Why 'high returns' can be very risky... - The 5 Minute WrapUp by Equitymaster
Investing in India - 5 Minute WrapUp by Equitymaster

Why 'high returns' can be very risky... 

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In this issue:
» No let up in consumer prices in India
» Will the plan to revive Japanese economy work?
» China's state owned enterprises have a problem
» Getting new bank licenses will not be easy
» ...and more!

It is sad that a country like India which has good growth potential continues to be associated with corruption, scams and scandals. The incidence of scams has certainly increased in the past few years. It may be noted that the actual number of scams has actually increased. Or it feels that way because of extensive media coverage that was hitherto never there. But whatever be the case, the trend is certainly alarming.

So far big ticket scams such as the Satyam fraud and the 2G spectrum scandal have dominated headlines because of the mind boggling sums of money in question. But that is just the tip of the iceberg. Scams of all sorts and sizes seem to be taking place all over the country. The latest one that has come to light is the chit fund scam perpetrated by the Saradha Group and its MD Mr Sudipto Sen. Duping small investors with the lure of attractive returns, the chit fund scam has all the makings of a classic Ponzi scheme. The Group promised abnormally high returns to investors, which were only paid from the deposits from other investors. No tangible asset base was ever created. What makes the whole affair even murkier is the nexus with politicians in West Bengal and the fund collection agents being offered high commissions. And once again small investors have been at the receiving end as their money just vanished into thin air.

Cheating people of their hard earned money is certainly a serious offense and the perpetrators have to be punished for the crime they have committed. The Securities and Exchange Board of India (SEBI), on its part, has so far been doing a good job in protecting the interest of investors, but it needs to step up the ante.

But for investors 'Caveat Emptor' (Buyer Beware) cannot be emphasized enough. As investors we must be careful about investing our hard owned money and not be driven by greed. We believe that the path to 'high returns in a short span of time' is a slippery one. Good investing involves a lot of work and can be highly rewarding if one does the homework well. More importantly good returns require patience and cannot be earned overnight. Besides some basic groundwork, it is important to question relationship managers or fund agents consistently on the schemes that are being offered. Any scheme offering abnormal returns needs to be looked into further to determine how the scheme intends to do so. Remember, at the end of the day, no scamster can cheat any investor if the latter takes all precautions necessary in not getting duped.

Do you think that punishing the perpetrators of the chit fund scam will ensure that more such scams do not take place? Please share your comments or post them on our Facebook page / Google+ page

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01:26  Chart of the day
That the global economy has been slowing is a well accepted fact. It thus follows that in such times, prices should also head southwards. It certainly seems to be happening in China. The Chinese GDP has slowed as a result of which consumer prices have also come down. But quite worryingly India has not followed this trend. As today's chart of the day shows, consumer prices in India continue to hover in double digits. And this has made the job for the Reserve Bank of India (RBI) harder as it does not have much headroom to cut rates when consumer inflation is high. India's problems are quite structural. It is not that food is not plenty. There are just too many supply bottlenecks in the form of inadequate storage and warehousing facilities and lack of adequate investment in agriculture. Only when the government decides to pull up its socks on this front, can we not worry about high consumer prices remaining a permanent fixture on India's economic landscape.

Data Source: The Economist

The initial excitement over new bank licenses has fizzled out. After all these are no longer perceived the golden tickets to prosperity as they once were. The RBI, for one, has not minced words about its reservations in offering licenses to those who do not deserve. Secondly, the bank licenses will come with several riders. The entities that receive the licenses will have to meet PSL (priority sector lending) norms. PSL loans, given their risky nature are seen as a cost burden due to the provision requirement. Plus 25% of the bank's branches have to be opened in unbanked sectors. Currently, a large number of non-banking finance companies have less than 10% presence in rural areas. Even banking licence aspirants like L&T Finance, Mahindra & Mahindra Financial Services, Shriram Transport Finance and LIC Housing Finance have few branches in far-flung areas. That too despite the fact that their businesses service rural customers. Many of these players have rural touch points (one business correspondent) as against a branch in the rural areas. Hence having 25% branches in rural areas has severe cost and profitability implications. Thus there is little doubt that it will take quite some time for the new bank branches to see the light of the day.

Well, we just discussed yesterday about Japan's massive money printing program and how investment banks have been the biggest beneficiaries of it. Here are some more updates on the Japanese monetary policy and the economy at large.

