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The Hindu
6 days ago
- Business
- The Hindu
How can cat bonds plan for a natural disaster?
The story so far: While life insurance is a ubiquitous term in India, disaster risk insurance is not. A low penetration of disaster risk insurance for individual property and livelihoods leaves much of the population exposed to irretrievable damage and loss. Most peoples' assets and means of income remain largely uninsured. Globally, after the hurricanes of the late-1990s in the U.S., when even re-insurers suffered losses, catastrophe risk was farmed out to financial markets through catastrophe bonds (cat bonds). What is a cat bond? Cat bonds are a unique hybrid insurance-cum-debt financial product that transforms insurance cover into a tradable security. These bonds transfer hazard risk from the at-risk state to not just the limited stock of global re-insurers, but to deep-pocketed global financial markets through securitisation, opening up a much larger quantum of funds for post-disaster relief and reconstruction. Cat bonds are effective in transferring pre-defined risk to bond investors, ensuring quicker payouts and a much-reduced counter-party risk. Players that create cat bonds are sovereign nations, which sponsor the bond and pay the premium, with the principal being the sum insured. The sponsor requires an intermediary to issue the bond to reduce counter-party risk. Intermediaries can include the World Bank, the Asian Development Bank or a reinsurance company. If a disaster does occur, the investor runs the risk of losing a part of the principal — a key reason for higher coupon rates of such bonds, compared to regular debt instruments. There is much variation in coupon rates for a cat bond depending on the risks — earthquakes garner lower premiums, as low as 1-2%, compared to hurricanes or cyclones. Are cat bonds profitable? Nobel Prize-winner Harry Markowitz had famously stated that risk diversification is 'truly the only free lunch in finance'. Risk-seeking investors find the disaster risk curve most attractive for diversification, since climate or geological hazards are historically not related to financial market movements, being mutually exclusive and independent of the financial risk curve. Probabilistic and deterministic financial risk curves move differently from cat-risk curves, in effect de-risking the entire portfolio of an investor. Leading the pack of cat bond investors are pension funds, with a minority share being occupied by hedge funds and family offices, seeking to de-risk their market-centric risk profiles for sovereign-sponsored cat bonds. Observers assess that since the onset of cat bonds, there have been $180 billion worth new issuances of cat bonds globally with about $50 billion currently outstanding. Does India need a cat bond? In these times of climate change, disaster risk can become unprofitable for insurers and re-insurers, as is increasingly evident in the U.S. with the rising intensity of hurricanes and forest fires. This causes premiums to rise and demand to fall, leading to risk ratcheting back to the harried victim of disasters. This is where governments can step-in, sponsoring instruments like cat bonds. The unpredictability and increase in frequency of extreme weather events like cyclones, floods, forest fires and devastating earthquakes in South Asia have increased India's exposure to disaster-risk. India needs to ring-fence its public finances for post-disaster reconstruction. Given the credit standing of the Indian sovereign and the scale of India's hazard risk profile, it could be cost-effective to sponsor such an instrument, through an intermediary like the World Bank, utilising its established bond curves. Apart from assessing the existing risk curve, insurance companies typically build clauses requiring disaster mitigation into contracts with countries, in the absence of which coupon rates rise. On that count, the Indian government is far ahead, having already demonstrated pro-active risk reduction by allocating mitigation and capacity building funds worth $1.8 billion per annum since FY21-22. Given India's size and financial stability, India could be lead-sponsor for a South Asian cat bond, given that most such regional risks remain unhedged. In addition, the regional hazard matrix reveals an interesting variety of hazards, each with their own risk curve and a different flavour of history, vulnerability, and exposure. Imagine a regional cat bond for high-impact hazards like an earthquake in Bhutan, Nepal and India; or for a supra-cyclone or tsunami in India, Bangladesh, Maldives, Myanmar and Sri Lanka. A South Asian cat bond would spread risk, reduce premium costs and over time, make the region financially stronger to face disasters. What are the disadvantages? A defectively designed cat bond could lead to no payout despite a significant disaster. For example, an earthquake cat bond designed for a magnitude threshold of 6.6M for a certain grid may fail if a 6.5M event occurs and causes extensive damage. In addition, despite a contract if a disaster doesn't occur, it could lead to questions on the desirability of such expense. Hence, comparison of premium to be paid discovered through transparent government procedure, with historical annual costs of post-disaster reconstruction could be the best way forward. Safi Ahsan Rizvi is an IPS officer and adviser to the NDMA.
