9/11 opened the derivatives window for Biren Mehta, the 38-year old golf enthusiast and fund manager at JM Asset Management. A DSP Merill Lynch advertisement in a Gujarati daily for floor traders opened the door to the world of stock markets for Biren Mehta. While screen-based trading is the norm now, back in 1991, it was the 'ring' which was the centre of trading activity.
"In those four years (1991-95), I learnt how to deal with financial institutions, take market and limit orders and get familiar with the 'Tarawani' or the outcry system," says Mehta.
But technology caught up with this young trader and he had to look for alternatives when the BSE went on-line in January 1995. After stints with UTI Securities, Societe Generale and Credit Suisse First Boston in institutional sales trading, Mehta was looking forward to taking his career to the next level at BNP Paribas but 9/11 put paid to his plans.
The French bank shut shop a month later and Mehta was left at a cross-roads. He however used this to his advantage.
Banking on futures
Derivatives had been launched a year ago. And Mehta used this break to brush up on his basics and learn advanced techniques first at a training programme organised by the UK-based magazine Futures and Options Week and followed it up with a course on derivatives at the BSE.
The background helped as he was given the responsibility by Refco Securities to set up India's first derivative desk. After three years of helping FIIs understand the settlement system and the arbitrage opportunities available in India, Mehta moved to JM Financial and helped them launch the JM Equity and Derivative Fund.
This arbitrage fund was targeted at the retail investors. Derivatives, he says are the ideal tools for hedging, portfolio rebalancing and arbitrage.
While hedging is an effective tool that insulates you from short-term volatility, arbitrage is employed to benefit from price anomalies. To elaborate, suppose an equity share is trading at Rs 100 on the cash market and the futures of the same stock trades at Rs 101, then a trader could purchase the equity shares at one price and sell the futures contract at another to make a risk-free profit of Rs 1 or an annualised return of 12 per cent.
Since it is difficult to time the market, portfolio rebalancing is used by fund managers to make changes to fund constituents based on the premium/discount of the futures prevalent in the market.
Though derivatives were used extensively by institutional investors, they were out of reach for retail investors as the price of one trading lot was was minimum Rs 3 lakh.
"For Rs 5,000, an investor could invest in a category that would otherwise have been ignored while making an asset allocation plan," says Mehta.
After Sebi gave the green signal for funds to invest up to 100 per cent in derivatives, the company launched the JM Arbitrage Advantage Fund in June this year.
The JM Equity and Derivative Fund has outperformed its benchmark, the Crisil Liquid Fund Index with a one year return of 7.57 per cent (see table). Though the returns are good, should an investor consider such a fund when returns from debt instruments are equally good?
MEHTA'S PERFORMANCE
Scheme Performance (%) as on August 30, 2006 |
| JM Fund | Corpus
(Rs cr) | 1 yr | Since
Inception |
| Equity and Derivative (G) | 668.00 | 7.24 | 7.01 |
| Arbitrage Advantage | 697.00 | "� | 0.76* |
| Crisil Liquid Fund Index | "� | 5.51 | 5.24 |
| * Launched in June 2006 |
The derivative edge
"The investment decisions an individual makes will depend upon the asset allocation strategy and risk-taking ability," says Mehta. While equity funds give higher returns, they are risky. Bonds are less risky but the returns are not as high.
"Triple A-rated paper is considered a safe instrument and gives you decent returns, but history (GM, Ford, Enron) tells us that they can turn out to be junk," says Mehta adding that in a arbitrage fund there is no risk of capital loss as it is a completely-hedged product.
"Returns, too are on par or more than that for debt funds. There is no long-term capital gains tax and dividend distribution tax. This reduces the tax liability on short-term capital gains," he says.
While JM has a research team and an investment advisory committee which takes investment decisions, how does a retail investor zero in on a arbitrage opportunity?
Retail options
"Arbitrage opportunities can be identified based on market trends, spreads available, dividend stocks, event-based activity and stocks that have historically traded at a discount," says Mehta.
Giving an example he says, "When FII exposure breaches the permissible level for stocks such as Infosys, SBI, BHEL or TCS, RBI gives a three-day window to FIIs who wish to make purchases at the first given opportunity. The futures then trade at a premium."
Retail investors, he says should follow a three-pronged strategy. "Identify an entry point by looking at derivatives for mispricing between cash and futures, study technicals for entry and exit points and analyse fundamentals to understand the quality of stocks," he says.
While he believes that there will be a 10 per cent correction in the markets, over a three year period investors can expect a 15 per cent annualised return. His typical asset allocation strategy is 50 per cent debt, 25-30 per cent equity and the rest in cash.
"Investors who wish to take the mutual fund route must follow the trends in the market (equity/sectoral) and the reliability factor (safety of capital, track record) of a fund. While Mehta is bullish on stocks in the IT, cement and retail sectors, he is equally optimistic about gold and silver. "The industrial use of silver is on the rise and gold ETFs will ensure that demand for bullion will be high," he says.
A walk in the park
When the squaring of positions do not bother him, Mehta heads for the greens. He considers it the perfect de-stressing tool and would like to convert this weekend hobby into a daily habit once he is done with the markets.
