In your interest.
Online Personal Finance Magazine
No beating about the bush.
Do not invest because someone tells you that markets will rally and you will mint money. See equities as a long term wealth building opportunity rather than a short term cash cow
Every Indian who has seen the stock markets rally over the past six months, but didn't invest, is definitely upset over missing this great opportunity to make money. In fact, Indian stocks were not even seen as a serious investment about nine to 10 months ago. There were all kinds of difficulties experts spoke about, that include low growth rates, high inflation, high fiscal deficit, a depreciating rupee, no confidence in the Government and so on. Today, despite equities gaining aggressively and trading at the higher end of valuation parameters, there are experts out there who say that this is the 'once in a lifetime opportunity' to buy Indian equities. So what has changed in the past six months that has turned what was not even seen as an opportunity into Gold?
The Sensex has risen from about 18,000 in August 2013 to 25,000 in May 2014, around 40% in eight months. Stock markets are said to be reflectors or indicators of hope in the economy and that is true, there is definitely a great pick up of hope. Several stocks in the infrastructure, capital goods, manufacturing, oil & gas and power segments that were not even seen as prospective investment bets have now turned into the most attractive stocks. Take examples of IRB Infrastructure, Sadbhav Engineering, IL&FS, DLF, BHEL, Coal India, JP Power, Reliance Industries Ltd (RIL), ONGC, and Indian Oil. All these stocks have more than doubled in the last 6 months. One can call these speculative moves. However, when you look at public sectors banks like Canara Bank, Bank of India, Corporation Bank, or for that matter the State Bank of India (SBI) itself, they have rallied by 60%-70% in the past two-three months. Not long ago, experts were apprehensive of a price-to-book multiple of one in SBI, quoting their doubts on bad debts, and today we see strong advices on investing into the country's largest lender even when it trades at two times its book value.
There is a definite desperation to bring the retail investor back into the stock markets. This reminds me of 2007, when the stock markets hit all time highs and there was a euphoria across the nation. Just then, Anil Ambani's Reliance Power entered the markets and its initial public offering (IPO) was a super hit. People queued up to open demat accounts and invest in this company. Even those days, news articles, advisers, and experts set massive targets and said that it was a lifetime opportunity for retail investors to buy stocks. The stock market indices were already at their lifetime high then. An article on Rediff.com targeted the Sensex to hit 27,000 in 2008, another said Sensex will hit 100,000 in 15 years, Morgan Stanley said it would cross 50,000 by 2018 and JP Morgan said that it would hit 30,000 by 2013. We all know what happened after that in 2008 and how the retail investors who entered the stock markets lost money. There could be some investors who held on to their investments and made money, or at least be at the break-even point but a large number of them booked losses.
Now, we are in a similar situation again. The Sensex is trading at a lifetime high and the experts are saying that this is the best opportunity for the retail investors to get into the markets. Two months ago, Deutsche Bank saw the Sensex at 24,000 by the end of 2014, but now, they project it will touch 28,000, Goldman Sachs projects the Sensex will hit 28,000 by end of 2014, Karvy sees it at 100,000 by 2020, Ambit Capital sees it at 30,000 in FY15, BoFA-ML sees it at 27,000 by end of 2014, Edelweiss says 29,000, and so on. How different is 2014 from 2008?
When the Sensex hit an all time high in 2007, it traded at a price-to-earning (PE) of 25 times. In January 2008, the Sensex hit 20,800, its all time high then, and traded at 26 times its earnings. Unfortunately, after that, things went haywire and by January 2009, the Sensex was trading at about 9,000 levels, at 12 times earnings. Soon, the stock markets picked up and the Sensex was again trading at 20 times earnings during 2010 and 2011. However, in 2012 and 2013, the Sensex consistently traded at 17-18 times earnings. Today, at 25,000, the Sensex is trading at 18.5 times earnings. Thus, it is clear that we are not seeing an overvalued situation like in 2008, where it traded at more than 25 times earnings. Moreover, in 2008, the world was also on the verge of witnessing the US mortgage crisis followed by the global financial meltdown, which hit investor sentiments.
