US investors already lost trillions like this. Will you? - The 5 Minute WrapUp by Equitymaster
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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?"

Subhash Pareek

May 21, 2010

Citi Bank tried to sell a structured product when the market was plummeting in 2008. Luckily I refused.
Your statement is absolutely true. Commission is their only aim.



May 21, 2010

"complex products in the name of generating market beating returns": I was approached by my broker regarding the structured product - "Nifty Linked Structure with Capital Protection May 2010" This is offered as an NCD with all its terms and conditions. My minimum investment has to be Rs.10 Lakhs with a guaranteed return of the principal at the end of lock in period + 3 months (39 months). my broker is not able to answer some of my pointed queries on my locked up capital and so I am really wary of such zero sum game where my capital is available with the broker for a period of 39 months to play with and increase their business profit without offering any of them to me in return. The other product offered - "ING India BSE-200 Quant Equity Portfolio" is a pure derivative and complex derivative without any probability of positive returns to me. In addition, they will re-structure my entire portfolio and even the regular returns in the form of Dividends from my long term equity holdings are lost. I end of losing and the broker ends of making huge profit from my equity holdings surrendered to their PMS - What a wonderful way of playing with other peoples' money!!!



May 21, 2010

Lets understand one thing - Deriviatives neither creates money nor does it destroys money. It is a zero sum game wherein money is transferred from one pocket to the other pocket. While on one side it is said investors are loosing trillions of dollars due to structured products there would be someone who is making that kind of money (except holders of equity whose market value diminishes).

The only thing which is a problem is people entering into deriviatives without understanding the risks properly.


Hitesh Doshi

May 21, 2010

Recently I was explained multiple structured product by IIFL team. They all had a minimum unit price of Rs.10 lacs & ranged from 1 to 3 years. I was clearly mentioned about the upside & downside risks & potential as well as cap. I think it all depends upon how much interest you take & ask the necessary question. If you are thinking of putting this kind of money into some product, you are definitely expected to ask all the reasonable questions that would give you an idea of the in-herent risk in the product. Still you want to go ahead then its your money & your luck.



May 21, 2010

I have started investing in stock just 9 month back and only after I got reference of Equitymaster, but I am not bother with this up and bown as I know that your team have done good homework before suggesting us stock for buying and i have invested at cottect price and will always achieve target, I am looking for long term investment.

Equitymaster also provides update on every quarter but Sometime require intermediate intimation when stock cross target price also.



May 21, 2010

Your daily wrap-ups are, by far, the best I have seen among peer sites like yours. Pls congratulate the team involved for a job well done and do keep it up. The fact that you have such interesting snippets in each days mail is what make one look forward to it.


Parackal Thomas

May 21, 2010

Not only in the US, all investors throught the world have lost in the stock market- buy it is the PERCEPTION of the investers that matter for the future prospects. It seems international investors have a great deal of trust and confidence in the US and so the market will soon reflect that upward swing. Only time can tell.
You are doing a good service; please keep it up.



May 21, 2010

All 'Derivative Products' whatever the name it may be it is an imaginary product used for gambling. They are telling so many names, arguing so many logic. Then what is the surprise in losing money? The so called 'commodity market' also belong to this catagory.



May 21, 2010

Recently ING approached me into buying Duesctche management service Milesone Nifty linked Debenture. I wudnt know f it is good or bad. Coul you give ur view on it. I abstained from it although as the ticket size was 10 Lacs and thre was a lock in period of 3 years and it was speculative on the Nifty price.


Himanshu Shah

May 21, 2010

Comments on your article of
Brokerages in India selling complex synthetic derivatives

First the article is brief, very nice and true
But it applies not only to broking but all the industry
Generally the intent is to make money
The only difference in comparison to other industry is that the ticket size is small and you get some tabngible benefit in the form of goods or service.
In investing / broking it is like gambling which you are allowing other to do and also pay him for doing that on your behalf and fluctuation could be wide (stock or any such products up or down 50%)

It is on every individual how to make rationale decision of their hard-earned money

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