Revisiting some popular beliefs in investments

We often follow herd mentality and make investments. Though there is ample scope to evaluate things on a logical basis, investors tend to ignore them very often, as in the context of returns, these don’t make much difference

The world of investment runs on some popular beliefs. These beliefs have evolved a period of time. We often hear people say, “Invest for long period of time”, “Do not put all eggs in one basket”, etc. While some of these beliefs qualify the science of logic, there are many which are followed blindly as we often forget to apply appropriate logic to evaluate them. While going through an article published in a leading personal finance magazine, I came across a statement which stated that option buyer’s gains are unlimited while losses are limited. The statement sounds ok until it is dug deep. Let us look at this statement and many similar beliefs/ statements which are used in day-to-day conversation in finance but may not be logical.


Higher the risk, higher the return: This is the most used statement in the world of investment and finance. But is it appropriate to say that higher risk results in higher return? The statement somehow gives the impression that if an individual takes more risk, he will get more returns. Practically this does not work out like this. The appropriate statement should have been “Higher the risk, higher the expected return”.  With usage of word, “expected return”, a clear-cut picture comes out. The statement now means that if an individual takes higher risk, he can expect higher returns while he is not assured of it.


Option buyers have unlimited gains but limited losses: It is very often said that buyer’s of option contract have unlimited gains but limited losses. While this is absolutely fine as far as call option buyers are concerned, it is inappropriate to say the same thing about put option buyer. When a person purchases put option his losses are indeed limited but so are gains. What is the maximum gain that an investor can make in case of put option? When the price of the spot falls, the put option buyer starts making profit. It is open secret that spot price cannot fall below zero, so the gains naturally become limited. For example, in case of put option on Ashok Leyland for a strike price of Rs27.50 the maximum gain that a put option buyer can expect is Rs27.50 per contract and not more than that.


PPF is a risk-free investment: Public Provident Fund (PPF) means safety and assured returns to almost all the investors. Very few would even bother to listen to you if you say that PPF investment has a risk element in it—but hang on. PPF indeed carries risk and that is called as “reinvestment risk”. The rate of interest on PPF deposits have been changing over a period of time and as a result of this an investor who opens a PPF account or an existing investor cannot expect the same rate of return every year. Because of this reason, PPF can be classified as an investment option which has a risk but only reinvestment risk. The credit risk in PPF can be ignored based on the history.


The problem in finance is that we have often follow herd mentality and make investments based on what masses do. Though there is ample scope of evaluate things on a logical basis, investors tend to ignore them very often as in context of returns these don’t make much difference. We should all try to be what we are assumed to be, “Rational Investors”.


(Vivek Sharma has worked for 17 years in the stock market, debt market and banking. He is a post graduate in Economics and MBA in Finance. He writes on personal finance and economics and is invited as an expert on personal finance shows.)



Sudheer M

4 years ago

Rightly mentioned Vivek... However, people believe that high returns is in the range of 70-80%, which is not correct. The average "Expected High Returns" with "High Risk" can be only in the range of 20%.

On a lighter note, people who are expecting a returns of 50% returns should look at a "Critical Risk, Critical Return" category, and only instrument i see in this category is "Lottery Ticket"

Auto finance companies likely to benefit from consumption growth

Auto finance firms Shriram Transport Finance and Mahindra Finance are poised to benefit from the growth spurt in rural/semi-urban centres through increasing diversification of products, geographical reach and distribution channels, says Nomura Equity Research

Indian automobile NBFCs (non-banking financial companies) like Shriram Transport Finance (SHTF) and Mahindra Finance (MMFS) have put regulatory concerns behind them and have turned the corner by significantly increasing their leverage to consumption-driven growth, according to Nomura Equity Research in its report on the subject. Both companies are well poised to benefit from the growth spurt in rural/semi-urban centres through increasing diversification of products, geographical reach and distribution channels.


While slowing investment demand has impacted the corporate spending cycle, retail asset growth continues to be robust, driven by resilient consumption demand particularly in the semi urban and rural centres. SHTF has shifted its mix towards LCVs (light commercial vehicles) which are used in the “last mile” connecting to consumers, compared to MHCVs (medium & heavy vehicles), more driven by industrial demand and corporate capex. MMFS, on the other hand, has been increasing its mix and reach in the UV (utility vehicle) and car segments to offset the sluggish growth in its core tractor-finance segment, which has suffered from an increasing tilt to non-farm infra usage, according to Nomura.


Nomura expects a strong financing demand for cars, UVs, LCVs and also tractors in FY14, with potentially softer rates and governmental push on rural spend in a pre-election year.


Auto finance has seen intensifying competition from banks over the past few quarters. However, Nomura points out that SHTF enjoys market leadership in used automobile financing through its extensive reach, valuation expertise and receivable management skills, and MMFS dominates tractor finance and has a captive consumer base for UVs and LCVs sold by its parent.


