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Investment Insights

Suyash Choudhary

Even as the new government completes a credible month in office, the bond market has witnessed significant volatility with yields back-tracking almost 20 bps over the past 2 weeks. While it is true that some retracement after a 50 bps rally is only to be expected, there are 3 concrete reasons that are behind the market’s near term worry. These are:

1. Recent tensions in Iraq and their impact on crude oil prices: Brent prices are up some 5% over the past few days as fighting has flared up in Northern Iraq. While most oil facilities are situated in the southern regions, there are legitimate worries with respect to the trajectory of oil prices should violence escalate.
 
2. Prospects of monsoon under-performance: India’s Met department has a sub-par monsoon forecast and global weather forecasters are predicting a majority chance for an El Nino phenomenon this year; although recent oceanic and atmospheric conditions seem to have swung back into neutral territory. Furthermore, monsoon performance so far has been severely disappointing with rains tracking 38% below their long term average over June. Depending upon severity of the rain deficiency, market fears that primary articles’ prices may spike again in the months ahead.
 
3. Near term demand versus supply for government bonds: FIIs have bought approximately INR 30,000 crores of India’s government bonds post announcement of election results. This had significantly improved the demand versus supply scenario of bonds. However, the regulatory limits given to FIIs for government bond investments have now been almost completely utilized. Owing to this, and pending further relaxations to FII limits, demand versus supply for bonds is no longer looking as robust as it was before; at least in the near term.
 
All these 3 reasons are legitimate and, admittedly, in their worst manifestation can cause substantial volatility in markets. However, what is also true that almost all can be characterized either as ‘event based’ or having a limited period impact. On the other hand, there is another evolving development to keep track of; one that if continued can provide enduring improvements to our macro-economic situation with long term positive consequences for bond market returns: the performance of the new government in speeding along India’s adjustment process. While it is still early days, the government seems to have well and truly swung into action. Some of the key areas covered so far by the new government are as follows:
 
1. Host of steps on inflation including advising states to delist fruits and vegetables from APMC, increasing supply of potato and onions at retail outlets in Delhi, releasing rice stock into open market, and provision of credit to states for importing pulses.
 
2. A substantial hike in passenger fares and freight charges to improve railway finances. Media reports suggest that some staggered increases in kerosene and LPG prices may also be unveiled in the Budget in order to cap fuel subsidies.
 
3. Weighted average minimum support prices (MSPs) for kharif crops increased by only 2%. This was 6% in FY 14 and 24% in FY13. This is medium term positive for inflation control as higher MSPs used to put a higher floor to food prices.
 
4. Media reports suggest that disinvestment targets for the current year may be scaled up significantly thereby easing the pressure on fiscal deficit.

 
In our view, in absence of complementary government response, the burden of ensuring India’s macro-economic adjustment would have fallen squarely on the RBI. However, with a responsive government in place the RBI can be in wait and watch mode and let the government drive the adjustment process (please refer “The Great Adjustment Continues: A Bond Market Update”, dated 27th May). This is precisely what seems to be happening so far. The government has kicked into action whereas RBI’s latest commentary in the last policy review was decidedly a shade dovish on the margin. Ongoing developments have provided the trigger, and the recent rise in yields the opportunity, for us to switch a significant part of our 5 – 9 year exposure to the 13 – 16 year segment in our bond and gilt funds.
 
We are aware that should one or more of the bearish triggers mentioned above intensify, there may be further volatility in yields. However, we also recognize that as the ‘Great Adjustment’ progresses, it is bringing us closer to a phase of secular bullishness. It is to be noted that this assessment is a direct result of the election outcome and the policy intent that has been shown by the new government, which will likely allow RBI to take a back-seat. Thus it is quite different from the ‘perma-bull’ views that were calling for falling interest rates much before either the election outcome or the new government’s policy framework were known.
 
Finally, investors should keep a ‘portfolio framework’ in mind and avoid over-allocating to one profile of funds based on near term triggers. As explained above, in our view the medium term outlook is decidedly much more positive than it has ever been over the past 4 years. If investors agree with this prognosis, then their long term portfolio allocations should reflect this belief. At the same time, there are enough near term factors that can continue to cause interim volatility. A portfolio approach that matches risk appetite and investment horizon to product selection and avoids over-allocation to one profile of funds will help weather such volatility.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends. This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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IDFC MF

Warren Buffett, the world’s best-ever stock market investor is widely known for dispelling his secrets of sound investing.
 
