A case against borrowing Home Loans – Part 2

Link to Part 1 – A case against borrowing Home Loans

How I think about asset allocation

Most financial planners advise putting your surplus into real estate, gold, equities, liquid assets (fixed deposits/liquid funds, etc.) and some of them even suggest buying crypto currencies. I have no formal education in asset allocation. However, my experience of a decade, in equities, has convinced me that equities give you an indirect exposure to most, if not all asset classes. Let me tell you how.

Let’s go back in a time machine and do a thought experiment.

It’s 2002 and you are gainfully employed and a forecaster who never gets his predictions wrong, comes and whispers into your ear “Hey, don’t worry about the below average returns that real estate has delivered over the last couple of years. The next few years are going to deliver outstanding returns. Just take that home loan and buy a flat in a remote corner of Gurgaon, Bangalore, Pune or any other upcoming city and you’ll mint money.”

So, as an equity investor, how could you play real estate without actually buying a land/house. Enter Peter Lynch who once said,

“When there’s a war going on, don’t buy the companies that are doing the fighting; buy the companies that sell the bullets.”

So instead of buying that house, you would have been wiser to buy a basket of stocks of “bullet makers” such as Cera Sanitaryware, Gruh Finance, Shree Cements & Unitech.

Let’s start with Unitech, whose share price went up by jaw dropping 1374 times! I doubt anybody made 1374x on their investment because it is impossible to catch tops and bottoms.

Why did Unitech’s stock price shoot up the way it did? The answer is that between 2003 and 2008, there was a boom in real estate and infra companies and people were buying properties left, right and centre and this is reflected in Unitech’s sales figures in that period. Their sales grew at mind-blowing 76% CAGR (17x). A lot of this growth came from volume growth while a lot of it did come from realisation per square feet of land. That Unitech’s management screwed up on their balance sheet by over-leveraging during boom times, is another story. Today it is a penny stock.

Another “bullet maker” Cera Sanitaryware had a similar story. Sales were rising quickly, thanks to Cera’s dominance in their domain.

Resulting in an 11x return in 5 years, for their minority partners aka shareholders…

Gruh Finance – Another “bullet maker”

Gruh’s stock price went up 9x in five years.

Shree Cements – Another beneficiary of the real estate boom.

Also notice, this co. emerged unscratched by the global financial crisis of 2008-09, thanks to a fanatic promoter and a terrific low cost business model.

Shree Cements – Only when the tide goes out do you discover who’s been swimming in their full suit !!

Let’s move to another asset class – Gold.

One of the direct beneficiaries of higher gold prices is Manappuram Finance, a gold loan company based out of Kerala. Here’s how it’s stock compares to gold prices in India, between 2005 & 2013.

While gold gave stable returns, notice the triple digit returns given by Manappuram’s stock in 6 out of 9 years. If you were a prudent investor in Manappuram in 2005, 2006, 2007, etc. when their business was booming, and were following the story closely, chances are you might have done well and maybe managed to sell before it tanked all the way. Their business deteriorated (at least temporarily) in 2011 after RBI brought in a new rule which basically said gold loan cos can only lend up to 60% of a given borrower’s gold value and that put brakes on this high speed train.

The idea behind putting up this chart is that if you can stomach the volatility, then equity markets are the place for you. If for whatever reason, you can’t, then stay away from the markets, particularly stocks of banks and NBFCs which are usually way more volatile than secular growth stocks.

The mortgage lenders want you take that home loan. In my view, home loans are one of the most brilliant pieces of insidious financial engineering ever designed, so millions of zombies can be created. I am sure not everybody will agree and there are psychological reasons to buy that house. The counter view is that buying a house using borrowed funds is a functional equivalent of betting on future real estate prices. If this isn’t leveraged speculation, what is?

Barath Mukhi

Author: Barath Mukhi

Concentrated investor in Indian markets

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