Taking risk

Investors need to be compensated for faulty or misleading information

Equity investment is subject to market risk. This is a common advisory issued to those who want to capitalize on the inflation beating returns of stocks. In the pre-reforms era, the risk was confined to annual results or disappointment over a company’s conservative policy on bonus issues. Investors were satisfied with a modest appreciation. A portfolio made up of scrips like Bajaj Auto, Bombay Dyeing, Tata Steel, HLL, and ACC meant a steady cash flow through dividends. Investors now face far more uncertainty. ACC, now an MNC associate after promoter Tatas divested from the cement business, is a shadow of its former self. Bombay Dyeing is eyeing real estate instead of its traditional textiles business for growth. Tata Steel has a formidable rival in now listed government owned Sail. HLL has transformed into HUL but become a mediocre performer like other FMCG players. And Bajaj Auto is no longer a monopoly as it reinvents to stay in the two-wheeler race. In the meantime, party gatecrashers like Reliance Industries influences market movement, spunky Infosys Technologies determines market sentiment, aggressive Bharti Airtel symbolises the market’s hunger for growth, Dr Reddy’s Laboratories captures the market’s desire for risk taking on a global scale, NTPC epitomises emerging opportunities in the infrastructure space, and SBI offers a ride on the Indian growth story. There are more listed players to pick and choose, more opportunities to see unprecedented gains, but so also more risks to factor in — not only from revision in government policies and regulations but also from global markets including fluctuations in interest rate, currency, fiscal deficit and employment.

The earliest indication of how external factors could impact local markets was the flight of capital from the Far East economies in 1997 after a massive inflow of foreign investment into unproductive assets, particularly real estate, resulted in formation of bubbles and loss of investors’ confidence. The impact on India, in the early stages of opening up, was not as severe as on western economies, which viewed the emerging tigers as cheap sources of labour and lucrative markets. Next came the dotcom rush and bust at the end of last century. The collapse of highly priced IPOs whose valuation was based on eyeballs instead of revenue stream wiped out billions of dollars of market capitalization from the US stock markets and slowed the flow of investment to emerging markets like India. It took nearly three years for global markets to recover. Five years later, US investment bank Lehman Brothers collapsed as mortgage-based securities in its portfolio turned duds following the crash in housing prices. The after-effect was aversion to risk and drying up of credit. The ripples travelled all the way to India and China, whose growth slowed, while Europe went into recession as countries and institutions in the euro zone either had exposure to these toxic assets or had cranked up huge debt during the hey days to finance their expansion.

The recent decision of the Telecom Regulatory Authority of India on pricing of 2G spectrum and the Supreme Court judgement on pricing of natural gas are instances of risks assoicated with sudden changes in the rules of the game. The proposals to charge excess 2G spectrum held by incumbents at the price of the 3G spectrum sold and delink allocation from subscriber base are supposed to make good the loss caused by giving away 2G spectrum on a first-come-first-served basis instead of following the auction route to facilitate entry of new players in the ring. All this comes at the cost of existing services providers with surplus spectrum. It is also a setback to the shareholders who had invested in market leaders in the segment. Similarly, investors had bet on RNRL because the company and its upstream subsidiaries were to benefit from natural gas sourced from RIL at a cheaper rate than available to competitors. The Supreme Court dismissed the private memorandum of understanding between the Ambani brothers on this issue, resulting in value erosion in the ADAG companies. Last year, the government had predicted normal rains. Eventually, the southwest monsoon turned out to be below average, adversely impacting interest-rate sensitive stocks as foodgrain inflation rose and the Reserve Bank of India had to tighten money supply. What can be done to provide a safety net to those who enter stocks based on study of a set of data made available by government and companies? Maybe it is time for public and private sector units to put aside a percentage of their profit to set up a compensatory fund to make good losses suffered by investors acting on information that could prove to be misleading or faulty in retrospect.