One of his secrets that he has talked about a lot over the past many years is to focus on companies that generate a lot of “free” cash flow or FCF – cash that is available after all necessary expenses, like operating and capital expenses, are incurred.
 
Buffett often says, and has proved over the years, that companies that generate a lot of FCF and sustainably over the years, tend to have great competitive advantages over their competitors, and this helps them create a lot of wealth for their shareholders.
 
A company that generates a great deal of FCF can do all sorts of things with the money, like it can…
 
• Save it for future investment opportunities
• Use it to acquire other companies
• Buy back shares
• Pay higher dividends to shareholders
 
Positive FCF gives financial flexibility because the company isn’t relying on the capital markets to fund its expansion.
 
In fact, companies that have negative FCF have to take out loans or sell additional shares to keep things going, and can thus become a risky proposition when the financial markets are going through trouble.
 
A company that sustainably generates a lot of FCF is also an indication of a sound and capable management at help, which is another important requirement of a successful business.
 
In IDFC Premier Equity Fund, we invest in companies that are efficient allocators of capital and are able to generate positive free cash flows year after year.

This product is suitable for investors who are seeking* :

  • Create wealth over a long period of time
  • Investment predominantly in equity and equity related instruments across market capitalisation
  • High risk. (BROWN)Risk Categories

    Note: Risk may be represented as:

    • (BLUE) investors understand that
      their principal will be at low risk

    • (YELLOW) investors understand that
      their principal will be at medium risk

    • (BROWN) investors understand that
      their principal will be at high risk

*Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends.This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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IDFC MF

First Among Equals!

By: Punam Sharma

If you want to know what kind of companies to invest in, it’s important to know how a company is valued. Only when one understands what creates value in a company, can one look for characteristics that create value. In The Theory of Investment Value, written over 75 years ago, John Burr Williams set forth the equation for value: “The value of any stock, bond, or business today is determined by the cash inflows and outflows—discounted at an appropriate interest rate—that can be expected to occur during the remaining life of the asset.”
 
While for a bond, the coupon rate and therefore cash outflow/inflow is fixed and predictable, the same cannot be said of companies whose equity we hold. Equity therefore is a security with a variable coupon rate. The reason why some companies are more predictable than others lies in the fundamental business they engage in and their market position in their industry.
 
Market leaders may display some demand side advantages such as products with strong brands which are habitual in purchase, high search costs i.e. Cost of searching for alternative products, nature of products, high exit costs (costs for retraining on new products etc). Alternately, they could display supply side advantages like economies of scale and scope, lowest cost producers, licensed entry etc.
 
The entry barriers these businesses build (demand or supply related) ensure that they are relatively protected from competition. Companies with strong entry barriers display predictability of cash flows which is a prerequisite to predicting company value. Hence, market leaders find themselves in an enviable position versus competition.
 

If one can identify these market leaders and invest at a time when the risk return is in their favour, one can be set up for potentially favourable investment returns in the long run. Investing in market leaders is a not a “get rich quick” recipe but one which requires patience and conviction in equal doses. As Warren Buffett says, “Time is the friend of the wonderful business and enemy of the mediocre”
 
IDFC Premier Equity fund has attempted to build a portfolio around companies that, we believe, display or are on their way to market leadership.
 

This product is suitable for investors who are seeking* :

  • Create wealth over a long period of time
  • Investment predominantly in equity and equity related instruments across market capitalisation
  • High risk. (BROWN)Risk Categories

    Note: Risk may be represented as:

    • (BLUE) investors understand that
      their principal will be at low risk

    • (YELLOW) investors understand that
      their principal will be at medium risk

    • (BROWN) investors understand that
      their principal will be at high risk

*Investors should consult their financial advisers if in doubt about whether the product is suitable for them.

 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends.This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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Suyash Choudhary

The RBI kept policy rates on hold as was widely expected. However, some other key changes were as follows:
 
1. Cut banks’ SLR ratio by 0.5% to 22.5% of net demand and time liabilities (NDTL) of banks effective fortnight starting June 14th.
 
