Do you invest on the basis of AAA rating?

Oct 1, 2011

In this issue:
» India is one of the biggest arms buyer
» US CEOs are pessimistic on the economy
» Should you buy commodities now?
» Has the government committed a Satyam-esque scam?
» ...and more!
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Rating agencies like S&P, Moody's and Fitch played a starring role in various stages of the 'subprime crises'. They assigned AAA (highest) ratings to some toxic assets, which could blow up any minute. Seeing these top notch ratings pension funds, banks, and other unsuspecting investors piled up these assets. They had no idea that they were holding a ticking time bomb. Thus, without rating agencies, the crisis would never have reached such a huge magnitude. Their top ratings initially helped the markets reach never seen before highs. But, their eventual downgrade of the same securities sank firms and wrecked havoc across the markets worldwide.

Credit rating agencies were the most notorious villains of the credit crisis. The reason why they are so deadly is because they helped stoke one of the biggest financial crises in the history of the world. Moreover they have managed to go scot free. Not only that, they are still committing the same mistakes and no one is doing anything about it, yet.

A recent report by the Securities and Exchange Commission (SEC) finds that these rating agencies are not doing enough to protect their integrity. There are numerous examples of inadequate controls that the SEC found in its first annual review of these agencies. Inadequate policies to prevent conflict of interest, failure to adhere to their own formulas while assigning ratings, and inadequate disclosures are just some of the them. Ratings were also sometimes leaked before the actual reports were published.

Well, even Indian rating agencies are following the footsteps of their not so illustrious parents. In a recent management meeting with a small cap company, we found that a top Indian rating agency charged the entity Rs 5 lakhs for an 'independent' rating view on the stock. What's worse is that a higher payment fee was negotiated when it came to renew the report, with a better rating. When ratings can be bought, and formulas cannot be trusted, we believe that these firms need a complete regulatory overhaul. Only then can investors start trusting these ratings once again.

Do the ratings given by rating agencies govern your investment decision on stocks? Do you find them reliable? Share your comments or share your views on our Facebook page

 Chart of the day
Benjamin Franklin famously quoted that "in this world, nothing is certain but death and taxes." This statement is definitely true for most emerging markets. Today's chart of the day shows the personal income tax rates (at the highest bracket) for countries in the BRICS (Brazil, Russia, India, China, and South Africa) nations. Out of these only Russia is spared, having a flat tax rate of 13% applicable to domestic residents. In India, the highest tax bracket kicks off at Rs 0.8 m, and the maximum income tax rate on income is 30.9%, including an education cess of 3%. In China, the highest income tax rate is a whopping 45%. Both India and China pay taxes at a rate, well above their Asian peers. In the Asian region, the average rate remains at just over 23%.

Data source: KPMG Survey, 2011
*includes educational cess of 3%

A report for the US Congress points out some interesting facts about global arms and weapon deals. You would be surprised to know that in 2010 India topped the list as the biggest buyer of conventional arms in the developing world with deals totaling about US$ 5.8 bn (approximately Rs 285 bn). What is even more shocking is that developing nations were the biggest buyers in 2010. The total value of arms transfer deals with developing nations stood tall at US$ 30.7 bn, which was a whopping 76.2% chunk of the total worldwide deals. The defence budgets of developed nations have been witnessing significant cuts as part of their austerity programmes so as to reduce deficits and sovereign debts. In fact, during the period from 2003 to 2010, countries like Saudi Arabia, India and China have been the biggest arms and weapon buyers. On the other hand, the US and Russia have been the biggest sellers.

That economists, experts, investors have a pessimistic view on the US economy has been quite well known. But even businessmen in the US are quite bleak about the prospects of the US economy. This view became all the more negative with the worsening debt crisis in Europe and the standoff in the US about raising the debt ceiling. This means that over the next six months, CEOs of US companies are quite likely to cut jobs and not many expect to boost their companies' sales and capital spending over that time. Job cuts hardly spell good news for an economy which is grappling with an unemployment rate as high as 9%.

This has been one of the prime reasons that the government's misguided stimulus packages did not really work as they banked on Americans consuming more at a time when many were losing jobs. That said, there are some CEOs who are still a bit optimistic than the others although they admit that growth if any has been rather slow. Further, downgrading of US debt and higher oil prices have only added to the uncertainty surrounding the US economy. All in all, it looks like tough times are here to stay for the US economy for some time to come.

The long term pessimism of economic prospects of US and Europe has crept into the markets. The Asian stocks are no exception. Interestingly, commodities have followed the trend as well with an 8% to 10% correction in a period of just 10 days. So what will be the right theme to pick up that will award investors with a handsome payoff? Here is what Mr Mark Mobius, the Chairman of Templeton Emerging Markets Group has to say. He believes that one should wait for the valuations of Indian stock markets to correct even further. He further suggests that the recent correction in commodity prices is an opportunity to buy. However, there is a caveat for those who wish to follow his advice. In the backdrop of global economic scenario, one must enter commodities only with a long term perspective.

