The interim budget’s impact on the stock markets

I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.

Warren Buffet

The interim finance minister – Hon. Shri Piyush Goyal – presented the interim budget last Friday. Technically, the interim budget is supposed to be a stop gap budget, meant only for the express purpose of financing government expenses until the next elected government takes over. However, since it is the last budget before the general elections, historically governments have resorted to announcing populist schemes in the interim budget in order to woo the masses. And indeed, this has become the norm over the years. Hence holding true to this tradition, the finance minister doled out tons of largesse to the masses in the interim budget. Farmers with less than 5 acres of land will now get a cash benefit transfer of Rs 6000 per year directly into their bank accounts. This will benefit 12 cr farmers and cost the exchequer Rs 75,000 cr/per annum.  Allocation for MGNREGA which benefits landless farmers and laborers has been increased to 60,000cr. A mega pension scheme has been announced for the worker class who earn less than 15000 per month. The government will provide a matching contribution up to Rs 100 per month to provide them assured monthly pension of Rs 3000 per month when they retire. This will benefit 10 cr workers in the unorganized sector. Standard deduction has been raised 25% from 40,000 to 50,000. The tax-free income limit has been doubled from 2.5 lakhs to 5 lakhs. This will provide benefit of Rs 18,500 crore to about 3 crore middle class taxpayers.

So the question naturally arises – what does this interim budget do to the economy? Simply put it will put more money in the hands of the masses, increasing their spending power. It will stimulate rural growth, stoke inflationary expectations and put upward pressure on interest rates and downward pressure on GDP growth. The finance minster has already admitted that financing these schemes will increase the fiscal deficit from 3.1% to 3.4% of GDP. But analysts believe the deficit could be much higher. Financing this deficit will force the government to borrow from the bond markets which in turn will result in hike in interest rates. A small trailer of this was already witnessed when the 10 year bond yields jumped up about 1.7% immediately after the announcement of the budget!

What to hope for

As investors, the best thing to hope for is that the next incoming government comes in with an absolute majority. A hung parliament will be the worst case scenario at this time in India’s history, because then coalition compulsions will creep into decision making. In the worst case this will lead to proliferation of corrupt practices and in the best case the nation will be saddled with policy paralysis. Either way, it will be a setback for India from assuming its rightful stage at the world table. A stable majority government on the other hand will have the political support and the will to continue the path of fiscal consolidation for stimulating economic growth and the overall well being and prosperity of the nation and its citizens.

What to Do

As investors, it is futile to speculate which sectors of the economy and specifically which businesses within those sectors will do well due to the stimulus provided by the interim budget. Such top down approaches to stock picking are susceptible to errors of judgment that can go horribly wrong. A recent case in point was the big bet on the infrastructure sector five years ago by many fund managers and research analysts due to heavy spends earmarked for roadways, railways and waterways by the present government. However infrastructure stocks hardly benefitted from these spends and many of them continue to languish even till date. As investors, it is best to leave the market forces of demand and supply determine the winners and losers.
The best approach for investors is to always invest in businesses which fulfill the following three criteria:

1. Has a track record of making more money than its cost of capital 
2. Has a sustainable competitive advantage in the market place. 
3. Is available at reasonable valuations. 

The icTracker database is the only publicly available database that constantly scans stocks for these three criteria and the icAdvisor service is designed to guide investors to benefit from the findings of this constantly changing database.

The recent spate of stock buybacks

When stock can be bought below a business's value it is probably the best use of cash.

Warren Buffet

The Indian capital markets have seen a spate of stock buyback announcements in recent months, and that too from businesses of all sizes and industries. Here is a summary of some of the recent buyback announcements:

Company	Announcement date	Buyback price	CMP	Premium%	Buyback size (Rs cr)
Infosys	11-Jan-19	800	727.9	9.9	8260
IOC	13-Dec-18	149	137.35	8.5	4435
ONGC	21-Dec-18	159	141.05	12.7	4022
NHPC	14-Nov-18	28	24.45	14.5	2615.6
Bosch	10-Dec-18	21000	18171.95	15.6	2159
Oil India	19-Nov-18	215	170.3	26.2	1085.7
Mphasis	27-Nov-18	1350	972.8	38.8	988.3
HEG	26-Nov-18	5500	1980.3	177.7	750
Tata Investment Corp	16-Nov-18	1000	822.1	21.6	450
SKF India	4-Dec-18	2100	1920.05	9.4	399
Natco Pharma	5-Nov-18	1000	665.95	50.2	250
Persistent Systems	28-Jan-19	750	583.4	28.6	225
Triveni Turbine	1-Nov-18	150	106.35	41.0	150
Indian Energy Exchange	20-Dec-18	185	158.35	16.8	69