Mint
08-07-2025
- Business
- Mint
How you can invest in international markets
MUMBAI : 'Diversification is the only free lunch in investing," famously said Nobel Prize-winning American economist Harry Markowitz. One way investors can diversify their investments is by allocating a part of their portfolio outside the country. However, many popular mutual funds in India with international exposure are closed to new subscriptions due to regulatory limitations. In February 2022, the markets regulator directed asset management companies to stop accepting fresh inflows into international mutual funds because the industry had exhausted the overseas investment limit of $7 billion set by the Reserve Bank of India (RBI). The Securities and Exchange Board of India (Sebi) has allowed new investments in international schemes, but only to offset redemptions. Each AMC had a $1 billion overseas investment limit. However, if XYZ AMC had $600 million invested overseas when the industry breached the $7 billion limit in 2022, then that became its new upper limit. If any redemption occurs and the international exposure comes down to $400 million, then the AMC can accept inflows of up to $200 million to offset the shortfall. There are 61 international mutual fund schemes, showed data from BSE Star MF. Of those, 31 funds are closed for lump sum investments and 32 for systematic investment plans (SIPs). Most funds that invest in the US are closed to new investments as their investment quota has been breached quickly due to high investor demand. Combo funds If investors want to diversify into an international market but are unsure how to do it, they can consider funds that hold a mixture of domestic and global equities. Funds like Parag Parikh Flexi Cap Fund and DSP Value Fund have exposure to both international and domestic securities. Schemes with at least 65% in Indian equities are taxed at 20% if sold within 12 months and 12.5% if sold after 12 months. International schemes are taxed at 12.5% after 24 months and at a slab rate if sold within 24 months. 'It's difficult for investors to maintain a fixed international exposure through mutual funds, as most funds have already exhausted their overseas investment limits. This makes it challenging to allocate incremental inflows towards building or maintaining global exposure," said Arun Kumar, head of researchatonline mutual funds investment and stock trading platform FundsIndia. Kumar said he prefers having a separate fund for international exposure. However, if the fund is sold, tax has to be paid, whereas churning by fund managers inside a combo fund has no tax incidence. Sahil Kapoor, head of product and investment strategist at DSP Mutual Fund, said they still have room to accept international exposure and can maintain the current ratio of international to domestic positions even if they receive fresh inflows. DSP Value Fund currently has 30% exposure to international stocks and exchange-traded funds (ETFs). One should not paint all international investing with the same brush, said Nirav Karkera, head of research at Fisdom. He said investors should be aware of the sectors and geographies they're taking exposure to. For instance, he said, having exposure to a US index and a Brazilian index might mean two completely different things. International ETFs International ETFs are traded in stock exchanges. However, experts warn that many of these ETFs are trading at a premium to their underlying. Motilal Oswal Nasdaq 100 Fund of Fund Direct Growth gave a one-year return of 56% as of 19 December 2024, while Kotak NASDAQ 100 Fund of Fund Direct Growth returned 25% despite both the funds tracking the NASDAQ 100, showed data from investment research firm Value Research. This happened because the Motilal Oswal fund had Motilal Oswal Nasdaq as its underlying. The ETF was trading at a big premium to its underlying, as the regulatory quota halted fresh investment, but investor demand kept rising. On the other hand, the Kotak fund was feeding into the iShares Nasdaq 100 UCITS ETF, which is traded in global markets and was trading at its fair value. 'Whenever the overseas investment limit gets revised upwards, the present premium will disappear, and so investors in such ETFs need to be very careful of the premium that they're paying," said Kumar of FundsIndia. International ETFs have an overseas investment limit of $1 billion. As the industry limit was nearing, Sebi directed funds holding overseas ETFs as underlying to stop accepting fresh inflows from April 2024. Alternative route Investors can use the RBI's liberalized remittance scheme (LRS) of $250,000 to invest directly in foreign stocks and ETFs. However, experts say it comes with its own set of challenges like increased costs, currency conversion charges, and complicated tax compliance obligations. 