»5 Minute Wrap Up by Equitymaster

On This Day - 16 NOVEMBER 2010
Another 'UTI' type blow for investors?

In this issue:
» 3G windfall unlikely to aid Indian economy
» Sovereign funds show interest in Indian equities
» How the debt laden US will retain AAA rating
» China's brush with food inflation
» ...and more!!

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How often do you come across schemes that promise 'high' and 'assured' returns at the same time? It is fundamentally impossible for investments that offer very high upsides to have assured returns. However, this proposal is often used to lure unsuspecting investors. And ignorant investors fall prey to such shallow promises.

The latest testimony to this is the fate of the assured return schemes offered by India's largest insurance company LIC back in the 1980s and 90s. As per reports the extent of losses in three schemes offered by LIC has the potential to bring back memories of the UTI scam of 2001. Promising fixed returns of around 11 to 12%, these plans are currently running a deficit of a sterling Rs 140 bn! The invested money is from 1.3 m investors. Hence, there is little doubt that the insurer's inability to deliver returns could dislodge investor confidence once again.

Agreed that the notional losses could be attributed to trends in economy, interest rates, inflation and the like. Further, the outcome may not be as detrimental. This is because LIC seems to have enough liquidity at its disposal to tide over the crisis. But the economic factors are bound to have an impact on investments. And in no way can issuers of the instruments or investors undermine them. Hence it is most imperative for investors to recognize and be warned of the risks to the promised returns.

Investments in stocks at attractive valuations or in mutual funds through the SIP route can offer you some degree of safety. It could also enhance the likelihood of generating supernormal returns in the long run. However, there can never be any 'certainty' to the returns. And thus the promises to deliver assured returns need to be taken with a pinch of salt.

 Chart of the day
India Inc has done a good job of accelerating topline growth over the past few quarters. However, the investment books of some of the blue chip majors do not inspire much confidence when compared against the quoted market values. A comparison of the market value of quoted investments of the non banking companies in BSE 100 to their book values gives an aggregate negative figure for 3 out of last 4 fiscals. These can be primarily attributed to the devaluation of investments in Government Securities (G Secs). Also, realty companies have seen significant write downs in the value of their investments. All said, these companies may have to make significant provisioning if they are to comply with global accounting laws (IFRS) sooner or later.

Data source: CMIE Prowess

Sample this. The Government had budgeted Rs 350 bn in February this year to account for the sale of 3G and wireless broadband services. However, when the process finally wound up, the Government ended up generating a whopping Rs 1 trillion, nearly three times more than planned. Indeed, with such a windfall at its disposal, one would have expected the Government to quickly ramp up its investments in areas like infrastructure, health care and R&D. This is because it is these types of investments that will make us competitive in the long run.

It isn't that the policymakers have chosen not to spend the 3G windfall. Just recently, the government sought the approval of the parliament for an additional expenditure to the tune of Rs 450 bn, involving a cash outlay of Rs 198 bn. What is worrying is not that the Government has chosen to spend more. It is the fact that it has again decided to do all the wrong expenditure. As per reports, the higher expenditure will go towards subsidies for fuel, food and fertilisers. We believe that in view of the 3G windfall, the Government had an excellent opportunity to do something about the long term productivity of the economy. Instead, it has chosen to spend a significant chunk towards wasteful expenditure. Looks like another opportunity has gone down the drain.

PSU majors Coal India and Power Grid have recently seen much success with their IPO and FPO respectively. While the former raised almost US$ 3.5 bn, the latter ended up with around US$ 1.7 bn. These are big sums in the Indian context, and the success of these issues suggests that foreign and domestic investors are willing to put large money at stake for a pie of India's growing companies. Talking about foreign investors, a leading business daily reports that these public issues have also attracted a lot of money from sovereign wealth funds. These funds are increasingly allocating bigger sums to emerging market assets given that the western world had a dearth of such opportunities. While the long term intent of these funds is still doubtful, given the way foreign investors have behaved in the past, the short term intent is definitely to get higher returns on their investments using loads of money that has been created by the quantitative easing in the west and rising oil prices in the Middle-East.

The turn in fortunes of the IT industry is visible in their recruitment plans. Boosted by stronger growth, the industry is slated to be one of the biggest hirers this year. Recruitment plans of IT majors Infosys, TCS and Wipro indicate that amongst the three, they would be hiring nearly one lakh fresh engineers this year. Other IT companies plan to follow suit. This is definitely heartening news for engineering graduates.

However, we are not too sure of the fallout of such large recruitment on the IT companies. Such recruiting plans would lead to a huge workforce. Managing this workforce is not without challenges. Maintaining high utilization levels is just one of them. Another is the problem of high attrition rates, which is only going to get further intensified with rising numbers. Moreover, a larger workforce would also mean a larger wage bill. While expansion for growth is necessary, we just hope that these companies are not expanding their employee numbers just for the sake of expansion and are keeping in mind the consequences of the same.

A GDP of US $14.6 trillion. National debt of US $13.7 trillion. The US has the world's highest GDP. But, it is almost completely backed by debt. Despite this fact, it has an 'AAA' rating by Moody's. This is the highest credit rating given by the agency and signifies 'minimal credit risk'. The US needs to soon start following measures to reduce its debt spiral, else it will lose its AAA sovereign rating. According to Moody's, implementing a plan from Obama's commission on reducing the federal deficit will help safeguard its credit standing. This commission proposed a US$ 3.8 trillion plan to reduce the deficit. The plan includes cutting down Social Security and Medicare costs. It also plans on reducing income tax rates, increasing gasoline taxes and eliminating tax breaks, among others. These measures will help reduce the annual deficit from US $1.3 trillion now to a manageable level of US $400 bn by 2015. However, not surprisingly, this stringent plan was met with strong opposition in Congress. It will be an extremely uphill task for the commission to come up with a plan to reduce the federal deficit and keep everyone happy.

Food inflation is not a cause of worry only in India. Even China is witnessing similar concerns. The CPI in China has risen at its fastest pace over the last two years, predominantly led by the food items. These make up about a third of the Chinese index. However, the Chinese government has pulled up its socks and has outlined efforts to tame rising food prices. Some of them include price controls and subsidies for shoppers. It even intends to impose penalty on people found speculating on essential food items. Nonetheless, unlike the past, the main cause for inflation this time around is not a supply side issue. Money growth is the primary culprit here. And the loose monetary policy followed by the western world is not helping the Chinese either. Although China has a comprehensive system of capital controls it seems that the government needs to tighten its strings so as to avoid any speculative inflows.

After hovering close to the dotted line for most part of the early session, Indian markets nosedived into the negative territory in the final hours of trade. Led by weakness in commodity and financial companies, the BSE-Sensex was trading 402 points lower at the time of writing this. The BSE midcap and smallcap indices were down 1.9% and 2.7% respectively. Select telecom stocks, however, managed to remain in favour. Most other Asian markets too closed in the red. The European markets have opened on a cautious note.

 Today's investing mantra
"If you're an investor, you're looking on what the asset is going to do, if you're a speculator, you're commonly focusing on what the price of the object is going to do, and that's not our game." - Warren Buffett

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