The New Financial Year Beckons

It’s the end of FY2019 and we launch into a new financial year with the stock market at a high. In the next month two things will be at the top of financial news – Elections and Company Financial Results. These will determine only the near term changes in Indian markets, but the long term future of companies is likely to be determined by some other factors.

In the past, elections have been the source of extreme volatility. In 2004, when the Left had to be roped to make a government, the market tanked 30% in two months. And then started on an up-move that had stunned everyone – the Nifty went up nearly 3x in the next two years! In 2009, the market went up 15% in a day on a circuit, again because this time the Left was not required; and continued to be strong for the first two years.

We don’t expect the elections to be a game changer, no matter who comes to power. If the current dispensation falls, then it will roil markets temporarily but in the end, whoever will rule, will not rock the boat too much. The show will go on.

We think interest rates have got to fall, and have been harping on this for a while now. Rates by the RBI have reduced but interest rates in the market remain high. But recent changes by RBI with dollar swaps, relaxed lending to NBFCs and more addition of liquidity to the economy have tempered fears somewhat, and inflation continues to remain relatively low. There’s an RBI policy on Thursday which is where we should see a continued set of rate cuts.

Changed Expectations = Changed Goals?

This has implications for us. We calculated longer term goals at 5% inflation expectations. Has that changed? Should we be using a 4% number instead?

There’s a huge difference – a 40 year old spending Rs. 100,000 a month today needs about 6 cr. In 20 years as a retirement corpus if you assume 5% inflation. But if you assume 4% inflation instead, he only needs 4.5 cr., a full 1/4thlower! This also lowers equity return expectations in the long term – if inflation’s only 4% and we grow at about 7% on GDP, we are likely to see equity markets grow around 10% year, not the 12% to 18% we have seen recently. The future is not the past – and we should rework our assumptions appropriately.

The Foreign Interest

We had a recent podcast episode on the Stubborn Cost of Capital in India. The idea is that capital costs in India are high relative to inflation. So it’s actually become interesting to borrow money abroad (at their low borrowing rates) and bring the money to India where rates are high. The interest in doing such a trade has increased substantially in recent times, especially where there are distressed assets being sold that can’t be profitable because of high interest costs.

A case in point is the sale of Leela Hotels’ properties to the Canadian investor, Brookfield. The hotel can generate positive cash flow before interest – and the business give them a “yield” of about 8% to 12%, but their debt comes at a higher cost so they make a loss. To Brookfield, even 10% is a very good yield, especially now that we have lower inflation in India, so rupee depreciation is relatively unlikely. What’s horrible for an Indian company is good for a Canadian investor, and we believe that’s primarily due to interest rates being too high. Expect that to change, but at the same time, expect a lot more interest from foreign companies willing to buy Indian assets at lower yields simply because it’s not low for them.

We have benefited from another such deal – KNR Construction, one of our companies, has sold road projects to an external investor, for a very decent profit, transferring post construction collection risks to this new investor. That will save them a lot of debt going forward, and free up capital to load their balance sheet with more projects in the future. To the new investor, the yields are juicy compared to their cost of capital. It’s an interesting and healthy development.

Top Stocks, The Indian Consumption Story And Everything Else

It’s just strange that inflation is low and yet, consumption stories are in super demand. Yet, we overpay for a few companies, and underpay for others. This is usually not sustainable and we are a little worried that the market may be running a little too far, too fast.

As markets go, the top few stocks – Reliance, HDFC Bank, TCS and Infosys – have driven a substantial portion of returns in the last year. The rest of the market has been way lower, and we believe some of this is due to index funds gaining more market share. (The biggest mutual funds now are Nifty index funds, with over 50,000 cr. In assets and most of that goes to the top names in the Index, as above). The EPFO is investing large amounts of money in just these funds.

In the next year or so, this should become more secular by nature and interest is likely to return to the other stocks as well. March was an early move into that front, and we think once the elections are done and the uncertainty is behind us, that we should see valuations catch up in other pockets too. But it’s useful to say that we are a little scared the market is richly valued for some stocks.

While being careful we will also be diversifying the portfolio a little more, and perhaps booking some profits in stocks that we feel have gone too far. We want to buy into new stocks in Capital goods, in industrials and in consumer facing sectors where valuations aren’t exactly through the roof.

New Portfolios for you to Invest: Market Portfolio (now) and Momentum (in a short while)

We have currently a “long term” portfolio only – this is a multi-cap portfolio. We have been discussing recently about how it’s useful to just invest in “passive” ways – to just buy the indexes and not bother about individual stocks.

We’ve found a market beating strategy using the Nifty 50 (top 50 stocks in India), the Nifty Junior, or Next 50 (Stocks ranked 51 to 100) and the Nasdaq 100 (the top 100 stocks in the US Nasdaq). Basically the top 100 Indian stocks and the Top 100 US stocks in a 80:20 allocation between the two.

This combination gives enough returns that beat the top mutual funds in India, most of the time.We would like to offer this strategy to you, if you like, to invest part of your equity allocations, or to create an altogether new goal as well. This is the Market Portfolio. Here’s some details:

• The presentation that tells you what we are doing. (Link)
• The cost: only 0.25% per year
• Rebalanced by us regularly.
• You can shift to the index portfolio with part of existing capital or add new capital. The new amount has no lower limit, and you can even set up an SIP for it.

We also have a momentum portfolio that is currently going through beta with a few customers. This strategy involves buying strong moving stocks and churning the portfolio every month. It will have about 30 stocks, and we’ll probably move around 1/3rd of them each month. We will send a more detailed presentation on this later but the concept is similar – you can allocate from your existing capital or add new capital for this portfolio.

We find that the Market Portfolio has a low cost structure, a dollar-rupee inbuilt position, and a simple investment philosophy. The Momentum Portfolio is also driven by a combination of fundamental checks and (the larger bit) strength in the share price movement. These two are good ways to participate in the market as we have seen in the last few years, apart from our value+growth based Long Term Portfolio. Do go through the presentation and let us know if you have questions! (Reply or connect with akanksha@capitalmind.in)

Loss Harvesting to Save Taxes

Some of you would have seen a bunch of sales recently. Our process of slowly putting money into equity has meant that we book profits in the debt portion and invest in equity. That leaves us with taxes to pay on the profits booked in debt, while the equity portion is still being invested.

We therefore sold stocks for those of you who still had a large amount of taxable profits, in order to bring down your tax liability to a very small number, or to zero. We will in the process of the next few days, buy back those stocks sold as well, but it ensures lower tax requirements for nearly all of you.

The new financial year is on, and very soon, we will have audited reports for each of you in your mailbox. The progress website gives you intermediate data as well. There’s a lot more coming in the next year, and we hope that once the rigmarole of elections and politics is done with, the economy will rebound at multiple levels and give us the chance to make more profit.

Happy New Financial Yearingly,

Deepak

P.S: Our latest Podcast on "State of Financial Advice in India" is up. You can listen here.