In a buyback, a firm purchases its shares from existing shareholders, usually at a price higher than the prevailing market price. Buybacks are a more efficient way of returning money to shareholders compared to issuing dividends, since the firm avoids the burden of dividend distribution tax (DDT). A buyback announcement is a strong statement of belief by the firm’s management that the market is undervaluing the shares of the company. The management backs up this belief by using the firm’s money to buy back shares from the existing shareholders at a predetermined price (which it considers as the fair value), thus reducing the number of outstanding shares available. This boosts the earnings per share and consequently the price of the share as well.

Of late we are witnessing a phenomenon where an increasing number of companies are choosing to announce buybacks. This indicates general fatigue in the market for correctly valuing shares of the firm. Moreover, the above table shows that the price of the share continues to lag behind the buyback price by a significant amount despite the buyback announcement. Although the data presented here is from the last quarter of 2018, this trend has been witnessed throughout 2018 and is nothing sort of an anomaly. The management of the firm has the best view of the business and competitive landscape and if they think that buying back their own shares is the best use of cash then that belief deserves nothing but support.

What to Do

A buyback announcement presents investors with an opportunity to exit their investments at the buyback price in a depressed market, of the kind that we are witnessing now. Hence in such times investors should always subscribe to the buyback to the fullest extent possible. The buyback ratio is calculated differently for different categories of investors and it determines the percentage of shares in an investors holding that qualify for the buyback. After subscribing to the buyback to the maximum extent possible, investors should hold on to the balance shares until the market price reaches the buyback price, which is an event destined to happen sooner than later.

How to find businesses with wide moats

I was a chartist. I loved all that stuff. I had charts coming out my ears. Then, all of a sudden a fellow explains to me that you don't need all that, just buy something for less than it's worth.

Warren Buffet

In the investing world, “moat” is a term that has been popularized by the legendary investor Warren Buffet to mean the amount of competitive advantage that a business enjoys in the marketplace over the competition. Moats create entry barriers for the competition and enable the business to harvest uninterrupted profit from its products and services. Therefore moats are a very desirable attribute for investors, when screening for investment opportunities. If they exist at all, moats can be either wide moats or narrow moats. Obviously wide moats are preferred over narrow moats, not only because of the extent of competitive advantage that they provide to the business but also because such an advantage may even be sustainable in the long run. Businesses with wide moats are therefore the ones that long term investors want to ‘Buy and forget’. In the Indian context, such investments fall in the category known as ‘Buy right, sit tight”.

Wide moats in a business may exist for a number of reasons. Some of these include strong brand, widespread distribution network, loyal customer base, low cost of operations, etc. Whatever be the reason for the wide moat, the search for the source for it always ends in an intangible asset – i.e. an asset that is not present or reported on the balance sheet of the business. Isn’t this strange – the one asset that gives the business a wide moat and hence a lasting competitive advantage does not even make it to the company balance sheet and hence never ever reported to investors. This is the single biggest reason why screening for businesses with wide moats is a task fraught with danger, because the person doing the screening may have to rely on hearsay and assumptions rather than hard facts. Unless of course there was a way to measure the intangible assets of the business and value it in monetary terms, in the first place!

This is where the icTracker comes in. We developed this software explicitly to address this very problem i.e. to measure the intangible assets of the business from the company’s reported financials and value it in monetary terms. Next we developed a ratio called the Knowledge Basis – which is just the ratio of the Intangible Assets over the Total assets of the business. Note that Total assets equal the Intangible Assets as calculated plus the physical and financial assets which are reported on the Balance sheet of the Business. The Knowledge Basis then becomes a simple measure for checking if the business has a wide moat. As a thumb rule we consider that a Knowledge Basis greater than 50% means that the business has a wide moat, else it has a narrow moat. The icTracker software has therefore quantified the calculation of wide moat and made it objective, thus making screening of stocks easier and more importantly, reliable. Our icAdvisor service in fact uses the icTracker database when designing and rebalancing client portfolios.