Both SHTF and MMFS have largely overcome the impact on liquidity and margins from recent regulatory changes on securitization norms, while the mandates on priority sector lending appear to be net positive for them. Nomura does not expect a big impact on the credit cost from the Usha Thorat guidelines on NBFCs which are expected to come out in end-November.


In conclusion, on stock picks among listed auto NBFCs, Nomura has recommended a ‘Buy’ for the shares of SHTF and MMFS.


Petroleum Regulator PNGRB’s model Gas Transmission Agreement could open a Pandora’s Box

In the case of the PNGRB’s model guidelines for Gas Transmission Agreements, even as the intent may seem good, uniform provisions may not be workable, says Nomura Equity Research

The Petroleum & Natural Gas Regulatory Board (PNGRB) has issued Development of Model Gas Transmission Agreements (GTA) guidelines, providing provisions which are to be applied uniformly to all GTAs. Several provisions, such as uniform ship-or-pay (SOP) exclusion of volumes on government directives, are contentious and seem skewed toward consumers (at the cost of transmitters). Even as intent may seem good, uniform provisions may not be workable, according to Nomura Equity Research in a Quick Note on the subject.


Nomura says that each GTA can be different, depending on source (APM—Administered Price Mechanism, domestic–private/ government, marginal, Coal Bed Methane, LNG–long/short term, etc, term—days, weeks, months, years) and customer’s needs (power, CGD— city gas distribution—have unique needs) and may need bespoke provisions.


In Nomura’s view, model guidelines as the name suggests should be just guidelines. But, these guidelines are effective immediately (15 November 2012), and require modification in all existing contracts. This could be problematic, and may open a Pandora’s Box. None of the key gas transmitters would implement these on their own. And, if regulators try to enforce them, companies would challenge the norms. Skewed against transporters; SOP provision is the most contentious. For example:


  • Uniform 90% ship-or-pay (SOP) liability on annual basis—to be levied provisionally at 95% on monthly basis with final adjustment annually.
  • From SOP specific exclusion of quantities reduced due to direction of central/state government or any government agency.


Nomura points out that the 90% annual SOP provision not in line with the tariff determination method. Most current GTAs have 90%-95% SOP provisions (few also have 100%), and most are reconciled on a monthly basis. Transmitters seek high SOP (90%-100%) and early settlement (daily or monthly). The reasons include:

  • For tariff determination, the PNGRB uses 100% capacity, and any underutilisation due to lower throughput is not compensated immediately.
  • Annual reconciliation leads to revenue losses for periods when capacity is not used. Unlike product or commodity, pipeline capacity not used is lost forever and thus need for real-time settlements.
  • Monthly/annual reconciliation would also be difficult under a new Service Tax regime, as per gas transmitters.


Nomura explains that consumers, on the other hand, want more liberal norms. For example, given their unique needs CGD companies demand no or very low SOP provisions, with liberal annual or quarterly settlement. Power companies also seek flexibility, as their demand has a lot of fluctuation.


Nearly 19% of GAIL and GSPL’s (Gujarat State Petronet) combined transmission revenue would be due to SOP charges, on Nomura’s estimates. But, as some KG-D6 volumes have been replaced by LNG in the same contract, Nomura analysts think that actual impact would be somewhat lower at 10%-15%. Companies do not separately provide break-up of ship-or-pay volume or revenue. Nomura estimates that a 10% reduction in transmission revenue would impact GAIL’s FY14 EPS by 6% and GSPL’s by 15%. But, such exclusions not legally tenable, says Nomura.


In Nomura’s view, all GTAs are legal binding contracts. And, any reduction due to government directive impacts commercial terms, and should attract contractual SOP provisions. Government directives are often done on an ad-hoc basis, and transmitters which have made substantial investment should not suffer due to such decisions. Government directives are not force majeure events.


Other key provisions which are also skewed against transmitters include:

  • If a transporter uses system-use gas (would also include unaccounted gas), it would need to be paid for at prevalent market price. Nomura’s view: PNGRB has consistently disallowed unaccounted gas and even normative system-use gas (0.6%) while determining tariffs, despite demand by most transmitters. Presently in most contracts, any additional gas losses are considered as transmission loss, and borne by shippers. It is unlikely transmitters will agree to bear the cost of these losses, unless compensated in the tariff determination process.
  • Increase in LD (long distance) charges sought for shortfall due to transporters fault from current levels of 50% to 90% of tariff. Transmitters have argued that any LD compensation should be limited to what service providers can forgo, i.e., its profits or return on equity. Nomura’s view is that it is negative for transmitters. However, instances of such defaults are rare.


Nomura concludes that PNGRB’s focus remains on consumer interest and not entities.


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