CHENNAI

14

YOUNGINVESTOR

THE HINDU BUSINESS LINE ..SUNDAY, FEBRUARY 20, 2011

Planning for futures

Futures can give you higher leverage than stocks, but plan well as they can also be risky.
Rajnish Kumar

Money Talk
Mr Tushar Agarwal, CEO of the nancial services and investment banking rm AGROY, has spent over 12 years in the Indian stock markets. His experiences over the years have taught him many lessons on investments . Read on as he shares with Business Line his cheat sheet on investments.
What are your top nancial goals?

My top nancial goals are to get reasonable returns with adequate safety on my investments. I am generally quite happy with a yield of above 18 per cent on my investments and prefer to book prots if I achieve it.
How has your idea about money changed over the years?

If you are an avid business news follower, you may have come across articles and discussions on futures and options across newspapers and business news channels. While those in the know would highly appreciate the intricacies and nuances of such discussions, here are some brass tacks on futures for the so-far uninitiated.
WHAT ARE FUTURES?

At a young age, like with everyone I guess, money meant big house, big cars, the latest gizmos etc. However, now I view money as a tool to earn more money, as more money means a secure future.
Tell us about your most successful investment - the one which made the most money for you.

Though futures exchange markets were rst set up in Japan in the 1730s, trade for standardised contracts started in 1864 when the Chicago Board of Trades (CBOT) listed standardised forward contracts. These were initially offered for grains. Nevertheless, they started a trend, which saw many other commodities and nancial instruments being offered by various exchanges across the world over a period of time. Futures is a contract between two parties, traded through an exchange to buy or sell a specied quantity of an asset at a future date and at a predetermined price. The asset can be a commodity such as gold, oil, wheat etc or nancial instruments such as stocks or currency. An underlying asset can also be intangible such as an index or interest rate.
OBLIGATION TO BUY OR SELL OF FUTURES, MARGIN CALLS AND RISKS

When I was very young, the most successful investment I made was in Bajaj Auto. At that time, it used to be one of the most sought-after blue chips and had an excellent track record of dividends and bonus. I could see my investments multiply with Bajaj Auto! And that really gave me more condence to enter this eld. Subsequently, Reliance Industries is a stock which I have cherished and nurtured. It has continued to give me good returns with adequate safety.
One mistake on investing or saving that you regret?

Most investment mistakes committed by me have been in real estate. I have usually invested in the best real estate opportunities, but the timing of exit has not been correct.
What has been your most valuable learning experience so far?

When you buy a futures contract, you have an obligation to buy the underlying asset at a pre-determined price on the day when the contract matures (also called the expiry date). Futures are exchange-traded instruments. In India, where trading is electronic, the Stock Exchange does the matching of bid and ask prices placed by the buyers and sellers and ensures that the transactions take place. Clearing and settlement of the trades is guaranteed by the exchange. Futures were traditionally settled by actually delivering or buying the underlying but now they can be cash settled. Futures traded in India are cash settled, which means on the date of expiry you just pay or receive the difference between the spot price and the contract price. Futures are offered by NSE (National Stock Exchange) for nancial instruments such as index, stocks, currency and interest rates. Commodities futures and currency futures are traded through MCX and NCDEX exchanges. To trade in these futures, you will need to open a trading account with brokers who are members of these exchanges.

Futures come with higher risks as they give you a high leverage. While you can gain signicantly more, know that you can also lose money very rapidly. Heres how. When you buy or sell futures you will rst need to provide a margin to the broker called initial margin. When you buy one lot of futures contract, you will not be required to pay the full amount. Instead you will pay only a part of it as initial margin. This will range from 15-20 per cent for most stocks and about 10-15 per cent for Nifty futures (index). Margin requirement is xed by the exchange and can vary every day. The margins can be in the form of cash. It can also be stocks that serve as collaterals. Futures contracts on NSE are available for three maturity dates at any point in time current month, near month and far month. Each of these contracts expire on the last Thursday of the respective months. When you buy a contract you need to choose the month of expiry. Like any other security, the price at which the future contract is available is determined by market forces and keeps changing constantly.

Every day, you will receive a debit or credit in your account depending upon whether price of the contract moves up or down. Hence, you make money when prices move up if you have bought a futures contract, and if you have sold a contract you make money when the futures price moves down. This daily debit or credit implies your contract is settled on a daily basis and you can square off your position anytime by exiting the position. In case you get a large debit due to adverse price movement or increase in margin requirement by exchange, your broker will ask you to bring in more margin.
SHOULD YOU OPT FOR FUTURES?

