Tag Archives: Market Trends

Carnage in Mid & SmallCap Stocks pulls down MF Returns

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Greetings from PenguWIN:

                                        Over the past few weeks, I received questions from half a dozen investors on the performance of the Equity funds and wanted to know whether their portfolio needs to be rejigged. My answer is “please hold” as it’s a phenomenon across different categories of funds, pronounced in Small and MidCap funds. The Sensex and Nifty are at all-time high with returns of 2.57% and 4.87% over the past 6 months while the mid and small caps have been battered with negative returns of (11.42%) and (16.46%). Over 50% of Mid and Small Cap stocks listed in NSE have lost more than 25% of their value.

            I am outlining some of the key reasons that has resulted in this poor performance.

  • Huge valuation of Mid and Small Cap stocks. Typically, in the past Mid and Small Cap stocks have traded at a discount to LargeCap. However, in the recent run till 2017 end, Mid and Small Cap stocks were trading at more than 200% of Price to Earnings of LargeCap (Nifty and Sensex)

 

  • SEBIs mandate on Categorization and Rationalization of MF Schemes in Oct 2017. Mutual Funds did not have clear definition of boundaries of Large, Mid and Small Caps and each fund house had its own definition. There were also multiple schemes of the same category, like 3 LargeCap funds in the same fund house. As a result of the SEBI mandate, fund houses have to merge/modify existing funds and also clean up the stocks that a scheme owns. Many funds, even Large Cap had sizeable allocation to Mid and SmallCap stocks forcing them to sell to adhere to SEBIs definition. When all fund houses tried to reduce their Mid and Small Cap stocks at the same time, there were not enough buyers resulting in steep valuation drop. Thus, MFs pressure to sell Mid and SmallCap stocks was a key driver

 

  • Surveillance Measures. Mid and SmallCap stocks are happy playgrounds for speculators and valuations go sky high without any change to the company fundamentals. SEBI in coordination with the BSE and NSE stock exchanges had been subjecting speculative stocks to surveillance measures since 2017. This covers both the changes not attributed to the fundamentals of stocks and also high volatility. Some of the highly traded stocks came under the scanner resulting in steep falls in price.

 

  • Governance Risks. Governance issues have surfaced among Mid and SmallCap companies where Auditors like Deloitte and PwC quit just before the results announcement citing inadequate disclosure. Auditors of over 30 listed companies have quit in 2018, till date, wherever they doubted the veracity of numbers. Both individual as well as institutional investors were caught unaware resulting in a selling spree bringing down the valuations to more than 50% in many stocks

 

Conclusion: While the Mid and Small Cap stocks correction might continue further, investors with higher risk appetite, investing systematically, will be rewarded handsomely. Just make sure that your asset allocation commensurate with your Risk Appetite and Risk Tolerance.

I believe the returns on investment in the poor are just as exciting as successes achieved in the business arena, and they are even more meaningful! - Bill Gates

<Blog # PenguWIN 1061 – Carnage in Mid & SmallCap Stocks pulls down MF Returns>

Anticipating Budget 2018-19

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Warm Greetings from PenguWIN:

            In a few hours, Finance Minister Mr. Jaitley will be presenting the Union Budget for 2018-19. No, this is not a commentary on Budget or a wish list as Budget details are kept confidential.

In this blog, I plan to highlight an important change with respect to Equity investing. The change might not be proposed by FM (like last year when it was expected but finally did not occur), significance of the change could be lower or more. Every business vertical including Banks, SME, NBFCs, Insurance and Mutual Funds prepare a wish list and send it the F.M. However, there is no certainty whether the proposals will get accepted or turn out to be worse than anticipated.

MFs proposal include, bringing down LTCG (Long Term Capital Gains) tax of the debt funds from 3 years back to 1 year, which was the treatment until 2014, approval to launch Debt based Tax saver funds like Equity Linked Savings Scheme – DLSS, lowering threshold limit from 65% to 50% for equity-based taxation and removal of Securities Transaction Tax (STT) for MFs and Exchange Traded Funds. The ask on reversing the debt fund taxation from 3 years to 1 year is a little too much in my POV, when the FM is grappling for new resources to fund schemes for sectors like Agriculture.

Equity investing (Mutual Funds and Stocks) is attractive for 2 reasons; primary one being the potential to deliver highest and inflation beating returns, among the various asset classes (proven across the globe). Second is the unique tax aspect where LTCG is zero. i.e. principal and gains held greater than 1 year is tax free (15%, if the holding period is less than a year). No other asset class enjoys this kind of tax benefit which was Implemented in 2005, to encourage people to invest in Equity. But, the logical reasoning of Equity as a long-term investment vehicle and wealth creator is paradoxical with the tax benefit of reaping the gains in a years’ time. Equity is not a product for 1-year time horizon and because it has given excellent returns in a year like 2017, it should not be misconstrued.

There are lot of rumours going around saying that the FM will bring back the LTCG Tax for Equity. Some say it would be made 3 years instead of 1 which means the second and third year redemptions will also attract 15% tax, a flat tax rate of X% when funds are redeemed or a progressive structure (tax rate increases with the income slab). However, the same commotion happened during the run up to last years budget and finally the FM maintained status quo

Some of the major countries in the world do tax capital gains from stocks:

  • US has LTCG tax for equities which is a progressive structure
  • Germany has gains taxed fully, including a 25% withholding tax,
  • Canada has 50% deduction on CGs split between Federal and Province
  • Brazil has progressive taxation on CGs between 15 to 22.5%
  • Singapore does not tax capital gains

What will be the outcome if FM introduces LTCG in some way for Equity Investments in India?

