Hindu Undivided Family - Advantages.

The HUF concept is not new in India, and is one of the best ways to save tax. Any married man from the Hindu, Jain, Sikh, or Buddhist community can form an HUF, and will act as the “Karta” or the head
of this family. According to Indian law, an HUF will be considered as a separate entity from the individual for tax purposes, which benefits married couples from these communities to save a substantial amount on taxes.
HUF is a separate entity in itself and qualifies for all tax benefits under Section 80C (up to ~1 lakh),
80D (health insurance premium), 80G (donation), 80L (income from bank account), Section 54 (capital
gains) and so on. Tax slabs applicable to income of an HUF is similar to that of any individual taxpayer, with the basic exemption at ~2 lakh. First, any two family members with the karta (male member of the family) can create an HUF. For a married individual, family will mean wife / husband and children, if any. An HUF can be used for any purpose apart from receiving salaries, which means that one can form an HUF to keep ancestral property, or to run a business. For example, if a married man has a salary of ~5 lakh, and gets rent on ancestral property of ~3 lakh, as an individual he will be paying taxes of approximately ~1 lakh (assuming ~1 lakh is invested under section 80C). However, if he shifts the property to an HUF, then he will be paying only ~20,000 as taxes as an individual and the HUF will be liable for no taxes (assuming that both the individual and the HUF has invested ~1 lakh under section 80C). This results in a tax saving of around ~80,000.

Let us look at a more detailed example to see how a HUF can save one’s taxes.  Forming of an HUF is relatively simple, with all married men and their wives becoming an HUF automatically. There are, however, a few simple procedures to be followed, such as executing a deed on a stamp paper to transfer assets to the HUF - this can be property, cash, jewellery, etc. One will also have to get a PAN card in the name of the HUF and open a bank account. There can be multiple instances of HUF’s in each family, with each married couple being part of their own HUF. There are also cases with women only HUF’s, where the Karta has
passed away, and left behind onlyfemale descendants - in such a case, the daughter assumes the role of
the Karta.

Transferring money into an HUF is not as easy as it seems as one cannot just transfer money orassets into the HUF name, as this gets combined into a single entity under the existing law and taxed as such. The ideal way to setup a HUF is to put some of the gifts (cash, jewellery, etc) received at one’s wedding into the HUF. The other way is to set up the HUF using ancestral property from a will - though in this case the will should specify that the property will go to the HUF and not the individual. Another pitfall one should be
aware of is that while transferring gifts to the HUF, there is no exemption on receiving gifts from specified relatives like in the case of an individual - the HUF is liable to pay taxes on all gifts. However, since the HUF gets tax benefits like an individual entity, gifts of up to ~2 lakh (limit can go up to ~3 lakh if the tax benefits under Section 80C are fully used) are exempt from taxation.   Assets and liabilities in the name of the HUF will belong to the HUF and this will be treated as a separate entity. For example, if a business is being run under an HUF all business expenses will be deducted from the HUF income. This includes any salary paid to family members who are part of the HUF. Additionally, a member of an HUF has to maintain books of
accounts and all paperwork for the HUF separately. Transfer of assets to HUF happens only one-way. You
can create assets for the HUF, but these can be taken out only by dissolving the entity. However, financial assets, gold and cash, can easily be distributed among members. But there are some disadvantages also by forming an HUF. For instance, if you are looking to sella property that is in an HUF’s name, it may not find many takers as everybody wants a clear property title. If there is a legal dispute around the property, then selling it can become impossible.  An HUF can be dissolved if all the members agree. A partial dissolution is not possible.   It qualifies for all benefits of Section 80C like an individual, and, therefore, gives twice the exemption.

Gold

In the James Bond film "Goldfinger", the gold-intoxicated villain - the film's namesake - leaves Bond with this thought: "This is gold Mr. Bond. All my life I have been in love with its color, its brilliance, its divine eminence."

Movies like this epitomize the human fascination with this precious metal and the greed that it sometimes inspires. Contrary to what Goldfinger thought, gold may not be the most valuable investment in the world - it may be nothing more than a form of insurance.

Here we look at the major issues facing gold, such as its demand/supply imbalance and its potential to share the same fate as silver. We also revisit the gold standard, and examine what gold really means as an investment.

Gold's Unique Demand/Supply Imbalance
The biggest factor influencing gold's price is the staggering amount of it held by central banks around the world. This is a legacy from the days of the gold standard, which existed in one form or another between 1821 and 1971. During this period, U.S. and European central banks hoarded massive amounts of gold.

