Saturday, February 22, 2014

The Gods must be crazy- Man vs Man thanks to Faith and Creed

The VHP seems to be advising all Hindus to have more children. The self appointed guardians do not even know how many branches of Hinduism exist.And for them, India is the cow belt in the north / central India. The south is not even aware of the existence of VHP.

One fear that the VHP tries to broadcast is that muslims will outnumber hindus because of conversion.

VHP should be addressing the issue. Why do Hindus get converted to any other religion? Are Hindus just one large group ? Is there unity amongst Hindus? Why is there a caste divide? Why is VHP itself a brahmin dominated entity?

The VHP should also be doing positive things. As a Hindu, I studied in a convent. The christian missionaries flooded India with schools and hospitals. Today, the Hindu who converts, does so simply because he finds that his economic needs get addressed by those engaged in Proselytization. He walks out of Hinduism often because he is a victim of the caste divide or because of economic reason. God has nothing to do with the conversion.

And, what does it matter what religion or God one worships? Does it make someone a smaller or bigger human being?

Man is out here to make a peaceful living. He surely could do without wars and hatred. So if VHP is serious about its desire to be a champion of Hindus, it should do a few things:

1. Remove caste distinctions.

2. Promote schools, hospitals.

3. Abolish rituals.

I know it is structurally not possible to unify. Every village in India has a different God, different caste, different economic order and a caste hierarchy that is patently unfair and unjust. There is no point in increasing hatred in this world.

Tuesday, February 18, 2014

A FUDGET - come in to my parlour-said the spider, opening his fly

SUSPENDED ANIMATION A 'fudget' was presented. Ripley's "Believe It Or Not" series seems tame compared to this. A freebie to the rogue automotive industry. A false impression that the fiscal is on the path to recovery- by suppressing expenditure and inflating income.

As we wait for the elections, the stock markets, which always has its own mind, is struggling.

None of us have any doubts that there is a marked slowdown in the economy. There is consensus on this, and everyone safely presumes a ride back to growth sooner rather than later. No one has any basis for prognosis and there are vague references to what is very wrongly and loosely labelled as ‘green shoots’.

On the ground, the slowdown is palpable. Talk to businessmen or a look at the job market confirms this. From automobiles to soaps, the consumer is cautious. Banks are sitting on a huge pile of problem loans and are trying their desperate best to keep it hidden from scrutiny. It is possible that if prudent norms were followed on write-offs, many banks will not have any net worth left.

However, the ‘experts’ are saying that the ‘worst’ is over. With stock markets at all time highs, is this the ‘worst’? The problem is that we do not know where we are at the present moment! High quality stocks are very expensive and the valuation of poor quality or those with dubious management or businesses are not very cheap either. So, assuming that the ‘worst’ is over for the markets, is there any significant upside left in the markets?

What growth the world is witnessing, seems to be more of productivity gains and efficiency improvements rather than growth along with more jobs.

Business can be divided in to two groups- One that is dependent mainly on government policies and spending- infrastructure, capital goods etc. After a change in government, a new government has to have strong economic policy that gives thrust to development expenditure. Given the precarious finances, whichever government comes, this looks very difficult. There is simply no money. And if someone says that public private participation will be the engine it would be very tough to visualise. With so much emphasis on transparency and public scrutiny, the enthusiasm for these kinds of projects is going to be low. We saw environmental clearances, corruption and other things holding up government policy formulation and implementation. If a third front government comes, do you think this will get any better? And if UPA or BJP manage to come to power, the problems would be higher- boycotting parliament, creating policy paralysis, uber-socialism is going to take away the revenues for populist schemes.

The second set of business (FMCG, Consumer durables, pharmaceuticals, etc) are driven by consumer spend and retail credit expansion. There could also be some impact on this by the freebies thrown at people by populist moves like NREGA etc. This sector is the one keeping economic growth in positive territory for the last few years. There is a distinct possibility that the lack of new jobs can threaten this story.

Political uncertainties have not stopped the flow of funds in to this market. So, in a sense, the surge of liquidity in to our markets has been very benevolent. In such a situation, global economic trends would tend to cast their shadow far deeper than they normally would. This is because our markets are more dependent on global money flows rather than any serious domestic investor moneys.

So, again, it is a question of wait and watch. If you are a serious investor, pray that the political uncertainty gives room to pessimism. And we also have to hope that the good quality stocks crack. The market is so finely strung that any minor disappointments from results can cause deep price swings.

It is time to keep the shopping list handy and start praying for negative impact news flow on the markets which are tightly strung now. The sectors to keep an eye out for would be limited to the consumer spending domestic group. And IT majors, if they correct seriously. I do not sense ‘investment opportunities’ any other place.