'Investors trying to find alternatives to the RBI-imposed cap by using the LRS can consider direct investments in overseas equities. However, this route also poses challenges, including high costs and complex tax compliance. As a result, investors find themselves in a tough spot until the RBI eases the restrictions—something unlikely in the near future given the pressure on the rupee," said Abhishek Kumar, a registered investment advisor and founder of SahajMoney. Gift City is another option retail investors can explore. Recently, Mint reported on 3 July that DSP launched India's first outbound retail fund. The fund was launched on 2 June and has a ticket size of $5,000. The Gift City structure sidesteps the need for cumbersome tax filings and high brokerages as compared to investing overseas using a foreign brokerage account. The fund will invest in 30-50 global companies across markets such as the US, Europe, Japan, South Korea, China, and Canada. Kumar from SahajMoney said such a retail fund structure might provide a good opportunity for retail investors to diversify internationally, going forward, until the RBI revises the cap on overseas investment limit for the mutual fund industry.
Mint
25-06-2025
- Business
- Mint
What is the ideal number of stocks you should have held in your portfolio?
Retail investors often find themselves stuck between two extremes. On one side, they spread their money across 50–60 stocks with tiny allocations, thinking more stocks mean more safety. On the other hand, they put most of their money into just 5–15 stocks they "believe in". But both approaches have their downsides. That brings us to the fundamental question: how much diversification is enough? Let's unpack the data and reasoning behind this magic number. In the world of investing, the advice "don't put all your eggs in one basket" is more than just a cliche; it's backed by decades of financial research. At the core of this idea is Modern Portfolio Theory (MPT), introduced by Harry Markowitz in 1952. It explains how investors can construct an optimal portfolio that balances risk and return, primarily through diversification. Diversification in a stock portfolio means different stocks, market caps or sectors to reduce risk. The logic is simple: if one investment underperforms, others in the portfolio can help offset losses. But like many things in investing, more is not always better. Two kinds of risk that affect your stock portfolio: Systemic risk: Economy-wide factors, such as inflation, RBI interest rate changes, or global tensions like the Iran-Israel conflict, impact the entire market. No company, no matter how strong or well-managed it is, can escape these risks entirely, not even through diversification. Economy-wide factors, such as inflation, RBI interest rate changes, or global tensions like the Iran-Israel conflict, impact the entire market. No company, no matter how strong or well-managed it is, can escape these risks entirely, not even through diversification. Unsystematic risk: Risks like a company defaulting on its debt, a key managerial figure being caught in fraud, or sudden regulatory changes have a profound impact on that company's stock. These are known as un-systemic risks; they are specific to a particular company or sector and do not entirely affect the broader market. For example, during COVID-19, many hospitality companies suffered due to lockdowns, while pharma companies thrived. Because these risks are company- or sector-specific, they can be reduced through diversification. If one company in your portfolio suffers, gains in other unrelated sectors can help offset that loss. That's why spreading your investments is essential for managing un-systemic risk. Modern Portfolio Theory shows that diversification initially reduces risk sharply. But after a certain point, adding more stocks stops making a big difference. Portfolio risk This graph clearly shows that most of this risk reduction occurs in the first 20 to 30 well-selected stocks. Beyond that, the curve flattens out, meaning adding more stocks doesn't reduce overall risk by much. That's why holding more than 30 stocks often adds complexity without offering meaningful benefits. It's not just about how many stocks you hold; it's also about how much you allocate to each. The right approach is to ensure that no single stock takes up more than 5% of your portfolio. This way, each holding is meaningful, but no single mistake can do too much damage. India's equity indices offer clear evidence that a well-diversified portfolio of 30 stocks is enough to capture the benefits of diversification without adding unnecessary complexity. CAGR Despite having 20 more stocks, Nifty 50 hasn't offered any significant advantage over Sensex 30, neither in terms of long-term returns nor in reducing volatility. In fact, the Sensex, with fewer stocks, has delivered slightly better returns and marginally lower risk. This clearly shows that beyond a certain point, around 30 well-selected stocks, adding more doesn't meaningfully improve the overall performance or lower risk. Then why should your personal portfolio be any different? Diversification is essential, but it needs to be done right. The evidence is clear that 30 well-chosen stocks strike the right balance between risk, return, and simplicity. Go beyond that, and you're likely adding complexity without reward. That's precisely the idea behind Finology 30 - a basket of 30 high-quality stocks built only for long-term investors. Finology is a SEBI-registered investment advisor firm with registration number: INA000012218. Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.