In its monetary policy meet yesterday, the Bank of Japan (BOJ) released its inflation and GDP forecasts. The Japanese central bank expects to achieve its 2% inflation target by fiscal 2015. On the GDP front, it expects the economy to recover moderately by mid-2013. Thereafter, it expects the economy to be a bit affected on account of two scheduled consumption tax hikes. But later again, it expects the economy to continue growing at a "pace above its potential".

Does it not sound like a fresh MBA student making a hunky-dory presentation? All the rosy forecasts that the Japanese central bank has made come tied with several assumptions. And most of them hardly seem realistic. For instance, the very first assumption is that global financial markets remain stable. It expects economies such as China and the US to pick up moderately. Secondly, it expects that its massive dose of liquidity (US$ 1.4 trillion) will stimulate demand and prop up the economy.

There are several other assumptions. But let's just take these two for the time being. Are they by any measure realistic? We don't think so. This means that the entire plan to revive the Japanese economy is built on a house of cards. Any negative shocks in the global economy would spell doom for Japan.

After the recent correction in gold prices, the yellow metal has registered a sharp rally over the last few days. But the question is whether the rally was just attributable to fall in prices and will subside soon. Or does it really have the legs from here on? Well, in order to answer that question first we need to understand why the gold prices corrected so that we know if the new price adequately reflects the underlying economics or not. Then we can have a look at the reasons whether the rally has legs or not.

It is believed that the prices corrected as Cyprus was about to sell its reserves. Some attributed the fall to exchange traded funds' (ETF) redemption. Now, whatever the case for correction, once it happened people started queuing up to buy the metal. The reason being, correction was deemed as an attractive buying opportunity. In short, faith in the metal was intact. As such, the demand dynamics were in place.

Now, let us have a look at the reasons which makes the case of a further rally even stronger. First, central banks across the world are buying gold. In fact, for some countries like Columbia and South Africa the addition in gold reserves has hit a 50 year high. Most gold importing banks in India are also out of stock. Thus, they are likely to import which will further support prices. Lastly, in this uncertain environment where paper currencies are losing faith and equities are losing sheen due to recessionary environment gold seems to be the best investment bet. All these factors make a strong case for a continued bull rally and having a small proportion of the metal in your portfolio.

China has owed a large part of its stupendous growth to exports. But what has made the country's exports so competitive in the global markets? The answer is lower input costs. One way in which the country has been able to keep input costs at check is by offering subsidies. This is the finding of a recent study carried out in a book the results of which were carried by the Economist. The book that has been co-authored by Usha and George Haley has calculated that the Chinese government offered subsidies to the extent of US$ 300 bn between 1985 to 2005. And this is just to the state owned enterprises (SOEs). The subsidies were given in the form of cheap capital and low cost inputs. These subsidies made behemoths of the SOEs. At the same time the managers of these SOEs were encouraged to pursue other goals. The other goals included things like resource acquisition, foreign policies, etc. So these managers ended up becoming all too powerful as well.

As a result China now has a major problem. It has large SOEs that are unproductive and unaccountable. And these are managed by people who hold important political positions and are resistant to change. What could the implications of such large behemoths be for an economy like China that is desperate to jumpstart its growth again? Well the answer to this is something no one can predict. But one thing is clear, if China wants to get back to its growth trajectory, it needs to make many major changes. One of them includes making its industries and companies more productive and accountable. Just giving subsidies to them does not help.

Most of the global stock markets witnessed a week of gains except China (down by 0.9%). In the US, higher corporate earnings brought cheers to the investors. On the economic front too, there was good news in the form of lower jobless claims. The jobless claims reduced by 16,000 last week. However, towards the end of the week the Department of Commerce reported that first quarter gross domestic product increased just 2.5%, lower than the expected 3%, causing some concerns to the investors.

Among the other stock markets, China (down by 0.9%) was the only exception to the list of gainers. France and Japan (up by 5% each) were the top gainers.

The Indian stock markets ended the week in the green, up by 1.4%. The earnings season provided boost to the stock markets along with the hope of an interest rate cut by the Reserve Bank of India (RBI) soon.

Source: Yahoo finance, Equitymaster

04:56  Weekend investing mantra
"You get recessions, you have stock market declines. If you don't understand that's going to happen, then you're not ready, you won't do well in the markets." - Peter Lynch
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9 Responses to "Why 'high returns' can be very risky..."


