In a controversial order, the Gujarat government has asked all profit-making public sector enterprises (PSEs) in the state to contribute up to 30% of their annual profit before tax to Gujarat Socio-Economic Development Society (GSEDS), set up to support weaker sections of society.
The request has had a cascading effect on several PSEs that have lost Rs 1,336 crore in terms of market cap since the Wednesday directive.
Confirming the Gujarat government’s decision, state commissioner of Bureau of Public Sector Enterprises, Arvind Agarwal, told TOI , ‘‘Because these companies earn good profits, their contribution to Gujarat’s socio-economic development will help the state achieve its social objectives.’’
But in the last two trading sessions alone, the market capitalisation of Gujarat Mineral Development Corp (GMDC), Gujarat Alkalies and Chemicals (GACL), Gujarat State Fertlizers and Chemicals (GSFC), Gujarat Narmada Valley Fertilisers Corp (GNFC), Gujarat Industrial Power Corp (GIPCL) and Gujarat State Petronet Limited (GSPL) has fallen by Rs 1,336 crore.
And the value of government’s holding in these companies got shaved off by Rs 721 crore.
GMDC, which has declared in its annual report that it would contribute nearly Rs 123 crore for social causes, continued to fall sharply, down by 17% in two days since the decision. While the managing directors of the six listed PSEs have made a strong representation to the state government that the move would erode the rating of PSEs, the government has remained undeterred in its pursuit to milk the profit-making PSEs for its social goals.
While bureaucrats manning these PSEs are disturbed by the slide in the stocks, a government spokesperson told TOI that ‘‘there’s no question of going back on this.’’
‘‘It’s a retrograde step from the capital market point of view. A better way to implement CSR is to ask PSEs to increase the dividend payouts so that the Gujarat government receives higher sum to donate to any society of its choice,’’ said V K Sharma, the head of Anagram Securities.
Saturday, September 6, 2008
PSEs shed Rs 1,300 cr on Modi's welfare call
In a controversial order, the Gujarat government has asked all profit-making public sector enterprises (PSEs) in the state to contribute up to 30% of their annual profit before tax to Gujarat Socio-Economic Development Society (GSEDS), set up to support weaker sections of society.
The request has had a cascading effect on several PSEs that have lost Rs 1,336 crore in terms of market cap since the Wednesday directive.
Confirming the Gujarat government’s decision, state commissioner of Bureau of Public Sector Enterprises, Arvind Agarwal, told TOI , ‘‘Because these companies earn good profits, their contribution to Gujarat’s socio-economic development will help the state achieve its social objectives.’’
But in the last two trading sessions alone, the market capitalisation of Gujarat Mineral Development Corp (GMDC), Gujarat Alkalies and Chemicals (GACL), Gujarat State Fertlizers and Chemicals (GSFC), Gujarat Narmada Valley Fertilisers Corp (GNFC), Gujarat Industrial Power Corp (GIPCL) and Gujarat State Petronet Limited (GSPL) has fallen by Rs 1,336 crore.
And the value of government’s holding in these companies got shaved off by Rs 721 crore.
GMDC, which has declared in its annual report that it would contribute nearly Rs 123 crore for social causes, continued to fall sharply, down by 17% in two days since the decision. While the managing directors of the six listed PSEs have made a strong representation to the state government that the move would erode the rating of PSEs, the government has remained undeterred in its pursuit to milk the profit-making PSEs for its social goals.
While bureaucrats manning these PSEs are disturbed by the slide in the stocks, a government spokesperson told TOI that ‘‘there’s no question of going back on this.’’
‘‘It’s a retrograde step from the capital market point of view. A better way to implement CSR is to ask PSEs to increase the dividend payouts so that the Gujarat government receives higher sum to donate to any society of its choice,’’ said V K Sharma, the head of Anagram Securities.
The request has had a cascading effect on several PSEs that have lost Rs 1,336 crore in terms of market cap since the Wednesday directive.
Confirming the Gujarat government’s decision, state commissioner of Bureau of Public Sector Enterprises, Arvind Agarwal, told TOI , ‘‘Because these companies earn good profits, their contribution to Gujarat’s socio-economic development will help the state achieve its social objectives.’’
But in the last two trading sessions alone, the market capitalisation of Gujarat Mineral Development Corp (GMDC), Gujarat Alkalies and Chemicals (GACL), Gujarat State Fertlizers and Chemicals (GSFC), Gujarat Narmada Valley Fertilisers Corp (GNFC), Gujarat Industrial Power Corp (GIPCL) and Gujarat State Petronet Limited (GSPL) has fallen by Rs 1,336 crore.
And the value of government’s holding in these companies got shaved off by Rs 721 crore.
GMDC, which has declared in its annual report that it would contribute nearly Rs 123 crore for social causes, continued to fall sharply, down by 17% in two days since the decision. While the managing directors of the six listed PSEs have made a strong representation to the state government that the move would erode the rating of PSEs, the government has remained undeterred in its pursuit to milk the profit-making PSEs for its social goals.
While bureaucrats manning these PSEs are disturbed by the slide in the stocks, a government spokesperson told TOI that ‘‘there’s no question of going back on this.’’
‘‘It’s a retrograde step from the capital market point of view. A better way to implement CSR is to ask PSEs to increase the dividend payouts so that the Gujarat government receives higher sum to donate to any society of its choice,’’ said V K Sharma, the head of Anagram Securities.
Saturday, April 19, 2008
ALL ABOUT INFLATION
What is Inflation?
A simple commonly used definition of the word inflation is simply "an increase in the price you pay or a decline in the purchasing power of money".
In other words, Price Inflation is when prices get higher or it takes more money to buy the same item.
Inflation is measured by the Bureau of Labor Statistics in the United States using the Consumer Price Index.
Inflation Cause and Effect
I often receive letters from students, that demonstrate a fuzzy understanding of inflation and its causes. Unfortunately, I often get the same type letters from teachers and business people too!
It seems that people often confuse the cause of inflation with the effect of inflation and unfortunately the dictionary isn't much help. As you can see in my article What is the Real Definition of Inflation? the modern definition of inflation is
"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money..."
In other words according to this definition inflation is things getting more expensive.
But that is really the effect of inflation not inflation itself. The American Heritage® Dictionary of the English Language, Fourth Edition, Copyright © 2000 Published by Houghton Mifflin Company goes on to say:
...caused by an increase in available currency and credit beyond the proportion of available goods and services.
In other words, the common usage of the word inflation is the effect that people see. When they see prices in their local stores going up they call it inflation.
But what is being inflated? Obviously prices are being inflated. So this is actually "price inflation".
Price inflation is a result of "monetary inflation".
Or "monetary inflation" is the cause of "price inflation".
So what is "monetary inflation" and where does it come from?
"Monetary inflation" is basically the government figuratively cranking up the printing presses and increasing the money supply.
In the old days that was how we got inflation. The government would actually print more dollars. But today the government has much more advanced methods of increasing the money supply. Remember, "monetary inflation" is the "increase in the amount of currency in circulation".
But how do we define currency in circulation? Is it just the cash in our pockets? Or does it include the money in our checking accounts? How about our savings accounts? What about Money Market accounts, CD's, and time deposits?
"The Federal Reserve tracks and publishes the money supply measured three different ways-- M1, M2, and M3.
These three money supply measures track slightly different views of the money supply with M1 being the most liquid and M3 including giant deposits held by foreign banks. And M2 being somewhere in between i.e. basically Cash, Checking and Savings accounts.
Interestingly, the FED has decided to stop tracking M3 effective March 23, 2006 for some mysterious reason. See the article on M3 Money Supply for what they could be hiding.
But back to the question of the cause of inflation. Basically when the government increases the money supply faster than the quantity of goods increases we have inflation. Interestingly as the supply of goods increase the money supply has to increase or else prices actually go down.
Many people mistakenly believe that prices rise because businesses are "greedy". This is not the case in a free enterprise system. Because of competition the businesses that succeed are those that provide the highest quality goods for the lowest price. So a business can't just arbitrarily raise its prices anytime it wants to. If it does, before long all of its customers will be buying from someone else.
But if each dollar is worth less because the supply of dollars has increased, all business are forced to raise prices just to get the same value for their products.
What is Deflation?
In common usage deflation is generally considered to be "falling prices". But there is much more to it than that. Often people confuse deflation with disinflation or with Depression (as in "the Great Depression"). These three terms are related but not synonymous.
According to Investorwords.com the definition of Deflation is "a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. The opposite of inflation."
What Causes Deflation?
Although everything said above is true it doesn't present the true nature of deflation. It tries to define it by presenting several possible causes. For a true understanding of both Inflation and Deflation we need to understand Supply and Demand. Just like every other commodity there is a supply of and a demand for "Money".
In this article I am not going to address the issues of what true money is, for the sake of this article we will assume money is simply something other people are willing to accept in exchange for goods or services.
Price levels are the direct result of the relationship between the supply and the demand for any given item. But the value of the money used to pay for those items is also subject to the same relationship.
For the sake of simplicity let's assume that we are on an island and there are ten equally desirable goods in our universe and ten $1.00 bills available to purchase them with. We can safely assume that each item will end up costing $1.00 each.
If the quantity of money increases to $20 (without increasing the quantity of goods) the price of the goods will increase to $2.00 - that is inflation.
If, however, the quantity of money decreases to $5.00 the price will fall to 50¢ (deflation). This is what the first part of the above definition is referring to. The money supply can also be reduced if someone on our island hoards half of it and refuses to spend it on anything no matter what. This is the second part of the definition (reduction in spending).
So far we have only looked at part of the equation, the supply of money. But what happens if the quantity of goods available increases? What if instead of having ten items we build ten more? We now have twenty items and only $10. 00 so once again each item is worth 50¢.
This form of deflation is the good type. Everyone assumes that deflation is bad because the last major deflation that we had was during the "Great Depression" so deflation and Depression are synonymous in many peoples minds. In actuality if prices go down because the goods can be manufactured more cheaply this ends up increasing everyone's wealth.
This is exactly what happened in the late 1990s , with cheap productivity available from former Communist countries the quantity of goods is increased while the money supply increased at a slower rate.
What about Demand?
What about the demand for goods? If everyone on our island already has one of the items available and no one needs any more, naturally the price will also fall as sellers try to find someone to take them off their hands.
So far we have dealt with the supply of money, the supply of goods and the demand for goods, but what about the demand for money?
Is it possible that the demand for money could increase or decrease? Generally, the demand for money is measured by how much people are willing to pay to borrow it (i.e. interest rates). If inflation is high, interest rates will have to be higher to compensate for the loss of purchasing power. But also if the demand for money rises banks can charge more to loan it. Conversely, if the demand for money falls interest rates will also fall.
So there are four causes for Deflation.
Decreasing Money Supply
Increasing Supply of Goods
Decreasing Demand for Goods
Increasing Demand for Money
Note:
Increasing demand or decreasing supply of money have the same result i.e. "tight money" either way people want more money than is available.
Both could also result in (or cause) higher interest rates. But the higher interest rates should also tend to balance (or decrease the demand for money because it is now more expensive).
In other words as interest rates rise at some point the demand drops off because people don't want it bad enough to pay such high rates.
Is Deflation Good or Bad?
Actually, deflation itself is neither good nor bad. It depends on the cause of the deflation whether people will suffer or rejoice. As I said, if the cause is increasing supply of goods that would be good. Another example of this is in the late 1800's as the industrial revolution dramatically increased productivity.
However, if deflation is caused by a decreasing supply of money as in the great depression, that would be bad. The stock market crash sucked all the liquidity out of the market place, the economy contracted, people lost their jobs and then banks stopped loaning money because people were defaulting. The problem compounded as more people lost their jobs and money supply fell further causing more people to lose their jobs, etc. etc.
Note: During the Depression demand for money was high (but no one could afford it) because supply was low.
So deflation can be caused by several different things and thus can be good or bad depending on the cause.
How Do I Calculate the Inflation Rate?
The Formula for Calculating Inflation
The formula for calculating the Inflation Rate using the Consumer Price Index is relatively simple. Every month the Bureau of Labor Statistics (BLS) surveys prices and generates the current Consumer Price Index (CPI). Let us assume for the sake of simplicity that the index consists of one item and that one item cost $1.00 in 1984. The BLS published the index in 1984 at 100. If today that same item costs $1.85 the index would stand at 185.0
By looking at the above example, common sense would tell us that the index increased (it went from 100 to 185). The question is how much has it increased? To calculate the change we would take the second number (185) and subtract the first number (100). The result would be 85. So we know that since 1984 prices increased (Inflated) by 85 points.
What good does knowing that it moved 85 do? Not much. We still need a method of comparison.
Since we know the increase in the Consumer Price Index we still need to compare it to something, so we compare it to the price it started at (100). We do that by dividing the increase by the first price or 85/100. the result is (.85). This number is still not very useful so we convert it into a percent. To do that we multiply by 100 and add a % symbol.
So the result is an 85% increase in prices since 1984. That is interesting but (other than being the date of George Orwell's famous novel) to most people today 1984 is not particularly significant.
calculating a specific Inflation Rate
Normally, we want to know how much prices have increased since last year, or since we bought our house, or perhaps how much prices will increase by the time we retire or our kids go to college.
Fortunately, The method of calculating Inflation is the same, no matter what time period we desire. We just substitute a different value for the first one. So if we want to know how much prices have increased over the last 12 months (the commonly published inflation rate number) we would subtract last year's index from the current index and divide by last year's number and multiply the result by 100 and add a % sign.
The formula for calculating the Inflation Rate looks like this:
((B - A)/A)*100
So if exactly one year ago the Consumer Price Index was 178 and today the CPI is 185, then the calculations would look like this:
((185-178)/178)*100
or
(7/178)*100
or
0.0393*100
which equals 3.93% inflation over the sample year.
(Not Actual Inflation Rates). For more information you may check the current Consumer Inflation Rate and Historical Inflation Rates in table format. Or if you believe a picture is worth a thousand words you may prefer the Annual Inflation Rate plotted in Chart format.
What happens if prices Go down?
If prices go down and we experienced Price Deflation then "A" would be larger than "B" and we would end up with a negative number. So if last year the Consumer Price Index (CPI) was 189 and this year the CPI is 185 then the formula would look like this:
((185-189)/189)*100
or
(-4/189)*100
or
-0.021*100
which equals negative 2.11% inflation over the sample year. Of course negative inflation is deflation.
How Does Inflation Affect You?
When people go the the grocery store and see ever higher prices they know how inflation affects them. But when they are feeling more philosophical they might reason that if all wages and prices increased at the same rate it would all balance out in the end right?
Well theoretically yes but in reality it never works that way. Prices of various items all increase at different rates so some people are benefiting while others suffer. Those on fixed incomes suffer the most because the cost of things they are buying increases but their income stays the same.