But then, it may be interesting to note that the retail investor is not showing much interest in the stock markets despite a desperate attempt by brokerages, mutual funds and other financial firms dealing in equity markets to attract them. May be the retail investor has not recovered from 2008. In fact, even when the Government of India launched the Rajiv Gandhi Equity Savings Scheme (RGESS), there was a muted response despite the fact that the investor was promised taxation benefits. Its a different story that whoever did invest under this option would have minted money in the last one year. There is absolutely no doubt that the retail investor is keeping a watch on all this but is still not ready to take that the plunge. Companies will have to ponder what is keeping them away.
One point definitely is that savers and common investors do not understand the functioning of equity markets and how or why or what makes the prices of stocks move. That is the major reason why investors and savers have stayed away from getting into equity investments. Even mutual fund investments have been dull for the last five years. The average assets under management (AUM) have remained at around Rs7 lakh crore for a long period, except the appreciation that we have seen recently. India has a abysmal retail participation in equity markets. However, there is a huge opportunity here, and none of the companies have been able to crack it. Even if 1% of our population (12 million) invest Rs1 lakh each in the stock markets, that will be Rs1.2 lakh crore. This makes good for the total foreign institutional investor (FII) inflows in the Indian markets for 2013.
So all considered, what do we do now? I would stick to the standard answer that has held good across ages and economic cycles. Do not invest because you are seeing the markets go up or down. Do not invest because someone tells you that the markets will run and you will mint money. Do not invest because you are desperate to join the rally. Spend time, read books, go through content on equities, economy and related pieces, learn and explore more, get an understanding, and then, take the call. Equities have undoubtedly outperformed almost every asset class in the long run. Most often, we spot gold only after it glitters. After all, that itself is its prime feature. So, do not try to jump the bandwagon or time the markets. Markets are always full of opportunities. That is exactly why they are termed markets. See equities as a long term wealth building opportunity rather than a short term cash cow. Take your investment decisions on your own. You are the best fund manager your money can have.
With investor participation already at abysmally low levels, the SEBI in its hurry and disregard for implications of it actions, may bring another nail down on the retail investor coffin
Virendra Jain of Midas Touch Investors Association sent a strongly worded letter to UK Sinha, chairman of the Securities and Exchange Board of India (SEBI) protesting the exit options provided by the market regulator to regional stock exchanges (RSEs) leaving lakhs of investors in these exchanges in a lurch. According to Jain, none of the guidelines issued by SEBI for RSEs, provide exit options for shareholders. In fact, none of the processes required for relisting have been probably instituted or overseen by the SEBI, he alleged.
“We once again request that RSEs should be de-recognized only after ensuring protection of interest of investors in companies exclusively listed on them and that (a) The exclusively listed companies on non-compliant stock exchanges have been listed on nation-wide stock exchanges or failing which (b) Such companies are 'compulsorily delisted' by the concerned regional stock exchange and their shareholders have received the exit price in accordance with Section 21 A [Delisting of securities) of the SCR Act and Rules and Regulations framed there under,” Jain said in his letter.
For those wondering what the hue and cry is about, here is the situation as it stands today. The letter states, “According to SEBI data, as on 1 March 2002, about 9,644 companies were listed on 23 stock exchanges all over the country. The number of investors in these companies totalled over two crore. Out of the 9,644 companies, 4,644 companies are exclusively listed on RSEs. The market cap of these companies would be above Rs2 lakh crore.”
Now we come to SEBI's latest directions with respect to these RSEs. SEBI had approved 'Guidelines' that would provide an exit option to RSEs, first on 29 December 2008, with revisions on 30 May 2012, and finally on 22 May 2014. In effect the guidelines set in motion, a process to de-recognise exchanges that had an annual turnover of under Rs1,000 crore before 30 May 2014.
