US investors already lost trillions like this. Will you?

May 21, 2010

In this issue:
» Brokerages in India selling complex synthetic derivatives
» Greece crisis not to affect India: Pranab Mukherjee
» We need to build new cities says Deepak Parekh
» US passes a sweeping Wall Street reform bill.
» ...and more!

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Trust and incentive - these are such powerful words in the world of business. And even more important when it comes to investing. You should always entrust your investments to or take investment advice from people whose incentives are aligned with yours. They should make money with you, not off you.

Unfortunately, the incentives of investment bankers and brokers are not aligned with those of the retail investors. They will sell whatever possibly can be sold. What is being sold to you might make you money, or you might lose your shirt in the process. It is not really their concern. As long as their commissions keep coming that is.

Thus, we weren't very surprised at seeing a recent report that some leading brokerages in India have begun selling complex synthetic derivatives products. This they sell to their portfolio management service (PMS) clients in the garb of structured notes. No specific rules govern these products. And they are quick to take advantage of this ambiguity. Further, these products are quite complex. They are often based on contingent events, the outcome of which can only be speculated. And if the outcome doesn't get you, a lack of proper understanding of the product can.

In our view, you will be well advised to instead invest in stocks of well-run companies with a good track record and future prospects available at a reasonable price. That is pretty challenging and rewarding by itself. The West is still reeling from the impact of such complex derivative products that no one truly understands.

Has your broker ever tried to sell you complex products in the name of generating market beating returns? Let us know your views.

 Chart of the day

Source: Lok Sabha question

After the recent ruling in the Ambani vs. Ambani case and the government's decision on revising APM gas prices, the next big announcement is expected to be in auto fuel prices. India has a complicated pricing system in place for both auto (diesel and petrol) and kitchen (kerosene and LPG) fuels. On the one hand, the government doesn't allow oil marketing companies to charge market prices. It says, a huge section of Indian citizens would not be able afford high fuel costs. On the other hand, a large chunk of the price is actually made up of taxes levied by the government. As today's chart of the day shows, nearly 50% of the price you pay for petrol is towards taxes. So, more than freeing fuel prices, the first thing the government needs to do is to simplify the pricing mechanism.

There are numerous stories doing the rounds that the Greece crisis will have little or no impact on India. In fact, even our belief is the same. But what perhaps matters the most is how people who govern India's finances view the entire situation. And who better person for this than the country's finance minister? Thus, we were all ears when Mr. Pranab Mukherjee spoke to a leading daily about the impact of the Greece crisis on India. The finance minister is of the opinion that India's exposure to troubled Euro nations like Greece, Spain and Portugal is just 4% of its total exports. Thus, there is hardly going to be any impact from an economic point of view.

However, he also cautioned that if the European crisis were to take a turn for the worse then the impact will be difficult to gauge. We are of the view that even if the impact is significant in the short term, it will not matter much from a long-term perspective. It should be noted that it was India's resilience and its domestic driven growth model that pulled us out of global financial meltdown sooner than most other nations. And it is likely to be the same during the current Euro crisis as well, if at all it worsens.

Are you among those who have lost hope of buying a house in Mumbai? Trust the man credited with making houses affordable to Indians to come up with novel ideas. Deepak Parekh, the Chairman of HDFC, believes that real estate prices in metros like Delhi and Mumbai cannot come down unless we build new cities. In an interview to a business daily, Mr. Parekh said that most of the growth in loans for affordable housing is coming in from the suburbs. However, to make prices more affordable in metros, the government will need to concentrate on improving transport infrastructure and build new cities. He also cited the examples of island countries like Hong Kong and Singapore. Stating that these have grown on reclaimed land, Mr. Parekh suggested a similar option for Mumbai. Having said that, he also explained the importance of creating jobs to support the population in the new cities.

After a sharp rise over the past few days, gold has become too hot to handle for Indian investors. And if experts are to be believed, gold imports by India could drop for a third straight year in 2010 as record high prices scare off traditional buyers. In fact, as per Mr. Suresh Hundia, president of the Bombay Bullion Association in Mumbai, "Forget buying for the festival, on the contrary people are selling. There is a queue of sellers."

Gold prices have jumped almost 12.5% this year. This has been on the back of fears that inflation would rise globally, especially with the passage of the bailout package to prevent the Greek crisis from spreading to the rest of Europe.

As per the latest issue of The Golden Truth, 'gold has been the ultimate store of value in times of financial confusion.' We also believe that the case for gold looks very strong. But while having the metal in your portfolio does make sense, one should refrain from going overboard with it.

The US banking industry will have to brace itself for some tough times ahead. The US Senate has approved a sweeping Wall Street reform bill. The bill, when it comes to law, will ensure tighter regulations for banks and reduce the industry's profits for years to come. This is hardly surprising. It is a well documented fact that banks had a major role to play in sowing the seeds of the global financial crisis. As a result, they had to be bailed out from bankruptcy by the government using taxpayers' money. While there are concerns that this would stifle the free market principle, which have been the hallmark of the US, President Obama thinks otherwise. He maintains that the purpose of the bill is to make financial firms more accountable and would not thwart the free market. US banks in the past chased fatter profits and relegated the principles of sound, conservative banking to the sidelines. This new bill that looks all set to come into force will ensure otherwise.

