How Flipkart sealed the deal with Myntra

Flipkart’s Sachin (left) and Binny Bansal (right) have agreed to keep Myntra as a separate entity that will retain its website and continue to be led by Mukesh Bansal (centre). Photo: Hemant Mishra/Mint

Bangalore/New Delhi: In May 2014, For Flipkart.com and Myntra.com, merging with each other is all about remaining separate. Flipkart, India’s largest e-commerce firm, announced that it had bought Myntra, India’s largest online fashion retailer, in the biggest deal ever in India’s Internet space.

The e-commerce business in India is valued at $3.1 billion, excluding travel services and tickets, according to a November report by CLSA.

The long-awaited, cash-and-stock deal is likely to value online fashion retailer Myntra at more than $330 million, one person familiar with the matter said, requesting anonymity.

Following two-month long negotiations that led to Thursday’s announcement, both sets of Bansals—Sachin and Binny at Flipkart and especially Mukesh at Myntra—were clear that for a merger to make sense, Myntra would need to be kept independent.

The lessons of the past two years showed that apparel, unlike books and electronics, is a product category that requires specialization, deeper understanding of fashion, aesthetic presentation and experience, rather than volume-focused approach of Flipkart.

“Mergers are risky and integration can be very dicey,” Myntra’s CEOMukesh Bansal said in an interview. “So it was very important for me to ensure that we would not be integrating anything. Most of the discussions were to ensure that there is absolute alignment about the management autonomy.”

He got what he wanted.

Flipkart has agreed to keep Myntra (pronounced Mint-rah) as a separate entity that will retain its website and continue to be led by Mukesh Bansal, co-founder Ashutosh Lawania and the rest of the current management team.

For Flipkart, which started selling apparel two years ago, the deal is about gaining size and keeping Amazon India, Snapdeal and others at bay. The company started selling fashion products only two years ago but fell way short of its target to be the No.1 in the category by October 2013.

The deal was stitched together over several meetings in March, mostly held at the coffee shop in the Grand Mercure hotel near Flipkart’s office in the Koramangala area of Bangalore. The two sets of Bansals talked about how the merger could be mutually beneficial.

“The Flipkart team reached out to us and expressed interest in a merger. So we got involved to understand what they have in mind. As we interacted over a month, I could see they seemed very credible and authentic,” Myntra’s Mukesh Bansal said.

They discussed various ways in which he could achieve his goal of generating $3 billion or Rs.20,000 crore in gross sales by 2020. It was clear he would need $150-$200 million more. If Myntra didn’t merge with Flipkart, it would need to raise possibly more because the market was only going to get more competitive with Amazon carving out aggressive long-term plans for India.

A powerful case

By early April, Mukesh and his senior management team were convinced the best way to secure the future of the brand he had built was to join hands with his cross-town rivals.

“We could’ve have tried to do this alone. But we have key battles ahead. The choice was: we can fight all the four players (Flipkart, Snapdeal, Amazon, Jabong) or we can join hands with the strongest player and collectively fight the two key battles. One is the dominance of the horizontal marketplace and the other is the dominance of the fashion vertical. As I saw it, it made more and more sense to use money to fight the other players together rather than burn money to fight each other. I was really convinced that 1+1 can be four,” Myntra’s Mukesh Bansal said.

He spent April discussing the merger and valuations with other board members, investors such as Accel’s Subrata Mitra, Tiger Global’s Lee Fixel and Kalaari Capital’s Vani Kola.

Bansal wouldn’t give details on the discussions and the valuation but said that there were initially some directors, who opposed the merger and wanted Myntra to continue on its own. “But by that time, considering all that we’d discussed, there was such a powerful case for merger that it didn’t take more than a few conversations to convince anyone. Our board culture has always been such that they give the management autonomy and if most of the management team supports a decision, they usually agree to go ahead with it,” said Bansal.

Myntra board member Sudhir Sethi, chairman and managing director at IDG Ventures India, said the board of directors evaluated other options such as a future initial public offering (IPO), but decided unanimously that there were “big benefits in merging with Flipkart”.

“The fact that there are common investors, the founder teams are comfortable with each other, Myntra would get well-capitalized and also that both the companies are based in Bangalore—all these factors played a role. Myntra will also get access to the large traffic that comes on Flipkart as well as its massive delivery network,” Sethi said.

Achieving success in fashion is critical as apart from offering the juiciest margins, it is also expected to be the largest category in e-commerce over next five years. Buying Myntra, with its strong brand, fashion expertise, experienced management team and deep relationships with apparel manufacturers and retailers, is a straightforward way of ensuring a leadership position for Flipkart.

Nerve-wracking crunch

The case wasn’t as straightforward for Myntra and Mukesh Bansal, at least not in January. The company just raised $50 million from Premji Invest and others in January, following a year when it was forced to burn most of its cash in fending off deep-pocketed rival Jabong and, guess who, Flipkart.

The worst was behind it and by then large, global investors had shown willingness, at least in private, to invest in e-commerce, so Myntra could have raised more cash this year.

Then there was the personality aspect: Myntra’s Bansal is seen as a mentor by entrepreneurs including his namesakes at Flipkart and is much senior to them in age and experience.

He had rejected a similar merger idea put forth (in informal conversations) by common investors Accel Partners and Tiger Global Management late last year.

But as Flipkart’s Sachin Bansal reached out to Mukesh Bansal over the phone in late February with a serious merger proposal, the latter’s thinking had already changed to some extent.

