The job may get easier for long term investors! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

The job may get easier for long term investors! 

A  A  A
In this issue:
» Fraud cases rising in PSU banks
» India fails to safeguard its intellectual property
» Mr. Paulson warns against another crisis
» Tougher times for China ahead?
» ...and more!

What are the most important non-financial filters that you as an investor use to screen stocks? Corporate Governance or management quality is perhaps the first response to this question. A lot of people base investing decisions on the quality of management. And more often than not, it gets defined by two three people at the top such as Managing Director (MD), CEO, CFO etc. Now imagine a scenario where one fine day you get to know that there has been a sudden change in the management or the MD/CEO will no longer be associated with the company you have invested in. What will be your immediate reaction? Panic, confusion and may be sell off. The event is likely to shake your confidence to some extent.

Last week, the shares of Tata Motors slumped by around 6.7% post the sudden death of its Managing Director Mr. Karl Slym. The decline can be attributed to concerns about the company's operations once the leader was out of the scene. The position will eventually be taken by someone. However, one can not rule out some chaos in the meanwhile. Also, whether the replacement is perfect and a good enough fit is something that time will tell. Until then, the business remains exposed to certain risks. Not to mention the opportunity costs.

This was just one instance. As per Indian Boards statistics, around 112 executive directors in 116 NSE companies have died since 2006. Around 50% of these were holding the post of Chairmen or MD at the time of death. It would indeed be an interesting exercise to see how share prices of these companies reacted to the news of sudden demise of the respective leaders.

Such events highlight the importance of succession planning. This is against a replacement that is common to most of the Indian companies in the present. The former shows preparedness and proactiveness of the management. The latter, just a hurried and unplanned reaction, unlikely to be in the favor of the business and investors.

It is unfortunate that so far there is no mechanism and regulation to take care of such events that have such strong influence on share price and stakeholders' interests. Barring multinationals and some large Indian firms, the practice is not in vogue in Indian companies. However, the good news is that this gap may get addressed soon.

As per an article in Economic Times, Securities Exchange Board of India (SEBI) is likely to make the succession planning for Board and senior management positions compulsory for all Indian listed companies .We believe that such a regulation will fill a huge lacuna in the existing corporate governance practices. An orderly and well thought succession plan will ensure that there is no chaos in the cases of death, exit or poor performance of an existing leader. Afterall, such events don't just result in sudden impact on stock prices, but are imperative in the long term for internal stakeholders such as employees and investors. Overall, the regulation will offer comfort with regards to financial performance, strategic direction, and productivity in the long term. Even beyond the tenure of existing manager.

SEBI has further proposed a periodical review of the process. It underscores the importance of having a plan that can adapt to the rapidly evolving demands on the leader. This will help firms identify potential successors for key positions and improve training and leadership development processes. It will further motivate deserving candidates and test well in time whether the new person will be a good fit with the existing culture and goals of the organization. Not to mention that this will instill faith in shareholders. In fact it will make the job of assessing management quality even easier for long term investors.

What are the corporate Governance practices missing in the Indian listed companies at present that need urgent attention of the regulator? Let us know your comments or share your views in the Equitymaster Club.

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01:20  Chart of the day
What if the person you have trusted your hard earned money with squanders it? This could be the worst nightmare for any depositor! Unfortunately, for depositors of some of the so-called top PSU banks in India, the nightmare has come to be true! Hindustan Times has published a shocking revelation about the kind of money lost by select PSU banks to frauds. The total amount stands at a steep Rs 230 bn. As seen in the chart, Indian Overseas Bank has lost the maximum amount of Rs 30 bn. However, others like SBI, Canara Bank, United Bank and UCO Bank also lost substantial amounts. An application via RTI has revealed the figure to the publication. Now, the RBI has made several attempts to ensure that banks report cases of fraud immediately to investigating agencies. However, it turns out that the top management of some of these banks were themselves involved in fraudulent sanctioning of loans. This shows a clear disregard of depositor trust and investor safety. Banks meanwhile allege that use of alternate channels of banking has led to rise in fraud rates. However, we do not think that can be taken as an excuse. In fact not just the depositors but also the shareholders of such banks should hold the management responsible for such a callous act.