Mint
11-06-2025
- Business
- Mint
The 'not-so-fixed' nature of fixed income markets
The term 'fixed income" sounds reassuring—evoking stability, predictable returns, and minimal risk. But in today's market, this label can be misleading. From wild price swings to rate-driven gains and losses, fixed income is no longer as 'fixed' as it once was. The roots of what we now call fixed income go back at least 250 years, when the British government issued 'Consols"—a type of perpetual bond used to finance wars. These bonds had no maturity date and paid fixed coupons indefinitely, until redeemed by the government. The term gained prominence with the advent of modern portfolio theory in the 1950s, when economists like Harry Markowitz developed frameworks around diversification and risk. These theories clearly distinguished between 'equities' (stocks) and 'bonds,' the latter defined by their steady, fixed returns. Over time, as large asset management firms grew in influence, 'fixed income" became a standard industry classification, covering bonds and a wide range of debt instruments. Many investors take the term at face value, assuming bonds or debt-based funds are inherently low-risk. 'Fixed income" feels comforting, as if one is promised consistent returns regardless of market conditions. But today, this assumption doesn't hold. Also read: How you can invest in a fully valued market Reality check While the core principles remain, the fixed income landscape has changed dramatically. Financial markets today are more complex, interconnected, and reactive. Innovations in debt instruments, investment vehicles, and valuation models (like mark-to-market and NAV) have introduced a layer of volatility. What was once considered the domain of stable returns now exhibits price and yield fluctuations akin to equities. Variables such as changing interest rates, shifting credit spreads, and evolving liquidity conditions can all disrupt the 'fixed" nature of returns. When bonds behave like stocks Take the example of Austria's 100-year bond issued during the Covid-19 pandemic, which offered a 0.90% yield. As global rates rose over the next three years, the bond's price crashed from €135 to €33—wiping out around 75% of investor value. Closer home, Indian gilt mutual funds reported a yield-to-maturity (YTM) of 7.30% in April 2024. But falling interest rates boosted returns to 11% over the year. Similarly, a 30-year Indian government bond jumped from ₹98 to ₹107 in early 2025, delivering a 16% gain. 'Not-So-Fixed' isn't necessarily a bad thing Volatility isn't always a drawback. In fact, it creates opportunities to manage risk and enhance returns—provided you understand the levers at play. What investors should watch for: Central bank cues and bond duration: Rising rates mean better reinvestment opportunities via newer, higher-yielding bonds. Falling rates can lead to capital gains in long-duration bonds. Credit quality and research: Conservative investors should favour high-rated government or corporate bonds. Those with higher risk appetite can benefit from well-researched strategies that anticipate upgrades or downgrades. Don't blindly trust YTM: The yield-to-maturity assumes holding bonds till maturity and reinvesting at the same rate—conditions that rarely hold. It's not a return guarantee. Liquidity matters: Whether you invest directly or via mutual funds, understand how easily you can exit. If flexibility is important, favour short-duration or highly liquid instruments. Review regularly: Just like equities, fixed income investments require monitoring. Keep tabs on rate cycles, credit ratings, and broader liquidity shifts. Also read: This CEO has no fixed-income investments, and has never done an SIP Summing up The world of fixed income has changed. Interest rates, credit risks, liquidity conditions, and market sentiment now have a more visible impact on returns. To navigate this landscape, investors need to let go of outdated assumptions and embrace a more active, informed approach. As this evolving asset class offers both stability and strategy, it may no longer be entirely 'fixed," but it remains very much relevant. Also read: Mastering Fixed Income Trinity: Balancing income, duration, and liquidity for smarter investments Bhupendra Meel, Head – PMS & Alternative – Fixed Income, Bandhan AMC. Views expressed in this column are personal.