According to conversations with Mukesh Bansal, and investors at the two Bangalore-based firms, four things convinced Mukesh to sell: the presence of common shareholders Tiger Global and Accel Partners offered familiarity and comfort; the mutual respect between him and his counterparts at Flipkart; the guarantee of access to a significantly large pool of funds that is unique to Flipkart; and finally, the nerve-wracking experience of the January fund raising, which was closed just as Myntra was due to run out of cash within couple of months.

In 2013, Myntra was looking to raise fresh funds but because of a number of factors—the depreciating rupee, overall negative sentiment about investing in India, Flipkart’s and Jabong’s aggressive push in fashion—most of the investors declined to risk putting in money into the company.

“The feedback from most of them was: we are interested and we like what you are doing, but not now. But we needed money then so ‘not now’ was not very helpful. We had cash till early 2014 so we were not in imminent danger of running out but still, six months of cash is nerve-wracking,” Mukesh said.

When Flipkart came to him with a proposal in February, the lure of money—Flipkart has raised $560 million, including $360 million in the past year—was much stronger.

From there on, it was only a matter of time before the deal was done. Flipkart and Myntra together generate more than 50% of the online fashion sales and the companies aim to increase that number to 60-70% over time.

Mukesh Bansal on Thursday announced the merger in style. Coming on stage, Bansal said he had an “exciting” announcement to make. Then, pausing, he said, “Let me introduce two colleagues of mine.”

And out walked Sachin and Binny Bansal.

Why we don't invest in financial markets?

The Indian markets are in a buoyant mood. Hopes are high that the new government will be able to bring in big ticket economic reforms. Foreign institutional investors (FIIs) have already pumped in huge amounts of money into the markets. However, the market euphoria seems to have affected retail investors too. The optimism on the street is being driven by the hope of better days ahead. At such a time we would like to point out a sobering reality that may not change anytime soon. This reality has prevented investors from creating wealth.

As the chart below shows, the share of household savings in financial assets like stocks, bonds, mutual funds, bank deposits and pension and insurance funds, has fallen (as a % of total savings) since 2008. While the government has not released the data for FY14 yet, the situation is not likely to have changed much from FY13. As of today, nearly two thirds of household savings are in physical assets like Gold and Real Estate. Thus it is clear that retail investors have missed out on this market rally. It is indeed sad that when the markets were trading at reasonable valuations over the last three years, savings of Indian households did not find their way into the stock markets. Instead, a disproportionally large amount of savings went into Gold and property. Why did this happen?

Trust in financial savings has eroded
There is a two part answer to this question. Firstly, over the last five years, the Indian economy has suffered from negative real interest rates. In simple words, this means that the rate of inflation was higher than the interest rate offered by banks. Thus people had no incentive to keep their hard earned savings in bank deposits (or any other financial asset). To preserve their wealth, they moved their money into assets like Gold and property. The second part of the answer can be summarized in one word: Trust. Time and again, investors have been swindled by unscrupulous people and have lost their shirts in the stock markets. Even in the current up move in the markets, we have seen how brokers have tried to lure investors in to the markets with claims of high Sensex levels. Investors are being tempted by their so called 'advisors' to speculate in the markets with their hard earned money. Corporates, desperate to raise money, have already begun to draw up plans for expensive IPOs. We are all aware what can happen in times of euphoria. Rational thought is often sacrificed for quick profits. This can lead to huge losses as we had seen in 2008. It is such losses that scare away retail investors from markets. In a case of 'once bitten twice shy', they park their funds in so called safer investments like property and Gold.

However, the shift of household savings from financial assets to physical assets can have grave consequences for the economy as well. If savers prefer land and Gold over bank deposits and equity, then corporates will find it harder to raise money from banks and the stock markets. This has caused many corporates to delay their capex plans. In such a situation, corporates are unlikely to hire in large numbers. If the private sector does not create jobs, any economic recovery is  likely to be an illusion.

The only long term solution is to bring inflation under control as soon as possible and improve regulation in financial markets. A healthy combination of positive real interest rates and better regulation will bring back the trust of retail investors. We certainly hope the new government will not disappoint investors in this regard.

If you do not own gold, now is the time..

Imposing import duty on gold has been just one of the attempts of UPA government to arrest current account deficit (CAD). The policy may not have had a meaningful impact on the deficit. However, what it certainly did was bring down the gold import volume dramatically (down 80% YoY). Meanwhile, the quantity of gold smuggled into the country has also growth disproportionately. And that has in many ways defeated the purpose of the import duty. So in what may come as a huge relief to gold investors, the NDA government is contemplating to cut the import duty. Given that the sentiment towards buying gold is already muted, the government probably does not fear stoking CAD concerns. More importantly, the constant foreign inflows after the change of government have also eased deficit concerns to an extent. Further fall in gold prices, in the event of a duty cut, should be seen as an opportunity to buy more gold we believe. While investors may not want to speculate on near term trend in gold prices, holding 5 to 10% of one's assets in gold continues to remain important. And the duty cut will certainly tilt the risk-reward balance for gold firmly in favour of the latter.  

The Dubious Recovery

Post the 2008 financial crash, loan growth has been relatively much lower than it usually has been. The loan growth has largely been restrained below the 8% levels at peak and declining as seen in the chart below - much lower growth than it used to be coming out of recession. It indicates that the consumer has not been confident enough to borrow. The absolute condition of balance sheets matter and we should not be surprised that this is a factor weighing on consumer and business confidence. People are waking up to the fact that they can't randomly borrow their way out just on the basis of notional wealth which can quickly vaporize at the first signs of risks to the economy.

Chart: Total Consumer Credit

Some might argue that although growth has remained relatively muted it has now turned positive which is far better than the deleveraging i.e. paying off the debt to decrease the financial leverage, that ensued as a result of the aftermath of the crisis.

