f o r    m a n a g i n g    t o m o r r o w
JUNE 17, 2007
 Cover Story
 BT Special
 Back of the Book

Rupee Rise
Though an appreciating rupee is a cause for concern for many industries, it is proving to be a boon for some, particularly those that have large foreign currency borrowings. A weaker dollar is making repayments cheaper. Also, state-run refineries and those in the aviation sector are well-positioned to benefit from the stronger rupee. The Indian currency is up 8 per cent this year and is Asia's strongest currency against the dollar in 2007.

The ECB Route
The cap on maximum external commercial borrowings (ECBs), an annual ritual for the government, is fast losing its significance. Since the bulk of the foreign borrowings is raised under the automatic route by companies, it is becoming difficult to enforce the cap. The government had raised the annual limit of ECBs last year from $18 billion (Rs 81,000 crore) to $22 billion (Rs 99,000 crore). Now, it seems that total inflows will cross the $22-billion mark.
More Net Specials

Business Today,  June 3, 2007

The Top Guns
Only a handful of funds has performed consistently over time. What did they do right and should you invest in them now?

These are the best of times for the fund management business. Inflows are steady and performance has been relatively easy, particularly because of the soaring stock markets. On a three-year basis, 48 out of 89 funds have managed to beat the S&P CNX nifty in performance. Yet, if you take a closer look, you will find that not many have been able to beat the market on a yearly basis.

Consistent performers managed to beat the market's benchmark (in this case nifty) on a sustained basis. Of the total 48 equity funds (excluding index funds) that have been in existence for the past five years in the market, only six have done well on a sustained basis: SBI Magnum Sector Umbrella-Infotech Fund, Birla Sun Life New Millennium Fund, Franklin India Prima Plus, SBI Magnum Global Fund 94, Franklin India Opportunity Fund and HDFC Equity Fund. They reported returns from 166.5 per cent to 286 per cent compared to 116 per cent of nifty in the last three years.

So, what makes these funds different from others? Says Prashant Jain, Chief Investment Officer (CIO), HDFC Mutual Fund: "The key for outperforming is not in targeting high returns with high risk each year, rather in avoiding big mistakes in every single year." Despite the varied investment styles and objectives-from a sectoral fund to a thematic fund-there's much in common in the management of these funds. Their fund managers don't hesitate to move out of stocks that are lagging behind and yet follow a stock-specific approach that is based on fundamentals. Says A. Balasubramanian, CIO, Birla Sun Life Mutual Fund: "Flexible approach is the best for achieving consistent returns."

It's difficult to repeat a good performance every year. It requires many things, apart from a keen eye on the stocks of the future. Says Hemant Rustagi, Chief Executive Officer (CEO), Wiseinvest: "These are good funds and you have to grant it to the fund manager for his efforts to maintain consistency."

The Rise of Money Managers
To Prepay or Not
News Round-up

The Big Guns

The SBI Magnum Sector Umbrella-Infotech Fund has been the biggest gainer in the last three years, recording a massive 286 per cent return. The fund's mandate has been to provide maximum growth opportunity by investing in it stocks. At this point, the fund has shored up cash which is about 26 per cent of its portfolio, but 68 per cent of it is currently invested in it stocks, and the rest in top-class telecom, pharmaceutical and electronic companies. Sanjay Sinha, the fund manager, has predominately invested in mid-cap it stocks. Of the total 17 stocks in portfolio, 13 are from the mid-cap space with Infotech Enterprises being the largest holding with 13.1 per cent in the portfolio. "Picking stocks in IPOs has helped us deliver superior returns," says Sinha, CIO, SBI Mutual Fund. He feels his confidence in newly-listed it companies has delivered results.

"Picking stocks in IPOs that have doubled since listing has also helped us to deliver superior returns"
Sanjay Sinha
Fund Manager/ SBI Magnum Sector Umbrella-Infotech Fund
"Flexible approach has been crucial for achieving consistent returns. Our proactive approach in handling stocks and investment more towards mid-cap has helped in outperforming the benchmark"
A. Balasubramanian
CIO/ Birla Sun Life Mutual Fund

Sinha has, however, followed a different approach in SBI Magnum Global Fund 94. Primarily a mid-cap fund, it is quite diverse with 64 stocks in its portfolio as on April 30, 2007, but no stock accounts for more than 4 per cent of the total corpus of the fund. "Superior stock selection and complete bottom-up approach has worked in our favour," says Sinha. His approach: stay in cash if you don't see value in the market. In Global Fund 94, he is sitting on cash, money market instruments and debt worth Rs 500 crore (33 per cent). For the past three years, the fund has recorded 285 per cent returns.