Yahoo
10-06-2025
- Business
- Yahoo
Modern Portfolio Theory explained: A guide for investors
Investing can often feel like navigating a maze of endless options and ever-shifting market conditions. This is where the Modern Portfolio Theory (MPT) comes in, offering a roadmap for making smarter investment decisions. Developed by Harry Markowitz in the 1950s, MPT has become a cornerstone of investment management, providing a framework to construct portfolios that maximize returns for a given level of risk. Definition: MPT is a mathematical framework of investment decision-making that quantifies the relationship between risk and return in financial markets. It provides investors with a systematic method to construct portfolios that maximize expected returns for any given level of risk tolerance. At its core, MPT is based on the idea that risk and return are inherently linked and that by carefully selecting a diverse mix of assets, investors can optimize their portfolios to achieve the best possible returns while minimizing risk. This is in contrast to traditional investing approaches, which often focus on picking individual stocks or timing the market. In this guide, Range breaks down this Nobel Prize-winning theory into practical insights you can use to build a more efficient investment portfolio. At the heart of MPT are a few key concepts that every investor should understand: One of the central tenets of MPT is that there is a direct relationship between risk and expected return. In general, investments with higher potential returns also come with higher risks. MPT distinguishes between two main types of risk: Systematic risk: Also known as 'market risk,' this refers to the risk inherent to the entire market, such as economic downturns or interest rate changes. This type of risk cannot be reduced or eliminated through diversification. Unsystematic risk: This is the risk specific to individual securities or sectors. Also called 'diversifiable risk,' this type can be lessened through proper diversification. Diversification is the practice of spreading your investments across a variety of asset classes, sectors, and geographic regions to minimize risk. By including assets with low or negative correlations (for example, assets that tend to move in opposite directions), investors can potentially offset losses in one area with gains in another. The efficient frontier represents the set of optimal portfolios that offer the highest expected return for a given level of risk or the lowest risk for a given level of expected return. Portfolios that lie on the efficient frontier are considered the most efficient, as they provide the best possible tradeoff between risk and return. MPT aims to identify the best possible portfolio on the efficient frontier that aligns with your specific risk tolerance and financial goals. Asset allocation strategies Asset allocation is the process of dividing an investment portfolio among different asset categories, such as stocks, bonds, and cash (this includes savings accounts and other liquid accounts), based on their correlation to each other. For example, stocks and bonds often have low correlations, meaning they tend to move differently in various market conditions. By combining assets with low correlations, investors can potentially smooth out their portfolios' performance over time. Diversification techniques Within each asset class, investors can further diversify their holdings by: Asset class: Spreading investments across various asset classes, such as equities, fixed income, real estate, and commodities. Geographic location: Investing in domestic and international markets can mitigate country-specific risks. Sector: Distributing investments across different sectors, such as technology, healthcare, and energy, to minimize the impact of sector-specific risks. MPT introduces the concept of risk-adjusted returns, which consider an investment's return and the risk taken to achieve it. One common measure is the Sharpe Ratio, which compares an investment's excess return (return above a risk-free rate) to its volatility. A higher Sharpe Ratio indicates a better risk-adjusted return. Other performance metrics, such as Alpha and Beta, also help investors compare the risk-adjusted performance of different portfolios or investments. Portfolio optimization is selecting the best possible allocation of assets to maximize the expected return for a given level of risk. This involves looking