This is where COLA or "Cost Of Living Allowance" comes in it is an adjustment that is made to compensate for the increase in prices due to inflation.
But even if costs are adjusted they are adjusted after the fact so that you have already been paying the higher prices for a year before your income is adjusted.
One side of inflation that most consumers appreciate is the fact that they can pay off their debts with "cheaper dollars". So as you borrow the value of the money you borrowed goes down so it takes fewer hours of work to pay back the lender.
This is one reason why debt is so prevalent today. Unfortunately, this is a subtle but insidious poison because it trains us to feel good about cheating others. In the past a man's honor was tied to his ability to repay his debts but today inflation has taught us that it is good to try to cheat lenders out of their due. This has led to a higher rate of bankruptcies and if the trend continues it could lead to the breakdown of commerce.
Once lenders can't be assured of getting repaid they will stop lending (or have to charge exorbitant interest rates) and as interest rates increase the economy grinds to a halt. So even the "good" side of inflation is really "bad" for the economy in the long run.
Who Does Inflation Hurt Most?
When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn't everyone be affected equally? The fact of course is that everyone isn't affected equally.
Our second assumption might be that the poor would be hurt the worst because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them.
The reason for this is that debtors borrow valuable money and the number of dollars they must repay is fixed. So over time the value of the dollars they must repay is less and less (so they are easier to obtain than if the value of the dollar wasn't inflated away.) This is called repaying with "cheaper dollars".
However, bigger beneficiaries would be the average middle class person with a large mortgage because the debt is for a longer term so inflation has longer to work it's "magic".
On the other hand, the biggest losers due to inflation are those willing to loan money. An extreme example would be during the hyper-inflation of 1923 in Germany. If you had loaned a friend enough money to buy a car in early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender of course was the big loser.
At first this looks like the ultimate Robin Hood scheme, robbing from the rich bankers and giving to the poor borrowers. However, the other big losers those on fixed incomes like the elderly and anyone whose income isn't indexed to inflation.
Inflation affects them especially hard because the prices of things they buy go up while their income stays the same. In addition, the poor are generally renters so they don't even benefit from a "cheaper" mortgage while they are paying higher prices for their groceries.
Also even though their wages may be indexed to inflation there is a time lag since it is usually only re-indexed once a year. During this time they are on the old wages while prices for things they buy have already gone up.
Interestingly the biggest debtor in the world is the US government and thus it is also the biggest beneficiary of inflation.
And not coincidentally the Government is also the one who controls the money supply and thus inflation.
In a way, inflation works as a hidden tax because the government borrows money from investors. It spends this valuable money and then gets to pay back its debt with cheaper dollars.
The poor unsuspecting investor who is convinced that Government notes, bonds and T-Bills are "Low-Risk investments" accepts these dollars at face value but before long realizes that they won't buy as much as the dollars they loaned to the government in the first place.
Generally, the Government walks a tightrope though, it can't inflate all its debt away too quickly, without destroying the economy, so it faces a constant balancing act.
One big disadvantage of inflation is the fact that it discourages lending (smart banks need more interest to make up for the lost value). This prices some borrowers out of the market making loans too expensive.
Inflation also makes planning for the future more difficult, so businesses are less likely to take risks. No risk means no advancement which stifles the entire economy.
On a small scale lenders are the losers from inflation and borrowers are the winners but on a bigger scale the biggest beneficiary is the Government and the overall economy is the biggest loser.
Other losers are those on fixed incomes and those who are priced out of the loan market.
Inflation and Financial Services
What is the Impact of Inflation on Financial Services Performance?
The most obvious effect of inflation on financial services is that an investment has to perform that much better just to remain even. For instance, under normal circumstances 10% is considered a good rate of return. However, if inflation is 100% and you only earn 10% you have not made any money you have actually lost 45% of your purchasing power.
The calculations are as follows:
100 + 10% = 110
110/200 = 55%
55% of the original value is a 45% loss.
But you would need to earn at least 100% just to stay even with inflation and you would need to earn 110% to earn a good rate of return. But in areas of high inflation investors generally require higher rates of return to compensate for the higher risk associated with the higher inflation. So they might require 120% or even 200% to account for the higher risk.
In Zimbabwe, where inflation rates are often 1000% all kinds of economic distortions take place and investing becomes a matter more of concern for return of capital rather than return on capital. So investors will often switch to real physical goods like Gold or in more extreme cases even food in order to protect themselves from loss of purchasing power. Or even worse a lack of availability of critical goods.
A simple commonly used definition of the word inflation is simply "an increase in the price you pay or a decline in the purchasing power of money".
In other words, Price Inflation is when prices get higher or it takes more money to buy the same item.
Inflation is measured by the Bureau of Labor Statistics in the United States using the Consumer Price Index.
Inflation Cause and Effect
I often receive letters from students, that demonstrate a fuzzy understanding of inflation and its causes. Unfortunately, I often get the same type letters from teachers and business people too!
It seems that people often confuse the cause of inflation with the effect of inflation and unfortunately the dictionary isn't much help. As you can see in my article What is the Real Definition of Inflation? the modern definition of inflation is
"A persistent increase in the level of consumer prices or a persistent decline in the purchasing power of money..."
In other words according to this definition inflation is things getting more expensive.
But that is really the effect of inflation not inflation itself. The American Heritage® Dictionary of the English Language, Fourth Edition, Copyright © 2000 Published by Houghton Mifflin Company goes on to say:
...caused by an increase in available currency and credit beyond the proportion of available goods and services.
In other words, the common usage of the word inflation is the effect that people see. When they see prices in their local stores going up they call it inflation.
But what is being inflated? Obviously prices are being inflated. So this is actually "price inflation".
Price inflation is a result of "monetary inflation".
Or "monetary inflation" is the cause of "price inflation".
So what is "monetary inflation" and where does it come from?
"Monetary inflation" is basically the government figuratively cranking up the printing presses and increasing the money supply.
In the old days that was how we got inflation. The government would actually print more dollars. But today the government has much more advanced methods of increasing the money supply. Remember, "monetary inflation" is the "increase in the amount of currency in circulation".
But how do we define currency in circulation? Is it just the cash in our pockets? Or does it include the money in our checking accounts? How about our savings accounts? What about Money Market accounts, CD's, and time deposits?
"The Federal Reserve tracks and publishes the money supply measured three different ways-- M1, M2, and M3.
These three money supply measures track slightly different views of the money supply with M1 being the most liquid and M3 including giant deposits held by foreign banks. And M2 being somewhere in between i.e. basically Cash, Checking and Savings accounts.
Interestingly, the FED has decided to stop tracking M3 effective March 23, 2006 for some mysterious reason. See the article on M3 Money Supply for what they could be hiding.
But back to the question of the cause of inflation. Basically when the government increases the money supply faster than the quantity of goods increases we have inflation. Interestingly as the supply of goods increase the money supply has to increase or else prices actually go down.
Many people mistakenly believe that prices rise because businesses are "greedy". This is not the case in a free enterprise system. Because of competition the businesses that succeed are those that provide the highest quality goods for the lowest price. So a business can't just arbitrarily raise its prices anytime it wants to. If it does, before long all of its customers will be buying from someone else.
But if each dollar is worth less because the supply of dollars has increased, all business are forced to raise prices just to get the same value for their products.
What is Deflation?
In common usage deflation is generally considered to be "falling prices". But there is much more to it than that. Often people confuse deflation with disinflation or with Depression (as in "the Great Depression"). These three terms are related but not synonymous.
According to Investorwords.com the definition of Deflation is "a decline in general price levels, often caused by a reduction in the supply of money or credit. Deflation can also be brought about by direct contractions in spending, either in the form of a reduction in government spending, personal spending or investment spending. Deflation has often had the side effect of increasing unemployment in an economy, since the process often leads to a lower level of demand in the economy. The opposite of inflation."
What Causes Deflation?
Although everything said above is true it doesn't present the true nature of deflation. It tries to define it by presenting several possible causes. For a true understanding of both Inflation and Deflation we need to understand Supply and Demand. Just like every other commodity there is a supply of and a demand for "Money".
In this article I am not going to address the issues of what true money is, for the sake of this article we will assume money is simply something other people are willing to accept in exchange for goods or services.
Price levels are the direct result of the relationship between the supply and the demand for any given item. But the value of the money used to pay for those items is also subject to the same relationship.
For the sake of simplicity let's assume that we are on an island and there are ten equally desirable goods in our universe and ten $1.00 bills available to purchase them with. We can safely assume that each item will end up costing $1.00 each.
If the quantity of money increases to $20 (without increasing the quantity of goods) the price of the goods will increase to $2.00 - that is inflation.
If, however, the quantity of money decreases to $5.00 the price will fall to 50¢ (deflation). This is what the first part of the above definition is referring to. The money supply can also be reduced if someone on our island hoards half of it and refuses to spend it on anything no matter what. This is the second part of the definition (reduction in spending).
So far we have only looked at part of the equation, the supply of money. But what happens if the quantity of goods available increases? What if instead of having ten items we build ten more? We now have twenty items and only $10. 00 so once again each item is worth 50¢.
This form of deflation is the good type. Everyone assumes that deflation is bad because the last major deflation that we had was during the "Great Depression" so deflation and Depression are synonymous in many peoples minds. In actuality if prices go down because the goods can be manufactured more cheaply this ends up increasing everyone's wealth.
This is exactly what happened in the late 1990s , with cheap productivity available from former Communist countries the quantity of goods is increased while the money supply increased at a slower rate.
What about Demand?
What about the demand for goods? If everyone on our island already has one of the items available and no one needs any more, naturally the price will also fall as sellers try to find someone to take them off their hands.
So far we have dealt with the supply of money, the supply of goods and the demand for goods, but what about the demand for money?
Is it possible that the demand for money could increase or decrease? Generally, the demand for money is measured by how much people are willing to pay to borrow it (i.e. interest rates). If inflation is high, interest rates will have to be higher to compensate for the loss of purchasing power. But also if the demand for money rises banks can charge more to loan it. Conversely, if the demand for money falls interest rates will also fall.
So there are four causes for Deflation.
Decreasing Money Supply
Increasing Supply of Goods
Decreasing Demand for Goods
Increasing Demand for Money
Note:
Increasing demand or decreasing supply of money have the same result i.e. "tight money" either way people want more money than is available.
Both could also result in (or cause) higher interest rates. But the higher interest rates should also tend to balance (or decrease the demand for money because it is now more expensive).
In other words as interest rates rise at some point the demand drops off because people don't want it bad enough to pay such high rates.
Is Deflation Good or Bad?
Actually, deflation itself is neither good nor bad. It depends on the cause of the deflation whether people will suffer or rejoice. As I said, if the cause is increasing supply of goods that would be good. Another example of this is in the late 1800's as the industrial revolution dramatically increased productivity.
However, if deflation is caused by a decreasing supply of money as in the great depression, that would be bad. The stock market crash sucked all the liquidity out of the market place, the economy contracted, people lost their jobs and then banks stopped loaning money because people were defaulting. The problem compounded as more people lost their jobs and money supply fell further causing more people to lose their jobs, etc. etc.
Note: During the Depression demand for money was high (but no one could afford it) because supply was low.
So deflation can be caused by several different things and thus can be good or bad depending on the cause.
How Do I Calculate the Inflation Rate?
The Formula for Calculating Inflation
The formula for calculating the Inflation Rate using the Consumer Price Index is relatively simple. Every month the Bureau of Labor Statistics (BLS) surveys prices and generates the current Consumer Price Index (CPI). Let us assume for the sake of simplicity that the index consists of one item and that one item cost $1.00 in 1984. The BLS published the index in 1984 at 100. If today that same item costs $1.85 the index would stand at 185.0
By looking at the above example, common sense would tell us that the index increased (it went from 100 to 185). The question is how much has it increased? To calculate the change we would take the second number (185) and subtract the first number (100). The result would be 85. So we know that since 1984 prices increased (Inflated) by 85 points.
What good does knowing that it moved 85 do? Not much. We still need a method of comparison.
Since we know the increase in the Consumer Price Index we still need to compare it to something, so we compare it to the price it started at (100). We do that by dividing the increase by the first price or 85/100. the result is (.85). This number is still not very useful so we convert it into a percent. To do that we multiply by 100 and add a % symbol.
So the result is an 85% increase in prices since 1984. That is interesting but (other than being the date of George Orwell's famous novel) to most people today 1984 is not particularly significant.
calculating a specific Inflation Rate
Normally, we want to know how much prices have increased since last year, or since we bought our house, or perhaps how much prices will increase by the time we retire or our kids go to college.
Fortunately, The method of calculating Inflation is the same, no matter what time period we desire. We just substitute a different value for the first one. So if we want to know how much prices have increased over the last 12 months (the commonly published inflation rate number) we would subtract last year's index from the current index and divide by last year's number and multiply the result by 100 and add a % sign.
The formula for calculating the Inflation Rate looks like this:
((B - A)/A)*100
So if exactly one year ago the Consumer Price Index was 178 and today the CPI is 185, then the calculations would look like this:
((185-178)/178)*100
or
(7/178)*100
or
0.0393*100
which equals 3.93% inflation over the sample year.
(Not Actual Inflation Rates). For more information you may check the current Consumer Inflation Rate and Historical Inflation Rates in table format. Or if you believe a picture is worth a thousand words you may prefer the Annual Inflation Rate plotted in Chart format.
What happens if prices Go down?
If prices go down and we experienced Price Deflation then "A" would be larger than "B" and we would end up with a negative number. So if last year the Consumer Price Index (CPI) was 189 and this year the CPI is 185 then the formula would look like this:
((185-189)/189)*100
or
(-4/189)*100
or
-0.021*100
which equals negative 2.11% inflation over the sample year. Of course negative inflation is deflation.
How Does Inflation Affect You?
When people go the the grocery store and see ever higher prices they know how inflation affects them. But when they are feeling more philosophical they might reason that if all wages and prices increased at the same rate it would all balance out in the end right?
Well theoretically yes but in reality it never works that way. Prices of various items all increase at different rates so some people are benefiting while others suffer. Those on fixed incomes suffer the most because the cost of things they are buying increases but their income stays the same.
This is where COLA or "Cost Of Living Allowance" comes in it is an adjustment that is made to compensate for the increase in prices due to inflation.
But even if costs are adjusted they are adjusted after the fact so that you have already been paying the higher prices for a year before your income is adjusted.
One side of inflation that most consumers appreciate is the fact that they can pay off their debts with "cheaper dollars". So as you borrow the value of the money you borrowed goes down so it takes fewer hours of work to pay back the lender.
This is one reason why debt is so prevalent today. Unfortunately, this is a subtle but insidious poison because it trains us to feel good about cheating others. In the past a man's honor was tied to his ability to repay his debts but today inflation has taught us that it is good to try to cheat lenders out of their due. This has led to a higher rate of bankruptcies and if the trend continues it could lead to the breakdown of commerce.
