1. communiqué November 2010
FROM THE DESK OF SRIKANTH BHAGAVAT
OVERVIEW How nature has its own ways of correcting excesses never ceases to amaze me. Take
the instance of SKS, which is fresh in our mind. The IPO was issued at a fancy pricing
From the desk of Srikanth
beyond 40 times price earnings multiple. The past rate of growth of the company was
Bhagavat
cited as the justification for the high pricing, the implicit assumption being that the
The 'Why's and 'How's of Asset same high rate of growth would continue. The enormous hype ensured a good
Allocation subscription and a high listing. The consequences of the hype were the heightened
Positives & Negatives attention on the micro-finance industry, its high profit margins and arguably, the
recovery practices. And to add to this, random events like the sacking of its CEO!
Let's Learn!
Whether there was a scandal or not, even a whiff of a juicy scandal is enough
Fund of the Month instigate change. Result – demands for regulation of the previously un-regulated
industry; attention to the very high rates of interest being charged by MFIs; questions
as to whether they are instruments of social reform (as portrayed) or simple for-
POSITIVES profit organisations like the rest of the capitalist world; arrest warrants against
Another round of stimulus from employees for harassing borrowers; allegations of bad loans; and now the demand
the Fed will be a booster for to lower rates and a possible restraint in lending by banks to MFIs. All this is more
emerging market asset prices than enough to reduce profitability and growth. Since all this broke out, the stock
price has slipped below issue price. What I am keen on pointing out is that at high
So far second quarter results are
encouraging. Aggregate results pricing, expectations are also high, leaving no room for error or chance events. One
of 572 companies show an cannot fault the issuer for issuing a fully priced share – it is for the investor to
increase in sales by 21.79% and discriminate and choose to invest in appropriately priced instruments. Margin of
net profit by 20.86%. safety is a must in our assumptions.
India's economy is seen growing Is there room for error in the pricing of our market as a whole? At 20 times forward
comfortably at 8.5% earnings, the market expects higher rates of growth and an assumption that the FII
flows would continue to India at the same rate. True, the Finance Minister has stated
Coal India IPO success indicates
appetite for good and quality that the government would not want to cap these flows. True, that the Fed in the US
Indian IPOs is seriously contemplating further monetary stimulus which can sustain FII flows.
True, that Indian growth story is strengthening and attracting hype. But any event
Large IPOs create deeper
that could change these assumptions could lead to correction. Oil prices, inflation,
markets
rupee appreciation, suffering exports, lower current account deficits, dis-investment
Corporate tax collections grew targets, unemployment in the US.... We think that we know the list. We may not. At
by 21.7% as per data released by high PE multiples, the room for error is reduced. Do not rush out, do not rush in.
CBDT Follow a discipline and be ready for course corrections. The long term story remains.
Cheers.
NEGATIVES
High PE multiple of the
Nifty/Sensex THE ‘WHY’S AND ‘HOW’S OF ASSET ALLOCATION
Rise in annual food inflation Asset Allocation is one of the most oft repeated pieces of advice that is doled out by
(16.37%) is worrisome wealth planners. But is it really all that it's made out to be? Do you really need an
expert or will some common sense just do the trick, thereby saving you the fees of a
The CII's 74th Business planner - money that could actually be invested? The following passages attempt to
Outlook Survey showed the dissect this topic with a common-sense view.
industry lobby's business
confidence index for Oct-Dec
2010 fell by 1.4 points to
66.2.
No improvements seen in
developed economies yet

2. November 2010
The most fundamental advantage of Asset Allocation is diversification. Lessening the returns correlation between investments
improves the stability of returns of the portfolio. The returns from a diversified portfolio will certainly not be as stellar in a bull
run, but neither will it take as severe a beating during a bear run.
The next advantage is rather less discussed than diversification, but nonetheless, equally powerful.
Buy low and Sell high is the credo by which every investor lives. Of course, that is easier said than done. The barrage of
information from the television, newspapers, magazines and tips from well-meaning friends always leaves one second
guessing an investment “buy” or “sell”.
A process of dynamically allocating your assets between risky and less risky investments, invariably leads one to stick by the
“buy low sell high” credo. How so? Well, the main asset classes of debt and equity are mostly inversely correlated because of
simple human tendencies.
When equities tank, the investors attempt a flight to safety and money flows into debt. A larger demand for debt drives the
prices of debt instruments higher, soon to un-attractive levels. In the meanwhile, as with all cycles, equities recover and begin
to look good. The money starts flowing back to equity. Anyone following this cycle will be doing the opposite of “buy low, sell
high”. A simple way to beat the markets involves using the above mentioned herd thinking to one’s advantage.
Take the example of Mr. X. He wants to remain with a portfolio divided equally between debt and equity, so he starts off with Rs.
50,000 in debt and Rs. 50,000 in equity. A bear market ensues. The Rs. 50,000 in equity becomes Rs. 38,000. His debt portfolio
grows marginally and totals Rs. 58,000. The current distribution of the portfolio is 40% in equity and 60% in debt. Since Mr. X
wants to stick to his allocation of 50:50, he automatically re-balances his portfolio and buys equity at low valuations
(remember, we said buy low, not lowest!) .With this, Mr. X has managed to book profits in the debt market and also enter the
equity markets at good valuation, all while maintaining peace of mind!
The execution challenges of the above process lie in identifying at which point to re-balance the portfolio and what the
allocation should be, in the first place.
Asset Allocation uses the simple idea of not putting all of your eggs into one basket. The guiding question while deciding how
and where to divide the eggs, should be “how much risk can I take?”, as eventually the process results in dividing your money
into risky and less risky assets. The ideal way to do this would be combine the process of a questionnaire and a discussion with a
well-informed and qualified planner. The discussion is important as there is no questionnaire that can capture with complete
accuracy all the nuances of one's psyche, financial situation and financial needs.
To answer the question of when the portfolio must be rebalanced, stick to a particular percentage as a cut-off at which you will
book profits and re-align your portfolio. In order to maintain balance and not get greedy, the guidance and discipline of a
planner becomes an invaluable factor and this is where you'll find your money's worth.
As with other investing strategies, discipline and consistency are key. This simple idea of asset allocation is quite often known as
the “only free lunch in investing”. So don't let a free lunch go while trying to forecast market trends. To quote John Kenneth
Galbraith, there are two types of forecasters - those who don't know and those who don't know that they don't know!