The Stockholm Syndrome

Why Goldman Sachs and the IPL’s suspended boss may end up getting sympathy despite their excesses

How the powerful have been humbled! In the US, the top brass of the mighty investment bank, Goldman Sachs, was subjected to intense grilling by a Senate subcommittee in the full glare of TV cameras. In India, the ruling dispensation came down with all its might by leaks to media to force out Indian Premier League commissioner Lalit Modi for taking on a Union minister. Both the episodes had all the ingredients necessary to make for compelling drama: big money, tattered aura of invincibility, hints of fraud, complex transactions, and unrepentant protagonists. The defiant performance of the main players was a chilling reminder that what is good for businesses need not be good for their markets. The investment bank marketed derivates that offered insurance against fall in mortgage-based securities. Cricket’s newest czar invited private ownership of teams by auctioning players to the highest bidders. Profiting from opportunities presented by the market is as legitimate an exercise as is the ego-massaging desire of a group of moneyed individuals to possess a sports team. What is not is when the investment bank allows for contra bets on its own product and the real owners of the franchise are not upfront about their identity. The insatiable appetite of Goldman Sachs and IPL for big money is neither surprising nor shocking. Investment banks in India are bringing out highly priced IPOs to compensate for the finer fees they have to contend with due to rising competition. At the start of the last decade, it was mobile telephony that proved to be a magnet for business houses. Now the latest fad is to own a cricket team for its capacity to generate eyeballs and, hence, revenue.

As has been seen from the IPO boom of the early 90s, the prospect of making a quick buck inevitably attracts hot money, resulting in controversies over allotment, be they bids for 2G spectrum or IPL franchises. What are the lessons learnt from these two blowouts? First, a simple idea can end up causing disservice to the cause. Savvy investors go long and short on a stock or the index to protect from downside risk. Still Goldman Sachs’s double role rankled as it was known to follow high standards of ethical behaviour. The IPL head’s desire to discourage opaque shareholding was selective rather than encompassing: many more teams have tangled equity structure. Second, business should not only operate in a fair manner but appear to be doing so to earn credibility. Goldman Sachs’ defense that what it did was simply a business strategy has failed to arouse sympathy as the slide in US home prices has been blamed for the global financial crisis. Lalit Modi’s tweet about the suspicious composition of the Kochi team would have seemed like a genuine concern were the holding pattern of other teams too was transparent. The third lesson is conflict of interest invariably leads to bust. Goldman Sachs was creating a product that was supposed to insure subscribers against declining mortgage bond prices but benefited others who were bearish on them. Though Modi was IPL’s regulator, he was accused of cronyism. The fourth lesson is that even one indiscretion is enough to unite foes.

Goldman Sachs’ transgression has been the trigger for US lawmakers on both sides of the aisle to pass the financial regulation bill, which will the change the shape of the financial services industry from a risk taker to a money processor. The government’s displeasure at the IPL helmsman taking on a cabinet minister provided ammunition to his detractors outside and inside the IPL. The fifth lesson is that success leads to complacency. Goldman Sachs was among the few investment banks to have withstood the financial market meltdown. The security of its leadership role perhaps led it take on risks that it should not have. The IPL owes its success largely to its organiser’s vision and execution, apparently emboldening him to assume that he is the first among equals. Goldman Sachs and Lalit Modi are not the only losers following the unravelling of their misdeeds. Turning over into a new leaf by investment banks may come at the cost of innovations, depriving investors of opportunities to make profit. The IPL money-making machine is too lucrative to be dismantled. The show will go on but will it get bigger and better? The ringside participants — investors and spectators — may suffer from the Stockholm Syndrome just like kidnapped heiress Patty Hearst, who started identifying with her captors. Fatigued by the recent tales of greed, they may ignore the failure of investment banks in protecting their clients as excesses by governments pull down the markets and conclude that the IPL boss was a victim of a witch- hunt rather than the casuality of a clean-up.