Category: Jargons

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What is DIPAM?

dipam

DIPAM stands for the Department of Investment and Public Asset Management. It is one of the Departments under the Ministry of Finance. It works in the Government investments in equity as well as disinvestment of equity in Central Public Sector Undertakings. The Department of Disinvestment was formed on 10th December 1999. On 14th April 2016, it was renamed the Department of Investment and Public Asset Management (DIPAM).

The major domain of their work pertains to Strategic Disinvestment, Minority Stake Sales, Asset Monetisation and Capital Restructuring. For example, if the Central Government has to sell some part of their stake in a company like BPCL, it is DIPAM who looks into it. It is DIPAM who advise the Central Government in the matter related to the financial restructuring of PSUs.

The Prime Minister of India, Narendra Modi, has already stressed that “the government has no business to be in business.” Thus, in the next one or two years, we can see the government selling some of their equity stakes to the private sector. Whether this privatization through disinvestment is correct or not is a different debate. But, it is DIPAM that dives deep into these financial restructuring matters.

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What are Depository Receipts?

A Depository Receipt (DR) is a negotiable financial instrument issued by a bank that represents a foreign company’s publicly traded securities. It is a well-established method by which foreign companies or institutions gain access to global markets. DRs allow investors to hold shares of companies that are listed on stock exchanges in foreign countries.

DRs are a more convenient and inexpensive method as compared to purchasing stocks directly from foreign markets. For example, the Depository Receipt of Infosys is listed on the New York Stock Exchange. Through this, investors in the US can easily buy shares of the Indian IT company. 

How Does it Work?

Suppose a company listed in India wishes to raise funds by selling a particular stake to overseas investors. The company will have a local Domestic Custodian that holds certain shares on behalf of it. Now, let us imagine that a firm in the United States is willing to buy or invest in equity shares of this Indian company. The Domestic Custodian will then inform its counterpart in the US, which is known as an Overseas Depository Bank (ODB). An ODB is basically a bank established outside India that acts as a custodian of equity shares of the issuing company (in electronic form).

Thus, the ODB will update/inform the US-based investor and provide an acknowledgement that it will hold a specific quantity of shares of the Indian company on their behalf. This ‘acknowledgement’ that the ODB provides to the foreign investor is known as a Depository Receipt. In this case, the DR will be listed on the US stock exchange and can be traded.

Types of Depository Receipts

1. American Depository Receipt (ADR): An ADR is a negotiable certificate issued by a US depository bank that represents a specified number of shares held of a foreign company’s stock. In simple terms, an ADR represents shares of a foreign company that is being traded in the US stock markets. As of April 16, around 15 Indian ADRs are being traded on the US stock markets. ADRs and their dividends are priced in US Dollars.

2. Global Depository Receipt (GDR): A GDR is a certificate issued by a bank that represents shares of a foreign company on two or more global markets. GDRs usually trade on US stock exchanges, as well as European and Asian exchanges. GDRs and their dividends are priced in the local currency of the exchanges where the shares are traded.

We also have Indian Depository Receipts (IDRs), which are denominated in Indian rupees and are issued by a Domestic Depository in India. [A domestic depository is a custodian of securities registered with market regulator SEBI]. IDRs are issued against the underlying equity of a company to enable foreign firms to raise funds from the Indian market. On the other hand, IDRs allow Indian citizens or firms to invest in the shares of foreign companies.

Advantages of Depository Receipts

  • Depository receipts allow investors to easily diversify their portfolio and purchase shares of foreign companies.
  • DRs provide investors with benefits such as voting rights and dividends. It opens up certain markets that investors would not have access to earlier.
  • Depository receipts offer more convenience and are less expensive than purchasing stocks in foreign markets. They help reduce administrative costs that are levied when investors try to acquire shares of foreign companies.
  • DRs allow large international companies to raise capital very easily from global markets.

Disadvantages of Depository Receipts

  • Many depository receipts may not be listed on a stock exchange. In some cases, only institutional investors would be trading them. 
  • There may not be many buyers and sellers of ADRs, which leads to low liquidity.
  • A country where a foreign company is located may experience a recession or other socio-political issues. Due to these economic risks, the value of a depository receipt (that represents the foreign company’s shares) could fluctuate.
  • Fluctuations in exchange rates (or conversion expenses, foreign taxes) could heavily impact the value of depository receipts.
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What are Block Deals in the Stock Market?

You would have often seen the term ‘block deal’ used in our articles. But, are you aware of what it really means? Let’s clear all the doubts one set for all!

Block Deals

A block deal is said to be a trade where more than 5,00,000 shares or shares worth more than Rs 10 crore of a particular company are traded. This should happen as a part of a single transaction. The deal cannot be squared off as we do with our intraday positions. Once done, it cannot be reversed. The price at which this is done should be between +1% to -1% of the current market price or the previous day’s closing price. 

Also, the broker has to inform the exchange of any kind of block deals. The details which have to be passed on to the exchange include the following: 

  • Name of the scrip. 
  • Name of the clients (Buyer & Seller).
  • The number of shares bought or sold.
  • The traded price at which the deal is done.

Stock exchanges are bound to inform the public about the deal with all the details on the same day after market hours. Generally, HNIs (high net worth individuals), mutual funds, financial institutions, insurance companies, banks, venture capitalists and foreign institutional investors (FIIs) are the participants of these block deals. To learn more about FIIs, click here. Promoters of the company can also use this window to buy or sell a major chunk of their share.