2. Reduce liquidity under export credit refinance (ECR) and compensate the same fully by introducing a special term repo facility. The quantum involved is 0.25% of NDTL of banks or approximately INR 20,000 crores.
 
RBI’s Assessment
 
The RBI’s commitment towards achieving its intended disinflation targets (8% CPI by January 2015 and 6% by January 2016) continues to show through and cannot be doubted. However, the commentary on inflation is perhaps a shade more sanguine that it was hitherto. Thus it assesses the recent uptick in CPI on the back of primary articles as largely seasonal while core CPI has been edging down. Furthermore, the central bank thinks that the risks to the first inflation goal post (of 8% by January) are largely balanced, with potential upside risks from supply side (primary and fuel) getting balanced by possibility of stronger government action on food supply and fiscal consolidation, as well by pass through of recent currency appreciation. Finally, the RBI says that if the economy stays on its intended disinflationary course, further tightening will not be warranted. On the other hand, if disinflation adjusted for base effects, is faster than currently anticipated, it will provide headroom for an easing of policy stance.
 
Takeaways
 
While the commitment to see through the disinflation process is unwavering, the RBI has acknowledged that the government may lend a larger helping hand in the adjustment process. This is very consistent with our own framework for analyzing the market (please refer our note “The Great Adjustment Continues: A Bond Market Update”, dated 27th May for details). As is evident, what matters the most for future policy outlook is the pace of disinflation going forward. As per RBI’s current expectation, the course of disinflation may just be sufficient to ensure its target and hence it considers the current setting of policy rates as appropriate. However if, basis complementary government actions, a higher pace of disinflation comes about then the central bank can see itself easing policy somewhat. However, and this point needs to be stressed, we believe that any sort of monetary easing will only come about if the RBI is relatively certain that the pace of disinflation will ensure not just its first goal post (8% CPI by January 2015) but also its second one (6% by January 2016). At this point, this leads us assign a greater likelihood of RBI being on hold for the rest of the year.
 
The other takeaway for us is that the RBI is implementing the recommendations of the Urjit Patel committee with relative speed. It may be remembered that in the last policy, the central bank had further curtailed access to overnight liquidity window. This process has been taken forward by curtailing sector specific liquidity access via the ECR window and moving it to variable rate term repo. On the SLR cut, the move is consistent with the longer term objective of reducing statutory limits in order to free up banks’ resources for productive lending. As fiscal consolidation progresses and other sources of demand for government bonds get more robust(like FIIs), SLR will progressively get cut further. On a related topic, we would also expect RBI to progressively reduce banks’ held-to-maturity (HTM) limits to realign it to SLR ratio. This can be done outside of policy dates as well.
 
Portfolio Strategies
 
As mentioned before, we are maintaining a strongly overweight position in 5 – 9 year government bonds in our bond and gilts funds. The demand versus supply scenario here continues to be very robust as FII demand is strong whereas supply compared with longer end is much lesser. That said, at some juncture when we are more confident of demand – supply dynamics at the longer end as well as the continued pace of disinflation, we may look to start building exposure to the long end as well.
 
Disclaimer:
 
MUTUAL FUND INVESTMENTS ARE SUBJECT TO MARKET RISKS, READ ALL SCHEME RELATED DOCUMENTS CAREFULLY.
 
The Disclosures of opinions/in house views/strategy incorporated herein is provided solely to enhance the transparency and should not be treated as endorsement of the views or as an investment advice. The information/recommendation provided is for informative purpose only and may have ceased to be current by the time it may reach the recipient, which should be taken into account before interpreting this document. The decision of the Investment Manager may not always be profitable, as such decisions are based on the prevailing market conditions and the understanding of the Investment Manager. Actual market movements may vary from the anticipated trends.This information is subject to change without any prior notice. The Company reserves the right to make modifications and alterations to this statement as may be required from time to time. This update has been prepared on the basis of information, which is already available in publicly accessible media or developed through analysis of IDFC Mutual Fund. Neither the IDFC Mutual Fund / IDFC AMC Trustee Co. Ltd./ IDFC Asset Management Co. Ltd nor IDFC, its Directors or representatives shall be liable for any damages whether direct or indirect, incidental, punitive special or consequential including lost revenue or lost profits that may arise from or in connection with the use of the information.

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