Friday, November 26, 2010

Birla and their skills in managing money

Read this article.

It is scary to think that groups like this would get a banking license.

Wednesday, November 24, 2010

With my palms open..

The news of a scandal involving LIC Housing Finance and some PSU banks is noteworthy. Why? No one is surprised, but what is surprising is that some arrests have been made. An obscure financial services co which suddenly shot in to the limelight with a huge fund raising, has apparently been the go between or the ‘arranger’.
Corruption in public sector is a given thing. Given the salary scales, there is no other reason why someone should work in those organisations (yeah, there are exceptions, you say, but they only go to prove the rule). Corruption in money lending is universal. When one sits at a desk with powers to hand out loans, the temptation is huge. Even private sector is not immune. In the private sector, corruption takes many forms. It could be personal gratification (money, women etc). I know of a private lender, who is innovative. He gives loans to builders in return for giving flats to friends, family, associates and employees at ridiculously low rates. And the lender makes sure that he always sides with a few people and deny loans to competition. So, here, can you point a finger? Especially if the organisation does not have to write off any loans? No one can establish the loss of revenue. That is beyond the realm of audits.
In all cities, there are ‘fixers’ who arrange loans from PSU banks at a price. They could be accounting firms, financial service brokers or just an individual with a suitcase. In fact I cannot imagine a single area of the financial services industry where corruption does not exist. Some fund managers take all kinds of gratification to invest in dubious securities. Or they take it to invest in good companies at high prices. I know of many fund managers whose lifestyle and assets are far beyond what they earn as salaries and bonuses.
The financial services industry (lending, borrowing, broking) is as filthy as it gets. In the seventies, grease was used to get loans from financial institutions. Private sector executives would take money to hand out mandates on investment banking. Some ‘clean’ broking houses would use ingenious routes to generate cash and pay the executives.
Corruption is a way of life in India. Nothing will change it. It has become a part of the blood stream. And believe me- it is higher than ever before. We have a PM who is universally recognised as a clean man. I think his reign has witnessed the highest level of corruption in independent India.
Live with it. Accept it. It is all around you. Right from the moment you pay a bloody tip to an attendant in a five star toilet who holds out his palm to you after giving you a paper towel to your paying capitation fee for a college admission for your kid, you do not escape the web of corruption. You start by paying ‘speed’ money to get a birth certificate and end with your kin paying it for getting your death certificate.

Thursday, November 18, 2010

Promoters are Not like you and me. They have special rights...

- George Orwell, Animal Farm
So long as a promoter does not invite others to be shareholders in his company,
He can legally and morally do what he wants with the company. There is no one to whom he is answerable. The moment his company has other shareholders, he can no longer have the right to do his bidding. He has to have the consent of other shareholders for most actions that impact the shareholders as a universe. This is the spirit and letter of the law. In real life, though, this receives scant attention from the promoters. They use the company as their personal fiefdom. When it comes to raising fresh capital, the law states that there is a right of refusal to all the shareholders. In other words, if I am a shareholder, I cannot be denied a right to subscribe (as proportionately as possible) to any shares / warrants or such instrument.
However, the law has been perverted by the businessman. They introduced an obnoxious amendment to the law which permits issuance of shares on a ‘selective’ basis. This could be in the form of a private placement with an institutional investor(s), or to a collaborator, or to the promoters. In each case, to deny the general shareholder, a ‘special’ resolution needs to be passed. This means that seventy five percent of shareholders present at a shareholder meeting have to agree to this. In India, this is easier done than said. Not many attend meetings. And institutional shareholders always side the promoters. Mutual funds do not generally vote. So, it is a simple thing for a promoter to do what he chooses.
To me the most obnoxious practice by a promoter is the subject of ‘preferential’ warrants to himself. He has only to pay 25% of the conversion price and has 18 months to make the balance payment, at a time of his convenience. This provision is the one used by promoters to abuse the markets and the shareholders. First they ramp up the stock prices, and then sell their holdings. Then they screw up the performance, drop the share price and then issue warrants to themselves. This is like a ‘merry go round’. This is the one clause that SEBI has to get rid of. I also wonder where is it that promoters get the money to subscribe to these shares and warrants. In some cases, I would not be surprised if it is through money skimmed off the company through some devious means.
Why should a promoter not pick up shares from the secondary market instead of issuing warrants to himself? SEBI permits the promoter to do so. With such a window available, I do not see any rationale for issuance of warrants to promoters.
One argument that some promoters put forth is that when new shares are issued to themselves, the company gets the money. If the company really needs the money, surely a ‘rights’ issue is possible? And when ordinary people are buying shares from the market by paying spot cash, why should a promoter have the luxury of getting extended credit for buying shares? The legal system has been in league with the promoters and will perhaps continue to be such forever.
I also wonder when promoters decide to acquire a company or a football team or a cricket team or buy a personal aircraft with the shareholders’ money. These kinds of acts are the clearest indications that they give a damn for the other shareholders. And in no time we see kith and kin in action, burning shareholder money for some unrelated activities like ‘art’ shows, ‘social’ initiatives etc., If a promoter wants to fly in a private aircraft, let him do so with his own money. In this age of instant communication where is the need for intensive travel? As a shareholder, I am perfectly content to see the CEO travelling economy or business class. A co paid aircraft is used by family members, friends and political contacts.
Corporate governance is a fashionable term that does not exist in the real world. Same is the case with Corporate Social Responsibility (CSR). It is fashionable to devote two pages in the Annual Report to CSR and half a sentence to explain the losses borne by the company. Perhaps if the CSR were eschewed, the losses would have been smaller. And in matters of CSR, you always see the beaming faces of the friends and family members of the promoter on page three. I invest in a company for dividends and capital appreciation. No fund manager or investor gives a share a higher price because of CSR. So, let the promoter give me the money and let me decide whether I want to be charitable and if so I will choose the path I wonder how is it that CSR related expenses are permitted by the tax authorities as legally deductible ‘business expenses’?
The whole world is happy to build this facade of CSR, corporate governance etc to assuage their guilt. And the media is a willing partner.