Block Deal Timings

As a block deal involves a large number of shares, it is important to allot a particular time slot. Otherwise, a surprising block deal at any time can increase volatility in the market. The exchange has made two slots for any type of block deal to take place.

  • Morning Window (First Session): 08:45 AM to 09:00 AM
  • Afternoon Window (Second Session): 02:05 PM to 2:20 PM
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What is India VIX? Find it here!

You must have seen us talking about India VIX on The Stock Market Show on YouTube and our Pre-Market Reports. But are you really aware India VIX is? Does it tell you something about the market? How should retail investors read this parameter? Find all about this here!

India VIX

VIX stands for Volatility Index. This tells that India VIX is nothing but India Volatility Index. It tells about the volatility which can be expected by the investors in the Indian market. In simpler terms, volatility is referred to as the “rate and magnitude of changes in prices” expected in either direction. Originally, VIX is a trademark of the Chicago Board Options Exchange. The National Stock Exchange of India (NSE) has been granted a license to use this mark with the name of India VIX.

The calculation of this volatility index is done with the help of the NIFTY Index Option prices. It is the representation of the annualized change that can be expected in the Nifty 50 for the duration of the next 30 days. Do focus on the word annualized change. Let’s take an example to make it clearer. 

Suppose India VIX is 20.97%. That means for the next 30 days, Nifty 50 is expected to move in either direction by the investors by an annualized rate of 20.97%. The value of VIX cannot go below 0 and cannot exceed 100.

How Does Vix Affect You?

It has been seen previously that VIX and Nifty move in opposite directions. We saw the biggest example of this during Covid-19 last March. On 24th March 2020, India VIX touched the mark of 83.63! This is when the market was unpredictable due to the Covid-19 lockdowns around the world. But, do not judge the direction of the market with the movement in VIX. The India VIX will only tell how big a move can happen in the market irrespective of the direction. 

The higher the VIX, the higher the risk is for retail investors. Equities may not be a very safe asset class when VIX is unusually high. India VIX is said to be normal if it is around the 20-mark, which it is currently at as of April 2021.

You cannot buy/sell India VIX, it is not a tradeable index.

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What are Junk Bonds?

We have already studied in-depth what bonds are in this article. Bonds are basically companies raising debt from the public rather than going to a bank.

Now, what if a company issues a bond with a yield of 1%? No one will subscribe to it as better investment opportunities are available. What if a failing company offered you 8% returns if you subscribe to their bond? Will you buy it, considering the high risk? What if it offered a 20% yield as they were desperate for money? This is what a junk bond is.

Junk Bonds are those bonds that are rated below “investment-grade” that give a higher yield or return than other “high-rated” or “investment-grade” bonds. These are high-risk bonds that also give high returns. 

Investment grades are those stocks that are rated above ‘BBB’ by Standard and Poor or Moody’s. Anything below this ‘BBB’ rating is considered a non-investment grade. Any bond is subject to credit risk and default risk. To put it in simple words, bonds are used by corporates to ‘borrow’ money from people or institutions. If a company fails to pay back its lenders or pays less than what it ‘promised’, its credit rating decreases. 

A company’s bonds’ credit rating is subject to many factors like:

  • Ability to pay its lenders
  • Liquidity management
  • Interest and Tax management
  • Regulation and Competition in the market
  • Financial flexibility
  • Ability to generate cash flows, profits, or revenue

If a company fails to meet the above metrics, it could be rated as a ‘Junk Bond’.

Should I Invest In Junk Bonds?

A company issuing bonds might get caught up in poor credit ratings by agencies despite having strong financials if all other companies in the industry are performing badly. This would be a good investment opportunity since despite having bad ratings, the company had good financial health and paid high returns at the same time.

A bond becomes junk whenever the company’s probability of paying its bondholder decreases. One should invest in junk bonds when there is an expansionary policy or quantitative easing in the market or whenever the Government has put money in the market Why? One simple reason, whenever there is money in the market, the economy is growing, businesses prosper and they make money. Companies are less likely to default on payments or more likely to give their bondholders a good return. The increase in demand for these bonds also increases their face value.  

The increased demand for the bond results in rising prices and falling yields. Despite falling yields, the price increase gives a good return to an investor. To summarize, one should buy junk bonds in the expansion phase of the business cycle.

It is recommended that a bond investor looks through market rates, industry conditions, company’s credit history, and financials before investing in any high-risk bonds.

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What is Insolvency? How Do Companies Go Bankrupt?

We often come across reports of companies being declared bankrupt or ‘insolvent’. We also see large investment firms or business groups entering into tough competition to acquire these insolvent companies. Recently, Piramal Capital acquired debt-ridden DHFL for Rs 34,250 crore! Let us have a detailed understanding of what insolvency means and look into the insolvency procedure followed in India.

What is Insolvency?

At some point in time, a company or an individual may not be in a position to pay off their debt or other financial obligations. This may be due to a variety of factors such as a sharp decline in revenue (or income), increase in competition, poor market conditions, bad financial management, lack of proper budgeting, high debt, and failure of debt recovery procedures. The state of being unable to make repayment of debts by a person or company is known as insolvency. Those entities that are in a state of insolvency are said to be insolvent. In most cases, the insolvent company or person has to convert their assets into cash to pay off their lenders.