Yes, borrowing from consumers has been growing but the major contribution has been coming from federal government guaranteed student loans which is unlikely to add to consumption. The past credit boom came from the likes of credit card debt, the auto loans and the home equity line of credit; these are the ones still showing signs of deleveraging.


Source: FRBNY Consumer Credit panel / Equifax

But that's not all; many of those in their early 20s, seeing how hard it is to find a job, are staying in college for longer, amassing outrageous levels of student debt in the process. Consumer credit increased by US$173bn YoY as on March 2014, with federal student loans accounting for US$125bn or 72% of that total increase. It's indeed logical to see the interest on student loans rising by the day and are now at all time highs. The bulk of the credit is taken to pay for the burgeoning education fees and this will likely be a drag on the economy even over the long run as well. This is obviously not a sustainable solution.

One bright spot

We can clearly conclude that from a consumer perspective, it's been a weak recovery from an employment side and also the resulting ability of consumers to borrow and spend seems compromised. However, there is one thing that we are closely watching for - if there are any signs of economic momentum building up. It is worth noting that recent months have seen a bit of a pickup in the commercial and industrial (C&I) credit. Much of the increase in bank credit has been primarily driven by the increase in C&I loans. As of March 2014, the total bank credit grew at 2.9% YoY whereas the growth in commercial and industrial (C&I) loans was 9.8% YoY.

Chart: Bank Credit and Commercial & Industrial Loans Growth (YoY)

We would continue to monitor this space but it's unlikely to lead to an economic breakout. This pessimism is largely on account of a few signals already alarming caution. A survey of senior lending officers revealed a greater percentage of banks easing standards and reducing spreads on C&I loans to firms of all sizes. There's deterioration in contract terms and pricing and that's potentially the kind of behavior that drives a crisis...sounds familiar.

Rest, The recovery enthusiast

The improvement in consumption is also likely driven by people dipping into their kitty. US personal savings have fallen from 5.1% of disposable income in September 2013 to 3.8% in March 2014 is indicative of the fact that people have been forced to fall back on their savings to make ends meet as incomes are not enough if at all and they are clearly shying away from borrowing their way out. Clearly, a pickup in consumption does not look that convincing if it is only driven by a falling savings rate.

Chart: U.S Savings rate

However, optimists continue to point out at recovery in house prices and surging stock markets as signs of growth.

One important aspect of all the supporters of the necessity of QE is clearly the improvement in household balance sheets caused by the recovery in house prices and the surge in American stock market. With all the liquidity sloshing around it's not surprising to see asset markets increase in value. With housing, the story is always more complicated than the top-line numbers suggest. The all-important housing market pending home sales index has largely been in a declining trend. The new purchase mortgage applications index has also continued to fail to pick up in a convincing fashion.

There is one thing that high asset prices do accomplish, however: the so-called "wealth effect."Along with booming stock prices, higher property values make people feel rich - "notional wealth". This then encourages them to go out and spend money. The policymakers have been fueling an asset reflation story with a hope that they can keep the US economy going until income growth and employment growth finally pick up convincingly.

The striking problem with the asset inflation story is that it only furthers extreme wealth distribution. Corporate profits have skyrocketed and the stock market has rebounded, but these successes have not translated into widespread prosperity. The benefits are only accruing to those at the top - the 1% - while leaving everyone else to fight over the few opportunities available. This problem is not going to fix itself.

Digging deep, it really seems convincing that the recovery is indeed dubious. It eventually will fall out like a pack of cards and will likely have a domino effect on the financial economy when it hits the wall. It's pretty uncertain as to when the day of reckoning arrives but the outcome is going to be disastrous. An allocation to gold in such uncertain times is important for investors. I reiterate that the main reason to own gold is just the sheer fact that it is one of the good portfolio diversification tools and thereby may help you to reduce overall portfolio risk.

Data Source: Bloomberg, World Gold Council

Importance of CIBIL score and Credit Information Report (CIR)

A good credit score is one of the most important eligibility criteria based on which a bank gives you a loan. Your credit score, which the Banks check through CIBIL, is a precise indicator of your credit history which reflects factors like: -

• Record of late payments and defaults.
• Loans and credit cards that you currently hold.
• Diligence towards paying loans and credit card bills.
• Number of loan and credit card applications submitted by you.

Diligence towards repayment and having secured loans like home or auto loans works positively for your CIBIL score. On the other hand, payment defaults and too many loan or credit card applications can have a negative impact on your CIBIL score.
A good CIBIL score helps banks to determine your credit-worthiness and approve loans and credit card applications faster.

 What is CIBIL?
Established as the Credit Information Bureau (INDIA) Limited or CIBIL in August 2000, CIBIL is India’s first Credit Information Company (CIC) and is the central recorder of the credit information of all the borrowers. CIBIL collects and maintains all the record of each particular individual regarding the loans and credit cards and provides the same information to all other financial institutions, so that the banks can be aware of your credit history before approving your loan.
This information is provided to CIBIL by the member banks and finance houses. Every time you borrow a loan or avail a credit card, your credit and repayment information is collected and submitted by the member bank to CIBIL on a monthly basis. This information is collected and recorded to create a Credit Information Report (CIR), which is in turn shared with all the other banks and financial institutions.
The next time you walk into a bank to apply for a loan, your CIR is first verified by the bank, to prevent the bank from providing a bad loan or lending money to borrowers who may not be credit worthy.
Thus, the CIR is your credit score sheet, which the bank verifies before approving your application. CIBIL has played an important role in the Indian financial system, providing efficient information and preventing a bad situation.

