It took $500 billion in asset write-downs to bring the more than $13 trillion-dollar American economy to nearly a grinding halt with a list of casualties that would have been the envy of any asset manager in happier times. Bear Stearns, Lehman Bothers, Fannie Mae, Freddie Mac, Merrill Lynch, and insurance big boy AIG. Naturally the American economy which lives on leverage (borrowing more than it earns) looks to be in a deep mess.

Since the economic liberalization in 1991, India has seen staggering GDP growth backed by relaxations in FII and FDI norms, catapulting the benchmark market index to 21000 levels in January 2008. The market is down nearly 50% and the mood remains apprehensive and pensive.
But despair is the time when true character is revealed, be it of any organization or individual - when pushed to the corner, its time for the champion boxer to take one more up his chin and still stand his ground.

Will India survive?

The point here is to know can there be a simple way for a small investor to instill confidence back on the street.

As markets across the globe are looking to pack their bags for a long time, in this entire mess one investor segment just might prove to be the saving grace: you and me. On 2nd April 2007, the BSE Sensex closed at 12455.37. on 31 March 2008 it stood at 15644.4, returning a cool 25.8%, year-on-year. RBI data for 2007-2008 suggested that only 10.5% of household savings found its way into the equity and debt markets amounting to Rs 77000 crore, the rest probably cooling its heels in the banks as currency or currency equivalents (Gold). This means that domestic households have matched the $15-17 billion brought in by FIIs for FY ‘08. Now with FIIs deciding to retreat and having already pulled out just over $9 billion from domestic markets since January ‘08, they would be rethinking about their equity allocation for India in the future. This makes way for a huge opportunity to Indian households who by increasing their share of investment in the domestic markets can hope to turn its tide as well as their own. As an individual investor, every incremental investment shall improve his/her long term (>1 year) returns. At the same time, incremental investment in gold would hedge him/her against any inflationary pressure and any unforeseen down turn.

50 million people in India are at present in the middle class category. This is expected to balloon to 583 million by 2025 according to a study by McKinsey & Co. This represents the real buying power. Even if we assume that these 50 million actually only save and their savings find their way into the banking system, imagine what a higher percentage of investment will do to the economy if they decide to flirt a bit more with the investments to savings ratio. We need to realize that FIIs are like mercenaries who will flee their camps first when the chips are down and that domestic investors are the real face of the investment community.

By now it’s a known fact that we are in midst of unprecedented global turmoil. India is surely not insulated from whatever is happening around the globe. To add to that we have our own local problems like high inflation, subdued IIP numbers, which in turn have posed a big threat to our GDP growth. Stock markets are bound to react to whatever is happening around the globe and there is no surprise that our own stock index has shaved off almost 50% from its peak much in line with other indexes around the world. Such is the retail investor psyche that these same buyers who were queuing up to buy at 21,000 odd levels now shudder at even the thought of investing in the market!

The fear is well warranted considering the uncertainty we are facing.

I don’t know where this will end or how much more downside we can eye from here. Not because I am ignorant but only because it should not matter for me as a long-term investor in the equity markets. Notwithstanding all the macro and micro gloomy data points together with the uncertainty hovering around, the fact remains that the current turmoil gives an excellent opportunity for an Investor to build a long-term portfolio in equity markets.

Yes, I do agree a lot will depend on the quality of stocks we pick in the portfolio. But here again, remember that investing is simple. It is only as complicated as you make it. Considering the fact that we are almost trading at 2-year lows on the Index, this is an excellent opportunity for first-time investors to build fresh exposure in the equity market. It surely doesn’t get better than this.

So, where does one start??

The index has shaved off more than 50% from its peak dragging with it all the heavy weight stocks.

