State of the market

The recent fall and bounce-back indicate India will attract foreign investment on availability of cheap credit
By Mohan Sule

Three recent but separate events, if viewed together, reveal the state of the market. The first is the advertising splash heralding the new chief of the Securities and Exchange Board of India. As head of UTI Asset Management Company prior to his new posting, the issues facing the mutual fund industry obviously would at the top of mind for U K Sinha. The ad splash to prompt investors to shift to online trading of mutual units, though unexpected, was therefore not surprising. Ever since the ban on entry load took effect, mutual funds have been disappearing off the radar of investors and not because of their lack of interest. Rather, asset management companies have stopped pushing mutual fund products. Going online has eliminated the need for distributors, both for AMCs and investors. Instead, investors now have to seek online brokers. Mutual funds are the only or the first step to exposure to the stock markets for many of them. Accustomed to home visits by their friendly neighborhood distributor, they now not only have to compare online brokers to choose but also get a demat account. Sticking out in this episode is the glaring disinterest displayed by fund houses in enlisting subscribers. As a result, Sebi had to take the initiative, which ideally should have been coming from asset management companies or even online brokers, which would be the end beneficiaries. What this means is that despite their public proclamation of love for the small investors, the prime motive of new launches by AMCs was to collect funds to earn management fees. All the talk of harnessing the power of the retail investor to checkmate the brute power of foreign funds through mutual funds is just wishful thinking. The disinclination of online brokers to aggressively woo mutual fund investors also shines a light on their business model. Competition has beaten down broking charges to such an extent that the piddling investment through systematic plans holds no charm for these brokers, who would rather procure institutional business.

The second puzzling trend is the return of foreign funds since end of March after beginning to pull out from early this year, complaining of high inflation and interest rates and the endemic corruption that has spread rather than diminished along with the reforms process. Recovery in the US economy and signs of stability in the Euro zone overwhelmed the attraction that these investors had for high yielding Indian paper. So, why has there been a reversal from outflow to in inflow of foreign portfolio investment barely three months? Headline inflation remains stubbornly high. Food prices are cooling but non-food prices are heating up. The central bank has increased its lending rate by 200 basis points and borrowing rate by 250 basis points in the year to March 2011 and could ramp them up further by 50 to 75 basis points during this year. There has been no downward revision by the government or the central bank in the growth figure projected in the budget, which is anyway being taken with a healthy skepticism by foreign investors, who are factoring in the contribution of inflation in padding up the GDP. Instead of bottoming out, the fall of the government in Portugal suggests more euro nations could get caught in the sovereign debt crisis. Notwithstanding the lackluster housing starts and job data, US auto sales have spurted despite costly fuel, indicating that the recovery, though slow, is holding. What has changed is the availability of money. Following the earthquake off Japan and the resulting devastation, G7 countries pumped in yen to cap its appreciation, thereby taking the global economy back to the old days when arbitrageurs borrowed in low yielding yen to invest in high return emerging markets.

The lesson from this changing complexion of the market is foreign investors are not prepared to buy anything Indian irrespective of valuation, disrupting the secular up or down movement of the market. Irrespective of optimistic growth forecasts, the market will remain attractive as long as easy money is available and there is opportunity for quick returns. As soon as there is overheating, funds will move to another and return once the market cools down. Perhaps this could explain why Warren Buffet has still not invested in a single Indian company during his recent high-profile visit. The investor with a Midas touch has repeatedly said he invests in companies he understands. This leaves out hi-tech and emerging sectors. His biggest investment outside the US so far has been is his purchase of 80% stake for $4 billion in metal tool cutting maker in Israel. He has spent $230 million for 10% stake in a Chinese battery company making green cars. Instead he has become an agent for the non-life insurance of Bajaj Allianz. What does this say for the Indian market unless investors uncharitably dismiss him as out of touch in view of his clean chit to his deputy who purchased shares of a company before recommending it to his boss? One of the ways to look at it would be that most of the frontline companies whose businesses he understands are expensive despite Buffet’s remarks triggering a rally in the market. It also implies that the next big thing in India would be insurance. The taste of things to come is the Rs 3000-crore Nippon Life Insurance deal for 26% equity stake in Reliance Life Insurance. Buffet’s foray into the Indian market could also be a subtle reminder to the Indian government to open up the sector with the muscle to step in to substitute foreign investors to calm the markets during volatility.