How does it work?
To approve you a loan, the credit lending organization must gather your credit score and repayment history, which may be spread over at various institutions. CIBIL collects and organizes your data and provides the same to all the banks and financial institutions, which by default are members with CIBIL. The bank uses this collective credit history to determine whether your application should be approved. It helps the bank to function efficiently and in an economical way.
Thus a CIR is a factual report which provides an idea on your credit and payments history. Every time a lender seeks a CIR of an individual from CIBIL, a unique nine digit control number is generated which the CIBIL uses to track an individual’s report from its database. A new control number is generated every time a request is made.

Can you check your CIR?
Every individual has the right to obtain his/her respective Credit Information Report (CIR). It is through this that you can determine your credit scores and standings. CIBIL does not mark you or any individual as a defaulter, but it is just mentions a particular score on your CIR. It is entirely dependent on the respective bank to determine who it considers a defaulter. The CIR credit score or the Trans Union score ranges from 300-900.
You can access a copy of your CIR by applying over the CIBIL website. You can make the payment online as well. You can find out more details at www.cibil.com.
Documents to be required in the process:

• A CIR request form
• Identity Proof of the requestor (Voters ID/PAN card/DL/Passport)
•  Address Proof (Electricity bills/Passport/Bank statements)
• In case you have cleared off your debts but your CIR has not been updated with CIBIL, all you need to do is to:
• Log on to the CIBIL website. https://www.cibil.com/
• Purchase your CIBIL credit report.
• Identify the error.

Get in touch with CIBIL through the Online Dispute Form to get the error corrected.

Be advised that CIBIL needs the Control Number of a CIR when you are raising a Dispute Resolution request so that it can review your report and make the necessary amendments.

What you should know to invest in gold

Gold is an asset that has dazzled investors in recent times. And investors have all the reasons to be happy about owning gold. Since the end of 1978, the yellow metal has delivered nearly 620% in terms of returns. The following graph is a testimony to the good times that gold has given to people who believed in it and held it for a long time. 

Data Source: World Gold Council

Even since June 2011, the precious metal has delivered a return of nearly 6%. Obviously if you compare it to the peak yearly return of 52% that it delivered in September 2011, this return looks low. But nevertheless, there are still investors who swear by gold. And they have every reason for it. 

Reasons to buy gold 

Gold has long been considered as a natural hedge against inflation. This means that in terms of price of the essential items, gold has not lost any value over time. So if back in 1978, you could buy x number of loaves of bread with one ounce of gold, you can still buy the same x number of loaves with the same one ounce of gold. This is one of the biggest reasons why investors love gold. While inflation eats away returns on other asset classes, till now gold has managed to remain insulated from it. 

Another major reason for buying gold is its safe haven status. At a time when uncertainty and volatility have become the words of the hour, gold's ability to preserve its value becomes invaluable to investors. The crisis in the Euro zone, slowdown in US and the seesawing US dollar, all combine to help direct the flow of money to gold. Since the supply of the metal remains restricted, the higher demand can only result in prices moving northwards. True, that in recent times, gold has seen some decline in prices, but most rational investors look at it as an opportunity to invest. 

But does it mean that investing in gold comes without any risk? Not at all. Like any other investment option, gold too has an argument against it. 

Reasons to not buy gold 

The one big area of concern in investing in gold is its price. Like any other investment option, it is necessary to keep valuation in mind when it comes to putting money in gold. The prices of gold have run up quite a bit in recent times. If we look at the following 5 year price chart for gold, we can see that the prices of gold have only moved north. 

Source: World Gold Council

But prices have corrected since their peak in September 2011. Since then, the price of gold has dropped by nearly 14%. But does that mean that gold looks good to invest in? Unfortunately, there is no clear answer to this question. The reason for this is that unlike other asset classes, it is not possible to pin point a definite intrinsic value on gold. Due to its aspirational value as well as its safe haven status, gold investment is largely driven by what investors expect the price movement to be. So if they expect prices to fall in the future, they sell gold and vice versa. It is more of an individual decision. 

Another problem with investing in gold is the form in which it should be bought. Some investors prefer to own gold in its physical form but that has a problem of storage and insurance involved in it. Some prefer to invest in e-gold or gold ETFs (Exchange Traded Funds) but in that case there are transaction costs involved which could cut down the total returns. 

Most important reason to not invest in gold is its 'hedge against inflation' status. In fact this is a reason that has been cited by even the legendary Warren Buffett. Though investing in gold can help to preserve the value of the investment. But if in time, it does not cover inflation rates or help earn returns higher that inflation, then what is the point of investing in it? 

Though it has its own pros and cons, gold nevertheless has caught the fancy of nearly every investor. And particularly for Indians like us, gold will always remain an object of desire. So the next question that pops into mind is how to go about investing in gold. In the next article we will discuss the various ways in which you could invest in gold. And the pros and cons of each way.

The Taper uncertainty

At the behest, as the uncertainty concerning the debt ceiling and nomination of Fed chair seemed to wane, the tapering was due. The Fed seems to have caved into market pressure to reduce the monetary extravaganza. Tapering in a more real sense would have involved giving an end point for when they will stop increasing the balance sheet.

Currently, the consensus estimate is that the Fed will continue to reduce the size of its QE program through 2014 and ultimately wind it up by the end of the year. However, this isn't necessarily a guarantee given that a) the program is data-dependant and b) both the Fed chairmanship and the several board positions will change early next year. As a result, both the timing and extent of the QE withdrawal remains uncertain.

In its endeavor to roll back QE, the Fed needs to strike a careful economic trade off. It needs to transform the growth trajectory from being policy-induced to a more sustainable private sector investment cycle-led impetus. This requires much higher levels of business and consumer confidence and a more distinct policy framework.

