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Why debt funds are a safer option for now

Devangshu Datta | December 15, 2008

The consensus opinion is that the Rs 3-trillion stimulus package will not have much positive effect on GDP growth. Institutions ranging from the World Bank and the ADB to RBI have revised GDP estimates down.

Actually most of the stimulus package consists of planned spending that was already scheduled. Less than 10 per cent is new commitments that will, at best, ensure investment doesn't totally evaporate. But the economy will remain capital-starved until a global recovery.

By all accounts, 2009-10 will be a hard year. Many, if not most, companies will register falling profits or move into the red. Debt servicing is likely to be a big issue for India Inc. In a year when cash flows will be low, there is a massive overhang of ECBs as well as domestic debt to be dealt with.

More than the stimulus package, RBI's move to cut policy rates could offer a lifeline for investors seeking returns in the next 12 months. Lower reverse repo and repo rates must translate into lower commercial rates. This is already being signalled by lower cut-off yields in the latest T-Bill auctions.

Given that demand for industrial and consumer credit is low and falling, bank rates will follow suit. Although defaults and NPAs are rising and will rise further, lower rates also mean a potential upside for debt funds, which have been moribund for the past two years.

Lending institutions, especially PSU banks, appear to be cheap now with the caveat that NPAs will rise.  Eventually, cheaper credit should stimulate consumer demand and pull in more investment as well. But for that, there needs to be a return in confidence.

For the long-term investor, valuations already appear to be within the zone of safety. Stock prices will fall further in the next financial year. But they are likely to be considerably higher than the current levels within the next three years.

The essence of value investing is a focus on strong balance sheets and a long-term perspective rather than immediate profitability or revenue growth. A Graham disciple, who steers clear of high indebtedness can cherry-pick blue chips with a degree of confidence. The value investor has to be cautious however, since even conservative dividend yield plays could go wrong in the current climate.

The most visible long-term growth opportunities are still scattered across the infrastructure space. India continues to suffer from a massive infrastructure deficit and there will be continuous policy efforts to attract capital.

In infrastructure, telecom has the best growth rates and foreign investors are still interested in the Indian market despite the liquidity crunch. The major players are profitable despite ferocious competition and controversial policies that have led to much litigation.

It is also in the government's interest to get 3G and Wi-Max auctions over and done with within this financial year itself. This would not only help balance public finances, it would mean the UPA takes a larger war chest into the general elections.

Unfortunately for investors, the auctions will alter the telecom playing field all over again. Several new players are likely to enter the fray and it's possible that the market leadership could be altered once the dust settles. Not all the new players will be listed either. Nevertheless, there appear to be opportunities in telecom and that is more than can be said of almost any sector in the next year or so.

Other than these, the best chances of short-term returns seem to lie in trading opportunities. The basic requirement for a trader is liquid markets and that is not a problem. Remarkably, the F&O market is still generating over Rs 40,000 crore (Rs 400 billion a day and even the commodity exchanges have ample liquidity. Volatility is high as it tends to be in bear markets.

That means a trader, who is good or lucky, can continue to make money or lose it because, of course, the risks in short-term trading are very high. A safer alternative is to invest judiciously in debt funds for the short term and equity for a longer time-frame.

It is frightening to think that there are so few sectors appearing capable of generating exceptional growth in the context of the next 12 months. This bear market is a mirror image of the bull market between 2004-2007, when almost every sector shot up.



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