It is true that the broad indices have had a total pull back from 2008. However, the number of stocks participating has been far lower. Quality has become expensive, since 2008. The rest have become merely a trading opportunity. Thus, a long term investor has to bide his time. He could end up holding cash for long periods in time, should markets continue to be like this.

Corporate results have begun to show some tiredness. Most corporate are uncertain about the future. Even in the US, whilst the last quarter has been an exceedingly good one, the guidance on the future is not very hot. Thus, the markets are stuck in a groove. We are stuck In a trading range, for some time to come. The election results could give some push to the market. Till then, it is sensible to hang in there and use any serious rallies or pull back.

Reading the Balance Sheet- Abusing Capital

We buy shares in specific companies because we use these companies as a proxy to participate in the business they do. For example, if I am betting on Colgate, I am betting on the toothpaste business predominantly. If I buy shares in Cummins, I am betting on their being able to produce and sell diesel engines far more efficiently than many others.

Thus, I expect each company to have its capital almost fully allocated to the main business I choose it for. “Capital Allocation” by every company is a key factor for me to take a call on the company. Just to give an example, let us take L &T. It is known for its competence in engineering related skills and strength. So I would expect the company to use the resources to focus on that business. In case it generates far more cash than what can be used by the business, I would expect the company to pay higher dividends. Or it could do a share buyback. But, what does the company actually do? Let us see:

Eng &Con Elec/Elec Mchinry IT Fin Dev Proj Others Elimin Total

(Rupees crores if not mentioned otherwise)

Top Line 58616 4846 2880 4999 4080 1406 52 -1683 75196

Seg P&L 6051 547 458 1107 848 412 8 -105 9326

65% 6% 5% 12% 9% 4% 0% -1%

Seg Ass 52170 3658 2146 3218 36593 33755 196 131736

40% 3% 2% 2% 28% 26% 0% 0%

Seg Liab 29782 1540 944 870 30141 6658 21 69956

The above data is from a section called ‘segment’ reporting from the latest annual report. Essentially, this section shows how much of assets are deployed in various businesses and what revenues it derives from each. There is one level after this, where there are expenses and assets that cannot be allocated to a specific business, which comes off from the total profits etc.

I look at the above and wonder- Why are they deploying so much money in to two segments named Finance and Developmental Projects? I recall that they used to have a modest finance business to support their sale of earth moving equipments. But it now seems to be a monster, with nearly 30% of the assets attributed to that company and that contributes to less than ten percent of the bottom line, before allocations. The case with Developmental Projects seems even worse. Maybe the company executives know better. Maybe when these projects can be exited from, the company will make piles of money. Who knows?

There are innumerable such examples. For example, I think ITC share prices are depressed because they have allocated capital to poor businesses like hotels, paper, and consumer products etc which earn far less than the highly profitable cigarette business. I think that if ITC did not have the other cyclical and poor return businesses, the share price could have been a couple of times higher than what it is today. I do not buy the argument of being protective of the future. Should the cigarette business have to be shut down, it does not matter to me as a shareholder. I know the risks. If I want to be present in hotels or consumer products, I may buy shares in Indian Hotels or HUL. In fact, if we take the amount that ITC has shovelled in to FMCG business over the years, including the massive losses and put it in to shares of HUL or Gillette or Godrej Consumer Products, the returns would have been spectacular.

When management or promoters decide to wrongly allocate capital, it is a negative sign. Let us take the latest move of the Government of India to force one company to acquire shares in the other. Why should the government do this? If I wanted to, I would buy a mutual fund or an investment company share. If I buy ONGC shares, it is for the prospective return from Oil exploration etc and not by making money in the share market.

Ultimately, if we put money in to shares of companies that wrongly allocate capital based on whims of owners and managers, the returns suffer. The owner is using our money to fuel his personal whims and fancies. Whether it be buying a private jet or a helicopter or investing in totally unrelated business with poor returns, the impact is the same- lowering of returns to the shareholder.

Misallocation of capital is perhaps one of the biggest corporate governance issues. As a minority shareholder, we never get a choice to have a say in this. For example, we had to read from the newspaper that Exide (a company that one invested in because it made automotive batteries) suddenly became the owner of an insurance company! The promoter did not even bother to take shareholder approval and the independent directors must have simply nodded their heads when the investment call was taken. Or when Piramals used the cash to buy shares in Vodafone, the principle was the same. Just because a decision turns out to be subsequently profitable, does not justify the wrong.

Same is the case where the Birla Group uses one company to hold shares in another. What they are doing is essentially create holding companies which they can control, using public money. And also spoil the returns for the other shareholders.

I get worried when I see companies sitting on large cash balances. It is like money burning holes in the pocket. One day, some investment banker will come and make the promoter buy out some business where there could be personal ego fulfilment, but no shareholder returns. IT companies like Infosys or TCS are worrying due to large cash balances that are kept in bank fixed deposits. Surely they do not have to worry about finding money if they have to buy something. The share is a fantastic currency. And after Satyam, there is always a niggling worry about the existence of the cash balances.