According to the World Gold Council, in 2003 this stockpile consisted of 33,000 metric tons, accounting for nearly 25% of all the gold ever mined. In that same year, a total of only 3,200 metric tons of gold was supplied to the marketplace through mining and scrap.

This means that the central banks' stockpile of 33,000 tons could overwhelm the market if it were sold. In other words, there is enough gold in the vaults of central banks to satisfy world demand for 10 years without another ounce being mined! That’s a pretty significant demand/supply imbalance.

Furthermore, without a gold standard, this precious metal has limited strategic use for these central banks. Because gold does not earn any investment interest, some central banks - like that of Canada during 1980-2003 - have already eliminated their gold stock. The potential for gold supply to dwarf its demand poses a hindrance to the metal's potential return well into the future.

Note the gradual decline of the central banks' reserves since the fall of the gold standard. As this decline continues, the price of gold also faces a continual downward stress. Sixty percent of the current gold reserves are held by U.S., Germany, France, Switzerland and Italy. Data provided by the World Gold Council.

Does Silver Foreshadow Gold's Future?

Silver and gold have shared a common history over the past five millennia. Prior to the 20th century, silver was also a monetary standard, but it has long since faded from this monetary scene and from the vaults of central banks around the world. If the current stockpile of gold were to be sold off, the downward pressure on its price could result in it having the same fate as silver.

Perhaps history demonstrates that it is just too difficult for the world to work under a monetary standard based on a commodity because the demand for these metals depends on more than monetary needs.

When these metals were used as monetary standards, the divergence of the market price and mint price for these metals seemed to be in continual flux. (The mint price refers to the price a mint would pay someone to bring gold or silver in to be melted down into coinage.) And continual arbitrage opportunities between market and mint prices created havoc on economies.

The rise and fall of the silver standard - which just happened to be the first victim - perhaps demonstrates how gold's price as a commodity cannot absorb the demand/supply distortions created by its past position as a monetary standard.

The Real Meaning of Gold

So how should an investor really view gold? For the most part, it is a commodity, just like soybeans or oil. So, when making any buy or sell decision, an investor should put future supply and demand issues at the forefront.

At the same time, gold can be seen as a form of insurance against a catastrophic event hitting the global financial markets. However, if that were ever to happen, it's possible that gold would be of use only to those investors who held it physically.

Gold also may be helpful during periods of hyperinflation as it can hold its purchasing power much better than paper money during these periods. However, this is true for most commodities.

Hyperinflation has never occurred in the U.S., but some countries are all too familiar with it. Argentina, for example, saw one of its worst periods of hyperinflation from 1989-90, when inflation reached a staggering 186% in one month alone. In such situations, gold has the capacity to protect the investor from the ill effects of hyperinflation.

Conclusion

Gold means many things to many people. Its history alone has lured some investors. One of gold's most important historical roles has been as a monetary standard, functioning much like today's U.S. dollar. However, with the gold standard no longer in place and industrial demand representing only 10% of its overall demand, gold's luster - as an investment - is not quite as bright.

Until the fate of the gold stockpile accumulated by governments is determined, the price of it will have difficulty. Therefore, holding gold as an investment is really a form of insurance against a period of hyperinflation or a catastrophic event hitting our global financial system. However, insurance comes at a price, and is that price worth it?

Capital Gains

There are various asset classes like equity, debt, gold, & real estate where you invest according to the time horizon of your goals and risk appetite. The gains from these investments are termed as capital gains and taxed differently. Since any tax liability impact your returns from the investment, it's important to have awareness on the net gains you will receive. 

The capital gains from above mentioned asset classes is classified as long term or short term based on the holding period of investment. For e.g. in real estate, if you have held the asset for more than 3 years it is treated as long term. Contrary to this in equities, investment for more than a year is treated as long term.

Here are some calculations to show how long term and short term capital gains are derived and how it can help in reducing your taxability:

1. Long term Capital Gains: A long term capital gain arises when you hold any asset for a defined period. This period ranges from one year to three year across different asset classes. The table below shows the holding period for long term gains in various asset classes and the applicable tax rate:

As can be inferred from the data, equities enjoy zero taxability on long term capital gains while in real estate or physical gold investment you have to pay a flat rate. Due to these variations the post-tax returns from these asset classes can vary substantially. There are provisions in income tax to reduce LTCG through indexation or save LTCG tax from some of these instruments by investing it in other alternatives.

Indexation Benefit:  Inflation constantly erodes real value of money through rise in prices. Due to this even if your investment have risen four times the purchasing power of money will have went down 50% from the time you made investment. To reduce the impact of inflation on your investment, indexation benefit is provided in calculating long term capital gains. Through this benefit you can adjust your capital gains from inflation by applying an appropriate factor from cost inflation index to the original units.