Similarly, HDFC Equity Fund has a 10-year track record of consistency; across market capitalisations, its concentration has been predominantly in the top 3 companies and in large caps. "Stronger companies reduce risk in bad times. Our preference has been for strong and well-managed companies across capitalisation," says Jain, its manager. His fund maintains a focussed portfolio with the target to generate higher alpha. The fund has reduced the peak exposure of individual large cap stocks to 6 per cent from the earlier 9 per cent

But not all funds have banked on this approach. Another strong performer has been a fund that has not hesitated to take large exposures in select growth stocks and sectors. "Compared to other equity funds, our fund takes more concentrated positions," says K.N. Siva Subramanian, who manages the Rs 855-crore Franklin India Opportunity Fund. "It will continue to follow a bottom-up approach to stock selection, in keeping with the overall investment philosophy". The top four stocks in the portfolio-India Cements, HLL, sail and Bharat Electronics-account for over 30 per cent of its portfolio. Yet, despite its relative concentration, the fund manager has been able to beat the benchmark nifty for the past five years: The fund has generated a 370 per cent return compared to Nifty's 238 per cent.

"Our research focusses not only on the track record of the company, but also on its future strategy and its ability to continue to generate wealth on a sustained basis"
R. Sukumar
Fund Manager/ Franklin India Prima Plus

Franklin Templeton Prima Plus has also maintained a consistent performance, but with a different style of investment. Managed by R. Sukumar, the fund's strategy is to scout only for fundamentals and valuations. Prima Plus invests in wealth-creating companies whose competitive advantage will translate into superior return on capital. "Our research focusses not only on the track record of the company, but also on its future strategy and its ability to continue to generate wealth on a sustained basis in a competitive business environment. This strategy has helped the fund in providing superior risk-adjusted returns over the last 12 years through various market cycles and short-term volatility in the markets will not have an impact on this approach." In the past five years, the fund has recorded a whopping 458 per cent return compared with the 238 per cent rise of nifty.

"We have focussed on stocks/sectors with higher growth potential. This fund will continue to follow a bottom-up approach to stock selection, in keeping with the overall investment philosophy"
K.N. Siva Subramanian
Fund Manager/Franklin India Opportunity Fund

Apart from housing & construction and capital goods sectors, computer and telecom sectors have been largely responsible for the impressive performance of these funds. In fact, the Birla Sun Life New Millennium fund, which invests mainly in the TMT sector, was able to deliver better returns than its peers due to its flexibility of investing in banking, printing and stationery sectors. "Our proactive approach in handling stocks and investment more towards mid-cap has helped in outperforming the benchmark," says Balasubramanian of Birla Sun Life.

Consistency Pays

Of course, past performance does not guarantee future returns. But sticking to those fund managers who have a finger on the pulse of the market always reflects on the performance. Says Rustagi of Wiseinvest: "Consistent performance and long-term track record are crucial for a fund." Investors must have a good chunk of their investments in these funds, but yet at the same time diversify and look out for new themes emerging in the market like the infrastructure play. But one must not junk some of their existing funds because of one bad year. "There are funds that may have one bad year, but overall may be good funds," says Rustagi. Look for funds that have a track record of good performance and have the flexibility to approach different markets and business cycles. There's a fairly good chance your portfolio will reflect their performance.

The Rise Of Money Managers
Are you planning to outsource your portfolio to professional managers? Here's what you should know.

"A PMS manager can invest a smaller corpus either on a high risk theme or a low risk theme"
Nitin Jain
Head (PMS)/ Religare Securities
"Many companies talk of big asset bases. PMS should be of a manageable size to benefit all"
Shashank Khade
Senior VP/ Kotak Securities

Lately, a large number of brokers are getting into portfolio management-essentially tailoring your portfolio to your requirements and managing the same for a fee. The business is huge and growing as the number of high net-worth individuals rises as well. But there's a reason why you could consider portfolio managers: This business has come of age.

Many portfolio managers have been around for a couple of years. Says Shashank Khade, Senior VP, Kotak Securities: "We have been through the learning curve and have seen it all." From your perspective, that essentially means a better handle on managing your stocks.

