What are Sector Funds and How to invest in Sector Funds

Sector funds, as the name suggests, invest in particular sectors. The basic idea of a sector funds is to enable investor to take advantage of industry cycle .They have the potential to offer attractive return if the timing is right. However ,they do not provide the downside risk protection available in diversified funds.

Thematic fund lock for trends that are likely to result in the out performance of certain sectors or companies. In other words ,they key factors for these funds are those that can make a difference  to business profitability and market values. Thematic  funds  focus on structural as well as a cyclical factor that play an important role in the economy .

Who Should Invest In these Funds?

Sector funds can be an ideal option for investors who understand sector as well as its future potential and seek diversification within that sector. Besides, these funds can play a supporting  role in diversified portfolio by allowing investors to increase exposure to sector that may be under represented in their portfolio.

For those who invest in stocks directly , sector fund offer advantages over individual stocks ,as fund  manager   tracks the industry sector developments for investors .Since the performance of sector funds fluctuates depending in how the respective sectors industries are performing in the market ,a wrong selection of sectors  can adversely impact the overall portfolio returns. Therefore it is essential for a sector fund investor to have the ability to withstand short term fluctuations in order to enhance long-term returns.

Key Points

1.Sector funds can be ideal option for investors who understand a sector as well as its future potential ,and seek diversification within those sectors.

2.Sector and thematic funds carry a high degree of risk but also have the potential to provide better returns then diversified funds.

What should be the strategy for investing in these funds be?

Broadly speaking sectors and thematic fund should  constitute only a limit portion of an investor’s portfolio .Hence only those investors ‘s Who already have a well –diversified portfolio and who have the risk appetite to absorb extreme volatility should consider investing in these funds .

Individuals can adopt different strategies to reduce the risks generally associated with such funds. One such strategy is to have limited exposure to three –four sectors /themes .It is also advisable to review your portfolio to ensure that you are not investing in a sector them that you already have a sizable exposure to through other funds.

Before investing in these aggressive funds though , you need to access certain key criteria that may be important  to your profile. These are:

·          How diversified is your portfolio?

·         Do you have an appetite for risk and the temperament to track the volatile nature of sectors funds ?

·         Do you have the capacity to hold these funds  for the longer term ?Can you curb the urge to switch from one sectors /theme to another?

How Much exposure should one have in Sector/thematic funds?

As a thumb rule, for an individual who has decent exposure to equity funds and is conversant ,around 10-15 percent of portfolio can be invested in sector and thematic funds. Remember , who these funds can be riskier than diversified funds, they also have the potential to provide a better returns .The key is to select funds carefully and monitor their progress over the investment period .

What are the risks involved in thematic fund investing?

On the flip side ,there is always the risk  that the market may take a longer time to recognize the views of the funds house with  to particular them that forms the basic of a fund.

Besides there can be ambiguity in a fund’s definition of a them. For example, some of the infra fund have a low percentage of exposure to the crore infra sector and their portfolios have exposure to more sector then even a well –diversified equity fund. There is also the risk of a fund manager ‘s style becoming t o individualistic ,which may be difficult to follow if the manager decides to leave the fund.

Best Mutual Funds for 2012

The year  have been mixed bag for mutual fund investors .While equity fund investors have been having a harrowing time as the stock market plunged by 28 percent ,the rising interest rate scenario has been good for investors of dept fund like liquid funds ,ultra short term dept funds and fixed maturity plans (EMPs) . However, the RBI pause of rate hikes after 13 rates hikes in a row is likely to change the scenario .With inflation beginning  to moderate, further rate hikes may not be warranted. In fact clearly realizing   the risk to growth, the RBI has indicated a likely reversal in the cycle. If this materializes, the emerging interest rate scenario would warrant a few changes in the portfolio composition for dept fund investors .Here is how some of the dept fund categories are like to perform going forward.