at the expected returns, volatility, and correlations of various assets and using mathematical models to identify the optimal portfolio on the efficient frontier. Implementing modern portfolio theory can: Reduce risk through diversification: By spreading investments across various asset classes and securities, MPT helps mitigate unsystematic risk. Even if some individual investments perform poorly, your portfolio may still generate positive returns. Offer optimized returns based on risk tolerance: MPT allows investors to identify the portfolio with the highest expected return for their specific risk tolerance. This helps investors avoid taking on unnecessary risks while still achieving their goals. Provide a scientific approach to investing: MPT offers a data-driven approach that removes emotion from decision-making. Make managing your portfolio more efficient: MPT can help investors build more efficient portfolios by focusing on the optimal combination of assets rather than individual security selection. While MPT has revolutionized the investment landscape, it's important to acknowledge its limitations: Assumptions about market efficiency: MPT assumes that markets are efficient and that all investors can access the same information. In reality, markets can be inefficient, and some investors may have an informational advantage. Real-world constraints: The mathematical models used in MPT often simplify the complexities of real-world investing. Factors such as taxes, transaction costs, and liquidity constraints can impact the implementation of MPT. Human emotion and error: MPT assumes that investors are rational and risk-averse. But behavioral finance research has shown that investors often make irrational decisions based on their emotions and biases. Researchers have developed various extensions and modifications to MPT in response to these limitations, such as the Capital Asset Pricing Model (CAPM) or the Arbitrage Pricing Theory (APT). These models attempt to address some of MPT's shortcomings by incorporating additional risk factors and market dynamics. Implementing MBT in your own investment portfolio involves: Assess your risk tolerance and investment goals. You'll want to clearly define your investment objectives, time horizon, and income needs. Understanding your ability and willingness to tolerate market fluctuations will help you pick the best portfolio allocation. Determine your optimal asset allocation based on your risk profile and objectives. Diversify your portfolio across asset classes, sectors, and geographic regions. Monitor and periodically rebalance your portfolio to maintain your target asset allocation. You'll also want to decide on an implementation strategy—for example, which specific vehicles you want to invest in, such as mutual funds, ETFs, or individual stocks. Review your portfolio regularly and rebalance as needed to maintain your target asset allocation, especially as your situation or market conditions change. Sophisticated software and algorithms can now analyze vast market data in real time, helping investors make better, data-driven investment decisions. Artificial intelligence and machine learning techniques are specifically used to enhance portfolio optimization, risk assessment, and market forecasting. These tools can identify patterns and insights that traditional methods may miss. What's more, technology platforms offer portfolio optimization and monitoring features designed to ensure investors maintain properly balanced, diversified, and tax-efficient portfolios. What is the main goal of MPT? The main goal of MPT is to maximize the expected return for a given level of risk by optimally allocating assets within an investment portfolio. How does MPT reduce risk? MPT reduces risk through diversification, spreading investments across various asset classes, sectors, and geographic regions to minimize the impact of any one investment or market event. Who invented MPT? MPT was developed by economist Harry Markowitz in the 1950s. Markowitz's work laid the foundation for modern investing, earning him a Nobel Prize in Economic Sciences. How do you apply MPT? To apply MPT, assess your risk tolerance and investment goals. Then, use mathematical models to determine the ideal asset allocation for your portfolio. Regularly monitor and rebalance your portfolio to maintain your desired risk-return profile. This story was produced by Range and reviewed and distributed by Stacker.