The Service

Portfolio managers are usually from companies that deal with equities. Stockbrokers find portfolio management services (PMS) a way of augmenting revenues, so do fund houses and boutique investment bankers. The services on offer are both discretionary and non-discretionary, depending on your requirement. A discretionary service is where the broker or fund house takes all the decisions of investing, i.e., buying and selling shares on your behalf, leaving you hassle-free.

There are concept schemes or products that target specific ideas or themes in the market. Like in the case of mutual funds, you can opt for a product depending on your taste and risk appetite. However, instead of a bunch of units, your holding is in stocks of companies against your name. You can start by a minimum of Rs 10 lakh, but this varies between schemes and brokers.

The Management Mantra
What you should know about portfolio services.
» Unless it is a high risk fund (with market triggers on volatility), the longer you stay, the better
Check out on the services provided, and the fee. Transparency and retail interfacing are important. So is the SEBI registration in case you have a grievance
Portfolios can be tailored according to your preference or choice
The more experienced your PMS provider, the better. He will understand the ups and downs of the market. Nevertheless, monitor your portfolio regularly and keep up with related news and prospects
If you realise that direct investments in stock markets or mutual funds could deliver the same or more, you can go it alone. There are good online brokers, if you want to buy stocks, where you can get suggestions and buy calls

The Costs

Usually, the fees are fixed or variable or a combination of both, depending on the scheme or your manager. A fixed fee is charged on the corpus, much like a mutual fund. A variable fee, on the other hand, is charged on the profits that the portfolio has generated. For example, Religare Securities charges a fixed fee of 2 per cent per annum and the performance-based variable fee ranges from 10-20 per cent on profits with a hurdle rate of 12 per cent return on portfolio (up to this nothing is charged). In another scheme, it charges only on "out performance," which is scheme returns minus benchmark returns.

But there's a flipside to the charges. The losses have to be entirely borne by you. "Remember that it is only the profits that get shared, not the losses," says Gaurav Mashruwala, CEO, ace Group, and a certified financial planner.

A Choice of Styles
There's a lot to choose from the different schemes on offer.
Kotak Securities
Small- and mid-cap portfolio with focus on future stars
ANNUAL RATES: The fixed and variable components do not exceed 4 per cent of portfolio totally and levied
MINIMUM INVESTMENT: Not specified, though average collections range Rs 25 lakh per person

Religare Securities
Aims to achieve higher returns by taking aggressive positions across sectors and market caps
ANNUAL RATES: 2 per cent fixed and performance-based variable from 10-20 per cent with a hurdle rate of 12 per cent return levied

Motilal Oswal
Value PMS
A low churn portfolio that aims to buy undervalued stocks and sell overvalued ones with a capital preservation consciousness but not guarantee

Parag Parikh Financial Advisory Services
Equity stocks; conservative outlook with steady returns and no cyclicals
ANNUAL RATES: 2 per cent flat or 1 per cent and 10 per cent of profits

Franklin Templeton Mutual Funds
FT Select
Large-cap stocks benchmarked against BSE Sensex with good liquidity and with hedged strategy
ANNUAL RATES: Fixed is 2.5 per cent of the daily average of net assets excluding brokerage; Variable is 1.5 per cent of daily average of net assets of the account excluding brokerage plus profit sharing of 20 per cent with a hurdle rate of 12 per cent per annum
MINIMUM INVESTMENT: Rs 50 lakh (cash) or Rs 1 crore (for portfolio)

HSBC Mutual Funds
DESCRIPTION: Stocks with a long-term growth potential available at a discount to intrinsic value; maximum stock exposure is 10 per cent and maximum sector exposure is 25 per cent
ANNUAL RATES: Three options, i.e., Upfront (1.75 per cent with 0.5 per cent per annum of daily average of net assets); 2.5 per cent per annum charged monthly of daily average of net assets;or fixed 1.25 per cent per annum charged monthly of daily average of net assets and 15 per cent of profits with a hurdle rate of 10 per cent

Product samples available with brokers and fund houses

The Advantage

The nature of a PMS product is different from, say, a mutual fund. Says Nitin Jain, Head (PMS), Religare Securities: "Cash management is better here, which translates to better returns than a mutual fund, which operates under a restricted framework." For example, a PMS can sell out all stocks against your name if you so desire, which a mutual fund can't do. Likewise, unlike a mutual fund, a PMS operates on a narrower portfolio of stocks due to its smaller corpus. "A PMS manager can invest a smaller corpus either on a high-risk theme or a low- risk theme," avers Jain.