Fixed Maturity Plans (FMPs)

With bound yield closer their peaks, FMPs remain an attractive investment option currently, as, investors can lock in their money for various fixed maturities ranging from three months  to three years. FMPs aim to generate predictable returns and at the same time, protect investors from interest rate volatility. While structurally, FMPs may be similar to fixed deposits ,the tax efficiency of these schemes makes them a much better option .However ,one must be quite sure about the time horizon ,as the liquidity provided by these plans through listing on the stock exchange is not very efficient ,both in term of the liquidity itself as well as the pricing.

Ultra Short-Term Dept Funds

The investment objective of these schemes is not to generate reasonable returns and liquidity, primarily through investment in the money market and short term debt instruments .Although these are potentially better than the liquid funds the longer maturity of up to one year or so can result in slight volatility .If interest rates fall, the returns from these funs too will fall.

Key Points

1. The rising interest rate scenario has been good for investors of dept funds like liquid funds, ultra short-term dept funds and fixed maturity plans

2. While structurally FMPs may be similar to fixed deposits, the tax efficiency of these schemes makes them a much better option

3. If the interest rates fall, the returns from ultra short term dept funds too will fall.

Short-Term Debt Funds

Short-Term funds predominantly invest in dept instruments with one two year maturity. These are potentially better than ultra short –term funds, but can be more volatile, as the mark to market component in the portfolio is higher. However ,when compared to medium term dept funds and gilt funds ,short term dept funds experience lower interest rate volatility but offer attractive returns in a falling interest rate scenario. Therefore investors with a time horizon of 6-12 months can invest in these funds and reap the benefits when the RBI begins to cut the rates.

Debt/ Income Funds

 Income funds invest primarily in dept and money  market with the twin objectives of optimum returns and liquidity for meeting investros medium terms needs .These funds strive to earn study return by actively managing their portfolios on interest rate movments  and cridet risks.Since there  is an inverse realtionship between the interest ratres and bond prices,thease funds benifit from capital gains on bond in a falling interest rate scenario .However there is  also the risk  of bond market rally mot materialising in the manner being envisaged currently ,due to higher government borrowings and a depreciacting rupee.There for it will not be prudent for risk averse investors to invest in these funds just because everyone is taking about this emerging opportunity .Besides investors must have a time horizen of 18-24 month for investing in these funds .

Gilt Funds

Gilt fund also provide a great opprtunity to investors to benefit  from rate cuts.Gilt securities are interst bearingf instruments issued by the government  as a part of its borrowing programme .While gilt funds are ideally suited for those who are looking for saftly  as government securities carry zero default risk and are highly liquid,the downside is that the prices of government securities fluctuate sharplydue to higher sensitivity towards the interset rate moment.As a result ,gilt funds can be very volatile in the short- term.

Commodity prices and future in 2012

Politics rather than economics play a dominant role in determining the prices of this commodity .The rise in the prices of crude in 2011 again illustrates this point suitably enough. Brent crude oil prices have consistently remained over USD 100 per barrel since march 2011, Which sadly has nothing to do with a significant increase in demand .Rather, we find that the global oil demand has continuously been revised downward .The international energy Agency (IEA), in the recent monthly market report, lowered the global demand of crude oil by 0.2 million barrels per day (MBPD) TO 90.3 MBPD, it’s fourth cut  for the 2012 forecast .The rise in prices was more due to a disruption in supply from middle  east and north African (MENA) countries flowing political unrest there .

However, we believe that in terms of supply, things will normalize by the second half of 2012.Moreover, OPEC  alone is investing around USD  300 billion  in the next five year, which will improve the spare capacity leading to softening of crude prices in 2012,Nevertheless we cannot expect the fall in crude prices  to be sharp as we saw in 2008 ,on account of an increase in the break even cost of crude oil ,which is about USD 80-90 per barrel .Therefore in the absence of a robust demand ,we  expect the prices to be in the range of breakeven (USD-   80-90/bbl)levels  unless there is any significant  change in the equilibrium either due to demand destruction of the breaking up of the euro or any unforeseen political upheaval   that cause supply disruption .”Apart from the European crisis concern over Iran’s nuclear program will also dominate sentiments, says Deo.  