Once lenders can't be assured of getting repaid they will stop lending (or have to charge exorbitant interest rates) and as interest rates increase the economy grinds to a halt. So even the "good" side of inflation is really "bad" for the economy in the long run.
Who Does Inflation Hurt Most?
When we first think of inflation we assume that it will affect all people equally. After all if everyone is using the same dollars wouldn't everyone be affected equally? The fact of course is that everyone isn't affected equally.
Our second assumption might be that the poor would be hurt the worst because they earn minimum wage and everything they buy is getting more expensive. However, if the minimum wage is indexed to inflation they would about break even. So interestingly if the minimum wage earners are also deep in debt inflation actually helps them.
The reason for this is that debtors borrow valuable money and the number of dollars they must repay is fixed. So over time the value of the dollars they must repay is less and less (so they are easier to obtain than if the value of the dollar wasn't inflated away.) This is called repaying with "cheaper dollars".
However, bigger beneficiaries would be the average middle class person with a large mortgage because the debt is for a longer term so inflation has longer to work it's "magic".
On the other hand, the biggest losers due to inflation are those willing to loan money. An extreme example would be during the hyper-inflation of 1923 in Germany. If you had loaned a friend enough money to buy a car in early 1923 and he had repaid it at the end of 1923 you might have been able to buy a box of matches with it. So it is easy to see that the borrower got a car and he was able to repay it with pocket change. The lender of course was the big loser.
At first this looks like the ultimate Robin Hood scheme, robbing from the rich bankers and giving to the poor borrowers. However, the other big losers those on fixed incomes like the elderly and anyone whose income isn't indexed to inflation.
Inflation affects them especially hard because the prices of things they buy go up while their income stays the same. In addition, the poor are generally renters so they don't even benefit from a "cheaper" mortgage while they are paying higher prices for their groceries.
Also even though their wages may be indexed to inflation there is a time lag since it is usually only re-indexed once a year. During this time they are on the old wages while prices for things they buy have already gone up.
Interestingly the biggest debtor in the world is the US government and thus it is also the biggest beneficiary of inflation.
And not coincidentally the Government is also the one who controls the money supply and thus inflation.
In a way, inflation works as a hidden tax because the government borrows money from investors. It spends this valuable money and then gets to pay back its debt with cheaper dollars.
The poor unsuspecting investor who is convinced that Government notes, bonds and T-Bills are "Low-Risk investments" accepts these dollars at face value but before long realizes that they won't buy as much as the dollars they loaned to the government in the first place.
Generally, the Government walks a tightrope though, it can't inflate all its debt away too quickly, without destroying the economy, so it faces a constant balancing act.
One big disadvantage of inflation is the fact that it discourages lending (smart banks need more interest to make up for the lost value). This prices some borrowers out of the market making loans too expensive.
Inflation also makes planning for the future more difficult, so businesses are less likely to take risks. No risk means no advancement which stifles the entire economy.
On a small scale lenders are the losers from inflation and borrowers are the winners but on a bigger scale the biggest beneficiary is the Government and the overall economy is the biggest loser.
Other losers are those on fixed incomes and those who are priced out of the loan market.
Inflation and Financial Services
What is the Impact of Inflation on Financial Services Performance?
The most obvious effect of inflation on financial services is that an investment has to perform that much better just to remain even. For instance, under normal circumstances 10% is considered a good rate of return. However, if inflation is 100% and you only earn 10% you have not made any money you have actually lost 45% of your purchasing power.
The calculations are as follows:
100 + 10% = 110
110/200 = 55%
55% of the original value is a 45% loss.
But you would need to earn at least 100% just to stay even with inflation and you would need to earn 110% to earn a good rate of return. But in areas of high inflation investors generally require higher rates of return to compensate for the higher risk associated with the higher inflation. So they might require 120% or even 200% to account for the higher risk.
In Zimbabwe, where inflation rates are often 1000% all kinds of economic distortions take place and investing becomes a matter more of concern for return of capital rather than return on capital. So investors will often switch to real physical goods like Gold or in more extreme cases even food in order to protect themselves from loss of purchasing power. Or even worse a lack of availability of critical goods.
Thursday, April 3, 2008
Mutual Fund- FAQs - General
How do I invest in a mutual fund scheme?
Mutual funds usually issue advertisements in the newspapers, announcing the launch of new schemes. Investors can also contact the funds' agents and distributors for information and application forms. Filled application forms may be deposited with the funds, through the agents or distributors. Of late, post offices and banks have also begun to distribute the units of mutual funds. However, these schemes are merely being marketed by the banks and post offices. The banks and post offices offer no assurance of returns.
What is a prospectus or offer document?
This is a document that all mutual funds are required to provide to investors. As an investor, you should read this document carefully before investing in these funds. Ensure that you are referring to the latest offer document. An offer document must be updated at least annually. The prospectus must contain the following:
· Date of issue: This is the start and end date of new fund offers.
· Minimum investment to be made: Mutual funds prescribe the minimum amount to be invested through new fund offers and multiple amounts in addition to the prescribed minimum.
· Investment objectives: This section details the broad criteria that the mutual fund will follow with regard to investing in a particular security.
· Investment policies: The offer document will also outline the general strategies the fund managers will implement, types of investments, and asset allocation pattern considered appropriate for the fund.
· Risk factors: The offer document is required to describe the risks associated with investing in the fund. You should be familiar with the differences between varieties of risk, why these risks are inherent in particular funds, and how these risks fit in with risks in the overall portfolio.
· Benchmarks used: Check the benchmarks chosen by the fund to ensure that its relative performance is appropriate. Be careful to read the fine print in these sections.
· Fees and expenses: Offer documents are also required to list the limits on fees, including entry and exit loads, switching charges, annual recurring expenses, management fees and investor servicing costs. The prospectus also indicates the impact these have had on fund investment.
· Key personnel: This section details the qualifications and professional experience of the top management in the fund company, including those of the chief executive officer (CEO) and fund managers.
· Tax benefits information: Mutual funds enjoy significant tax benefits. For example, equity funds enjoy no long term capital gains or dividend distribution tax benefits. Careful reading of the tax benefits is essential before you to plan tax benefits so as to enhance post-tax returns.
· Investor services: You have access to the services (such as automatic reinvestment of dividend and systematic investment/withdrawal plans) that are mentioned in the offer document.
Can investors appoint nominees for their investments in mutual fund units?
Yes. Nominations may be made by individuals applying for or holding units on their own behalf, either singly or jointly. Non-individuals including societies, trusts, corporate bodies, partnership firms, Kartas of Hindu undivided families, or holders of power of attorney cannot nominate.
Can non-resident Indians (NRIs) invest in mutual funds?
Yes. The offer documents of schemes provide information on how NRIs may subscribe to mutual fund schemes in India.
What should I look for in offer documents?
The mutual funds are required to provide an abridged version of the offer document to investors; this version contains useful information. Read this version carefully. The application form for subscribing to schemes is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. Due care must be given to portions relating to the scheme's main features, risk factors, initial issue expenses and recurring expenses, entry and exit loads, sponsor's track record, performance of other schemes launched by the fund, and the qualifications and experience of key personnel including fund managers.
How are mutual fund issues different from initial public offerings (IPOs) of companies?
Company IPOs may open at prices that are lower or higher price than the issue price, depending on market sentiment and investor perceptions. However, in the case of mutual funds, the par value of units is unlikely to rise or fall immediately after allotment. Mutual fund schemes require time to invest in securities. The value of securities in which the scheme deploys its funds will drive the scheme's NAV.
How much should I invest in debt and equity-oriented schemes?
That is for you to decide. But remember to factor in your risk-taking capacity, age, and financial position before investing. Schemes invest in a variety of securities, as disclosed in the offer documents, and offer varying returns and risks.
What is the net asset value (NAV) of a scheme?
The NAV denotes the performance of a mutual fund scheme. NAV is the market value of the securities held by the scheme. Since market value changes every day, NAVs of schemes also vary on a daily basis. The NAV per unit is the market value of a scheme's securities, divided by the total number of units on a given date. If the market value of securities is Rs.200 lakh and the mutual fund has issued 10 lakh units of Rs.10 each to investors, the NAV per unit of the fund is Rs.20. Mutual funds are required to disclose their NAVs on a daily or weekly basis, depending on the type of scheme.
What is a load or no-load fund?
A load fund is one that charges a percentage of the NAV for entry or exit. That is, each time you buy or sell units in the fund, you pay a charge. The fund uses this charge to meet its marketing and distribution expenses. Let's say the NAV per unit is Rs.10: if the entry and exit load charged is 1 per cent, you would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund get only Rs.9.90 per unit. You should, therefore, take the loads into consideration while investing, as these affect your returns. You also need to factor in the fund's performance track record and service standards. The efficient funds often offer high returns despite the loads.
A no-load fund is one that does not charge for entry or exit. This means that you can enter the fund or scheme at NAV and no additional charges are payable on purchase or sale of units.
Can mutual funds impose fresh loads or increase loads beyond levels mentioned in offer documents?
No. Changes in load are applicable only to prospective investments and not to original investments. In case of imposition of fresh loads or increase in existing loads, the funds are required to amend their offer documents so that new investors are aware of the loads while investing.
What is a contingent deferred sales charge (CDSC)?
Some funds charge varying loads, depending on the extent of time the investor has stayed with the fund; the longer the investor stays with the fund, the lesser the exit load is likely to be. This is called CDSC.
What do I get as proof of my holdings?
You get an account statement, which is similar to a bank passbook. This is a non-transferable document, which includes details of all purchases and sales, along with the price at which the purchase or sale was made. It also indicates the amount invested and redeemed to date, and the number of units held, helping you track investments.
Fresh account statements will be sent to you reflecting your updated holdings after every transaction. Generally, account statements are sent within three working days on receipt of purchase or redemption request at an investor service centre. The AMC may also issue a non-transferable unit certificate to you within six weeks of the receipt of request for the certificate.
Will I have facilities to switch between funds?
You may switch all or part of your investments in one fund to another available fund. AMCs do not charge fees for such switches. To process a switch, you need to provide clear instructions, by completing a form and submitting it on any business day at an investor service centre, or the office of registrar or transfer agent. The form may also be sent by post. An account statement reflecting the new holdings will be sent to you within three days of completion of transaction.
Who is the custodian?
The custodian is the company responsible for the possession, handling and safekeeping of all securities purchased by the mutual fund.
How can I find out where the mutual fund scheme has invested the money mobilised from investors?
Mutual funds are required to disclose the full portfolios of all of their schemes on a half-yearly basis; these disclosures are published in the newspapers. Some mutual funds even send these disclosures to unit holders.The portfolio disclosures indicate the levels of investment made in each security such as equity, debentures, money market instruments and G-Secs, and their quantity, market value and per cent to NAV. They also disclose the extent of illiquid securities in the portfolio, investments made in rated and unrated debt securities and non-performing assets (NPAs). Some mutual funds also send newsletters to unit holders on a quarterly basis, disclosing these data.
Are mutual funds allowed to indulge in speculation/day trading?
No, they are not. SEBI mandates that all trades done by mutual funds be settled by delivery. The latest budget has allowed mutual funds to short sell, but only when backed by delivery after a lending/borrowing mechanism is in place.
How do I evaluate the performance of mutual fund schemes?
The NAV, disclosed on a daily basis in the case of open-end schemes, and weekly basis in the case of close-end schemes, will help you evaluate performance. The funds are required to publish NAVs in the newspapers. The NAVs are also available on the funds' web sites. In addition, the funds are required to disclose their NAVs on the AMFI web site (www.amfiindia.com), where you can access the NAVs of all mutual funds. The funds also publish half-yearly results, which include the returns over periods of time; these half-yearly results also provide details such as the percentage of expenses of total assets, which affects yield. You will also receive annual reports or abridged versions of the annual report from the fund at the end of the year.
Studies relating to mutual fund schemes are published by the financial newspapers on a regular basis. Research agencies also publish reports on the performance of mutual funds and rankings of schemes in terms of performance. Such reports and analyses will also help you keep abreast of developments. Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity-oriented schemes with benchmarks such as the BSE Sensitive Index and S&P CNX Nifty. Monitoring the performance of funds will help you decide when to enter or exit a scheme.
How do I choose a scheme for investment from a number of available schemes?
You need to read the offer document of the mutual fund schemes carefully. Remember to evaluate the past performance of the schemes you wish to choose from, provided these schemes have similar investment objectives. Though past performance is not always an indicator of future performance, it is nevertheless an important factor that needs to be considered while making investment decisions. In the case of debt-oriented schemes, you should also evaluate the quality of instruments, as reflected in their ratings. Schemes with lower rates of return, but with investments in higher-rated instruments are safer than those with higher yields, but with investments in lower-rated instruments. In equity schemes too, you will do well to look for the quality of the portfolio. Also, remember to seek the advice of experts you can trust.
If a variety of mutual funds offer schemes in the same category, should I choose the scheme with the lowest NAV?
Some investors prefer schemes that are available at low NAVs. However, remember that in the case of mutual funds schemes, low or high NAVs have little or no relevance. You should choose schemes based on factors such as the fund's past performance, service standards and level of professional management.
Consider the following example: Scheme A is available at an NAV of Rs.15, while Scheme B is available at Rs.90; both are diversified equity-oriented schemes. You have invested Rs.9000 in each of the two schemes. You would get 600 units (9000/15) in Scheme A and 100 units (9000/90) in Scheme B. If the markets go up by 10 per cent and both schemes perform equally well, the NAV of Scheme A would increase to Rs.16.50, while that of Scheme B would increase to Rs.99. Thus, the market value of both investments would be Rs.9900, and on both investments, you would get identical returns of 10 per cent. Thus, low or high NAVs have little relevance when you are making investment decisions. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs.90, their NAVs should not be the overriding factor that influences your investment decision.
It is likely that the better-managed scheme with a higher NAV may give better returns than a scheme that has a lower NAV, but is not managed efficiently. Efficiently managed schemes with high NAVs are unlikely to fall as much as inefficiently managed schemes with low NAVs. Therefore, you will do well to give more weightage to professional management, rather than to the NAV.
How significant are fund costs while choosing schemes?
The costs of investing through mutual funds are not insignificant, and deserve due consideration, especially when you are considering to invest in fixed income funds. Factors such as management fees, and the fund's annual expenses and sales loads can eat into significant portions of your returns. Also, carefully consider the fees charged by funds for entering or exiting a scheme.
What are"Fundamental attributes" of a scheme?
The following are classified as "fundamental attributes" as per clause (d) of sub-regulation (15) of regulation 18:
· Type of a scheme
· Open ended/Close ended/Interval scheme
· Sectoral Fund/Equity Fund/Balance Fund/Income Fund/Index Fund/Any other type of Fund
· Investment Objective
· Main Objective - Growth/Income/Both.