PSU banks' losses in fraud cases (April 10 - September 13)

India in the current decade seems to have made many strides in innovation. But it still scores quite low when it comes to protection of intellectual property (IP). As per an article in Business Standard, the 2014 International IP index has awarded a percentage score of 23%. This is a fall from 25% that India scored in 2012. Nowhere has this issue been more prominent than in the pharma sector. Indeed, when the product patent law was introduced 2005, it was seen as a positive step towards patent protection in line with international standards. But the MNCs have not been happy since then. Patent revocations, continued use of compulsory licenses and weak enforcement mechanisms are some of the common complaints cited. For instance, compulsory licensing is adopted when there is an emergency and there is a shortage of the patented drug required. In such instances, the government can award a compulsory license to another player to produce more of the drug. This is even if the patent is still in force. This typically happens in case of emergencies such as epidemics. But the complaint against India is that the government has been awarding such licenses even when there is no emergency as such. Not just India, most of the BRIC countries face serious challenges when it comes to patent protection. Not surprisingly, the developed world scores very strongly on this front. Whether the scenario in India especially the pharma sector is likely to change anytime soon remains a big question mark.

With the stock markets doing well, it would be easy for one to think that the situation in US is improving. However, US Treasury Secretary Henry Paulson has a few words of caution. As per Mr. Paulson, the US is sowing seeds for another crisis. While the government may have been working to fix the financial markets, he is of the view that other aspects have not been addressed properly. One of which includes the mortgage market. According to him, the country needs to rethink the way it deals with such matters. He is also of the view that the bailed out 'too big to fail' mortgage finance majors - Freddie Mac and Fannie Mae need to be wound down, so as to curb the risks to tax payers; especially if another crisis situation were to arise. Whether the same will happen or not is a different story; considering that the two giants are paying huge dividends to the debt ridden government. In essence, Mr Paulson wants the private sector to take some of the housing market risk. As reported by the Business Insider, he prefers winding down of the two agencies to form the Federal Mortgage Insurance Corporation (FMIC), as per the suggestions made in a bill that was introduced in mid 2013. The FMIC would act as an insurance agent.

As the website reports, this is just one of the aspects that seem to be bothering Mr. Paulson. Shadow banking, money market funds and repo markets are some of the other areas of concern.

Last week, China announced its 4Q GDP figures. The growth came in at 7.7%, marginally lower than 7.8% witnessed in the same quarter previous year. With growth slowing down many believed that China is in for a soft landing. It is in a period where economic growth is high enough to avoid recession. However, as per an article in Business Insider, China is expected to witness a prolonged period of slow growth. In other words the period of soft landing may get extended. This is due to the reforms being planned to stabilize GDP growth rates and reduce China's dependence on outside investment. It is known fact that China's GDP is driven by external investment. With policy makers now shifting the focus to consumption from investment, the economic growth is likely to suffer for the next few years. Notwithstanding the near term growth concerns, the said move of policy makers to focus on consumption driven growth will lend stability to GDP figures. With growth not being at mercy of external investment it shall now resemble domestic demographics.

Clearly, the US Fed's decision to scale back its quantitative easing by another US$ 10 bn has made investors jittery. Even as we write this, markets across Asia have cracked. And given the sentiments, we won't be surprised if more pain follows in the coming days. This is therefore likely to test the mettle of investors. And most of them would certainly look around for some sound advice. The one we have has been borrowed from Warren Buffett. It is all about seeing equities from a different vantage point. All you have to do is ask yourself one simple question. Are you going to be a net buyer or seller of equities over the next five years? If it is the former than lower prices should make you happy. Simply because you can buy more shares at lower prices just as lower merchandise prices enable you to buy more merchandise. Of course the stocks you buy should be strong fundamentally and should have a strong chance of going up in the long run. Well, all of a sudden, this makes you see equities in a different light, isn't it? And you rejoice at lower prices rather than feel all nervous and jittery.

The Indian stock markets were trading below the dotted line. At the time of writing, the benchmark BSE Sensex was down by 235 points (1.1%). All sectoral indices were trading in the red with realty, metal and banking stocks being the biggest losers. Most of the Asian stock markets were also trading weak led by Japan and China.

04:50  Today's investing mantra
"I've found that when the market's going down and you buy funds wisely, at some point in the future you will be happy." - Peter Lynch
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1 Responses to "The job may get easier for long term investors!"

Dr Atul Tiwari

Jan 30, 2014

Idea is good only if-
Successors are nominated on the basis of their performence track record.
But remember that with exceptions of some companies like TATA's most of the successors are family relatives. In case of deaths most of the companies never promotes next man in que in thier own company istead they appint a new man working at same cader in some other company (Ghar ki Murgi Daal barabar).
Still this norm is also expected to change the seen.

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