When we try to gauge the higher range of the crude prices, we find that according to Citi report USD 120 per barrel  is a pain point (Thought it is dynamic  and will change with moment of USD )When expenditure  on energy would consume about nine percent of the global GDP. Historically, this has proved to be recessionary for the world economy, and we believe that any increase in prices about that will trigger more supply from the spare capacity that is currently at MBPD, leading to downward pressure on crude prices. Hence we feel that the international markets crude oil prices will trade in the range of USD 80-120 IN 2012.

Whatever happens globally ,on the domestic front we cannot expect the prices to be in the range as we suffer from one extra risk point ,which is the INR’s movement against the USD .The rupee has already depreciated by almost 18 percent year till date ,with most of that happening in the last four months. A depreciating rupee adversely impacts downstream companies like HPCL, BPCL, etc. and positively impacts upstream companies like ONGC. Since fuel prices are yet to be fully decontrolled, any increase in crude prices increase and under recovery and subsidies that will impact the oil marketing companies adversely.

In the current scenario it is estimated that for every 1 depreciation against the dollar, the under recoveries of state run of marketing companies increase by approximately 8400 crore and the net of impact bills goes up by 9000 crore .We believe that in 2012, the prices are going to be more stable than in 2011 and are likely to hover around USD 100 per barrel. However this sector is still dominated by the state owned companies and the absence of any clear policy guidelines in term of implementing the Kirti Parikh report on de-regulating the sector will make returns from it is sector uncertain as the government can change its sharing burden.

Future of Copper in 2012

Copper which is also known as industrial application in construction, electrical, consumer product, etc-makes it an economic bellwether. Therefore it is no coincidence that the worsening global economic condition is accompanied by a sharp fall in copper prices .Since march 2011, copper prices have fallen by more than 30 percent . Rio Tinto got the order for making Olympics 2012 Medals Tally Update , where they will be manufacturing Olympics Gold , Bronze and Silver Medals . Shakeel Ahmed ,CMD, Hindustan copper explains such a fall by saying ,”There are actually two drivers  of copper prices :one is the  Chinese  economy and the second is the us economy .At the current moment ,the Euro  zone crisis is the biggest dampener that has led to correction in the prices of copper .”There would have been further fall had there been no production cuts in Chile, Peru the United States by four percent that account for almost half of the copper ore production globally.

However China, which accounts for around 401 percent of the worlds copper consumption, influence copper prices in a major way. The current weakening in the copper prices has a lot to do with that is happening in China. According in the international copper study group (ICSG , China’s apparent usage declined by six percent in the first half of the year. It’s refined copper imports too declined by 40 percent .This was mainly due to a lack of seasonal restocking that Chinese buyer undertake during the spring .Instead they turned to drawing on inventories amid historic high prices and tight credit conditions.

Going forward the copper prices in 2012 will be determined by the inventory cycle of China and the economic data coming from the USA and Europe .According to the ICSG, the world copper usage for 2012 is expected to grow by 3.6 percent, mainly supported by a growth of six percent in China .However if we want to put a range to the prices of copper this year, it would be at USD 4000 at the lower end and USD 80000 at the higher end .According to Ahmed ,”My mining cost of  production  is USD 3000 per ton , but since we have fixed costs of other activities , it take it to around USD  4000 per ton “This is applicable  to almost 90 percent of the total producers  of copper around the world.

As far as the upper range of copper prices is concerned, we believe that it will be around USD 8000 per ton .This will result from the demand pickup in the latter half of 2012,as the US home sales data will improve further .Japan will start its comprehensive reconstruction  programming after  the  tsunami and most notably ,China’s power industry that solved its  technical problems in 2011 will once again start demanding more copper Ahmed agrees with this adds ,”I do not see it going above USD  8000 per ton ”.

