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Current Market Meltdown – An Opportunity


• What has happened in the Global Markets?

• Impact on the Indian Markets
• Why the Current Market Levels are attractive
• Answers to Customers
• Mutual Funds Vs Direct Investments
What has happened in the Global Markets?
Resulted in High
Inflation & Low Interest Rate
Increasing Interest

Led Growth & Availability of
Asset Price Easy Money &
Bubble. Excess Liquidity.

Borrowing by US
What has happened in the Global Markets?
 Sub-prime Issue:
• Sub Prime lending is lending to people who have very poor credit
• In US, a lot of loans, particularly mortgages, were extended to a wide
target group including people who had very low repayment capacities
and paid very low margin.
• These loans then were bundled into packages by Investment Bankers
and were sold to investors like pension funds, insurance companies,
hedge funds etc. Today these loans constitute the largest component of
the US Debt Market.
There are mainly two reasons why this market became so large:
• Sustained Lower interest rates in the US saw most asset prices going
up for long time. This encouraged prospective home buyers to take
loans and buy houses.
• Around the same time, a lot of financial innovations took place, main
being securitization of assets. In this, mortgage companies used to
extend loans to home buyers and sell these loans onwards to investors.
• Since mortgage companies were not holding these mortgages, basic
due diligence of creditworthiness of home loans deteriorated. On the
other hand, due to lower interest rates, there was a lot of demand for
mortgage bonds as they were yielding attractive yields.
Leverage Game in US

Rate Of
Particulars Income
Investments 3000 10.00% 300
Loan 2900 8.00% 232
Capital/NW 100 68.00% 68
Return of Capital 68.00%
Leverage ratio of US Banks

Bear Stearns 35 to 1
Fannie Mae & Freddie Mac 24 to 1 When markets were booming,
borrowed money fueled
Lehman Brothers 36 to 1 record earnings. Investors
showed few signs of concern.
 Merill Lynch 32 to 1 The ugly flip side of leverage
is now obvious, and massive
 Morgan Stanley 33 to 1 write-downs have shattered
confidence in Wall Street's
 Goldman Sachs 28 to 1 risk-management machinery.
 Bank of America & Wachovia 11 to 1
How Mortgage Market Shaped Up in the USA

By the end of 2006, share of sub-prime in total lending had crossed 20%. And
by Q2 of 2007 out of the total mortgage bond market of $6.8 trillion, distressed
debt was of $2.8 trillion.
US Housing Price Trend

As we can see, housing prices doubled between 2002 to Q1 of 2006

Leverage Game in US

 Now what happens if the property prices fall???

Value Fall Value Fall
When the value of by 4% by 20%

property falls by Investments 3000 2880 2400

only 4%, the value Loan 2900 2900 2900

of Investments Capital/NW 100 -20 -500
become 2880
against the original
investment of 3000. So on a Capital of 100 the loss of
Investment comes to 120.
Enough to wipe off the entire
What has added fuel to the fire?
• Solvency fears have hurt liquidity flows
There have been more than 500 billion dollars of NPAs in the US. But
what has added fuel to the fire is that Banks have become very
cautious in lending and they are hardly lending to any borrowers for
the fear of these borrowers being bankrupt. Hence this has impacted
the Credit flow.
• Selling pressure because of Capital Adequacy Requirements.
When the bank provides for NPAs…they take a hit on their capital.
EXAMPLE:- If the capital of the Bank is 100 and the NPA is 5
the capital becomes 95. Due to this they have to infuse new
capital (raising capital in current times is also difficult)against
their hit to meet the Capital Adequacy Requirement.
Summing Up……Of the Crisis

• Over Leveraging (Greed)

• Bad Regulations (Ease)
• Over Sophistication and Complication
• Fear and Distrust (Affecting Liquidity Flows)
Where can the Impacts come on the
Indian Markets?
• Financial Crisis
• Growth Rates
• Liquidity Flows
Impacts on Indian Markets –
Financial Crisis
• We have stringent banking regulations.
• Solvency issues are extremely low
• Hardly any exposure in foreign assets (The collective exposure
of Indian Banks towards failed Western Banks totals to around $1
billion at September end, which is a fraction of their total loan book of
$510 billion, according to Central Bank)
• Indian consumers are less leveraged compared to global
• Indian companies are very low leveraged compared to
what they were five years back.
• Pro-active Central Bank and Government
Stringent Regulations
• There are stringent reserve requirements for Indian banks
and they are adequately capitalized.
India (%) China (%) USA (%) EU (%) Bank Leverage Position
Total CAR Requirement 9 8 8 8 Bank as of March 08
Tier 1 Capital 6 4 4 4 UBS 98.3 x
Liquidity Reserve Requirement SLR: 25 Selective Deutsche 64 x
NIL NIL Dexia 54.4 x
CRR:6.5 CRR:17
Commerzbank 40.2 x
Loan/GDP Ratio 50 110 340
Fortis 29 x
Credit Suisse 23.3 x
Source: Reliance Mutual Fund Citigroup 17.2 x
UniCredit 16.6 x