What to Do

When making investment decisions for your stock portfolio, always ensure that the underlying business has a wide moat. But that is the easy part – the difficult part is staying on top. Moats can disappear very quickly if a new competitor takes over the market for instance using a superior moat. Hence it is very important to check the moat of the business every quarter to ensure that the competitive advantage it enjoyed earlier is still in place. It is well and good if you have the time and passion for doing this yourself. If not, you should approach a SEBI Registered Investment Adviser to help you with this process.

2018 - Letter to Clients

After the stellar run of the stock markets in 2017, 2018 turned out to be somewhat of a damp squib for Indian investors. Here is how the year panned out for various asset classes during the year.

The Nifty started the year at 10,533 and ended it at 10,863 – giving a meager return of 3.14% in the process.  But at least it gave positive returns. The Nifty Midcap 100 and Nifty Smallcap 100 on the other hand did much worse, giving deep negative returns during the year. In comparison, the average annual return of client portfolios under our advice clocked in at 2.29% this year. Considering that our client folios are made up of a mix of Largecap, Midcap and smallcap stocks depending on the client’s risk profile, this performance was very satisfactory. Inflation was at 4.7% during the year which meant that only the relatively safe asset classes beat inflation during 2018 – none of the equity classes did so, as shown by the table above. 2018 was therefore the year of safety - but more importantly it was also the year of volatility. There were three major trends in the stock markets during the year – two on the downside and one on the upside. The quantum and duration of these trends were as follows:

This can be seen visually in the daily chart of the Nifty during 2018 below.

Although volatility is a basic attribute of the stock markets, high volatility of this kind spooks retail investors and scars them for life. As for our part, we saw the first downtrend coming in early Jan and advised our clients to sell major portions of their portfolio and sit on cash at that time. We got them back in the market after April when the results of the quarter started coming in. This action benefitted all our Clients. However, we missed catching the next downtrend which started in early September, primarily because it was not a systemic downtrend – rather it was based on fears about risk in the NBFC space triggered by default of IL&FS – a leading lender to the infrastructure sector. The extent and impact of such sector specific risks are always difficult to assess but the markets always take a safe route by first pushing prices down and then analyzing the impact. Since none of our Client folios had investments in the NBFC space we considered it prudent not to react to this kind of downtrend but rather ride it out. In hindsight we can say now that this approach did not do too badly for our Clients.

On the economic front, the year was characterized by high crude oil prices (which moderated towards the year end), inflation fears, fiscal slippages and systemic liquidity concerns. State elections in five major states during the year also made the market nervous. SIP inflows into equity mutual funds continued at an increasing pace reaching a run rate of billion dollars a month by the end of the year, despite high selling by foreign investors. These flows found their way mostly into largecap stocks leading to their stability at the expense of midcap and smallcap stocks.

What can be look forward to in 2019? For one, the Indian economy continues to be the fastest growing economy in the world growing at a rate of 7.2%. It is poised to become the fifth largest economy in the world this year overtaking the UK in the process. The central elections are due in May 2019 and this will be a time when we can expect some nervousness and volatility in the markets. If the elections throw up a majority Government, then the markets will settle down and could even start a rally. If on the other hand the elections throw up a fragmented mandate then we could be in for a long phase of consolidation. At this point the best thing to do therefore is to stay invested. Investing is a long term game and those who stock to their convictions during difficult times get rewarded by the stock markets ultimately.

At the end of such a difficult year, it is well worth the time to take a moment and review the fundamentals of long term investing. We enumerate them here for quick reference:

1. Asset allocation – Diversify your financial assets across Debt, Equity, Real Estate, gold, etc. depending on your risk profile and age. In the current scenario, real estate and gold are no longer sources of capital appreciation. Hence these assets should be used to satisfy consumption needs only. It means that your assets should be spread only across Debt and Equity. One simple rule of thumb to do this quickly is to subtract your age from 100. The number you get should be the percentage of your assets that you should allocate to equity - the rest should be allocated to Debt.
2. Financial planning - Identify your financial goals and classify them by time horizon – short term, medium term and long term. Use Debt assets to achieve short term goals, mix of Debt and Equity assets to achieve medium term goals and Equity assets for achieving long term goals. This will be the basis of your financial plan.
3. Reviewing your plan - Review your financial plan yourself or with your advisor at least once a year and make adjustments depending on the prevailing situation.
4. Invest right - When it comes to equity, invest in the right businesses and then give markets time to give you returns. This calls for patience in the face of volatility. Speak to your financial advisor whenever you are in doubt and need a second opinion.