  • In case if LTCG is announced, the chances that the markets will react negatively is high. This will be a temporary phenomenon as taxing capital gains is a practice in most countries and we need to reconcile to reality.
  • What are the alternative investment options? Can Real Estate or Gold or Bank, Govt. and Company deposits provide better returns. I can confidently say that even after taxation, Equity will continue to be the best asset class for long term wealth creation. We can take the cue from the level of equity penetration, which is far higher in countries where LTCG is in place, compared to India.
  • Investors with a short time frame and using Equity markets for short term gains will slowly disappear and only investors who want to invest with a minimum or 3 years+ will remain in the market (PenguWIN recommends pure Equity investing only for time frame of 5Y+)

Viewing budget telecast live is an interesting experience and if you have interest in finance, I would definitely recommend.

Keep a track on Sensex, Nifty and other key indices and you will see them moving up and down with every announcement that is favourable or unfavourable to markets.

At the end of the day when our CEOs are asked by reporters/analysts on how they think the budget was, I can tell that they will present a positive picture, irrespective of whether it is good or bad. A few bold CEOs will give the real perspective and ones who are close to the opposition will say that its insipid and wasted opportunity

 

<Blog # PenguWIN 1057 – Anticipating Budget 2018-19! >                                             

Equity Market Dynamics

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Friends,

            Apologies for the long silence (excluding the folks for whom it might have been a bliss) – Some investors even asked me if I had stopped writing Blogs. Income Tax Filing and GST Registration took a toll on my time – Need some excuse, right?

I have realized that starting a new habit like walking, running, swimming, meditation is easy. But, sustaining it for a long period of time is extremely difficult. I am telling this in the context of publishing blogs on a periodic basis rather than adhoc.       

  • ‘Invest cautiously through dynamic asset allocation funds’
  • ‘Move from mid-caps to large cap’
  • ‘Lower your return expectations’
  • ‘Earnings continue to be muted’
  • ‘Cash holding and arbitrage positions have increased’
  • ‘Risk-Reward is unfavourable for Equities’
  • ‘GDP growth takes a hit’
  • ‘Foreign Money is chasing India’s Reform Story’

 

The above statements were made by key fund managers and analysts, both Indian and International, in the recent weeks. Has our reform story taken off or yet to take-off? Statements like price to earnings P/E is more than 10-year average; 1 to 15 is considered cheap, 16-20 is considered fair and greater than 20 is considered as expensive may not be relevant in the current context. Currently Nifty and Sensex are trading at close to 24 P/E. I would tend to argue that there are major changes to the investment pattern which will change the contour of equity investments and following are some of the points why I think so.

  • Retail Investor participation in markets through MFs and ULIPs is at all time high with inflows increasing month over month. Equity MFs had an all-time high net-inflow of Rs. 21,875 Crores in Aug 2017. How was it before? Equity MFs had an all-time high net-inflow of Rs. 14,480 Crores in July 2017. This highlights the appetite of Indian Retail Investors which was not the case earlier.
  • Other than MF Equity route, inflows are high from sources like National Pension Scheme, Provident Fund, ULIPs.
  • The reason attributed to this heavy inflow is not that Investors have started embracing equity but also due to stagnant Real Estate Sector, Gold still struggling to cross 2012 levels and lowering of Bank/Post Office/Company Fixed deposit rates.
  • Instead of yearly dividend payments which was the norm until a few years ago, Quarterly and Monthly dividends in Equity Funds are being paid to attract gullible investors.
  • Some Wealth Management firms and independent practitioners, enticed by the volume and immediate benefits, invest huge lump-sums of their clients, running into crores, even in the current market.
  • The argument of average 10-year Price Earning is something that I don’t subscribe as there will be demand-supply mismatches which inflates the PE of a good stocks with earnings visibility

So, as sensible investors, what is that we can do in this frenzied Bull Run:

  1. Investors who embark on direct equity in this period need to know that, during bull runs, even the worst of stocks do well. Warren Buffet, the Oracle of Omaha and considered as the god of equity investing quoted ‘Only when the tide goes out do you discover who’s been swimming naked’.
  2. Do not go for Lump-Sum investments and invest through systematic plans – SIP and STP – Almost all Chief Investment Officers and Fund Managers of Fund houses are unanimous with this message.
  3. Medium and Small Company stocks have become overvalued and the hit will be heavier during correction. Advice is to stick with Large Company Stocks or move allocation from Small and Mid to Large. This is also a unanimous message
  4. The Equity markets would have changed the asset allocation pattern – skewed towards Equity than Debt and this needs to be rebalanced.
  5. Cashing out of Equity, especially MFs, is not a good idea as it is extremely difficult to predict when the correction will happen and when the market will go back to the original high. I remember atleast 3 popular fund houses, that took cash calls during the 2008-9 global crisis and for a short period those funds were doing better as they contained losses. But the celebration for those funds was short lived as the markets turned around sharply, not allowing the funds to re-deploy the cash. Some of these funds are still languishing.
  6. Even if there is a 10 to 20% correction, the macro factors for India is good which will life the markets – Inflation down, GST Implementation, Current Account and Fiscal deficit, Government gaining due to low Crude Prices – The only reason to be cautious is if we get another shock like Demon. or Beef ban or unrest with neighbours

 

<Blog # PenguWIN 1055 – Equity Market Dynamics>