Virendra Jain, in his letter points out that in the December 2009 circular, Paragraph 8 of the circular deals with pre-requisites for the de-recognition of RSEs that did not fulfil the turnover obligations. As quoted in the letter, Paragraph 8 of the guidelines says the following:
“In case of companies exclusively listed on those derecognised stock exchanges, it is mandatory for such companies to”
1. “Either seek listing at other stock exchanges or”
2. “Provide for exit option to the shareholders as per SEBI Delisting Guidelines / Regulations after taking shareholders’ approval for the same, within a time frame, to be specified by SEBI, failing which”
The letter goes on the say that none of these exits for the shareholders have been made available, and none of the processes required for relisting have been instituted or overseen by the SEBI. As always, this leaves the small investor in these companies out in the cold.
“At the outset, we would like to bring it to your notice that issue of 'vanishing companies' was raised by us only, way back in mid-1990s and order along with directions were issued by Allahabad High Court in 1999 on our public interest litigation (PIL) no659 of 1998. The central monitoring committee (CMC) and Task Forces have been working since then. We are aware of the ineffectiveness of the action taken and their results. For the retail investors, the exercise has been meaningless as none of them got any money back in the companies identified as vanishing nor a single rupee was recovered from such companies and their predatory promoters and directors by SEBI and Ministry Of Corporate Affairs (MCA). Further, the criteria of vanishing companies adopted by CMC is erroneous. No action has been taken by SEBI under the Securities Contracts (Regulation) Act, 1956 (SCR Act) against the companies identified as vanishing and their promoters, directors, Chartered Accountants (CAs) and company secretaries (CSs), ” Jain said in his letter.
Indian regulators, exchanges and intermediaries have never been famous for their investor friendly policies. This latest mess flies in the face of the SEBI “trying to protect investor interests.” Finally, the letter says, “Lastly, the stock exchanges which are in the process of de-recognition have huge assets, which vary from exchange to exchange. Generally, substantial part of these assets/ reserves have been built, over the years, through various concessions, tax rebates/exemptions given by the government and investor services funds etc. We request SEBI to issue detailed guidelines for treatment of these assets, their valuation and equitable distribution amongst all stakeholders. We emphatically demand and hope that SEBI would give meaningful representation to investors association for deliberations on this score.” Here's hoping that the SEBI will act swiftly and equitably in this instance.”
Earlier in March, the investor association raised the issue to non-compliance by companies. It was estimated that as much as Rs1 lakh crore of savings have been flushed down the drain because of poor supervision and regulation. This attitude continues to be evident in the regulators’ stand on public interest litigations (PILs) filed by Midas Touch Investors' Association. The PIL filed in the Delhi High Court alleges, among other things, that stock exchanges have failed, as first line regulators, to ensure compliance of the listing agreement by companies and take action in the event of non-compliance. How did SEBI react? Its affidavit in response says, the PIL is “devoid of merit”and has been filed by the petitioner “without appreciating the fact that the interest of the investors have duly been taken care of and protected” by SEBI.
The Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) told a committee chaired by MS Sahoo in 2010-11, that 1,845 companies listed at BSE and 203 companies at NSE were not in compliance of the listing agreement terms. Trading in securities of most of these 2,048 companies (out of 5,000 companies listed on the BSE and NSE) has since been suspended leaving small shareholders holding illiquid shares. In effect, investors pay the price when companies do not meet listing norms—the companies themselves get away scot free. The table provides the number of companies that are suspended by the BSE each year since 1995.
Midas Touch estimates that the total value lost to investors due to these suspensions is a high as Rs1 lakh crore due to their investment in around 3,000 such companies listed on the BSE, NSE and 14 regional exchanges.
Corporate governance in PSUs is negligible, while the prime motive of family run business is to maintain control and not produce profits for shareholders. So for increased returns on your investment, pick companies with the most corporate oversight and the best governance
Over the centuries judges in common law learned something about human nature. They realised that agents might not be particularly honest when acting on behalf of their principals. To remedy this problem, they created the highest duty under the law, a fiduciary duty, and assigned it to agents. This duty is now borne by all sorts of agents including trustees, employees, partners, and corporate officers. Wisdom of this judge-made law is confirmed by game theory. In game theory an agent’s best move is to cheat the principal.
