Every Breath Bernanke Takes

Normally I wouldn't post this.... but this one I could not resist!
Have fun...

Why Indians are interested in Jaguar and Land Rover?

Reports have been circulating lately that two Indian conglomerates are biding for U.K premium auto brands Jaguar and Land Rover. Tata Motors (TTM), India's largest private sector group with 98 companies and Mahindra & Mahindra (M&M - MAHMF), one of the top manufacturers of farm equipment in the world have shown interest in biding for the brands. Jaguar and Land Rover labor union leaders in U.K have publicly endorsed the bid by Tata Group. Birmingham Post just ran article declaring that Tata has won the biding at 1 billion pounds ($2 billion).

By most accounts these brands are not exactly selling like Mustangs (2007 data shows that year over year Jaguar sales plunged 27% and Land Rover sales increased 7.6%). Any company that owns just these brands in western markets are going to be under heavy pressure to reduce emissions based on a new European Union regulation in the offing. M&M has no compact or mid size cars in the European and US markets. Tata does sell few compacts in Europe. Having compact and mid size cars in the fleet would help a company meet its average fuel efficiency goals set by US and European regulators.

As Ford promised to the local union leaders and government, any deal would likely include restrictions on job reduction in U.K, preventing Indian owners from moving manufacturing to India in the near future to reduce costs.

So why would an Indian company spend $2 billion on a deal on the surface looks like a loosing proposition? Indian groups are looking for a short route to obtaining three things they need to enter western markets and compete with global brands in the home market: Technology, Brand and Credibility.

For Tata and M&M to be taken seriously in the western market, obtaining latest automotive design and manufacturing technology is a must. Both the companies also need to be able to fend off all the international players entering the home market including Ford. Both of these require their R&D labs to be up to par with the rest of the industry.

Both Indian manufactures have no western presence to speak of. M&M have long been exporting its farm vehicles to the developing world and recently announced plans to ship its SUV to US. Tatas have been exporting to developing countries as well as Europe for some time, but none of their brands are well known. They need the power of well known brand(s) to gain credibility with the consumers.

If the Tata Motors can capitalize on all these factors to enter into western markets and fend of other international players in the home market, this deal will be worth it even if it can't turn around the declining sales of the brands.


Related Articles:
Tata's bid means hello to big time - Birmingham Post

Why China may not dump USD reserves?

Couple of reasons why China may not dump their significant investments in US treasuries in a hurry.

First... this may sound strange.... A comment from a senior Chinese official indicated that China may need to take advantage of the stronger currencies (read Euro) to achieve better returns for their huge foreign exchange reserves. These comments led currency markets to dump dollars and move to Euro. Euro now is at all time high against the dollar. If China really wanted to do this, who in the right mind would speak out so publicly against an investment they hold large numbers. The comments have decreased the value of their holdings significantly and increased the price of their future investments (Euro).

Second... Most of Chinese export revenue comes from US (something like $200 billion out of $270 billion total exports goes to US). These exports are the primary driver of economic growth in China. As I have noted before, Chinese investment in US treasuries indirectly help fund the consumer spending in US which in turn results in more imports from China. China would not want to jeopardize this circle of dependency on a short order.

China would certainly want to diversify their holdings and they have shown that in the past. Over time they may move out of USD positions but they are likely to do so in a slow and methodical manner.

But, other countries with export powered economies and huge foreign reserves may feel the need to get out USD sooner then the rest. Unless they coordinate among themselves and agree to a common approach proposed before, we will see more turbulence in the currency markets in the coming months.

Index based mutual funds

Jonathan Clements of Wall Street Journal has posted a very good analysis of ETFs vs Index based mutual funds, I would recommend everyone to check it out. He rightly points out many that for your regular investing into preselected asset classes mutual funds are far better.

Wealth Of Nations

The meeting of finance ministers and central bank governors from G7 countries has showcased the growing debate between relatively slow growing G7 vs high growth developing countries.

One discussion is about the voting rights of various countries at IMF and how that should be updated to reflect the growing economic might of BRIC . Emerging economy countries including Brazil are threatening to walk out of the fund and establish their own if the rules are not changed. Some formulas under discussion might provide hyper growth China, more voting power than U.K. and France.

Another area of concern for G7 countries is the sovereign funds established by countries and how they should be used. Although some of the developed countries have similar funds, most of the new and growing money is coming from China and Russia. Both countries have shown (link) that they are willing to use the money to fund state companies buying strategic assets aboard rather than manage it as strictly a portfolio seeking higher returns than US government bonds (most of the Chinese money is invested in US government bonds, more on this here).

