Communique -- December 2010
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Transcript of Communique -- December 2010
Index Watch
Positives & Negatives
From the desk of Srikanth Bhagavat
Social Investment
Let’s Learn!
Fund of the Month
OVERVIEW
at the time of printing
communiqué
Globally, signs of improvement seen in real GDP and consumer confidence.
India’s GDP growth is 8.9 % in Q2 of 2010-11. The momentum is still strong
October IIP growth at 10.8%; (partially due to base effect)
RBI has responded on the liquidity concerns during the policy meet through OMO operations upto 48K cr / SLR cut by 1%
POSITIVES
NEGATIVES
European financial stability concerns still persist
Rising commodity prices will put pressure on inflation in emerging markets
Inflation at 7.5% in November 2010, is still not in the comfort zone of RBI
FROM THE DESK OF SRIKANTH BHAGAVAT
December 2010
INDEX WATCH
In my last column, the markets were soaring high and I wrote about the lack of a
margin of safety in the valuations - and see what happened. The markets dived by a
good sum to 19000, losing about 8%, and the mid cap indices lost even more at about
15%! Was it the 2G scam? Or was it the innumerable 'baby scams' that were put out
as red herrings to distract attention of the public? No. I think when markets run
higher than they are supposed to, they look for any excuse to fall. Even the news
headlines in some popular websites that track financial information were telling. If
one day the headlines announced that the markets were cheering the Ireland
bailout, the next day the same headlines spoke of nervous markets on account of
Irish debt woes! If you were to ask me, they were just high on an overdose of dark,
frothy, Guinness!
So if we, at Hexagon, thought that markets were likely to fall did we sell all our clients'
holdings and buy them back at 19000? No. Not as dramatic – in one of the strategies
we follow at Hexagon, we have been selling little by little since a long while, and hold
about 35% cash in those portfolios at the moment. Here we follow the time tested
philosophy of Benjamin Graham- the king of value investors. Factoring fundamental
attributes such as Price-Earnings multiples, interest rates, corporate earnings & rate
of growth among others, we are either underweight on equity or over-weight on
equity in the portfolio. So when valuations seem higher than warranted, we go under
weight on equity; and buy excess of equity when otherwise. This dynamic system
helps keep the desired margin of safety in our portfolios. By regulating the
proportion of equity in the portfolio we reduce the risk of over exposure, and at the
same time have enough cash on hand to buy on dips. We do not take the risk of being
completely out of the market unless valuations are hyper. Such strategies keep
'sentiment' and mass hysteria out of the picture and allow us to take unadulterated
decisions for investors wishing to reduce risk in their portfolios.
Of course, in any such strategy, discipline is paramount. It is akin to following one's
Dharma. Whichever be the strategy, unless it is followed with great discipline and
over a long term, the results do not show. Since the results are evident only after a
complete market cycle, the robustness of the model, and our conviction in it, both,
are important. What about our model? Well, Benjamin Graham was the guru of
Warren Buffet......
SOCIAL INVESTMENT
Investing can have many objectives – early retirement, putting idle cash to generate
returns, attaining family goals and also investing to create an inheritance. But how
about investing to generate social impact? And yes, it can clearly be defined as an
investment and not a grant. We describe a trend in the investing world where the
objectives of getting returns and making a social impact are merged. Hence, you have
an investor who can have the satisfaction of contributing socially while not really
granting his money away.
BSE SENSEX: 20060.32
NIFTY 50: 6000.65
The merger of the two objectives gives rise to the phenomenon called “Social Investing”. The advent of Social Investing
marks an important milestone for both the social sector and the investment sector. The many problems that the word is
currently riddled with are pre-dominantly social in nature (poverty, health, and environment). So how can organizations
that seek to address the world's largest and most pressing needs (in a market sensible way) seem like unintelligent
business opportunities? Plus, with the market valued at $6 trillion dollars (in 2005-- World Resources Institute) and
slated to grow at 5% annually (Drayton and Budinich, HBR, Sept 2010), it’s sure to catch investment interest soon too.
