Thursday, October 28, 2010

Understanding econoMISTs- Gobbledygook

About inflation, commodities and effective substitutes, and proteins
October 28, 2010 05:27 PM |
R Balakrishnan

An article in The Wall Street Journal a couple of days ago, left me all mixed about some everyday issues

I guess one of the most essential things for someone who is always in the glare of the media, is to be articulate. Often you have to say something which sends the reader into a tizzy. For fear of sounding stupid, the reader does not ask anything.
Today, I stumbled upon an article titled, "RBI: India Experiencing Structural Food Price Shock", in The Wall Street Journal. (You can access the report at
004575575421547641584.html .) The article reports on a speech by Reserve Bank of India governor Subir Gokarn. Each of the quotes is worth reproducing. I am not an economist, so to me the sentences were high octane economics. Here goes:

"Persistent price increases in commodities for which there are no effective substitutes, with other things remaining equal, will raise the potential rate of inflation over a period of time," Mr Gokarn said in a speech.

I tried to break down the sentence at different places and still ended up as confused as ever. Does this mean that when the price of something goes up, inflation happens? Or does it mean that inflation happens only when prices of commodities, of those that have no effective substitutes, go up? (Wonder what the term 'effective' substitute' means?) One brilliant sentence and the readers can enter into a debate about the meaning, context and the impact. I think what it means is that when price rises, inflation happens. Wait. Maybe it means that when prices rise, the 'rate' of inflation will go up. One thing, though, was clear. Inflation is here to stay. The only thing to wonder is why and what makes it happen. Part of the answer is in the explanation given. Inflation is because of 'persistent' price increases.

This sentence followed immediately:

"This means that actual inflation or interest rates would be higher than they would be in the absence of such increases."

The sentence is far more profound. One thought that there is more than one kind of inflation. One is 'actual' inflation referred to in this statement. The second part though should defeat a layman like me. That if the prices do not increase, the inflation or interest rates could be lower. I hope I got it right. Or, does it mean that because of prices rising, inflation is higher than what it could be without such increases? Well, I am all at sea.

The next quote is something out of this world:

"Increasing demand for protein appears to be an inevitable consequence of rising affluence. The affordability and availability of protein is an important indicator of an equitable and sustainable development with implications for both nutritional balance and macroeconomic stability," Mr Gokarn said. A powerful supply response to all sources of protein is needed, he added.

The first half is clear to me. As we Indians get richer, we want more proteins. This includes our dals and perhaps chicken. (You see, in Chennai, most shops selling chicken have the word 'protein' in their name). The next part of the sentence was a Eureka moment for me. The more of dals and chickens I have, the more prosperous my nation is! And the gentleman has drawn another interesting relationship. That affordability is not enough by itself. One should be able to lay hands on it also. And how much of dal and chicken we can have and access tells the story of how healthy we are (nutritional balance?) and how healthy our economy is (macroeconomic stability)! What deep linkages.

So, the solution lies in making available more dal and chicken to all. Sure it is not enough by itself, but proteins are an important indicator. Since I do not eat chicken regularly, I must eat more dals. That is a sign of my growth. And of course I stay healthy and the nation also remains stable.

I never knew that economics, inflation, chicken, dal and proteins were so closely linked and that they are key determinants of social and national development. And as the gentleman says, we need a powerful 'supply' response. We need a national campaign to grow more dals and hatch more eggs.

Friday, October 22, 2010

IPO's and errors in documents

The above article is from "Mint" newspaper about the recent IPO of Coal India.
Moneylife also has an article on this. (

There are big arguments about errors being made in the Red Herring Prosepectus / Offer Documents that are being prepared. The surprising thing is that someone actually spotted the error ( kudos to the Regulator for having spotted these).
The argument is about whether the error is serious enough to warrant SEBI offering an exit option to the investors.

