Friday, May 31, 2013

Is your cheque CTS compliant?

This article was originally published in Postnoon on May 30, 2013; Co-Author: Anuj Hetamsaria


Mr. Mukherjee was holding a sheet of paper and walking towards me at the Park. He looked agitated as he always is whenever faced with financial decision making or difficulty in understanding something. He held out the paper even before he greeted me.
Prof. Nicky: What is this Mr. Mukherjee?

Mukherjee: Read it. I got it from my bank as an email today. What does this mean? What am I supposed to do?
Nicky: Okay, let me see.

The email read, "The RBI has introduced a new Cheque Truncation System (CTS). All cheques issued from 1st August, 2013 needs to be CTS 2010 compliant. Any old cheques or non CTS cheques will not be accepted after 31st July 2013".
You don't need to worry Mr. Mukherjee. RBI is implementing a new cheque clearning system called cheque truncated system which is meant for faster clearance of cheques.

Mukherjee: What is this CTS?
Nicky: CTS was introduced and implemented in the National Capital Region (NCR) in February 2008 on a pilot basis. The number 2010 in 'CTS-2010' is because the guidelines for CTS came up in the year 2010.

As per wikipedia, CTS is basically an online image-based cheque clearing system where cheque images and Magnetic Ink Character Recognition (MICR) data are captured at the collecting bank branch and transmitted electronically.

Mukherjee: But why should I worry about it? Since you taught me to use internet banking, I hardly ever use the cheque. I transfer money using RTGS and NEFT. Pay bills through internet banking.

Nicky: But didn't you give post dated cheques when you took a home loan? Also, you may need to pay for your daughter's education through cheque, many a times payments to government agencies need to be made by cheques, you may receive cheque from someone. If not immediately, you will definitely get affected by it in the future. So it would be best to be prepared rather than sorry. This system is anyways for your safety and benefit.

Mukherjee: How so?
Nicky: Its easier for banks to implement and is less costly than physical movement of cheques. It will result in shorter clearing cycle, superior verification and reconciliation process. It will be faster as the physical movement of cheques will stop and an electronic image of the cheque will be transmitted with key important data. As the system matures, it is proposed to integrate multiple locations and reduce geographical restrictions in cheque clearing. Hence, there are chances of multi-city cheques getting cleared on the same day, going forward.

It's not only beneficial from users perspective, it's good from regulators and banks' angle too. It reduces operational risk in banking. Scope for frauds are minimised under the CTS regime, which is good for banks.

Mukherjee: What kind of information will be transmitted electronically to the other bank?
Nicky: Information like date of presentation, presenting bank details, data on the MICR band.

Mukherjee: And what about the changes to the cheque leaf itself?
Nicky: A CTS compliant cheque leaf is different from a normal cheque leaf you currently use, and has certain distinct features. Certain benchmarks have been prescribed like quality of paper, watermark, bank’s logo in invisible ink, void pantograph, etc, and standardization of field placements on cheques. This will achieve standardization of cheques issued by banks. The printer details along with the words ‘CTS-2010’ is mentioned along the area where you tear off the leaf from the cheque book. The new symbol of the Indian rupee is printed beside the area where the amount in figures needs to be written. The words ‘please sign above’ are mentioned indicating the space where you will need to sign the cheque.
Mukherjee: It's good to know that the regulators are taking steps to introduce safer processes for us!

Wednesday, May 29, 2013

All you wanted to know about Exchange Traded Funds

This article was first published in the business section of on May 29, 2013

Exchange Traded Funds (ETFs) have become universally acceptable as an alternative investment instrument. Since ETFs denote a collection of stocks, they can be compared to Mutual Funds (MFs). However, they differ from MFs in that, like closed-end funds (CEFs), ETFs are traded all through the day. They are like stocks as they trade on the stock exchange but they are shares of a portfolio, not of a company.
ETFs closely monitor various market indexes. There is no limitation on the number of shares that ETFs can have, hence these are not CEFs. ETFs, like MFs and CEFs, are sold by prospectus, can be bought on margin and can be purchased through traditional and online brokers.

The trading value of ETFs is determined by market price of index securities throughout the day. To cite an example, Nifty ETFs will attempt to replicate CNX Nifty returns.
There is significant flexibility in the trading pattern of ETFs, they have lower expense ratio when compared to more actively managed investment tools like MFs and CEFs. There are no backend redemption charges too, hence, cost wise ETFs are highly competitive.

