Equities or Debt - what's my solution?

Retail equity investors always make a mistake of entering markets at wrong time and exiting at even worst point. Equity Investors are not happy given current market conditions and many investors have given up on investing in Equities all together. The average return given by the debt (short-term and long-term) fund category has been higher than those delivered by the Sensex, Nifty or the equity diversified fund category in the past three, six and 12 months. Alarmingly, even in the past two years, average returns delivered by equity diversified funds and key equity indices aren’t significantly different from those of debt funds. Given that equity is a relatively riskier asset class compared to debt, it is also expected to deliver better returns than the latter.

The fact that debt instruments have beaten equities in the developed markets, like the US, in the recent past, as well as over longer time frames of say 30 years only increases the scare if a similar situation could occur in India as well. If the trend in Indian equity markets doesn’t improve visibly from here on, the equity category might end up delivering below-par returns in the two- to three-year periods, as well. However, experts say though Indian equities have been laggards in recent times, a trend which may continue for some time, the asset class should undoubtedly outperform debt in a longer time frame of 3 to 5 years. This is why we feel it is important to balance your portfolio with right investment class at the right time.

EQUITY: A LONG-TERM PERFORMER
Scheme/Index	3-month	6-month	1-year	2-year	3-year	5-year	10-year
Debt Short-Term Average	8.45	9.25	8.38	6.72	7.84	7.91	6.74
Debt Long-Term Average	6.11	7.46	6.82	5.68	7.16	6.71	6.78
Equity Diversified Average	-3.08	-3.96	-17.03	7.4	21.71	7.26	24.7
BSE Sensex	-0.74	-4.91	-15.94	5.06	18.21	5.99	19.11
Prices of Gold	16.44	25.61	42.28	29.6	34.18	24.96
S&P Nifty	-0.89	-4.57	-15.88	5.91	18.92	6.78	18.13
Returns in %. For debt schemes, returns for less than 1 year are simple annualized, and greater than 1 year are compound annualized.
For equity diversified schemes, returns for less than 1 year are absolute, and greater than 1 year are compound annualized. Data as on Nov 4
Source: Icraonline.com

It is very subjective how you see long term equity returns. Value investors like Warren Buffet and Peter Lynch benefited from market corrections as they added majority of their portfolios when common investors were running away from the capital markets and valuations were attractive. If one manages his/her portfolio actively (shifting from equity to debt when markets are volatile or selling when markets are running above historical averages) it is very easy to secure 15-20% per year from equities. Warren Buffet has proved it over the years that fundamental investing can create life-time wealth for long-term investors.

Gold has been on an exceptional run for last few years outperforming every asset class. Gold has provided more than 24% p.a. for retail investors in last 5 years.

As we recently discussed with our research team, 2011 was the easiest and most predictable crash of recent times. Retail participation in equities has been very low in 2011 and very few fund managers have burned their hands this year with above average portfolio allocation. Pi Square financial advisers has been advising HNI Investors from start of the year to shift in debt and invest in equities below historical averages (post-August 2011). In short, the near-term outlook for the debt category looks good. But, if you are looking at equities with a longer-term horizon, of three years or more, this may not be a bad time to put in your money in bits and pieces.

For more information, please feel free to call us or email us at investors@pisquareinvestments.com

Thanks,

Vishrut Pathak

Pi Square Investments

Global Challengers 2011

Earlier this year BCG (Boston Consulting Group) came up with BCG Global Challengers 100 list, rising stars from rapidly developing economies are reshaping global industries. The 2011 global challengers are a diverse group, reflecting the dynamic nature of global competition. The list came from 16 countries, with China, India, Russia, Brazil, and Mexico dominating the list –although less so then they did in previous years.

Western corporate now fully recognize – even if they don’t understand – the rise of companies with global aspirations from rapidly developing economies. Established western brands such as Jaguar and Land Rover are now owned by Tata Group of India. Huawei Technologies and ZTE, both of China, are the second and fifth largest global manufacturers of mobile equipment, ranked by overall revenues. Mexico’s Grupo Bimbo is the largest bread baker in the world. Brazil’s JBS, the largest meat producer; and Russia’s United Company Rusal, the largest producer of aluminium. Revenue from these global challengers rose 18% annually from 2000 through 2009, triple the average annual growth achieved by both global peers and non-financial firms from S&P 500. All this reflects in return created by these global challengers. A long term, emerging market investor earned 17% p.a. compared to -0.7% from S&P 500 and 0.5% from Global peers.

The economic downturn took a tall on the total shareholder return of nearly all companies. But the performance of the global challengers has bounced back more quickly and strongly than that of other companies. It is very important for Long Term investors from developing economies to look at this new wave of growth engines of future. In 2011, BCG listed 20 companies from India, next only to china. This has been the greatest shift since 1999.