Here is how indexation benefits works:

Cost of purchasing a property in 2007- Rs 3500000

Cost of selling the property in 2011 - Rs 5000000

Inflation Index- 2007   -  551
                        2011  -  785

Indexed Purchase cost- 3500000*785/551= Rs 4986388

Long Term Capital Gains= 5000000-4986388 = Rs 13612*

Tax on LTCG= 13612*20%=  Rs 2722

Education Cess= 2722*3% =  Rs 82

Total Tax on LTCG = Rs 2804

*The non- indexed gain would have been Rs 15 lakh

Thus, the indexation benefit reduces the tax liability substantially which otherwise would have been a huge payout for any investor.

2. Short Term Capital Gains: Investments in any asset class if held for a very short period is taxed as short term capital gains. Except equity, short term gains from other assets is included in investor's income and taxed at slab rate. The data below highlights the  taxation structure in case of short term capital gains:

*Education cess of 3% is applicable on all tax rates

This is how short term capital gains are calculated:

Cost of Equity Mutual Funds units bought in 2011- Rs 100000

Price of same units sold after 6 months - Rs 120000

Short Term capital Gains - Rs 20000

Tax Applicable- 20000*15%= Rs 3000

 Education Cess -  3000*3%=Rs  90

Total Tax payable= Rs 3090

With complex capital gains tax structure, it's wise to first make yourself aware on the net returns i.e. post tax returns you will earn, whenever you intend to make any investment. This will help in analyzing the amount of wealth creation you will create after paying your tax liabilities.

How Much Gold Do Big Countries Hold

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  1.    United States
Gold holdings: 8,133.5 tonnes
Percentage of total foreign reserves: 76.6%
Consumer demand in Q2 2012 for Jewelry: 19.8 tonnes
Consumer demand for total bar and coin invest in Q2 2012: 14.4 tonnes

2.    Germany
Gold holdings: 3,395.5 tonnes
Percentage of total foreign reserves: 73.9%
Consumer demand for total bar and coin invest in Q2 2012: 34.2 tonnes

3.    IMF
According to the International Monetary Fund, it holds a relatively 
large amount of gold among its assets, not only for reasons of financial 
soundness, but also to meet unforeseen contingencies.
Gold holdings: 2,814.0

4.    Italy
Gold holdings: 2,451.8 tonnes
Percentage of total foreign reserves: 73.2%
Consumer demand in Q2 2012 for Jewelry: 4.8 tonnes

5.    France
Gold holdings: 2,435.4 tonnes
Percentage of total foreign reserves: 73.2%
Consumer demand for total bar and coin invest in Q2 2012: 0.6 tonnes

6.    China
Gold holdings: 1,054.1 tonnes
Percentage of total foreign reserves: 1.8%
Consumer demand in Q2 2012 for Jewelry: 93.8 tonnes
Consumer demand for total bar and coin invest in Q2 2012: 51.1 tonnes

7.    Switzerland
Gold holdings: 1,040.1 tonnes
Percentage of total foreign reserves: 11.7%
Consumer demand for total bar and coin invest in Q2 2012: 17.3 tonnes

8.    Russia
Gold holdings: 934.5 tonnes
Percentage of total foreign reserves: 10.1%
Consumer demand in Q2 2012 for Jewelry: 18.6 tonnes

9.    Japan
Gold holdings: 765.2 tonnes
Percentage of total foreign reserves: 3.4%
Consumer demand in Q2 2012 for Jewelry: 3.8 tonnes
Consumer demand for total bar and coin invest in Q2 2012: 5.1 tonnes

10.  Netherlands
Gold holdings: 612.5 tonnes
Percentage of total foreign reserves: 61.1%

11.  India
Gold holdings: 557.7 tonnes
Percentage of total foreign reserves: 10.6%
Consumer demand in Q2 2012 for Jewelry: 124.8 tonnes
Consumer demand for total bar and coin invest in Q2 2012: 56.5 tonnes

FIIs lose more than MF when market tanks.

Call it default or design, local fund managers have been luckier than their global counterparts by remaining underinvested in smalland mid-cap counters on more than a single occasion when these shares have tanked. 

While FIIs have been the single largest contributors of liquidity in the Indian stock markets, their track record of picking small- and mid-cap stocks does not inspire much confidence. 