The Satyam scandal in 2009 redefined the term 'cooking up books'. The promoter of the supposedly blue-chip IT bellwether took the worldwide investor community by shock. His blatant acknowledgement of accounting fake revenues, profits and even employees seemed to be a stroke of wild imagination. However, the impact of it all finally sunk in when investors lost millions in the stock over the next few sessions. Ever since, the scandal has remained the biggest point of reference when it comes to accounting fraud. We came across an article in Firstpost that equaled the government's annual budgeting to Satyam's faulty financial reporting. It accused Finance Ministers of committing the same crime as Mr Ramalinga Raju.

Accounting for government liabilities on account of subsidies appear as off balance sheet items. This means that the liabilities are not supported by assets in the government's balance sheet. While Mr Raju's attempts were to meet shareholders' expectation of quarterly earnings growth guidance, Finance Ministers shoulder the responsibility of pleasing the vote bank. In either case, wishful thinking takes precedence over rationality. However we believe that the similarity ends here. Satyam's books were open for scrutiny only to its auditors. However, the governments accounting policies are available for public scrutiny. The fact that government's liabilities on account of subsidies far exceed tax collections is not news to anyone. Nor is the accounting of off balance sheet items illegal as per law. But be it government or financial institutions that build up huge off balance sheet exposure, each have to eventually repent for the excesses.

Fears of a Greek default and gloomy outlook for the US economy continued to weigh on investor sentiments throughout the world. The after effects of the announcements of "Operation Twist" could be seen across the global stock markets. Investors are also worried about the Chinese economy slowing down and are maintaining a cautious stance. Sentiments however improved towards the latter half of the week on expectations that European leaders and policy makers would take steps to tackle the crisis in Greece.

Indian stock markets were very volatile through this week on the back of disturbing global cues. The BSE Sensex ended the week higher by 1.8%. Among the other world markets, there was mixed response. China (down by 3.2% and Brazil (down by 1.7%) were the biggest sufferers. Singapore and Hong Kong were also on the losing side. However, France and Germany were both up by 6% each.

Source: Yahoo Finance

 Weekend investing mantra
"Humility about how little I know has encouraged me to listen more carefully and more wisely." - John Templeton

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9 Responses to "Do you invest on the basis of AAA rating?"

Nikhil Sutradhar

Nov 9, 2011

Pl Supply AAA rating list of Indian Company.

Like (2)


Oct 3, 2011

What else is a credible alternative to retail investor while investing in fixed income instruments who is risk averse and is in top tax bracket?

Like (2)


Oct 3, 2011

Yes, the rating agencies in US did not cover themselves with glory in the recent financial crisis. Riveting to India, it is imperative that these agencies do not commit the same errors. Your reporting of an agency seemingly trading their rating is disturbing. In our land of scams, do we need another? I hope this is taken note of and remedial steps are taken before it goes out of hand.
Yes, I do give prime importance to credit rating before investing.

Like (2)

Balinder Lal

Oct 2, 2011

No.In most of the cases, the rating agencies are found wanting.

Like (2)


Oct 2, 2011

very true1 rather than targeting small fry like IFAs SEBI and RBI would do much better to regulate these so called credit rating agencies.

Like (2)

anupam garg

Oct 1, 2011

though it continues to amaze me how can these rating agencies continue, despite being responsible for such a chaos...may b coz they hav taken inspiration from the fact tht no punishment or not even severe criticism was done

many stakeholders hav vested interests associated with rating agencies...the word 'trust' doesn't even come under consideration

Like (2)

shome suvra

Oct 1, 2011

In India credit rating is done on the parameters of industry risk, market position, management evaluation, accounting quality, financial stability and operating efficiency of a company. These information s are collected from plant visit, records and management meetings, industry experts, business operating heads, bankers, auditors, dealers, distributors, consumers, competitors and suppliers. Every system has its loopholes if not implemented properly.

Like (2)


Oct 1, 2011

I definitely follow ratings.Without any CAPEX so many firms looted share holders money by inflating share prices and after making money brought down the prices resulting bankruptcy of poor investors.The investment advisers also made huge money.That is why this huge cry

Like (2)

Jaydeep Shah

Oct 1, 2011

The rates of taxation has to be seen in context of how much of the taxes direct & indirect is ploughed back in the economy by the govt, and how much goes into paying interest on the debt. A large chunk of the taxes does not find its way to the intended use, and gets leaked. Also the figure 30.9 % is misleading as India has one of the highest rates of indirect taxes, such as Excise Duty, Customs duty, Vat and Central sales tax. have also to be seen. We do not have a vatable system for the indirect taxes so far.

Like (2)
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