I think, SEBI is right. In fact, there were two earlier IPO's where such things happened. SEBI is being consistent.
To me, the following are the points to look at:

i) The Investment bankers (merchant bankers who advice the issuer and take care of all documentation) are getting away scot free. They are the ones who are directly responsible for errors;
ii)One practical point in favour of SEBI keeping quiet, is that no one actually reads the DRHP or the offer document.IPO's are sold on hype, grey market premium and the aggression (both official and otherwise) of the lead manager. Institutional investors usually do not bother much about going through the details.So, if there is an error in the DRHP, it hardly matters. The fund manager who invests, just looks at the 'flip' gains that he can make;
ii) SEBI never punishes the investment banker. This is exacerbated by the recent import of 'compounding' from the US of A. This implies that there is a tariff card for wrong doing. The investment banker has merely to estimate the likely compounding tariff vis a vis the potential gain. Compounding expenses today have become a part of the Business Plan of intermediaries. They can screw up, mislead investors and /or hide the truth, without worry. No one is going to threaten their existence;
iii) Investment bankers are hiring poor quality people. This is because they want to show off. They tend to hire from the "B" schools, whose products have no patience for the details. All of them are potential CEO material and are excellent at hustling or putting together a concept paper. In the olden days, the document verification, data input in offer documents etc used to be seen with a critical eye, by old timers who could smell mistakes;
iv) The so called 'exit' option supposed to be offered by the issuer of the IPO is hardly seen. Why cannot SEBI insist that this exit option be announced prominently, in each and every publication/media where the IPO offer was splashed? Also, it should be a distinct ad and not hidden somewhere in a jungle of print.

Fairness is required in this industry. Alas, no one wants it and no one is bothered by it. Even the issuers are not concerned, I think.

Tuesday, October 19, 2010

Mutual Funds - All weather harbour


I met quite a few investors over the last couple of weeks. Clearly, there is discomfort in equities at these levels. Whilst they are not too worried about the growth of the economy, there is a feeling that the markets have run ahead of the fundamentals. There is a reluctance to put additional money in to the broad market and most of the HNI’s I know have been switching out to other avenues. Some are going in to MIP’s (having some comfort in the fact that the schemes generally cap exposure to equities and will keep booking profits in order to do so in a rising market), being happy with the returns. Whilst MIP’s will not deliver chart busting returns, they do generally give better returns than a bank deposit, with tax advantages that mutual funds enjoy. Here, one has to be careful, since just around half a dozen of them have given ten percent or more returns in the last twelve months. You also have some of them delivering sub five percent returns.
Some are shifting to income funds. The general view is that interest rates are close to peaking and will start to correct. The problem with Income funds in India is that these funds need the benefit of timing. Without that element in your favour, the returns are generally pathetic. One year returns on long term debt funds have ranged from SUB ONE PERCENT (!) to around nine percent. Not a very encouraging sign. Here, one has to time the entry and after getting a near double digit return. If you stretch it to three years, about half a dozen have returned near ten percent annualised, with the vast majority being under five percent. Not very encouraging and indicates that even the fixed income fund managers are unable to match bank deposit returns.
From my long term experience I have found that diversified equity funds tend to deliver the best returns if you take a perspective of three years and more. Not every fund in the category, but definitely the top ten. Here I do not find much difference between a mid cap and a large cap. Yes, over a short term period there are divergences, but over a longer term it tends to even out. Even sector funds (with the notable exception of banking sector, which seems to be on a roll now) are no different. So, it is not much use choosing between different types of funds. With almost all funds in any one category having similar or same stocks, diversification does not happen.
To me, the biggest disappointment has been the ELSS category. In the initial days, the thought was that ELSS funds will outperform, because the fund manager will not face redemption pressures and could plan a longer term investment strategy. Alas, churn seems to be a better reward, unless one opines that the fund managers do not think long term. Or is it simply that the ELSS schemes tend to be a small percentage of the overall AUM with fund houses and that they neglect it? Whatever be the reason, the ELSS funds have delivered almost five percent lower annualised returns over three years, as opposed to the diversified funds! The lower returns have virtually nullified the effects of any tax saved on that count. As a long term strategy, it seems best to avoid the ELSS category.
I do not like the Gilt funds category. This is because these schemes are either used by PF’s or institutional investors. More important, with the underlying assets trading in market lots of 5 crores, there is an inbuilt inefficiency. In the old days, the banks used to park money in gilt funds for speculating on the movement of interest rates on the ten year bonds. In 2004, spectacular returns were had, when the interest rates on 10 year paper fell from eight percent to sub five percent. However, if you take a longer term frame (three or five years) the returns are a decent ten to fifteen percent per annum for the three and five year periods respectively. However, the corpus is not large enough to warrant a general endorsement of this category. As a class, it has done better than Income funds. From the safety point of view, I would certainly rank the gilt funds higher. So far, our Income funds have not taken any blows (except in the early years, when one of the AMC’s took it upon itself to bail out the investors by buying a defaulted paper from the fund), the risk remains.
Some of the HNI friends seem to of the view that of the different sector funds, the Infrastructure sector funds are lagging behind and are putting money there. The expectation is that this sector will do well, with real estate stabilising etc etc.,
The lesson I have learnt is that it pays to remain invested for a long term. Churn does not benefit the investor. Perfect timing of every move is not possible. One bad move is all it takes to wipe out a lot of hard work that has been put in. I do believe that the mutual funds have done a decent job in India and for those who do not have the knowhow to do their own homework they offer the best avenue. I would keep away from PMS because of their tax inefficiency.