Finally, I want to inform all my Clients that during the year we made optimization improvements to our stock picking algorithm based on observations and our own backtesting. These improvements will ensure that we pick long term winners that have a high probability of returning generating alpha for our Clients. Having said that I have to add that there is always scope for further improvements in our stock picking and monitoring process and with the help of the active support of our Clients we will keep working diligently on such improvements. I also want to thank all my Clients whose active support and trust in us got recognized by Silicon India magazine in their 2018 ‘Consultant of the Year’ award to us.

In passing, I want to take this opportunity to thank you for putting your faith in our investment thesis and in our icAdvisor service with your hard earned money. Your continued trust makes us stay committed to the vision encapsulated in our tagline – ‘Growth through Knowledge’. I believe that we can grow only when you see value in our service and growth in your own portfolios. I am available to address client queries at all times and am approachable via email or whatsapp. I am also open to feedback and suggestions and welcome you to provide the same. I also hope that if you have benefitted from our service, you will spread the word to your own friends, family and colleagues and have them share the benefit as well. 

Finally, let me wish you and your family a very happy and prosperous Happy New Year and hope that our relationship will continue to grow for many years to come!

Abhijit Talukdar

Founder, Attainix Consulting

SEBI Registered Investment Adviser

SEBI ends AMC malpractice in direct plans

Someone is sitting in the shade today because someone planted a tree long time ago.

Warren Buffet

Last time I wrote about how SEBI is making multiple changes to the investing framework to make investing more transparent and equitable for retail investors. I also bemoaned the general apathy of the retail investing community towards these changes which is the single biggest reason why these changes are not yet making the desired impact. It turns out however that the apathy of the investing community is so taken for granted by the AMCs that some of them have actually been taking rampant advantage of their ignorance and indifference to favor the distribution community, much to the displeasure of SEBI and definitely in contrary to the spirit of the SEBI guidelines. Here is how investors have been taken for a ride by these AMCs.

Remember how SEBI mandated AMCs to introduce direct plans in all schemes for the benefit of the retail investor who wanted to avoid distributor commissions. This was a very welcome move by SEBI intended to reduce the cost of investing for savvy investors or those who took the services of an advisor. Considering that AMCs pay between 75 to 125 bps as commission to distributors, the TER (total Expense ratio) of direct plans was expected to reduce in the same proportion compared to regular plans. However, would you believe that AMCs actually raised the fees in direct plans to compensate for revenue losses that they incurred in regular plans for having to reduce charges in those plans due to ceiling guidelines? Many leading business newspapers have reported on this prevailing malpractice which you may read on these links – Economic Times, Live Mint and Business Standard. This is a clear case of favoring distributors over investors by AMCs and a violation of their fiduciary responsibilities towards their Customers. It also contravenes the spirit of the ‘Mutual Fund Sahi Hai’ campaign that the MF industry has been promoting diligently for so long now.

Well, the good news is that this malpractice is set to end soon. Taking note of this malaise SEBI’s circular on transparency in TER of mutual fund schemes has directed that the difference between the TER of a direct plan and a regular plan should at least be equal to the distributor commission. In effect, it means that expenses towards distributor commissions should be booked in regular plans only – they cannot be booked in the direct plans. This guideline is expected to reduce the TER of direct plans in the coming months and investors should start getting notified about these changes from AMCs starting Jan 1 2019.

What to Do
This is yet another opportunity for investors to increase their returns from Mutual Funds by making the switch from Regular plans to Direct plans. The best way to do this is however is to review your financial goals with the help of a financial advisor and plan the switch in a manner that can best address those goals. A SEBI Registered Investment Adviser is best qualified to help you in this process.

SEBI bans upfront commissions to Mutual Fund distributors

Honesty is a very expensive gift. Don’t expect it from cheap people.

Warren Buffet

Last month SEBI asked Mutual Fund Asset Management companies (AMCs) to stop paying upfront commissions to distributors and instead adopt a full trail model of commission in all their schemes. This is a very admirable move by SEBI, to the large discomfort of a lot of distributors who had made a practice of earning extra income by churning their client’s portfolios frequently. Such upfront commissions were in the range of 1 to 1.5 percent and hence very lucrative to distributors. Each churn earned them an upfront commission from the AMC at the cost of the beleaguered client who was left to wonder why her MF investments were not delivering the expected returns.