For investors, the most important aspect of this concept is corporate governance. The basic idea of good corporate governance is to develop methods where the true owners of a corporation, its shareholders, have some sort of say over the agents running the corporation, the officers and directors.
Some of the basic principals include that executives and their pay should be accountable to shareholders. Companies should be transparent. Shareholders should exercise their stewardship over the companies they own by participating in all votes. Finally, investors should be more concerned about the long-term outlook for the company, in contrast to employees who know that their tenure may be limited.
Depending on the country, some of these concepts are either enshrined in law, regulations or sometimes listing contracts. Their importance is correlated with the distance between the owners and the officers. In small companies they are not needed because they owners are the officers. They are absolutely necessary though for widely held listed companies.
In the largest markets, the rights of the shareholders are often not exercised by them. These days they are often outsourced to large proxy advisors, who have become very powerful. Large fund managers are also the arbitrators of shareholder rights. This may concentrate power away from the final owners, but well-informed opposition to management might not be such a bad idea.
Even in the large well-developed markets, elites, not shareholders, call the shots. In France, corporate policy is often dictated by a combination of well-connected industrial families, state investment agencies, large unions, and last but not least the industry minister. Being an alumni of one of the three elite “Grand Ecoles”, whose networks Harvard alums can only envy, usually connect this web of government, union and corporate officers. Fortunately the power of this elite is breaking down. The reason is that foreigners, who insist on higher standards, now own half of the shares of the biggest French firms listed on the CAC-40.
Italy has had the same issues. There are no Grand Ecoles in Italy, but there is Mediobanca. Mediobanca is an investment bank at the center of a web of cross-shareholdings, shareholder pacts and nested stakes, that allow control despite ownership of relatively small shareholdings. Mediobanca is in theory selling many of its stakes in other companies, but old habits die-hard.
Italy may have problems, but it doesn’t compare to Japan. In Japan nearly 600 of the 1,400 listed firms still do not have any outside directors. In contrast China, South Korea and India, not paragons of corporate governance, all require them. Only 0.2% of Japanese listed companies had majority independent boards. In the US the number is 90%, 50% in the UK and 30% in Singapore.
As part of Prime Minister Abe’s third arrow reform efforts, there is a proposal to change the rules. The proposal includes guidance for appointment of independent directors. The provision is voluntary, but refusal requires explanation. The powerful Keidanren business lobby is opposing the provision. It has been successful in blocking all such proposals before.
Still Japan is far ahead of other Asian markets in one respect. It has the largest percentage of firms with diverse owners. Only 28% of Asian firms fall in this category and the vast majority are listed in Japan. Most firms in Asia are either state owned (40%) or family run (27%). Neither type of firm is known for allowing shareholders a major say in a company’s operations.
The probability for reform of corporate governance of state owned firms is negligible. For government officials, their largest asset is their potential for corruption and patronage. The largest listed Chinese and Indian firms each employ between a quarter and a half million people.
Family firms are equally difficult to change. Their prime directive is for the family to maintain control, not produce profits for shareholders. These firms are often excellent examples of crony capitalism. Large state owned banks are the source for cheap capital for both family and state owned firms. Seven of the ten largest firms in India have been tainted with corruption scandals. The ten most indebted firms account for 13% of the banking system’s bad loans.
So who cares? Why would investors or policy makers want to encourage good corporate governance anyway? The simple reason is money. Good corporate governance makes companies attractive to investors and makes them more profitable. The firms in the TOPIX 500 index had an average return on equity in 2012 of 7%, compared with over 15% for American and European companies. State run firms in Asia with their terrible corporate governance have lost a trillion dollars in value since 2007. Their aggregate PE ratio is half of private firms.
In developed markets, recent research has shown that the best governed companies did not out perform their peers, but the 10%-20% of firms with the worst corporate governance definitely underperformed.
So the conclusion is simple. If you want the best management team who will do the most to increase your investment, pick companies with the most corporate oversight and the best governance.
(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 speaks four languages.)