Besides the cost factor, ETFs are diverse, simple, tax efficient and transparent. The quantities of stocks are clearly spelt out, and underlying stocks are known. The mode of investment is simple and can either be made directly through a fund house or the stock exchange.
ETFs and CEFs do not require a minimum investment, while MFs do. ETFs, thus, are an asset to first time investors as investments can be made with a small corpus. The minimum ticket size is 1 unit (in case of IIFL Nifty ETF, 1 unit is approximately 1/10th of the Nifty level, i.e. INR 500, when Nifty is at INR 5000).

Investors who are looking for low-cost diversified portfolios and traders who are unable to invest in index futures due to less capital, welcome ETFs as a suitable investment option. ETFs have also found takers among those institutional investors who may be looking to make temporary investments during a portfolio's transition. Arbitrageurs who carry out operations with low impact cost often use ETFs.
ETFs have several factors going for them, but they have yet not made inroads into India as they have globally.

Fund managers of ETFs have limited freedom to pick securities from outside the index to which the ETF is pegged. Thus, unlike CEFs, ETFs do not allow fund managers any level of leverage to attempt a style drift.
This feature may sometimes dampen the prospects of ETF as a preferred investment tool, especially among risk-taking investors.

ETF investments do not closely follow the widely accepted indexes. Since these investments are confined to market indexes that have a narrow base, there is the possibility of high costs and higher risks.
As some countries believe in large-cap stocks, profits from investments in mid or small-cap stocks could be denied to such investors. Long-term investors find ETFs unattractive as these are possible only in intra-day trading.

The natural corollary to this is that ETF investments may result in a higher bid-ask spread, as they are made in a low volume index as compared to actual stocks.
Finally, ETFs may be losing out because selling them is difficult if the market is volatile or there is a thinly traded issue.

How are ETFs used?
Investors and active traders use a plethora of strategies when it comes to investing in ETFs. ETFs allow investors to diversify portfolios across asset classes as well as loosely correlated investments like commodities, real estate, small-cap stocks, etc.

While investors troubled by untimely inflation can hedge it by investing in inflation-protected bond ETFs, those worried about foreign currency exposure can hedge it with currency ETFs. Until long-term investment decisions are taken, ETFs provide investors with the option to put their money in stocks.
This prevents them from missing out on price rises and the resultant income. Another strategy, Tax-loss harvesting, is used for coping with capital losses in a taxable income and then re-applying the sale proceeds among similar investments.

This leaves investor portfolios largely unchanged. When an investor wants to gain exposure to specific sectors, styles or asset classes without obtaining any expertise, completion strategy is often used.
Fund managers also adopt different strategies when it comes to trading on ETFs. In the Large-Cap Value Strategy Fund, managers use a bottom-up approach by concentrating on things like the fundamentals of a particular company rather than an industry.

With Large-Cap Growth Equity Strategy Funds, managers identify investment opportunities and construct the ETF portfolio by combining fundamental and quantitative analysis with risk management. Several macroeconomic factors, market conditions, and a company's financial condition are considered while using this strategy.
Current scenario and road ahead

Lured by gold as an investment option, Indians are increasingly investing in assets held through gold ETFs. Gold ETFs, compared to physical gold, have additional benefits like security from theft and zero storage cost. While investment in gold in the futures market requires only 4 per cent upfront cash, gold ETF requires 100 per cent.

Launched in February 2007, the value of gold ETFs stood at Rs 10,402.37 crore in India. Compared to the popularity of gold ETFs, equity ETFs have not picked up much in India. In fact ETFs are far more popular in other emerging markets.
In an interview with Mint, Debashish Mallick, MD & CEO, IDBI Asset Management Limited, stated that with increased liquidity, the bid-ask spread would get narrowed, which would result in ETFs picking up in India.

He emphasised that market-makers should ensure that there are buyers for ETFs or they should position themselves to get a huge credit line to overcome the liquidity crunch.
Lack of investor confidence and retail participation in ETFs hinders their growth, as investors prefer to either buy stocks directly or invest in MFs.

The current state is that neither have fund houses launched ETFs regularly, nor do brokers feel too comfortable with them. They still prefer individual stocks and derivative markets.

