Rs 1.6 lakh crore scam you've not heard of! - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Rs 1.6 lakh crore scam you've not heard of! 

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In this issue:
» Can gold go up another 5-fold?
» Indian currency undervalued by more than 60%, says this index
» Grantham believes most global assets to be overpriced
» US shale boom in danger of turning into a bust
» ...and more!

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It won't be an understatement to say that India is hugely underinsured. As a result it came as a shocker to us that the first-year premiums dropped nearly 10% in FY12 when on the contrary, they should be recording strong growth rates. An article in a leading business daily has perhaps an answer to this anomaly. And this anomaly is nothing but a simple four letter word, ULIP (Unit Linked Insurance Plan). Clearly, no other product has caused as much damage to investor confidence in markets as ULIPs we believe. Launched right at the cusp of the de-regulation of the insurance industry, ULIPs highlight everything that is wrong with the industry in India.

Being an insurance product, one would expect ULIPs to have a higher insurance component in it. But that didn't seem to be the case. Instead, ULIPs were blatantly sold as some sort of a get-rich-quick scheme where the money was invested mostly in equities and debt. Insurance was only a very small part of it. To make matters worse, rules allowed companies to push most of the commissions that would otherwise accrue over the entire life cycle of the product towards the first year itself. And if this was not enough, many other fees and penalties were levied that really broke the back of the policy holder.

The consequence of all this was that a product where the agents promised to double the money in three years, in fact ended up wiping out even the premiums that the policyholders had paid towards the policy in the initial years. Needless to say that insurance is a very long term commitment. Thus, the connivance of companies, sales channels and agents towards promising very high returns in a short span of time is in itself an act of gross mis-selling.

That all of this happened right under the nose of regulatory agencies is indeed shocking. Of course, we could draw some solace from the fact that they finally woke up about a couple of years back and changed most of the toxic rules around the product. But what about the huge loss of 1.6 lakh crores that, as per estimates by LiveMint, the policyholders have incurred by way of most of their premiums having wiped out. In fact, even these numbers could be fairly conservative. Sadly, they may have no other option but to bid good bye to this huge quantum of money. But the biggest loser in all this is the Indian capital market we believe. And as long as scams like these keep happening, gold and real estate will continue to be preferred mode of investing. And we will have to live with the embarrassment of being a capital starved country despite having a rich tradition of saving.

Do you think scams like these keep people away from committing investments to financial markets? Share your comments or post them on our Facebook page / Google+ page

01:28  Chart of the day
By how much do you think the Indian currency is undervalued vis-a-vis the US dollar? 10% may be. Or about 20% maximum. What if we tell you that as per a popular metric, the undervaluation is as high as around 60%? Hard to believe, isn't it? But that's what the Big Mac index seems to be indicating. In fact, as per the index, India has the most undervalued currency amongst the major economies of the world. The index, that forms its exchange rate based on the price of a standard McDonald burger in each country, is of the view that an exchange rate of Rs 20.4 to the dollar will buy you the same burger in US that you buy in India. Of course, this exchange rate cannot be fully relied upon but what is also true is that on purchasing power parity basis, India does punch above its weight in the economic pecking order.

Source: The Economist

Where do you think gold prices are headed? Do you think gold prices could reach anywhere between US$ 3,000 and US$ 10,000 over the long term? A certain gentleman who answers to the name of James Rickards certainly believes so. He has an interesting explanation to substantiate his belief. As per him, the global monetary system is heading towards disaster. The so-called 'currency wars' started in 2010 as the US central bank went on a money printing binge. This has had a ripple effect across central banks. So as to retain their export competitiveness, several other countries such as Japan, Switzerland and Brazil also followed suit.

Simple economics tells us that too much money eventually causes high inflation. This, in turn, could cause the international monetary system to collapse. If this indeed happens, gold prices could shoot up phenomenally. Of course, this will not happen all of a sudden. As such, we suggest investors to invest about 10-15% of their investment portfolio in gold. This will act as a solid hedge against high inflation that could erode your purchasing power.

It is one thing to have resources; quite another to be able to put them to intended use. Much has been said and written about the US oil production boom unlocked by advances in shale drilling technologies. But this euphoria could be misplaced. While prominent energy agencies in US paint an optimistic scenario for oil production, the ground realities suggest a different picture. The newly unveiled supplies are being restricted by logistical and policy issues, thus limiting their benefits to all.

At the core of the issue is a serious disconnect between the price of newly unleashed crude supplies and retail product prices in US. The US crude oil trades at a deep discount to the global benchmarks because of the transportation and logistic bottlenecks during the journey from oil wells to refineries. However, these benefits are hardly extended to American end users. This is because the pricing of US retail products follows the trends in the global markets and are less governed by demand supply dynamics in the region itself.

Another issue is stiff restriction on export of the US crude. While US refiners have adapted by exporting refined products instead, there is a limit to the amount of new supplies that US oil refineries can absorb. This is because they are not that well geared to process the grade particular of newer supplies. In the wake of limited growth in US refining capacity, the trend could nip the oil boom in the bud. We just hope that right policies are framed soon to avoid these new supplies becoming economic unviable.

Legendary investor Warren Buffett may well have fallen short of following the adage 'Practice what you preach'. Indeed, Buffett is renowned for the investment gems that he doles out annually in the Berkshire Hathaway annual reports. One such was the importance of sticking within one's circle of competence. This means that investors should invest only in those businesses that they understand and stay away from those that they do not. But it now seems that he may have forgotten his own advice. And this has become apparent with none other than his investment in the credit ratings agency Moody's.