Source: Reuters

There is cause for concern here one we are talking about lot of money... more than $2 trillion from various export oriented economies according to Reuters research. Most of the funds are created with the reserves from the central bank of the respective countries. See the Merrill Lynch report on the central bank reserves.

Whether these countries manage funds purely to get better returns or use the money to buy strategic assets all over the world, the influence is significant. Russia wants to use this money to buy oil distribution infrastructure in eastern Europe and Caspian regions. China and India have shown their willingness to fund state companies to buy oil assets overseas.

We will be tracking investments of these companies as they are known. Stay tuned for more posts on this topic.

Emerging markets: Political and Market Risk

Eurasia group has released their annual index calculating the political risk among emerging market economies giving Hungary the top score and Pakistan plagued by Islamic fundamentalism and political unrest the lowest score. Among the larger countries Brazil has scored the most followed by China, India and Russia in that order.

Other countries at the bottom of the list include Valenzuela, Nigeria and Iran.

Here is a list of ETFs with exposure to some of these countries

Templeton Emerging Market Fund (EMF) a closed end ETF has exposure to many of the low risk countries such as Brazil (14.8%), China (12.6%), Turkey (9.7%) and South Korea (7.9%)

Hungary: GUR (7.8%)
South Korea: EMF (7.9%), APB (20%), KEF (100%), ARR (20%)
India: INP (100%), IFN (100%)
China: FXI (100%)
Brazil: EWI (100%)
Venezuela: MSD (5.9%), LBF (8%)

Click here for a interactive map of the world with political stability ranks. Additional media coverage of this topic here and here.

iPath India (INP) Premium/Discount

One subject I did not cover in detail about the INP in my earlier post is premium/discount of this ETN from the net asset value (NAV) or intrinsic value of the assets held. One big advantage of INP compared to IIF (Morgan Stanley India Fund) and IFN (Blackstone India fund) is that with INP one doesn't need to risk the premium/discount issues associated with other ETFs. For e.g. as of this writing following are the premium/discounts of the three securities according to etfconnect.com

INP: 0.12% (premium)
IIF : -12.38% (discount)
IFN: -11.37$ (discount)

In other words IIF and IFN are trading at about 12% discount from the underlying assets. If you bought one of these funds in the past they have not appreciated as much as the securities they are holding. Although some of the discount can be attributed to the dividends they pay (read more on this here) there is no guarantee that they will continue to do so. If you want to understand the reason behind why iPath ETN (INP) is trading close to the net asset value, read on, but I must warn you that this is bit technical for non financial professional.

iPath India ETN (INP) is based on MSCI India total market index. This index is calculated by MSCI, independent of the Barcleys which issues the security. Barcleys is interested in making sure that the security performance in the open market accurately reflects the underlying index. In order to ensure this Barcleys offers a weekly redemption option through which anyone can redeem (minimum 50,000 securities) securities for the weekly redemption value calculated based on the index.

Barcleys expectation is that arbitrageurs (traders who take advantage of difference in a security's value in two different markets; in this case open market and weekly redemption option) will ensure that the INP value does not deviate too much from the index value. In fact there are some indications that this is the case. If you look at the chart of INP vs NDEUSIA which represents the MSCI India index at Bloomberg, you would notice that the security is tracking the index closely. Off course during the day/week there will be some differences due to the demand vs supply for the security as well as what investors expect from the next days market in India.

How your next trip to Toy"R"ous affects bond yields

When you go to ToyRous this week end to buy the latest Little Tikes Endless Adventures Tikes Town for your son or daughter you are not just helping ToyRous with their revenue and profit, in the global connected world your purchase has the potential to affect treasury bond yields!!

Most of the toys, electronics and clothing sold in US are imported from Asian countries including China and Japan. When ToyRous imports its toys, most of them from China, it pays Chinese manufacturer in US $. The Chinese manufacturer needs to local pay wages and other expenses in Chinese local currency Yuan. When they convert the US $ to the local currency Chinese government is left with US $s, this is then becomes China's foreign exchange reserves. Thanks to China's ever rising exports to the rest of the world, their current foreign exchange reserves are estimated at a whopping US $1.2 trillion! It also continues to grow at about US $200 billion a year.

