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.