Cutting the time frame for disclosure by issuers and allowing side-pocketing of bad assets by mutual funds will benefit neither the issuers nor the investors
The return of foreign portfolio investors beginning second half
of the calendar year 2018 pushed up the headline indices into unexplored territory
by the end of the third quarter. Their arrival was seen as a response to the
bargain prices at which large caps were available as also a confirmation of the
recovery of the Indian economy from the disruption caused by the implementation
of the goods and services tax a year earlier. Their intervention came at an
appropriate time. Mid and small caps were undergoing a brutal correction after
domestic funds and investors had propelled their discounting to unrealistic levels
at the beginning of the last year. The rally lost steam thereafter, with
slightly less than half of the large caps off from their historic milestones giving up over 20%. While the withdrawal symptoms of NBFCs following the collapse of
IL&FS has hogged the limelight, what has escaped attention is the role of
the regulatory framework in dampening the enthusiasm for mid and small caps. As
many as 1,000 small caps have shed half of their values from their annual peaks
and are unlikely to regain the position in near future. Despite continuing to command
a premium compared with large caps due to large local institutional presence, about 60% of those that have declined from their 52-week highs are down 20% and more .
Ranking by market capitalization and imposing 5% circuit
breakers and physical delivery on those identified for increased surveillance have
marginalized day traders who are so vital for price discovery. Categorizing the
first 100 stocks by market value as large caps and the next 150 as mid-sized erases
the arbitrariness and flexibility in their selection by equity schemes. The
downside is that fund managers have to reshuffle the holdings every six months
to confine to their theme. Volatility,
which is becoming a rule rather than an exception as the market’s reaction is
no longer restricted to domestic events, is compounding the problem. As a
consequence, the retreat of the small investors from the trading ring will
accelerate rather than reverse. The shift has been long in the making and was
triggered by the switch to book-building of IPOs. Despite the 35% quota and up
to 10% discount to the offer price, retail buyers have little influence on the
price band. Now the requirement for
issuers to disclose the financial performance has been compressed
to three years. Unwittingly the modification helps institutional actors. They
have access to management. It will also provide quicker exit to venture
capitalists and private equity. At the same time, the impatience to mop up
capital to scale up without notching up profit for five consecutive years does
raise doubt about the issuer’s commitment to the long haul. Instead of the
dilution of the track record norm encouraging more participants to list, the
worry is the market getting saddled with ideas that are half-baked or fads.
The clumsy attempt to ease the doing of business for promoters
has been balanced by capping mutual funds' expenses at 2.25% of the corpus and replacing
upfront distributor commission with that linked to the stickiness of the
investor. Populism seems to have overwhelmed prudence. If not,
the regulator would never ever have allowed something as bizarre as
side-pocketing of toxic debt. It is yet another instance of how the default by
IL&FS in repayment of loans has not only increased risk aversion but distorted the regulatory landscape. The objective of containing a financial crisis from
turning into contagion by ring-fencing exposure to institutions in the center of the conflict is attractive but as appalling as the concept of assured gains
by market instruments. Rescuers need time to assess the damage and nurse the
scarred player back to health or, if the disaster is due to macro-economic
headwinds, for the storm to blow over. UTI’s bailout by separating the bad and
good portfolio, eventually leading to the extinguishing of the liabilities, is
obviously the template. What causes unease is how easily the process allows
adventurism by fund managers. The complicity of rating agencies and the sloth
of the board are forgiven and forgotten. It will open the floodgates to dubious
paper with high yields during boom times.
There will be no compulsion to exercise caution. After all, the
investment can be written off. The NAVs will stay pristine for new investors at
the cost of the shareholders of the asset management companies. Just as grading
of IPOs, which has now been junked, created a false narrative of the market
regulator vetting the offer when it merely scrutinized the completeness and
accuracy of disclosures, the latest move to level the field creates an illusion of
rewards without risks.
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