China invests most of this money in US government backed bonds, one of the safest investments in the world. The pattern is similar for Japan. These investments have been funding US government deficits over several years and have been keeping robust demand for US treasuries. Analysts
including Bill Gross the founder and Chief Investment officer of Pimco believe that this high demand has pushed the yields of these bonds down by at least 0.5% (in other words they are more expensive to buy due to demand).

ToyRous toy purchase to bond yields... that is the power of globalization.

We have written few times before on China chasing better yields than offered by US government through an investment company funded by portion of the foreign exchange reserves. The company already made its first deal investing $3 billion in US based private equity firm Blackstone. It has been reported recently that China is likely to continue to invest in other assets in order to maximize returns. This trend should reduce the demand for treasury bonds in the coming years.

There you go, Little Tikes to bond yields!

An ETF family tree

The Bespoke group has a nice ETF family tree that lists all popular US ETFs by style/category such as large, growth, value, fixed Income and commodities.

I have been wanting to create one for the international market securities trading in US. This is a great one for US equities.

Links: Blog , ETF Family Tree

All you need to know before investing in iPath India ETN:INP

Does this look like a latest travel offer to fly to India? that is what I thought before I clicked on the ad, it took me to the iPath ETN site promoting Barcleys India exchange traded note.

What is an exchange traded note?

Exchange traded note as the name suggests is a bond like instrument but trades like a regular stock in the stock exchange. All the iPath ETNs are issued with 30 year maturity and 0% coupon/interest rate, meaning that the debt like security will not pay any interest for the 30 years. Unless you are planning to invest more than 50,000 stocks of an ETN your best bet is to buy this just like a stock through your broker. If you are buying more than 50,000 stocks you can deal with Barcleys directly.

iPath India ETN (INP)
By most accounts iPath India ETN (INP) is a welcome change for an US investor interested in investing in India. Previously the options were limited to two closed end funds Morgan Stanley's IIF and Black stone's IFN and Mathews India mutual fund (MINDX). There are other ETFs and funds such as iShares emerging markets (ADRE) and Vanguard Emerging Markets (VWO) that provide exposure to India as part of larger emerging market exposure.

Unlike other India only funds, iPath India ETN is based on MSCI India Total Market Index with no active management. In general this translates to lower fees, in fact INP's 0.75% expense is lower than all other India only funds.

But before you hit that buy button on your online broker site, you should know what is good and bad about it.

Differed taxes: One important difference between an ETN and regular ETF is that ETNs
do not pay any dividends. All the returns will be paid out at the end of the 30 year period. Off course you can cash out prior to that period by selling the holdings in the open market. If you are bullish on the long term prospects of India and does not want to incur dividend tax during the period you are holding the note, this is the best bet. I am assuming that we are talking about investing out of a taxable account.

Index Tracking: This is the only India fund that tracks an index (MSCI India Total Returns Index) with no active management. Tons of research performed over long term has shown than index based investing beats active management when adjusted for expenses. The MSCI index reflects the returns after reinvesting all the dividend income. The only concern I have about index is that the telecom and communication sector which is a huge growth area in India is underrepresented with only 3 companies and 5% of the total assets. For e.g. all the big name companies with huge cell phone networks including Bharati Telecom and BSNL is missing from the index. This may have to do with index definition "the top marketcap companies trading in National Stock Exchange". So if a company is not listed in the exchange you are out of luck.

Tax treatment: Barcleys, the fund manager believes that investors are not liable for any tax until the security matures (30 years) or whenever you sell your holdings in the open market. But IRS has not ruled on this one way or the other. If IRS does not agree with this interpretation, there may be tax consequences. Here is the relevant text from the prospectus

The United States federal income tax consequences of your investment in the Securities are uncertain. In the opinion of our counsel, Sullivan & Cromwell LLP, your Securities should be treated as described above, but it is possible that the Internal Revenue Service may assert an alternative treatment. Because of this uncertainty, we urge you to consult your own tax advisor as to the tax consequences of your investment in the Securities.

While the dividend reinvestment is good, the prospectus states that dividend is reinvested after withholding income tax with the assumption that the security holder will be subject to double taxation, both in US and India. US and India has double taxation treaty that allows for tax exemption in US if the income is already taxed India. The fund does not seem to take advantage of this treaty.