Indian Banks
BOI 16.9 x
• Indian banks leveraged positions are way PNB 16.2 x
below their western counterparts. SBI 14.7 x
Axis Bank 12.5 x
HDFC Bank 11.6 x
ICICI Bank 8.6 x
Solvency Issues or Quality of Lending

Source: Reliance Mutual Fund

• Indian banks’ asset quality has improved in last ten years.

• Gross NPL has fallen from 15.7% in FY 97 to 2.4% in FY
Low Mortgage Loan to GDP Ratio:

Source: Reliance Mutual Fund

• India has very low loan to GDP ratio. It is less than 5% in

India compared to 80% in the USA and 83% in the UK.
Break up of Various Consumer Loans Ratio:
Other Retail Loans / GDP
Mortgages / GDP(%)
50 40
41 35
40 India 30
30 Thailand 25
Malaysia 20 Malaysia
20 16 17 17
Taiwan 15 13
10 8 Korea 10 9
5 4
0 India Thailand Malaysia Taiwan Korea
0 India Thailand Malaysia Taiwan Korea

Consumer Loans /
GDP(%) Credit Cards / GDP (%)
60 58 140
50 120

40 India India
36 82.4
Thailand 80 Thailand
30 Malaysia Malaysia
26 60
Taiwan Taiwan
20 Korea
Korea 40
10 8 20
0.4 2.8
0 0 India Thailand Malaysia Taiwan Korea
India Thailand Malaysia Taiwan Korea

• Consumer loan/GDP ratio in India is at 8% compared to over 137% in the USA. Even
among Asian countries it is at the lowest level. Source: Bank of Baroda – Data as of2006
Corporate Loans/Leverage has come down:

Source: Enam Securities

• With Financial Restructuring corporate leverage has come down
from high of 25% in FY04 to little less than 15% in FY 08 and
will further drop to 5% by FY 10 due to higher profitability
which allows companies to generate high internal reserves and
reduce dependence on borrowed funds..
Proactive Government & Central Bank
• The US sub-prime turmoil has had a snowball effect towards the
world financial system leading to Liquidity Crisis.
• RBI has responded with multiple liquidity enhancement measures to
deal with issue…which has resulted in the infusion of around Rs
185,000 crore into the system.
• Reduction in CRR from 9% to 5.5%
• Reduction in SLR by 1% to 24%
• Repo rates lowered by 1.5% to 7.5%

