The horrible year has passed, ushering in a new one with fresh hopes and expectations. At the White House President Obama takes over from George Bush, an event that is eagerly awaited. Back home, in J&K, the electorate has strongly participated in democracy with a high voter turnout, rejecting separatists and voting in a young, moderate and erudite leader, Omar Abdullah, as the next CM. Oil prices have fallen 75%, bringing down global inflation. But before we analyse likely market movements in the new year we must reflect on events in the year gone by and draw lessons from it.
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First, mutual funds. The mutual fund industry has grown, and is now larger than the banking industry, by virtue of a marketing, rather than a performance, success. More than half the mutual funds underperform the index. Mutual funds are marketed as 'open ended' funds, allowing anytime exit at NAV (somewhat like ATMs); the closed ended funds find little favour. There is thus huge pressure on fund managers for short term performance, for fear his investors would exit. This pressure translates into pressure on corporate managers to better short term, or quarterly, performance, which is at the root of most of the current problems.
Investors must also know that fund managers do not make exit decisions; even if they felt that, at 21,000 the sensex was too high, they would not exit. They claim, as justification, that the 'asset allocation' decision is made by the investor and not by him. This is patently unfair, judging by the fact that when he wants the investors' money, he claims to be better equipped than an individual investor for selection of stocks. That better qualification vanishes when it is exit time. I suspect the 'd' to be silent in fund manager.
The lesson for mutual funds investors is managers do not get you out in time; you are on your own. The lesson for SEBI is that it should discourage open ended funds and encourage closed ended ones and that it should give a higher limit for cash holding for equity mutual funds, which brings out differences in performance. The current system is like giving champion filly Snowhite, Yokozuna for a jockey!
Second, corporate governance. It is the pressure for short term results, imposed on fund managers, which they pass on to corporate management, that has led to the global financial crisis. Corporate management themselves succumb to such pressures, simply because institutional holding is now at over 80% of corporate equity, and individual holding under 20% (the ratio was the reverse in the 70s, prior to the advent of institutionalisation of money thanks largely to the growth of the mutual fund industry). So corporate managements treat themselves to quarterly bonus and to options which, if they go under, are repriced.
It was this pressure on improved quarterly performance that led industrial companies and financial institutions to take inordinate amounts of risk in 2008. Spurred by easy liquidity generated to pump the US economy after 9/11 financial institutions gave all sorts of loans to all sorts of people, simply in order to improve quarterly performance, never mind the risk of default!
Look at this article on Washington Mutual a bank founded in 1889 which survived the great depression and the savings and loan scandals through prudent lending. It threw to the winds any sort of diligence in assessing borrowers, including their identity, leave alone their repayment capacity! No wonder it was taken over.
Closer home, the case of Satyam Computer Services Ltd's foiled attempt at trying to have a merger with two family owned companies at terms more favourable to the latter, at the cost of the former's non promoter shareholders, comes to mind. There are several lessons here.
For one, good corporate governance yields a reward. Infosys, perhaps the best example of it, has a market cap. which is Rs 50,000 crores more than Satyam's mcap of Rs 11000 crores. A goodly chunk of that is thanks to better governance, which takes into account interests of all stakeholders.
For another, as popular press says, a low promoter holding is not necessarily indicative of poor governance on the logic that promoter has little to lose. Promoter holding in Infosys is 16.5% (divided amongst several promoters making each one's share smaller than Satyam's promoters) compared to 8.6% in Satyam. Nor is it the quality of the Board, the independent directors were all eminent names and were eminently qualified to look after investor interests. What matters more is the intention of the promoter group and the standards they lay down. At Infosys, for example, immediate relatives of founders do not get jobs if they fail to qualify.
The independent directors resigned after they discovered that the (low) promoter holding of 8.6% had been pledged and, with the lender selling stock, it may be below 5%. Their resignation after the event is akin to the downgrade by rating agencies after the damage. Too late to do good. Lesson for stock exchanges and SEBI: when asking for reporting on promoter holding, insist on a disclosure of pledges of such holdings and make that publicly available.
Ironically, Satyam had got corporate governance and investor relations awards from two entities. One is the Institute of Directors, started by Najma Heptullah, which, in Sep, awarded Satyam the Golden Peacock award for excellence in corporate governance, in the category 'risk management and compliance issues!' Strangely, the site, on its home page, says 'be an independent director, earn millions!' One would think that a non profit organisation like IOD ought not to use greed in order to promote independence!
Another award is from Investor Relation Global Ranking, an international site which gives international ranking regionwise. In the Asia Pac region, Satyam got ranked 2nd in corporate governance, 3rd in financial disclosure and 5th in investor relations. Lesson for such sites which award: re examine your methodology. You may end up doing more harm than good.
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Third, economic management: We have a huge current account deficit ($12.5b in Q2) mainly due to oil imports when crude prices were high. Contributing to this deficit is the foolish subsidy we give to petro products, including petrol and diesel which cannot by any stretch of imagination be said to be meant for the deserving poor. It is only now, after several commentaries on it, that the Government is asking the Bureau of Energy Efficiency (BEE) to lay standards for fuel efficiency, which would come into force in 2010. Why couldn't Government have become a bee in the auto manufacture bonnet earlier? And now that crude oil prices have fallen, why cannot we free petrol/diesel prices, so that market forces determine their consumption? Similarly, India may soon face a sugar shortage, despite having the largest area in the world under sugarcane cultivation. This is because all facets of its manufacture are controlled, cane pricing, cane availability (monopoly supply to a factory in its vicinity), sugar pricing and release of sugar to market. Lesson: interference in free market forces destroys industries.
In public governance it is appallingly distressing to read a comment by the Chief Justice of India that, should the captured terrorist Kasab fail to get legal representation, he may be acquitted by a higher court on technical grounds! This is a farce and a mockery! The faith of the people of India in its political class is shaken after the terrorist attack; let it not be shaken in the judiciary!
Last week the BSE-Sensex closed at 9958 for a weekly gain of 629. The NSE-Nifty closed at 3046, up 189. Where, now?
In the immediate term, there could be a further rally. There is a significant amount of cash sloshing around, $ 8.8 trillion according to an article in Mint. This is 74% of US market cap. Another indicator is the falling TED ratio, which is the difference between 3 month interbank rate and 3 month US T Bill rate. It had gone up sharply when the former rose, as banks were scared to lend to each other. The drop indicates more willingness to lend interse, hence more confidence. The Indian Government is to announce another economic stimulus package. This should perhaps cause a rally in January. The rally should be taken as an exit opportunity.
Thereafter, we would get into the Budget, which would not be kind, given that the fisc is more out of control than some of our politicians. Then we would get into general elections, expected in Apr/May.
More worrying is the global economic slowdown as expressed in view of author Reggie Middleton that another big bank failure is more likely to occur. He expects the recession to last (hold on to your chairs) 3 to 6 years! The amount of toxic assets in the system are far too many and cannot be dealt with benignly, by pouring more money. It would take that amount of time, he reckons, for the toxicity to disappear. It seems too pessimistic! But for sure, 2009 would be a painful year.
So, exiting in the rally that is expected to ensue in January may be considered.