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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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As we step in

Posted by Muthu on January 1, 2012

Wishing you a very happy and wonderful new year. 

My profession demands that I wish you prosperity too:-)You would do well financially if you stick to the chosen philosophy and approach. More of it later. 

I was able to write to you only once last month due to a viral infection which liked staying with me for longer than required. I would continue to stick to writing twice a month.

I’ve been getting mails asking to write more than twice a month. I’m grateful for your interest. I would see what best I can do from April onwards.

Today is not only the New Year but also we stepping into 6th year of our profession.

When I walked out of BPO career in December 2006, I never thought I would get so many excellent relationships.

Markets, industry and regulatory environment have not been favorable for most part of the above period and in fact been very tough. We survived because of you. Even now, there is no clarity and visibility on professional model due to ever changing and uncertain regulatory environment. Once I used to worry about these things. Now a days I worry a lot less. If you are ready to fail, the worry level automatically falls:-) 

As someone who is wired to anticipate failure more than success, this relative success in the last few years despite strongly counting (!) on to fail is itself a pleasant surprise. Thank you.

We understand from industry sources, in Chennai, under ‘Independent Financial Advisors’ category, we’ve the largest SIP book size, in terms of value, as at the end of 2011. Assuming this information is true, I’ve to thank you again for the same. As per our philosophy, we do not focus on instant gratification and probably that is why we are here. Personally I’m not bothered about these ‘positions’ as they would always keep changing. I do not have any targets to work for and by nature neither ambitious nor aggressive.

Sensex has fallen by 24% in 2011. This is the second worst year in nearly last one and half decades.

Since we normally suggest a tenure of not less than 10 years for equity and as most of you have a disciplined approach of investing regularly, these kind of falls help you to acquire more due to cheaper prices.

We strongly believe that investing regularly for long term or SIP or rupee cost averaging is the best way to create wealth through equity by participating in long term growth of our country. As I always repeat, what I tell for our country now need not hold good for all the countries. Likewise if you apply what I tell for equity funds blindly into stocks, the result may be disastrous.   

Globally lots of negative things are happening since 2008. Despite that, our absolute growth from April’08 to March’12 would be around 30% (assuming a 7% growth rate for this fiscal). This is real rate of growth (i.e.) after adjusting for inflation. Considering both external and internal factors, this is really significant.

The only other major economy which can talk about similar growth during the above period is China. But no one knows the reality of Chinese numbers. The growth models of both the country are different. The economic stories of nations tell us that if a country follow hyper investment and creates excess infrastructure or manufacturing capabilities, it leads to a bubble and collapse.China is having a double digit growth rate for nearly 2 decades without democracy or freedom. Being an export dependent country, it’s fate is more closely linked with that of  U.S. and Europe and their future protectionist policies.

Real estate prices in many parts of China have corrected by 20% to 30% in 2011 and there are forecasts of further correction by even 50% in 2012. If it happens, it is actually good for the country in long run. Asset prices, if it does not correct periodically would result in over heating and a subsequent crash. But considering the amount of NPAs already held by Chinese banks, I’ve no clue what impact this correction may have on their banking system.

Talking about asset prices and banks; someone in media asked me about gold finance companies. I’m skeptical about their model. I hear that they provide around 75% of the value of the gold mortgaged as loan. Gold of olden days is not the gold of today. It has become a very volatile asset class as it is being traded in derivative markets too. So if all of a sudden gold falls by 40% in a short period, how they would be able to recover their loans? Even if they sell the gold, distress selling coupled with the fact most of the mortgages are not pure gold bars or coins but gold ornaments, they may realize lesser than the prevailing (reduced) market value. So the assumption seems to be gold prices would not fall by more than 25%. This is questionable, especially at these price levels.

Internationally, in 2011, in dollar terms, gold has given a return of 11%. Due to strong depreciation of rupee, the return inIndia is around 30%. What if gold prices fall by 20% internationally and rupee appreciates by 15%? I don’t know what model of risk analysis and management are in place by these companies.   

When some became very bullish on silver at higher levels, I suggested caution and moderation. You would have noticed how wildly the prices fluctuated during last year. Precious metal prices are no longer determined only by demand and supply. For gold, silver etc., the position in the futures market may be far higher than their physical availability in the planet. These are speculative positions which may be aided by leverage too.

So unwinding of these positions by entities like hedge funds can cause significant price correction. Not only that when the prices fall, they may even go short resulting in further fall or even crash.

That is why no asset is safe if you’ve leveraged your position. When the tide is favourable, your gains become multifold by the aid of leverage. But when the tide turns, which no one can predict precisely, leverage can actually destroy you. If you loose lot of money, it is very difficult to make it up again. We’ve to get rich only once in our life as long as we don’t do anything stupid. The greed and fear in us would naturally nudge us to do stupid things. How we avoid them is all about the investment game. 