· Investment pattern - The tentative Equity/Debt/Money Market portfolio break-up with minimum and maximum asset allocation, while retaining the option to alter the asset allocation for a short term period on defensive considerations.
· Terms of Issue
· Liquidity provisions such as listing, repurchase, redemption.
· Aggregate fees and expenses charged to the scheme.
· Any safety net or guarantee provided.
Can mutual funds alter asset allocations (investment pattern) while deploying the investors' funds?
Considering the market trends, any prudent fund managers can alter the asset allocation (investment pattern) i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors.
However the trustees shall ensure that no change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affects the interest of unitholders, shall be carried out unless,—
· A written communication about the proposed change is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation as well as in a newspaper published in the language of region where the Head Office of the mutual fund is situated; and
· The unit-holders are given an option to exit at the prevailing Net Asset Value without any exit load.
Can mutual funds change the nature of schemes from the one specified in the offer document?
Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes such as structure or investment pattern is allowed unless a written communication is sent to each unit holder and an advertisement is published in an English daily with a nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. Unit holders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The funds are required to follow a similar procedure while converting schemes from close-ended to open-ended or while changing the sponsor.
Offer documents are required to be revised and updated at least once in two years. New investors are informed of material changes by way of addendum to the offer document till the offer document is revised and reprinted.
Are investments in mutual fund units safe?
No stock market related investments can be termed safe with certainty; they are inherently risky. However, funds have varying risk profiles, as stated in their objective. Funds, which categorise themselves as low risk, invest generally in debt, which is less risky than equity. Mutual funds are, however, always safer than direct investments in the stock markets as they have access to the services of expert fund managers.
What are the risks inherent in mutual funds?
Equity Funds are open to market risks; the price of the stocks in which the fund has invested may reduce. Conversely, the prices may go up, enabling the funds to earn profits.
Debts Funds are open to credit and interest rate risks. Credit risks refer to the possibility that the company that has issued the bond or debenture in which the fund has invested may default on interest or on principal payments. Debt fund managers take care of this by investing in bonds with a strong credit rating. Interest rate risks refer to the possibility that the price of the bond in which the fund has invested may go down, because of an increase in interest rates in the economy. In general, it is useful to remember that this is an inverse relationship - bond prices (and therefore, NAVs) go up when interest rates drop, and drop when interest rates rise.
Are mutual fund schemes suitable for small investors?
Mutual funds are meant specifically for small investors. Although small investors may not be able to carefully monitor and analyse investments in the stock markets, the mutual funds are usually equipped to carry out thorough analysis and thus, ensure superior returns to investors.
Is the higher net worth of the sponsor a guarantee for better returns?
The offer documents of mutual fund schemes mention financial performance and net worth of the sponsor for a period of three years. This helps the investor evaluate the track record of the company that has sponsored the mutual fund. However, the sponsor's high net worth does not mean that the scheme would offer better returns or that the sponsor would compensate investors if the NAV falls.
Are mutual funds insured?
No. Unlike certain types of savings accounts and certificates of deposit, mutual fund units are not insured by the government, or any government agency, and do not have any other type of insurance. There is no guarantee that when you sell your shares, you will receive what you paid for them.
How long will it take for the transfer of units after purchase from the stock markets in the case of close-ended schemes?
According to SEBI Regulations, transfer of units has to be done within 30 days from the date of lodgement of certificates with the mutual fund.
How long will it take for investors to receive dividends/repurchase proceeds?
A mutual fund is required to despatch to the unit holders the dividend warrants within 30 days of the declaration of dividends; redemption or repurchase proceeds are to be sent within 10 working days from the date of redemption or repurchase request made by the unit holder.
In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, the AMC is liable to pay interest as specified by SEBI from time to time (15 per cent at present).
If mutual fund schemes are wound up, what happens to the money I have invested in them?
If a scheme winds up, the mutual funds pays a sum based on the prevailing NAV, after adjustment of expenses. Unit holders are entitled to receive a report on the wind up from the mutual funds, which provides all the necessary details.
Are 'mutual benefit' companies the same as mutual funds?
No. Companies with the tag, 'mutual benefit,' in their names are not mutual funds. These companies do not come under the purview of SEBI. Mutual funds, however, can mobilise funds from investors only after getting registered with SEBI.
How do I get my grievances redressed?
The name of the person to contact for redressal of grievances is mentioned in the offer document. Trustees of mutual funds monitor the activities of the funds. The names of the directors of the AMC and trustees are also provided in the offer documents. You can also approach SEBI for redressal of complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up on these till the matter is resolved.
Mutual funds usually issue advertisements in the newspapers, announcing the launch of new schemes. Investors can also contact the funds' agents and distributors for information and application forms. Filled application forms may be deposited with the funds, through the agents or distributors. Of late, post offices and banks have also begun to distribute the units of mutual funds. However, these schemes are merely being marketed by the banks and post offices. The banks and post offices offer no assurance of returns.
What is a prospectus or offer document?
This is a document that all mutual funds are required to provide to investors. As an investor, you should read this document carefully before investing in these funds. Ensure that you are referring to the latest offer document. An offer document must be updated at least annually. The prospectus must contain the following:
· Date of issue: This is the start and end date of new fund offers.
· Minimum investment to be made: Mutual funds prescribe the minimum amount to be invested through new fund offers and multiple amounts in addition to the prescribed minimum.
· Investment objectives: This section details the broad criteria that the mutual fund will follow with regard to investing in a particular security.
· Investment policies: The offer document will also outline the general strategies the fund managers will implement, types of investments, and asset allocation pattern considered appropriate for the fund.
· Risk factors: The offer document is required to describe the risks associated with investing in the fund. You should be familiar with the differences between varieties of risk, why these risks are inherent in particular funds, and how these risks fit in with risks in the overall portfolio.
· Benchmarks used: Check the benchmarks chosen by the fund to ensure that its relative performance is appropriate. Be careful to read the fine print in these sections.
· Fees and expenses: Offer documents are also required to list the limits on fees, including entry and exit loads, switching charges, annual recurring expenses, management fees and investor servicing costs. The prospectus also indicates the impact these have had on fund investment.
· Key personnel: This section details the qualifications and professional experience of the top management in the fund company, including those of the chief executive officer (CEO) and fund managers.
· Tax benefits information: Mutual funds enjoy significant tax benefits. For example, equity funds enjoy no long term capital gains or dividend distribution tax benefits. Careful reading of the tax benefits is essential before you to plan tax benefits so as to enhance post-tax returns.
· Investor services: You have access to the services (such as automatic reinvestment of dividend and systematic investment/withdrawal plans) that are mentioned in the offer document.
Can investors appoint nominees for their investments in mutual fund units?
Yes. Nominations may be made by individuals applying for or holding units on their own behalf, either singly or jointly. Non-individuals including societies, trusts, corporate bodies, partnership firms, Kartas of Hindu undivided families, or holders of power of attorney cannot nominate.
Can non-resident Indians (NRIs) invest in mutual funds?
Yes. The offer documents of schemes provide information on how NRIs may subscribe to mutual fund schemes in India.
What should I look for in offer documents?
The mutual funds are required to provide an abridged version of the offer document to investors; this version contains useful information. Read this version carefully. The application form for subscribing to schemes is an integral part of the offer document. SEBI has prescribed minimum disclosures in the offer document. Due care must be given to portions relating to the scheme's main features, risk factors, initial issue expenses and recurring expenses, entry and exit loads, sponsor's track record, performance of other schemes launched by the fund, and the qualifications and experience of key personnel including fund managers.
How are mutual fund issues different from initial public offerings (IPOs) of companies?
Company IPOs may open at prices that are lower or higher price than the issue price, depending on market sentiment and investor perceptions. However, in the case of mutual funds, the par value of units is unlikely to rise or fall immediately after allotment. Mutual fund schemes require time to invest in securities. The value of securities in which the scheme deploys its funds will drive the scheme's NAV.
How much should I invest in debt and equity-oriented schemes?
That is for you to decide. But remember to factor in your risk-taking capacity, age, and financial position before investing. Schemes invest in a variety of securities, as disclosed in the offer documents, and offer varying returns and risks.
What is the net asset value (NAV) of a scheme?
The NAV denotes the performance of a mutual fund scheme. NAV is the market value of the securities held by the scheme. Since market value changes every day, NAVs of schemes also vary on a daily basis. The NAV per unit is the market value of a scheme's securities, divided by the total number of units on a given date. If the market value of securities is Rs.200 lakh and the mutual fund has issued 10 lakh units of Rs.10 each to investors, the NAV per unit of the fund is Rs.20. Mutual funds are required to disclose their NAVs on a daily or weekly basis, depending on the type of scheme.
What is a load or no-load fund?
A load fund is one that charges a percentage of the NAV for entry or exit. That is, each time you buy or sell units in the fund, you pay a charge. The fund uses this charge to meet its marketing and distribution expenses. Let's say the NAV per unit is Rs.10: if the entry and exit load charged is 1 per cent, you would be required to pay Rs.10.10 and those who offer their units for repurchase to the mutual fund get only Rs.9.90 per unit. You should, therefore, take the loads into consideration while investing, as these affect your returns. You also need to factor in the fund's performance track record and service standards. The efficient funds often offer high returns despite the loads.
A no-load fund is one that does not charge for entry or exit. This means that you can enter the fund or scheme at NAV and no additional charges are payable on purchase or sale of units.
Can mutual funds impose fresh loads or increase loads beyond levels mentioned in offer documents?
No. Changes in load are applicable only to prospective investments and not to original investments. In case of imposition of fresh loads or increase in existing loads, the funds are required to amend their offer documents so that new investors are aware of the loads while investing.
What is a contingent deferred sales charge (CDSC)?
Some funds charge varying loads, depending on the extent of time the investor has stayed with the fund; the longer the investor stays with the fund, the lesser the exit load is likely to be. This is called CDSC.
What do I get as proof of my holdings?
You get an account statement, which is similar to a bank passbook. This is a non-transferable document, which includes details of all purchases and sales, along with the price at which the purchase or sale was made. It also indicates the amount invested and redeemed to date, and the number of units held, helping you track investments.
Fresh account statements will be sent to you reflecting your updated holdings after every transaction. Generally, account statements are sent within three working days on receipt of purchase or redemption request at an investor service centre. The AMC may also issue a non-transferable unit certificate to you within six weeks of the receipt of request for the certificate.
Will I have facilities to switch between funds?
You may switch all or part of your investments in one fund to another available fund. AMCs do not charge fees for such switches. To process a switch, you need to provide clear instructions, by completing a form and submitting it on any business day at an investor service centre, or the office of registrar or transfer agent. The form may also be sent by post. An account statement reflecting the new holdings will be sent to you within three days of completion of transaction.
Who is the custodian?
The custodian is the company responsible for the possession, handling and safekeeping of all securities purchased by the mutual fund.
How can I find out where the mutual fund scheme has invested the money mobilised from investors?
Mutual funds are required to disclose the full portfolios of all of their schemes on a half-yearly basis; these disclosures are published in the newspapers. Some mutual funds even send these disclosures to unit holders.The portfolio disclosures indicate the levels of investment made in each security such as equity, debentures, money market instruments and G-Secs, and their quantity, market value and per cent to NAV. They also disclose the extent of illiquid securities in the portfolio, investments made in rated and unrated debt securities and non-performing assets (NPAs). Some mutual funds also send newsletters to unit holders on a quarterly basis, disclosing these data.
Are mutual funds allowed to indulge in speculation/day trading?
No, they are not. SEBI mandates that all trades done by mutual funds be settled by delivery. The latest budget has allowed mutual funds to short sell, but only when backed by delivery after a lending/borrowing mechanism is in place.
How do I evaluate the performance of mutual fund schemes?
The NAV, disclosed on a daily basis in the case of open-end schemes, and weekly basis in the case of close-end schemes, will help you evaluate performance. The funds are required to publish NAVs in the newspapers. The NAVs are also available on the funds' web sites. In addition, the funds are required to disclose their NAVs on the AMFI web site (www.amfiindia.com), where you can access the NAVs of all mutual funds. The funds also publish half-yearly results, which include the returns over periods of time; these half-yearly results also provide details such as the percentage of expenses of total assets, which affects yield. You will also receive annual reports or abridged versions of the annual report from the fund at the end of the year.
Studies relating to mutual fund schemes are published by the financial newspapers on a regular basis. Research agencies also publish reports on the performance of mutual funds and rankings of schemes in terms of performance. Such reports and analyses will also help you keep abreast of developments. Investors can compare the performance of their schemes with those of other mutual funds under the same category. They can also compare the performance of equity-oriented schemes with benchmarks such as the BSE Sensitive Index and S&P CNX Nifty. Monitoring the performance of funds will help you decide when to enter or exit a scheme.
How do I choose a scheme for investment from a number of available schemes?
You need to read the offer document of the mutual fund schemes carefully. Remember to evaluate the past performance of the schemes you wish to choose from, provided these schemes have similar investment objectives. Though past performance is not always an indicator of future performance, it is nevertheless an important factor that needs to be considered while making investment decisions. In the case of debt-oriented schemes, you should also evaluate the quality of instruments, as reflected in their ratings. Schemes with lower rates of return, but with investments in higher-rated instruments are safer than those with higher yields, but with investments in lower-rated instruments. In equity schemes too, you will do well to look for the quality of the portfolio. Also, remember to seek the advice of experts you can trust.
If a variety of mutual funds offer schemes in the same category, should I choose the scheme with the lowest NAV?
Some investors prefer schemes that are available at low NAVs. However, remember that in the case of mutual funds schemes, low or high NAVs have little or no relevance. You should choose schemes based on factors such as the fund's past performance, service standards and level of professional management.
Consider the following example: Scheme A is available at an NAV of Rs.15, while Scheme B is available at Rs.90; both are diversified equity-oriented schemes. You have invested Rs.9000 in each of the two schemes. You would get 600 units (9000/15) in Scheme A and 100 units (9000/90) in Scheme B. If the markets go up by 10 per cent and both schemes perform equally well, the NAV of Scheme A would increase to Rs.16.50, while that of Scheme B would increase to Rs.99. Thus, the market value of both investments would be Rs.9900, and on both investments, you would get identical returns of 10 per cent. Thus, low or high NAVs have little relevance when you are making investment decisions. Likewise, if a new equity oriented scheme is being offered at Rs.10 and an existing scheme is available for Rs.90, their NAVs should not be the overriding factor that influences your investment decision.
It is likely that the better-managed scheme with a higher NAV may give better returns than a scheme that has a lower NAV, but is not managed efficiently. Efficiently managed schemes with high NAVs are unlikely to fall as much as inefficiently managed schemes with low NAVs. Therefore, you will do well to give more weightage to professional management, rather than to the NAV.