In times like these it is always advisable to start building exposure in the markets through the frontline stocks for the following reasons:

1. These are fundamentally good stocks, available at attractive valuations. Typically, during periods of panic, market players tend to over-do the concerns surrounding the stocks pushing the prices much below their intrinsic value.
2. Whenever there is a reversal of trend in the markets, these stocks will be the first to bounce from their lows giving a sharp recovery

How can you take exposure to these stocks?
There are various ways in which you can start building exposure to these front liners:

• Index Funds: Index funds (passively managed funds) from mutual funds could be a good option. These could be funds tracking a particular index (say Nifty or Sensex).

• Diversified Equity Funds: One can have exposure to diversified equity fund schemes of mutual funds, where the exposure could be towards the blend of mid & large-cap funds as per the schemes’ objectives. But please make sure you check the top 20 holdings of the scheme you are planning to invest in, as your objective is to be a part of the frontline stocks.

• Nifty BeES: Nifty BeES is the first ETF (Exchange Traded Fund) in India.

The investment objective of Nifty BeES is to provide investment returns that, closely correspond to the total returns of securities as represented by the S&P CNX Nifty. Typically value of Nifty BeES will be 1/10th value of the prevailing Nifty price (For example, if Nifty is currently trading at 3500, Nifty BeES could be available @ 350) and it can be bought and sold on the National Stock Exchange like a share. In short, you buy/sell the broad Indian market using just 1 scrip.

• Direct Equities: You can even directly buy the stocks form the market in a staggered manner, provided you fully understand the nitty-gritty of investing in equities. If you don’t possess the requisite expertise, simply turn to a professional money manager.

Whatever may be your mode of investing make sure you do some serious investing at these levels. If you feel jittery to invest the entire chunk, start investing at least 30-40% of your investible surplus in equities. And remember always, that best of the investments are always made in the worst of the times.

Kapil Mokashi is an Associate Financial Planner, working with Sharekhan Ltd. as an equity advisor.

In my last article I had mentioned that there are several methods, or styles, to investing profitably in the equity markets.

Let me start with suggesting that you, the potential investor, spend some time analysing your investments. If one were to assume that your money is indeed “hard earned”, would it not be unfortunate if is easily lost?

Most professional advisors compare their performance to benchmarks, which are indices. For example, if a fund generated returns of 20%, while its benchmark’s returns were 15%, this “outperformance” of the index by 5% is called an ‘Alpha’. This is a good measure to evaluate fund performance, provided the benchmark is reliable. If reliable, it would be a good measure to evaluate even personal portfolios returns.

The BSE Sensitivity Index of 30 shares is the most popular Indian stock market index. If one were to track this over 5 year periods, starting in 1992 (this is the year of the infamous Harshad Mehta boom, which is a relevant beginning simply because this is the first time there was retail participation in the capital markets), we would find that pre-2003 (the start of the latest boom), the index returned less than bank FDs. Even if we go from 1992 to the current date, the index returns are disappointing. This should indicate that equities are a poor long term investment, but are actually among the best options!

In fact, a well diversified portfolio, built over time and given a few years, at reasonable valuations (PE of close to 10, certainly lower than the Sensex’s long term average of 14 times) will outperform the benchmark or almost any other investment. The great Warren Buffet, however, considers that “wide diversification is only required when investors do not understand what they are doing”. If you know, and you need to know, why you make an investment, you should also have guts to invest plenty in it. Again, quoting Mr. Buffet, “Why not invest your assets in the companies you really like? As Mae West said, “Too much of a good thing can be wonderful.””

Diversification or concentration of portfolios can be achieved through investments in mutual funds. Concentration is through sectoral or thematic funds. Concentration is good only if you are an expert and can time your entry and, more importantly, your exits. Avoid being carried away by the noise. Most fund managers consider themselves to be God’s Greatest Gift to Investments (GGGI) in a bull market. However, when they crash with the markets they are quick to point to outperformance, if any, on the index, i.e. “The index has fallen 30%, but I have been brilliant and have lost only 25% of your money”. I have not met any investor who hands out money to be lost, whatever the market conditions. My advice is to ignore the froth from the fund managers, or brokers. If you are convinced the market is cheap, put in all your money. In an uncertain market do an SIP. But when the market seems overvalued sell. (By the way, have you ever heard a fund manager advice you to sell, or redeem your units in a bull market?) A crash always follows a euphoric bubble. Cash is supreme in bad times. It is a good feeling, and also very profitable to buy when the market is down 70%!!