• FIIs corprate bond limits hiked

• Banks can borrow upto 0.5% of their NDTL for MF liquidity
Chronology of Measures taken by RBI
to infuse Liquidity
Date Measures Effect
RBI hikes interest rate ceilings on NRI deposits Expected to infuse additional dollars into
September 16, 2008 and permits additional support under its the system, banks have already taken Rs.
liquidity adjustment facility (LAF) 91,500 crore from the RBI under LAF
MoF raised overseas borrowing caps for
Not expected to bring in additional dollars
September 22, 2008 infrastructure companies for capex in rupees
as the global credit markets are tight
from $100 to $500 million
Not expected to bring in more dollars as
October 6, 2008 SEBI lifts curbs on P-Notes
global investors have lost appetite
RBI reduced the CRR by 50 bps to 8.5% - first Expected to inject Rs 20,000 crore into
October 6, 2008
cut since June 2003 the system
MoF expands definition of infrastructure
Not expected to bring in big dollars due to
October 7, 2008 companies to include mining, exploration and
global credit squeeze
refining companies for ECB purposes
RBI reduces CRR by another one percentage Expected to release Rs 40,000 crore into
October 10, 2008
point to 7.5 per cent the system
RBI announces 14-day Term Repo Facility to Expected to help Mutual Funds to manage
October 14, 2008
meet liquidity requirements of Mutual Funds liquidity pressure
Chronology of Measures taken by RBI
to infuse Liquidity
Date Measures Effect
RBI reduces CRR by another one percentage Expected to release Rs 40,000 crore into
point to 6.5 per cent; the system;
Banks can borrow up to 0.5% of their net Expected to help Mutual Funds further to
demand and time liabilities (NDTL) to meet manage their redemption pressure
liquidity requirements of Mutual Funds; effectively;
Rs. 25,000 crores under the Agricultural Debt
October 15, 2008 Further liquidity will come into the
Waiver Scheme is to be made available to
banks immediately;
Expected money would flow – likely to
Interest rates on NRI Deposits increased;
ease the pressure on the rupee
MoF raises FII debt limits for corporate bonds
to US$6bn
Repo Rate cut by one percentage point to 8%; Expected reduction in home, consumer,
October 20, 2008 corporate and personal loan rates which
Auction of Gsec of Rs. 10,000 crores cancelled will help to increase economic activity
SLR cut by 1% to 24%, CRR cut by 1% Additional liquidity of Rs 40,000 cr into
November 1, 2008 brought to 5.5%, Repo rate cut by 0.5% to the system; pave way to reduce interest
7.5% rates of loans
Impacts on Indian Markets –
Growth Rates
• Strong Demographic
• Low Dependence on Exports
• Substantial Reduction in Commodity prices
• Strong Financial System
Can their be an Impact on India Growth Story ?
Demographic Advantage:
•1.1 billion population
•54% of the Indian population
is less than 25 years of age
•One quarter of the world’s youth
lives in India
•By 2013 the net addition to the
productive population (aged 25 – 44 years)
would be 91 million
Which leads to :
Huge Consumer Base
Large and Cheap labour force
Educated labour force
Impact on Indian Markets – Growth Rates
• Export driven industries like Software, Diamond and
Textiles will get affected for next few quarters.

• Raising Capital in certain sectors will become difficult

• Economic growth rate will come down from high of 8.5 –

9% range to 6.5%-7.5% range. ( Which also are very high
by global standards)
India’s fundamentals are strong
• Two of the Biggest concerns on India have been:
– High crude oil prices (makes the governments finances vulnerable)
– High Inflation
The crude oil prices have already corrected from the peak and other
commodity prices have also corrected in the range of 40 – 50%.

• Crude and Commodity prices have come off sharply in the past 8 months. This
would help ease pressure on the fiscal deficit and inflation.
Commodit y High Low Gain/Loss
Crude 146.2 69.85 -52.20%
Copper 8720 4630 -46.90%
Aluminium 3317 2130 -35.80%
Zinc 2365 1180 -50.10%
Period: Feb-08 to Oct-08
Positive Macro Indicators
• Growth Rate: No doubt a global
slowdown will affect our growth rate.
But India will still continue to grow at
7% p.a., a high growth rate in itself
and will also continue to be the
second fastest growing economy in
the World. . Indian exports are only
18% of the GDP so we are not
dependent on US to drive our growth.

• More importantly what can seen from

the IMF estimates is that our Growth
Gap over the rest of the World will be
• Chart 1 & 2 shows the actual and forecast
GDP growth in 2007 and 2009
respectively as per the World Economic
Outlook report issued by the IMF in
October 2008.
India Growth Story – Long Way to Go….

This is where we
Impact on Indian Markets –
• The fall in the Indian Markets has been mainly because of FII outflows
at least the journey from 15000 to 8500.
• FIIs have remained net sellers by pulling out $12 bn from Indian
markets in first 10 months of 2008 but we have witnessed surge in FDI
inflow in 2008.
• Compared to $8.5bn received during April-August 2007 we have
received more than $16bn during the same period in 2008 in form of
Strong Domestic Ability to Bring Inflows
• India is a Savings Economy
• India’s saving rate is close to 36% ($410 bn) of GDP of $1.18
• Outstanding Fixed Deposits with Banks of Indian Consumers
31.13 Lac Crores (As on 26 Sept 2008)
• In FY08, FIIs invested $16 bn in Indian equity but compared
with this, insurance & MF inflow were of $19 bn
• The inflows from Insurance Companies and MFs shall only
increase in coming years.
Strong Domestic Ability to Bring Inflows
• A strong debate has been going on for a long time now whether
Pension Funds should be allowed to invest at least 5% of their
corpus into Indian Equities.
•Under the New Pension Fund Scheme it has been decided that the
subscribers shall have the following options:
•Invest fully in Government Securities
•Investment of funds upto 5% in equity and upto 10% in equity
linked mutual funds.Pensions shall be privatised and allowed to
invest in equities.
• Out of total of $15 bn pension and PF money, at least 5% is
expected to come into equities. Measures such as these are expected
to increase the flow of funds to equity markets once the New
Pension System is fully operational.
Trend of Institution Investment in Equities:
Equity Fund Inflows
55000 53933.1