CDS (Credit Default Swaps) has been allowed in our country recently. We’ve to wait and see how they are going to be regulated. As I’ve written before, CDS allows you to insure things on which you’ve no financial interest. This would lead to lot of speculation and even occasional collapse of financial system.

For example, if I feel that a gold finance company may default on its bonds, I can buy insurance for the bonds that I don’t own through CDS. If I feel that company may default, I can insure Rs.1 crore worth bonds say at 0.5% of its value per annum. So by paying Rs.50,000/- premium every year, I’m protecting myself against the default of bonds I don’t own. What I get by doing this? Simple, if the company defaults, I get Rs.1 crore:-) If it doesn’t, the other side pockets the premium as income.

What is wrong with the above? We need to understand that there has to be a counter party for every contract. So if I’m taking insurance for Rs.1 crore by paying 50K; someone else is providing me the insurance from other side. In the recent financial crisis, the other side happened to be insurance companies like AIG, banks etc. That’s why they collapsed. Why did they do it? The 50K premium received can be shown as income in their statement. So they were able to show more income instantly boosting the bottom line, rewarded themselves with fat bonuses, share prices went up and finally ended up being bankrupt:-) 

One of the reasons for our growth being moderated in the recent time is the raising interest rate cycle which peaked out recently. There has been 7 rate hikes in 2011. There was 6 rate hikes before in 2010. 13 rate hikes in less than 2 years did take a toll on the economy and it came unexpected. The good thing is that we may even expect falling interest rates (rate cuts) this year. It looks like the question of  how soon and how far they will do than whether they will do. This is because the food inflation is now close to 6 year low and the overall inflation is expected to be around 6% in next 3 months.

This year may be a good year for debt oriented funds like MIPs.

As far as equities are concerned; it is always a combination of sentiment and fundamentals in the short run and mainly fundamental in the long run. Being the election year, we may expect some positive sentiments from U.S. Some short term boosters may be given to the economy in lieu of elections though the long term direction is unclear. Europe; I may have to write a separate piece even with my limited understanding. No one expected dollar to get strengthened last year. The dollar got better because Europe got worse. Any more unexpected negative news from Europe can even strengthen the dollar further; though the currency is intrinsically very weak.

As the interest rates start going down, the investment cycle would pick up here. Pick up in investment cycle would have positive impact on growth in the coming years. Market has discounted lot of negative news including the possible further downgrade of corporate earning in the coming quarters. Likewise it may start discounting the future growth once the investment cycle picks up. Market act in anticipation rather than to the current situation. So it is not the question of whether the bull market would happen but when.

Since you are in the accumulation phase, ‘when’ need not be a concern. ‘When’ should be the question only when you plan to withdraw money for your goal. That planning needs to start generally two years before the goal. So as an investor with a disciplined approach and long term outlook, cheaper prices in terms of lower market levels should actually make you happy. I know it is emotionally not easy, but definitely worth giving it a try.

Our long term growth story is intact and I would not be surprised if we enter into a double digit growth phase during this decade.

All we’ve to do is be a disciplined and regular in investments. Additional lump sums can be invested when the markets are attractive but never in the heated up bull markets. Sticking to the asset allocation proportion (in terms of equity, debt, real estate and gold) and being emotionally disciplined would make us reach destination safely.

Remember the investment in bear and flat markets contributes for long term success than trying to time the market. We’ve seen in the past as to how just missing the ten best days in a decade would have halved the returns and how missing the best 30 days would have infact eroded the capital. These best days happen randomly and cannot be predicted in advance. Staying invested for long term ensures that you reap the benefit of these best days.

If you want to do well in the world of investments; please do not keep looking at the value frequently. It is a dreadful disease. A yearly review would suffice; that too more from accounting and planning perspective, not from an emotional perspective. Getting emotional with investments would kindle fear in the bear markets and greed in the bull markets. These two emotions, when becomes excessive, can end up being our own enemies. Though I don’t believe in New Year resolutions; if you are in the habit of having one; I would suggest trying the above.

We’ve to keep looking at markets because it is our profession. We don’t ask a Doctor why he goes to the hospital or a jailer why he goes to the prison every day:-)

NHAI have come out with tax free bonds. I read that retail portion alone has not been subscribed fully. A tax free return at 8.2% per annum (interest payable in October every year) locked for 10 years is really attractive. NHAI is not a government company but part of Government of India itself. So there is an implied sovereign guarantee. The limit for retail investment category (per person) is Rs.5 lakhs. The flip side is that you may not have liquidity though the bonds would be listed; because there is not much depth to retail bond market in India. If you do not need this money for ten years at all, then you may consider investing the same. If interested, we can facilitate this for you.

Request you to bear with me for this longer than usual long piece:-) Since I’m writing to you after a month and wanted to cover few things…..

Once again, thanks for sustaining us and help us get into our 6th year today. Happy birthday:-)

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