Data since 2001 shows that FIIs, which held more shares in momentum stocks than mutual funds, suffered higher losses during the 2001 Ketan Parekh scam, the 2008-09 stock market plunge and the recent carnage in small- and mid-cap stocks. For instance, MF holdings stood between nil and 3% in stocks such as Core Education, Arshiya International, Tulip Telecom, Jindal Cotex or Gemini Communications, which fell more than 60% this year. However, FII holdings in these companies was between 5% and 22%. The case was similar before the Ketan Parikh scam in 2001 that rocked the markets and the 2008-09 global financial recession which caused a 50% erosion in the value of midcaps like Fedders Lloyd, Birla Power Solutions, Moser Baer, Jindal South West and GVK Power, in which FIIs held 20-32% stake. 

Taking investment calls based on business models, rather than on balance-sheet fundamentals, interacting more frequently with management and, ironically, a failure to muster fresh corpus from investors have saved domestic MF managers from burning a bigger hole in their pockets than foreign institutional investors . 

“It’s about being able to base a decision on a business idea rather than just on market-cap and liquidity,” says Chokkalingam G, chief investment officer, Centrum, with . 1,500 crore worth of assets under management. 

“Local fund managers believe, and rightly, that market cap and liquidity are outcomes of great business ideas and don’t apply these parameters to base their investment decisions unlike many FIIs which are process-driven and will invest in a counter only if it, say, has a market cap higher than $300 million–500 million and enjoys high liquidity.” Market experts says though FIIs are aggressive investors and have made good returns by investing in India’s blue-chip stocks, they have failed to identify good mid- and smallcap stocks which demand a bottom-up approach of investment among other things. 

“The foreign fund manager based out of Hong Kong or Singapore typically sits on a folio from 10 countries, has a small team with each person responsible for selecting stocks from three countries, making it impractical for them to have a bottom-up approach that’s needed in small- and mid-cap stocks,” said Ramanathan K, CIO & ED, ING Mutual Fund. “Indian fund managers, on the other hand, have continuous assessment monitoring and management interactions and can take decisions guided not solely by the balance sheet.” 
The difference in approach is borne by a well-known foreign brokerage having recommended a ‘Buy’ on KS Oils on June 28, 2011 (FII stake: 11.21%, MF stake: 0.1%) with a price upside of 137% even though the stock had fallen 52% to . 19 in the prior six months. The stock has fallen continuously since then to . 2.79 apiece at present. Factors such as these, feel Chokkalingam and Ramnathan, were responsible for equity mid-cap and small cap mutual funds posting average returns of -7.98% over the past three months against a 10.84% fall in the BSE Mid-cap index and a 17.66% decline in BSE Small-cap index. 
However, rather than attributing the relatively better performance of domestic MFs to design, experts like Nirmal Jain, chairman, India Infoline, said rising redemptions and lesser fresh fund inflows were responsible for their underownership of small- and mid-cap stocks. 

“Over the past five years, mutual funds and insurance companies have faced more redemptions and are getting lesser fresh fund inflows at a time FIIs have pumped in billions of dollars,” said Jain. “This is one of the main reasons markets have become shallow and tank on selling by FIIs.” 

‘The Home (-sickness) Bias of Foreign Holdings’, a recent academic paper, finds that among US-based fund managers, a Brazilian-born manager who speaks fluent Portuguese and is familiar with the country's business culture had better results when investing in Brazilian companies than a German-born manager. 
“Domestic fund managers were perhaps more successful in containing losses as they looked beyond just the balance sheet,” said a fund manager who focuses on mi-caps. 

Sensex and PEG ratio: Are valuations justified?

PEG ratio is the P/E ratio dividend by the EPS growth of a company. The general thumb rule is that an investor should avoid buying into a company when the PEG ratio is in excess of one. What this means is that the valuations should be justified by the earnings growth. As stated by Peter Lynch, "The P/E Ratio of any company that's fairly priced will equal is growth rate".

We shall apply this logic for the Sensex. We will take a look at two things - the P/E ratio of the Sensex and the index's year on year change in earnings per share. We have compared these parameters for two five year periods - one ended 2007 and the other starting 2008.

If we see the Sensex P/E ratio over a long term, it has averaged at about 18.5 times. Going by the logic of the PEG, the P/E ratio would be justified if the earnings growth rate was in excess of this figure. This seems to have been the situation prior to 2007.



As you can see, the Sensex EPS was volatile (may not be a 100% accurate due to the method we have calculated the EPS growth; at the same time, the extreme volatilities may be due to non-adjustment of extraordinary items, change in the index constituents, amongst others) during this period, but it would be fair to assume that the growth rates were in excess of 18.5%. Taking an average of the EPS growth during the period, it stood at nearly 27%. The average P/E during this period stood at about 18.2 times.