Organizations involved in producing a socially relevant product/service to which market value can be attached are called
“Social businesses”. Relying on grants for these set ups has given rise to inconsistency in obtaining funds. It also takes up
plenty of resources to obtain these grants. McKinsey puts the cost of getting “philanthropic capital” at 25% to 40% of
what is received after factoring in the cost of pursuing the capital (A new alliance for global change: Harvard business
review, Sept 2010). But if the products/services have market value, why, one may ask, isn't the traditional route of
banking finance etc being availed? This is because there are a couple of roadblocks for a social organization. They require
patient capital – i.e. returns might not come flowing in very soon. If the product/service is priced low, then it might be a
while before economies of scale are realized. And sometimes, the risk-(financial) return trade off might not be balanced
because the risk factors might be higher than the monetary returns justify. But of course, what one compromises in
financial return is compensated through social return.
Social investing can take many avatars but the chief overall objective is to have a double bottom line – that of social
impact and returns on investment:
An exciting new form involves creating a Hybrid value chain. It is called a Hybrid because it involves a partnership
between the business sector and the social sector. Considering the complexity of the many social problems and needs,
an idea that blends the strengths of both to deliver a solution might be the most effective way to address the problem.
Such examples are coming up all over the world and have been successful too. Bangladesh provides an example of a
collaborative effort between Grameen Bank and French Dairy company 'Danone' to produce nutrient-rich Yoghurt at an
extremely affordable price to reduce malnutrition among children. In this case the company has decided to focus on
abolishing malnutrition and any profits generated go back to the expanding operations.
Another simple idea with a double bottom-line approach is Socially responsible investing (SRI) which has been around
for a while. SRI looks at investing in companies with a social conscience. i.e. it avoids companies involved in tobacco,
alcohol etc. The return on the FTSE KLD 400 Social Index has had a five year annualized return of 0.10% v/s -0.17% of the S
& P 500 (data as on March 31st 2010).
Social businesses do include Microfinance institutions too. Maybe that introduces an element of scandal considering the
recent SKS Microfinance fiasco. But the sector is still nascent and as it grows, regulations will certainly be introduced to
delineate the balance between investor interests and social interests. But with the sector continuing to attract talent
even from the top B-schools of the world, growth and promise are certainly pointed in the right direction.
The future could create a structure for the ordinary retail investor too, to partake in this phenomenon by creating
investment products like maybe mutual funds. Of course there is plenty of regulatory distance to be covered for that to
occur but the idea is inspired. Relying on the government to provide solutions to social problems has meant a long,
unsatisfactory wait that has resulted in disillusionment. As with everything else, if one solution hasn't worked, it
becomes time to try something else. And in this case, Social investing might just be it.
December 2010
Let's Learn!December 2010
The upcoming IPO season has plenty of opportunities presented to the investor but sifting through the ocean and picking a winner requires a certain amount of due diligence. Let's learn throws some light on the important questions to ask before investing.
When a company decides to issue stock to the public, it has to submit information about itself and the issue to the Registrar of companies and SEBI in a document called the Draft Red Herring Prospectus (DRHP). This document is available for public scrutiny on the SEBI website and also on websites like moneycontrol and indiainfoline.
Buying into an IPO with a long term perspective requires an examination of the fundamentals of the company. The main parameters can be divided into the 4Ps - Promoters, Performance, Prospects and Price.
Promoters: A strong management track record is a very important factor during evaluation - management experience in the
industry and performance of other companies managed by them. Ensure that the promoter's track record is clean and any
investor complaints and litigation against the promoter do not jeopardize the future of the company. A record of the lawsuits is
divulged in the DRHP and also in a website called www.watchoutinvestors.com.
Performance: For a basic evaluation, look at the ratio of debt to equity and also compare income to expenses. A healthy
standing in the above two metrics is a positive indicator. A comparison of the debt-equity ratio to the peers in the industry
gives a sense of whether the company is optimally leveraged. Calculate Return on equity (Profit after tax divided by
Shareholders' equity), net profit margin (Profit after tax divided by Sales), EBIDTA and ensure that the metrics are not below
the industry average. Also, look for performance consistency. Be cautious of unexplained spikes in profits or sales the year
before the IPO. Make a close study of the numbers to spot possible “bloating”. Look out if the bulk of the profits comes from
“other income”, if there are changes in accounting policies (reducing depreciation reduces the tax liability and buoys the profit
after tax) and significant notes to accounts. Note the presence of patents, trademarks, copyrights etc that protect the
business.