Coming back to India, the country faces an imbalance between copper production and its smelting capacity .in 2010, India reefing capacity in 2010; India refining capacity was more than one million ton, which requires 100 million tons of copper  ore (assuming one percent of copper content).Compared to that we have mined merely 3.6 million tons of copper  ore. However the demands for copper in India is just o.6 million ton and the rest of the refined copper is exported .Hindustan copper is the only company in the listed space that is vertically integrated and percent in the entire value china of copper .In addition to this the order two major players that have major refining capacities are Sterlite and Hindalco industries.

How to save tax safely?

The central board of direct taxes has recently allowed four firms to rise up to 30000 crore though the issue    of tax free bonds in FY 12.Tax free bounds means that the interest earned from these bounds is exempt under the income tax Act and is not added while computing   the total income .The national highway authority of India (NHAI) and the Indian railway finance corporation (IRFC) have been allowed to raise up to 100000 crore, while the housing and Urban  development (HUDCO)  and power finance corporation (PFC) have both been allowed to rise up to 5000crore .

NHAI is an autonomous authority of the government of India under the ministry of road transport and highway (MORTH). The main objective of NHAI is the development maintenance and management of the national   highway entrusted to it by the government of India .The infrastructure sector has been the prime factor in the growth story of India, and road development has been the focus within that. NHAI has been at the forefront for the same .NHAI is now tapping the market to raise funds aggregating to 5000crore, with an option to retain an oversubscription of up to 10000crore, through tax –free secured redeems –able non –convertible bounds.

The funds raised through this issue will be used to finance various upcoming project of the company .This issue opened on December 28,2011and will close on January 11, 2012. Of the total issue size, 40 percent is reserved for companies, Flls, mutual funds, etc. around 30 percent is for HNI investors, while the remaining 30 percent is retail   individuals .The bound has the highest credit rating of “AAA’ of from CRISIL, CARE and the Fitch, indicating the highest level of safety   and timely servicing of debt obligations This also tells us that the company has very strong fundamentals.

This minimum application size for the bonds is 50000 (50 bonds of 1000 each), following which one can apply in multiples of 1000 (1 bond).To be listed on the Bombay stock Exchange (BSE) and the national stock Exchange (NSF), there are two option available for investors in these bonds .Option I has a coupon rate of 8.30 percent for annum with a tenure of 15 years. Interest will be paid annually on October 1 of every year.

We are of the opinion that the Indian economy is growing at a very rapid pace, and in the longer run, we may not see the same kind of high interest rates that the being offered now .As the country grows the interest rates tend to reduce, which is evident from the fact that developed economies have very interest rates .So this is a good opportunity for long- term investor. However, the bound is more attractive to investors who come under higher tax brackets..In case of individuals who come under the highest tax bracket (30.9 percent), the effective yield work out to be 11.87 percent in the first option, while for the second option .the yield is 12.01 percent.

These bonds are unlike tax-saving infrastructure bonds which had a minimum lock-in period of five years  and where the interest  was taxable .Even though these bounds will be traded in the market , one should  note that the volume in the exchange in quite low. Hence, liquidity could be one of the problems .Also these bonds are treated as long term capital assets if they are held for more than 12 months, and there will be no tax deduction at source on interest earned. Hence, one should invest in the bond if one has a longer-term Horizon and does not require funds in the short run.

We believe that investing in the second option is better, as it’s effective yield is greater than that of the fist one.

Source: Dalal Street Journal

Impact of Inflation on Interest Rate

Inflation is at an all time –high these days. As a result, the cost of living has soared and the prices of essential commodities too have peaked .One element that few people tend to think about while considering inflation is the impact rising inflation has on one insurance needs. While the rules of thumb state that you should look at life cover of around 10times your annual income (after deducting your investment asset plus any liabilities), it’s also important to consider the impact of increasing inflation on your insurance portfolio.