The real impact

The Fed has been seeking a measure of inflation for five years now without success. Also, that economic growth has disappointed despite such aggressive stimulus suggests that monetary policy is not working very well. If the Fed were to suddenly suspend QE3, it is doubtful whether the real side of the economy mainly concerning spending, production and employment would show much impact. Beyond a point, the asset markets could start feeling the pinch of withdrawal.

True State of the Economy

At the first glance, the Fed’s decision to slow down bond-buying, starting with a $10 billion reduction in January, is a sign of confidence that the economy is starting to stand on its own two feet. But a closer look at the underlying economy indicates a very weak labor market – the most important indicator of the health of an economy.

Although, the unemployment rate has fallen from its peak of 10.0 percent in 2009 to 7 percent in 2013, this seems to be mostly because people have given up looking for work. The labour participation rate stands at 63% - a multi decade low. The employment to population ratio is just 0.4 percentage points above its low for the downturn suggesting no real improvement as suggested by the unemployment rate. It is still more than 4.0 full percentage points below pre-recession levels, corresponding to 9.5 million fewer people with jobs.

And this is not a story of retiring baby boomers. Employment among people aged 25-54 is down by 4.0 percentage points from its pre-recession level. Furthermore, the weakness of the labour market drags down large segments of the workforce as many workers find it impossible to get wage increases when the labour market is so weak. The number of people living on food stamp assistance is at record highs testifying a weak labour market.

Policy – the way forward and potential pitfalls

It remains an undisputed fact that debt levels across major economies still remain unsustainable. Central banks are making it easier to carry this debt overload by keeping interest rates at record-low levels. But lowering the financing costs is only a partial and temporary solution because the absolute condition of balance sheets matter and we should not be surprised that this is a factor weighing on consumer and business confidence. People are smart enough to know that high government debt levels mean higher taxes and/or reduced services down the road.

There is a good chance the unemployment threshold for the Fed to begin thinking about rate hikes will be lowered from 6.5% to 6% as the decline in participation rate would suggest. And that means zero rates could be with us until well beyond 2015 if the economy shows fewer signs of improvement.

Once the cash injections end for the Fed then their insistence that rates will remain low for a long period of time until the economy recovers is what is likely to keep markets under check. However, the real test is whether they will be believed by markets who determine the rate at which they will lend to the government over the longer term. When a central bank holds interest rates below their natural market level, it stands there to provide however much liquidity is required to keep the rate suppressed. QE is one form of this liquidity, and the extent to which QE is reduced must be compensated for by other means if interest rates are going to be kept at the target level.

After all, in line with Fed’s endeavor there is a growing belief that inflation will take off given the vast amounts of money infused in the economy. If so, then market participants are unlikely to lend money at a low nominal interest rate since their real return is the difference between the nominal rate and inflation down the line.

Gold – the reaction and way forward

With the Fed beginning the end of their bond buying, and inflation numbers remaining well below targets the precious metals simply have fallen out of favor with many investors. Markets have been busy running ahead speculating on their expectations not just with gold but other asset markets akin. Government bond yields, particularly for the weaker eurozone states do not reflect credit risk. Equity markets are priced on the back of zero rates as far as the eye can see. Even credit is being extended on the back of the assumption of a prolonged period of zero rates. The important point is not tapering, but a hazardous assumption of zero rates.

It’s going to be extremely complicated task of juggling market expectations to perfection. All those stashing gold, linking it just with unwinding of QE are effectively pushing a one-sided argument and ignoring the moral hazards of cheap money policy and have tended to forget the Greenspan era.

Some of the tail risks facing the global economy may have diminished, but many structural problems remain. There still exist serious imbalances and problems in many countries, including excessive private and/or public debt, the unsustainable divergence between record corporate profits and steadily declining wages, rising inequality, and mispricing of asset markets at best. It is futile to think that easy money and higher asset prices can really be a solution to current economic problems. We are in a phase of experimental central banking, which is likely to end badly due to the dislocations of capital it has caused through prolonged periods of negative rates.

The explosive growth in central bank balance sheets can result into unpleasant long-run consequences of generating high inflation and can derail financial stability. Policymakers who got us into this mess are unlikely to navigate us out of it as exit processes lack a clear road map and therefore could be indeed confusing for the current state of highly sensitive markets. The unintended consequences of such unconventional polices on asset markets would probably be felt at the time of unwinding.

Year end positioning by investors looking to book losses to offset big gains in the equity markets could add additional selling pressure on the precious metals as we move into the last trading week of 2013. Meanwhile, if the global economy is indeed trapped in a subpar growth environment then it will likely translate into central bankers getting further aggressive in building ever-greater balance sheets with ever-greater negative consequences down the road.

Investors would do well to remember that gold is one of the good portfolio diversification tool and thereby may be helping you to reduce overall portfolio risk.

Data Source: Bloomberg, World Gold Council

The Right Approach to Investing

The Right Approach to Investing

• Understand your own risk tolerance (...if volatility makes you nervous then risky investments such as stocks and equity mutual funds may not be the ones for you. You then might as well invest in fixed income instruments instead, such as fixed deposits, PPF, etc.)
  
• Ascertain the risk involved while investing (...you see, every asset class - equity, gold, debt and real estate - has risk associated with it and therefore it is necessary to know about the same before investing your hard earned money)
  
• Know your investment objective (... It is important to know that there are various investment avenues which are meant to cater to respective investment objectives. So enough care should be taken while investing your hard earned money. Ideally each of your investments should match your investment objectives)
  
• Consider your age (...this can help you have the right investment instruments appropriate for your age)
  
• Consider the time period before you need money (...Remember: The longer you are away from the time you require your hard earned money, the more risk you can take, and hopefully even earn more by investing in risky asset classes.)
  