Prospects: Understanding the company's long-term prospects is key. One tool you can use is the IPO grades issues by credit
rating agencies like CRISIL, which will be included in the prospectus. These grades are assigned on a five-point scale. Higher
grades suggest stronger fundamentals. IPO grades consider factors such as the industry, the company's financial position,
competitive advantages, quality of the management and legal issues such as litigation. But a high IPO grade cannot be
construed as a recommendation to buy. Also, do note that a SEBI approval of the DRHP only mandates that the information in
DRHP is authentic. Make a first-hand study of the risk factors disclosed in the prospectus like concentration of earnings,
number of big customers and how they are geographically spread.
Price: The offer price of an IPO is an important factor in determining your potential gains. You can evaluate the offer price by
studying the price earnings ratio (PE ratio - current stock value divided by EPS). It can tell you how expensive the stock is.
Higher the PE multiple, more expensive the stock. Don't go by the absolute value of the stock to determine its worth. Also, PE
as a standalone number is not useful. Compare PE to the company's peer group and also to the broader market. You can also
use the Price-Earnings-Growth (PEG - PE ratio divided by the expected earnings growth %.) to see if the share is underpriced or
overpriced. The PEG ratio determines a stock's value while taking future earnings growth into account. If the PEG ratio is more
than 1, then the share may be overpriced as compared to the anticipated earnings growth. This may be due to excess
enthusiasm in the market for the stock. If it is below 1, then the share may be underpriced as compared to the anticipated
earnings growth.This indicates a value buy.
Some final words of caution - dont get enthused by subscription numbers. This is mostly dependant on market sentiments and
is not indicative of fundamental strength and don't get deflated by lacklustre performance during the intial days of the IPO.
Some of the most successful companies like Coca Cola and Bharti Airtel had a choppy ride during the first year but are now
counted among the best stocks.
LL6: How to evaluate an IPO
Please contact:
Aravind Thondan: 9008355222, if you would like to know more about us
Low Moderate High
Fund of the month
Fund Note
Disclaimer: Hexagon Capital Advisors Pvt. Ltd. Has prepared this document and is meant for sole use by the recipient and not for circulation. This document is not to be reported or copied
or made available to others. It should not be considered to be taken as an offer to sell or a solicitation to buy any security. The information contained herein is from sources believed to be
reliable. We strongly recommend that you contact us before making any investment decisions. Hexagon's clients can access the research report at www.hexagononline.com. Contact us at:
Hexagon Capital Advisors Pvt. Ltd. S-209, Suraj Ganga Arcade, 332/7, 15th cross, 2nd Block Jayanagar, Bangalore-560011. Ph: (+91) (080) 26572852. E-mail: [email protected]
December 2010
Templeton India Short-term Income Plan provides an ideal intermediate debt investment opportunity that focuses on short-
term corporate bonds and is placed to help the investor weather uncertain debt market conditions. In recent times, yields
have moved sharply higher due to RBI policy measures and are now at more appropriate and attractive levels to get invested.
The StrategyFund manager, Sachin Padwal-Desai, is managing the fund since August 2006 and his take on the debt market and positioning
of the fund has been quite impressive. For instance, during 2008 credit crunch, the fund was positioned to take credit risk in
GOOD QUALITY papers (Corporate bonds, pool and single PTC's) with significant spread on the market yields. As the graph
illustrates, the actual returns the fund delivered on a one year basis, YTM of the fund in Nov 2009 was 14.93%, while the YTM
of fund during Nov 2008 was 12.65%. This additional return over the YTM was possible due to the active management of the
fund where along with the focus on accruals, the fund also exited some of the papers at right time giving room for capital gains
as well. The fund has also changed its exit load from 6 months to 9 months (w.e.f Dec 20th 2010) to signify the positioning of
product as accrual based/hold till maturity.
Currently, the fund manager has maintained portfolio duration of around 1 year (1 year as of Nov 2010) and is overweight on
corporate bonds. The fund has invested predominantly into AAA and equivalent papers (63%) and AA equivalent papers (22%)
as of November 2010. The fund carries a very attractive yield to maturity (YTM) of 9.19% which is marginally higher than an
FMP with similar duration. Given the duration and quality of the portfolio, the fund is positioned as High quality with medium
sensitivity to interest rate risk.
In the current dynamic economic conditions, it is important to be in a position to take advantage of emerging opportunities
while staying invested in the safety of debt. While FMPs offer relative safety, due to the passive management of their
portfolios, they may miss out on taking advantage of changing interest rates and other market opportunities which a short
term fund like TISTIP can capture.
Templeton India Short term Income Plan