Monday, October 18, 2010

The IPO swindle

Please read this report that came in DNA newspaper on 11th October:
Enam Securities and IDFC Deutsche Equities (India) were the book running lead managers to the issue.
ICICI Prudential, Birla MF, AIG Global, Canara Robeco, Kotak Mahindra MF, Morgan Stanley MF, Goldman Sachs, Axis MF, HSBC MF, Sundaram BNP Paribas MF and ICICI Lombard GIC as anchor investors.

Looks like merchant bankers will go to any lengths to cheat public. Also shows the shoddy nature of work done by the company and the investment bankers.Also a great reflection on the quality of people churned out by the colleges (IIM's ??)who cannot analyse or even present a balance sheet number!
These kind of investment bankers should be banned for life.
Apparently the co offered an option for investors to pull out. I do not recall seeing any ads. Wonder whether you did.
The right thing would have been for full refund, barring the investment bankers for at least five to ten years and tell the co to file papers with a new banker.
But, commerce prevails over justice to the small investor.
The funny thing is also the due diligence done by the anchor investors! When they put in other people’s money, this is the care they show. Wonder whether there is much more to this issue than meets the eye.
Of course, the media kept quiet either because they were not aware or because they did not want to upset the investment bankers.

Sunday, October 10, 2010

Foreclosures gone wild MarketWatch First Take - MarketWatch

Foreclosures gone wild MarketWatch First Take - MarketWatch

This is always the case. India or US, I guess it makes no difference. Harvard did this study. It is people from institutions like theirs, that have designed the process, written complicated laws and generally prescribed documentation of forty pages, where four would suffice.
But, to me, the more important thing is the indulgence being shown to individual defaulters. Virtually the world is looking at 'small borrowers' vs lenders as a "David vs Goliath" story. Media sympathy seems (wrongly) with the small guy.
Maybe it is one way of levelling things. The big corporations swindle billions of taxpayers money from the banks in single deals. Guess the small guy is entitled to piece of the action!


(Recently published in Moneylife magazine)

Some people seem to think there's no trouble just because it hasn't happened yet. If you jump out the window at the 42nd floor and you're still doing fine as you pass the 27th floor, that doesn't mean you don't have a serious problem. I would want to address the problem right now." - Charlie Munger