3. November 2010
Let's Learn!
with inputs from TATA Mutual fund's Prof. Simply Simple
The upcoming G-20 summit is keen to address the current account imbalances that are present in the world economy now,
with China and the U.S. likely to be at the eye of the storm.
China currently holds the Yuan at an artificially low level to aid exports by pegging it to the dollar. This (among other things)
has led China to become the exporting power house that it is right now, and therefore responsible for its large current account
surplus. Let’s learn explains how and why China is holding the Yuan at the current artificial levels and what its impact can be.
When a currency is free floating the market forces determine the price of a currency depending on the demand and supply of a
currency. i.e. when a country exports a lot of goods, the demand for the country’s currency rises, hence leading to currency
appreciation and vice versa for imports. But, when a currency X is pegged to another currency Y, the value of X fluctuates in
tandem with Y. The process of pegging does not allow the price of a currency to react to its demand. Therefore, in a situation
where exports are high, pegging keeps the currency artificially low, making exports unfairly competitive.
The main advantages for China holding the Yuan at these artificially low levels are:
1. Its exports become more competitive:
Let’s presume the exchange rate is $ 1 = Yuan 100. Now if an item costs Yuan 200 in China, a buyer in the U.S. would have
to pay $ 2. Now if China were to devalue its currency to $ 1=Yuan 200, the item would cost the American buyer only $1
instead of $2.This, therefore makes Chinese exports extremely competitive. As China gets access to larger global
markets, it gains from economies of scale which makes their goods even more competitive.
2. It attracts higher foreign investment: (FDI not FII)
Due to its depreciated currency the cost of land and labor for a foreign investor works out to be very attractive. Say the
cost of land in China was Yuan 100,000 & the exchange rate was $ 1 = Yuan 100. This land would then have cost $ 1,000. If
China were to depreciate its currency to $ 1 = Yuan 200, then the land would cost $ 500. Therefore, it becomes cheap for a
foreign investor to set up a manufacturing facility in China.
So why isn’t the strategy of devaluing currency followed by other exporting nations, such as India?
Understanding the flip side of currency devaluation will help explain this. A depreciated currency makes China’s import more
expensive. But quite clearly, China’s exports surpass its import requirement and hence the trade-off is in China’s favour. This is
not the case with India, where imports far exceed exports. Moreover, oil constitutes 80% of our imports. Hence, keeping oil
imports favourably priced forms an important part of the political agenda for any party at the helm. The second challenge is of
rising inflation. As the Yuan depreciates, the central bank will have to print more Yuan to balance the surge in dollars through
increased trade. But as China has abundant land and labour, they are able to off-set the inflationary pressures by higher
productivity through economies of scale. It is also interesting to note that unlike India, China is not a democracy. Hence, it is a
nation where the people’s voice against inflation can be silenced.
Political clout is also something that is required to follow the agenda of pegging the currency. Since China is an economic
powerhouse with $2 trillion in its kitty, it is able to withstand pressure from the international community, and this is something
not all countries can do.

4. November 2010
Fund of the month Dividend yield funds
Fund Note Low Moderate High
As the nomenclature indicates, dividend yield funds are those which predominantly invest their corpus in a well-diversified
portfolio of companies with relatively high dividend yield, which provides a steady stream of cash flows by way of dividend.
Thus, dividends received from these companies are earnings for the scheme along with some capital appreciation on the
equity stock. Simply put, dividend yield is measured by annual dividend paid divided by its latest share price.
UTI Dividend yield fund and Birla Sunlife Dividend yield plus fund are the pioneers in the pack on the basis of risk adjusted
return. These two funds encompass a different approach in their stock picking strategy. The former focuses on the good large
cap dividend yielding companies while the latter is focused on the Midcap segment. Both are well diversified with 51 and 63
stocks respectively. Apart from the 3 common sectors in both the portfolios, UTI fund is overweight on IT and Auto while Birla
is overweight on Pharma and Petroleum sector. Historically, 3 year monthly average exposure in large cap for UTI fund is
around 63% and Birla fund is around 37%, signifying that Birla fund has a significant proportion of its portfolio invested in mid-
cap stocks. Despite this, it has countered downsides through a combination of higher cash position and increased exposure to
defensive sectors. UTI and Birla fund carry a beta of 0.81 and 0.77 with downside risk of 10.20 and 10.31 respectively. Funds
that focus on dividend yield typically are more stable with low beta and restrained downside risk compared to a large or
diversified fund such as HDFC Equity fund which has a beta of 0.93 with downside risk of 11.60 (on 3 year basis).
Both the funds have managed to outperform the broader market, S&P CNX Nifty, across all periods. On a five-year basis, the
Birla and UTI fund have marginally gained over the benchmark's returns. But if the returns generated by these funds in last 3
years are considered, the returns are comfortably more than the broader market.
Within these two funds, Birla has outperformed UTI significantly and the risk taken is justified by the return generated. These
funds are suitable for investors looking for steady rather than superior returns along with good diversification.
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