Will IPOs ever shed their bad reputation?

Dec 20, 2012

In this issue:
» Sensex shocks gold over a 30 year period
» Hedge funds have a terrible decade
» Direct cash transfer could stoke inflation, feels world bank Chief Economist
» Massive fine for UBS in the LIBOR scandal
» ....and more!

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There's an interesting satirical quote about the stock market. It terms the market as the place where people with experience meet people with money. And after a while, the people with experience have the money and the people with money have the experience!

Well, we are not sure whether this applies to the stock market as a whole. But one place where it would not find itself out of place is the IPO market we believe. For no matter how far back we look, we get little or no evidence of investors making huge money on a consistent basis out of the primary market issuances.

And this fact has not been lost on one Mr Sinha, the Chief of India's capital market regulator, Securities and Exchange Board of India (SEBI). He came down rather heavily on the intermediaries entrusted with the task of carrying out IPOs (Initial Public Offerings). These intermediaries, whom we have given the rather dignified status of investment bankers, are no better than matchmakers as per the Chief. Whether the bride is ready or not does not matter to the matchmaker he opined. But he will still go out and sell all the good qualities about the bridegroom.

Mr Sinha couldn't have hit the nail better on the head we believe. And he does give us the numbers to support his claim. As per him, 72 stocks out of the 117 public issues in the past three years are trading below issue prices! Agreed that the overall market has not done well during the period under consideration. But the record still comes out poor even after we account for this fact as per him.

It becomes clear after studying these facts that the investment bankers are certainly not doing the job required of them. They seem to be more content minting money for themselves and their corporate clients. Even if this means taking the small investor for a ride. But is this a sustainable business model in the long run? Certainly not. Infact, the repercussions are already being felt by way of a marked decline in the level of retail investor interest in IPOs.

While efforts are on to curb the profit maximising tendency of investment bankers, we doubt anything positive will come out of it. The only viable long term alternative is for retail investors to step up their own diligence. They should be wary of companies that have nothing else but promises to offer. Instead, they should insist that the IPO candidate have a long term record of profitability and a healthy balance sheet. The integrity and the experience of the management should also be looked into. And last but not the least, the issue should not be excessively priced. Checking for these parameters will go a long way in improving the odds from IPOs than depending on bankers or regulators for help we believe.

Do you think IPOs will ever shed their bad reputation or retail investors will have to fend for themselves? Share your views or you can also comment on our Facebook page / Google+ page

 Chart of the day
Gold may have outperformed Sensex over the last decade or so. But what about a period as long as 30 years. Well, if today's chart of the day is any indication, the yellow metal has not come even remotely close to matching the performance of the Sensex over the last three decades ending March 2012. While gold has proved to be an excellent inflation hedge as shown by its outperformance against the CPI index, stocks are a must have in one's portfolio for long term wealth creation according to us. In CAGR (compounded annual growth rate) terms, while Sensex has returned around 16% between March 1981 and March 2012, Gold has given close to 10% returns during the same period, proving that it can be counted upon to beat inflation in the long term.

Data Source: RBI, ACE Equity
*Gold prices are average while Sensex value is year end value

Is the gold rally about to end after 12 years of gains? Well, gold prices have been falling off late as investors are dumping the precious metal and are instead opting for the greenback. This is a trend that could carry forward into 2013, notes expert commodity investor, Jim Rogers. Fears that the United States may fall over the dreaded fiscal cliff and go into a recession have sparked demand for safe-haven investments like the dollar. The dollar is a popular asset that moves inversely from gold in uncertain times.

Gold is currently in midst of a correction that has been going on for 15-16 months now. And it is possible that it will continue for a while longer. Gold bullion experienced its last major correction during the 2008 financial crisis, where it contracted 32%. Most asset classes correct by 30% or so every year or two. Gold has done that only once in the past 12 years. Well, since a correction seems to be overdue, it may be wise to wait for sometime before investing in this commodity. But, from a longer term perspective, we believe that gold prices will be able to outride any temporary slump.

The term hedge fund brings to mind thoughts of high-risk high-return funds scouring for money-making opportunities. These are traditionally known to be aggressive in their approach, making highly leveraged risky bets across asset classes. But this doesn't seem to be the reality any more. The one word that best suits to describe the performance of hedge funds over the last decade is 'mediocre'. The S&P 500 index, for instance, has beaten the hedge fund index for the entire last decade with the year 2008 being the only exception.In fact, an investment portfolio comprising 60% in equities and the rest in sovereign bonds has delivered returns of more than 90% over the last decade. On the other hand, hedge funds have returned only 17% after fees during the period. If you factor in inflation, the return would be negative. The reasons for the underperformance vary. Some point the fingers at excessive intervention by government agencies which tend to undermine underlying economic forces. Others admit to having no edge in the current highly uncertain environment. The changes in the hedge fund industry point to a tectonic shift in the financial world.

