Polls or not, invest in equities for long term

Post actual results of polls on May 16, depending on the outcome, there will be volatility. But soon after, the markets will again focus on macroeconomic fundamentals, which we believe are improving and that is the basis of the rally over the next three-five years.

The markets have rallied significantly and the common feeling among retail investors is of being left out. Many large investors and institutional investors are experiencing a similar syndrome. The reason is very clear because no investor has ever been able to buy at the bottom and sell at the top. In this market, initial moves are sharp and swift and not with much delivery volumes. In todays age of ubiquitous information and analysis, more or less everybody reaches the same conclusion at the same time. If one analyses performance of any successful stock investor, it is more through prudent asset allocation and discipline of time and less by timing the market of stock picking. The stock markets witness cyclical gyrations and no bull market gets over in a few weeks.

Let us look at market fundamentally and technically. Fundamentally, India is a great long-term investment story that can deliver 18-20% per annum returns to a prudent equity investor. The returns will mimic the earnings growth of largely industrial and services sector in nominal terms. A sustained GDP growth of 7-8% per annum with inflation of 5-6% can let many corporates sustain 18-20% yearly earnings growth. Technically, markets were sluggish for six years and seem set for a cyclical uptrend. The broader markets underperformed in the last six years with slowdown in economic and investment activities. The investment slowdown was not caused by lack of demand or non-availability of capital but due to policy logjam and confusion in the wake of a few scams. These things can be set right easily and we can witness a beginning of a new bull market for next five years.

No doubt, euphoric run-up will witness sharp corrections. Therefore, while I advise increased allocation to equities, I do not recommend leverage or trading in futures and options. Invest in stock markets with a long-term view and restrict exposure to an amount which need not dip into at least for three years. Also, do not make the mistake of selling too early to book small profits. When one tries to make up for the lost rally by investing more than what they can hold for longer term, one invariably gets trapped in down cycle and lose all their positions at a loss.

For instance, if you have bought good quality stocks, you should not fear even if NDA falls much short of the expected majority. India is on a gust of a major breakthrough on all parameters. With or without the positive elections results, the macroeconomic conditions are improving. We are seeing the rupee stabilizing and appreciating and the current account deficit coming under control. Although it is too early to see whether there are actual green shoots of recovery in the economy, clearly the worst is behind us.

Our advice to the retail investor is not to get carried away by the sensex gyrations in the short term. Post actual results of polls on May 16, depending on the outcome, there will be volatility. But soon after, the markets will again focus on macroeconomic fundamentals, which we believe are improving and that is the basis of the rally over the next three-five years. A new stable, pro-reforms government can further boost the growth rates. For those investors who cannot invest in research, large cap diversified equity mutual funds are the best bet. For those, who can spend time and energy researching stocks, build a diversified portfolio of quality names. Do not panic the party has not ended but has just begun.

Need to Enhance Liquidity and Funnel Savings into Equity

Many a time, our policy makers confuse speculation with manipulation. They put too many restrictions that curb even healthy speculation. I have heard even comments like we should encourage genuine investors but not speculators.

In FII-led euphoria, we should not forget the importance of domestic money for equities through individuals, mutual funds, insurance companies etc.

According to RBI data, flow of domestic savings into equity dwindled from 7.4% of GDP in 2007-08 to as low as 0.5% in 2013-14. Let us look at some more data points in the five years from March 2009 to March 2014. Shareholding of FIIs in Indian-listed companies has increased from 13.8% to 22.4% whereas domestic equity mutual fund has witnessed a net outflow of $6 billion. FII investment in Indian equity has averaged less than $20 billion per annum. Compare this with domestic savings averaging $373 billion, including financials savings of $144 billion. Its obvious that domestic pool of savings is large enough to easily counterbalance the FII volatility.

Yet, our market is over-dependent on FII money. If FIIs flee for reasons purely external such as global liquidity squeeze, unviability of carry trades, crisis in their home countries, the impact will be disastrous on Indian markets. For a typical global fund, India is a small investment and can be dumped in crisis. It would cause havoc here by way of sudden losses immediately, but worse, loss of investor confidence for several years, thereby making it difficult for entrepreneurs to tap equity markets, slowing investment, employment and so on.

Nobody would disagree that we need growth and for growth, we need investment. And also that for investment, the foundation has to be of equity capital which can be leveraged by loans from banks and other sources. In contrast to FIIs penchant for large caps, domestic investors tend to invest more in small and mid-cap stocks. For inclusive growth, small and medium enterprises need impetus. To attract domestic investors, tax sops have little utility.

What they need is a liquid vibrant market, where an investor can enter and exit easily. Unlike investment in real estate or other assets classes such as gold, ownership and management are separated in equities. Therefore, liquidity is the most fundamental requirement for equity markets.

Many a time, our policy makers confuse speculation with manipulation.

