What are your Systemically Important Investments?

Just yesterday, RBI announced the names of Systemically Important Banks of India. To put it simply, these are those banks whose failure will lead to catastrophic consequences for the country and its people, that is, us.
This concept of Systemically Important Banks (or SIBs) gave me an interesting idea about our own personal finances. Now it may sound a little far fetched… but I request you to hear me out.

Important Investments

But before I move forward with my ideas, I guess there is a need to give a brief background about the concept of SIBs.
After the 2008 Credit Crisis, few smart* economists and financial wizards* decided to do something for the good of the global financial system. They announced a series of reformative measures, which were popularly referred to as the Basel III Norms, to improve the resilience of the banks and the banking systems.

* Sarcasm is intentional 🙂
However, it was felt that Basel III measures were not adequate to deal with the risks posed by systemically important banks. Therefore, it was decided that these SIBs should be governed by stricter norms.
Hence another committee of financial wizards, the Basel Committee on Banking Supervision (BCBS) came out with a framework for identifying the global Systemically Important Banks. This committee also recommended that all member countries (including India) should have additional loss absorbency requirements applicable to these SIBs.
Now I am not sure whether these norms are any good or not. Or whether adherence to these norms can prevent any future crisis or not. But nevertheless, these norms resulted in RBI coming out with its own list of ‘Systemically Important’ or ‘Too-Big-To-Fail’ Banks.
In yesterday’s announcement, RBI identified State Bank of India (SBI) and ICICI Bank as the 2 systemically important banks of India. According to RBI, the failure of these two banks has the potential to screw up the economy (something similar to what happened in US in 2008-2009).
So that was the short background about the Systemically Important Banks. Now lets come back from the world of big banks to the world of personal finance.
Once again, I ask you to hear me out completely and then throw bricks at me. 🙂
Now lets see how RBI defines these Systemically Important Banks:
A few banks assume systemic importance due to their size, cross-jurisdictional activities, complexity, lack of substitutability and interconnectedness. The disorderly failure of these banks has the propensity to cause significant disruption to the essential services provided by the banking system, and in turn, to the overall economic activity. These banks are considered Systemically Important Banks (SIBs) as their continued functioning is critical for the uninterrupted availability of essential banking services to the real economy.

Now I will adopt this statement to define something else.

In life, a few personal investments assume systemic importance due to their size, lack of substitutability and interconnectedness with other investments. The disorderly failure of these investments has the potential to cause significant disruption to the financial well-being of an individual, and in turn, to the overall well-being of his family. These investments should be considered as Systemically Important Investments as their continued growth is critical for the uninterrupted and timely availability of essential funds for the previously-identified goals of the individual.

I will suggest you read the above paragraph again.

I know you must be having some thoughts about what you just read. And I am sure that you already understand that few investments that you make, are more important than many others in your life.

So for someone who is around 30, a systemically important investment might be real estate (I am 30 and I am afraid that I don’t have much interest in real estate as investments).

On the other hand for someone who is around 45-50, retirement savings might be his systemically important investment.

For somebody else, it might be ensuring timely availability of funds for his child’s education.

Now just take a pause and think about your own Systemically Important Investments.A failure of these investments will lead to non-achievement of your goals – which in most cases, will be a big failure for an individual.

Just imagine what will happen if you retire with a retirement corpus which will only provide for your expenses for 5-10 years. After that you will have to depend on your children. Nothing bad about that. But even then, you will become dependent – a concept which I am personally not very comfortable with.

Now when you don’t have money to sustain yourself when you reach 70, then it also means that you will not have any financial legacy or portfolio for your children and grand-children. Doesn’t sound nice. Isn’t it?

For a moment, lets go back to the concept of Systematic Importance of Banks. So why is it that RBI wants to recognize these banks? It is to ensure that they can be further strengthened to make them more robust and less prone to failure. Right?

Same is my concept of Systemically Important Investments. We need to identify them to ensure that they are less prone to failure. And more importantly, help us achieve our goals.

Lets take retirement corpus as an important investment. Suppose for years, you have been investing diligently. But somewhere down the line, you had an emergency and you had to withdraw a part of your retirement corpus to pay for it. You did it because you did not have a sufficient emergency fund in place.

You might feel that it won’t matter much. But concept of compounding is not as forgiving as you or me. You have committed the biggest sin of personal finance. You have disturbed the process of compounding. Withdrawing a few lacs from the retirement corpus, mid way through your investment life (around 45), will result in you ending up with tens of lacs short of your target retirement corpus when you turn 60.

The above example clearly shows that your systemically important investment was not robust. You did not have a contingency plan to take care of unplanned expenditures. One small withdrawal from the retirement corpus resulted in shaving off a few years from your well-funded retired life.

Think of it. Have you stress tested your investments? How will you handle a sudden need of money when all of your money is invested in mutual funds or PPFs? Think about it when you are free and you will understand the importance of identifying important investments and stress testing them.

I have seen people withdrawing money from their Provident Funds to buy property or for other expenses. And many of these people don’t even have any other significant investments towards retirement. They might still lead a good life. But the keyword in previous statement is ‘might’.

