MOSt Shares M50 ETF — Hybrid strategy
The unique concept of having both active and passive features may help investors to earn higher returns for the same risk.
Exchange Traded Funds (ETF) in India have not taken off in a big way as many actively managed funds continue to give superior returns when compared with key indices.
ETFs as an investment class have only mopped 0.19 per cent of the latest assets under management despite being in existence for almost a decade now.
Given this back drop, Motilal Oswal Asset Management Company has launched MOSt Shares M50 ETF, an open-ended equity ETF which tracks its in-house MOSt 50 basket.
Objective: MOSt 50 basket was introduced with the idea of earning higher returns for risk equivalent to the Nifty basket. It is a fundamentally weighted index with constituents of Nifty index getting weights based on the fundamentals rather than weights based on the market capitalisation (followed by the Nifty basket).
The ETF seeks to earn superior returns by giving preference to companies with reasonable valuations and consistently good fundamentals within the Nifty basket.
The illustration of the index shows 13 percentage points higher returns on an annualised basis for a little over a three-year period for MOSt 50 basket.
However, Most 50 index basket has tracked the Nifty basket from April 2007 to the lows of March 2009. It is only from March 2009 that MOSt 50 index gained multiple times that of Nifty.
Strategy: The Motilal Oswal AMC has designed this proprietary basket, which attributes weights to companies depending on pre-defined metrics such as return on equity, net worth, retained earnings and price.
The financial measures are taken on a historic basis. Then an algorithm classifies stocks into one of the three categories: over-weight, under-weight or equal weight, depending on their financial performance and valuations.
This weight would be different from that of the Nifty basket. For instance, while the Nifty 50 index has 15.8 per cent weight on the oil sector, MOSt 50 has given only a 2.4 per cent weight to this segment. While the ETF is passively managed to the extent that tracks the stocks in the index, it will be dynamically re-balanced periodically, based on changing fundamentals and whenever the constituents of Nifty index are changed.
Review: The unique concept of having both active and passive features may help investors to earn returns higher (called alpha returns) than what is commensurate with the risk of the basket. In addition ETFs have a low-cost structure and don't entail any exit load, as they are traded like any other stock on the bourses.
Risks: As the fund considers historic data for evaluating fundamentals, any new development may not be factored into the rebalancing right away and, often, the market's response by way of , re-rating/de-rating happens very quickly.
For instance, oil price de-regulation would not tend to reflect in the performance of MOSt basket, as against the Nifty 50 basket, given the low weights in the former.
The active strategy to a set basket of stocks also poses certain other risks. At times, higher weight to stocks that are under-valued for long (on expectations of re-rating), may affect the performance of the ETF, when compared with the Nifty index.
Weights based on pre-defined rules, lack of human intervention inability to diversify outside of the Nifty universe to boost performance may also heighten risks.
Besides, the MOSt 50 index still has to hold all the Nifty stocks, irrespective of their valuations. The NFO closes on July 19.
The risk perception
Factoring in risks goes a long way in determining your investment outcome.
Ever had your friend exclaim at your investment choices with phrases such as "That sounds like a very risky bet'' or "That's a very risky stock''? How about asking the friend to rank your investment risk on a scale of 1 to 10. The friend stares back blankly, implying either you have lost your marbles or they're lost in translation. So what do you perceive as the risk in your investments?
Fundamental risks
Risk in its varying degrees of perception is the magnitude of fear at the thought of losing something. It could be the fear of losing your home, friend, mobile phone, or money. When it comes to investing, the idea of the risks intrinsic in the business, its operations and environment are also known as 'fundamental risks'.
To borrow the idea of investor Warren Buffett's 'fundamental' risk of investing in a business, there are five primary factors in appraising this risk: The first would be on how confident you are in your judgment of the long-term economics of the business you want to invest in. Take, for example, the much-maligned telecom sector, which has been in the news for deteriorating economics and expensive expansion.
Investing in this sector would entail having a perspective on how consumer behaviour is likely to evolve over the next five years and whether consumers are likely to spend more on value-added services or more time on the phone. Add to this, the large number of players in several circles, which means little pricing power.
These are just a couple of factors in the economics of the business on which one needs an informed perspective. A rapidly changing business is often a risky one for an investor who is not watching it closely.
Human element
The second and third factors deal with the ability of people to run their businesses effectively and their propensity to reward the shareholder and themselves in a proportionate and acceptable manner. Retail investors have traditionally had little say or sources on management. However, gauging how effectively the company communicates to its shareholders through interviews, press releases and annual reports can give you a cursive idea of the management behind a stock. A crooked manager or misinformed, yet ambitious, CEO is a major risk to an investor, considering how he can derail an otherwise good business. An instance of such behaviour includes the Satyam episode that saw the slipshod Maytas merger attempt as a prologue to the expose of Ramalinga Raju's number fudging.
The fourth factor is the effect of external factors such as inflation and taxes on a business. Companies in sectors such as alcohol or tobacco have the constant risk of taxes being hiked at various levels, considering how the products they produce are viewed as 'vices'.
Inflation ravages business with little pricing power or scope for passing on costs. Cyclical industries such as automobiles and consumer durables have often been squeezed by rising costs during periods of low consumer demand, as prices cannot be hiked.
Businesses which are easy scapegoats for government taxation or companies that can be squeezed by the economic cycle are inherent fundamental risks. Sugar companies are a classic example of a sector which gets pushed to extreme highs or lows depending on season, crop yield and a host of other factors. Scale is a saviour in such a scenario as small mills become unviable and often go broke during the cyclical lows.