Seven Global challengers are from conglomerates; the most notable is Tata Group from India, which is operations in chemicals, communication, IT, beverages, automotive and steel sector. Over the last decade, the Tata Group has completed cross-border acquisitions whose value exceeds $17.5 billion. Tata Group now owns global names like Anglo-Dutch group Corus, General chemical industrial product, Eight’O Clock (a leading Coffee brand), Land Rover, Jaguar, British Salt and Tetley Tea. The Tata Group works collaboratively with its acquisitions. The acquired companies generally remain separate organizations and have operation freedoms. Tata also emphasizes the retention of top managers. The link that holds the acquisitions together is Tata’s corporate centre.

List of Indian companies part of BCG Global Challengers 2011

Name	Price (INR)	Market Cap (INR in Billions)	P/E
Bajaj Auto	1640.00	474.94	13.72
Bharat Forge	284.35	66.37	18.99
Bharti Airtel	377.90	1435.47	19.88
Crompton Greaves	137.90	88.43	13.93
Dr. Reddy Laboratories	1530.15	259.28	23.51
Hindalco Industries	121.65	233.09	10.37
Infosys Technologies	2722.70	1563.35	22.83
Larsen & Toubro	1336.00	816.08	20.22
Lupin Pharmaceuticals	465.00	208.32	28.63
Mahindra & Mahindra	801.10	492.44	18.19
Reliance Industries	835.40	2736.58	12.50
Suzlon Energy	36.15	64.34	19.33
Tata Chemicals	308.90	78.53	21.38
Tata Communications	182.70	52.16	30.91
Tata Consultancy Services	1048.25	2054.79	22.68
Tata Global Beverages	84.90	52.38	20.60
Tata Motors	177.95	526.25	31.06
Tata Steel	432.15	415.34	4.37
Vedanta Resources*
Wipro	353.90	870.12	16.30

 * Not Listed in India

Revenues at Indian equities are growing annually at more than 20% for last 3 years and are expected to grow at 20-30% for next 5 years. India provides a unique investment opportunity to create a lifetime wealth for long-term investors. Indian equities provided 717% returns in last 10 years compared to -0.7% for S&P 500.

For more information, please call us at +91-9925001805 or email us at investors@pisquareinvestments.com

-Vishrut Pathak

Pi Square Investments

(Download detailed copy of this report at  http://www.bcg.com/documents/file70055.pdf)

Steve Jobs – Visionary, Inventor, Leader and above all the greatest entrepreneur

In India, we find it difficult to replicate FaceBook, Google or Apple business models where inherited entrepreneurship and wealth accumulation works against product innovation and long term sustainability. Even at “Local Innovation” Infosys or Tata Nano are still rare case-studies.  Let’s introduce innovation or product valuation in financial valuation models. As Apple and Pixar’s example show, investing in firms that have an innovation edge can generate returns few other investment styles can beat.

Steve Jobs will perhaps be best remembered for the innovative devices and industry-changing technologies he built as co-founder Apple Inc. Apart from his huge impact on the computing industry; the Silicon Valley entrepreneur has left an indelible mark on the entertainment and cell- phone industries. Besides, through the computer animation work of Pixar Animation Studios Inc., he has had a large influence on the movie-making business as well.

Steve Jobs, an entrepreneur taught Investors that product innovation and product placement is more important in the business world compared to quarterly financial success and wall-street views. Apple’s investors gained 17.25% since company’s initial public offer more than 31 years ago. While in his second innings Steve Jobs leadership and vision resulted in 39% annual average rate of return compared to 1.5% for S&P 500 Index. $10,000 invested with Apple from July 1997 would turn in to $1.1 million in October 2011 (10,000% return in 14 years)

Apple not only redefined business case studies in management schools but also re-created history in product innovation. It’s an “ijourney” for Investors from iMacs to iTunes to iPods to iPhones to iPads. Today Apple is the world’s most valued company with fraction of sales compared to companies like ExxonMobil or Wal-Mart. Apple’s sales grew from $4 billion in Q4 2006 to $18 billion in Q4 2010 (4X in 4 years). Apple began selling iPhone in June 2007. Job’s goal was sell 10 million of them in 2008, equivalent of 1% of the global cellphone market. The company sold 11.6 million iPhones in 2008.

My Apple investments introduced me to P.I (product innovation) ratio which I find much more important than commonly discussed P.E (Price Earning) ratio or D.C.F models (Discounted Cash Flow).  Retail investors, looking for long term capital appreciation should look at leadership, product innovation, and product growth cycles. As Peter Lynch famously quoted “I find more investment opportunities in a shopping mall than on balance-sheets”. Look for next opportunities around you - in your shopping baskets, in malls, in banks, in movie-theatres.

In Financial valuations, we need to introduce product innovation premium. Let’s not judge a company based on P/E (Price/Earnings) or ROE (Return on Equity) alone. We need to understand leadership and products as a consumer before we invest our hard-earned money in capital markets. How many investors accumulated Apple shares when they bought their first iPod or iPhone? I was happy to off-load my Apple shares in 2009 with just 50% returns (loosing most of those gains in Mutual Funds in 2011).  Investors need to evaluate his or her portfolio every quarter but I recommend that we allocate 10% of our funds to companies with strong brand recognition and product innovation.