One of the main advantages of trading in futures is that unlike stocks you dont need to square up position intraday if you have short-sold. Hence, you can gain from a falling market much better. You also get very high leverage. Unlike when you buy stocks on delivery, your brokerage in futures is very low. If you intend to trade regularly this can lead to signicant cost saving. However, thanks to its high leverage, it also comes with some associated risks. If you are on the wrong side of the market, you can lose money very

rapidly. It can even erode your capital in no time if the market moves sharply. That said, if you take care of a few basics you can also benet from futures. Keep a stop loss on positions: This means you should know and give clear instructions to your broker to square off your positions when your losses hit a certain level. This will ensure you will limit your losses when your directional calls go wrong. Use it to hedge your portfolio: If you feel markets may go down and erode the value of your portfolio, you can go short on index futures. And if the markets do correct, the prot on your short position would, to a large extent, hedge the losses in your stocks portfolio. Use only a part of your investible surplus for trading in futures: Depending on your risk appetite, allocate only a portion of your funds to trade in futures. While it can denitely boost your portfolios earnings, do keep in mind that it comes with some risks. So, remember to always keep tabs on your futures position.
The author is Executive Vice- President of Fullerton Securities and Wealth Advisors Ltd.

In the long run, if you are able to generate a return of 15-18 per cent on your investments, then you have done a great job. Most short-term gains are usually also offset Mr Agarwal , CEO, AGROY by short-term losses and mistakes. Hence, whenever you invest, you must set a target and then actively book prots as per the targets.
What is the amount of wealth you hope to retire with? How are you creating this corpus?

It is extremely difcult to put a gure to this. However, I hope to retire a happy man with enough wealth to take care of my wife and I. If my current investments in stocks and other xed income instruments give me a return of approximately 18 per cent, I should be able to create the desired corpus.
How do you plan your investments to beat ination?

Around half of my investment is in xed income securities like PPF and Fixed Deposits. The balance half is invested in real estate and stocks. I usually invest only in large cap stocks, which have a steady record and are usually able to give stable returns.
Whats your message on saving and investing to young people just starting out on their career?

While investing, two important considerations to be kept in mind are liquidity and knowledge. At the end of the day, you dont want to invest in something you cant easily get out of or you dont know anything about And real estate usually looks very attractive but one needs to be very cautious about liquidity and transparency.
SRIVIDHYA SIVAKUMAR

Simple Economics Ant intelligence!

MARKETS IN A MINUTE

Buyback basics
Buyback refers to a company repurchasing shares from existing shareholders.
Anand Kalyanaraman

With the results season over, the next triggers for the markets will come from the upcoming Railway and Union Budgets. Heres a sneak peek into the tug of war between our panellists: Aashka, the innate bull; and Pramod, the not-so-bullish. Aashka: What a week it has been! At last, some semblance of bulls returning to the market! Pramod: Cmon! A week of positive gains in the market and you think its all back to the good old days, hmmm? With so many scams and scandals to deal with, you think institutional investors will look only at the faint silver lining? Aashka: Ah! You truly are a pessimist. The PM has reiterated that he will bring the many culprits of the many scams to justice. Lets cut him some slack, shall we? Besides, India has only seen over $1.5 billion worth of outows so far. This seems like nothing compared to the $54 billion of portfolio inows we have seen in the last two years. Pramod: May I remind you that as far as investing in the markets is concerned, it is always about the future? Do you think we can see another $54 billion of inows in the next two years? Aashka: Of course it is not easy to answer that! But who would have said the same two years back? My friend, money has to come where there is growth! India will grow at 8.5 per cent this year too So, I would say it is only a matter of time before monies return. Besides, ination and interest rates are shortterm worries. Pramod: Anyway, what do you think about the upcoming Union Budget? It sure will give the right picture of the Governments reform agenda. Aashka: At last, we have something to agree about. I hope the Budget is as strong and clear in its agenda as the Indian cricket fans aspiration of the elusive World Cup. The industry wish lists are pouring in while some are genuine and muchneeded; there are some ludicrous ones too! Whats wrong in wishing, as they say? Pramod: Dont say that! I am wishing hard that India wins the World Cup this time. After all, isnt wishing the rst step towards fullment? Aashka: Ah! If only you could be half as optimistic and condent about our markets! But for now, lets not to steal the thunder from Pranab da and Mamata didi! Wonder what the cash-strapped Railways would present this time? Pramod: Well, some social schemes and more trains to West Bengal! Dont forget the state assembly elections are due in April. Aashka: Well, lets not speculate so much.
SRIVIDHYA SIVAKUMAR