How significant are fund costs while choosing schemes?
The costs of investing through mutual funds are not insignificant, and deserve due consideration, especially when you are considering to invest in fixed income funds. Factors such as management fees, and the fund's annual expenses and sales loads can eat into significant portions of your returns. Also, carefully consider the fees charged by funds for entering or exiting a scheme.
What are"Fundamental attributes" of a scheme?
The following are classified as "fundamental attributes" as per clause (d) of sub-regulation (15) of regulation 18:
· Type of a scheme
· Open ended/Close ended/Interval scheme
· Sectoral Fund/Equity Fund/Balance Fund/Income Fund/Index Fund/Any other type of Fund
· Investment Objective
· Main Objective - Growth/Income/Both.
· Investment pattern - The tentative Equity/Debt/Money Market portfolio break-up with minimum and maximum asset allocation, while retaining the option to alter the asset allocation for a short term period on defensive considerations.
· Terms of Issue
· Liquidity provisions such as listing, repurchase, redemption.
· Aggregate fees and expenses charged to the scheme.
· Any safety net or guarantee provided.
Can mutual funds alter asset allocations (investment pattern) while deploying the investors' funds?
Considering the market trends, any prudent fund managers can alter the asset allocation (investment pattern) i.e. he can invest higher or lower percentage of the fund in equity or debt instruments compared to what is disclosed in the offer document. It can be done on a short term basis on defensive considerations i.e. to protect the NAV. Hence the fund managers are allowed certain flexibility in altering the asset allocation considering the interest of the investors.
However the trustees shall ensure that no change in the fundamental attributes of any scheme or the trust or fees and expenses payable or any other change which would modify the scheme and affects the interest of unitholders, shall be carried out unless,—
· A written communication about the proposed change is sent to each unitholder and an advertisement is given in one English daily newspaper having nationwide circulation as well as in a newspaper published in the language of region where the Head Office of the mutual fund is situated; and
· The unit-holders are given an option to exit at the prevailing Net Asset Value without any exit load.
Can mutual funds change the nature of schemes from the one specified in the offer document?
Yes. However, no change in the nature or terms of the scheme, known as fundamental attributes such as structure or investment pattern is allowed unless a written communication is sent to each unit holder and an advertisement is published in an English daily with a nationwide circulation and in a newspaper published in the language of the region where the head office of the mutual fund is situated. Unit holders have the right to exit the scheme at the prevailing NAV without any exit load if they do not want to continue with the scheme. The funds are required to follow a similar procedure while converting schemes from close-ended to open-ended or while changing the sponsor.
Offer documents are required to be revised and updated at least once in two years. New investors are informed of material changes by way of addendum to the offer document till the offer document is revised and reprinted.
Are investments in mutual fund units safe?
No stock market related investments can be termed safe with certainty; they are inherently risky. However, funds have varying risk profiles, as stated in their objective. Funds, which categorise themselves as low risk, invest generally in debt, which is less risky than equity. Mutual funds are, however, always safer than direct investments in the stock markets as they have access to the services of expert fund managers.
What are the risks inherent in mutual funds?
Equity Funds are open to market risks; the price of the stocks in which the fund has invested may reduce. Conversely, the prices may go up, enabling the funds to earn profits.
Debts Funds are open to credit and interest rate risks. Credit risks refer to the possibility that the company that has issued the bond or debenture in which the fund has invested may default on interest or on principal payments. Debt fund managers take care of this by investing in bonds with a strong credit rating. Interest rate risks refer to the possibility that the price of the bond in which the fund has invested may go down, because of an increase in interest rates in the economy. In general, it is useful to remember that this is an inverse relationship - bond prices (and therefore, NAVs) go up when interest rates drop, and drop when interest rates rise.
Are mutual fund schemes suitable for small investors?
Mutual funds are meant specifically for small investors. Although small investors may not be able to carefully monitor and analyse investments in the stock markets, the mutual funds are usually equipped to carry out thorough analysis and thus, ensure superior returns to investors.
Is the higher net worth of the sponsor a guarantee for better returns?
The offer documents of mutual fund schemes mention financial performance and net worth of the sponsor for a period of three years. This helps the investor evaluate the track record of the company that has sponsored the mutual fund. However, the sponsor's high net worth does not mean that the scheme would offer better returns or that the sponsor would compensate investors if the NAV falls.
Are mutual funds insured?
No. Unlike certain types of savings accounts and certificates of deposit, mutual fund units are not insured by the government, or any government agency, and do not have any other type of insurance. There is no guarantee that when you sell your shares, you will receive what you paid for them.
How long will it take for the transfer of units after purchase from the stock markets in the case of close-ended schemes?
According to SEBI Regulations, transfer of units has to be done within 30 days from the date of lodgement of certificates with the mutual fund.
How long will it take for investors to receive dividends/repurchase proceeds?
A mutual fund is required to despatch to the unit holders the dividend warrants within 30 days of the declaration of dividends; redemption or repurchase proceeds are to be sent within 10 working days from the date of redemption or repurchase request made by the unit holder.
In case of failures to despatch the redemption/repurchase proceeds within the stipulated time period, the AMC is liable to pay interest as specified by SEBI from time to time (15 per cent at present).
If mutual fund schemes are wound up, what happens to the money I have invested in them?
If a scheme winds up, the mutual funds pays a sum based on the prevailing NAV, after adjustment of expenses. Unit holders are entitled to receive a report on the wind up from the mutual funds, which provides all the necessary details.
Are 'mutual benefit' companies the same as mutual funds?
No. Companies with the tag, 'mutual benefit,' in their names are not mutual funds. These companies do not come under the purview of SEBI. Mutual funds, however, can mobilise funds from investors only after getting registered with SEBI.
How do I get my grievances redressed?
The name of the person to contact for redressal of grievances is mentioned in the offer document. Trustees of mutual funds monitor the activities of the funds. The names of the directors of the AMC and trustees are also provided in the offer documents. You can also approach SEBI for redressal of complaints. On receipt of complaints, SEBI takes up the matter with the concerned mutual fund and follows up on these till the matter is resolved.
Capital protection-oriented funds (CPFs)
What are CPFs?
CPFs are funds where the structure of the scheme, with or without external support, ensures protection of the original investment at the scheme's maturity. In India, capital protection has to be ensured by the scheme's portfolio characteristics; third party protection is currently not permitted. CPFs are attractive opportunities for investors looking to enhance yield on their portfolios through exposure to risky asset classes such as equity, and yet seeking assurance on the protection of principal. CPFs offer a platform to risk-averse investors who wish to participate in the upturns in equity markets, but at the same time, do not want to suffer erosion in the value of the invested amount. The CPF's structure and the performance of the debt and equity markets are factors that determine the returns on investments.
What are the highlights of SEBI's regulation pertaining to CPFs?
SEBI has issued detailed guidelines pertaining to the launch of CPFs in India. SEBI defines a capital protection-oriented scheme as "a mutual fund scheme which is designated as such and which endeavours to protect the capital invested therein through suitable orientation of its portfolio structure." SEBI stipulates that the CPFs launched be close-ended, and that AMCs do not repurchase units before the end of the maturity period. Debt investments in the case of CPFs must be in the highest-rated investment grade papers. Another pre-condition to the launch of CPFs by AMCs is that the scheme's units be rated by a registered credit rating agency, from the perspective of the portfolio's ability to protect the capital invested therein. This rating must be reviewed on a quarterly basis. Further, the trustees are required to continuously monitor the structure of the portfolio of the CPF and report the same in half-yearly trustee reports. The AMC is required to report the same in its bi-monthly compliance test report to SEBI.
How does a CPF's structure ensure capital protection to investors?
CPFs are schemes with underlying portfolios structured in such manner as to ensure capital protection to investors. There are four broad ways in which capital protection can be ensured. They are:
· Static Hedge: Here, capital protection is provided solely through the debt portfolio. Put simply, the debt portfolio invested matures to the capital value (initial consideration) at the end of the scheme. The remainder (the difference between the capital raised and present value of capital) is invested in equity, which could provide the possible upside to the investors. Investments in debt instruments are typically done on a held to maturity (HTM) basis, thereby negating the impact of market risk on account of interest rate movements. Also, since the debt investments will be in fixed-income securities of very good credit quality, the risk of default is mitigated. Appreciation in the equity component constitutes additional returns to investors.
· Dynamic Hedge: Here, capital protection is provided through a mix of debt and equity. An amount slightly lower than the present value of the protected principal is invested in debt and the remainder, in equity. A combination of the maturity value of the debt portfolio and certain minimum equity component ensures capital protection. In this case, contributions from the equity portfolio are required to ensure capital protection. A covenant to switch back that much equity allocation to debt which together with interest thereon will provide capital protection at maturity on the breach of a pre-determined tolerance level is incorporated. The initial allocation to debt will be lower than in the case of static hedge. The upside will however be higher in the case of dynamic hedge than in the case of static hedge. The downside will be nil in both cases if the scheme warranties are diligently adhered to.
· Constant proportion portfolio insurance (CPPI) is a form of continuous dynamic hedging that was introduced by Fischer Black and Robert Jones of Goldman Sachs in 1986. CPPI is a popular, broadly-applicable and efficient model of portfolio insurance. Globally, the transactions of most hedge fund-linked protection-oriented securities are structured using the CPPI model. Some key advantages of the model are that it does not involve investments in options, is suitable for portfolios consisting of all types of marketable securities, and is relatively simple and easy to understand.
The CPPI strategy maintains a portfolio's risk exposure at a constant multiple of the excess of wealth in the portfolio over a pre-defined floor level. CPPI allocates portfolio wealth between two assets; a risky asset (assumed to be equity) and a risk-free asset (assumed to be debt), in order to maintain a constant risk exposure. The risk-free asset (consisting typically of high-quality fixed income securities) is expected to earn an acceptable minimum, usually at least the risk-free rate. The risky asset is expected to earn a higher rate of return than the risk free asset. The quantum of exposure to be taken in the risky asset is computed by means of a multiplier. This indicates how many times the excess of wealth in the portfolio over a pre-defined floor level is invested in the risky asset.
Should the risky asset increase in value, more of the portfolio is invested in this asset in an effort to take advantage of the rising asset values. If the risky asset declines in value, the portfolio is rebalanced to reflect an increased weight in the risk free asset. The portfolio's funds are thus constantly rebalanced (at daily/weekly/fortnightly intervals) to reflect the performance of the risky asset and to maintain a constant risk exposure. The exposure to risky assets is always maintained at levels such that the fund manager can, at short notice, convert the entire risky asset into risk-free investments up to an overall predetermined floor, thus ensuring the minimum, specified payoff at maturity.
· Dynamic Portfolio Insurance (DPI) is a variant of CPPI and allows the fund manager to dynamically change the multiplier, depending on the outlook on the volatility of the risky asset. The multiplier could be low when markets are volatile and high when the markets are stable.
What are capital-guaranteed funds (CGFs)?
CGFs are a variant of CPFs with a guarantee feature embedded in the scheme. In the case of CGFs, the AMC is bound to return the guaranteed amount to the investor if the structure fails to ensure capital protection. This guarantee may also be provided by a third party on payment of a fee. Regardless of how the fund performs at the end of the maturity period, the investor will thus recover at least the guaranteed amount.
Are CGFs permitted in India?
No, SEBI permits no guarantee in India. In its regulations, SEBI states that the orientation towards protection of capital should originate from the scheme's portfolio structure and not from a bank guarantee or insurance cover. The CPF therefore has to be structured in such a manner that its portfolio constitution ensures protection of the original investment on the scheme's maturity.
What are the key risks in CPFs?
The key risks in CPFs are the following:
· Credit risk: This refers to the risk of default of the debt instruments held in the portfolio. Current SEBI regulations also restrict CPFs from investing in debt instruments rated below 'AAA.'
· Reinvestment risk: As interest rates vary, interim cash flows from interest-bearing debt instruments may be reinvested at a lower yield than the original yield.
· Float risk: The structure may have a lower yield than projected if there are delays in deployment, or if the debt instruments are not co–terminus with the scheme maturity.
· Liquidity risk: Liquidity concerns can become impediments in the case of both debt and equity securities.
· Transaction costs: Frequent churning between debt and equity on every rebalancing date, may lead to increased transaction costs.
Is there a surveillance process for CPFs?
Rating agencies will monitor all assigned CPF ratings on a quarterly basis as per SEBI guidelines. As part of this exercise, the rating agencies will seek information from the respective AMCs in a pre-specified format. Using the information thus obtained, the rating agencies will analyse the probability of the portfolio value falling below the initially-contracted principal value, and of investors getting their money back in full.
CPFs are funds where the structure of the scheme, with or without external support, ensures protection of the original investment at the scheme's maturity. In India, capital protection has to be ensured by the scheme's portfolio characteristics; third party protection is currently not permitted. CPFs are attractive opportunities for investors looking to enhance yield on their portfolios through exposure to risky asset classes such as equity, and yet seeking assurance on the protection of principal. CPFs offer a platform to risk-averse investors who wish to participate in the upturns in equity markets, but at the same time, do not want to suffer erosion in the value of the invested amount. The CPF's structure and the performance of the debt and equity markets are factors that determine the returns on investments.
What are the highlights of SEBI's regulation pertaining to CPFs?
SEBI has issued detailed guidelines pertaining to the launch of CPFs in India. SEBI defines a capital protection-oriented scheme as "a mutual fund scheme which is designated as such and which endeavours to protect the capital invested therein through suitable orientation of its portfolio structure." SEBI stipulates that the CPFs launched be close-ended, and that AMCs do not repurchase units before the end of the maturity period. Debt investments in the case of CPFs must be in the highest-rated investment grade papers. Another pre-condition to the launch of CPFs by AMCs is that the scheme's units be rated by a registered credit rating agency, from the perspective of the portfolio's ability to protect the capital invested therein. This rating must be reviewed on a quarterly basis. Further, the trustees are required to continuously monitor the structure of the portfolio of the CPF and report the same in half-yearly trustee reports. The AMC is required to report the same in its bi-monthly compliance test report to SEBI.
How does a CPF's structure ensure capital protection to investors?
CPFs are schemes with underlying portfolios structured in such manner as to ensure capital protection to investors. There are four broad ways in which capital protection can be ensured. They are:
· Static Hedge: Here, capital protection is provided solely through the debt portfolio. Put simply, the debt portfolio invested matures to the capital value (initial consideration) at the end of the scheme. The remainder (the difference between the capital raised and present value of capital) is invested in equity, which could provide the possible upside to the investors. Investments in debt instruments are typically done on a held to maturity (HTM) basis, thereby negating the impact of market risk on account of interest rate movements. Also, since the debt investments will be in fixed-income securities of very good credit quality, the risk of default is mitigated. Appreciation in the equity component constitutes additional returns to investors.
