The Aisapaisa.com Angle

Fixed Maturity Plans or FMPs are a product class offered by Mutual Funds and have gained immense popularity in the last few years given their tax attractiveness vis a vis fixed deposits and the fact that they provide predictable returns very low risk.
FMPs have typical maturity periods ranging from one month to three years and invest in various types of debt instruments such as corporate bonds, government securities, commercial papers, debentures and call money thus offering enough safety for the risk averse investor, a key feature of these investments being that they are made in instruments whose maturity coincides with the time period specified by the scheme.
The tax attractiveness of FMPs derives from the fact that whereas interest accrued on fixed deposits is fully taxable, returns accrued on FMPs are subject to either dividend distribution tax/capital gains tax which are almost 10% lower than the former.
Currently more than 200 FMP schemes are active in the country.

With inflation at 12%, investments in debt instrument (bank deposits) which offer yield of around 10% no longer seem attractive. High dividend yield stocks provide both consistent cash flows as well as a potential for capital appreciation.

What is dividend yield?
Dividend Yield = annual dividend per share / stock’s price per share

This measurement gives the percentage of return paid out to the share-holders in the form of dividend. Older companies tend to have a much more higher and consistent dividend yield than smaller companies.

Dividend Yield Trap

Companies which pay high dividends are typically good long term investments. However, the investor must be display some caution and look at the company’s fundamentals before investing in the stock. Buying a company which is on a decline may not help, as it may not be able to payout the dividends in the future. Dividends are paid out of cash flows, so check if the company the company has healthy cash flows and consistent earnings and growth.

Other Factors

Removal of dividend tax also makes some of these stocks very attractive. So watch out for companies which have a high dividend yield and a low payout ratio, as this means that these companies have enough money to pay the investors as well as enough to plough-back into the business. Investment in high-dividend yield stocks is considered to be a defensive strategy as historically, these stocks have done well during market downturns. They also provide possibilities of capital appreciation during reviving markets.

Simply put, these stocks give the triple benefits of dividend income, downside risk management and scope for capital appreciation.

Electrosteel Castings, Honda Siel Power, EID Parry and Tata Investment Corporation are few stocks with a high dividend yield and low payout. Coromandel Fertilisers is another bright stock with a dividend yield as high as 8.5 per cent and a payout of 30 per cent in the past.

Others would include companies such as Castrol and Ashok Leyland.

To the uninitiated, derivatives (based on securities) as a segment is meant for sophisticated investors with deep pockets but, even a cursory analysis of the participants in this segment would reveal that over 60% of derivatives’ volume is generated by retail investors and this has been a consistent trend over the past 5 years indicating that there is something in it for small investors too.

The fact that volumes in this segment are typically 3-4 times that of the cash market (equities) further underlies its importance and even if as an investor one shies away from trading in the same, one must keep a keen eye on it to understand market dynamics better.

Derivatives are an essential feature of mature capital markets worldwide, not only do they facilitate price discovery and allocation of risk, their speculative element is also desirable (within limits of course!), since speculators provide necessary liquidity to the market and liquid markets are less prone to sharp fluctuations.

Lower capital requirements and the option of taking both bullish and bearish views make derivatives extremely attractive though understanding their dynamics requires some time and effort. Derivatives in securities can be classified into Futures and Options and this is where the great divide in terms of retail investor interest takes place.

Equity based futures as a class has not only been embraced by retail investors but is being encouraged by market regulators as well. India has the highest number of equities that serve as the underlying for single stock futures. At the same time, regulators and exchanges are trying to increase retail participation in index futures also – by introducing index based futures in small lots. Index futures constitute over 25% of the total turnover in the FnO segment. Volume figures for a typical trading day (May 28, 2008) corroborate this fact:

On the other hand, despite the obvious lure of options (especially for hedging) and the introduction of Index based options, retail participation is very low are perhaps rightly so since historical data suggests that more than 90% of options go unexercised, benefiting the option writer (retail participants cannot write options) who is usually a seasoned trader. To overcome some of these glitches SEBI is contemplating upon introducing long-term options contracts in equities in order to make it easier for retail investors to hedge.

Figures for Index options (May 28, 2008)

The volumes in both futures and options segments indicate that these are highly liquid markets and with increasing activity, retail investors who are yet to explore the same, should not shy away from the derivatives segment and commit a part of their portfolio to this segment to increase their returns from the market.

The prevailing market conditions present testing times for the investors. The market seems to lose in a week what it takes more than 3 months to gain, and the investors lose money rather quickly. In such a market, investors who are averse to losing money should look for rock-solid investments. By rock-solid, we mean stocks which are not too susceptible to the ups and downs of the market, and whose prices don’t free fall when the market crashes. These are low-beta stocks.

The beta of a stock is an indicator of the correlation between the movement of the market index and the movement of the stock price. For example, during a period, if the market index changes by 10% and the stock price changes by 6%, then the beta of the stock is 0.6. Hence, the stock price of a share having high beta would change faster than the market, and the price of a share having low beta would change lower than the market.

Thus, stocks with lower beta (beta < 0.5) would be less volatile than the market, and stocks having higher beta would be more volatile than the market. Hence, it would be prudent for a low risk investor to invest in low beta stocks when he expects the market to be volatile, as they hold up better during downturns. Such stocks have the potential to cushion losses in a bad market while allowing for the possibility of gains–though not as much as from high-beta stocks–in the event of a market revival. They make for great portfolio picks in bearish and uncertain markets.

One year returns (May 2007 to May 2008) for some low beta stocks:

The table above suggests that though there is merit in the low beta argument, an investment decision cannot be based solely on these criteria.

An investor should remember that beta is an indicator of the historical volatility of the stock. There is no guarantee that the stock will behave the same in the future as well. Having said that, most actively traded stocks do justice to their historical beta values. So, the next time you get ready to invest in a stock, do glance over its beta value.