The recent steep fall in the price of the Reliance Infrastructure stock prompted the company to announce a buyback of its shares. The indicative price for the buyback was much higher than the prevailing market price. A few months ago, Piramal Healthcare also announced a share buyback following the sale of a chunk of its business. What is buyback and why do companies resort to it?
MOTIVATIONS

the managements condence about the companys prospects. In any case, a buyback would go through only when it is priced at a premium. Else, shareholders would rather sell in the market, and give the buyback proposal a short shrift. Also, promoters sometimes use the buyback route to increase their stake in the company at no extra cost to them. This happens when other shareholders give up their shares while promoters hold on to their stake. Promoters get to up their stake with the companies (and not their personal) funds being used for the buyback.
DO THEY WORK?

Clearly, buybacks can be used to kill several birds with one stone. But do they always Simply put, buyback of shares refers to a serve their purpose? Do share prices go up company using the cash on its books to (and stay there), and are shareholders realrepurchase shares (up to limits specied by ly better off? It has been observed in several cases that the efcacy law) from shareholof price signalling in ders. The motivabuybacks is temporations include ry at best. This is returning excess mostly observed when cash to shareholthe open market ders, sending unroute is used by the dervaluation company for the buysignals, increasing back. Under this, the per share earnings, buyback resolution and raising promoter stake. allows the company A cash-rich comto acquire up to a JARGON BUSTER pany may not see certain number of further growth aveshares, up to a cernues to deploy its resources preferring to tain maximum price per share, up to a return the cash to shareholders through particular date and involving the total outbuyback, rather than let it remain idle on its lay of up to a certain maximum amount. Now, the proposals may not necessarily books. With the acquisition price being higher than the market rate, the company be followed through to conclusion by the portrays the buyback as rewarding its sha- company, or it may choose to acquire the reholders , as was seen in the case of Pira- shares in the open market at a lower rate. Essentially, shareholders may not be able to mal Healthcare. Buybacks also serve the purpose of exit at the maximum price mentioned in boosting per share earnings. Indian corpo- the announcement. In this context, the tender offer route of rate law requires that shares bought back need to be extinguished. So, after a buy- buyback carries certainty on both price and back, the company will be left with a lesser quantum parameters for shareholders. Unnumber of shares, which increases the der this , the company acquires shares diearnings per share. Buybacks also help rectly from shareholders at a xed price companies signal to the market that its and on a proportionate basis. However, shares are trading below what the manage- since tender offer buybacks are not subject ment perceives to be its intrinsic value. This to securities transaction tax, they do not usually happens in a protracted bear mar- enjoy tax benets on capital gains. In many ket, or when the shares get hammered due cases, special dividends may reward shareto company specic events and news, as holders better since they would apply to all was seen in the recent case of Reliance shares (and not just a proportion as in the Infrastructure. The proposal to buyback case of buybacks), and are tax exempt for shares at a higher price is intended to attest shareholders.

Ants tend to follow the leader.

B. Venkatesh

Consider this. You visit your usual sweet shop and nd that the owners have parted ways and have set-up shop adjacent to each other. You do not know which shop to patronise. How will you decide? It turns out that you will most likely use behavioural psychology to make your sweet decision. How? We often look for evidence to take a decision, especially when we are unsure of our choice. Often, evidence is the crowd inside each shop. It is most likely that you will consider the crowded shop to be the better one. Why? You presume that the other patrons made a conscious choice to enter the shop. The crowd, therefore, suggests that the shop offers better quality products than its competitor. You are, in other words, banking on wisdom of the crowd. Of course, it could be just as well that the crowd in one shop was purely random. Confused? Take this example.
GETTING ANTSY

You drop two lumps of sugar not far from each other in your living room . You know that ants will soon populate the area. They do not, however, divide their attention between the lumps. Instead, the lead ants randomly choose one lump. And as you watch the ants clinically collect the sugar , you will notice that the population would most often drift towards one lump. Why? Ants realise that there could be danger near the food source. If an ant returns with food, it means the source is safe. And that prompts other ants to access the same source. Our behaviour mimics that of the ants in many ways. Whether it is buying sweets or stocks, we mostly follow the crowd, as we take comfort in large numbers. Besides, we often consider it better to be wrong with the crowd than risk being right alone! This behaviour typically leads to boom and bust in the markets, and explains why portfolio managers herd and why some brands are popular.
(The author is the founder of Navera Consulting. He can be reached at enhancek@gmail.com)

...CH-X