Is this a good time to invest? Yes and no. An important lesson from Joseph Kennedy, almost a century old, is to sell when the shoe-shine boy gives stock tips. I believe this is true today. When the taxi driver is thrilled to take you to the share bazaar and asks for stock tips en route, the stranger at the party gives you sure shot stock bets and the daily newspaper has headlines of the local housewives club betting their grocery money on stocks – GET OUT. This is the best signal to sell your shares.

And buying? This would be when that party animal with best buys stops partying, the Big Bull has jumped off the 13th Floor and there is a funereal feeling at Dalal Street. Buy when the mention of a good company has people grit their teeth and give you dirty looks. And, of course, the index has a low, mouth watering PE!

One of my own gurus told me never to confuse the market with stocks. “The market is irrelevant”, he said, “buy the right stocks and you will always make money.” If you have his stock picking skills, which I do not, this article is not for you. If you are one of the simple folk, hoping to beat inflation and make a little money on your savings, the market at over 18 PE all this week (18.80 on Nifty on September 4, 2008) remains expensive. Look then for gems that might become multi-baggers.

Otherwise hang on to your precious cash. A better day to buy will dawn, when PEs are closer to 10 than 20. Get into SIP mode then. Market corrections can be both deep and long. Losing opportunity (interest cost of your money) is about as unfortunate as losing capital.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.

Personal loans are gaining popularity among loan seekers in a big way. Be it planning a vacation or getting you daughter married, down payment of your new house or medical obligations, a personal loan may be used for any purpose. A personal loan may be a secured or an unsecured loan where the end use of the money is not supposed to be declared while taking the loan. The rate for unsecured personal loans ranges from about 15 % to 25 % per annum depending up on the credit history and the income of the loan seeker. This type of personal loan is more popular among the public.

The problem begins when people take these kinds of loans for investments into various instruments including equities. Markets have been pretty volatile for last few months and are expected to behave the same for quite some time. So if you planning to take a personal loan and invest in to equities of mutual funds thinking that the markets are at low then think again. The inflation rate has been moving up. The last numbers posted was well above 12%. With the growth in the Gross Domestic Product (GDP) around 8% to 9% the economy may see a negative growth in the current fiscal. The Reserve Bank of India has tried to tighten the liquidity situation by increasing the Cash Reserve Ratio (CRR) by 50 basis points. They may increase it by another 50 to 100 basis points if needed to keep a check on the inflation numbers. The condition worsens if the loan you have taken is on a floating interest rate. You end up losing money in the equity markets and pay more towards the loan at the same time. This is like being the rope in a tug of-war match where both sides are trying to pull you towards themselves to the fullest.

A better way to invest into equity market is by the way of arbitrage. It is buying in the cash market using the loan amount taken and selling it in derivative market by way of futures at a price which is more than the price bought added with the interest amount. On the day of maturity you reverse your position on both the markets and difference of the amount over and above the cash market price added with interest on the loan and the price sold in the futures market is your profit.

To explain arbitrage lets take the following example.

One lot of Reliance Industries Limited (RIL) is of 75 shares. Suppose the price of one RIL share is Rs. 2200 on 1st July, 2008. The maturity is on 31st July, 2008. The total amount of loan of 75 shares is (2200*75) = Rs. 165000. If the interest rate is 18% per annum then for one month the amount of interest is (165000*1.5%) = Rs. 2475 which is (2475/75) = Rs. 33 per share. Thus you need to short one lot of Reliance at any price which is more than (2200+33) = Rs. 2233. If you manage to short at a price say Rs. 2250, then you make a profit of (17*75) = Rs. 1275 on one lot which is almost 9.3% per annum. Now no matter what the price is on the expiry, you will manage to earn the amount stated above as you have already squared off your position.