Types of Insolvency

1. Cash-flow insolvency – This is when a person or a company has enough assets to pay what is owed, but does not have an appropriate form of payment. For example, a person (the debtor) may own a large house or other valuable properties, but may not have enough liquid assets to pay his debts when it falls due. [A liquid asset is anything that can be converted into cash easily, within a very short period of time. Eg- cash, stocks, savings account in banks, etc]

2. Balance sheet insolvency – This is when a person or a company does not have enough assets to pay all of their debts. In most cases, these entities might enter bankruptcy, which is a legal process through which they may seek relief from some or all of their debts. Once a loss is accepted by all creditors (or lenders), the parties would negotiate and resolve the situation.

The Insolvency & Bankruptcy Code, 2016

Until 2015, an insolvency resolution in India took an average of 4.5 years to complete. There were constant delays in court proceedings and a lack of clarity. The entities involved in these cases used to incur very high legal costs. Thus, Indian lawmakers wanted to introduce a more structured and time-bound procedure for completing the entire insolvency process. 

The Insolvency and Bankruptcy Code (IBC) was brought into effect in 2016. It is the one-stop solution for resolving insolvency cases in a very economical manner. The code protects the interests of small investors and makes the process of doing business more efficient. The IBC has over 255 sections and 11 Schedules.  When a default in repayment occurs, creditors (lenders) gain control over the debtor’s assets and must make decisions to resolve insolvency within a 180-day period. The code also provides a framework for creditors and debtors to have detailed discussions on how to resolve the issue.

Insolvency Procedure

Let’s say a company- ABC- is in a poor financial state and is unable to pay off large debts. The lenders of the firm submit a plea for insolvency to the National Company Law Tribunal (NCLT). The NCLT is the adjudicating authority for insolvency proceedings in the case of corporate entities. It looks into the financial records and information provided by the lenders of ABC and must reject/accept their plea within 14 days.

  • If the plea is accepted, the tribunal has to appoint an Interim Resolution Professional (IRP), who will draft a resolution plan for ABC within 180 days (this can be further extended by 90 days).
  • A resolution plan is a proposal that seeks to resolve the company’s insolvency by finding methods to pay off creditors. During this period, the Board of Directors of ABC will be suspended. The promoters do not have a say in the management of the company.
  • The IRP will manage ABC’s assets and provide information to its creditors and assist them in decision-making.
  • The insolvency professional forms a committee of creditors (CoC) who lent money to ABC. The CoC will decide the future of the outstanding debt owed to them. They may choose to revive ABC’s debt by changing the repayment schedule or by selling (liquidating) the assets of the company.

In case the Corporate Insolvency Resolution Procedure (CIRP) fails to revive the company within 180 days, the liquidation process is initiated. This means that all of ABC’s assets will be converted into cash through auctions or direct acquisitions. Proceeds from the sale of these assets will be distributed to the creditors, priority shareholders of ABC, and equity shareholders. The IRP will also receive remuneration for his contribution to the insolvency proceedings.

A Recent Example

Dewan Housing Finance Corporation Ltd (DHFL) was the first financing company in India to go through insolvency proceedings. It had been facing liquidity issues (cash crunch) and had defaulted on loans. Upon further investigation by the Enforcement Directorate (ED), it was found that DHFL had diverted thousands of crores illegally. In November 2019, the Reserve Bank of India (RBI) filed for an insolvency proceeding to be initiated against DHFL. The financial creditors of DHFL submitted claims worth Rs 86,892 crores against the company! The share price of DHFL, which was trading at ~Rs 600 levels in 2018, fell to Rs 15 within a year

The Committee of Creditors (CoC) of DHFL failed to formulate a resolution plan within 180 days. It was decided that the financing company and its assets would be put up for auction. In October 2020, several reports stated that Adani Group, Piramal Enterprises, US-based Oaktree, and Hong Kong’s SC Lowy had placed bids for acquiring DHFL. After months of negotiations and counter-bidding, Piramal Capital emerged as the successful owner of DHFL.

Now, you may wonder why these firms had shown interest in acquiring a company that was poorly managed and involved in illegal activities. The main factor is the cost of the acquisition. Buying a company in the same industry is often time-consuming and expensive. When these investment firms and large corporations want to expand, it is easier and more economical to acquire distressed companies at very discounted prices. Moreover, Piramal took a risk and found value in the DHFL brand- which has a great hold in semi-urban and rural markets. 

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What are Partly Paid Shares?

You may have come across various partly paid-up shares while trading in the stock markets. Reliance Industries Partly Paid (PP) shares, Tata Steel PP shares, Aditya Birla PP shares are some of the prominent examples. A partly paid share is a share in a particular company that has only been partially paid compared to the face value. This means that investors like you and I can buy these shares by not paying the full issue price. The balance amount to be paid for PP shares can be made through installments.  

When a company that issued partly paid shares requires more funds, calls will be made to the shareholders (that hold PP shares) from time to time until the shares are fully paid. Thus, investors who hold partly paid shares have a liability to pay as and when the company calls for it. These ‘calls’ will be notified to each shareholder. The notice will contain details regarding the deadline and instructions on how to make the payment. Normally, cheques and demand drafts are the preferred payment options. 