Our markets continue to be on a tear. The flood of FII money, with more than thirty billion dollars having come in the last twenty months, has been the main driver. Domestic flows have been small and on its own could not have provided the legs for this rally.
Foreigners across the globe want to be invested in Indian markets, because our bumbling efforts to get any kind of decent share in global trade have suddenly become a virtue! For foreign investors the routes are limited to using either the registered FII route or the ETF route. The ADR stock of Indian companies is lower than that of Chinese companies, so the money flow is severe. Also, China does not allow FII moneys like we do.
As the indices keep shooting up, the first fear is of 2008 happening all over again. I was talking to a friend and he said that these are the ‘bull’ factors for the markets:
i) Our economy will grow at 8% plus, irrespective of global conditions. (this may be true in the short term alone. In the long term, if the global economy does not recover, Indian growth will slow down as retaliatory/protectionary measures set in);
ii) The forward earnings multiples today are lower than what they were in 2008. One estimate says that the BSE Sensex, at 19500 is trading just at 15 times 2011-12 earnings. I think the earnings growth keeps getting revised upwards by brokers as the markets keep going higher. The advance tax numbers to September 2010 show only a 13% rise in advance tax numbers for the top 100 companies. This means that the earnings growth is under 15% or else the numbers are getting fudged;
iii) The long terms story is that as Indian economy keeps growing, over the next ten years, in each industry sector, we will have two to four giant players (for inst RIL, BHEL, SBI, HLL) who will be global size and if you look at their profile ten years from today, you are getting them cheap today. Foreigners have realised this and are piling on to the front line stocks. This is a logical argument, but it is like buying 2015 earnings now. What if in 2015 the earnings have not caught up? Upside from here seems to be absent;
iv) The US dollar is set to weaken and hence the foreign investors would also like to invest in Indian equities which not only have a good story, but strengthening of the Indian rupee will also contribute to a higher return on investment. Looks logical, but with India running a trade deficit in excess of US$ 10 billion per month and inflation upwards of 8%, the rupee has no legs. It is only the capricious capital flows that are propping up the rupee. Also, the regulators have a defeatist approach to Indian exports and will not let the rupee strengthen;
v) The general argument is that whilst valuations are a bit aggressive, this time the downside seems small because the fundamentals are strong. This argument does not hold water. Fundamentals are markets do not go hand in hand for any length of time. Markets remain overvalued for long time and remain undervalued only for short periods. This is simply because there is too much money in the world which due to the global meltdown, gets no return and has turned to markets like India in their greed for higher return. Our markets can tank below the 2008 levels if the FII flows were to reverse. When I tell this, I am a loner in the room. No one wishes to believe or accept that if the FII’s pull out, say twenty billion or so dollars over a fortnight, we will reach that kind of a level. Of course, what will prompt them to do that seems to hold the key. Let me say, I am less in disagreement with this than most other bull arguments;
vi) Real estate sector is yet to recover. If you look at the index, it is just around five stocks (SBI, HDFC, L&T, ITC, HDFC Bank) that have contributed to the rise. Hence, the markets have a long way to go, as other stocks also participate in this bull run. I find this argument full of holes. After a long time, I see that the sensex does not have a single stock with one digit P/E multiple. Even cyclical stocks like Hindalco trade at near twenty multiples. In fact, it is difficult to find any value buy in this market. You have to bet on high growth. Many will falter, some will achieve. It is a tightrope of expectations, where one stumble can happen anytime. Talking about real estate, the stocks are trading at anywhere between thirty to fifty times earnings. Finance sector is now trading at over four times book value!

Without being alarmist, I would definitely advise people to take a pause and then proceed. Interest rates are still high and may go higher, even though the policy makers seem to indicate that they have run out of ammunition to halt inflation. They have now taken recourse to changing the method for calculating inflation. Wonder when they will realise that it is not money supply which is the cause for this inflation but the simple fact that there is a supply shortfall. I was at a friend’s office that has an agency arrangement for motor vehicle spares. Most spares have a waiting period! Demand has gone up due to reckless credit expansion and the service industry job creation that has thrown easy money at so many people with virtually no skills. Every company I talk to is scared about the quality of labour they get and the high attrition rates. These are definite pointers to inflation being a real scourge.
The other factor to look out for is the slowing down in the pace of deposit growth at banks. This will lead to an increase in deposit rates, as banks use it as a tool to attract a larger market share of deposits. Our banks still worry about deposits size rather than profitability.
State and central governments are throwing freebies after freebies at the populace as many states enter in to an election phase from next year. The combined fiscal deficit of state and centre continues in double digits. A onetime bonanza from the 3G auction is being wrongly accounted to show a lower deficit. It is like selling family wealth to meet the food bill.
A record IPO flow is going the hit the markets in the balance of this year. I have not seen so much aggressive pricing even in 2007-08. Add to this the fancy pricing for exotically labelled sectors like microfinance. This is a right brew that usually points to a peaking in the bull story. Promoters have stopped issuing shares to themselves at these prices, rather choosing to dilute. They have all tanked up their personal treasuries with warrants issued to themselves during the fall in 2008. Now they are primed to dump it on the investors.
I also see a big range of upward revision in earnings forecasts, which seem dubious and smells more like a ‘sell’ side attempt to justify higher prices. When the markets were near 10K, I saw at least three in ten were ‘sell’ recommendations from brokers and research analysts. At 20K, the ‘sell’ reports are missing altogether from the brokers. This is perhaps a good indicator of where the markets are headed.
Take care. The markets are slippery.

R. Balakrishnan
September, 18th, 2010

Monday, October 4, 2010

IIT Coaching Classes and the present education system

In one of my earlier writings ( I had moaned about the problems facing the IIT's in the matter of finding teaching staff, due to their being poached by the private classes. I had suggested doing away with the entrance exams in the present form, in order to contain this malaise.
Alas, this has to be done sooner than I thought.
See this article:

The problem continues. Solution lies not just in opening new IIT's but also finding teachers for them. And reforming the tenth to twelfth standard education to make sure that there is just one standard to measure it. State Boards must go. One national standard is a must. Only then can the IIT's be liberated from the clutches of the coaching classes. Today, many state boards have made a mockery of education by having lax standards.