The main thing over here is to find the right price to buy in the cash market and sell in the futures market. If you manage to hit the right price over the screen, then bingo! You have made money where everyone is losing it.

I had just started college in 1981. Some saved pocket money and small prizes added up to Rs. 125, which became my first investment in shares. 3 years later I got out of college with some education, a portfolio of about Rs. 10,000 and a lesson in keeping my mouth shut…Knowing my dad also had some investments in shares (from the addresses on the mail) I mentioned a particular stock at home. Dad promptly took me out and warned me never to speak of shares in my grandmother’s hearing. The belief was that investing in shares was as big a sin as gambling – anathema for a small town middle class family.

Stories of legendary wealth created from investments (Warren Buffet, according to an email doing its regular rounds, started at age 11 and used profits to buy a farm at 14, to turning into one of the richest men in the world), to tales of suicides by big losers would suggest that investments in shares is gambling and that the stock market is a huge gambling den. Is it?

Starting at the beginning, what is a share? If I may use examples, a person starting a small business could use his/her money, if a little more money were needed. He/she could rope in friends as partners, or borrow from banks, but would be hard-pressed if the capital required were substantially larger. Such a businessman could split the entire owners’ capital into small units, of normally Rs. 10 and sell it to a large number of ‘investors’, each being a partner in the business to the extent of the money invested (’shares’ bought). The business would be in the form of a ‘Joint Stock Company’ (Company).

The share market? If the investor, from my previous paragraph, had invested in a share of a profitable company, others interested in being a part of the venture would try to buy shares in that company. This would take the prices up. Conversely, if the company were not profitable the holders would try to sell it bringing down the price of the shares. The share market is a forum that facilitates and controls the transactions, to ensure the investors’ transactions are safeguarded.

This does not mean that the stock exchange guarantees profits to all investors. Every transaction of a share bought involves another where a share is sold (shares are not created at will). While the buyer would purchase a share expecting the price to go up, the seller would expect it to drop. One would be right. The Stock Exchange is a place where a seller can find a buyer. The Exchange also ensures that the buyer receives his shares and seller his payment.

Returning to the beginning and my grandmother? How is investing different from gambling? While gambling involves chance (I do not know anything more about gambling in any form), investing involves the science of numbers. All stocks traded (stocks are bundles of shares) are at a price. This price is normally based on measurable factors, including but not limited to the profit of the company (from which is derived the profit per share, also called Earnings per Share or EPS), Book Value (which indicates the amount of profit plowed back in the business), ROE (Return on Equity) and ROCE (Return on Capital Employed, showing how well money has been used to make profits by the Company). Out of these come other ratios relevant to the price, like PE (Price/ Earnings, a fundamental value), PEG (PE/ Growth), P/BV (Price/ Book Value) and others. The market becomes a casino when these values are ignored and shares are bought because it is fashionable to have some!

The guru of investors, Warren Buffet, has said that he considers ROE, followed by PE, the most important values.

Returns are the most important simply because that is the reason for any investment. With a number of options available, the investor would be unwise to use the less profitable. Therefore, knowing that your company earns reasonable returns on the money invested in its business (Return on Equity and Return on Capital Employed) is the basic parameter to value a company and its share.

PE tells us the price we pay for the returns. Simply PE is the number of years it takes to get your investment back as profits, at the present rate of profit. Obviously the investor would like to recover his investment early, so a small PE would normally be better. An example, most small businesses are started with loans from parents or uncles, autorickshaws, fruit juice stalls, vegetable vending and the like, which are numerous successful businesses in India. The loans are taken with a promise to repay (mostly honored) the loan after deducting daily personal expenses. The loans are to be repaid in 2 or 3 years, indicating a PE of 2 or 3. Would the lending ‘uncle’ be as generous if the loan were to be repaid in 30 years? I doubt it. But in shares investors often disregard their ‘pay-back’ period (the BSE Sensex was at a PE of 30 a few months ago), clearly indicating gambling was getting the better of investing. The market fall to a current level of about 18 PE was a natural phenomenon of valuations and better sense descending!