Tuesday, May 28, 2013

In Conversation with a Macro Hedge Fund Manager

This article was first published in ISB Insight, Volume 10, Issue 4, 2013, pp48-50

Vilas Gadkari, founder of the Nilgai group of companies, was formerly the Managing Director and Chief Investment Officer of Salomon Brothers Asset Management from 1992-1999, a co-founder of Rubicon Hedge Fund and Partner at Brevan Howard Asset Mgt LLP from 2008-2011 He is currently the non-executive Chairman of Pratham Institute for Literacy, Education and Vocational Training. During a visit to the ISB in January 2013, Gadkari shared his thoughts on identifying global macro imbalances, managing risk and his predictions for the coming years.

Following is an excerpt of the interview between Nupur Pavan Bang, Senior Researcher, Centre for Investment with the fund manager who has more than 30 years of experience in global markets.

Tell us about your journey from a degree in operations research to becoming a hedge fund manager.

After graduating from IIT-Powai, I went to the US to earn a Master’s Degree in Operations Research. In the late 70s, US investment banks were starting to use a lot of quantitative techniques and this attracted many analysts. For example, Salomon Brothers had a number of nuclear physicists and PhDs in mathematics on board. Like many others, I also turned my attention to Wall Street and joined Salomon Brothers. I was initially in the systems development department developing quantitative models. I quickly realised that the heart of the firm was on the trading floor, but I had never studied either finance or economics. I decided to return to university and learn as much as possible about these subjects. I became a PhD student at Columbia University and my thesis topic was “Foreign Currency Option Pricing.” While I was doing my PhD, I continued to work part-time in the economics research department of Salomon Brothers, which was headed by the legendary Henry Kaufman. My years at Salomon Brothers were a tremendous learning experience.
In 1998, the firm was bought by Smith Barney and then merged with Citibank. It went from being a 6,000-people company to a 160,000-people global conglomerate. It was such a large cultural change that five of us left Salomon and started our own hedge fund called Rubicon.

What is the thought process behind your global macro strategy?
Global macro strategy is principally about macroeconomics. There are always imbalances in global economies. The idea is to try and locate if there is a macroeconomic dislocation or imbalance somewhere. Economic policies are often designed to achieve certain political goals. European integration is a classic example where the idea of a single currency has very strong political desires supporting what is arguably an imperfect economic policy. This situation has turned Europe into a classic global macro trade that many types of global macro fund managers have taken advantage of for the last two decades.

The existing global financial crisis that started in 2008 is another example of global macro imbalances that resulted in very large dislocations in the financial markets. This crisis is still playing out and may continue to play out for another five or ten years.
The investment strategy then focusses on instruments and positions in the financial markets that would benefit from further evolution of the crisis.

How do you identify imbalances?
To begin with, we monitor several macroeconomic variables such as GDP growth, inflation, trade and current accounts, etc. In-depth research and analysis can usually point to sectors and countries that are moving away from sustainable trends. The key is always to find countries that are moving away from sustainable equilibriums.

There are three main financial markets that we track: one is the equity market, the other is the interest rate or the bond markets, and the third is the foreign exchange market. They all tend to react to a given crisis at different times. The pricing or valuations in these markets allow us to take positions to benefit from the evolution of the expected crisis.
Interest rates, if you watch the monetary authority, are relatively easy to predict. Monetary authorities are focused on fewer variables, so they are easier to identify and they are usually transparent. In fact, they are more and more transparent these days. Monetary authorities try to tell you what are they looking at and how they make their decisions. Even if this still doesn’t make it very easy, at least you have a lot of information to work with.

Equity markets and currency markets are very difficult because there are many different players in these markets who buy and sell for very different reasons. If you take the foreign exchange markets, there are short-term speculators, investors making medium-term investment decisions and importers and exporters. Thus, it is much harder to identify which flows are occurring and which flow is dominant.
Similarly, business cycles across countries create opportunities. If the cycles in major economies are desynchronised, it can create disruptions in certain sectors, whereas if they are synchronised, some sectors will get a tremendous boost. Once again, we turn to in-depth macroeconomic research to understand these economic developments.

