The minister for state for finance told parliament that LIC made a profit on PSU investments until 31 March 2012. It has certainly racked up big losses since then
Namo Narain Meena, the minister of state for finance, told the Rajya Sabha in response to a question that Life Insurance Corporation of India (LIC) has made a profit on its investments in public sector undertakings. Let’s look at how wafer-thin this profit was and what has happened since.
According to Press Trust of India (PTI) release, the minister said, “the book value of the total outstanding investment as on 31 March 2012, was Rs59,116.36 crore and its market value was Rs59,851.16 crore.” This means that even on that day, the investment was barely above water with a notional capital appreciation of barely Rs730 crore on this massive portfolio.
Now here’s what has happened since. The Public Sector Unit (PSU) index of the Bombay Stock Exchange (BSE) has fallen sharply by 5.36%, from 31 March 2012 till 8 May 2012. If the value of LIC’s PSU holding has fallen by around 5%— it would have been Rs 56,641.34 crore on 8th may. The PSU index was 6,711.27 on 11th May, which, if subtracted from the 31st March market value, LIC’s holding would be approximately Rs54,937.97 crore.
The Rajya Sabha question is especially pertinent in view of the widely held perception that LIC suffered losses in the ONGC disinvestment. During March, the government had raised Rs12,767 crore through auctioning of Oil and Natural Gas Corporation (ONGC) shares, and LIC had subscribed to a huge chunk of the issue. While the ONGC share sale was subscribed 98.30%, LIC had picked up over 84% of the shares on offer. This move has been controversial and attracted a lot of flak from the investment community.
Mr Meena said, “the amount of money invested by LIC in ONGC till 31 March 2012, is Rs20,493.60 crore. The value of this investment as on 31 March 2012, is Rs21,752.91 crore.” Which means that the value of ONGC shares held by LIC were barely above water even on 31st March. The share price had dropped 3.44% until 8 May 2012 on which the minister answered the parliament question and the investment value further fell to Rs21,004.21 crore by then. This means that the value of ONGC shares held by LIC would be around Rs20,723.45 crore on 11th May, if one were to deduct 4.73% from the 31st March market value.
The balance sheet of LIC, as of March 2011, stood at a whopping Rs12.82 lakh crore. But market circles point out that PSU stocks and ONGC are not the only questionable investments made by LIC. It also has a huge exposure to private sector entities in aviation, power generation & distribution and telecom, which have been seeking repeated restructuring of their loans.
There are frequent allegations that LIC buys and sells the shares of private sector companies in a manner that benefits their promoters. Questions about the sale and purchase of Reliance Industries’ shares have been making the rounds of the email circuit and there are demands that LIC must be forced to disclose all big ticket purchases which are directly from entities connected to corporate houses.
Markets tend to be sceptical about good news, which partially explains the muted reaction to this quarter’s positive earnings numbers. Bad news, on the other hand, is considered far more credible
As earnings season in the US winds down, investors might be feeling rather optimistic. It seems that companies, especially US multinationals, have again exceeded expectations. Over 79% of them have posted earnings per share that beat analysts’ forecasts. This is an exceptionally high number of ‘beats’. It is on a par with the record set for the third quarter of 2009. It is also far better than the average ‘beats’. In a typical earnings season over the past 20 years just 62% of companies exceed analysts’ predictions. The question is why?
It is easy to understand why companies would beat expectations in 2009. The global economy was just beginning to recover from the disaster that started in the fall of 2008. The financial community was reeling from a brush with catastrophe. It is reasonable to expect cautious forecasts. The present number might be harder to explain.
One possible reason was that the pre-earning guidance provided by companies in the first quarter was very negative. Companies cutting their guidance outnumbered companies increasing it by two to one. The last time this happened again was in 2009, but in the first quarter when the global economy was falling apart. With companies issuing negative signals, the low estimates were predictable.
With such distortions we might suspect that managers were intentionally massaging their guidance. Certainly they have large economic incentives to do so. Convincing the market that the company is doing better than anticipated often results in a rise of the stock. Since many executives are also compensated in stock, a bit of a boost never hurts provided that the market actually believes you. This season it was more sceptical. Exceeding analysts’ estimates usually results in a 1% rise in share prices. This time stocks only rose 0.5% for a ‘beat’.
One of the economic incentives to manipulating expectation is not so much to create dramatic surprises, but to create a sense of stability. According to a recent survey, 96.9% of CFOs (chief financial officers) prefer a smooth earnings path. A nice earnings graph without spikes or troughs can mean less perceived risk which translates into lower costs for capital, better credit ratings and more credibility with investors.
This is especially true for firms which can present earnings as exhibiting a pattern of consistent earnings growth. The core competency of Jack Welch, the former CEO (chief executive officer) of GE, was manipulating earnings. His reputation and fame are based on his skill at being able to ‘manage’ quarterly earnings. He was able to deliver 15% earnings growth every quarter for many years. Not only did he deliver consistent growth but also managed to slightly exceed expectations.