24218.5 25000
9062 11982

2006-07 2007-08 April 08-Oct 08



Insurance Cos Mutual Funds FIIs

All figures are in Rs Cr. Insurance cos figure for April-Oct 08 is industry estimate.
Indians are Under Invested in Equities:

• Domestic savings are highly concentrated in government

securities and fixed deposits. Only 6% of domestic savings
of $410 bn get channelized into equities.
Summing UP

• India has strong fundamentals,it shall be impacted by

global crisis however it shall continue to be in the high
growth economies in the world.
• Financial Crisis seems unlikely
• Liquidity flows shall put pressure on the markets in the
short run but in the long run fundamentals works and there
is potential of substituting the FII flows by Indian
Back to Basics

• Relationship of Price and Profit Growth

• Current Market Valuations
• Where can the Markets go
Equity Prices are Slaves of Corporate Earning:
Equity markets always, ultimately, reflect the fundamentals and
growth of the economy and corporate profits.
HDFC Bank Profit-Stock Price Growth







31st 31st 31st 31st 31st 31st 31st 31st 31st 31st 31st
March 98 March 99 March 00 March 01 March 02 March 03 March 04 March 05 March 06 March 07 March 08

Profit Stock Price

1 Year 2 Years 3 Years 5 Years 7 Years 10 Years

Profit Growth 39.31% 35.14% 33.68% 32.62% 33.52% 38.07%
Stock Price Growth 39.52% 31.13% 34.69% 41.52% 28.64% 34.19%
How Corporate Profit Drives Stock Price:

RIL Profit-Stock Price Growth Relation








31st 31st 31st 31st 31st 31st 31st 31st 31st 31st 31st
March 98 March 99 March 00 March 01 March 02 March 03 March 04 March 05 March 06 March 07 March 08

Profit Stock Price

1 Year 2 Years 3 Years 5 Years 7 Years 10 Years

Profit Growth 62.92% 46.48% 36.97% 36.51% 32.98% 27.97%
Stock Price Growth 65.35% 68.78% 60.69% 52.13% 28.60% 29.19%











Market PE Chart
Trailing PE

Sensex Trailing PE
Current Valuations Offer Great Opportunity:
Sensex Levels

Price Earning Ratio \ Years 1 2 3 5 7 10

14 13,455 16,146 19,375 27,901 40,177 69,426

16 15,377 18,453 22,143 31,886 45,916 79,344

18 17,299 20,759 24,911 35,872 51,656 89,261

20 19,222 23,066 27,679 39,858 57,396 99,179

22 21,144 25,373 30,447 43,844 63,135 109,097

Current EPS assumed at 800 with SENSEX of 9771 and earning growth of 20%.

Sensex Levels
Price Earning Ratio \ Years 1 2 3 5 7 10

14 12,895 14,829 17,053 22,553 29,826 45,361

16 14,737 16,947 19,489 25,774 34,087 51,842

18 16,579 19,065 21,925 28,996 38,347 58,322

20 18,421 21,184 24,361 32,218 42,608 64,802

22 20,263 23,302 26,798 35,440 46,869 71,282

SENSEX earning growth of 15%.