Movements in capital flows, changes in interest rates, economic cycles ¾ many of these variables would depend on social, economic and political policy making, would they not?
Yes. Policy framework is very important for us. As macro managers, we look to identify an imbalance in the policy framework. As fund managers, we want asymmetry. For instance, if there is a recession and policy makers have responded to it, then the chances are that the economy is going to start emerging from recession. On the other hand, the asymmetry would suggest that the chances of the economy plunging into deeper recession are lower. As a result, taking positions with that view has a higher probability of success.

How do you identify whether the policy framework supports or reduces the imbalance?
A typical business cycle (you can start anywhere in the cycle) is where the economy is in recession or going into recession. The monetary authority will then start cutting interest rates and provide some stimulus. Often, the fiscal authorities will also take some form of action. Sometimes, there are automatic stabilisers. As unemployment starts rising, governments start providing unemployment benefits. That means the government is infusing more money into the economy. What you have to do as a global macro player is to follow the capital flows and price actions to look for the signs of change and predict when that is going to happen.

Can you give us a few examples of the sort of imbalances that you have seen in the past?
The last 10 years have been the favourite of global macro fund managers in this respect ¾ where imbalances were created by economic policies that were put in place for political reasons. There is no shortage of such examples. China, for instance, has a mercantilist policy where they intentionally encouraged investment in the export sectors and subsidised those investments so that Chinese exports became cheap and Americans would buy them. That created significant trade and current account imbalances. Cheap Chinese goods kept US inflation under control. It tempered US inflation. US interest rates were lower than they should have been; US bond yields through the nineties remained very low.

European integration, specifically German unification, is another fantastic example.
Let's take the case of the European integration. What were the imbalances and how would you take positions?

European exchange rates were pegged between the countries in the European Union, within a band, in order to achieve greater economic integration in the region. It followed that German and French interest rates were very similar. In 1990, when East and West Germany unified, capital flooded into Germany in search of opportunities, such as cheap labour and cheap assets. 
In order to cool the economy, Germany needed to raise rates. France, however, needed to cut rates as they were experiencing a slowdown at that time due to the global environment, but they were locked into pegged exchange rate regimes. Hence, neither could Germany raise their interest rates nor could the other countries cut rates. This put a lot of pressure on the exchange rates. The central banks initially said that they would not change things and that the exchange rates would remain same. However, they slowly started to intervene in order to try to stabilise exchange rates. The imbalance here was really in the exchange rates. The actual exchange rates were increasingly getting out of line with the fundamentals.

This was a great opportunity for macro managers. Because of the pegged exchange rates, the Deutsche Mark was grossly undervalued and the French Franc was overvalued, so we bought Deutsche Mark-Dollar Calls and sold French Franc-Dollar Calls as the currencies were free against the dollar.
Hedge funds are highly leveraged. Risk management becomes very important as margin calls could quickly go out of hand. How do you ensure the safety of your principal along with being leveraged?

Options offer a good tool for risk management. Buying calls is a safe bet as the initial investment is lower. If the bet goes wrong, you only lose the premium. And if you both buy and sell options, as we did in the case of Deutsche Marks and French Francs, the initial investment becomes even lower. The probability of losses are lower when taking positions in long calls. The gain could be considerable if the bet pays off and the situation starts to turn. We often also use covered positions and stop losses to manage our risks. It is also important to realise that there are no free lunches. There is a cost associated with each alternative. These are tools for risk management.
You had a dream run at Rubicon for five years and then a couple of difficult years. When there is an imbalance, and you are correct in identifying it, how can you go wrong?

We were fortunate that after the NASDAQ crashed in 2000 and 2001, our strategy, "global macro," became quite fashionable and we significantly grew our assets under management. By 2005 we were up to about  US$3.5billion. 
The problem with global macro is that while it may be relatively easy to identify the macro imbalances, it may be a long time before those imbalances begin to reduce. You first have to decide whether you want to bet on the imbalances continuing to grow, or on the likelihood that something will soon happen to reduce these imbalances since they cannot be sustained forever. It sometimes takes a very long time before the imbalances and the markets turn. Therefore, when we start taking positions with a view that the turn will come soon, we need to be patient and also take positions in such a way that we do not lose a lot of money while we wait for the markets to do the right thing ¾ or what we think is the right thing. In the mid-2000s, the US housing market was booming. By 2005, we were convinced that it had gone too far; thus, we started shorting the US housing market in late 2005 ¾ a little bit too early. It wasn't until the middle of 2007 that it really started to turn. We had a couple of difficult years. It is a part of the ups and downs of the business.