Usually, there's no load. But Khade believes in trying to encourage investors to stay in for the long term to get good results. "We sometimes charge an exit load to discourage investors from selling out," he says. Besides, keeping the corpus at a manageable level can give better results to investors. "Many companies talk of big asset bases," says Khade. "PMS should be of a manageable size to benefit all."

There are tailored products and also those that tap a particular segment of the market, including derivatives. "We do invest in derivatives for hedging and in money market funds for cash management," says Jain.

But if you invest, check the costs and the product you select. Mashruwala feels that since portfolio managers charge a hefty fee, opting for a differentiator is important, which usually is in the non-discretionary portfolio-you must have a tidy Rs 1 crore for investing here.

Remember to compare the performance with the market's benchmark Sensex. If your portfolio has outperformed, then your outsourced fund manager has been worth it.

To Prepay Or Not?
It's the million-dollar question. Here's how and when to prepay your home loan.

It's a tricky situation for homeowners with a loan. With the rising interest rates-which are at a five-year high-the big question they face is: Should I prepay the home loan? A swift round of four rate hikes since October 2006 has jacked home loan rates up by a whopping 25 per cent. And if you are among the many who have taken a home loan very recently, you've probably faced a financial double blow: The impact of rising interest rates and skyrocketing real estate prices.

For most individuals who bought houses when rates were the lowest at around 7.25 per cent in December 2003, the impact of the rising interest rate is huge. Of course, part of it has been compensated by the surge in property prices that increases your home equity. But on your home finances, the result is excruciating. Consider this: your EMI (equated monthly installment), taken at 7.25 per cent, increases by a whopping 32.8 per cent. On a larger Rs 50 lakh loan, the EMI increases by a tidy Rs 12,950-that's a big increase.

Banks have been sending out letters to older borrowers to prepay a part of their loans or re-balance their monthly installments to reflect the current rise in rates. Says Rajiv Sabharwal, Head (Retail Assets), ICICI Bank: "We wrote to customers to prepay a certain amount and there has been an increase in prepayments"

When and Why

But when do you prepay a loan? There are a few factors that could affect your decision. First, if your interest rate has been very low, say 7.5 per cent, and the current rate is around 11 per cent, your whole EMI is not enough to cover the current interest cost. Banks re-adjust your monthly installments to reflect current levels, and also encourage you to prepay a part of the loan.

"We have seen an increase in prepayments and many people are coming forward"
Rajiv Sabharwal
Head (Retail Assets)/ICICI Bank
"If your money is earning you a rate lower than your effective post-tax rate, go for prepayment"
Amar Pandit
Certified Financial Planner

Ideally, a prepayment strategy should be based on three factors: Affordability, opportunity cost and the tenure of your loan. Says Amar Pandit, a Certified Financial Planner (CFP): "You have to consider a combination of factors, like when was the loan taken, and your effective interest rate and the amount of surplus funds you have." The first is not a major hindrance as there has been an increase in annual incomes of most individuals.

But for many others, it's, perhaps, a good idea to consider the opportunity cost of prepaying your home loan. In economics, there's something called the opportunity cost. A home loan costs around 11 per cent today, which is your cost. But if you can earn more elsewhere, then prepayment, in the short-end, is not for you. It's only when you have idle long-term money and it's earning you lower than what you pay, can you go for a prepayment as it will help wind up that loan earlier. Adds Pandit: "If you have money and it's earning you a rate lower than your effective post-tax rate, then you can go for prepayment."

For others, especially those who have been affected by the tenures, a prepayment makes sense, too. If you have taken a loan that is about two years old, your tenures can nearly double with the recent spate of rate hikes. So a 20-year loan can turn into a 40-year loan, even more, depending on your contracted rate. It's here that you can take a decision to make a part prepayment. Ideally, your home loan tenure should not extend beyond your working lifetime or about 22-25 years, beyond which the total cost of the house becomes expensive. You can decide the amount of prepayment. Says Sabharwal: "The homeowners can decide what is best. But we have seen that when the rates are low, a customer prefers to increase tenure. If the rates go higher, he prefers an increase in prepayments." But if your tenures go up beyond your retirement age, says Pandit, it makes economic sense to go for a partial prepayment.


Trade Your Policy?
There's still enough value in a lapsed policy.

