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What should be your investment strategy after Budget 2011-12 - Views on News from Equitymaster
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  • Mar 2, 2011

    What should be your investment strategy after Budget 2011-12

    The Budget 2011-12 has laid down the path, for the economy to perform in the fiscal year 2011-12. The Finance minister has kept the growth agenda intact, as infrastructure, agriculture, banking & finance and education has been catered to in a balanced way by sufficiently increasing their respective allocations.

    Sector Allocation (Rs in crore) Objective
    Infrastructure 214,000 Suitable infrastructure to attract FDI flows and overall
    improve the state of infrastructure
    Rashtriya Krishi Vikas Yojana  7,860 Remove production and distribution bottlenecks
    Agriculture credit to farmers  475,000 Making credit affordable
    Education 52,057
    (Rs 21,000 crore to
    Sarva Shiksha Abhiyan)
    To increase literacy level and improve
    infrastructure for education
    Regional Rural Banks (RRBs) 500 To maintain a Capital Reserve Adequacy Ratio
    (CRAR) of at least 9% as on March 31, 2012
    Public Sector Banks 6,000 To maintain their Tier I Capital to Risk
    Weighted Asset Ratio (CRAR) at 8 %

    (Source: Union Budget 2010-11, PersonalFN Research)

    In a measure to provide an impetus to the mutual fund industry, the Government has now proposed to allow foreign investors to invest in Indian mutual funds after them having met the KYC norms.

    This move while it may enable mutual fund houses to garner more Asset Under Management (AUM) as foreign investors participate in the Indian equity markets (through the mutual fund route), we believe that this may also bring in some wild swings in the flow of funds to the mutual fund industry (unless we get long term foreign investors)

    However upsetting the corporates investing in mutual funds, for liquid mutual funds, the Dividend Distribution Tax (DDT) has been increased from 25% to 30%, but for debt funds it (DDT) has been increased from 20% to 30%, thereby attempting to remove the advantage which the corporates enjoyed by investing in liquid and debt mutual funds (for a period of less than 1 year) over Fixed Deposits.

    Dividend Distribution Tax
      Liquid / Money Market Schemes Liquid Plus / Ultra Short Term Debt /
    Floating / Income / Gilt Schemes
    2010-11 2011-12 2010-11 2011-12
    Resident Individual / HUF 27.681% 27.038% 13.841% 13.519%
    Partnership Firms / AOP / BOI 27.681% 32.445% 22.145% 32.445%
    Domestic Companies 27.681% 32.445% 22.145% 32.445%
    NRIs 27.681% 27.038% 13.841% 13.519%
    Tax rates mentioned above are inclusive of surcharge and education cess
    For 2010-11, surcharge is 7.5% and education cess is 3%
    For 2011-12, surcharge is 5% and education cess is 3%
    (Source: Union Budget 2010-11, PersonalFN Research)

    Mutual funds would not find it easy to attract short term surplus funds from corporates who park their surplus funds in liquid and debt mutual funds. However corporate who wish to park their long term funds (for a period of over 1 year) can still look at debt mutual funds by participating in the growth option as it still remains tax efficient (as it will continue to provide indexation benefit on long term capital gains).

    On the direct tax front, by reducing the tax slabs the Government has provided a relief (by increasing the base exemption limits in the respective categories) to the country’s citizens who are suffering the pinch of already high inflation.

    Income-tax rates in Budget 2011
    Taxable Income Tax Rate
    Upto Rs. 180,000 Nil
    Rs. 180,001 to Rs. 500,000 10%
    Rs. 500,001 to Rs. 800,000 20%
    Rs. 800,001 & above 30%
    For Womens, the base exemption has been kept unchanged at Rs. 1,90,000;
    For Senior Citizens, the base exemption is now increased to Rs. 2,50,000;
    A New category called Very Senior Citizen has been introduced who will enjoy a base exemption limit upto Rs. 5,00,000

    Taxable Income Rs.   10,00,000
    Upto 160,000 Nil -
    160,001 to 500,000 10% 34,000
    500,001 to 800,000 20% 60,000
    800,001 & above 30% 60,000
    Tax payable   154,000
    Education Cess 3% 4,620
    Total Tax (Rs.)   158,620
    Taxable Income Rs.   10,00,000
    Upto 180,000 Nil -
    160,001 to 500,000 10% 32,000
    500,001 to 800,000 20% 60,000
    800,001 & above 30% 60,000
    Tax payable   152,000
    Education Cess 3% 4,560
    Total Tax (Rs.)   156,560

    So, say for a male individual who is having a net taxable income of Rs. 10,00,000; will now get a relief of Rs. 2,060.