Recently, market regulator SEBI announced that an additional payment mechanism, such as Application Supported by Blocked Amount (ASBA), can be used for making payments of balance money for calls for partly paid shares.

If an investor fails to pay when a call is made by the company, their shares will be forfeited. This means that the allotted shares are canceled by the issuing company because of non-payment of installments.

The amount at which PP shares can be bought and important details regarding the schedule of calls can be found in the company’s prospectus. A prospectus is a legal document that describes the equity or debt securities that have been issued by a company. It clearly states the purpose for which securities have been offered. Moreover, the prospectus contains general details regarding the company’s operations. Calls can also be made at the discretion of the company’s Board of Directors. 

Such a practice was initially conducted by prominent financial institutions. Banks or insurance companies would issue partly paid shares to certain shareholders. Whenever these firms had to raise funds quickly, they would make a call to these shareholders. These investors were obligated to pay what was due for their shares. 

Examples

Suppose the actual stock price of a company is Rs 100. An investor purchased it for Rs 65 per share. At a future date, the company that issued the share can call the shareholder to pay up the balance amount of Rs 35 (or make an installment). If they fail to pay, their shares will be forfeited. 

Last month, the Board of Directors of Tata Steel approved the first and final call of Rs 461 per partly paid shares. The call was made on 7.76 crore outstanding partly paid-up equity shares (of face value Rs 10 each). The call of Rs 461 per partly paid share comprised Rs 7.49 towards face value and Rs 453.50 towards securities premium. (Share premium or securities premium is the difference between the issue price and the face value of the stock) The board had fixed February 19, 2021, as the Record Date to determine the holders of partly paid-up equity shares to whom the call notice will be dispatched for payment. 

At the time of the call, Tata Steel PP was trading at Rs 239.25 per share. 

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What is a Real Estate Investment Trust (REIT)?

Real Estate Investment Trusts or REITs have revolutionised how individuals invest in real estate. REITs provide an avenue for both newcomers and seasoned investors to participate in the world of real estate without the burdens of property management. This article provides a complete overview of Real Estate Investment Trusts (REITs). We will explore what REITs are, how they work, and the advantages & risks of investing in REITs. We will also look at how to invest in REITs.

What is a Real Estate Investment Trust (REIT)?

A real estate investment trust (REIT) is very similar to a mutual fund. In the case of mutual funds, many people invest their money into a fund and fund managers allocate that sum to different asset classes. Similarly, a REIT gives you an opportunity to invest in real estate properties and derive income from them. A REIT owns, operates, or finances income-generating real estate properties. These trusts take money from small and big investors and allocate it to real estate assets. A REIT can possess a number of properties like complexes, infrastructure, healthcare units, apartments, and more.

For example, imagine a shopping complex in one of the popular spots in your city. A REIT could be the owner of that mall. The rent that is collected by the trust is shared with investors like you and me. This means, the more units you own, the higher the income you will derive. In a way, you are a partial owner of that famous shopping complex! How amazing is that, right? Similarly, by investing in REITs, you can own some part of high-priced real estate.

The United States Congress introduced REITs in 1960 to democratize real estate investment in the country. A legislation created a tax-advantaged structure for REITs, mandating them to share a part of their taxable income as dividends with shareholders. This encourages REITs to generate earnings from real estate assets and distribute them to investors.

What are the Types of REITs?

One of the key aspects of REITs is their ability to specialise in specific property types or investment strategies. These different types allow investors to tailor their portfolios to align with their investment preferences and goals. The three types of REITs are:

Equity REITs

Equity REITs own and operate income-generating properties such as residential apartments, office buildings, retail centres, and industrial warehouses. They generate revenue primarily from rental income. Investors in equity REITs participate in the growth and income potential of the underlying real estate assets.

Mortgage REITs

Mortgage REITs focus on providing financing for real estate transactions. They invest in mortgages and mortgage-backed securities (MBS), earning income from interest payments. Mortgage REITs can be more sensitive to interest rate fluctuations than equity REITs. Investors in mortgage REITs primarily benefit from the interest income generated by the mortgage portfolio.

Hybrid REITs

Hybrid REITs are a combination of both equity REITs and mortgage REITs. They own and operate properties, while also engaging in mortgage financing activities. Hybrid REITs offer a diversified investment approach, allowing investors to benefit from rental and interest income.

How do REITs work?

Real Estate Investment Trusts (REITs) operate through a unique structure that allows investors to access the benefits of real estate investing. REITs are typically organised as Trusts.

Asset Acquisition and Management

REITs acquire real estate properties through various means, including direct purchases, development projects, and partnerships. They engage in property management activities such as leasing, maintenance, and tenant relations. Professional management teams handle the day-to-day operations of the properties.

Rental Income and Dividend Distribution

REITs generate revenue from rental income received from tenants. They distribute a significant portion of their taxable income as dividends to shareholders, as required by law. Dividend distributions are a major attraction for income-oriented investors, as they provide regular cash flow.

Taxation and Compliance

REITs enjoy special tax advantages under the Income Tax Act. To qualify as a REIT, the entity must meet certain criteria, such as distributing at least 90% of its taxable income to shareholders, investing a minimum percentage of assets in real estate, and maintaining a diversified portfolio. Meeting these criteria allows REITs to transfer most of their earnings to shareholders without incurring corporate-level taxes.