What is your outlook for the coming years?
The US economy is starting to grow, but slowly. The risk of a fiscal cliff continues to hang over their heads. Emerging markets have relatively more healthy fundamentals, but the risk of a Chinese hard landing remains. Europe continues to be in recession and will continue to have very low growth for many years. The global monetary policy will remain loose to stimulate developing economies for several years as well. I feel that there are opportunities in fixed income instruments of countries with lower default probabilities and in a sub-set of emerging markets. In equities, one ought to look at companies with resilient earnings, low leverage and high dividends.

Thursday, May 23, 2013

It's about confidence

This article was originally published in Postnoon on May 23, 2013
Vishal was not ready to leave my office till his curious brain was satisfied. He wanted to start investing in stocks. In spite of my telling him to first get a demat account and then come back to me, he continued to ask questions.

Vishal: Professor, if I invest in a particular company, I would get dividends and/or capital appreciation. That's how I would get my returns. But how does my trading in the market have an impact on the company? Why should the company worry about the share prices? They don't get anything if I buy from trader A and sell to trader B!
Nicky: You are right. The company does not get any money out of your trade. But what if the company needed more money to expand and wants to raise that money through equity? Who will subscribe to the public offering of a company which has not been performing well? Ultimately, share prices are closest indication of the value of a company that the investors have.

Vishal: Could you explain it with an example please?
Nicky: Yes. Let us say we have only two companies in the market. One gives a return of 10% and the other gives a return of 5%. Every investor would want to invest in the first company. Increase in demand will lead to increase in prices of this company and the low demand for the shares of the other company will lead to fall in prices of that company.

Now let's say that both the companies want to raise money and come to the market with a public offering. Which company will you chose to invest your money in?
Vishal: Obviously the company which gives a 10% return, whose share prices are rising.

Nicky: Correct. Due to increased share prices, this company will be able to raise the same amount of money as the other company by issuing lesser number of shares. The earnings per share will not get as diluted as in the other company.
Vishal: Ah, got it. But what if the company does not want to raise money through the stock market and goes to a Bank for a loan?

Nicky: Higher stock prices indicate confidence of the investors in a company. Even if the company goes to a bank for loan or a financial institution for private placement of shares, the bank or the financial institution would prefer to give funds by way of equity or loan to companies which enjoy better goodwill and confidence in the market.
Vishal: Now I get the big picture. Thank you.

Friday, May 17, 2013

Demat Account for investing in stocks

This article was originally published in Postnoon on May 16, 2013

Prof. Nicky was distracted by the knock on her door. Vishal, a first year MBA student, with a rich dad, was peeping through the door.

Prof. Nicky: Come in Vishal. What brings you here?
Vishal: Professor, I have some spare pocket money with me, say around Rupees fifty thousand. I am quite fascinated by the world of the stock markets and wanted to invest in a few shares. But I don't know from where to start. Could you help me please?

Nicky: Do you have a Demat Account?
Vishal: No I don't. How do I get one? And why do I need one?

Nicky: You need a Demat account because the shares are stored in an electronic dematerialised form now a days. Paper shares are no longer issued. So to ensure that the shares bought by you are properly credited in your account, the demat account is mandatory.
You have to first select a Depository Participant (DP) like IIFL, HDFC Securities, India bulls etc. Then fill up the Demat account opening form given by the DP that you choose. Attach all the documents required by them like proof of identity and address. You will also need to produce your original Permanent Account Number (PAN) card while opening your account.

Vishal: The procedure seems similar to opening a bank account! Will the DP do the transactions for me?
Nicky: Once the account is opened, the DP will provide you a Unique Beneficial Owner Identification (BO ID) to quote while making transactions. While selling and buying shares, you need to specify your BO ID and provide the DP with instructions to buy or sell, for example, which company, how many shares, at what price, which exchange, etc. Following which your Demat account will get updated and payment for the transaction will be made through broker/ sub broker / bank.

Vishal: How will I be able to keep a track of my transactions then? How much will they charge me?
Nicky: The DP will provide you with periodic statements of your stock holdings and transactions. The charges for opening and maintaining the Demat account differs with DPs. A fair idea of comparative rates can be obtained from the NSDL and CDSL websites.