Inflation refer to the general rise in prices   measured against  a standard level of purchasing power .The most well known measure of inflation are the consumer prices index (CPI), Which measure consumer prices ,and the GDP deflator  ,which measure inflation in the domestic economy .From 1969 to 2010,the average inflation  rate in India was  7.99 percent. So for instance, anything that could be purchased for 10lakh in 2011 would cost approximately 45lakh in 2031at eight percent inflation rate.

With respect a insurance, thought inflation also cause premium rates to rise, The most significant factor for consumer is the reduction is value of the benefit amount, For example a person who buys a life insurance policy of 10lakh may find that this coverage does not serve the purpose when s/he needs it. Thought 10lakh may have been sufficient amount at the time of purchase, s/he may not use the coverage for 20years.Finally when the insurance benefit may not be enough.

With the passage of time, yours family’s needs are bound to increase .Unforeseen events do occur, and all individuals wish that their family can sustain the same lifestyle even when they are not around to provide for them .Unless you are purchasing a term life insurance  policy for  a three five  year period ,Inflation is sure to catch  up. It is for the reason that the further value of money should figure in your calculations, and hence arises the need to continuously evaluate your life insurance needs, especially for periods of 10 years more.

A term life policy is generally paid over a long period of 10-30 years. Policyholders pay a fixed rate for term life insurance over this span of time .As the rate of inflation is commonly in the range of about seven to nine percent annually, the value of the rupee decrease by this percentage each year. Hence, one   is not able to acquire the same amount of coverage benefit as in previous year; the premium you pay per month for life insurance today will in rupee terms be the same, but will have lesser value 10 year from now due to inflation.

An increasing term insurance policy may provide the flexibility to increase the sum assured by five to 10 percent each year to reflect the rate of inflation .Thus it will hedge against the rising cost of living with the option of increasing the sum assured. Such policy insures adequate financial protection at an affordable cost. Most companies provides the enhanced insurance with appropriate rider option at a nominal extra cost, AS well rewards for healthy lifestyle  habits like non –smoking etc. If you are concerned about rising inflation and are buying a policy relatively young in a life, for example just after having a child, this may be suitable option for you .However, it’s worth nothing that the cost of insurance premium is also likely to rise to reflect the increase sum assured .So, you will need to be certain that you would be able to afford the increased premiums.

While many people fear inflation wreaking havoc on the financial markets and causing  a decline in the economy in general ,many overlook how inflation affect insurance .As inflation cause a loss of the Rupp’s  buying power ,It is also reduce  the value of an insurance  policy. Of course  , certain type of insurance coverage are more seriously  affected then other .Health coverage and auto insurance  premiums  change yearly, and hence  ,are less affected .Insurance policy held for many year before  use are those inflation  has the most significant effect on .While life insurance that inflation often  affects ,As a consumer is likely to pay premiums for decades  without using the insurance .By understanding how inflation  often effects ,as a consumer is likely  a premiums  for decades without using the insurance policies ,policyholders can take considered step to ensure  that the sum assured remains adequate at the time when it’s required .

Will Rupee Strengthen against Dollar

Although  the broader market index declined by 25 percent  in 2011,the performance was even worse in dollar terms ,because its declined by 36 percent .The reason for such a  dismal performance was sharp depreciation of the rupee  vis –a the us dollar in the second half of the year .Last year ,the rupee depreciated by 19.24 percent against the us dollar , with most of the depreciated –almost 18.66 percent taking place in the second half of the year alone .

For flls it was a double whammy, First the suffered the worth of a downfall in the equity market end the second was the concern of the depreciating rupee .The volatility in the rupee remained one of important reason why the flls shied away from the Indian equity market .However, with the down of this year .Thing are taking a turn for the better.

