the most of the market run up and exit the not so high quality businesses in the process as well.

Do you think it makes sense to increase exposure to fixed income instruments in present times? Let us know your comments or share your views in the Equitymaster Club.

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01:50  Chart of the day
The last couple of years have been quite challenging for the commercial vehicles (CV) sector. Indeed, among all segments of the auto industry, this segment has been the worst performing of the lot. Since the fortunes of this segment are very closely linked to that of the economy, considerable slowdown in GDP growth hampered CV volumes as well. It did not help that the erstwhile UPA government did nothing about reviving the industrial sector.

CV volumes: On the brink of a turnaround?

But the month of August 2014 has been different. Indeed, medium & heavy CVs (MHCVs) posted a strong 20% growth led by increased mining activity and freight movement and also because last year's base was very low. Does this mean that the worst for the CV sector is over? Not necessarily. Because volumes of light commercial vehicles (LCVs) and buses are still down and have weighed heavy on the entire CV sector. The bus segment at least is expected to see a revival as both Tata Motors and Ashok Leyland have won orders from various states. MHCV growth is also likely to continue as economic activity picks up. How LCVs pan out remains to be seen. But overall, it does seem that the outlook for CV space is much better than what it was last fiscal.

After a long hiatus, the government finally seems to be on track to meet its divestment target of over Rs 400 bn for the current fiscal. As per a leading financial daily, the Cabinet Committee on Economic Affairs (CCEA) yesterday, cleared stake sales for Coal India, ONGC and hydropower utility NHPC. At the current stock price levels, disinvestment in these companies is expected to meet the budget target of Rs 434.25 bn. CCEA has cleared a 5% stake sale in ONGC in which the government currently holds 68.94% stake. This is likely to fetch over Rs 190 bn at current price levels. CCEA has cleared a 10% stake sale in Coal India in which the government currently holds 89.65% stake. This could fetch the government close to Rs 240 bn at current prices. The proposed 11.36% stake sale in NHPC is expected to fetch over Rs 30 bn. Given the buoyancy in the markets, achieving the divestment target may not be a big challenge if the government gets the pricing right. The proceeds will be great help in meeting the fiscal deficit target for the fiscal which has been pegged at 4.1% of GDP.

The restructured loan books of PSU banks are sufficient indicators of poor credit quality of Indian companies. The fact that companies with leverage are having to service loans at steep rates has added to their woes. Companies in the infrastructure and utilities space have also to contend with unfinished and stuck up projects. Therefore the Bloomberg report, published by Mint, saying that Indian firms are at risk of default hardly came as a surprise.

However, what we would beg to disagree with is the claim that India's credit risk is higher than other regions in Asia, Europe and the US. Europe and American companies are in fact living out of cheap funds. And they run the risk of going landing into financial trouble the minute rates start rising. In Asia too, the quality of corporate credit in Japan and China are no better. So, it is true that India needs to pull up its socks and bring PSU banks out of the restructured loans mess. However, it is a relief that unlike the US, Europe and China, which claim ignorance, we at least acknowledge the magnitude of the problem. And that itself will keep India's financial system relatively safe.

We don't know what economic school of thought we belong to yet. But it certainly isn't the school of thought that Paul Krugman believes in. For our views run counter to what the Nobel Laureate has to say more often than not. Therefore, whenever he discusses something, we tend to find huge holes in his theories. And this is exactly what we found when we read excerpts from his recent interview. As per Krugman, the interest rates in the US are still very high! Well, we for the life of us cannot figure out how this can be the case despite rates being near zero. It turns out that Krugman's measure of interest rates has to do with full employment. The right level of interest rate as per him is the one where the economy has full employment without inflation. And since the US does not have full employment, rates are too high as per him.

Now, this really defies common sense according to us. Our understanding suggests that pushing interest rates artificially lower leads to overconsumption by consumers. And firms hoping that this boom is for real also embark on a capital expansion spree. But once rates start moving up to their normal levels, demand takes a back seat and the economy is then saddled with a lot of non-performing assets which had been created to satisfy the high demand. Consequently, the need of the hour is not to suppress them further as Krugman has highlighted but to bring them higher to their natural levels. Else we will have greater non-performing assets than what we had during subprime crisis. What do you think?

After opening firm, the Indian stock markets were hovering around the dotted line during the post noon trading session. At the time of writing, the BSE-Sensex was trading down by 6 points (0.02%). Majority of sectoral indices are trading in green with capital goods and Banking stocks leading among the gainers. Most of the Asian markets were trading weak led by Taiwan and Korea. However, the Japan market was trading positive. European markets have opened the day on a weak note.

04:55  Today's investing mantra
"I once owned 17 stocks. But that was way too much" - Philip Fisher
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2 Responses to "MFs are moving to cash, should you?"

Swagata Guha

Sep 12, 2014

Markets are at a very high valuations. As we know the market follows a cycle. Putting money in high market becomes very risky. So It is better to put money in short term bank deposits (say 1 year ) and earn interest. In the mean time when market will fall say 10-15% then put some money in equities.


Dr Ketan Jinwala

Sep 12, 2014

I definately believe that valuation in the market at present have gone ahead of fundamentals. At present p/e ratio of nifty is trading at 21.6 one should book profit & park their money to debt or from equity funds to balance funds. Dont forget that in January 2008 p/e ratio of nifty had gone upto 26 & crashed to around 10 in March 2009 so come out from greed.

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