Vishal: How do I choose a company to invest in?

Nicky: There are various ways of valuing a stock. You can do it personally with the help of past records of the companies or you can take the help of an advisor/broker. But, to begin with, go get a demat account opened. We can chat about picking stocks after that. And please ensure that you inform your parents that you are going to be putting their money in the stock market.

Vishal: Sure Prof.!

Monday, May 13, 2013

Exchange Traded Funds

This article was originally published in Postnoon on May 9, 2013

Regarded as the most revolutionary alternative investment instrument, Exchange Traded Funds or ETFs have evolved rapidly in the last few decades. However, despite proving their effectiveness globally, ETFs are yet to make a stronghold in India.

What Are ETFs?

ETFs are index funds that, like stocks, are traded on the stock exchange; but unlike stocks, they are the shares of a portfolio and not of a particular company. Like mutual funds (MFs), ETFs represent a collection of stocks; but unlike MFs, they are traded throughout the day. ETFs closely track the performance of different market indices during the trading day. Unlike closed-ended funds, they do not have a limited number of shares. An ETF’s trading value is based on the market price of the underlying stocks in the target index, like a Nifty ETF will look to replicate CNX Nifty returns.


ETFs can be traded real time during market hours as well as in advance. Since they are a passive investment tool with low turnover, ETFs, compared to active MFs and closed-ended funds, have a lower expense ratio and transaction cost. They do not impose backend redemption charges. Adding to the attractiveness of ETFs is their high diversification quotient, simplicity and transparency. In ETFs the underlying stocks are known and quantities are already defined. Investment in ETFs can be directly made through the fund house or the stock exchange. Unlike MFs, ETFs report holdings on a daily basis and transact based on the market price. They are tax efficient as they seek to minimize capital gains by exchanging the stocks that are sold out of the index with those funds that are added to it. ETFs are a good choice for new investors with a small corpus. The minimum ticket size is 1 unit (in case of IIFL Nifty ETF, 1 unit is approximately 1/10th of the Nifty level, that is INR 500, when Nifty is at 5000).


These advantages notwithstanding, ETFs have certain demerits that have derailed their growth in India. ETF investments are limited to narrow-based market indexes and some of them result in higher costs and risks as they do not track the widely accepted indexes. With ETFs being limited to large-cap stocks in some countries, investors could be deprived of gains from investments in mid/small-cap stocks. Compared to actual stocks, ETF investments are generally made in a low volume index, which could result in a higher bid-ask spread. Further, ETFs, like stocks, cannot be wilfully sold if it is a thinly traded issue or if the market is experiencing high volatility.

These might explain why ETF investments, though attractive, have yet not found a significant place on the investment bandwagon in India.

Friday, May 3, 2013

Silver linings playbook

This article was originally published in Postnoon on May 2nd, 2013

After a long hiatus, Professor Nicky was back to the campus. After the cool breeze of the hills, the heat of Hyderabad summers was not helping her mood. The innumerable messages, mails and posts needed her attention, as also a long list of people who wanted to meet her. As usual, she took a cup of coffee and strolled out of the campus to clear her head. Just outside the campus gate, she bumped into Laxmiamma.
Laxmiamma was always a pleasure to meet. With a smile on her face, she greeted Nicky. But the smile was extra wide today.

Nicky: Oh hello there! What is the reason for your million dollar smile today?

Laxmiamma: First reason is that you are back....
Nicky: Thank you. What's the second?

Laxmiamma: Gold prices fell by more than 20% last month. I bought 50grams of my favorite metal. I will buy more if it falls further.
Nicky: You are above 60 years of age. Why do you need to buy gold now? I've never seen you wear any ornaments.

Laxmiamma: What does age have to do with buying Gold? And anyways I buy it as a security for the future, for bad times.
Nicky: Then why just Gold? Why not Silver as well?

Laxmiamma: Silver?
Nicky: Yes. While Gold has given a total return of around 325% over the last 10 years period, Silver has given a return of around 375% over the same period. And it is expected to give a much higher return than Gold in the future.