Mohan Sule

A lopsided field

The charging of Corporate America’s Rajat Gupta and the 2G spectrum scam show the system favours insiders

If the Niira Radia tapes blew off the lid on the cosy collaboration between media and companies they cover, the secret recordings of phone conversations of a US hedge fund promoter, Raj Rajaratnam, has entangled respected figures on Wall Street and even Corporate America. The similarity between the investigation into the throwaway sale of second-generation (2G) telecom spectrum and the trial to press charges of conspiracy to profit from illegal stock tips is the shortchanging of ordinary investors by insiders. Rajaratnam has been accused of cultivating a network of spies in various companies to alert him of possible breakthroughs or deals. He is said to have made $45 million by trading in 35 different stocks. The informants ranged from scientists as well as corporate movers and shakers such as Rajat Gupta, the first Indian to head the global consultancy firm, Mckinsey, and also a director of MNC Proctor & Gamble. While still being on the board of Goldman Sachs, Gupta was believed to have disclosed the impending $ 5-billion investment by Berkshire Hathaway into the investment bank. Rajaratnam, whose hedge fund Galleon once managed $7-billion assets, has dismissed these charges, claiming that he spoke to officials of various companies as part of research. His lawyers have compared Rajaratnam to a dogged investigative journalist, working with disparate sources to collect as much data as he could about the companies in which he invested. What is trading on insider information to prosecutors is “detailed meticulous research into company fundamentals” to the defending team, which has called him “a distinguished and an exceptional analyst and portfolio manager”.

The thin line dividing trading on legal and illegal information makes it as difficult to determine guilt as does policy makers’ response that revisions in framework are often made as a reaction to the altered dynamics of the market place rather than to enable a few to profit. Yet companies that have managed to bag the first round of 2G licences have blamed the eagerness of the new entrants for the changes in policy, while the latecomers have accused the older ones of trying to restrict competition. The first-mover advantage was mostly enjoyed by Old Economy groups. Ideally their entrenched positions should have been under threat due to the opening up of the economy. Instead, their effortless entry signifies how easy it is for dominant businesses to consolidate their status at the top of the pole by pressing the appropriate levers of powers to get rules customized to fit their shape and size. The winners of the second round of 2G licences were tier II companies that had won their spurs on the eve of liberalisation in tightly-controlled sectors. Most of the asset management companies are offshoots of industrial groups, just as telecom services providers are, and are set to become even more influential as the Reserve Bank of India prepares to hand them licences to run banks. Even among the Old Economy group, there are companies with excellent corporate governance record and lots of cash like Bajaj Auto, which have not ventured into unnecessary diversification, least of all telecom and real estate. L&T manufactures capital goods and also gets revenue from infrastructure construction, but has refrained from turning into a developer of residential and commercial properties.

These companies perhaps smelled the stink and balked at the compromises that certain emerging sectors entail. The fear is that, in the absence of fresh entrepreneurial talent, the Indian economy would be run over by oligarchs as in Russia. It is understandable if a power distributor wants to put up plants to generate energy and bid for oil and natural gas blocks to ensure smooth supplies. But why should the group provide telecom services and make movies as well? One of the last global conglomerates is General Electric of the US, which manufactures equipment for the power and healthcare sectors and also owned broadcast television network NBC, before selling in December 2009 a controlling 51% stake to cable operator Comcast, with an option to divest its remain holding after seven years. Of late, however, a majority of GE’s revenue is coming from financial services. How difficult it is for newcomers to gatecarsh into the exclusive club comprising established players, politicians and bureaucrats is illustrated by the meteoric rise and fall of Shahid Balwa, the promoter of real estate company DB Realty and the second-round winner of 2G licence, who is now alleged to have sought finances from outside the mainstream channels. What should investors do? Should they take exposure to a trailblazing stock knowing well that the growth is based on promoter-politician nexus? Or should they snap up a mutual fund providing solid returns based on insider information? A cruel dilemma, indeed!

Mohan Sule