Now let us move on to the period post 2007 i.e. from 2008 till present. The scenario changes quite a bit. And this at a time when the general view (including ours) was that the overall markets are attractive considering that the benchmark index is trading below its long term average P/E ratio. But when we apply the above mentioned logic, it does seem to paint a slightly different picture.




As you can see, unlike the pre-2007 era, the EPS growth rates declined or reduced substantially. While the earnings growth rates have improved off late, they still stand below the average growth rates during the period 2003 to 2007.

With these data points, it does seem like the argument about the Sensex being attractive especially when compared to the historical valuations does not hold true.

So, are Sensex stocks expensive?

Ideally, the PEG ratio should not be applied to an index which has a basket of stocks from different sectors - including those from cyclical industries/businesses. The ratio is useful to compare two firms in the same industry with similar fundamentals and also in some sense for companies with steady growth levels. As such, based on this analysis one cannot conclude that all Sensex stocks are expensive at current valuations.

Should you or Should't you ape FIIs or DIIs

If there is one thing certain about the stock markets, it is the uncertainty. The stock ticker always seems to tread a shaky and capricious path. With no clarity in sight, small investors often resort to taking the cue from the big investors. Are the foreign institutional investors (FIIs) buying or selling? Which stocks and sectors are the FIIs betting on? Where are the domestic mutual funds putting their money? What are the fund managers saying about the market and the economy? 

Investors are often under the impression that the so-called big guys really know what's going on in the economy and the stock markets. With so many experts crunching loads of data, this presumption may not be too farfetched. But the thing is that the economy is way too complex and intricate for any expert to fully fathom it. As such, following FIIs and domestic institutional investors (DIIs) blindly could be misleading. 

An article in Moneylife points out at some interesting data. Through most of 2012, FIIs were pumping money into the Indian stock markets. For 10 of the 12 months, they were net buyers. On the contrary, DIIs were net sellers for 9 of the 12 months. 

But this is not where their differences end. Both FIIs and DIIs have differing views on different sectors, sometimes even stark opposite. For instance, FIIs have been bullish on banking and financial services sector. However, DIIs are bearish on this sector. If you compare the top 10 FII underweight list and the top 10 overweight list of domestic mutual funds, you will see that FIIs are buying some of the same stocks that the DIIs are selling, and vice versa. 

If two so-called experts share opposite views, whom should you listen to? Our answer is no one. Why so? There are several factors and institutional compulsions that determine FII and DII investing behaviour. For example, redemption pressure and scarcity of new fund inflows could force mutual funds to sell off their stocks. On the other hand, FIIs have their own set of problems. Any adverse financial situation in their home country could force them to flee away from the Indian markets. Plus, they have to deal with the currency risk as well. 

In addition, both FIIs and DIIs are often prone to following the 'institutional imperative'. For the uninitiated, Warren Buffett  describes the 'institutional imperative' as that urge for managers to mimic what their peers are doing even if it may seem irrational. The performance of fund managers is closely monitored over the short term. This may make them short-sighted and unwilling to take contrarian bets. 

It is certainly easy to accept that small investors are not constrained by the above mentioned limitations and have significant advantages over these big investors. As such, it would be best you do not pay much heed to what the FIIs and DIIs are doing. Do your own research and stick to the principles of value investing. This has worked brilliantly for some of the world's most successful investors. There is hardly any doubt why it will not work for you. 

Theoretically the stock markets are considered to be the barometer of an economy. Considered a lead indicator, they are supposed to reflect the direction the economy is going to take in the coming times. Therefore when our very own BSE-Sensex breached the 20,000 mark in January 2013, everyone thought the economy is taking a turn for the better. But the recently released economic data seems to point to the contrary. Dismal numbers for the IIP (Index for Industrial Production) suggest that the economy is still not out of the woods. So why have the stock markets been heading upwards? Simple, it is because of the flood of cheap money that has invaded our markets. With developed economies printing money like there is no tomorrow, a large part of it has found its way into India. This has led prices of asset classes, particularly stocks, to run up in recent times. As a result, stock markets do not seem to be reflecting the true state of the economy. However, it must be remembered that this can only continue for a short period of time. In the long term, the relationship between earnings and stock prices has to hold. So either the economy would take a turn for the better. Or the stock markets would come crashing down. 

"So it's a terrible mistake to look at what's going on in the economy today and then decide whether to buy or sell stocks based on it. You should decide whether to buy or sell stocks based on how much you're getting for your money, long-term value you're getting for your money at any given time. And next week doesn't make any difference because next week, next week is going to be a week further away. And the important thing is to have the right long-term outlook, evaluate the businesses you are buying. And then a terrible market or a terrible economy is your friend." - Warren Buffett