Laxmiamma: Why?
Nicky: Well, for one, the reserves of Silver have been going down, thereby making its supply limited. It is used in small quantities in many industrial processes. It is one of the most widely used commodity, with over 10,000 uses. Hence, the demand for silver is growing, but the supply is limited. Another parameter is the Gold-Silver ratio. The current ratio between the gold and the silver prices is approximately 1:60. Whereas, historically, this ratio has been around 1:15 to 1:20.

Laxmiamma: You are losing me.
Nicky: Sorry. What I mean to explain is that, either Gold is priced too high, or Silver prices are too low, or it's a combination of both. We can expect the Silver price rises to be steeper than the Gold price rises in the future. We should see a correction in the ratio.

Laxmiamma: So are you saying that I should not invest in Gold?
Nicky: No. I am not saying that. I am saying that Silver is also a good option and you should try investing in Silver too, if the aim is to invest. Anyways it is better to diversify your investments.

Laxmiamma: Yes. Like you keep saying, "don't put all your eggs in one basket"!

Thursday, May 2, 2013

Put India's Gold to Work

This article was first published in the Financial Times, Beyond Brics, on May 1st 2013

Co-Author: Saumya Rastogi

When gold prices fell below $1400 in mid-April, investors across the globe panicked and tried to exit their gold-based investments. Yet the scene was quite different driving through the Somajiguda area of Hyderabad, in India.
Both sides of the road, which is lined with jewellery shops, were overflowing with customers. As a valet at one of the largest shops put it: “People have been buying like gold is being distributed for free.”
The scene is testimony to the craze for gold among Indians. This craze is often blamed for India’s burgeoning current account deficit, and for a failure of household savings to reach the financial markets.
With cultural values that laud fiscal sagacity and shun profligacy, Indians traditionally save more than they spend. The household savings rate in India has always been above the global rate of 20 per cent. It was close to 30 per cent in 2012, making the year’s savings around $400bn.
But a very small part of these savings gets invested in stock markets (just 2 to 5 per cent). A large portion goes into fixed deposits (45 per cent) and a significant amount finds its way into buying the yellow metal (8 to 10 per cent).
Reduced real rates on bank deposits and small savings funds coupled with a volatile stock market have made gold even more popular among Indians. The risk-averse Indian considers gold a hedge against inflation and a safe asset with high investment potential – and rightly so.
Source: Authors
Let’s look at the normalised prices of gold and the Sensex equities index of the top 30 companies listed on the Bombay Stock Exchange. A person who invested in the Sensex in 1997 and held his investment until today would have earned as much as a person who had invested in gold. However, it is also evident from the graph that while gold prices have risen steadily in the last 15 years, the Sensex has been very volatile since 2007. Since it is very difficult to time the market, a lot of investors might have ended up losing money if they had invested in the Sensex in 2006-2007 and then tried to exit. However, gold continued its steady rise even during those tumultuous years.
It is ironical that people buy gold and hoard it for years, but people buy stocks and sell at the first opportunity. If they held onto stocks as they do gold, their stocks might give them the same or maybe better returns. The difference in behaviour may be attributed to an emotional attachment to gold.
Another point worth noting is that aversion to risk is inversely proportionate to the level of education. According to a study by the National Council for Applied Economic Research, supported by the Securities and Exchange Board of India, risk-taking ability is highest among individuals with 15 years of schooling. Investment in mutual funds is much higher in villages close to urban centres, than in villages in remote areas.
There is a lack of financial awareness and innovation in India. Only 55 per cent of the country’s population has bank deposits, 9 per cent has bank credit accounts, less than 20 per cent has life insurance coverage and only 10 per cent has access to other kinds of insurance.
Clearly, financial services in India are under-penetrated and there is a need for inclusion of financial products and services to channel household savings into the financial markets. It is essential that people are educated about the existence of investment options and their associated risks and possible returns. The Indian market is up for grabs but more financial players will have to be encouraged to develop products and services aligned with the risk-averse nature of Indian households.
It would be wrong to expect that investment in gold can be quickly replaced with investment in financial instruments in India. However, measures that integrate gold and financial markets can provide a solution. Instrument like gold-backed deposit schemes, where households can deposit their surplus gold, in any form, in a bank and earn interest on it, gold exchange-traded funds, and so on, could facilitate the penetration of financial products in India. Better penetration and participation of households in the financial markets would definitely stoke the country’s economic engine.