The Aisapaisa.com Angle

Money that flows frequently from one country to another seeking out the most favourable rate of interest is called hot money.

It has a substantial effect on the balance of payments between two countries and tends to strengthen the currency of the recipient country at the cost of the currency of the country where the money was previously held.

Such money flows largely originate from hedge funds and speculators. In fact, these transactions were the immediate cause behind the currency crises in Mexico and East Asia in the 90s.

Due to the highly volatile nature of such investments and the potential consequences of their sudden exit, market watchdogs across the world keep a keen eye on them. To curb any excessive inflow of hot money into the country SEBI has made it difficult for hedge funds to conduct operations in the country and closely manages P-notes, the only trading instrument available to them.

This is an investment philosophy that involves going against prevailing market sentiments/trends by buying poor performing assets in the hope of selling them at a profit in future - taking a contrarian view.

The basic premise being that market sentiment is bullish when most people have already invested and have negligible purchasing power left, which means that the markets can only go down, similarly when a bearish sentiment persists most people have already sold out and hence the markets can only go up. The same would apply to individual securities as well i.e. a contrarian investor would tend to spot securities that are either neglected or do not happen to be the current ‘hot’ sectors as this methodology focuses on the actual value associated with a company/asset rather than just judging it by current market movements.

Many maverick investors such as George Soros, Marc Faber etc. are associated with this investment style and many Indian investors are also adopting the same, with mutual funds taking the lead and as many as eight of them launching ‘contra funds’ in the last few years.

Securities that are not traded on stock exchanges due to their inability to meet certain listing requirements are known as unlisted securities, these are instead traded in over-the-counter (OTC) markets that exist in all major economies.

Usually companies that are not old enough to be listed, small in size or companies having capital assets that rely primarily on their investments in intellectual capital belong to this category, with their aim being to eventually enter the primary market.

In India such securities are traded on the Over The Counter Exchange of India (OTCEI) which has been in existence since the early nineties and is found to be similar to the NASDAQ model in many ways. The OTCEI has met with limited success but has assisted many companies in the entering the primary market, gain access to capital, build brands etc. (NDTV, VIP, Sonora Tiles etc.).

Mutual Funds are also known to trade in the same.

Informal markets in which shares of forthcoming Initial Public Offerings are traded are known as IPO grey markets. These are found to exist in many Indian cities and are particularly active in Ahmedabad, Kolkata and Rajkot. Individuals participating in these markets pledge to buy or sell shares prior to the listing and all trades are settled on the day of listing. The market operates as follows –

Once a deal is settled at a particular price, the seller has to deliver the shares after he has been allotted the same by the issuing company. If the seller does not receive the requisite number of shares he must purchase them from the secondary market to honour his obligation, the buyer on the other hand must pay the agreed upon price irrespective of the actual market price.

Grey market sentiment i.e. the discount/premium prevailing on an IPO is a valuable indicator of its actual performance however such markets are often marred with rumours and inefficiencies and are liable to be manipulated.

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.

We often hear market experts giving credit to/blaming FIIs (Foreign Institutional Investors) for significant market movements. Have you ever wondered who these people are and what really calls for their importance?

Well, FIIs are foreign companies investing in Indian stock markets; these may be banks, mutual funds, endowments, pension funds etc. This form of investment must not be confused with foreign direct investment which entails long term commitments and creation of physical assets, institutional investors are simply market players but given their deep pockets their actions often become crucial hence, their role is keenly monitored by market watchdogs, not only do they require prior registration with SEBI but are also required to follow specified guidelines, one of the major ones being placing limits on their ownership in domestic companies. Currently there are about 1300+ FIIs registered with SEBI.

FIIs fall into the group of ’smart money’ investors since they are known for their well planned moves and have a signalling effect on other investor classes. Even though the volume of trades executed by them is not very high in comparison with other market participants, they often drive market sentiments. Given their expertise at choosing good bets within a market, many domestic market participants follow their footsteps. They are found to invest across market segments (including units of mutual funds), with an increasingly active role in equity based derivatives and often change their sectoral preferences, current favourites being IT and FMCG. It is also interesting to note that the percentage of equity held by FIIs in many companies is often comparable to the percentage of retail investor holdings (typically 10-20%).

Given India’s impressive growth record in recent times FII activity has also picked up tremendously, in 2007 alone they made investments worth $17.2 billion (source IBEF) and since the market turnaround this January have been blamed for causing stock prices to soar previously due to the excessive demand created by them.

It must be noted that FII investments are not determined by the state of the Indian economy alone since such investors have massive holdings in their home and other markets too and in the case of losses in these, their Indian holdings are often sold to cover the same. Net FII outflows in two months in 2007 are attributed to the subprime crisis; the current recessionary trend in western economies has also had its effect, which is evident from the net inflows in the last six months:

The extent to which FIIs influence the overall health of the market is often debated and the extent of this dependency is yet to be ascertained, however their role has been artificially curbed to some extent by market regulators. But whatever the case might be, next time you think of investing in a company, it might be worthwhile to understand how FIIs are viewing it.

Real estate as an asset class has been always been popular in India and to cash in on this popularity amongst the small and middle income group we find asset management companies launching Real Estate Mutual Funds (REMFs) – after years of deliberation and issuance of guidelines since 2006, SEBI finally allowed the same on April 16. There was initial skepticism regarding infusing more money into an already volatile and pricey sector but considering the performance of such products world over market regulators eventually relented.

REMFs function with the objective of investing directly or indirectly in real estate property, with a mandatory 35% in finished assets and a minimum of 75% (overall) in real estate/real estate backed securities (shares/debentures of real estate companies or mortgage backed securities etc.).

These are close ended schemes with a typical maturity period of 3 years, tradable on stock exchanges based on their net asset values, they offer the unique opportunity of investing in this asset class to small investors and in most countries they have shown returns in line with the returns of equity based mutual funds, even though real estate is known to bear lesser risk as compared to equity.

Not only are REMFs beneficial for investors but they are expected to provide finance to the industry especially for buying land as banks do not finance this activity.

Having said that one must not forget that Indian property markets are plagued with low liquidity and price-inefficiencies and a small investor must undertake the minimum necessary trouble while evaluating real estate in any form as an investment option.