They put too many restrictions that curb even healthy speculation. I have heard even comments like we should encourage genuine investors but not speculators. Genuine investors i.e. two sets of people who simultaneously get fundamentally bearish and bullish from a long-term perspective will be few and far between. Even in a stock like Reliance, they will meet once in a few months.

They will also not transact if the markets are not liquid. Without speculative trading, genuine investors will also not come to equities. Also, many a time, speculators moderate the event risk by building up positions in anticipation of events. For instance, this set of speculators starts expecting very good or very bad results, and the real impact of announcement of results will not be a spike or a crash but relatively moderate.

Our government and regulators can do the following to improve liquidity and encourage domestic investors to go for equities:

a) Remove STT and CTT completely: For any liquid market at any given point in time, spread between buy and sell price should be as narrow as possible. The incidence of STT and CTT increases this spread artificially, impacting liquidity, and therefore, attractiveness for genuine investors as well. STT contributes a minuscule amount to exchequer of less than $1 billion. The market will not mind even some increase in capital gains tax in lieu of removal of STT and CTT.

b) Encourage financing of equity investment: Sebi should simplify margin funding norms. The current reporting norms are too cumbersome to make the scheme popular. RBI should enhance banks limits for funding retail equity investors. There can be safeguards in terms of eligibility of scrips for funding and margin ratio.

c) Enhance EPFO and retirement funds limits for equity investment from the current 15% to 30%: Over long term, its well established that growth markets like India will offer equity investors much higher returns than fixed-income investors.

But there is risk in stock selection as well as timing of investment. Our regulators and market participants have done a great job of enhancing investor education and the effort continues.

Now, they should address the key issue hindering flow of domestic money into equities market. This will help domestic investors participate in wealth creation that equities typically allow when economic growth accelerates.

How black money finds its way out of India, and how it comes back as white

In February 2008, R Prasad, the then chairman of the Central Board of Direct Taxes (CBDT), led a team of tax sleuths to Port Louis, the capital city of Mauritius. Backed by a team from the ministry of external affairs, Prasad made an attempt to convince Mauritius officials to re-negotiate the double tax avoidance agreement (DTAA), which was resulting in massive tax losses to India.

Prasad's attempt was unsuccessful, but what he discovered in the process was startling: a handful of persons acted as directors for about 30,000 companies located in that island nation. Also, companies there exist only on paper, as addresses of many of those begin with a mere post box number.

And the challenge before the investigators is to establish the criminality of those involved in such activities," says Prasad, who retired as CBDT chairman six years ago. Now, the Supreme Court-appointed Special Investigation Team ( SIT) on black money wants such tax treaties to be re-drafted, a move that will put the government in a spot.

Only this week, a reluctant government had to hand over to the apex court a complete list of 627 Indians who have accounts in HSBC Bank, Geneva.

"The debate so far has been what comes first: investment or tax? Is India ready to sacrifice investments worth billions of dollars for the sake of some tax gain? So far as Mauritius is concerned, any retreat from India's side will allow China to woo the island nation," says a finance ministry official who did not want to be named, explaining why New Delhi hasn't been assertive with Mauritius, a nation where Indian defence forces harbour strategic interests.

In Black and White

While tax havens like Mauritius will help black money come back into the country as white, Indians continue to send illicit money abroad.

This is done through various methods, hawala transactions — where money is transferred abroad without any real movement of funds — being one of them although, according to a finance ministry white paper on black money released two years ago, hawala transactions have actually dwindled over the past decade.
"In recent years, after the 9/11 incident in the US, due to intense scrutiny of banking transactions, enhanced security checks at airports and ports and relaxation of exchange controls, transfer of money through hawala has reduced significantly," says the report. "...increasing pressure on financial operators and banks to report cash transactions has also helped in curbing hawala transactions."

 However, there are other methods to siphon black money out of the country, two of which are manipulation of export invoices and setting up of trusts abroad.

Two income-tax officials told ET Magazine that a large number of the accounts of the 627 names based on data stolen by an employee of HSBC, Geneva, would be of such trusts. The modus operandi adopted here is as follows: black money moves abroad through routes like hawala.

Then a trust is formed in, let's assume, the Netherlands. The trustees in this case will be Dutch nationals, but the beneficiaries will be relatives of an Indian back home who put in the initial corpus.
"But we can initiate a probe only when money gets reflected in the accounts of the beneficiaries," explains one of the tax officials.

As the incometax department and the Enforcement Directorate (ED) will now work under SIT, one can expect more urgency in the mission to bring back unaccounted money. Yet, genuine hurdles may come in the way of that endeavour.

The classic example of such a hurdle is seen in the case of Pune-based stud farm-owner Hasan Ali Khan, who was raided by the I-T department seven years ago. Documents and data in his laptop established that he had a Swiss bank account with a whopping $8 billion (roughly Rs 48,000 crore) in deposits. Ali was sent to jail, but the ED that probes money laundering cases found out from the Swiss authorities that Ali's accounts had been emptied.
The multi-billion dollar question then: how many of the 627 whose names exist in a sealed cover would have done the same?