If we look at the rupee –dollar exchange rates, it primarily depends upon two factors –the balance of payment (BOP) and capital flows (both portfolio and direct investment).Last year the sudden and persistent rise in oil prices coupled with lower tax collection (owing to slowing economy) made the BOP situation worse. According to  Sengupta ,however ,BOP risk is overdone for India ,”He believes that the situation will improve here on ,”The reason is because the dollar itself   is strengthening .We think that the dollar will peak at around 1.25per Euro by March 2012,and will settle down at around 1.3by December 2012.Moreover ,we have a high current account deficit f there percent plus ,but that should be covered by capital inflows .We are  surprised by the upside  of inflows.ECB is USD 10 billion ,FDI is high ,NRI deposits have been high and the invisible number are high .If you see BOP , It is the same  at that in September last year. So it means that   it is low as a percentages of the GDP, he adds.

Therefore we believe that the risk to the rupee is less then what has been priced in. Also, out of the total external debt, almost 17 percent companies NRI deposits and a lot has been in trade credits to oil companies that will we rolled over .Even if we look at the de-leveraging of the European banks in India have around USD 6 billion borrowing, which is not that big, Sengupta explains .The market also seems to understand this and ,its reflected  in the current strengthening of the rupee against the US dollar. Year till-date (January 20, 2012), the rupee has already strengthened by 5.6 percent and in Sengupta’s opinion; it will be around 49 per US dollar by the end of year.

How to control Inflation

Beside the policy inaction, sky touching inflation was one of the biggest deterrents to FIIs. Inflation remained uncontrolled and high for more than 10 months of 2011 fiscal year . How ever it is not inflation in itself that acts against the Fll inflows. Rather the action taken by central bank to curb inflation has impacted the flows. The RBI has hiked its key policy rates 13 times (totaling 350basic point) since March 2010 to tame demand and in turn, curb inflation.

Since the fill investments are primarily driven by the stock market return, which in turn depend  on the corporate performance a sharp  increase in interest rates has and will probably impact corporate profitability .This has indirectly impacted Fill investments in the stock market .If we look at the rise in the interest cost (excluding financials) for BSF 500 companies between the march 2010 quarter , which the RBI started raising the interest rate , and the September 2011 quarter , it is up by almost 60 percent. For the latest quarter (Q3FY12), out of 199 companies (excluding financials), the interest cost is up by 33.62 percent on yearly basis.

In turn of percentage of sales, the interest cost has increased from 2.2 percent 2.8 percent of sales .This factor has played its on part in bringing down the overall profit margin of the companies from 9.8 percent to 5.1 percent in the same period .We believe that the interest rates have peaked of for now and we may see some sort of easting in FY13. Indranil Sengupta Chief Economist for India at Boa will reduce rates by 200bps in two parts first by 100 bps in the first half of fiscal 2013 and then by 100bps in the second half “He further said that this will lead   to “leading rates coming down by 150bps”.This definitely going to be a booster for the sagging Indian economy .The 50bps CRR cut effected by the RBI  in its January 24 meeting is a sign of thing to come .This cut itself is expected to inject almost 32000cror in to the system .

A cut in leading rates will not only reduce the cost of companies and help them to post good numbers, It will also help In another way .Lower interest rates will help equities to attract an increasing amount of portfolio allocation between equities and bunds .The lower interest rate will make the equities look cheap (though lower discount rates while valuing equities), and will make the bounds unattractive .In 2011, we received 42068 Crore in dept compared to the outflow from equities.

Data for the last few year also indicated that whenever there is a sharp decrease in interest rates, the Fll investment increase with a little lag effect .For example 2009, we received a total of USD 17 billon of FLL investment after the reduction in key policy rates by 1.75 percent in addition to the 2.5 that we witnessed in the last quarter of 2008.”Even during 1995-1996, when the market was similar to what we saw last year, there was huge rally immediately after the first rate  cut itself “,says Jyotivardhan Jaipuria ,MD &HOR ,DSP Merrill Lynch (India ).Therefore be we believe that   a reversal of  interest rates in 2012is definitely going to reverse the trend of Fll ,and they will start investing  in Indian equities again.