Qualifications to Become a REIT

  • A minimum of 100 shareholders should be present.
  • It has to give at least 90% of the taxable income as a dividend.
  • Collect a minimum of 75% of total income from mortgage interest, real estate sales and rents.
  • A minimum of 75% of investment assets must be in real estate.
  • Less than five individuals should not have held 50% of its share.

Advantages of Investing in REITs

Investing in Real Estate Investment Trusts (REITs) offers a range of advantages for investors looking to gain exposure to the real estate market.

1. Diversification and Access to Real Estate Market

REITs provide investors with a way to diversify their portfolios by gaining exposure to the real estate market. Investors can access different property types, geographical regions, and market segments through REITs, without the need for large capital investments or property management responsibilities.

2. Regular Income Generation and Dividend Potential

REITs are known for their income-generating potential. They are required to distribute a significant portion of their taxable income as dividends, making them attractive to income-oriented investors seeking regular cash flow. Dividend distributions from REITs can provide a stable and predictable source of income.

3. Professional Management and Hassle-free Ownership

Investing in REITs allows individuals to benefit from professional management expertise. Experienced teams handle property acquisitions, operations, and maintenance. This reduces the burden of direct property ownership and management for individual investors. This makes REITs an attractive option for those seeking a hassle-free real estate investment experience.

4. Liquidity and Tradable Investments

REITs are listed and traded on major stock exchanges, providing investors with liquidity and flexibility. Unlike direct real estate investments, which can be illiquid and challenging to sell, REIT shares can be easily traded, allowing investors to adjust their positions according to market conditions.

5. Potential for Capital Appreciation

In addition to regular dividend income, REIT investments can offer the potential for capital appreciation. If the underlying real estate properties increase in value over time, the value of the REIT units/shares may also appreciate. This combination of income and potential capital gains can enhance overall investment returns.

Risks or Challenges of Investing in REITs

While Real Estate Investment Trusts (REITs) offer compelling advantages, investors need to be aware of the risks and challenges associated with these investments:

1. Interest Rate Risk

REITs can be sensitive to changes in interest rates. Rising interest rates can increase borrowing costs for REITs, impacting their profitability. Additionally, higher interest rates may make other investment options (such as bonds) more attractive relative to REITs.

2. Market Volatility and Economic Conditions

Like any investment, REITs are subject to market volatility. Economic downturns, fluctuations in real estate market conditions, and broader economic factors can impact the performance of REITs. It is crucial to consider these factors when assessing the potential risks associated with REIT investments.

3. Property Market Performance

The performance of REITs is closely tied to the performance of the underlying real estate properties they own. Factors such as occupancy rates, rental rates, and property market trends can influence the income and value of the properties, ultimately impacting the returns generated by the REIT.

4. Regulatory and Legal Risks

REITs operate within a regulatory framework and must comply with specific rules and regulations. Changes in tax laws, regulations related to REIT status, or legal disputes can affect the financial performance and operations of REITs. Investors should be aware of the potential regulatory and legal risks associated with investing in REITs.

5. Management Quality and Governance

The success of a REIT is highly dependent on the quality of its management team. Diligence should be exercised in assessing the expertise, track record, and governance practices of the REIT’s management. Poor management decisions or governance issues can negatively impact the financial performance and long-term prospects of the REIT.

How to Invest in REITs?

You can invest in any publicly listed REITs through your broker. However, you must keep in mind the following points before investing.

1. Research and Due Diligence

Before investing in REITs, it is essential to conduct thorough research and due diligence. Understand the REIT’s investment strategy, property portfolio, financial performance, and management team. Review regulatory filings, financial statements, and analyst reports to gather insights.

2. Assessing REIT Performance and Financials

Analyze the historical performance of the REIT, including its dividend history, earnings growth, and funds from operations (FFO). Assess key financial metrics such as occupancy rates, rental income growth, debt levels, and capital structure to evaluate the financial health and stability of the REIT.

3. Evaluating Property Portfolio and Sector Focus

Understand the types of properties held by the REIT and their locations. Evaluate the growth potential, market conditions, and demand dynamics for the specific property sectors in which the REIT operates. Consider factors such as diversification, tenant quality, and lease terms.

4. Understanding Dividend Policy and Growth Potential

Examine the REIT’s dividend policy, including the frequency and stability of dividend payments. Evaluate the potential for dividend growth over time. Consider factors such as the REIT’s ability to increase rental income, expand the property portfolio, and pursue value-enhancing opportunities.

5. Portfolio Allocation and Risk Management

Consider the role of REITs within your overall investment portfolio. Determine the appropriate allocation based on your investment goals, risk tolerance, and diversification strategy. Monitor and review your REIT holdings regularly, adjusting your portfolio allocation as needed.

In conclusion, Real Estate Investment Trusts (REITs) provide investors with a unique opportunity to gain exposure to the real estate market, while enjoying the benefits of professional management and regular income. Remember to conduct thorough research, assess performance metrics, and consider your own investment objectives and risk tolerance. With careful analysis and proper portfolio allocation, REITs can play a valuable role in diversifying your investment portfolio and potentially enhancing your long-term returns.

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Who are Foreign Institutional Investors (FII)?

Foreign institutional investors (FIIs) are those investors or funds who make investments in assets located in nations other than their own. The term is most commonly used in India, where it refers to outside entities investing in the nation’s financial markets. 