It is the Time that Matters & Not the
Market Timing

For Long term horizons, there is no difference between lowest, average and
highest return Source: ICICI Prudential Mutual Fund
Answers to Investors
Q. You never told us to sell when the markets were at 21,000 levels?
Rather you were saying that in long term one can get 15%-20%
 Mkts slightly overvalued @ 21000( P/E 24-26) written in FW ( article NOV,
 Exit calls cannot be given unless markets are unreasonable valued (P/E 45-50)
seen in past (i.e. Mkt levels above 30000)
 Profit Booking rather comes from Asset Allocation
 Profit booking is a function of total exposure to equities.
 SIP / STP is always a better way which we have been emphaisisng
 There are all possible chances of getting 10% returns from peak for an
inv.horizon of 5 – 7 years
 There were hardly FIIs inv. between 1979 -2001 however markets gave 17%
Answers to Investors
Q. At 14,000- 15,000 levels you aggressively came to us and said there is
a limited downside and you should start investing; markets are
looking very attractive?
 The journey of 21,000 to 15,000 was on account of:
- Rise in commodity prices mainly oil price which touched 150 dollar per
- Rise in commodity prices brought inflationary pressure resulting into slower
growth rates.
 Oil was lloking speculative ( Covered in FW editorial BOILING OIL – Month
June 2008)
 Mkt still looked attractive below 14000 and oil price rise was factored for
lower growth
 With oil price and commodity price correction market looked very attractive
below 14000
 We expected the mkt to double in next 5 years( WE still continue to believe
the same)
Answers to Investors
Q. Today also you are saying to invest but people say the economy has
entered into a medium to long term recession. We have already lost
significant portion of our capital, how do you expect us to invest
 The fall from 14,000 to 9,000 has been on account substantial liquidity issues
rather than any fundamental issues.
 It started from the announcement of bankruptcy of Lehman Brothers on 15th
September at 11.30 hrs IST and markets were at 13,500.
 FIIs pulled out close to Rs 20,361 crores of Equity investments in the month of
Sept-Oct. If we see the YTD 2008 figures, FIIs have pulled out Rs. 48,875
crores of Equity Investments. This is one of the reasons for the sudden fall in
the markets. (Data as on October 24, 2008).
 Major selling of FIIs is over , however we may see some corrections further
 Market available at extremely low valuations 10 P/E
Why Mutual Funds?
NAV of various MF
Particulars Date Levels PE ratio EPS Reliance Reliance HDFC HDFC Sundaram
Growth Vision Top 200 Equity Sel. Focus
Sensex 24-Oct-02 2908.05 12.58 231.16 26.87 23.63 15.00 19.87 9.68

Sensex 24-Oct-03 4757.37 17.10 278.21 55.67 49.74 31.63 41.69 18.09

Sensex 24-Oct-08 8701.07 10.63 818.54 201.51 126.41 86.23 105.29 51.21
Absolute Returns (%) 2002 - 2008 199.21 254.09 649.94 434.96 474.87 429.89 429.03

Absolute Returns (%) 2003 - 2008 82.90 194.22 261.97 154.14 172.62 152.55 183.08

CAGR (%) 2002 - 2008 20.04 23.46 39.91 32.25 33.84 32.04 32.00

CAGR (%) 2003 - 2008 12.83 24.09 29.34 20.51 22.21 20.36 23.14
If invested Rs.100000 2002 299206 749944 534956 574867 529894 529029
than the value shall be 2003 182897 361972 254142 272621 252555 283085

From 2002 to 2008, Sensex went up by 199% but the funds have gone in the range of
389% to 649% in absolute terms. Earnings of Sensex went up so did the Price. This
is where the OPPORTUNITY lies. Right now Equities are at hefty discount.
Why Mutual Funds?
• From 2002 to 2008 Sensex went up by 20% but the funds have up in
the range of 30% to 39% in CAGR terms.
From 2003 to 2008 Sensex went up by 12% but the funds have gone
up in the range of 20% to 29% in CAGR terms.
• If you compare the period of 2003 to 2008 the earnings have gone up
by 24% (CAGR) but the Sensex has gone up by just 12%. Prices will
catch up on the earnings. This is where the Opportunity lies.
• If Sensex is the benchmark for equities than MF outperform the Sensex
by wide margin and in multiplication times.
• The Best Vehicle for Wealth Creation is Equities……that too
Investments by way of Mutual Funds.
How Investment Gurus have behaved in Crisis
Sir Warren Buffett has always said:

‘ Be Fearful when others are Greedy

and be Greedy when others are
Debt Liquidity of Fund Houses

Liquid Semi-Liquid Illiquid

Mutual Funds  As per the
Assets Assets Assets
Reliance MF 42.66 33.34 24.00 analysis of MF
HDFC MF 42.36 30.51 27.12 debt schemes, we
ICICI Pru MF 67.26 16.42 16.32 can see the large
UTI MF 53.16 33.65 13.19
funds have majority
Birla Sunlife MF* 58.60 26.80 14.60
Franklin Templeton MF 31.18 42.61 26.21 of assets which are
Tata MF 70.00 26.33 3.67 liquid in nature.
Kotak Mahindra MF 43.24 41.86 14.89 Hence, MFs are in
DSP Merrill Lynch MF 50.61 35.29 14.10
a good position to
LIC MF 9.25 67.83 22.92
HSBC MF 40.43 42.54 17.03 manage the
Overall MFs under analysis 47.52 34.03 18.45 redemption pressure
As on September 30, 2008; Illiquid assets include Real Estate Papers & PTCs
* FMPs are not considered
as they have enough
liquid assets.
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