· Dynamic Hedge: Here, capital protection is provided through a mix of debt and equity. An amount slightly lower than the present value of the protected principal is invested in debt and the remainder, in equity. A combination of the maturity value of the debt portfolio and certain minimum equity component ensures capital protection. In this case, contributions from the equity portfolio are required to ensure capital protection. A covenant to switch back that much equity allocation to debt which together with interest thereon will provide capital protection at maturity on the breach of a pre-determined tolerance level is incorporated. The initial allocation to debt will be lower than in the case of static hedge. The upside will however be higher in the case of dynamic hedge than in the case of static hedge. The downside will be nil in both cases if the scheme warranties are diligently adhered to.
· Constant proportion portfolio insurance (CPPI) is a form of continuous dynamic hedging that was introduced by Fischer Black and Robert Jones of Goldman Sachs in 1986. CPPI is a popular, broadly-applicable and efficient model of portfolio insurance. Globally, the transactions of most hedge fund-linked protection-oriented securities are structured using the CPPI model. Some key advantages of the model are that it does not involve investments in options, is suitable for portfolios consisting of all types of marketable securities, and is relatively simple and easy to understand.
The CPPI strategy maintains a portfolio's risk exposure at a constant multiple of the excess of wealth in the portfolio over a pre-defined floor level. CPPI allocates portfolio wealth between two assets; a risky asset (assumed to be equity) and a risk-free asset (assumed to be debt), in order to maintain a constant risk exposure. The risk-free asset (consisting typically of high-quality fixed income securities) is expected to earn an acceptable minimum, usually at least the risk-free rate. The risky asset is expected to earn a higher rate of return than the risk free asset. The quantum of exposure to be taken in the risky asset is computed by means of a multiplier. This indicates how many times the excess of wealth in the portfolio over a pre-defined floor level is invested in the risky asset.
Should the risky asset increase in value, more of the portfolio is invested in this asset in an effort to take advantage of the rising asset values. If the risky asset declines in value, the portfolio is rebalanced to reflect an increased weight in the risk free asset. The portfolio's funds are thus constantly rebalanced (at daily/weekly/fortnightly intervals) to reflect the performance of the risky asset and to maintain a constant risk exposure. The exposure to risky assets is always maintained at levels such that the fund manager can, at short notice, convert the entire risky asset into risk-free investments up to an overall predetermined floor, thus ensuring the minimum, specified payoff at maturity.
· Dynamic Portfolio Insurance (DPI) is a variant of CPPI and allows the fund manager to dynamically change the multiplier, depending on the outlook on the volatility of the risky asset. The multiplier could be low when markets are volatile and high when the markets are stable.
What are capital-guaranteed funds (CGFs)?
CGFs are a variant of CPFs with a guarantee feature embedded in the scheme. In the case of CGFs, the AMC is bound to return the guaranteed amount to the investor if the structure fails to ensure capital protection. This guarantee may also be provided by a third party on payment of a fee. Regardless of how the fund performs at the end of the maturity period, the investor will thus recover at least the guaranteed amount.
Are CGFs permitted in India?
No, SEBI permits no guarantee in India. In its regulations, SEBI states that the orientation towards protection of capital should originate from the scheme's portfolio structure and not from a bank guarantee or insurance cover. The CPF therefore has to be structured in such a manner that its portfolio constitution ensures protection of the original investment on the scheme's maturity.
What are the key risks in CPFs?
The key risks in CPFs are the following:
· Credit risk: This refers to the risk of default of the debt instruments held in the portfolio. Current SEBI regulations also restrict CPFs from investing in debt instruments rated below 'AAA.'
· Reinvestment risk: As interest rates vary, interim cash flows from interest-bearing debt instruments may be reinvested at a lower yield than the original yield.
· Float risk: The structure may have a lower yield than projected if there are delays in deployment, or if the debt instruments are not co–terminus with the scheme maturity.
· Liquidity risk: Liquidity concerns can become impediments in the case of both debt and equity securities.
· Transaction costs: Frequent churning between debt and equity on every rebalancing date, may lead to increased transaction costs.
Is there a surveillance process for CPFs?
Rating agencies will monitor all assigned CPF ratings on a quarterly basis as per SEBI guidelines. As part of this exercise, the rating agencies will seek information from the respective AMCs in a pre-specified format. Using the information thus obtained, the rating agencies will analyse the probability of the portfolio value falling below the initially-contracted principal value, and of investors getting their money back in full.
Gold exchange traded funds (GETFs)
What is an Exchange Traded Fund (ETF)?
ETFs generally are mutual fund schemes that are listed on the stock exchanges and traded like common stock. The traded price of the ETF units on the exchange reflects, before expenses, the value per unit of the underlying assets of the fund.
What is a GETF?
GETFs are open-ended funds and present a relatively cost-efficient and secure way to access the gold market but without the necessity of taking physical delivery of gold. GETFs may be bought and sold on a stock exchange after listing.
How do GETFs work?
GETFs provide returns that, before expenses, closely correspond to the returns provided by the domestic price of gold through physical gold. Each unit will be approximately equal to the price of 1 gram of gold.
How do I invest in GETFs?
Initial investments may be made through a new fund offering (NFO) in the specified form of the mutual fund selling the GETF. Units during NFO will be available at the NAV-based price on allotment date. After the NFO, investors can buy or sell units on an exchange where the GETF is traded.
Who can invest in a GETF?
An individual resident, NRIs, firms, HUFs, companies, banks and trusts.
What type of account is required for trading in a GETF?
You need a trading account with an exchange through its broker and a demat account as GETF units are issued only in demat form.
How is a GETF valued?
According to SEBI, since physical gold and other permitted instruments linked to gold are denominated in gold tonnage, it will be valued based on the market price of gold in the domestic market, and marked to market on a daily basis. The market price of gold in the domestic market on any business day will be arrived at as under:
Domestic price of gold = (London Bullion Market Association AM fixing in US$/ounce X conversion factor for converting ounce into kg for 0.995 fineness X rate for US$ into INR) + custom duty for import of gold + sales tax/octroi and other levies applicable.
Which is the benchmark index for a GETF?
As there are no indices catering to the gold sector or to securities linked to gold, GETF is currently benchmarked against the price of gold.
What are the advantages of GETFs over physical gold?
GETFS have the following advantages:
· They are cost effective, because investors hold gold at the prevailing market price without being subject to designing and storage charges and insurance costs
· They carry no impurity risk unlike physical gold
· Their underlying asset, gold, is held by a custodian, and is, therefore, highly secure
They have high liquidity and can be easily sold in an exchange at prevailing prices. Investors can also buy as little as 1 gram of gold through a GETF.
ETFs generally are mutual fund schemes that are listed on the stock exchanges and traded like common stock. The traded price of the ETF units on the exchange reflects, before expenses, the value per unit of the underlying assets of the fund.
What is a GETF?
GETFs are open-ended funds and present a relatively cost-efficient and secure way to access the gold market but without the necessity of taking physical delivery of gold. GETFs may be bought and sold on a stock exchange after listing.
How do GETFs work?
GETFs provide returns that, before expenses, closely correspond to the returns provided by the domestic price of gold through physical gold. Each unit will be approximately equal to the price of 1 gram of gold.
How do I invest in GETFs?
Initial investments may be made through a new fund offering (NFO) in the specified form of the mutual fund selling the GETF. Units during NFO will be available at the NAV-based price on allotment date. After the NFO, investors can buy or sell units on an exchange where the GETF is traded.
Who can invest in a GETF?
An individual resident, NRIs, firms, HUFs, companies, banks and trusts.
What type of account is required for trading in a GETF?
You need a trading account with an exchange through its broker and a demat account as GETF units are issued only in demat form.
How is a GETF valued?
According to SEBI, since physical gold and other permitted instruments linked to gold are denominated in gold tonnage, it will be valued based on the market price of gold in the domestic market, and marked to market on a daily basis. The market price of gold in the domestic market on any business day will be arrived at as under:
Domestic price of gold = (London Bullion Market Association AM fixing in US$/ounce X conversion factor for converting ounce into kg for 0.995 fineness X rate for US$ into INR) + custom duty for import of gold + sales tax/octroi and other levies applicable.
Which is the benchmark index for a GETF?
As there are no indices catering to the gold sector or to securities linked to gold, GETF is currently benchmarked against the price of gold.
What are the advantages of GETFs over physical gold?
GETFS have the following advantages:
· They are cost effective, because investors hold gold at the prevailing market price without being subject to designing and storage charges and insurance costs
· They carry no impurity risk unlike physical gold
· Their underlying asset, gold, is held by a custodian, and is, therefore, highly secure
They have high liquidity and can be easily sold in an exchange at prevailing prices. Investors can also buy as little as 1 gram of gold through a GETF.
DEPOSITORY
Functions of depository?
A Depository can be compared with a bank, which holds the funds for depositors.
Hold securities in an account
Transfers securities between accounts on the instruction of the account holder.
Facilitates transfers of ownership without having to handle securities.
Facilitates safekeeping of shares.
Which are the depositories in India?
There are two depositories in India, which provide dematerialization of securities. The National Securities Depository Limited (NSDL) and Central Securities Depository Limited (CSDL).
What are the benefits of participation in a depository?
The benefits of participation in a depository are:
Immediate transfer of securities
No stamp duty on transfer of securities
Elimination of risks associated with physical certificates such as bad delivery, fake securities, etc.
Reduction in paperwork involved in transfer of securities
Reduction in transaction cost
Ease of nomination facility
Change in address recorded with DP gets registered electronically with all companies in which investor holds securities eliminating the need to correspond with each of them separately
Transmission of securities is done directly by the DP eliminating correspondence with companies
Convenient method of consolidation of folios/accounts
Holding investments in equity, debt instruments and Government securities in a single account; automatic credit into demat account, of shares, arising out of split/consolidation/merger etc.
Who is a Depository Participant (DP)?
The Depository provides its services to investors through its agents called depository participants (DPs). These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and SEBI registered trading members can become DPs.
Does one need to keep any minimum balance of securities in his account with his DP?
No. The depository has not prescribed any minimum balance. You can have zero balance in your account.
What is an ISIN?
ISIN (International Securities Identification Number) is a unique identification number for a security.
What is a Custodian?
A Custodian is basically an organisation, which helps register and safeguard the securities of its clients. Besides safeguarding securities, a custodian also keeps track of corporate actions on behalf of its clients:
Maintaining a client’s securities account
Collecting the benefits or rights accruing to the client in respect of securities
Keeping the client informed of the actions taken or to be taken by the issue of securities, having a bearing on the benefits or rights accruing to the client.
How can one convert physical holding into electronic holding i.e. how can one dematerialise securities?
In order to dematerialise physical securities one has to fill in a Demat Request Form (DRF), which is available with the DP, and submit the same along with physical certificates one wishes to dematerialise. Separate DRF has to be filled for each ISIN number.
Can odd lot shares be dematerialised?
Yes, odd lot share certificates can also be dematerialised.
Do dematerialised shares have distinctive numbers?
Dematerialised shares do not have any distinctive numbers. These shares are fungible, which means that all the holdings of a particular security will be identical and interchangeable.
Can electronic holdings be converted into Physical certificates?
Yes. The process is called Rematerialisation. If one wishes to get back your securities in the physical form one has to fill in the Remat Request Form (RRF) and request your DP for rematerialisation of the balances in your securities account.
Can one dematerialise his debt instruments, mutual fund units, government securities in his demat account?
Yes. You can dematerialise and hold all such investments in a single demat account.
A Depository can be compared with a bank, which holds the funds for depositors.
Hold securities in an account
Transfers securities between accounts on the instruction of the account holder.
Facilitates transfers of ownership without having to handle securities.
Facilitates safekeeping of shares.
Which are the depositories in India?
There are two depositories in India, which provide dematerialization of securities. The National Securities Depository Limited (NSDL) and Central Securities Depository Limited (CSDL).
What are the benefits of participation in a depository?
The benefits of participation in a depository are:
Immediate transfer of securities
No stamp duty on transfer of securities
Elimination of risks associated with physical certificates such as bad delivery, fake securities, etc.
Reduction in paperwork involved in transfer of securities
Reduction in transaction cost
Ease of nomination facility
Change in address recorded with DP gets registered electronically with all companies in which investor holds securities eliminating the need to correspond with each of them separately
Transmission of securities is done directly by the DP eliminating correspondence with companies
Convenient method of consolidation of folios/accounts
Holding investments in equity, debt instruments and Government securities in a single account; automatic credit into demat account, of shares, arising out of split/consolidation/merger etc.
Who is a Depository Participant (DP)?
The Depository provides its services to investors through its agents called depository participants (DPs). These agents are appointed by the depository with the approval of SEBI. According to SEBI regulations, amongst others, three categories of entities, i.e. Banks, Financial Institutions and SEBI registered trading members can become DPs.
Does one need to keep any minimum balance of securities in his account with his DP?
No. The depository has not prescribed any minimum balance. You can have zero balance in your account.
What is an ISIN?
ISIN (International Securities Identification Number) is a unique identification number for a security.
What is a Custodian?
A Custodian is basically an organisation, which helps register and safeguard the securities of its clients. Besides safeguarding securities, a custodian also keeps track of corporate actions on behalf of its clients:
Maintaining a client’s securities account
Collecting the benefits or rights accruing to the client in respect of securities
Keeping the client informed of the actions taken or to be taken by the issue of securities, having a bearing on the benefits or rights accruing to the client.
How can one convert physical holding into electronic holding i.e. how can one dematerialise securities?
In order to dematerialise physical securities one has to fill in a Demat Request Form (DRF), which is available with the DP, and submit the same along with physical certificates one wishes to dematerialise. Separate DRF has to be filled for each ISIN number.
Can odd lot shares be dematerialised?
Yes, odd lot share certificates can also be dematerialised.
Do dematerialised shares have distinctive numbers?
Dematerialised shares do not have any distinctive numbers. These shares are fungible, which means that all the holdings of a particular security will be identical and interchangeable.
Can electronic holdings be converted into Physical certificates?
Yes. The process is called Rematerialisation. If one wishes to get back your securities in the physical form one has to fill in the Remat Request Form (RRF) and request your DP for rematerialisation of the balances in your securities account.
Can one dematerialise his debt instruments, mutual fund units, government securities in his demat account?
Yes. You can dematerialise and hold all such investments in a single demat account.
Clearing & Settlement and Redressal
What is a Clearing Corporation?
A Clearing Corporation is a part of an exchange or a separate entity and performs three functions, namely, it clears and settles all transactions, i.e. completes the process of receiving and delivering shares/funds to the buyers and sellers in the market, it provides financial guarantee for all transactions executed on the exchange and provides risk management functions. National Securities Clearing Corporation (NSCCL), a 100% subsidiary of NSE, performs the role of a Clearing Corporation for transactions executed on the NSE.