Wednesday, November 3, 2010

Paying your money manager

This article was written for Moneylife magazine (


Fund managers are a revered kind. There are too few of them (excluding the millions of self styled investment experts) and the good ones do not like to be seen or heard. When the term ‘fund manager’ is used, what image does one form? An expert, who knows everything about every stock, every company and also knows which stock will go up or down including when. He is Warren Buffett and George Soros rolled in to one. Long term investment is the philosophy without missing a single short term play.
There are over thirty five fund houses, a dozen odd insurance companies and a few hundred licensed portfolio managers. In addition, we have thousands of ‘investment advisors’. In addition, we have a few more thousands of ‘technical’ analysts, who look at prices as they move tick by tick and forecast the likely outcomes over the next instant to a few months.
So, what is it that we expect when we give money to a fund manager? When we put money in a mutual fund, we are either choosing a ‘star’ fund manager or putting our faith in the fund house, without bothering about who the fund manager is. Whilst the statutory warning does say ‘past is no indicator of the future’, we do lay a high emphasis on track record. The second issue is one of paying fees to the fund manager. The industry structure is such that the payment does not seem to reflect performance. We pay fixed fees (in case of mutual fund industry) whether the fund house performance is in the top ten or the bottom ten. Often we are hustled in to a decision without getting sufficient time for analyses or thought. In case of portfolio management schemes, the situation is even worse. The manager takes a fee plus a share in your gains based on a ‘hurdle’ rate, which can be even a single digit number. In many cases, even if the PMS Manager delivers returns far below the market, you may have to pay him a ‘bonus’ for beating the hurdle rate! And in some cases, the PMS Manager may first lose a large part of your money (taking only his fixed fee for this splendid performance) and then when he recoups the losses, he may actually end up earning a bonus! It is a funny industry.
Let us now look at what is it that we should be expecting from a fund manager? To me, the first task that I expect from a fund manager is that he should be able to give me a higher than market return, to earn any fee at all from me. If I can buy an ETF and get market returns, the fund manager has to first clear this hurdle to earn anything at all. Otherwise, he has no business to be called a ‘fund’ manager. And, in a falling market, his expertise should enable me to preserve capital as far as possible. If he says that he lost only twenty percent of the money when the market fell twenty one, does he deserve a fee? Probably yes, but I would be reluctant to pay. If the expert cannot tell me when to get out, he is not an expert.
I see many fund managers who say that it is their ‘mandate’ to stay invested. I have an issue with this. A fund manager can miss some or most of a run up, if he is able to articulate that he is not comfortable investing at those levels. Surely, no one comes in expecting the moon. Of course, if there are such people, I have no truck with them. Greedy people do not deserve any sympathy or explanations.
So, what is it that I expect from a fund manager? There are many possibilities:
i) To give me a ‘better’ than market return. I am willing to go along with the ups and downs of the market. I am focused on the long term. So, to take any fee from me, the manager has to deliver better than market return’
ii) To give me a return ‘better’ than the most obvious fixed income return. For instance, I want a better return than a bank fixed deposit or a company deposit. Here, my interest is in preserving capital, but the returns are important to me. The investment is treated as an ‘earning’ member of my financial family. I know that there is a ‘theoretical’ risk of my losing some money, but think that it will not happen to me. Typical investments could include Fixed Maturity Plans (if I am very conservative) and Monthly Income Plans (Am a little ambitious);
iii) To give me a ‘decent’ return. I am not too bothered about beating the market, but am willing to give it to any manager who can deliver, say, twenty or thirty percent per annum. Here, my faith is more on charts and figures, with a ‘stop loss’ discipline (stop loss sounds good to me, but I know that in Indian markets, the stop loss limits are only a figure of speech). Here I am willing to pay a negotiated fee plus an incentive if the manager meets my goals;
iv) To absolutely ‘preserve’ my capital. Zero risk tolerance, because I need the money soon. Instead of it being idle, I want it to earn something. A fixed deposit is a good choice, but liquidity and tax is not very friendly. So, I choose a ‘liquid’ fund. No FMP for me, because exit in between would normally have a penalty; and
v) I am a compulsive gambler. I want the benefit of leverage. So, I give my money to a ‘derivatives’ fund manager, who can multiply my money manifold. Hopefully, give me double every time I check my portfolio. Here, I know that I run the risk of losing my entire stake. If it is going to bother me, I should not be here.
So, there are fund managers for every need. Should all of them be paid uniformly, irrespective of performance as well as meeting goals? In any case, if a fund manager does not generate excess returns over any passive investment, he should not be called a ‘fund’ manager. In fact, any fund manager who gives a return worse than the market, deserves to enter the Hall of Shame and be called a ‘Fund Damager’.
The regulator has already taken the first steps on the ridiculous fee levels being charged under Portfolio Management Schemes. Hopefully, it will also prescribe some qualifications required for someone to manage funds. We are probably the only market in the world where a distributor needs to pass an exam and absolutely no qualifications required for someone to become a fund manager. Fund houses that care about their image and investors generally put in good fund managers in place. I cannot say that same thing for many mutual funds as well as for Portfolio Managers. And another thing that bothers me is the number of schemes that a single individual manages. If I have to manage several schemes with different objectives, I cannot do justice to all. Someone is bound to suffer. This can be clearly seen that if you see the performance track every quarter, the top ten keep churning. Consistency suffers. And once a fund house loses its predictability, marketing becomes a seasonal affair. Marketing pushes the fund only when the rankings look good.