Aam Investors beware of repeating the mistakes of 2008! - The 5 Minute WrapUp by Equitymaster
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Aam Investors beware of repeating the mistakes of 2008!

Feb 11, 2015

In this issue:
» Unfavourable regulations for PEs could hurt entrepreneurial trend
» Bribes paid by corporations take a totally different avatar
» Will this move promote better banking practices at PSU Banks?
» ...and more!

  Chart of the day
Indian stock markets have been on a dream run ever since the Modi Government rose to power. While initially the rally was driven more by FIIs, with sustained gains in the markets and hopes of reforms, the retail investors did not take too long to jump on the bandwagon. And guess who has benefitted from this renewed optimism and confidence. Well, it is none other than asset management firms. The stock market rally has literally led to a torrent of new mutual fund schemes. Much like IPOs and FPOs wanting to strike when the iron is hot, these firms too have not left any stone unturned while making the most of the positive sentiments. So much so that the rise in investments in such schemes is higher than even the net purchases by FIIs!

There seems to be a deluge of new fund offers as you can make out from the chart of the day. The number of new fund offers launched has been the highest in almost a decade. And the year on year rise, the steepest. Further, the funds raised by mutual funds under equity based schemes have seen the sharpest surge of 413% in a year in 2014. This exuberance we believe warrants some caution.

Mutual funds cashing in on positive sentiments in markets

Unfortunately, the impulse to be a part of the rally has made investors disregard the principle of asset diversification. As suggested in an article in Business Standard, other asset classes, such as gold, have taken a backseat amidst the stock market momentum.

With GDP numbers improving, inflation easing and fiscal deficit narrowing, nothing seems to be holding investors back. Not even factors like disappointing corporate earnings, a lack of any visible change at the ground level, banking sector risks, vulnerability to global macro economic risks and last but not the least, high valuations.

Let us refresh our memories here. The maximum addition in investor accounts in such schemes happened in the year 2007-2008. And that was followed by a Sensex crash, as the global markets including India woke up to the US Sub prime crisis. As far as such risks are concerned, we are still not insulated. In fact, the Indian stock markets seem to be more vulnerable and volatile than ever. The list of factors that can make hot money reverse the direction is huge, and exposes Indian investors to significant risks. Not to mention the risk from the fact that whatever little recovery is seen is more driven by favorable external factors such as plunge in oil prices, and stands on a slippery ground. While the markets are going up more on hopes and expectations, facts are being blatantly disregarded. In such times, while fund managers and distributors are likely to raise the sales pitch and cash in on positive sentiments, it is important for investors not to get lured and analyze value proposition in mutual funds' equity schemes.

Do you tend to get lured by the hype created by new fund offers by fund managers? Let us know your comments or share your views in the Equitymaster Club.

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There is yet another breed of investors that deserve attention. Bank credit has not made much of a head way in funding capacity expansion plans over the last few years. However, with over US$ 80 bn invested in more than 3,000 companies since 2004, private equity (PE) funds have emerged as an important source of capital. In fact the contribution of PE funding as a source of capital has been an important driver of entrepreneurship in India. A significant number of entrepreneurs funded by PE constitute the first generation ones. Those who started out without access to collateral based bank funding.

In addition, as we know, besides being an alternative to bank credit in the early stages, the PE funding can also complement bank credit at later stages. Even well established companies, wary of leverage, have sourced PE funding to strengthen equity capital and improve credit rating. However, as per Mint, the constantly changing regulatory scenario and income tax laws pose a huge risk to the trend. Now, the bilaterally agreed, negotiated agreement between the company and PE investors offers the latter some protection. If the sudden changes to the laws do not act in the interest of PE funds, we could see many of them offloading their stakes. Besides the fact that this trend could harm companies where PEs are invested in, it could also hurt the entrepreneurial trend. Since it may not be possible for banks and financial institutions to take that much risk on their books, the flow of primary capital to fresh entrepreneurs through PEs is necessary. And hence clear regulatory norms for such investments must be a priority for policy makers.

With political parties promising transparency, better governance etc, the least that investors are hoping for is a corruption free environment. But it turns out that the same is easier said than done in India. For companies, under the guise of speed money, are busy greasing the palms of those who matter. And the payments are disguised quite well so as to look completely genuine. Most payments go through a large web of unidentifiable shell companies. Moreover, the movement of funds can be so rapid that the best of forensic accountants find it difficult to trace!

Now such kind of insider information can be difficult to believe. But when it comes from none other than HDFC's Deepak Parekh, you have no choice to sit up and take notice. Mr Parekh has alleged that bribes paid by corporations have a totally different avatar. And for the government to get to the bottom of black money malaise, the distinction between legal and illegal transmission of funds abroad will have to be well defined. Until then, the biggest culprits will continue to get away. Investors on their part will need to remain wary of companies fetching big ticket resource allocations too soon. Also managements that have the slightest inclination to have opaque decision making should sound the red alert.

We have often highlighted the woes of the public sector banks. Lack of autonomy, poor management and risk control systems have led to piling up of NPAs at these banks. In fact, it would not be wrong to say that risks in the banking sector are one of the key threats that could derail the potential economic recovery.

However, it seems time has come when these banks will be held accountable for the inefficiencies. The Centre has announced that the banks' performance (based on return on equity and return on assets) will be a key criterion to determine if they deserve equity infusion. As per the rating agency ICRA, such screeners have made 13 out of 22 banks ineligible for equity infusion. This will have a grave implication on their growth and compliance with Basel III norms. The decision marks a significant shift from the complacent attitude with regards to performance and profiles of public sector banks. However, the poor performance of these banks is also because of the lack of autonomy in operations, a structural issue that Government needs to address. While the move may lead to some nervousness in the short term, it is likely to bring much needed consolidation and promote efficient banking practices in the long term.

The Indian stock markets were trading strong today on the back of sustained buying activity across most index heavyweights. The capital goods, banking and auto stocks featured amongst top gainers. At the time of writing, the BSE-Sensexwas trading up by around 226 points.

 Today's investing mantra
"Price is what you pay; value is what you get" - Warren Buffett

This edition of The 5 Minute WrapUp is authored by Richa Agarwal and Tanushree Banerjee.

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3 Responses to "Aam Investors beware of repeating the mistakes of 2008!"

Shrinivas Moghe

Feb 12, 2015

Yes, the temptation is huge. But still investing in leaders of different sector companies, is a relatively better option. Make in India funds also appear to be good in the long run. If crude prices starts moving up, the effect of it on share bazar, is a subject of worry. Hopefully, in the new budget, impetus to manufacturing sector and infrastructure sector is likely to keep the market buoyant.


sridhar m g

Feb 12, 2015

Fortunately, I started SIP in an equity mutual fund in Jan 2008 and still continuing to invest. This means, I have invested when the market was at the peak in 2008 and also at the bottom of market. Such a regular investment has not only protected my capital but also given decent returns (about 12-14% p.a.). I feel that the present IPOs are over valued, but if it is from a reputed AMC and a reputed fund manager, investors can go for SIP route. (However, I am not investing in these IPOs)

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Feb 11, 2015


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