»5 Minute Wrap Up by Equitymaster

On This Day - 16 MARCH 2011
This is one company which towers over all others

In this issue:
» Wall Street bonuses on the rise again
» Cash can yield good returns
» Japan earthquake highlights global manufacturing pitfalls
» Do Indian banks need to tap overseas funding?
» and more!

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The fact that India is home to one of the largest number of billionaires as well as the largest number of people living below the poverty line is testimony to the huge contrast witnessed here. But this divide is not just restricted to wealth distribution. But is beginning to being seen in matters relating to ethics and integrity as well.

Take the case of HDFC. This financial institution is the sole Indian company figuring in Ethisphere Institute's (a New York City think tank) fifth annual list of the World's Most Ethical Companies. Now, this think tank may not be that well known in India. Hence, its views do come under the scanner. But what is important is that out of several Indian companies that it studied, only one made it to the list!

Ethisphere's stamp of approval or not, the point is that Indian companies need to do a fair amount of work on the ethics and good practices front. Indian companies have already begun making a mark in the international arena because of the low cost advantage that they enjoy and good English speaking skills. Many have also moved up the value chain and have done overseas acquisitions all by themselves rather than looked upon as targets by international majors. Some of India's big names in the corporate world such as Infosys and the Tatas are also widely respected overseas. But overall for India Inc on the governance front, efforts seem largely wanting. The Satyam fiasco, the telecom scandal and the murky dealings in real estate are some examples that have tarnished India's image.

Now, we are not recommending the stock of HDFC here. But, it would be to India Inc.'s benefit if it takes a leaf out of HDFC's book and steps up initiatives on the governance front. This is not just to make an entry into annual lists but step up investor confidence and widen the gamut of good companies that they can invest in. Please be informed that more than the Government it is the private sector that ensures long term wealth creation in an economy. And it is good governance that makes this wealth creation more equitable and sustainable.

Besides HDFC, which other Indian companies do you think have good ethical practices? Share with us or post your comments on our facebook page.

 Chart of the day
Today's chart of the day shows how Wall Street bonuses in CY09 and CY10 have been nowhere compared to the surge seen in CY06 and CY07. Not surprisingly, these plunged in CY09 when the subprime crisis developed into a full blown one. Now, the US and European economies have not completely recovered from this crisis. But that has not deterred Wall Street from taking home big bonuses. The difference now is that many of these payments will be deferred and so it could be a while before one will see the highs of the pre-crisis years.

Data Source: The Economist

The 2008 financial crisis brought to the forefront the ugly truth of the truly global nature of finance. Asset price collapse in regions like US and Europe made their reverberations felt as far as China and Japan. In fact, there was no big country of note that remained unaffected from the crisis. An interesting article in FT points out how the earthquake and tsunami in Japan is doing a similar thing to manufacturing. Of course, Japan's relevance in manufacturing has gone down over the years. But in certain items like memory drives and flash drives, it commands a lion's share of the global market.

Thus, a disruption in supply in these items will no doubt affect the entire supply chain and hurt a vast array of businesses therein. And this is not an isolated example. There have been cases where entire production lines in complex manufacturing industries like auto and electronics have been forced to shut down. Quite a few them, it should be noted, on account of supply disruption at a small, not so critical component supplier. Thus, it is time companies start taking this risk seriously. Cost savings by way of economies of scale is no doubt important. But what may not be acceptable is the risk of disruption of the entire supply chain that comes along with it.

The business of banking has got increasingly complicated in recent times. No more restricted to managing spreads, it involves ensuring that the duration of assets and liabilities are well matched. What this means is that the tenure of funds receivable and payable are kept at par. Only this can help the bank maintain margins across interest rate cycles. However, the fact remains that a majority of bank's payables are short term deposits. On the other hand a large part of the receivables are longer tenure loans like home loans and project loans. Herein arises the mismatch that forces the bank to compromise on margins and asset quality.

As per RBI deputy governor Dr Chakrabarty, raising long term funds is the key to managing this mismatch. The likes of SBI have already set the trend in this regard with their retail bond issuances. Dr Chakrabarty also believes that Indian banks need to tap overseas funding to meet their growing capital needs. We do agree with him. However, we believe that, if competent banks source long term funds from domestic markets at attractive rates, there would be no dearth of it. On the contrary, the domestic funds would be devoid of currency and global economy related risks.

We talked about how the world's best investor Warren Buffett is shifting part of his focus to the emerging market growth story. Now, what we read today is contrasting. As per a leading business daily, some of the world's largest fund managers are shifting away from Asian stocks in favour of North American equities. This shift is said to be happening owing to rising inflation concerns in Asia and an improving economic outlook in the west.

We are not sure whether this is a real sensible strategy for these managers. Stocks in the western markets, including North America, are artificially supported by the quantitative easing from their central banks. While this seems to be the case with equities in emerging markets of Asia as well, the real fundamental long term growth story still lies in Asia.

Is cash trash? Of course not. But then that is what many investors tell their clients. And the funnier part is that they justify their point. These investors compare the returns on cash, which are usually quite low, with that of bonds. As compared to the yield on a bond, the yield on cash appears low. But is it correct to compare cash yields to bond yields? As per noted value investor, Seth Klarman, this is an incorrect way to evaluate cash. Cash is an asset that represents future potential for the company. If invested correctly, it can yield huge returns. Cash represents a future opportunity, which cannot be measured by simply looking at its current yields. So the next time someone tells you that cash is trash, you may just want to drill some sense into the person.

The Japanese markets have corrected almost 12% following the unfortunate disasters in the country recently. So is the correction over? Or is there room for more? Let's look at a similar incident in history. The Kobe earthquake that occurred in 1995 is one of the worst earthquakes in the recent history of Japan. And while the earthquake happened in mid-January, the Nikkei had fallen by a good 25% before bottoming out after June.

Of course, history doesn't repeat itself exactly the same way. But there could surely be some essence of the past in the present turmoil. Let's look at the circumstances during both the catastrophes. The recent Tohoku earthquake may have a devastating effect on Japan's economy since the region contributes about 8% of the country's GDP. However, the impact on the global economy may be a bit muted compared to the Kobe earthquake of 1995. The reason is simple. In 1995, Japan contributed about 17.9% of the world GDP. That figure has halved to about 8.6% in 2010.

However, Japan may have a tough time ahead. In 1995, the country rebounded sharply on the back of robust public investment spending. However, the fiscal constraints may not allow Japanese policymakers to repeat the feat. The lengthy reconstruction will add further to the already high debt load of the economy. To give you a clear picture, the government debt to GDP ratio is already the highest in the world at 2:1. So the global economy may deteriorate only marginally. But the Asian patriarch will take a long time to recover.

In the meanwhile, Indian stock markets continued to rally with stocks from realty, consumer durables and banking leading the pack of gainers. At the time of writing, the benchmark BSE Sensex was trading higher by 250 points. The Asian stock markets had a mixed performance with Japan bouncing back while Hong Kong closed weak.

 Today's investing mantra
"Absent a lot of surprises, stocks are relatively predictable over twenty years. As to whether they're going to be higher or lower in two to three years, you might as well flip a coin to decide." - Peter Lynch

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