FIIs can include hedge funds, insurance companies, pension funds, investment banks, and mutual funds. FIIs are important sources of capital in developing economies. However, India has placed limits on the total value of assets an FII can purchase and the number of equity shares they can buy.

Developing economies generally provide investors with higher growth potential, as compared to developed economies. Since our country has a high economic growth rate and many fundamentally strong companies to invest in, you can find many active FIIs here. All FIIs in India must register with the Securities and Exchange Board of India (SEBI) to participate in the market.

You can find a list of prominent FIIs here.

Types of Foreign Institutional Investors

Here are the few types of foreign institutional investors in India:

  • Pension funds
  • Investment trusts
  • Banks
  • Mutual Funds
  • Endowments
  • Sovereign Wealth Funds
  • Foreign Central Banks
  • Asset Management Company
  • Insurance/Reinsurance Companies
  • Foreign Government Agencies
  • Foundations
  • University Funds
  • Charitable Trusts

Role of FIIs in the Indian Market:

Foreign Institutional Investors (FIIs) play a vital role in driving economic growth, and this holds true for India as well. With their considerable resources and extensive knowledge, these international entities have greatly contributed to enhancing the value of the Indian market. Their main roles include: 

  • FIIs play a crucial role in boosting capital/stock markets because they not only contribute funds but also have access and expertise around the globe.
  • Their investments improve market liquidity, efficiency, and confidence, which in turn attracts additional investment.
  • FIIs allow domestic investors (including institutional and individual investors) to diversify their portfolios by providing access to a broader range of international investment opportunities. 
  • Additionally, FII investments have reduced the cost of capital, making it simple to obtain affordable international credit and promoting the economy of the nation.
  • FII investments often involve converting foreign currency into local currency. This creates demand for the Indian rupee and affects the country’s foreign exchange reserves, exchange rates, and balance of payments.

Regulations for FIIs in India

The Indian govt allows FIIs to invest in its primary and secondary capital markets only through the country’s portfolio investment scheme. This scheme allows FIIs to purchase shares and debentures of Indian companies on the nation’s stock exchanges. Let us look at some of SEBI’s current regulations on FIIs.

  • The eligible categories of FIIs can now include university funds, endowments, foundations, charitable trusts, and charitable societies that have a track record of 5 years. All these entities must register themselves with a statutory authority in their country of incorporation.
  • Each FII (or sub-account of an FII) can invest up to 10% of the equity of any one company. The overall limit on investments by all FIIs, Non-Resident Indians (NRIs), and Overseas Corporate Bodies (OCBs) has been set at 24%. This limit can be raised to 30% if a company obtains shareholder approval for the same.
  • FIIs can invest in unlisted securities. [An unlisted security is any financial instrument that is not traded on a stock exchange]. Unlisted securities are traded on the over-the-counter (OTC) market (where assets are traded directly between two parties).
  • FIIs are allowed to invest in proprietary funds. Proprietary funds are used to account for a government’s ongoing organizations and activities that are similar to those found in the private sector.
  • FIIs who obtain specific approval from SEBI can invest up to 100% of their portfolios in debt securities (bonds, debentures, etc). Such investment may be in listed debt securities or dated government securities. It is treated to be part of the overall limit on external commercial borrowing.

What are the Disadvantages of FIIs?

  • The economy could experience inflation due to portfolio investment. There can be high demand for local currency due to a significant inflow of foreign institutional investment. As a result, the central bank (RBI) will have to release more money into the economy, increasing money flow and setting the stage for inflation.
  • When FIIs pour a huge amount into a country, they raise the demand for local currency, causing the domestic currency to become stronger. This makes exports expensive and less appealing in the global market, hurting demand and significantly affecting exports.
  • FIIs occasionally solely look for immediate gains. When they pull their investments, banks could face a shortage of funds.

What are Participatory Notes?

A Participatory Note, often referred to as P-Note or PN, represents a financial instrument issued by a registered foreign institutional investor (FII) to cater to overseas investors or hedge funds who wish to participate in the Indian stock markets. The overseas investors need not register themselves with SEBI. Using PNs, financial institutions in a country invest in securities of another country on behalf of their clients. Any capital gains and dividends accumulated through these PNs will go into the hands of clients. It’s worth noting that the majority of these ‘clients’ primarily consist of individual investors.

P-Notes provide quicker means of raising funds for the benefit of listed companies. Foreign investors can easily infuse funds into Indian securities, as they do not have to go through the hassles of government regulations. In fact, the guidelines set by SEBI for investments through PNs are very minimal. These small foreign investors can also remain anonymous.

Concerns over P-Notes:

Various government agencies and financial analysts have stated that this method could be misused by wealthy Indians. P-Notes can potentially be used to bring in significant volumes of foreign unaccounted funds and manipulate stock prices. It can be difficult to track the parties involved in the diversion or misappropriation of these funds. Thus, SEBI began to tighten restrictions and even imposed a ban on PNs in October 2007. This led to the Sensex dropping nearly 8% or 1,744 points on a single day! However, all restrictions were lifted due to concerns about capital outflows during the global financial crisis in 2008. Due to fears of a major market crash, the government is reluctant to introduce a proper ban on participatory notes.

You may Also Like: Who are Domestic Institutional Investors (DIIs)?

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Jargons

What are Options? Learn Basic Options Terms!