That’s it for this post. I want to further explore this concept and see how it can be applied to personal finance and goal based investing. Do let me know about your thoughts on this one.
Suggested Reading:

Detailed write-up on Systematically Important Banks on RBI’s website (It is not as boring as it sounds. Believe me)

PSU Banks are Losing Hell Lot of Money!! 1st Quarter Portfolio Update

Shares of PSU banks have been bleeding for some time now. And unfortunately, some time back I had created a portfolio for tracking PSU banking stocks for next 5 years. Though it has only been 3 months, the fact is that the news is not good. 🙁

The portfolio is down 11.90% compared to Nifty’s 1.5% loss. And if you remove the contribution of dividends, then it further goes down to 13.90%. Pretty bad for 3 months… Isn’t it?

But lets remind ourselves of our original expectation from this portfolio

“[We] expect these stocks to collectively give better returns than index (Nifty50) in next 5 years.”

And with this being the first quarterly update, we still have 19 more quarter to look forward to. As we all know, asset quality issues and competition from more efficient private banks still remain. But the journey has just started. A snapshot of the portfolio is given below:
PSU Banks 1st Quarter Returns

In case you want to get more details, please click on the image below to enlarge:
Detailed PSU Banks Tracker Portfolio - Quarter 1 Update
Detailed PSU Banks Tracker Portfolio – Quarter 1 Update
Please note that I am separately tracking dividends as these government entities are quite liberal in doling out dividends to their shareholders (read: government), and hence we cannot neglect the contribution of dividends in this portfolio.

One of Stable Investor’s loyal readers Subhodeep made an interesting point in the earlier post:

“Some PSU Banks may yield progressively more than their own FDs over next 5-10 years. In other words, for someone looking for supplementing his monthly income, it might be better to buy stocks, which might end up yielding eventually 15% (on initial cost) or so in next 10 years, instead of buying a 5 or 10 year monthly income certificate (8% or 9% taxable return) in the same PSU Bank.”

And this yield on cost makes quite a lot of sense. I personally know people who now earn yields in excess of 600% every year (on-cost) on their investments made almost two decades back!! 

But lets go back to banking sector for now. 🙂 March 2014 is almost here and pretty soon, its possible that there might be some important announcement about new banking licenses. So, it is once again possible that few of the PSU banking names may see a volatile quarter of price movements.

But already down close to 15%, these stocks look quite attractive for long term. What do you say? Do you think these stocks would make more money than index in next five years? Or we are not going to see these stocks make new life time highs in next 5 to 10 years?

Do share your views.


Large Cap Nifty Stocks – Returns since our call in December 2011

Important: Don’t miss the last paragraph.

When we wrote Large Cap Nifty Stocks available at deep discounts in December 2011, we were very excited to find a number of great companies available at very cheap prices. And since the world as well as Indian economy hadn’t fully recovered, it was really common sense that one stuck with businesses which could weather the economic turmoil. We advised and bought a few of these large caps for our personal portfolios.

So after an year, when index has given 25% returns, we checked the performance of individual stocks. And we must say that we are more than happy to see around 15 stocks giving 40% + returns. But there are a fair number of duds too. There are 10 stocks which trade at discounts compared to December 2011 prices.

Large Cap Nifty Stocks Returns One Year
Nifty Stocks: One Year Returns (Dec 2011 – Dec 2012)
As of now, markets are trading at a PE of close to 19 and since markets have run up around 800 points in last 4 sessions, we are not sure if it’s a good time to pick stocks. We would rather wait and watch for the time being.

Caution: Our post might make you believe that we have good predictive capabilities. The fact is that we don’t. Why? Markets have risen 25% in last one year. So have all stocks representing the market. And as Warren Buffett said: A rising tide lifts each and every boat. You only find out who is swimming naked when the tide goes out.


Large cap Nifty Stocks available at deep discounts

On 25thNovember 2011, Nifty closed at 4710 – A level 26% lower than highs of 2007-2008 and 2011. So does it mean that all 50 stocks that make the index are following a similar trend?
Before answering this question, I would like you all to know that Nifty is made up of stocks of 50 companies representing 24 important sectors of Indian economy. All these stocks have different weights. And for all practical purposes, the index can be considered to be a good enough representative of stock markets.
NSE itself provides a lot of information about Nifty like Full list of constituents, calculation methodologies, etc. for retail investors.
I did some quick calculations to see how individual Nifty stocks were placed with respect to their 2007-2008 & 2011 highs –
Nifty Stocks 2008 2009 Lows
Nifty Stocks – Discounts to their 2008 & 2011 highs
As evident, shares of companies like RCom (Reliance Communications) are down 92% & 66% from their highs of 2008 & 2011. RCom, because of various negative reasons may not be the best stock to evaluate. But this small analysis also throws up some interesting insights about other large caps –
  • Sterlite Industries – According to a few, another Reliance in making, is down 68% & 58% 
  • Tata Steel is down 64% and 50% 
  • BHEL is down 54% & 50% 
  • Reliance Industries – Bellwether of Indian stock markets, sitting on a cash pile of more than 16 Billion Dollars, generating cash of around a Billion Dollar every quarter is down a staggering 54% from its 2008 highs and 35% from its 2011 highs! 
So what should an average investor do after witnessing shares of mighty and blue chip companies fall like nine pins?
  • Long term investors should understand that though index is down around 25%, good individual stocks like Reliance Industries, Tata Steel, SAIL & State Bank of India are down more than 60%. And these are not small or mid caps; these are full-fledged large caps!
  • This analysis does not suggest that there won’t be any further fall in these scrips. 
  • It makes sense for long term investors to continue with their SIPs in good mutual funds or index funds. Also investor should start selectively buying these large cap stocks, which score high on sustainability parameter and have visibility in revenues/profits.