Indians can not buy: This is a strange rule; Securities and Exchange Board of India (SEBI) the securities regulator in India requires that this security not to be offered to NRIs (Indians living aboard) or PIO (Person of Indian origin, a status offered by Indian government for people with origins in India). This means that millions of affluent Indians living in US can not buy this. But Barcleys does not seem to enforce this rule. If you status is any of the ones mentioned here, you may want to check with your broker on restrictions.

Barcleys credit: Since this is debt instrument, Barcleys credit rating may affect the market price of the fund. Investors can expect ample warning in the media before such an event occurs. The value of the security is based on the underlying index and Barcleys offers a weekly redemption option that guarantees redemption of the security based on the index value. This should keep the market price close to the net asset value.

In summary INP offers an attractive way to invest directly in a hot emerging market in a cost effective way. If you are interested in investing for the long term in this market this is the best option out there. Investors should keep a watch for any new developments in the tax treatment that could negatively affect you.

China's investment company gets down to business

A post last month talked about the government of China's $400 billion investment company with the purpose of increasing its returns. Well.. their first deal is to invest in Blackstone the US private equity management company that is planning for an IPO in the coming weeks. The $3 billion investment would get Chinese a discount of about 5% from the IPO price.

Apparently Blackstone increased their offer size to accommodate the deal. China so far has invested mostly in US government backed securities. I would have expected this newly formed investment company to take more conservative approach then investing in private equity.

Full Report: Forbes

Merril Lynch survey of the emerging markets

Merrill Lynch recently surveyed fund managers all over the world about the emerging market trends here are the high lights. Comments are mine!

• 86% of them are upbeat about Brazil and holding positions (they need to be upbeat about their holdings so I wouldn't read too much into this!)
  
• 43% of them expect better profit growth among emerging market companies in the next 12 months (low but a solid number)
• 71% said emerging markets are fairly valued (read... there is some room for growth)
• 43% prefer Asian emerging markets and 38% prefer Latin American markets (anybody for east European markets, I think they are a big growth area as well)
• 62% of the managers are underweight on Mexico compared to 14% in April
• 52% of the fund managers have underweight positions on India similar to what they had in previous year (this is consistent with what I have been saying the last few posts)

Source: Merril Lynch and Market watch stories

More than 50% of S&P 500 revenues are from out side US

Standard and Poor estimates that more than half of the revenue for the companies listed in SP 500 index comes from outside US. I guess this is expected with companies such as Caterpillar, Microsoft and GE included in the index. This ought to be a consideration when deciding the percentage allocation for your domestic equity and foreign equity portions of the portfolio.
The foreign revenue does two things for the portfolio, it reduces the impact of a US economy slowdown and provides you more exposure to non US currencies.

I would still recommend to keep considerable portions of the portfolio invested directly in foreign equities, foreign equities are still the best and direct way of getting exposure to foreign markets/economies. Most of the S&P 500 companies while doing significant business in foreign countries does not represent the growth in all sectors of those economies. See the chart below that compares the performance of the S&P 500 with iShares MSCI EAFE Index Fund (EFA), a ETF that tracks the MSCI EAFE Index that represents the performance of foreign markets. EFA outperformed S&P 500 2 to 1 over a 5 year period. The performance is similar for the 10 year period.

Indian stock market outlook

Indian stock market will be going sideways for the next four to six months according a Wall Street Journal Asia article. Reasons are quite similar to the ones I had posted earlier.

- High interest rates
- High value of Rupee (around 41 against USD)
- High inflation
- More money is staying in the banks which earns about 9% savings rate

As I said before, I wouldn't not increase my Indian exposure at this time. But I think long term this is still a very good bet. I read a research report outlining Indian consumer demand over the next 10-15 years which is very positive for companies serving the domestic market, stay tuned for more details on this report.

Asset Allocation Vs Trading

I have spent some time thinking about trading vs asset allocation as a way of managing your money.

First off these comments apply only to people who do not manage their money on a full time basis, and I commend people who do manage their money on a full time basis for their courage especially people such as Mike D who has not had a financial career in their prior life.

I also commend people who manage to trade and invest at the same time; part of the portfolio based on long term goals and part of the portfolio focusing on short term trading opportunities. I would imagine such an approach would require lot of discipline.

Trading requires you to be nimble and spend significant portion of the day looking for good reasons to take a position or get out of a position. For someone (like me) who wants to manage money on their own but has another full time job this does not work. I will just stick to goal based asset allocation.

But I like the idea of using futures/options for hedging/lowering risk in a special situation.