What is Rolling Settlement?
Under rolling settlement all open positions at the end of the day mandatorily result in payment/ delivery ‘n’ days later. Currently trades in rolling settlement are settled on T+2 basis where T is the trade day. For example, a trade executed on Monday is mandatorily settled by Wednesday (considering two working days from the trade day). The funds and securities pay-in and pay-out are carried out on T+2 days.
What is Pay-in and Pay-out?
Pay-in day is the day when the securities sold are delivered to the exchange by the sellers and funds for the securities purchased are made available to the exchange by the buyers. Pay-out day is the day the securities purchased are delivered to the buyers and the funds for the securities sold are given to the sellers by the exchange.
At present the pay-in and pay-out happens on the 2nd working day after the trade is executed on the stock exchange.
What is an Auction?
On account of non-delivery of securities by the trading member on the payin day, the securities are put up for auction by the Exchange. This ensures that the buying trading member receives the securities. The Exchange purchases the requisite quantity in auction market and gives them to the buying trading member.
What is a Book-closure/Record date?
Book closure and record date help a company determine exactly the shareholders of a company as on a given date. Book closure refers to the closing of the register of the names of investors in the records of a company. Companies announce book closure dates from time to time. The benefits of dividends, bonus issues, rights issue accrue to investors whose name appears on the company's records as on a given date which is known as the record date and is declared in advance by the company so that buyers have enough time to buy the shares, get them registered in the books of the company and become entitled for the benefits such as bonus, rights, dividends etc. With the depositories now in place, the buyers need not send shares physically to the companies for registration. This is taken care by the depository since they have the records of investor holdings as on a particular date electronically with them.
What is a No-delivery period?
Whenever a company announces a book closure or record date, the exchange sets up a no-delivery period for that security. During this period only trading is permitted in the security. However, these trades are settled only after the no-delivery period is over. This is done to ensure that investor's entitlement for the corporate benefit is clearly determined.
What is an Ex-dividend date?
The date on or after which a security begins trading without the dividend included in the price, i.e. buyers of the shares will no longer be entitled for the dividend which has been declared recently by the company, in case they buy on or after the ex-dividend date.
What is an Ex-date?
The first day of the no-delivery period is the ex-date. If there is any corporate benefits such as rights, bonus, dividend announced for which book closure/record date is fixed, the buyer of the shares on or after the ex-date will not be eligible for the benefits.
What recourses are available to investor/client for redressing his grievances?
You can lodge complaint with the Investor Grievances Cell (IGC) of the Exchange against brokers on certain trade disputes or non-receipt of payment/securities. IGC takes up complaints in respect of trades executed on the NSE, through the NSE trading member or SEBI registered sub-broker of a NSE trading member and trades pertaining to companies traded on NSE.
What is Arbitration?
Arbitration is an alternative dispute resolution mechanism provided by a stock exchange for resolving disputes between the trading members and their clients in respect of trades done on the exchange. If no amicable settlement could be reached through the normal grievance redressal mechanism of the stock exchange, then you can make application for reference to Arbitration under the Bye-Laws of the concerned Stock exchange.
What is an Investor Protection Fund?
Investor Protection Fund (IPF) is maintained by NSE to make good investor claims, which may arise out of non-settlement of obligations by the trading member, who has been declared a defaulter, in respect of trades executed on the Exchange. The IPF is utilised to settle claims of such investors where the trading member through whom the investor has dealt has been declared a defaulter. Payments out of the IPF may include claims arising of non payment/non receipt of securities by the investor from the trading member who has been declared a defaulter. The maximum amount of claim payable from the IPF to the investor (where the trading member through whom the investor has dealt is declared a defaulter) is Rs. 10 lakh.
A Clearing Corporation is a part of an exchange or a separate entity and performs three functions, namely, it clears and settles all transactions, i.e. completes the process of receiving and delivering shares/funds to the buyers and sellers in the market, it provides financial guarantee for all transactions executed on the exchange and provides risk management functions. National Securities Clearing Corporation (NSCCL), a 100% subsidiary of NSE, performs the role of a Clearing Corporation for transactions executed on the NSE.
What is Rolling Settlement?
Under rolling settlement all open positions at the end of the day mandatorily result in payment/ delivery ‘n’ days later. Currently trades in rolling settlement are settled on T+2 basis where T is the trade day. For example, a trade executed on Monday is mandatorily settled by Wednesday (considering two working days from the trade day). The funds and securities pay-in and pay-out are carried out on T+2 days.
What is Pay-in and Pay-out?
Pay-in day is the day when the securities sold are delivered to the exchange by the sellers and funds for the securities purchased are made available to the exchange by the buyers. Pay-out day is the day the securities purchased are delivered to the buyers and the funds for the securities sold are given to the sellers by the exchange.
At present the pay-in and pay-out happens on the 2nd working day after the trade is executed on the stock exchange.
What is an Auction?
On account of non-delivery of securities by the trading member on the payin day, the securities are put up for auction by the Exchange. This ensures that the buying trading member receives the securities. The Exchange purchases the requisite quantity in auction market and gives them to the buying trading member.
What is a Book-closure/Record date?
Book closure and record date help a company determine exactly the shareholders of a company as on a given date. Book closure refers to the closing of the register of the names of investors in the records of a company. Companies announce book closure dates from time to time. The benefits of dividends, bonus issues, rights issue accrue to investors whose name appears on the company's records as on a given date which is known as the record date and is declared in advance by the company so that buyers have enough time to buy the shares, get them registered in the books of the company and become entitled for the benefits such as bonus, rights, dividends etc. With the depositories now in place, the buyers need not send shares physically to the companies for registration. This is taken care by the depository since they have the records of investor holdings as on a particular date electronically with them.
What is a No-delivery period?
Whenever a company announces a book closure or record date, the exchange sets up a no-delivery period for that security. During this period only trading is permitted in the security. However, these trades are settled only after the no-delivery period is over. This is done to ensure that investor's entitlement for the corporate benefit is clearly determined.
What is an Ex-dividend date?
The date on or after which a security begins trading without the dividend included in the price, i.e. buyers of the shares will no longer be entitled for the dividend which has been declared recently by the company, in case they buy on or after the ex-dividend date.
What is an Ex-date?
The first day of the no-delivery period is the ex-date. If there is any corporate benefits such as rights, bonus, dividend announced for which book closure/record date is fixed, the buyer of the shares on or after the ex-date will not be eligible for the benefits.
What recourses are available to investor/client for redressing his grievances?
You can lodge complaint with the Investor Grievances Cell (IGC) of the Exchange against brokers on certain trade disputes or non-receipt of payment/securities. IGC takes up complaints in respect of trades executed on the NSE, through the NSE trading member or SEBI registered sub-broker of a NSE trading member and trades pertaining to companies traded on NSE.
What is Arbitration?
Arbitration is an alternative dispute resolution mechanism provided by a stock exchange for resolving disputes between the trading members and their clients in respect of trades done on the exchange. If no amicable settlement could be reached through the normal grievance redressal mechanism of the stock exchange, then you can make application for reference to Arbitration under the Bye-Laws of the concerned Stock exchange.
What is an Investor Protection Fund?
Investor Protection Fund (IPF) is maintained by NSE to make good investor claims, which may arise out of non-settlement of obligations by the trading member, who has been declared a defaulter, in respect of trades executed on the Exchange. The IPF is utilised to settle claims of such investors where the trading member through whom the investor has dealt has been declared a defaulter. Payments out of the IPF may include claims arising of non payment/non receipt of securities by the investor from the trading member who has been declared a defaulter. The maximum amount of claim payable from the IPF to the investor (where the trading member through whom the investor has dealt is declared a defaulter) is Rs. 10 lakh.
Abbreviations from the Capital Market
Abbreviations:
NSE- National Stock Exchange of India Ltd.
SEBI - Securities Exchange Board of India
NCFM - NSE’s Certification in Financial Markets
NSDL - National Securities Depository Limited
CSDL - Central Securities Depository Limited
NCDEX - National Commodity and Derivatives Exchange Ltd.
NSCCL - National Securities Clearing Corporation Ltd.
FMC – Forward Markets Commission
NYSE- New York Stock Exchange
AMEX - American Stock Exchange
OTC- Over-the-Counter Market
LM – Lead Manager
IPO- Initial Public Offer
DP - Depository Participant
DRF - Demat Request Form
RRF - Remat Request Form
NAV – Net Asset Value
EPS – Earnings Per Share
DSCR - Debt Service Coverage Ratio
S&P – Standard & Poor
IISL - India Index Services & Products Ltd
CRISIL- Credit Rating Information Services of India Limited
CARE - Credit Analysis & Research Limited
ICRA - Investment Information and Credit Rating Agency of India
IGC – Investor Grievance Cell
IPF – Investor Protection Fund
SCRA - Securities Contract (Regulation) Act
SCRR – Securities Contract (Regulation) Rules
NSE- National Stock Exchange of India Ltd.
SEBI - Securities Exchange Board of India
NCFM - NSE’s Certification in Financial Markets
NSDL - National Securities Depository Limited
CSDL - Central Securities Depository Limited
NCDEX - National Commodity and Derivatives Exchange Ltd.
NSCCL - National Securities Clearing Corporation Ltd.
FMC – Forward Markets Commission
NYSE- New York Stock Exchange
AMEX - American Stock Exchange
OTC- Over-the-Counter Market
LM – Lead Manager
IPO- Initial Public Offer
DP - Depository Participant
DRF - Demat Request Form
RRF - Remat Request Form
NAV – Net Asset Value
EPS – Earnings Per Share
DSCR - Debt Service Coverage Ratio
S&P – Standard & Poor
IISL - India Index Services & Products Ltd
CRISIL- Credit Rating Information Services of India Limited
CARE - Credit Analysis & Research Limited
ICRA - Investment Information and Credit Rating Agency of India
IGC – Investor Grievance Cell
IPF – Investor Protection Fund
SCRA - Securities Contract (Regulation) Act
SCRR – Securities Contract (Regulation) Rules
Thursday, March 13, 2008
C A N S L I M
Overview
CANSLIM is an acronym for a stock market investment method developed by William O'Neil. O'Neil is the founder and chairman of Investor's Business Daily, a national business newspaper. He also heads an investment research organization, William O'Neil & Company, Inc.
Drawing from his study of the greatest money-making stocks from 1953 to 1985, O'Neil developed a set of common characteristics that each of these stocks possessed. The key characteristics to focus on are captured in the acronym CANSLIM.
C urrent quarterly earnings per share
A nnual earnings growth
N ew products, New Management, New Highs
S hares outstanding
L eading industry
I nstitutional sponsorship
M arket direction
Interpretation
The following text summarizes each of the seven components of the CANSLIM method.
Current Quarterly Earnings
Earnings per share ("EPS") for the most recent quarter should be up at least 20% when compared to the same quarter for the previous year (e.g., first quarter of 1993 to the first quarter of 1994).
Annual Earnings Growth
Earnings per share over the last five years should be increasing at the rate of at least 15% per year. Preferably, the EPS should increase each year. However, a single year set-back is acceptable if the EPS quickly recovers and moves back into new high territory.
New Products, New Management, New Highs
A dramatic increase in a stock's price typically coincides with something "new." This could be a new product or service, a new CEO, a new technology, or even new high stock prices.
One of O'Neil's most surprising conclusions from his research is contrary to what many investors feel to be prudent. Instead of adhering to the old stock market maxim, "buy low and sell high," O'Neil would say, "buy high and sell higher." O'Neil's research concluded that the ideal time to purchase a stock is when it breaks into new high territory after going through a two to 15 month consolidation period. Some of the most dramatic increases follow such a breakout, due possibly to the lack of resistance (i.e., sellers).
Shares Outstanding
More than 95% of the stocks in O'Neil's study of the greatest stock market winners had less than 25 million shares outstanding. Using the simple principles of supply and demand, restricting the shares outstanding forces the supply line to shift upward which results in higher prices.
A huge amount of buying (i.e., demand) is required to move a stock with 400 million shares outstanding. However, only a moderate amount of buying is required to propel a stock with only four to five million shares outstanding (particularly if a large amount is held by corporate insiders).
Leader
Although there is never a "satisfaction guaranteed" label attached to a stock, O'Neil found that you could significantly increase your chances of a profitable investment if you purchase a leading stock in a leading industry.
He also found that winning stocks are usually outperforming the majority of stocks in the overall market as well.
Institutional Sponsorship
The biggest source of supply and demand comes from institutional buyers (e.g., mutual funds, banks, insurance companies, etc). A stock does not require a large number of institutional sponsors, but institutional sponsors certainly give the stock a vote of approval. As a rule of thumb, O'Neil looks for stocks that have at least 3 to 10 institutional sponsors with better-than-average performance records.
However, too much sponsorship can be harmful. Once a stock has become "institutionalized" it may be too late. If 70 to 80 percent of a stock's outstanding shares are owned by institutions, the well may have run dry. The result of excessive institutional ownership can translate into excessive selling if bad news strikes.
O'Neil feels the ideal time to purchase a stock is when it has just become discovered by several quality institutional sponsors, but before it becomes so popular that it appears on every institution's hot list.
Market Direction
This is the most important element in the formula. Even the best stocks can lose money if the general market goes into a slump. Approximately seventy-five percent of all stocks move with the general market. This means that you can pick stocks that meet all the other criteria perfectly, yet if you fail to determine the direction of the general market, your stocks will probably perform poorly.
Market indicators are designed to help you determine the conditions of the overall market. O'Neil says, "Learn to interpret a daily price and volume chart of the market averages. If you do, you can't get too far off the track. You really won't need much else unless you want to argue with the trend of the market."
CANSLIM is an acronym for a stock market investment method developed by William O'Neil. O'Neil is the founder and chairman of Investor's Business Daily, a national business newspaper. He also heads an investment research organization, William O'Neil & Company, Inc.
Drawing from his study of the greatest money-making stocks from 1953 to 1985, O'Neil developed a set of common characteristics that each of these stocks possessed. The key characteristics to focus on are captured in the acronym CANSLIM.
C urrent quarterly earnings per share
A nnual earnings growth
N ew products, New Management, New Highs
S hares outstanding
L eading industry
I nstitutional sponsorship
M arket direction
Interpretation
The following text summarizes each of the seven components of the CANSLIM method.
Current Quarterly Earnings
Earnings per share ("EPS") for the most recent quarter should be up at least 20% when compared to the same quarter for the previous year (e.g., first quarter of 1993 to the first quarter of 1994).
Annual Earnings Growth
Earnings per share over the last five years should be increasing at the rate of at least 15% per year. Preferably, the EPS should increase each year. However, a single year set-back is acceptable if the EPS quickly recovers and moves back into new high territory.