• Do sufficient research (...It is vital not to get carried away by exuberance and / or what your friends and family say. Instead, undertake solid fundamental research on respective investments, and please do not get caught up in hype....understand how the product works)
  

• Evaluate cost of investing (...Remember: gains can be easily eroded if you don't consider cost of investing and thus it is vital to keep an eye on terms and conditions associated with the investment avenue. Very often many indulge in trading in the stock market to make a quick buck without really understanding the associated costs they are paying for regular trading or churning)
  
• Aim at investing in investment products that can help you earn more than inflation(...if your investments manage to outpace inflation, it will help you achieve your financial goals smartly and efficiently)
  
• Recognise the tax implication (...this is important...after all, the objective is also to earn tax efficient returns. If you do not plan well, you may end up paying higher tax on your returns)
  
• Always start early (...as there are benefits of doing so. You can understand it well by taking a look at the following table and chart)
  
  

An Early Bird Gets A Bigger Pie

Let us take an example of 3 friends - Vijay, Ajay and Sanjay - All 3 had good jobs and wanted to retire at the age of 60. Vijay being the smarter of the lot, started planning for his retirement at the very initial stage, at 25, and invested Rs. 7,000 per month. Ajay realised the importance of planning for retirement once he was 30, while Sanjay could feel the guilt of being left out only when he was 35. See what they accumulated when they were on the verge of their retirement. 

Particulars	Vijay	Ajay	Sanjay
Present age (years)	25	30	35
Retirement age (years)	60	60	60
Investment tenure (years)	35	30	25
Monthly investment (Rs.)	7,000	7,000	7,000
Returns per annum	10%	10%	10%
Sum accumulated (Rs)	2,65,76,466	1,58,23,415	92,87,834

(Source: PersonalFN Research)
Disclaimer: The names and figures are fictitious and used for example purpose only.
Also, return per annum mentioned above is for illustration purpose only.

Not only this, they also noticed a wide deviation in the proportion of growth they saw on their invested corpus. While Vijay's money grew around 9 times, Ajay's money grew 6 times and Sanjay saw a growth of just 4 times

(Source: PersonalFN Research)
Disclaimer: The names and figures are fictitious and used for example purpose only.

Points to Remember for You to Save & Invest Wisely!

(Finally, to wrap-up this session of learning, here are some points one must keep in mind, now that you may have recognised why investing is imperative once you have saved)


To Save

• Do not splurge all what you earn...SAVE! (...Remember: It is important to economise on your expenses and save for a rainy day)
  
• It is never too early to save (...in fact, savings can help you feel financially secure and even sleep better at night)
  
• Start small but maintain the regularity 
  

While Investing

• Do not rush with investing (...undertake thoughtful research by doing a holistic study)
  
• Investing is a serious activity (...in fact, it could be essentially boring, and not exciting)
  
• Do not speculate (...while it can be a thrilling experience, it can be killing as well if the tide turns against you. So it is best not to fall for excitement and exuberance)
  
• Never use contingency funds to invest (...Remember, they are put aside as part of your savings to meet your requirements on a rainy day)
  
• Never invest from borrowed funds (...except in the case of investing in real estate or your own business; but again, while investing therein don't go beyond your means)
  
• Know your investment product (...understand how it works and undertake research; recognise the risk-reward relationship the product offers)
  
• Diversify (...Remember, this can help you reduce your risk to your overall portfolio if you diversify wisely)
  

Some Important Ratios to Track Your Personal Finance

Savings to Income Ratio =	Total Annual Savings
	Total Annual Income

This ratio simply tells you what part of your income you are saving annually. Higher the ratio, the better it is, as it facilitates you to invest and lets your money work for you. 

Total investment to Income Ratio =	Current Value of Total Investments
	Total Annual Income

This ratio helps you understand the current value of investments done as a ratio of current income. 

At a younger age this ratio tends to be lower. However with time one needs to accumulate enough savings and invest to fulfil various financial goals in life. 

Debt to Income Ratio =	Total Debt
	Total Annual Income

This ratio would help you evaluate the proportion of total debt as against the total annual income you earn. 

Lower the ratio, the better it is. 

Following these ratios, which you have just learned of, can help you keep a track of your finances.

Investing

Investing Meaning:

• An act of laying out your 'money saved' for productive use with an expectation of earning return more than inflation to preserve purchasing power of money
  
• A process of making your 'money saved' work for you (instead of simply stacking in your vault / bank locker or under the mattress)
  

Advantages of Investing

• Can grow your savings
  
• Helps your money work for you since it is put to productive use
  
• Can help in countering inflation and maintain purchasing power of money (You see, as money tends to lose its value over time due to inflation - which eats into your hard earned savings - you can counter the inflation bug by investing and maintain the purchasing power of money for your future)
  
• You can achieve your financial goals in life (...which could be...buying a dream home, a car, taking care of children's education needs, their marriage and your retirement amongst a host of others)
  
• Helps wealth creation
  
• Provides a sense of financial security 

Are You Saving OR Are You Investing

Are You Saving OR Are You Investing?

Alright so now let's get started.

Many people often misconstrue savings with investments. But let us tell you that there is indeed a difference between the two.

Merely putting aside money under the mattress, or in a vault, bank locker or savings bank account after meeting your expenses and liabilities may not mean that money works for you.

In times where the inflation bug is eating into your earnings, you need to move a step forward and invest. More importantly, invest wisely!

By now many of you may have realized that there is indeed a difference between saving and investing. So let's delve a little deeper and understand the difference between the two...which can help us march forward in our journey of wealth creation.