Aggarwal: Calls for trading in life policies that are likely to lapse

It may come as surprise to many-life insurance policies can be traded. This is seen as a solution to the many policies that would otherwise lapse. These policies affect the insured (gets lower surrender value), the agent (who loses his commission) and the insurer (overheads increase).

When a policy lapses, trading in life insurance is a way out. Says Rahul Aggarwal, CEO of Optima Risk Management Services: "Trading in life policies that are likely to lapse is a good way out and it is practised in many countries. It makes immense sense for a portfolio builder, though it has its downside for the original policyholder."

The life cover trade
» Pure life term policies don't get traded-only endowment policies
Look at the cyclicality of interest rates before buying such policies
If you have missed out on buying a policy earlier, make up for lost time now. Such policies have a shorter maturity period without compromising on returns

But if you are the original policyholder, then you might not gain much. Although you could get more money than the surrender value of the policy, there's a downside-the loss of life cover. In the event something happens to the original buyer, the acquirer of the policy becomes the beneficiary-and not the family members.

Brokers accumulate such life policies due to the maturity bonuses-the rate of return, depending on policy issue period, could work out to as much as 9 per cent. For individuals, perhaps, it's best to renew life policies and not let it lapse, but for investors and brokers, it makes for a good investment. For others, you can buy such lapsed policies to make up for the lost time.

Know Your Diamond
Here's a quick guide on how to buy that sparkling stone.

If you don't know anybody in the diamond business, you could very well get taken in the diamond buying process. But don't worry, here is enough information about diamonds to save you from the agonising, cold-sweat, high-pressure jewellery store experience. Just read these five tips before you go shopping, and you'll know what you're buying.

A diamond's beauty, rarity and price depend on the interplay of all the 4Cs: Cut, its (the diamond's) angular proportions; Carat, its weight; Clarity, to the presence of inclusions, and Colour, the degree to which it's colourless. So look for these precisely.

A lot of jewellers use terms like "deluxe" and "super-deluxe" to classify diamonds; more often than not this is a sure-shot way to dupe the customer. In order to ensure the quality of your diamond, buy it from one of the many companies offering branded diamonds as they are certified. Ask to see original certificates and not photocopies.

Ask to inspect diamonds under a 30X microscope. The so-called "loup", which is a handheld magnifier, is only of 10X magnification. Reputed jewellers should have a 30 power microscope.

You must shop around in more than one store as different stores specialise in different shapes, sizes and qualities. You must find a retailer that caters to your needs.

Last but not the least, ask the retailer/jeweller about the origin of the diamonds. Ask for the diamond company's policy on conflict diamonds, as well as a written guarantee from the diamond supplier that proves the diamonds are conflict free.

Happy shopping for your sparkle!

Attractively Small
Fund houses are targeting the small- and mid-cap space. Should you invest?

Naganath: Sees tremendous opportunity in micro-cap funds

It's now the turn of small- and mid-cap stocks. With the valuations stretched in the larger cap segments, fund houses are now training their sight on the small- and mid-cap segments. Last fortnight, two fund houses-HDFC and DSP Merrill Lynch-launched the HDFC Mid-cap Opportunities Fund and DSP Merrill Lynch Micro-cap Fund, respectively.

And the reason is not too far to seek: in the last one year, small- and mid-cap segments have not moved in tandem with their larger counterparts. And besides, most fund houses have open-end funds that are invested in the larger cap companies. Says S. Naganath, President & Chief Investment Officer, DSPML AMC: "We launched the micro-cap fund to complete our bouquet of offering to customers. Secondly, we see tremendous opportunity in some of these micro-caps growing to become a sizable company in the next few years."

The micro-cap fund is a three-year closed-end equity scheme, which will adopt the style of a private equity player and invest in stocks with a market capitalisation of less than Rs 1,500 crore. The fund targets a Rs 500-crore corpus, but will convert into an open-ended scheme after the lock-in period of three years. HDFC Mid-cap Opportunities Fund, another three-year close-ended fund, will invest around 5-15 per cent in small- and the rest in mid-cap stocks.

Interestingly, since the beginning of this year, this segment has livened up. Nine out of 25 new equity funds launched this year target the small- and mid-cap stocks. The market senses tremendous opportunity in this segment as some of these companies can scale up, expand their businesses, thereby increasing shareholder wealth. But there's a catch: not all small companies are cut out for the big league.