There are basically two ways to dole out subsidies. First, is to subsidize the product at the point of sale itself like it is being done now. For example, right now diesel and kerosene are being sold at subsidized rates. The second way is to get direct cash transfer in to your bank account. In this form of subsidy mechanism, you pay the full price of the product. However, the subsidy figure gets credited to your bank account directly.

We feel second option will enable rationalization of subsidies as only deserving people will be the ultimate beneficiaries and not the owners of guzzling sports utility vehicles (SUV). For instance, a rich man does not deserve a subsidy on diesel to run his SUV.

However, there is a risk associated with this form of subsidy mechanism. Chief Economist, Kaushik Basu, believes that subsidy by way of direct cash transfer might create an inflationary pressure in the economy. That's because subsidy is distributed via cash. And thus more money is pumped into the system. Another problem is that with inflation, the value of subsidy will erode. Nonetheless, both these problems can be sorted out. For instance, the value of subsidy can be indexed to inflation so that purchasing power remains intact. We feel that direct cash transfer is the lesser of the two evils. It targets true beneficiaries. It also helps curb fiscal deficit as undeserving people don't get the benefit thereby saving government money.

If a crime is committed, then the guilty has to pay for it. The statement is gaining more and more prominence in today's world. No matter how big or how small the perpetrator, the guilty has to be punished. The latest bank that has been punished for its misgivings is Swiss banking giant UBS. The bank was found guilty of its efforts to manipulate the Libor rate. It has been asked to pay a whopping amount of US$ 1.5 bn to the regulators in US, UK and Switzerland.

In addition to manipulating the Libor, the bank has also been accused of under reporting its borrowing rate. The latter was with the motive of making the bank appear financially strong through the global crisis period. The thing that investors need to understand here is that greed is not a product of size. Even big companies and banks can succumb to it. Such scandals and scams highlight the need for better governance standards and management ethics. It is therefore pertinent for investors to stick to strong and ethical managements.

Meanwhile, indices in the Indian equity market traded weak today with the Sensex lower by around 70 points at the time of writing. Stocks from capital goods and auto sectors were the ones under maximum pressure. While other Asian indices closed mostly in the positive, Europe too is showing a positive bias currently.

 Today's Investing Mantra
"It's almost a mathematical impossibility to imagine that, out of the thousands of things for sale on a given day, the most attractively priced is the one being sold by a knowledgeable seller (company insiders) to a less-knowledgeable buyer (investors)." - Warren Buffett on IPOs

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    3 Responses to "Will IPOs ever shed their bad reputation?"


    Dec 30, 2012

    The chart where gold is taken at average price and sensex at current price is misleading if you miss the fine prints.

    Apple to apple comparison is desirable


    Borkar M.R.

    Dec 21, 2012

    When I got initiated to Stock Market in and around 1970. I use to apply for IPOs (if I have surplus money) this was happening because the application money, invariably due to non-allotment of the previous applications will not come back for quite some time and the one which one got allotted will not see the bright light of the day. Of course there were few ecveptions like Tata Chem/Reliance etc. I then changed the course and decided to pay little more in the secondary market if required after the listing. Recent example of L&T Finance. I picked up in secondary market around 45/48. - Next is NMDC, I will buy it as and when my price comes. The basic "fear" and "Greed" among small investors, "if I do not apply I will loose the chance" of making quick money. If one is investor then making "money should not be the criteria. Creating the wealth for SELF AND FAMILY must be the primary conern. Of course sometime your picks in the secondary market also go wrong, but your success rate over a long period is much much better than "GET IN GET OUT" habit.- So HAPPY INVESTING for 2013. - Borkar


    sunilkumar tejwani

    Dec 20, 2012

    concept of value investing,applies to both whether IPO or secondary market IF the issuer has greedily priced IPO at a higher price or if the market has given over valuation to a stock, such instances should be avoided by a lay investor. Take the recent comparison of two IPOS". The one of CARE and the other of Bharti Infra tel. The former got a good public response, where as the later got a very poor response especially from the retail investors. I will not be surprised if CARE lists at a 20% premium than the offer price and Bharti Infra tel at a 20% discount to the offer price. For the obvious reason.

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