Savings Meaning:

• An act of putting aside money after defraying expenses and liabilities (...therefore the unspent income results in savings)
  

Savings = Income - All expenses including obligations towards borrowed money



• It's an act of economising 
  
• In Personal Finance parlance:
  

Savings refers to preservation of wealth for future use


The Right Approach to Increase Savings

• Refrain from impulsive buying (...It is imperative to stick to your immediate priority. Have a list while you go out shopping and be rational while making the list.)
  
• Make a monthly budget (...Ascertain your income... frame the budget in a way that allows you to save more.)
  
• Economise on expenses (...try to avoid those expenses which aren't necessary)
  
• Avoid excessive borrowing / credit (So while you may own and use a credit card, use it thoughtfully knowing your means - Remember: excessive credit can lead to a debt trap!)
  
• Start saving at an early age (...it always helps to plan for your future. Remember, you can always postpone your decision to buy your favourite gadget, but you should save for a rainy day.)
  
• You may start small, but save regularly (....Remember, your every bit of savings can help you attain financial freedom)
  

Conclusive remark on savings: 

Now that we have seen the right approach to savings, the question is, can saving alone help you achieve your life's goals? - Which could be: buying your dream home, your dream car, your children's education, their marriage, your retirement; amongst a host of other ones. 

Think about it. 

Do you know, over the years, the money that you have saved - kept aside in your vault, bank locker, savings account, or under the mattress - may lose value as the inflation bug eats into your savings if it is not allowed to grow at a decent pace? Therefore, in order for it to grow, you need to put your 'money saved' to productive use - and make money work for you! 

And what should you do to make money work for you? 

Well, the answer lies in INVESTING!

Morgan Stanley has cut its 2014 gold target

For over a decade, gold had a tremendous bull run before the precious metal suffered a correction in 2013. What more, it is likely that these losses could be extended in 2014 as well. That is why Morgan Stanley has cut its 2014 gold target by around 12% to US$ 1,160 an ounce. One of the reasons why gold found so many takers was the loose monetary policies of central bankers around the world. As the value of paper currencies began to be questioned, gold came to be regarded as a tangible, real asset having value. It was looked upon as a safe haven and a hedge against inflation. The tide turned against the precious metal in 2013 when the US Fed declared its intention of tapering the QE program. As equities began to evince interest, gold lost ground. 

As per an article in Money news, Morgan Stanley is of the view that there is more pain to come for gold because US equities will continue to perform strongly. We believe that while the Fed has decided to reduce its bond purchase program, interest rates still continue to hover near zero. Besides, whatever recovery has been seen in the US economy has been the product of Fed policies. So once the Fed withdraws support, there is the possibility of the economy slumping once again. This may prompt the Fed to loosen its strings again. Which is why we believe the case for gold remains strong from a longer term perspective. And any correction should be looked upon as an opportunity for the metal to form part of one's portfolio.       