There are several methods to investing and they will be covered in time. The most important is to invest with some knowledge. Data is available today, as easily to the rookie, as a professional. If the money invested is hard earned, the investor has a duty to himself, to see that the money is not lost to stupidity. Three basic types of research are Fundamental, Technical and Logical.

Fundamental research is a study of the Profit & Loss account, as well as the balance sheet of a company to check the financial health and profitability of the business. The ratios mentioned earlier all stem from this.

Technical research is a study of graphs and patterns, best left to experts. This is used to identify the best time to buy, or sell, a stock.

Logical research is simply keeping ones eyes open. The daily news often provides information on opportunities. For example, increases in interest rates hurts companies that borrow, and banks that would see erosion in the value of their bond portfolios. Increased customs duty on steel would benefit the local steel manufacturers.

Till we meet again, a word of advise. Gather some knowledge, or go to experts (through Mutual Funds). Invest so that you keep your losses low (therefore invest cheap – not at low prices, but at cheap valuations). Prefer to lose opportunities, not money (Buffet’s 2 rules to his managers are:

1) Never lose your investors’ money

2) Never forget Rule 1

May your investments be profitable and your days peaceful.

Naveen Fernandes is a Certified Financial Planner and Vice-president, Orbis Financial Corporation Ltd, Mumbai. Orbis Financial is a SEBI-approved custodian.

Often people talk about asset allocation within various investment classes like equity, debt, real estate, gold etc. Your financial advisor draws up the plan for you and you sit very comfortably with an asset allocation of 60 – 30 – 10 which means 60% of your portfolio goes in to equities, 30% in to debt and the remaining 10% in gold. For debt you invest into post office or you buy fixed deposits. For gold you go and purchase gold biscuits or ornaments from the markets. Now the question here is how to go about the 60% of the portfolio which is supposed to be invested in to equities according to the financial plan. Buying equities is not as simple as buying gold and or buying fixed deposits.

The first step to be taken here is to decide if you want to invest directly in to equities or want to go the mutual funds or the portfolio management services (PMS) way. The minimum investments in to mutual funds are around Rs. 5000 whereas in PMS it is Rs. 5 lakhs. If you are not very comfortable with ratios and balance sheet then the best option is to leave it in the hands of experts. Mutual Funds or PMS are the best way to go for you.

But before you invest in to mutual funds, PMS, or directly invest in to equities you should think if you should invest in to large caps, mid caps, small caps or a mix of all of them. The risk return matrix of the equity classes can be explained as follows:

Large Caps – established companies, successful business model, so low risk, low returns
Mid Caps – yet to prove themselves but already in the process – riskier than the large caps, so returns will be higher
Small Caps – new entrants in the markets, they are called the babies of the markets – high risk, high returns.

The asset allocation to be done within equities has a lot to do with the risk taking capacity of an individual and doesn’t depend too much on the time horizon of the investments even though the time horizon can’t be completely ruled out.

Comfortable time horizon for each equity class:

Large Caps – 3 years and above
Mid caps – 5 years and above
Small and Micro Caps – 7 years and above

Before drawing up an asset allocation within the equity classes it is very important to draw up your risk profile. You should contact your financial advisor for the same as it is a very sophisticated process and a simple mistake in the process can lead to defeating results. Mutual funds and PMS products are available in all the mentioned equity classes. You can visit various personal finance sites to see the best of mutual funds in each category. Your financial advisor can help you to choose the best mutual funds in the industry. In case of PMS the providers usually have products for each class. You can discuss it at length with the provider.

The author is a Research Analyst working at Apnaloan.com Services (P) Limited.