Corporate guidance is a perfect example of asymmetric information. Management has it and you don’t. So one of the ways that quality corporations can increase their value is to signal their ability to consistently forecast and achieve growth. This increases their reputation relative to competitors and other players. Companies with the best reputations, for example those on Fortune’s America’s Most Admired Companies list, are more likely issue more frequent and more precise forecasts than do other companies. The most admired company, Apple Inc, has missed estimates only once since 2007.
The credibility of guidance depends not only on the reputation of the company but also upon the type of news itself. Good news is treated by the markets quite differently from bad news. Markets tend to be sceptical about good news, which partially explains the muted reaction to this quarter’s positive earnings numbers. Apparently the market suspects management’s motives.
Bad news, on the other hand, is considered far more credible and the market has a much greater reaction. Although the likely credibility is equal for both types of news, bad news can push a company’s stock down by as much as 10%. Since the management realizes that bad news has a greater potential to spark a selloff, the incentives are greater to err on the upside when releasing a negative forecast. Perhaps the greater reaction to bad news has more to do the cognitive bias of loss aversion which is people’s tendency to strongly prefer avoiding losses probably twice as much to acquiring gains.
Reducing asymmetry with better disclosure varies a great deal throughout the world depending on the local regulatory regime. Foreign companies listing in New York through ADRs often will voluntarily disclose to increase their reputation. Interestingly disclosure from some companies from the emerging markets of Brazil and India will disclose more than companies from more developed countries. Firms from Denmark, Finland, Greece, Hong Kong, Japan, South Korea, Portugal, and Spain, do not issue any guidance. Firms from Israel, India, Norway, Singapore, and the Philippines issued both more often and more accurate.
Perhaps the inaccuracy of companies’ guidance last quarter has less to do with motives than the world economy, which due to massive interference by unpredictable governments, is far simply harder to predict.
(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected]).
After a month of marginal net inflow, equity mutual funds suffer an exodus of Rs615 crore in April
The sales of equity mutual funds may have peaked in March 2012 reaching a high of Rs4,925 crore, however, in the following month sales just reached Rs2,903 crore, the lowest in the last 36 months, according to Association of Mutual Funds in India (AMFI) data that is released every month. Moneylife had pointed out the declining trend in sales from August last year, but this trend was broken in the months of February and March mainly due to inflows from Equity Linked Savings Schemes (ELSS). Fund flows into these schemes usually peak in the last few months of the financial year for last minute tax saving reasons. Sales of ELSSs amounted to Rs151 crore in April, one-fourth of the sales in the previous month. Therefore, without the rush of funds into these tax-saving schemes, equity sales have fallen again.
Redemptions were lower compared to the last couple of months but still, due the poor sales there was an outflow of Rs615 crore from equity funds. New Fund Offers (NFOs) seem to have dried up, as well. As a strategy, fund houses usually launch NFOs when the market is consistently rising. With in a downtrend, asset management companies are hesitant to launch NFOs. Apart from one ELSS scheme launched last month, there were no other new schemes launched in the last two months. As per AMFI data, numbers of equity folios as of March 2012 have declined by 4% over the course of one year, working out to 15.76 lakh accounts.
Securities and Exchange Board of India (SEBI) chief, UK Sinha, said that positive net inflows in FY2011-12 are an "encouraging development". However, in the same period there was a 25% drop in sales. According to the AMFI data, the financial year 2011-12 saw a net inflow of Rs122 crore, and FY2010-11 saw an exodus of Rs13,139 crore. But if we compare sales alone, in FY2011-12 sales declined by almost 25% to Rs50,560 crore from Rs66,592 crore in FY2010-11. Redemptions reduced by nearly 58% from Rs79,731 crore in FY2010-11 to Rs50,497 crore in FY2011-12. Therefore lower sales matched much lower redemptions leading to a positive net inflow.
Redemption is partly based on the investors' requirement. When he needs his funds he would withdraw depending on his investing horizon, his goal and the performance of the fund.
However, if sales fall, there is a serious problem despite positive net inflows. With lower sales there is a decline in new fund inflow and here is where the regulator has to step in. Entry load was banned in August 2009 and from the chart one can see there has been a steady decline since then. Except for the drop in sales in 2008, due to poor market conditions, sales failed to pick up and reach the levels of the earlier periods. In the 33 months post the ban, from Aug-09 to Apr-12, monthly sales averaged Rs4,920 crore per month, a drop of 28.54% compared to the sales in the 33 months (Nov-06 to Jul-09) prior to the ban, during which the average sales per month worked out to Rs6,885 crore per month.
With no incentive to sell mutual funds and the flat market conditions has made it even more difficult for the distributors to push mutual funds in the recent few months. SEBI is said to have set up a panel for the purpose of enhancing the reach of the mutual fund industry. With unclear incentive structure, the distributors would not find it feasible to reach investors in small towns and cities. What they need to come up with is a strategy that will benefit both the distributor and the investor.