Figure out what the future holds

With 2014 having just commenced, it is time to consider new investment strategies and take steps to seize opportunities missed during the previous calendar year. Technology is expected to play a key role going forward and that is again something that needs to be focused upon.

K. K. Mishra, CEO, TATA AIG General insurance Company Limited, opines that with the change in times and age and the younger generation investing in non – life insurance products, the companies will look at different distribution channels for sales. Online sale and m-sites and Mobile apps will see increased acceptance and further growth in 2014, he predicts.

Errors to avoid
Vidya Bala, Head of Mutual fund Research, FundsIndia.com, underlines that 2013 was a classic year of heightened volatility in equities, what with little support from corporate earnings growth or GDP growth. Those who tried to time the equity market would likely not have done a good job. But 2013 was also a year that demonstrated the utility of SIPs (in mutual funds) in tackling volatile markets. People who stopped SIPs fearing volatility would have lost opportunities while those who stayed invested made money.

Visible trends
"Just to give an example, an SIP started a year ago in a large-cap fund like Franklin India Bluechip and a mid-cap fund HDFC Mid-Cap Opportunities would have delivered IRRs of 12% and 21% respectively (as of December 6). But had you stopped the SIP by say June 2013, and just held the funds, the returns would have been a mere 6.3% and 11.8% respectively. This clearly demonstrates that stopping SIPs, fearing volatility, is the worst harm you can do to your fund portfolio," she emphasises.

Debt dilemma
Similarly, investors who saw the double digit returns in long-term gilt funds until early 2013 and invested in them would have been in for a rude shock post July 2013 as the tightening liquidity measures caused a sharp jump in yields causing gilt prices to fall. 2013 taught a good lesson – debt funds have to be chosen based on one’s investment time frame. A gilt fund investor needs to necessarily have a longer tenure. Besides, past returns of long-term debt funds may not repeat themselves if interest rate cycle turns.

Going forward
2014 could turn out to be a watershed year for both equity and debt. As signs of economy bottoming out is increasingly evident, a slow recovery could mean that it is a good time to accumulate equities. At the same time, even as rate hike uncertainties remain over the next quarter or so, an eventual cut in interest rates, when inflation numbers temper, could trigger a significant rally in medium and long-term debt instruments. Hence, this 2014 would be a year to stay invested and not stash too much in cash. The first half of 2014 can be expected to be moving sideways, until such time the economic metrics improve and elections are out of the way. Hence, an SIP approach to a basket of funds with allocation to both equity and debt would be a prudent way to build wealth, Vidya advises.

Expert speak

Wealth creation in the New Year
Merely expecting a change in stock prices is by definition speculation and not investing. Empirical evidence suggests that some companies manage to not only earn return on capital significantly higher than cost of capital, but also sustain the same over fairly long periods of time. This is called value creation. Such above-cost-of-capital profit may be termed uncommon profit and all generating companies, value creators. Uncommon profitability in percentage terms means return on equity (RoE) is greater than the opportunity cost of equity (CoE).

Opportunity cost of equity is usually taken as the long-period return on equity benchmark indices. In the Indian context, long-period return of BSE Sensex is 15-17%. Using the other approach for Cost of Equity (CoE), risk free rate in India is about 7% (post tax). Adding an equivalent equity risk premium, one again arrives at CoE around 15%. Thus, in India, any profit earned in excess of 15% RoE is uncommon profit. Accordingly, all companies which sustain RoEs over 15% are value creators.

Uncommon profits in companies = uncommon wealth creation in markets. Value creators invariably outperform benchmark returns over the medium- and long term. This is probably because no matter how efficient, the stock markets seem unable to accurately assess the 3-dimensional aspect of uncommon profit, viz, quality, growth, longevity.

There are two approaches for investors to benefit from value creators:
1. Invest in the well-established value creators like Asian Paints, Colgate, Nestle, HDFC, Titan Industries, etc, preferably during market corrections; and/or

2. Catch Value Creators early i.e. when they first emerge into the uncommon profit zone of 15% RoE. This will enable investors to participate more in the uncommon profits generated by a company over its lifecycle.

Check these out:
Companies which fulfilled criteria during FY01 to FY08 - Shriram Transport (85%), Titan Industries (85%), Accelya Kale (60%), Manappuram Finance (70%), Gruh Finance (60%) and Blue Dart Express (45%).

Potential emerging value creators which came up FY09 to FY13 include Bajaj Finserv, Bajaj Corp, Zydus Wellness, Symphony and Cairn India.

Raamdeo Agrawal, Joint Managing Director, Motilal Oswal Financial Services Limited