New Products, New Management, New Highs
A dramatic increase in a stock's price typically coincides with something "new." This could be a new product or service, a new CEO, a new technology, or even new high stock prices.
One of O'Neil's most surprising conclusions from his research is contrary to what many investors feel to be prudent. Instead of adhering to the old stock market maxim, "buy low and sell high," O'Neil would say, "buy high and sell higher." O'Neil's research concluded that the ideal time to purchase a stock is when it breaks into new high territory after going through a two to 15 month consolidation period. Some of the most dramatic increases follow such a breakout, due possibly to the lack of resistance (i.e., sellers).
Shares Outstanding
More than 95% of the stocks in O'Neil's study of the greatest stock market winners had less than 25 million shares outstanding. Using the simple principles of supply and demand, restricting the shares outstanding forces the supply line to shift upward which results in higher prices.
A huge amount of buying (i.e., demand) is required to move a stock with 400 million shares outstanding. However, only a moderate amount of buying is required to propel a stock with only four to five million shares outstanding (particularly if a large amount is held by corporate insiders).
Leader
Although there is never a "satisfaction guaranteed" label attached to a stock, O'Neil found that you could significantly increase your chances of a profitable investment if you purchase a leading stock in a leading industry.
He also found that winning stocks are usually outperforming the majority of stocks in the overall market as well.
Institutional Sponsorship
The biggest source of supply and demand comes from institutional buyers (e.g., mutual funds, banks, insurance companies, etc). A stock does not require a large number of institutional sponsors, but institutional sponsors certainly give the stock a vote of approval. As a rule of thumb, O'Neil looks for stocks that have at least 3 to 10 institutional sponsors with better-than-average performance records.
However, too much sponsorship can be harmful. Once a stock has become "institutionalized" it may be too late. If 70 to 80 percent of a stock's outstanding shares are owned by institutions, the well may have run dry. The result of excessive institutional ownership can translate into excessive selling if bad news strikes.
O'Neil feels the ideal time to purchase a stock is when it has just become discovered by several quality institutional sponsors, but before it becomes so popular that it appears on every institution's hot list.
Market Direction
This is the most important element in the formula. Even the best stocks can lose money if the general market goes into a slump. Approximately seventy-five percent of all stocks move with the general market. This means that you can pick stocks that meet all the other criteria perfectly, yet if you fail to determine the direction of the general market, your stocks will probably perform poorly.
Market indicators are designed to help you determine the conditions of the overall market. O'Neil says, "Learn to interpret a daily price and volume chart of the market averages. If you do, you can't get too far off the track. You really won't need much else unless you want to argue with the trend of the market."
CORRELATION ANALYSIS
Overview
Correlation analysis measures the relationship between two items, for example, a security's price and an indicator. The resulting value (called the "correlation coefficient") shows if changes in one item (e.g., an indicator) will result in changes in the other item (e.g., the security's price).
Interpretation
When comparing the correlation between two items, one item is called the "dependent" item and the other the "independent" item. The goal is to see if a change in the independent item (which is usually an indicator) will result in a change in the dependent item (usually a security's price). This information helps you understand an indicator's predictive abilities.
The correlation coefficient can range between ±1.0 (plus or minus one). A coefficient of +1.0, a "perfect positive correlation," means that changes in the independent item will result in an identical change in the dependent item (e.g., a change in the indicator will result in an identical change in the security's price). A coefficient of -1.0, a "perfect negative correlation," means that changes in the independent item will result in an identical change in the dependent item, but the change will be in the opposite direction. A coefficient of zero means there is no relationship between the two items and that a change in the independent item will have no effect in the dependent item.
A low correlation coefficient (e.g., less than ±0.10) suggests that the relationship between two items is weak or non-existent. A high correlation coefficient (i.e., closer to plus or minus one) indicates that the dependent variable (e.g., the security's price) will usually change when the independent variable (e.g., an indicator) changes.
The direction of the dependent variable's change depends on the sign of the coefficient. If the coefficient is a positive number, then the dependent variable will move in the same direction as the independent variable; if the coefficient is negative, then the dependent variable will move in the opposite direction of the independent variable.
You can use correlation analysis in two basic ways: to determine the predictive ability of an indicator and to determine the correlation between two securities.
When comparing the correlation between an indicator and a security's price, a high positive coefficient (e.g., move then +0.70) tells you that a change in the indicator will usually predict a change in the security's price. A high negative correlation (e.g., less than -0.70) tells you that when the indicator changes, the security's price will usually move in the opposite direction. Remember, a low (e.g., close to zero) coefficient indicates that the relationship between the security's price and the indicator is not significant.
Correlation analysis is also valuable in gauging the relationship between two securities. Often, one security's price "leads" or predicts the price of another security. For example, the correlation coefficient of gold versus the dollar shows a strong negative relationship. This means that an increase in the dollar usually predicts a decrease in the price of gold.
Correlation analysis measures the relationship between two items, for example, a security's price and an indicator. The resulting value (called the "correlation coefficient") shows if changes in one item (e.g., an indicator) will result in changes in the other item (e.g., the security's price).
Interpretation
When comparing the correlation between two items, one item is called the "dependent" item and the other the "independent" item. The goal is to see if a change in the independent item (which is usually an indicator) will result in a change in the dependent item (usually a security's price). This information helps you understand an indicator's predictive abilities.
The correlation coefficient can range between ±1.0 (plus or minus one). A coefficient of +1.0, a "perfect positive correlation," means that changes in the independent item will result in an identical change in the dependent item (e.g., a change in the indicator will result in an identical change in the security's price). A coefficient of -1.0, a "perfect negative correlation," means that changes in the independent item will result in an identical change in the dependent item, but the change will be in the opposite direction. A coefficient of zero means there is no relationship between the two items and that a change in the independent item will have no effect in the dependent item.
A low correlation coefficient (e.g., less than ±0.10) suggests that the relationship between two items is weak or non-existent. A high correlation coefficient (i.e., closer to plus or minus one) indicates that the dependent variable (e.g., the security's price) will usually change when the independent variable (e.g., an indicator) changes.
The direction of the dependent variable's change depends on the sign of the coefficient. If the coefficient is a positive number, then the dependent variable will move in the same direction as the independent variable; if the coefficient is negative, then the dependent variable will move in the opposite direction of the independent variable.
You can use correlation analysis in two basic ways: to determine the predictive ability of an indicator and to determine the correlation between two securities.
When comparing the correlation between an indicator and a security's price, a high positive coefficient (e.g., move then +0.70) tells you that a change in the indicator will usually predict a change in the security's price. A high negative correlation (e.g., less than -0.70) tells you that when the indicator changes, the security's price will usually move in the opposite direction. Remember, a low (e.g., close to zero) coefficient indicates that the relationship between the security's price and the indicator is not significant.
Correlation analysis is also valuable in gauging the relationship between two securities. Often, one security's price "leads" or predicts the price of another security. For example, the correlation coefficient of gold versus the dollar shows a strong negative relationship. This means that an increase in the dollar usually predicts a decrease in the price of gold.
EFFICIENT MARKET THEORY
The Efficient Market Theory says that security prices correctly and almost immediately reflect all information and expectations. It says that you cannot consistently outperform the stock market due to the random nature in which information arrives and the fact that prices react and adjust almost immediately to reflect the latest information. Therefore, it assumes that at any given time, the market correctly prices all securities. The result, or so the Theory advocates, is that securities cannot be overpriced or underpriced for a long enough period of time to profit therefrom.
The Theory holds that since prices reflect all available information, and since information arrives in a random fashion, there is little to be gained by any type of analysis, whether fundamental or technical. It assumes that every piece of information has been collected and processed by thousands of investors and this information (both old and new) is correctly reflected in the price. Returns cannot be increased by studying historical data, either fundamental or technical, since past data will have no effect on future prices.
The problem with both of these theories is that many investors base their expectations on past prices (whether using technical indicators, a strong track record, an oversold condition, industry trends, etc). And since investors expectations control prices, it seems obvious that past prices do have a significant influence on future prices.
The Theory holds that since prices reflect all available information, and since information arrives in a random fashion, there is little to be gained by any type of analysis, whether fundamental or technical. It assumes that every piece of information has been collected and processed by thousands of investors and this information (both old and new) is correctly reflected in the price. Returns cannot be increased by studying historical data, either fundamental or technical, since past data will have no effect on future prices.
The problem with both of these theories is that many investors base their expectations on past prices (whether using technical indicators, a strong track record, an oversold condition, industry trends, etc). And since investors expectations control prices, it seems obvious that past prices do have a significant influence on future prices.
Play with Technicals
Preferring simplicity in nearly all areas of my life, when it comes to using indicators in my trading I also try to avoid becoming overwhelmed with daunting algorithms and a plethora of lines and squiggles overpowering my trading screens. As such, in this three-part series on Fibonacci, I shall be speaking to you in layman's terms, so that even those with the most basic of technical analysis skills shall come away with a core skill set to immediately apply to improve market timing, and in the process, the most sought-after goal of consistent profitability. In this week?s segment, I will begin by laying the foundation for understanding the development and theories leading to this popular tool used extensively by technical analysts.
Leonardo Pisano, an Italian mathematician born in Pisa during the 12th century, was renowned as one of the most talented mathematicians of his day. He is most prominently recognized for his publication of the modern numbering sequence called Fibonacci series. The name Fibonacci itself was a nickname given to Leonardo. It was derived from his grandfather?s name and means son of Bonaccio.
Although Leonardo was not responsible for discovering the number sequence, it was his publication of Liber Abaci in 1202 which introduced it to the West. In his book, he used the sequence to suggest a solution to the hypothetical growth of a population of rabbits (assuming they never die, of course!). While many claims for the prevalence of Fibonacci series in nature are poorly substantiated, it does appear in many biological settings, such as in the progression of branches on a tree.
The Fibonacci numbering sequence, which can be traced as far back as the 2nd century BC in India, is created by first beginning with 0 and adding 1. At that point, each new number in the sequence is the sum of the previous two numbers. For instance, 0+1 = 1, 1+1=2, 1+2=3, and so on. The sequence of numbers hence looks like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, to infinity.
Although this numbering series is studied quite extensively in terms of its relevance to growth patterns in nature, it is when we take this series a step further that its applications become even more widespread. The relationship of each two adjacent numbers within this series yields a predictable ratio.
When you divide the former number by the latter after the first 3 pairs, beginning with 8 divided by 13, it yields approximately 0.618.
34/55 = .618181 ~ 0.618
55/89 = .617977 ~ 0.618
89/144 = .618055 ~ 0.618
Dividing the latter number by the former number after the first 3 pairs also results in another relationship from the sequence. This relationship yields approximately 1.618.
55/34 = 1.617647 ~ 1.618
89/55 = 1.618181 ~ 1.618
144/89 = 1.617977 ~ 1.618
The dimensional properties adhering to the 1.618 ratio occur throughout nature and the ratio is most referred to as The Golden Ratio. The uncurling of a fern and the patterns found on various mollusk shells are commonly cited examples of this ratio.
To take these relationships further, if you skip a number and then divide, the result is 0.382. This number, when added to 0.618, equals 1.
The ratios created using the Fibonacci series found their way into the financial mainstream during the late bull market of the 90s. Although futures traders had been using them for quite some time, it was not until the advent of real-time charting software was invented, which manually calculated the Fibonacci levels, that it became more readily available as a tool for the general public. The levels created by the Fibonacci series are now widely popular in all markets, although still most widely followed in the futures.
The main Fibonacci retracement levels which I use in the markets are the 138.2%, 100%, 61.8%, 50%, 38.2%, 0%, and -38.2% levels. Two other numbers often used by other traders of my acquaintance include 0.786 and 1.27. These are the square roots of 0.618 and 1.618. As I said earlier, however, I prefer to keep things simple and have never been compelled enough to add these to my chart analysis. The practical uses of Fibonacci ratios in technical analysis are as a means of projecting upcoming price corrections or retracement levels, and can be used both in terms of price projections, as well as time projections.
Leonardo Pisano, an Italian mathematician born in Pisa during the 12th century, was renowned as one of the most talented mathematicians of his day. He is most prominently recognized for his publication of the modern numbering sequence called Fibonacci series. The name Fibonacci itself was a nickname given to Leonardo. It was derived from his grandfather?s name and means son of Bonaccio.
Although Leonardo was not responsible for discovering the number sequence, it was his publication of Liber Abaci in 1202 which introduced it to the West. In his book, he used the sequence to suggest a solution to the hypothetical growth of a population of rabbits (assuming they never die, of course!). While many claims for the prevalence of Fibonacci series in nature are poorly substantiated, it does appear in many biological settings, such as in the progression of branches on a tree.
The Fibonacci numbering sequence, which can be traced as far back as the 2nd century BC in India, is created by first beginning with 0 and adding 1. At that point, each new number in the sequence is the sum of the previous two numbers. For instance, 0+1 = 1, 1+1=2, 1+2=3, and so on. The sequence of numbers hence looks like this: 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, to infinity.
Although this numbering series is studied quite extensively in terms of its relevance to growth patterns in nature, it is when we take this series a step further that its applications become even more widespread. The relationship of each two adjacent numbers within this series yields a predictable ratio.
When you divide the former number by the latter after the first 3 pairs, beginning with 8 divided by 13, it yields approximately 0.618.
34/55 = .618181 ~ 0.618
55/89 = .617977 ~ 0.618
89/144 = .618055 ~ 0.618
Dividing the latter number by the former number after the first 3 pairs also results in another relationship from the sequence. This relationship yields approximately 1.618.
55/34 = 1.617647 ~ 1.618
89/55 = 1.618181 ~ 1.618
144/89 = 1.617977 ~ 1.618
The dimensional properties adhering to the 1.618 ratio occur throughout nature and the ratio is most referred to as The Golden Ratio. The uncurling of a fern and the patterns found on various mollusk shells are commonly cited examples of this ratio.
To take these relationships further, if you skip a number and then divide, the result is 0.382. This number, when added to 0.618, equals 1.
The ratios created using the Fibonacci series found their way into the financial mainstream during the late bull market of the 90s. Although futures traders had been using them for quite some time, it was not until the advent of real-time charting software was invented, which manually calculated the Fibonacci levels, that it became more readily available as a tool for the general public. The levels created by the Fibonacci series are now widely popular in all markets, although still most widely followed in the futures.
The main Fibonacci retracement levels which I use in the markets are the 138.2%, 100%, 61.8%, 50%, 38.2%, 0%, and -38.2% levels. Two other numbers often used by other traders of my acquaintance include 0.786 and 1.27. These are the square roots of 0.618 and 1.618. As I said earlier, however, I prefer to keep things simple and have never been compelled enough to add these to my chart analysis. The practical uses of Fibonacci ratios in technical analysis are as a means of projecting upcoming price corrections or retracement levels, and can be used both in terms of price projections, as well as time projections.
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