Risks associated with Fixed Income Products

In our earlier articles, we had introduced debt market instruments and measures of valuing debt instruments . We had also looked into some of the factors, which affect the pricing and valuations of bonds . Although debt market instruments offer safe returns, they are not entirely risk free. There are several risks associated, arising mainly from change in external factors. Change in interest rate is the most influential risk, which primarily affects bond prices. We had earlier analysed the impact of interest rate risk and effect of other factors like monetary policy, fiscal policy, economic growth and inflation on bond prices. The purpose of this article is to highlight some of the other market related risks, which also influence bond prices. Some of the key risks factors associated with bond valuations are listed as follows: Interest rate risk Reinvestment rate risk Yield curve risk Call and prepayment risk Credit risk Liquidity risk Exchange rate risk Risk associated with inflation and erosion of purchasing power Risk due to political & regulatory events and government actions Interest rate risk:  Since we had already mentioned about interest rate risk in our previous articles, we will not go in its detail analysis. But just to refresh our memories, there is an inverse relationship between changes in interest rates and bond prices. The value of a bond is the sum total of the present value of its fixed future cash flows, discounted at the appropriate current market interest rate. Therefore, when the interest rate increases, a bond's value drops and vice-versa. A bond with longer maturity and higher yield will normally have less impact on price due to change in interest rates. On the other hand, an instrument with shorter maturity and low yield will tend to have larger impact on its price. The price volatility for low maturity and low yield instrument would however be on the lower side, as future cash inflows are lower compared to bond with long maturity period. Maturity Date Coupon Rate (%) Last traded price (Rs) Years to Maturity Yield to Maturity (%) 22-Nov-07 6.8 74 5.9 22.7 15-May-06 6.8 84.5 4.4 15.7 26-Jul-03 6.5 90.1 1.5 12 1-Sep-02 11.2 102.6 0.6 9.7 13-Dec-10 8.8 103.9 8.9 6.7 22-Apr-05 9.9 107.6 3.3 5.9 24-May-13 9 108.4 11.4 4.6 30-May-13 9.8 112.7 11.4 3.3 30-May-21 10.3 114.2 19.4 3 Source: NSE web site Let's take the practical example in order to understand the relationship between maturity, bond price and yield. As can be seen from the table above, bond having the highest yield to maturity (YTM) of 22.7% and longer duration (in this case 6 years) will be relatively more volatile compared to a bond having short maturity and low YTM (6.5% instrument having YTM of 12%). However, impact on price due to change in interest rate will be more on bond having a short maturity and low yield. Call and prepayment risk:  The issuer can call a bond if the call price is below the theoretical market price due to falling interest rates. This is due to the fact that if interest rate declines issuer can raise fresh funds at lower interest rates and would repay the loans raised earlier carrying higher interest rates. Also, the possibility of a call limits or caps the potential for price appreciation (if interest rate falls bond price can rise near the call price and not more than that). In India bonds issued with call options are generally not traded in markets (not listed). IDBI Flexibond 1992 issue (interest rate of about 16.5%) is the latest example of issuer calling the bond. The bond was originally issued for 25 years tenure, with a put and call option after every five years. The decision of the institution has come in the wake of softer interest rate scenario. IDBI could now raise fresh funds by about 500 basis points lower than the earlier 16% debt. Thus before investing in a non-government bond, the investor should evaluate the terms given for call option by the issuer which is likely to impact investor's future cash inflow. Reinvestment risk:  The bondholder is exposed to the risk of investing the proceeds of the bond (or coupon payments) at lower interest rates after the bond is called. This is known as reinvestment risk. The risk is intense for those investors who depend on a bond's coupon payments for most part of their returns. Reinvestment risk becomes more problematic with longer time horizons and when the current coupons being reinvested are relatively large. Home loan and personal finance companies are generally affected when home and auto buyers prepay their loans. In the lower interest rate environment, the finance companies get back their money sooner than expected, which adversely affects their future revenues. Credit risk:  For a bond investor, there are primarily three types of credit risk: default risk, credit spread risk and downgrade risk. Default risk  is defined as the possibility that the issuer will fail to meet its obligations (timely payment of interest and principal) under the indenture. Credit spread risk  is the excess return earned by a bond investor above the return on a benchmark, default free security (G-Sec). This is to compensate the investor for risk of buying a risky security. Interest rates on bonds issued by corporates are therefore generally higher compared to return from G-Secs. Yield on a risk bond = Yield on a default free bond + Risk premium Downgrade risk:  It is the risk that a bond is reclassified as a riskier security by a credit rating agency. The rating agency considers many factors for evaluating the credit worthiness of a particular instrument. This includes the economic environment at large, the ability of the issuer to make good on its promise and the general political condition in the country. When an issue is re-categorized or its credit rating is changed, the yield adjusts immediately to reflect the new rating. Liquidity risk:  It is the risk that represents the likelihood that an investor will be unable to sell the security quickly and at a fair price. Illiquid security will also have the risk of large price volatility. Quantitatively liquidity risk can be estimated through Bid-ask spread. Bid price represents the price at which dealers are willing to buy the security from traders/investors and ask price represents the price at which they are willing to sell the security to investors. The bid price is lower than the ask. The spread between these two prices is known as the bid-ask spread and it is used as a measure of a security's liquidity. High spreads signal an illiquid market. Investors like liquid markets so that they can buy and sell securities quickly and at a fair price. Liquidity may also improve as more participants actively engage in trading a security. For example, a 10.2% bond has the YTM of just 2.7%, but it is one of the most actively traded instruments with a longer maturity period. Thus it offers good liquidity to investors who can buy/sell the instrument easily. On the other hand instrument with a coupon rate of 10.8% with a maturity period of 13 years, although offers high YTM of 6.5%, has a relatively low liquidity. Maturity Date Coupon Rate (%) Last traded qty (nos.) Last traded price (Rs) Current yield (%) Years to Maturity Yield to Maturity (%) 11-Jun-10 11.5 2,500 115.5 10 8.4 3.5 11-Sep-26 10.2 1,500 115 8.9 24.7 2.7 24-Jun-06 13.9 1,200 121.4 11.4 4.5 2.8 19-May-15 10.8 100 108 10 13.4 6.5 5-Aug-11 11.5 54 117.1 9.8 9.6 2.7 19-Jun-08 12.1 50 116.4 10.4 6.4 3.6 23-May-03 11 45 99.8 11 1.4 11.1 21-May-05 10.5 28 110.4 9.5 3.4 5 Source: NSE web site Exchange rate risk:  When bond payments (coupons/principal) are denominated in a currency other than the home currency of the bond holder, the investor bears the risk of receiving an uncertain amount when these payments are converted into the home currency. For example if rupee appreciates against the foreign currency (US$) of the bond payments, each US$ will be worth less in terms of rupee. This uncertainty related to adverse exchange rate movements in known as the exchange-rate risk or simply the currency risk. Inflation risk:  It refers to the possibility that prices of general goods and services will increase in the economy. Since fixed coupon bonds pay a constant coupon, increasing prices erode the buying power associated with bond payments. This is known as the inflation risk. For example, if a risk free bond has a coupon rate of 7.5%, and prices increase at the rate of 4% per year, the investor's real return is 3.5%. Higher inflation rates result in a reduction of the purchasing power of bond payments (principal and interest). Event risk:  These are generally related to the occurrence of a particular event and its impact on bond price. These can be listed as disasters, corporate restructuring, regulatory issues and political risk. Disasters (earthquakes or industrial actions) may impair the ability of a corporation to meet its debt obligations. Corporate restructuring (mergers, spin offs) may affect the obligations of the company by impacting its cash flow or the underlying assets that serve as a collateral. Regulatory issues such as environmental and other restrictions may impose compliance costs on the issuer, impacting its cash flow negatively. Political risk consisting of changes in the government or restrictions imposed on foreign exchange flows can limit the ability of the borrower to meet its foreign exchange obligations. Volumes in the debt market are improving on increasing demand from banks. With credit growth in the system tinkering down, banks are investing in government securities over and above the minimum requirement for SLR. This has offered the good liquidity to the markets. Although, the bias is towards softer interest rates, retail investor should take into account the above risk factors before investing into a debt instrument. This is due to the fact that actual yield earned is determined by the price of a bond which is again the factor of the above listed risks.