»5 Minute Wrap Up by Equitymaster

On This Day - 28 MAY 2010
Why should investors pay for sales tricks?

In this issue:
» Why should mutual funds hide gifts to distributors?
» Swiss banks seek Indian black money, again
» Don't lend to the grasshopper
» Take away the tax break on debt
» ...and more!

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It is a basic lesson in economics that when you increase the price of a good, its demand should fall down. There are exceptions of course. But there is a particular example which Warren Buffett's partner Charles Munger likes to highlight. Increase the price and with the additional money, bribe the purchasing officer. Higher prices will thus lead to higher volumes.

As per a leading business daily, SEBI wants mutual fund houses to not include promotional expenses, such as those on foreign trips and gifts to distributors, in the expense ratio. This ratio should normally include fees paid to fund managers, advertising, legal, record-keeping and accounting costs, custodial charges and taxes. The regulator believes many costs are disguised as advertising and promotional expenses when actually they are paid to distributors for pushing sales.

In our view, SEBI is justified in taking this step. The money that investors put in mutual funds should go towards actual investments. True, there are administrative costs that fund houses cannot wish away. But when fund houses actually use the investors' money to get more investors, the least they can do is be honest about it. Yes, even the money you pay for a cold drink in the hot summer goes mostly towards pushing you to buy some more (advertising). But at least you get to see your favourite movie star or cricketer in the television commercial!

 Chart of the day

Source: RBI

Hardly anyone would contest the fact that infrastructure is the Indian economy's biggest stumbling block. Indeed, India must show a greater sense of urgency in building power plants, transmission and distribution networks, road, ports etc. A great deal of engineering and project management talent is required. What is also required is money. Thankfully, that does not seem to be a problem. As the chart of the day shows, the flow of bank credit to infrastructure has risen steadily over the years. In fact, the amount of credit flow in the 9 months of FY10 matched that of the full year FY09. This is particularly important considering that there has been a steep decline in total industrial credit during the same period.

What would be a dream come true for a bank? How about getting all its deposits free of cost? A dream come true it may not be, but it certainly is a very profitable proposition. Thus, it comes as no surprise when such a bank goes all out to woo its depositors. And this is exactly what seems to be happening with the world famous Swiss banks and their Indian clients. As per a daily, the famously secretive Swiss private banks, who pay little or no interest but are known for their ease of operations, are trying to persuade Indians to bring back the money they have pulled out from their numbered accounts. And given the benefits it brings to them, the Indian clients seem quite keen in obliging them.

It should be noted that for fear of government crackdown, many Indians had opted to pull out their illegal wealth from Swiss banks and put them in places like Dubai and Singapore. However, the lure of Swiss banking is proving to be too hard to resist. And thus, some of the account holders have moved back money to Swiss banks. But there is one catch here. The money may not have come into a secretive account. But instead, it could be a corporate deposit. After all, the fear of government crackdown still looms large. Having said that, given the lax income tax laws, we don't think anything worthwhile can be achieved by the government on this front. What do you think? Let us know your views.

In recent times, regulators, analysts and investors have all been up in arms against too much debt. The reason obviously lies in the multiple crises that overleveraging has created. Debt is considered a cheaper source of funding as compared to equity. Particularly because the interest cost on debt is tax deductible. While the dividends paid on equities are not. And probably this is the prime reason why managements more often resort to leverage. An interesting article that we came across in Financial Times suggests that if regulators wish to do away with the excess debt problem this anomaly needs to be sorted out. The article goes on to suggest that this prescription needs to be considered more seriously. For those who benefit from debt will lobby against such proposal. But doing away with a malady that threatens the stability of economies is in the interests of the financial community as a whole.

Gold continues to be the cynosure of investors' eyes. Now even big money managers are lapping up the yellow metal. They are doing this by way of gold-linked equities and exchange-traded funds (ETFs). Interestingly, the rising exposure to gold is taking place despite the extreme volatility in its prices. The flight to gold is a clear reflection of investors' concerns about the potential for paper currencies to depreciate going forward. This is because central banks worldwide are following extremely loose monetary policies to spur a global economic recovery.

An interesting analogy caught our eye this morning. We all have been brought up on a healthy dose of the 'ant and the grasshopper' story as kids in school. The story ends quite vividly. Winter comes, and the ants thrive on the resources they have worked hard to collect all summer. The grasshopper, for all his frolicking during that time, dies a sad death as winter intensifies and he has no food to bank on. Something uncannily similar is happening in the world today. But with one big difference. The ending may not be so similar after all. The ants are the Germans, Chinese and Japanese. The grasshoppers on the other hand are American, British, Greek, Irish and Spanish.

The ants have been producing enticing goods that grasshoppers want to buy. What the ants have been getting in return for selling their wares has been mostly been grasshopper debt. Promises that the grasshoppers will pay back in future their debts to the ants. But as the ants have realised, a consumption binge based on leverage can go on for a while. But not forever. The day of reckoning has now arrived. And the grasshoppers have nothing to pay the ants. So some of them print more money (Americans), and some try to convert to ants by slashing their fiscal deficits (Greeks). The former then end up paying back the ants with a currency of lower value. The latter leads to huge write offs as some grasshoppers die in the process. Either ways, the ants have turned out to be the losers. The new moral of the story? Do not lend to grasshoppers!

Meanwhile, the Indian stock market witnessed a positive trading session today after a firm start. At the time of writing, the BSE Sensex was up by about 160 points. Metal and realty indices led the pack of gainers. However, banking stocks bore the brunt of selling activity. The other major Asian indices ended in the green, while Europe has also opened in the green.

 Today's investing mantra
"A pin lies in wait for every bubble. And when the two eventually meet, a new wave of investors learns some very old lessons: First, many in Wall Street - a community in which quality control is not prized - will sell investors anything they will buy. Second, speculation is most dangerous when it looks easiest." - Warren Buffett

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