Apr 30, 2013

It is not right to put the blame on Government, There is constant research going in the minds of some people as how to make fast money, legal or illegal. Politicians are also doing the same thing and they get acquitted legally rest get caught or are made scapegoat by the politicians. Unfortunately we appoint only such politicians. Today even banks are not safe. So it is people who must pay for all mess.


m ram mohan rao

Apr 29, 2013

people who invest in ponzy schemes are not investors. they are either gamblers or illiterates. its a tragedy that in spite of many failures govt has done little to prevent such thugs to swindle people.apart from better regulation what is needed is speedy justice. Bearings case was quickly decided. but in india harshad mehtas case dragged on and he died. ketan parikh is still a free man.



Apr 29, 2013

Its not the runner who is responsible alone as its tendency of speculating, gambling lies with human and its not India but many developed nation accepted this now what could be done is only educate Investor so only person who came to try his luck knowing all will confront the up comings against his greed instead of a novice and if it is about punishing runner it could mitigate the problem but it will be there a midst of all in some different shape and route.
Conclusively parallel action is required punish the cheater but educate the tyro investor


parimal shah

Apr 29, 2013

Not only should the scamsters and fraudsters be punished but should be punished real fast - speed is the essence.
The laws are good but implementation is pathetic (due to various tricks politicians and those in power and with connections use as delaying tactics, as also willful acts of commission and omission.


Dr.P P Shastry

Apr 28, 2013

Awareness and Education is the key to avoid such scams. Lack of investor education and impatience -to become rich overnight are the factors that encourage the scamsters. Till these factors are addressed, scams will be a recurring phenomenon.


Suresh Kabra

Apr 28, 2013

I have been educating and advising my maid not to invest in Chit Fund. I and my wife also explained about the said scam and many such scams. But she won't listen and emphasize that nothing wrong will come to her. We have very large population of such people.
Wrongdoers must definitely be punished but this will not get victims their money. At most, the Govt will allot few thousand crores to help victims of the chit fund and win few votes. It is another case that most of such funds won't reach actual victims. But, allocation of such fund implies that reimbursement is made by tax-payers and not by politicians from their pocket or their party fund. Why are we tax-payers being punished for no fault of ours.
I am of the firm view that such nonviable schemes be banned and all individuals investing in such schemes also be held responsible and be told not to expect any help or sympathy.


vikas sivaraman

Apr 28, 2013

Yes. Indians respond very well to carrot and stick philosophy . Reward well and punish hard is the way to go!


Ajay Gupta

Apr 27, 2013

It is very easy to say that the investor should exercise caution while putting his hard eardned money in any scheme.
Why should such advisors forget that such fradulent schemes are citing various approvals and the regulatory agencies/ bodies fail to nip such companies in the bud. Why shall such inaction not be punished. An ordinary investor is not equipped to understand the nitty gritties of the schemes and it is the duty of regulating

authority to ensure that any organisation or scheme that is violative of norms is not allowed to continue.
The step to levy additional to partly compensate the sufferers is also a blow to the general public who is to shell out money for the misdeeds of someone else, who has enjoyed and squandered the money.


Jeevan Shetty

Apr 27, 2013

This story is not new. There are several such stories in all kinds of business, where smart operators who call themselves businessmen collect huge sums of money from retail investors and then dupe them. The main reason for this is the so called businessmen are exploiting the lax laws, corrupt system, corrupt bureaucracy and politicians. They are confident of getting away even if they are cought. The news papers and media are busy writing and talking about such events for the last several years.
'Caveat Emptor' (buyer beware) rule should not be an argument, as often retail investors are fooled by the high pitch media blitz where leading personalities participate and render semblance of trust.
The persons associating with such fraud to promote such business for consideration of money or power should also be held responsible and punished under the law.
The control the problem of cheating public by collecting money, a simple law whereby any person/organization public or private set for business or charity, who collect more than rupees ten crores, should compulsorily submit themselves to SEBI scrutiny at regular intervals. No information should be withheld from such scrutiny. The role of third party auditors in business has become just ceremonial. It is not serving to protect individual share holder interest. Auditors must be held accountable when such fraud takes place. They must conduct audit to verify that business is conducted within the laws of land. It should be obligatory for auditors to report to SEBI any irregularities they observe.
Business associations are not keep to push for such law. They are supported by other vested interests as elaborated. So the game goes on. In the current social setup, any mitigation seems to be unlikely.

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