An option gives buyers/sellers the right to buy or sell a given quantity of an underlying asset on the expiry date at a specified price. It is a derivative instrument and derives value from the price of the underlying security or stock.

The option buyer has the right to exercise his position and can choose whether to buy or not to buy. The option seller is under obligation to sell and does not have a choice to not sell at the end of the contract if the buyer demands. 

Options contracts are always only available in lots, just like future contracts or Initial Public Offers.

Options are of two types: Call Option and Put Option. Both are described below.

Let us take the example of this option contract of TCS to describe further options terms.

1. Spot Price: The current market price of the underlying asset. The Spot Price in the above chart is Rs 3,090.65.

2. Strike Price: The price at which the option holder has the right to buy or sell the given quantities of the underlying asset at the expiry. It is the price at which the contract is made. The Strike Price in the above chart is Rs 3,100.

3. Call Option: It gives the buyer the right to buy a given quantity of an underlying asset on a pre-decided date at a pre-decided price. To obtain this position, the buyer has to pay the option premium to the seller/writer of the option.

In the Money (ITM) Call Options are those in which the spot price (current market price) is GREATER than the strike price.

Out of the Money (OTM) Call Options are those in which the spot price (current market price) is LESSER than the strike price.

4. Put Option: It gives the buyer of this option the right to sell a given quantity of an underlying asset on a pre-decided date at a pre-decided price.

In the Money (ITM)  Put Options are those in which the spot price (current market price) is LESSER than the strike price.

Out of the Money (OTM) Put Options are those in which the spot price (current market price) is GREATER than the strike price.

When the spot price is the same as Strike Price, it is called At the Money (ATM) option, for both calls and puts.

5. Option Premium: It is the amount the option buyer has to pay to the option seller/writer. After paying this premium, the buyer acquires a right whether he wants to exercise his/her position on the expiry date.

If he chooses not to exercise his right, the option premium stays with the option seller/writer. Similarly, an option seller has to put his entire margin in front as well, so that he would not walk out of the deal if he faces losses. The Option Premium in the above chart is Rs 97. The buyer has to put forward only the premium amount of Rs 97 multiplied by lot size, while the seller will have to put forward a 1-1.5 lakhs margin regardless of the strike price/lot size and stock/index.

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Jargons

What are Municipal Bonds?

Municipal Bonds or Muni Bonds are bonds issued by local government bodies or Municipal Corporations. Bangalore was the first city to issue municipal bonds in India in 1997. Later, Ahmedabad followed by launching its municipal bonds in 1998. The funds raised by these municipal bonds are used for constructing bridges, parks, schools, and other public projects. Are these bonds safe? When should one invest in these bonds? What are the risks associated with these bonds? Let’s find out!

Why Do Local Bodies Need Bonds? 

Urban Local Bodies, like municipal corporations, public townships, etc. have always had a lack of funding and resources. According to a 2018 report by NITI Aayog, “The total revenues of all Urban Local Bodies (ULBs) in India amount to less than Rs 1, 50,000 crores, approximately, 1% of India’s GDP.”  

Most of the municipal corporations rely on grants or budgets allocated by state governments or the central government. Apart from these, they rely on water supply bills, property taxes, octroi, rents from municipal properties, vehicle registration fees, etc. The municipal bodies also had the responsibility of promoting socio-economic development in their areas. However, these are not sufficient to set up new projects or maintain already existing projects. To address this problem, local bodies started issuing municipal bonds. 

How Good Are Municipal Bonds?

  • Tax-Free Income- Municipal bonds are usually tax-free or taxed at a lower rate. It is advisable to check the placement memorandum and necessary paperwork before investing in a bond.
  • Lower Risk – Municipal corporations of big cities set up projects like metro rails, public transport, roads, flyovers, public parking spaces, gardens, redevelopment schemes, and housing schemes. These big municipal corporations are likely to recover the money that they spend. Such development is seen only in Tier-1 and Tier-2 cities and generally gave a credit rating above A- going up to AA+ which is actually good. 

    On the other hand, municipal bonds of smaller towns and cities tend to have fewer development projects in hand and therefore might depend on taxes collected to pay back their bondholders. This means that the returns might get riskier for smaller municipal corporations. These bonds have a credit rating lower than BBB+.
  • Strict SEBI Regulations- SEBI guidelines have assured that only those municipal bodies that are financially stable and have the ability to pay back their bondholders can issue bonds. You can read the official SEBI guidelines for municipal bonds over here.
  • Lower Default Rate – On average, municipal bonds have a default rate of 0.18% as compared to corporate bonds which have an average default rate of 3%. This means that municipal bonds are more likely to pay back an investor’s money.  

How Risky are Municipal Bonds?

  • Long Maturity Period – Most Municipal Bonds are issued for 10 years and generally start paying out after the 4th year from the date of issue. This means that Municipal Bonds may not be the best idea for those wanting to invest short term. 
  • Lower Returns – Municipal bonds offer a lower rate of return than corporate bonds due to various reasons like limited revenue base, tax base and risk factors. 
  • Call Risk – Like how companies ‘buy-back’ shares, bonds are ‘called’ back. Companies do so when the bond yield decreases and they want to increase the yield to attract more investors. When these bonds are ‘called’, they pay the bondholders the face value of the bond and the interest accrued on it.  This can cause the bondholder to lose potential interest or pay more taxes on the amount received. 
  • Dependence on Third Parties – Municipal projects aren’t the cleanest in nature. There is a lot of corruption and third parties (contractors) involved who may try to cut corners on the projects. Whether or not a project is completed depends on the company to whom the project was tendered to. 
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Jargons

What Are Bonds? Types of Bonds, Risks and Jargons

What Are Bonds?