An era of Innovation – “24/Feb/1955 – 05/Oct/2011”

Thanks,

Vishrut Pathak

Pi Square Investments



Infrastructure or India-fractured?

“Grass is always greener on the other side” I think many young Indians will feel the same way who left India in early 2000’s to pursue career growth. I left India in YR 2002, an early stage of India’s growth story, as all the asset classes across India have multiplied 5x in nominal terms in last 8 years. In the same period, most of the asset classes in North America saw zero to nominal gains. However, some threats to this scenario are gaining credence. First, inflation has proved far more sticky on the way down than one would have thought. The expected monetary easing cycle may be further off than what the bulls are expecting. Many investors are also expecting commodity prices to go parabolic after a positive monsoon, which can potentially derail any RBI easing.

As a full-time student of Economics, I always look for a larger picture. Our goal in this post is to see the economic future of the next decade in India, so we are purposely ignoring many commonly talked indicators like GDP, Industrial Production, PMI & so on.

Trust in Government :  We are not the first one to write this but recent stories of scandals & scams were a real example of how not to attract international investors. India is missing a leader/ decision maker in New Delhi to drive India’s economy to the next level. India is on the race-track with a new shiny car with no driver. When developed worlds are slave of their habitual love of debt accumulation, India has found slavery in corruption. Although we are glad that commonwealth games & 2G scams might work as a wakeup call for India’s politically inactive middle class.  Score - Big minus

Lack of infrastructure :   India needs to double its infrastructure spending to $1 trillion in next five years to achieve 10% annual growth rate and would require new funding sources, as the prime minister rightly said earlier last month. The country needs to upgrade its creaky and inadequate infrastructure to support growth that is expected to accelerate to 9% by 2011-12, and bulk of this new investment would come from private firms. Infrastructure will provide huge investment opportunities in private and public sectors. New Delhi will have to focus on this tremendous speed and invest much higher percentage of GDP to match the growing demand.  Score - Average

Source: Economist

Inflation : 9.8% of wholesale-price inflation must be keeping Mr. Subbarao up at night. RBI’s comfortable zone is 4 to 6% (which is still pretty high). For us two major factors driving the prices in India are rapid credit growth and volatile oil prices. When aggregate credit is growing at 20- 25% Y-o-Y, much of the rural India is still untouched and hardly have access to formal credit. So when RBI is actively managing credit growth, same tools might not be as effective as in US or Europe. Inflation cycle is picking and interest rates increase will come to an end soon, contrary to market opinion I think RBI won’t stop here. For us this is the biggest negative sticky point for India & a true test for RBI if they can balance growth and inflation. Score - Negative

Source: Reserve Bank of India

Credit Growth :  India’s growth story is largely attributed to the domestic consumption driven by rapid credit growth. Millions of consumers who had no access to credit in earlier decade can purchase new house, automobiles, appliances or many more things with easily available credit. We would have been worried if the banks were flushed with large NPA but banks are growing at a healthy rate with a low NPA (thanks to RBI’s conservative stance during the last decade). We are still amused, how public banks are still the only source of credit for the SMEs (small & medium enterprises). Absence of a liquid bond market is still a mystery. For now, thanks to large looming demand for the affordable housing, credit growth will continue for many more years to come. On the other hand most of the borrowers are deleveraging in US & Europe. Score – Big Positive

Real-Estate : How can we miss writing about the preferred investment when last decade has created thousands of overnight millionaires in India. Unlike US & China, India has a huge shortage of affordable housing. Debt-laden large realty companies will have to change their focus from luxurious housing to affordable housing. India will need to add more than 200 cities in next 10 years to accommodate growing urban population. Score- Big Positive

Demographics:  India has a huge demographic advantage in coming decades compared to other emerging economies. India’s non-working population (60+) is merely 7.2%, while almost 60.5% population is in highly productive age group of 15 to 59 years. The rest 32% is below age 15, which will keep adding in to the large work-force. In US on the other hand, baby boomers have already started hitting the retirement age. India's working age population will overtake China's in next 10 years, making India's workforce largest in the world. Score – Big Positive

Source: Bloomberg

Global uncertainty :  “The world is flat” – globalization has connected international economies more than ever. India’s dependence on global economies is much smaller than other emerging economies and her share will keep growing in coming years. India’s growth will slow down if  EU economies’ default or restructure their debt, but in the long-run India’s growth will be more driven by local consumption .

Summary :

We believe, for the long term investors it will be a wealth creation of unprecedented diversity and depth. Of course, the ride to riches won’t be smooth – it has never been, even for the richest people and nations. There will be periods of dramatic swings and falls in fortunes. But if you act now and act right, you can create a life-time wealth in 10 years or even less. We recommend investors to hold their assets in liquid bonds for short term and enter real estate + capital markets, once positive news starts flowing in.

For more information, please visit our website or email us at vpathak@pisquareinvestments.com.


- Kashyap Patel 

Pi Square Investments

Sensex : 16,446

USD / INR : 48.78

Date : 09/28/11