In the not too distant past, we recall that DLF, riding high on the back of an overpriced IPO and inflated market capitalisation, had diversified in to so many businesses, claiming ‘synergies’. Now they are trying to exit most of those, claiming that they want to be ‘focused’. Again, this is a case of misallocation of capital.

Misallocation of capital is worse when there is leverage or borrowing to fulfil that desire. Only time will tell whether the buying to Corus by Tata Steel or Novellus by Hindalco is good or bad for the shareholder who is left with underperforming shares and a large debt, apart from the ‘goodwill’ (the difference between the value of assets bought and the higher price paid to buy them) that has been eaten away. Ideally, one would have thought that before such a decision, other shareholders should also have a say. And it is more relevant, because in both these cases, the non promoter stakes are substantially higher than that of the promoter.

So next time you see an annual report, try and see this interesting section called ‘segment’ reporting. It is a good indicator of how much the promoter/ professional manager cares for the other shareholders. And just to add, don’t fall in to the trap of accepting CSR as an excuse for the manager or promoter doing dumb things with money.

Sunday, February 2, 2014


BALANCED FUNDS Balanced funds are an interesting investment option for those who wish to avoid the hassle of direct equities, do not want too much stress and can save regularly. Balanced funds are generally not as balanced as the name indicates. For instance, if I see the portfolio of the scheme run by ICICI or HDFC, the investment is almost two thirds in equities and one third in debt instruments.

The main investment strategy for balanced funds would be to have a higher proportion in equities when equities are doing well and to reduce the proportion of equities when the equities are richly valued and not much upside is expected. However, for reasons of taxation, many mutual funds prefer or have opted for a strategy where the majority corpus is always weighted in favour of equities.

However, it is interesting to see how two large balanced funds have done over different time periods. I must say that I do not have any preference or bias for or against any fund and simply choosing them since they are popular names.

Measuring point to point returns, I get the following (annualised percentages):

6m 1yr 2yrs 3yrs 5yrs

ICICI Pru Balanced 12.2 6.3 14.2 11.0 18.9

HDFC Balanced 16.9 7.4 11.1 9.5 22.4

Sensex 6.0 3.1 9.2 3.8 16.8

With around two thirds of the money in equities, these funds have delivered far better returns than the benchmark equity index. This is simply by protecting part of the corpus in fixed income securities and by actively managing the equity allocation out of the total corpus.

These are point to point returns. Let us see how the same group has done under the SIP route, over one, three and five years:

1 year 3 years 5 years

ICICI Pru Balanced 22.7 14.8 14.1

HDFC Balanced 26.2 12.1 13.7

Kotak Sensex ETF 13.2 9.1 8.8

(returns are in annualised percentage per annum. ETF is a proxy for the BSE Sensex)

Again, the active fund managers have beaten the passive indices by a big margin even under the SIP route.

Balanced funds are generally ignored by most investors simply because most assume that it is only a matter of allocating funds between equities and debt. However, the window of flexibility in changing the allocation between the asset classes actively is what seems to have given the extra edge to balanced funds as opposed to plain equities. And one can clearly see that the returns seem to be far higher in the SIP route.

Another interesting thing is that the SIP route shows balanced funds to be at a huge advantage as opposed to the index. Typically, if we take the SIP route in equity funds as opposed to the equity indices, the difference would not be of this magnitude.

Many investors think Balanced Funds are inferior to Income funds. However, Income funds in India have not done well over the last decade, simply because of the interest rate movements that have been wild. Following were the Income fund category returns (annualised) ;

5 years- 6.64 %

3 years- 8.13%

1 year 5.24%

Thus, Income has even lagged liquid fund returns in India. Liquid funds delivered annualised returns of 7.3%; 8.88% and 8.94% over five, three and one year periods, respectively. Thus, I would totally avoid Income funds and look at Liquid funds and Balanced Funds provide excellent options in the mutual fund investment route. If I had invested through the SIP in Franklin India Bluechip Fund, I would have got annualised returns of 10.25%, 8.89% and 14.5% over 5, 3 and 1 year periods. Again, the Balanced fund options have done better.

Well one could argue that the Balanced Fund performance has been good because of smaller size relative to the good equity funds. For instance, a fund like HDFC Top 200 has a huge corpus and investing that money in to good ideas is a tough ask. And small investments, even if they have great returns, do not impact the overall scheme performance. Thus, size can become an enemy of performance. However, even in those large sizes, the SIP route has delivered better than the stock indices.

So, next time you are thinking of a SIP through the mutual fund route, I would recommend a decent allocation to the Balanced Funds.

February 1st, 2014