Price
The fifth factor is possibly the simplest — the price you pay. Paying a sensible price can help the investor avoid a great deal of pain associated with moody equity markets. Several retail and professional investors got suckered into buying newly-fangled, esoterically-named, mutual fund schemes or over-priced IPO's during the market peak of late 2008 only to lose their shirts over the next year.
Overpaying is possibly the most common risk the investor overlooks. As Buffett says, the above factors are difficult to 'precisely quantify' but ''investors in an inexact but useful way 'see' the risks inherent in certain investments without reference to complex equations or price histories.''
The perception of various factors which are deemed 'risky' does not always lend itself to a convenient number. But acknowledging that they exist and attempting to base the price you pay after roughly factoring in those risks goes a long way in determining your investment outcome.
Exchange-traded currency options coming soon
| Reserve Bank to spell out norms in a week. |
Corporates and individuals will soon have one more tool for hedging their currency risks. The Reserve Bank of India (RBI) will next week come out with the contours of the exchange-traded currency options, a top official of the central bank, said.
"Very soon (a week or so) you will hear from us as far as allowing exchange traded currency options in SEBI-approved platforms (exchanges)," Mr G. Jaganmohan Rao, Chief General Manger, Foreign Exchange Department, RBI, told a seminar on currency risk management, organised by the PHD Chamber of Commerce and Industry (PHDCCI) here on Saturday.
He said the RBI had been in discussions with banks and industry participants over the last one year on the issue of exchange-traded currency options. "There had been 43 rounds of discussions in last one year," Mr Rao said. Currently, currency options are allowed only as over the counter (OTC) products.
The RBI Governor, Dr D. Subbarao, in the annual monetary policy statement released in April this year, had announced that the central bank had decided to permit recognised stock exchanges introduce plain vanilla currency options on spot dollar/rupee exchange rate for residents.
In India, the level of hedging as part of currency risk management is quite low. Only 3 per cent of those with forex currency exposure have gone in for hedging their risk, it was pointed out.
Convertibility
Meanwhile, Mr Jaganmohan Rao advised small and medium enterprises (SMEs) to limit themselves to simple products (forwards, options and swaps). "Never go for structured products," he said.
On full convertibility of the rupee, Mr Rao said that full convertibility was required, but noted that the country was not yet ready for that.
"We are still to meet certain conditions of the Tarapore Committee report (on full convertibility). But RBI Governor is the best person to answer when India will have full convertibility," he said in response to a question on full convertibility.
On how much the Indian industry had lost on account of the global financial crisis through the currency channel, Mr Rao said the RBI only had 'rough estimates' on how much the industry had lost.
"We know about the banks and not about industry. We only have some rough estimates on how much industry lost. As and when industry had to make huge payments, we get to see the tussle between industry and bankers and thereby get some more information," he said. Already, exchange traded currency futures are permitted in two recognised stock exchanges in respect of four currency pairs.
Investing in stocks is the best bet to beat inflation
| 20-year analysis shows returns outstrip gold, bank deposits and commodity futures. |
With prices rising at double-digit rates, where does it pay to invest? An analysis of stock returns over alternative avenues of investment such as gold, bank deposits and commodity futures shows that equities have been most successful in giving inflation-beating returns.
Over a 20-year period, according to the analysis, equities have managed a higher return compared to other asset classes during years of high inflation (Consumer Price Index in excess of 7 per cent).
The Consumer Price Index has been above 7 per cent annually in all the years since 1990. Equities have managed to out-perform other asset classes for six years during the period.
In 1991, when the Consumer Price Index rose above 14 per cent, equity investors made an 80 per cent return (measured by Sensex) on their investment. In 1997, when the CPI rose over 7 per cent, the equity market delivered a close to 20 per cent return. In 2009, when inflation was at a 10-year high of 11 per cent, investors could have raked it from the market had they only been venturesome enough.
Equities outperform
In the years when the inflation was over 7 per cent, returns from equities oscillated between 17 and 80 per cent. Adjusting for inflation, the real return has been at least eight percentage points higher. The reward for investing in equity has also widened in recent years.
An investor who bet on equities, rather than gold in the last five years, generated a 12-percentage-point higher return compared to the eight-percentage-point excess return in the mid-1990s. Needless to say, the equity returns are much higher than the returns on investments in bank fixed deposits too. Interest rates on fixed deposits have fallen sharply since the mid-to-late 1990s.
Gold was the second best choice for hedging against inflation in the last two decades. In 2008 and 2009, for instance, when inflation was over 10 per cent, gold yielded a 15 per cent return.
Gold as choice
Gold has caught investor fancy only in the last seven years. Perceived as a safe-haven in times of crisis, the investment demand for gold has been going up.
The data of the past 20 years, however, do not throw up any precise trend of gold being an out-performer in inflationary times.
Indeed if it outshone stocks, it was only when there were external shocks such as the one that happened in 1997, and more recently in 2008, when there was a crisis of confidence with the equity market across the globe. The conservative investors who preferred the fixed deposit route to investment saw negative real returns in most of the years of high inflation.
In 2009, the interest rate for deposits of one-to-three years was 7.25 per cent, with negative real return (factoring in the inflation rate) of 4 per cent.
This year, too, as inflation continues to remain at 12-13 per cent, bank FDs offer interest rates of 6-6.5 per cent.
Commodities too have not fared well to beat inflation. The Reuters Commodity index, a benchmark for measuring commodity price movements, has been in the red on most occasions of high inflation — in 2008, 1998 and 1997, for instance.
Monthly Market Update on http://www.indiabulls.com/securities/mailermis/monthly-market-report/monthly-market-report-july-10-2010.htm
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