As per the MET department, monsoons will arrive in mainland India by 1st June. We see this as a big boost for the growth of the India economy. A normal monsoon would give a much needed fillip for softening of food inflation, thereby increasing discretionary income in the hands of consumers. We also believe that it would cut down the food grain import bill affecting the balance of payment.

Although trading well above the day's low levels so far, the BSE-Sensex was trading down by 180 points (down 1.1%) as compared to yesterday closing levels. Selling activity was seen in stocks across sectors with those from the realty, metal and power sectors being the top losers. Stocks form the healthcare and auto spaces were trading marginally lower. Losses in India mirrored the overall sentiments in Asia as Japan (down 2.5%) and Hong Kong (down 0.2%) were trading weak. China's benchmark index, the Shanghai Composite was however the sole gainer (up 1.1%).

 Today's investing mantra
"Most businesses change in character and quality over the years, sometimes for the better, perhaps more often for the worse. The investor need not watch his companies' performance like a hawk; but he should give it a good, hard look from time to time." - Benjamin Graham

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21 Responses to "US investors already lost trillions like this. Will you?"

Prakash Holla

Aug 14, 2010

I bought more Maruti shares hearing of excellent May car sales. I bought even more after reading about June sales. I expected to exit with a nice profit! Now I understand Suzuki Jap had SEVEN times higher profit in Apr-Jun 2010 (compared to '09) mainly due to Suzuki India performance. Maruti Suzuki suffered much lower profits mainly on account of steeply higher royalty transfer to Japan! Now I am stuck with MS shares because of the greed of the Nips! Isnt there any way to stop looting of subsidiaries by parent cos? Isnt there any way to shame them?



May 24, 2010

I think brokers, by nature, tend to push for products that they themselves arent aware of. I am not too much into investing in ULIPs, and they take advantage of this fact and sell their products. The best way to go about this is to consult an investment advisor you trust and who shares a similar financial goal as you.


May 22, 2010

I am a Certified Chartered Accountant from the U.K.
I do not mind admitting that I have never understood derivatives nor have I tried to understand them.
I follow Equimaster's Guru's (Warren Buffet's)advice, namely; if a product is too complicated to understand then it is not worth buying.
It has saved me a few Pounds both in money and in weight!!


sn malhotra

May 22, 2010

A very good and timely warning. Wonder if SEBI can proactively do something about this; there is enough evidence of the havoc these products can create from the experience of USofA



May 22, 2010

yes, I have been pestered by numerous to buy products which were not in investors interest. Besides, complex structured products I have been chased for long term ULIPs.

Many of them are those I deal with regularly for my investments in equities or M.Fs.

I do not know get these off my back.


jagdish sanghvi

May 22, 2010

My broker has so far not tried any non sense approach with me so far. I dont even follow their normal stock recos.They know that, and hence no attempt from the broker.


Vinay Isloorkar

May 21, 2010

The same argument can be extended to the concept of mutual funds, where performance is not guaranteed nor accountable to the investors. But the costs of running the mutual fund are borne by the investors.

By extrapolation, if Gold is a safe haven, one must take delivery of physical gold and not keep money in eGold. The myth of "Too BIG to fail" has been exposed quite often by now.



May 21, 2010

There are a lot of structured products being offered by the leading investment banks. Most of these have capital protection and are NIFTY based, not stock specific. I am somewhat puzzled at EquityMaster's statements that;
(a)US investors lost trillions like this. Willyou?
(b)no specific rules govern these products
(c)you will be well advised to instead invest in stocks of well-run companies.
Can Equitymaster please clarify what kind of structured notes it is refering to..otherwise lay investors like us may get the wrong idea and stay away from perfectly safe products.
For example the comment made by Eisen above that he did not take the ING Milestone product will be reinforced by Equitymaster's article, when in my view, the Milestone product is safer than investing in direct equities



May 21, 2010

Lets learn a lot of things and gain experience from others at least, There are a lot of things to learn,, learning never ends you know. If one topic ends the other arise..... good Equity master has opened a window to debate one of the most important subject in the world at present on a day to day basis.... hope so the debate becomes useful to many.....


Rajkumar hallan

May 21, 2010

Equitymaster does not guide on simple derivative products like Options that (in other publications) are supposed to protect investor from short term losses (even Warren Buffet is said to have puts in place to protect his investments).
FOr example, a buy in Take solutions could have come with appropriate put strategy to take benefit of the movement to 23-24.
Further, the downmoves in Indian markets do not seem sustainable (the market seems to be resisting downmoves). Hope we will have the 21000 in July 2010.

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