    By increasing the base exemption limits the government has moved a step closer to DTC (Direct Tax Code), and has made an attempt to fuel India’s consumption story by leaving more disposable income in the hands of individuals.

    For corporates, the reduction in surcharge (from 7.5% to 5.0%) is intended to fuel their earnings and leaving them with more profits for expansionary purpose.

    In the long-term the budget will have a positive impact on the equity as well as the debt markets.

    Investment Strategy for Equity Markets

    As sufficient justice is done to the main areas (as the one’s mentioned above) of allocation, the Indian equity markets would reveal signs of confidence, as overall the Government is justifiably spending. Moreover, with the excise duty not being revised upwards, corporate earnings would be better. But the increase in the MAT (Minimum Alternate Tax) to 18.5% (from 18.0%) may act as a spoil sport.

    Concerns of high crude oil prices remain as the Government has has failed to factor in the rising crude prices in the subsidy numbers. Hence, given that we still might have an intermediate risks (including inflation) which may keep the Indian equity markets turbulent.

    So, taking an holistic view from the above we are becoming cautious, and therefore would recommend you to go slow with your investments in equities. It would be wise to stagger your investments and adopt the SIP (Systematic Investment Plan) route while investing in equity mutual funds, as this will enable you to manage the volatility of the equity markets well (through rupee-cost averaging) and also provide your investments with the power of compounding. Moreover, it may be prudent to adopt a defensive stance and invest in value style funds and refrain from investing in growth style funds which may turn out to be more risky.

    Remember, while investing select only those equity funds which follow strong investment processes and systems, and invest with a long-term horizon of at least 5 years.

    Investment Strategy for Debt Markets

    vAs the Government’s announcement of net borrowing figures (Rs. 3,43,000 crore) remained low than the market estimates (Rs. 3,80,000 crore), the yield would soften gradually. Moreover, since the budget estimates for inflation are at 5% for 2011-12 (as against 9% for 2010-11), that too would soften the yields as inflationary pressures are expected to ease out. But going by the present facts that inflation (8.23% in January 2011) is still over the comfort levels of the RBI, and the RBI is trying to tame the same (by increasing policy rates), we recommend that one stays away from pure long term income and Government securities funds till RBI’s next mid-quarter monetary policy review meeting schedule for March 17, 2011.

    Hence, if you have a short-term time horizon (of less than 3 months) you would be better off investing in liquid funds for the next 15 days or liquid plus funds with a 3 to 6 months horizon; while if you have a medium term investment horizon (of over 6 months), you may allocate your investments to floating rate funds.

    Short term income funds should be held strictly with a 1 year time horizon. While one can even consider Fixed Maturity Plans (FMPs) of 3 months to 1 year (strictly hold till maturity) as the short term rates are attractive and these FMPs can generate attractive yield for the investors. 14 to 15 months FMPs can also be considered in order to gain attractive post tax returns by availing the double indexation benefits.

    One can slowly start taking exposure towards longer duration funds (preferably dynamic bond funds) if looking for a longer investment horizon of 2 to 3 years.

    You can also consider investing your money in Fixed Deposits (FDs). At present 1 yr bank FDs are offering interest in the range of 7.50% - 8.75% p.a.

    Long-term infrastructure bonds (offering tax benefit under section 80CCF of the Income Tax Act, 1961) can also be considered for availing income tax benefit beyond Rs. 1 lakh limit availed under section 80C. However, one should consider those with high credit ratings and good post-tax yields.

    Refrain from investing in pure long-term income funds and Government securities funds (as they might turn highly volatile in the near term) till the next mid-quarter review meeting of monetary policy (scheduled on March 17, 2011), as we expect to see more policy rate hikes from RBI (in an attempt to tame inflation); which would then make long-term debt papers more attractive.

    This article has been sourced from PersonalFN has been providing independent research since 1999 on mutual funds, insurance, fixed income instruments and gold. It also provides research based advice on investments and financial planning to individual clients. To know about our financial planning services, simply write to info@personalfn.com.


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