Realty Bites….

In its first leg , the rally was rampant and all across . It was less discriminating and more democratic . It was “inclusive” to use the right political term . This was till June when the tide was high across and lifted all and sundry . Market is not as generous now in its second leg of its rally which began early Aug . It is more selective and choosy rewarding staunch stock pickers than fickle stock flirters. It is less forgiving and more grievous for the punters who bet too much on hope rally .

Going by the sectors that have been hit the most , it appears that the market could be suffering from the so called “Hi-beta Blues” .  High beta sectors such as Real Estate , Infra , Power  , Metals , Cap goods etc have terribly underperformed the benchmark in this leg of the rally . Realty with 14% fall in its index is the most hit followed by power (11% fall) , capital goods (9.5% fall) and PSU ( by 7.0 %) to name a few  . Metal index is not far behind with its 5.5% drop. In contrast , Sensex is up 4% this period with much sharper rise in Auto / Healthcare and other indices .    

While the fall in index in itself quite sharp , it does not tell the full story . Underneath , some of the prominent sector  stocks had a much sharper knock .  DLF and Unitech took the steepest cut of over 40% followed by India Bull Real Estate ,  DB Realty and  Omaxe falling by over 30% .  These are not small names . They are the bell weather stocks for the sector . This does portend ominous signals for the sector that one can ill afford to ignore .

The bite is quite deep and sharp for the Realty . Reasons are not difficult to fathom . Overburdened by excess supply and muted demand , the sector has been  reeling under vicious cash flow pressures for a while now . Add to that  the funding pressures and lack of credit from the banking channel , the fundamentals could not be more shaky . Muted demand outlook does not help much either . So the earning upgrade that the hope rally was factoring in ,  was met with a huge shock when the results were announced for the leading lights of the sector . Post the earnings shock , cracks started creeping in for the sector stocks , notwithstanding the hype around REIT ( Real Estate Investment Trusts) announcement in the budget . Relief from REIT is not anytime soon in terms of easing funds for the sector as the fund industry is less enthusiastic on the prospects given the tax tangles ( stamp duty from state side etc) and regulatory rigor ( restrictions on allocation to residential / under construction projects etc) .   

On fundamentals metrics , does the sector offer value at the current prices ? . While the macro recovery will help demand bouncing back in realty , the recovery is unlikely to be sharp given the sector headwinds discussed above. Moreover , given the stretched and opaque balance sheets of many underlying companies  , the sector is unlikely to match up with the stringent quality guidelines of long term investors any time soon .

As someone remarked , “Simplicity is the ultimate sophistication “.  Wise investors look for one-foot hurdle that one can “step over” in simple  companies with clean balance sheets that are  well-run by focused  management in a mature sector and strike it at opportune time when price is right  . Realty with its entangled balance sheets , murky governance and cyclical prospects  would hardly  qualify for the above prescription.     

Happy Value Investing !!!

ArunaGiri . N


Advantage Arbitrage….

If one wonders what FM has fixed in this budget  , the answer is , he has certainly put the FMP investments in a “fix” with his new taxation proposals . In short ,  Budget has dealt a lethal blow to “Fixed Maturity Plans”(FMPs) by hiking the tax and tweaking the duration . For the uninitiated , FMPs are simple fixed income mutual funds with return profile similar  to  Fixed Deposits , but with significant tax advantage as they qualified for capital gains . Under this , any FMP investment held beyond one year attracted concessional tax of 10% without indexation or 20% with indexation . With indexation running closer to FMP returns , the net tax incidence was close to zero .   This tax arbitrage gave a fillip to FMPs while their poor deposit (FDs) cousins suffered unduly because of differential tax treatment (  interest from deposits are taxed at the highest tax brackets i.e marginal rate of tax) . With this anomaly gone  for FMPs held for less than three years , such short-term FMPs are now on par with FDs on taxation and thus  losing its prime appeal to wealthy and corporate investors  .

Real returns ( after adjusting for inflation) were hardly positive for FMPs even in the earlier regime . Now , with tax efficiency taken out  , real returns have turned significantly negative matching those malicious fixed deposit numbers.  FMPs provided a convenient parking place for both corporate treasury benches and HNIs alike . This formed a significant chunk of mutual fund assets . As per industry estimates , close to 20% of overall MF assets of  INR 8.00 tn+ came from FMPs . With FMPs losing luster , what do these investors do to get their money work harder.

Here is where arbitrage funds come into play . These are funds that invest in equity based  arbitrage opportunities to enhance the return profile without taking market risk so as to deliver stable  returns . Since they are equity based , they enjoy concessional capital gains tax ( short-term tax of 15%) and hence provides attractive post-tax returns viz-a-viz competing fixed income products like FMPs and FDs.    

Arbitrage funds come in many flavors . Those that specialize in encashing the mispricing between futures and cash markets are more common and mutual funds have many schemes around it . Though they are less risky , historical returns from these schemes are anything , but inspiring . They range between 6 to 8% pre-tax and  are tad higher than FMPs/ FDs on post tax basis .On the other hand , there are specialist products that capitalize on the risk-free stock specific arbitrage opportunities arising out of  special situations like open-offer , merger , de-merger , delisting etc . Since these are based on   event based arbitrage opportunities  , they do not carry market risk and hence carries low risk . Such funds provide much higher spread  on post tax basis given their favorable tax treatment . Given their specialist nature , these products come from niche portfolio management houses (PMS) than from their larger peers ( mutual funds).

If historical returns are anything to go by , these funds have done exceptionally well with post-tax returns running at over 11-12%+ level outsmarting competing FMPs by over 500+ bps spread . TrustLine’s floater fund belongs to this category and has surprised on the upside on all performance metrics since inception .    

It is advantage Arbitrage , no less   . Budget has brought cheers to the arbitrage schemes of the PMS and mutual fund houses alike . Watch out for more actions on the arbitrage side !!!.

 ArunaGiri . N