A bond is a fixed-income security that a company or a government uses to raise money for a given period of time. In simple words, an organisation can raise debt/borrow money from investors (Mutual Funds, Foreign Investors, Domestic Investors, etc.). Bonds are low-risk investments that give fixed returns to an investor over a period of time. 

Bonds are less riskier than shares, provide a higher return than bank deposits and certain bonds are even tax-free or are charged less tax than other instruments. Bondholders hold a greater preference than shareholders in a company. This means that in case a company shuts down, the bondholders will get their money before the common shareholders do.

Companies on the other hand prefer issuing bonds than borrowing money from the bank. This is because they may require strong financials, cash flows, and credit profiles, without which banks may not lend money. In bonds, it is completely at the investor’s discretion to invest money in those which abide by certain guidelines issued by SEBI and RBI.

Some Important Jargons

  • Face Value/Par Value- The price or value of a single unit of bond when it is first issued. However, it can be traded at below or above its face value/par value.
  • Premium and Discount- If a bond is traded at a price above its face value, it is said to be at a premium. If a bond is traded at a price below its face value, It is said to be at a discount.
  • The Principal or Par Amount- The total amount invested in a particular bond. 
  • Maturity Date- The expiry date of a bond when the bondholder will get back the principal amount along with interest if any.
  • Coupon Rate- It is the rate of interest payable at a fixed interval till the expiry date (Annually, Semi-Annually, Quarterly).
  • Yield- Coupon Payment or Interest Payment received over one year divided by the face value of the bond. Example: If the face value of a bond is Rs.100 and the interest payment received is Rs.10, then the yield is 10%.
  • Yield To Maturity– Yield To Maturity or YTM is the total expected return for an investor if the bond is held till the maturity date.  

Factors Affecting Bond Prices and Yield

  • Market Interest Rates – When the market interest rates decrease, the price of the bond increases. Let us take an example: If the rest of the market is providing returns at 2% interest and the bond meanwhile is providing 4% returns, then more people would invest in the bond than the rest of the market, and this will increase its demand and its market price simultaneously. When market interest rates increase then the price of the bond decreases. 
  • Inflation – When inflation increases, the buying power of the interest earned also decreases. For example- If a bond pays 4% interest annually, and the inflation increases from 0% to 2% in a year, then the real return earned would be 4% minus 2%, which would be 2%. So the ACTUAL return received would be just 2%.
  • Credit Rating – Based on a company’s performance, its risk, and other factors, Credit Rating Agencies like Flitch and Moody’s rate the bonds according to their risk profile. The riskier the bonds, the lesser is its market price as very few would invest in them.

Types of Bonds

Bonds can be classified into many types based on the requirements of the investor. The bond market is an extremely diverse market with hundreds of different products. Not all bonds have a fixed coupon rate and Not all bonds provide regular coupon payouts. Mainly, Bonds are classified according to their issuer, the coupon rate, purpose, currency, country of origin, and much more. 

Broadly speaking, based on the issue of the bonds, they can be classified as follows:

  • Government Bonds- Bonds issued by the state or central government 
  • Corporate Bonds- Bonds issued by private companies
  • Municipal Bonds- Bonds issued by local governments or municipal corporation
  • PSU Bonds- Bonds issued by Public Sector Undertaking such as SBI, ONGC, etc.

Risks Associated with Fixed Income Securities

Inflation risk – that an increase in inflation might reduce the buying power of the returns received on the security. 

Interest rate risk – that increase in overall interest rates shall occur which in turn will decrease the price of the bonds. 

Currency risk – that exchange rates with other currencies will change during the security’s term, causing loss of buying power in other countries

Default risk – that the issuer will be unable to pay the scheduled interest payments or principal repayment due to financial hardship or otherwise

Example

Let us say, a company, Spanners Pvt. Ltd. manufactures nuts, bolds, and spanners. They wish to set up a new factory in Bangalore, but they do not have the sufficient capital required to set up the new factory. Spanners Pvt Ltd. decided to issue bonds of face value Rs 1000 per unit, with a coupon rate of Rs 100 paid half-yearly for a period of 10 years.

Kumar is a computer programmer with savings of Rs 10000. He wants to invest 50% of his savings (Rs 5000) in less risky investments. He does not want to invest in bank fixed deposits (FD) since he feels that they do not pay much interest and are illiquid. Kumar decides to buy 5 bonds of Spanners Pvt. Ltd for a par value or principal of – Rs.1000 x 5 Bonds – Rs. 5000. 

10 years later, Spanners Pvt. Ltd has become a big company and now it’s time to pay its bondholders. Since Kumar has earned Rs 100 every 6 months as a coupon payout for 10 years, he has earned – Rs 100 x 2 times a year x 10 years – which equals to Rs.2000. Meanwhile, Kumar also gets his principal or par value back which is – Rs.1000 x 5 Bonds – Rs.5000.

In 10 years’ time, Kumar invested Rs 5000 and got back Rs 7000 making a total profit of Rs 2000.