A few years ago, Buffett admitted in a Congressional hearing that he didn't know much about credit rating agency Moody's or the credit ratings market in general. Yet, as of September 30, 2012, Berskhire owns 13% stake in it. And the value of this investment has plunged. Berkshire is likely to have lost around US$ 291 m on the same. It is no secret that credit rating agencies have come under fire for their role in the run up to the global financial crisis. Moody's rival S&P in particular is being investigated for allegedly inflating its mortgage bond ratings. Moody's may not necessarily face the same problem. But we wonder why Buffett would choose to invest in a sector which is notorious for problems relating to conflict of interest.

That cheap liquidity is chasing scarce assets across the world is well known. Very likely that the excess liquidity will keep sloshing around global financial markets much longer. Meanwhile it will not only stoke risk appetite but also create asset bubbles. One may be tempted to take such a predication with a pinch of salt. But we are not sure if you can do so if the prediction comes from none other than Jeremy Grantham. The same gentleman who is credited for his bearish call on US stocks in 2000.

Not just that. He has been a long-time critic of both Federal Reserve Chairman Ben Bernanke and his predecessor Alan Greenspan. Quite understandably, given the cheap money obsession of both central bankers. But what worries us most is his latest quarterly update. Here Mr Grantham has not minced words in calling all global assets overpriced. He goes on to clarify that both stable and bad businesses are equally overpriced. We believe that investors should take cues from his comments and take a hard look at asset valuations.

Meanwhile, indices in the Indian equity markets have traded weak today with the BSE Sensex lower by around 46 points at the time of writing. Stocks from consumer durables and capital goods space are facing the maximum selling pressure. While most Asian stock markets closed lower today, Europe is trading mostly in the positive currently.

04:53  Today's investing mantra
"Growth benefits investors only when the business in point can invest at incremental returns that are enticing - in other words, only when each dollar used to finance the growth creates over a dollar of long-term market value." - Warren Buffett

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    27 Responses to "Rs 1.6 lakh crore scam you've not heard of!"

    Sudhindra Bhaumik

    Feb 18, 2013

    I have been subscribing Rs.30000/= annually for last 3 years
    on ICICI Prudential product and the present value of which is around Rs.89000/=(less than the amount invested Rs.90000/=).Last year when they approached me for the annual subscription I refused to pay because the there was a huge loss on my investment.But they said that if I do not pay the third year premium the surrender value of the policy will be very meagre (around 50 to 60 per cent of the total subscription). I do not know why our Govt. is allowing financial institutions to openly indulge in this kind of fraud and swindle away our hard earned money.

    Like (1)

    P K Garg

    Feb 16, 2013

    Your analysis is quite correct. Agents for most of such Insurance products falsely promised large returns. Even now, some of the agents try to mislead the public through false promises of bonus, etc. and then issue a new policy. Some such cases were reported to the concerned Insurance companies, but no action appears to have been taken against such agents.

    Like (1)


    Feb 16, 2013

    A much bigger one is on it's way - Banks owned by industrial houses - these will take retail deposits and "invest" it in their projects (scams?) which are unable to raise money in institutional markets because of quality or risk issues. That bankers will turn brokers, that the government is not only allowing, but pushing for this shows liberalization in India means ponzi schemes and loot of other's money. Be careful

    Like (1)


    Feb 12, 2013

    While those who have been trapped understand the truth , there are still many who get lured in by investment products from Insurance Co. There is no ethics in this business. All players do all kinds of dirty tricks to get subscription. with all apologies, I have also noticed, young good looking house wives are deliberately encouraged to do the selling. ICICI and HDFC etc also leak customer account information to the agents who approach unsuspecting investors. With commission disappearing in regular MFs, all the efforts of socalled brokers and their sub agents to convince investors to subscribe to ULIPs as a equity product and not an an insurance product. IRDA is a confused lot

    Like (2)

    J S Brar

    Feb 10, 2013

    ULIPs are the biggest fraud on the investors.

    Like (1)

    Ram Gidvani

    Feb 9, 2013

    So very true

    Like (1)

    Prashant Parashar

    Feb 8, 2013

    IRDA is solely responsible for allowing this right under its nose. Agree that the insurers should not have resorted to such mis-selling, over incentivising the advisor and sales channel, but why did IRDA approved such incentive structure. Insurance in India was not new, Private insurance company was a new thing. IRDA has made a mockery of its watchdog and regulatory role.

    Like (1)

    Archie Sequeira

    Feb 8, 2013

    So true. It is amazing that such scams & swindles are allowed by regulatory authorities. Hardly any regulation & control. It is one thing that they woke up of late and have introduced some new rules. But I strongly feel that the Fund Managers/Companies should be mandated to redress & recompense for loss occasioned by unconscionable appropriation of premiums. I know of a scheme by a well known Pvt Insurer under which the entire first year's contribution of Rs 5 lakhs has been appropriated towards premium on an insured value of Rs 25 lakhs !! The fund value after 3yeras is well below principal value. How could be this be allowed? The customer should have the option to cancel the policy upon adjustment of nominal premium for the expired period & claim refund of contributions made with interest.- A remedy for misselling/misrepresentation [with intent to deceive] has to be available.

    Like (1)


    Feb 8, 2013

    Two things I learned from the ULIP experience:

    1. Never trust your Investment Adviser who in reality is only a broker.
    2. I now shun all insurance products.

    While on this subject my personal experience is that Ins. Cos. in India try every thing possible to deny or reduce your claim except where the person dealing with the matter sees some benefit for himself.

    Like (2)

    Ashok P Wadhwa

    Feb 8, 2013

    After 1993 I never invested in ULIP, UTI Mutual Fund because of Fraud like these

    Like (1)
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