This move by SEBI is the latest in a series of moves by the regulator in order to bring greater transparency to the Indian Mutual Fund industry for the benefit of retail investors. Some of these include:

• Removal of entry loads in all schemes of all funds
• Introduction of Direct plans in all schemes of all funds
• Capping of maximum Total expense Ratios
• Tapering of Total Expense Ratios by Assets under Management
• Mandatory disclosure of expense ratios by mutual funds for all schemes
• Mandatory disclosure of any and all changes in expense ratios to existing investors
• Standardization in the naming of mutual fund schemes to prevent confusion
• Mandating fund houses to use TRI (Total Return Index) v/s PRI (Price Return Index) for benchmarking performance of funds
• Introduction of the ‘riskometer’ – a five point scale from low to high – to enable investors better understand the risk associated with the fund.

The point of all this is to understand that the regulator is taking proactive steps and making changes to the investing framework to protect the interests of the small investor. Yet none of it will succeed if investors themselves choose to remain uninformed or uneducated about the benefit of these moves. Many a mutual fund investor has become so used to the prevailing system of investing via mutual fund distributors that they are averse to take advantage of the new framework even when it is in their own interest.

What to do

The simplest thing to do is to switch over from regular plans to direct plans of the same fund. The difference in expense ratio between a regular fund and a direct fund of the same scheme can be up to 1.0%, and when this difference is compounded say over the next 10 years, it can mean an additional return of more than 9%! In other words, if you have Rs 10 lakhs invested in a regular plan today, you can earn an additional 208,000 over the next 10 years just by moving to the Direct plan now (assuming a 8% return on the fund in the regular plan).

But hold on, just making a blind switch is not in your best interest, if only because it will lock you in for the next one year (remember exit loads). So if you are convinced about the need to make the switch you will be better off contacting a SEBI RIA to go over your financial plan and link your investment plan to your financial goals. Working in your best interest, your advisor will also recommend the best funds appropriate for your level of risk tolerance. And then suggest you to make the switch in a structured and tax efficient manner.

Why deal with a SEBI-RIA only?

When you combine ignorance and leverage, you get some pretty interesting results.

Warren Buffet

The investing community in India has witnessed a history of mis-selling of financial products. A recent example of this was the rampant selling of ULIP plans by private insurance companies and their agents prior to 2010. That round of mis-selling ULIPs was encouraged primarily by upfront commissions of more than 60% of first year premiums to the agents. Although this situation was corrected by the IRDA (the insurance regulator) in 2010 by tightening selling rules and introducing disclosures, the damage was already done by then as was discovered by a host of ULIP investors who found that they had been sold nothing but false promises!

SEBI (the capital markets regulator) got into the act in 2013 and introduced the concept of SEBI Registered Investment Advisers as part of the Investment Advisers Regulations 2013. SEBI also warned the general investing public to only deal with SEBI RIAs going forward. The press release in this regard is shown below.

Why deal with a SEBI RIA 

There are several good reasons for engaging the services of a SEBI–RIA for your financial planning and wealth management needs. The primary advantage for the client is that she is dealing with an investment adviser rather than an investment (product) seller. This distinction generates the following benefits:

• No conflict – Since the SEBI RIA charges fees directly from the client, he is free of conflict with product manufacturers and acts in the best interest of the client. He is also accountable to the client for this reason
• Certified – SEBI RIAs have to go through a stringent process prior to registration with SEBI. This includes passing the relevant NISM series X-A and X-B exams - which have negative marking - as well as demonstrating proof of adequate qualifications, capital and infrastructure. Moreover SEBI RIAs have to renew their qualifications every three years by clearing the NISM CPE exams in order to retain their SEBI registration. 
• Customized Advice – SEBI RIAs are required to tailor their advice to match the risk profile of the client. This guideline ensures that they do not dispense a one-size-fit-all solution to all clients.

What to do

It is amply clear that seeking financial advice from a SEBI-RIA is in the best interest of the investor. Astute investors should therefore first verify the credentials of their financial adviser from the SEBI website and thereafter compare their services and fees with other advisers. Investors should select an adviser who is not only qualified and registered but also credible and available. 

Our stock advisory service based on the icTracker software not only picks quality stocks but also designs an efficient portfolio based on the investor’s risk profile. No wonder it is able to deliver consistent outperformance over the years. Check our backtesting results to see how our model portfolio has outperformed every major index handsomely in the past 10 years!