A question of balance

19 JUNE 2010

Both nature and economies have a way of correcting imbalances; this is what free market economics, on which the developed world is based, teaches us. The Americans popularised, in the late 80s, shareholder capitalism, which focuses more on creation of shareholder wealth, as a counter to the then prevailing stakeholder capitalism, which places equal value to other stake holders also. Germany and Japan, which had been practitioners of the latter, had booming economies as well as stockmarkets (remember Nikkei at nearly 40,000?). Promoting shareholder capitalism, by popularising mutual/pension/other funds and by making labour policies more flexible, worked. The US economy grew strongly and is now more than 3 times' Japans. The Nikkei is a quarter of the level it was end 1989.

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The focus on shareholder capitalism has swung the pendulum too far right and the recent global financial crisis is but an epitome of it. The promotion of the fund industry has led to a situation where the stock of global financial assets is about 4 times global GDP. The world's GDP growth cannot give a suitable return on this stock of financial assets, and so periodic destruction of wealth becomes inevitable. In order to get superior returns, financial players take excessive risks. Banks, aided by credit rating agencies, created and sold to investors, sub prime mortgages in order to get superior returns for their shareholders.

Now the same thing is happening in ETFs, or Exchange Traded Funds! See the story ETFs gone wild on. ETFs are funds which basically mirror the performance of the underlying index on which they are based. The composition of their basket of investment is almost exactly the same as the composition of stocks in the index. Hence ETFs costs are low; since they do not attempt to beat the index, they do not need to research stocks. In the US, ETFs, called passive funds, have now overtaken in size the active mutual funds. BlackRock, which took over Barclay's Global ETF business, is the largest fund, managing nearly $ 2 trillion in assets! According to the Bloomberg article, BlackRock is now complicating the simple ETF structure by "unleashing a new breed of "extreme ETFs" that use short selling, leverage and derivatives in a bid to capture a larger share of investor assets." Sounds familiar? It is how simple mortgages were packaged into complex products, and sold, with different layers, some of which got triple A ratings! Moody's, in a 5 day review exercise of their own ratings, downgraded over 90% of them from Triple A to junk, which showed the extent of their misunderstanding of the instrument.

Or consider the recent oil spill by BP, in its deep water oil rig. As we run out of fossil fuels the search for oil gets more complicated and goes into the deep sea. As the spill shows, this is not without risks, not only financial but also environmental. The financial risk has been quantified by pressure brought on BP by the Government of President Obama, at $ 20b. The environmental risk has not. Consider the third comment (Oil Spill- big picture) on this blog which points out that if the oil spill spreads, there is a danger of wiping out phytoplanton, which produces 80-90% of the oxygen needed by mankind. The next comment (Oil spill - scoop) gives a link to an article which maintains that the reason BP tried to contain the leak instead of shutting down the flow completely, was that the oil would generate a revenue of $ 3m/day. So this is the link between shareholder capitalism, excessive greed and environment damage. As investors we are concerned with our returns, never mind the consequences to the environment, or to society - BP shares went sharply up after it agreed to fund $20b. towards the clean up.

Another example of this was the plundering of the Amazon by Alcoa and Cargill. In their bid to set up a railway line in the Amazon forest, to evacuate bauxite from a mine inside the forest. The trees being burnt in order to clear a tract for the railway line, spew out carbon emissions "That equates to half of all the emissions from cars, trucks, planes, trains and ships in the world." We, as investors, are unaware, or unmindful, of this so long as we get our dividends and stock appreciation.

The search for alternatives to fossil fuel has led to a promising discovery in shale oil. It seems that the US has adequate stocks of shale oil to nearly eliminate its dependence on crude oil and hence on the Middle East/Russia/Venezuela/oil producing countries. This can have an immense geopolitical change. But the exploitation of shale oil is not without its environmental consequences either, as this article, Shale Game, shows. Shale oil is a greener alternative, producing 53 kgs of carbon dioxide per MMBtu, nearly half of coal and around 78% of oil. However, benzene, a carcinogen, was found to be 10,000 times the prescribed safety limit. Controlling the side effects of such corporate action would be the job of environmental protection agencies, but shareholder pressure would be nice, too.

In India we are witnessing a rerun of the 25 year old Bhopal gas tragedy. The contradiction in recompense, $450 m. for thousands of lives lost versus $20b. for the oil spill by BP, is stark. It only points to an abject failure of governance. Attention should be now focussed on whether we could, somehow, get more compensation from the company or, if not, how quickly to settle pending claims, and not on who let Warren Anderson, the then CEO of Union Carbide, go. And on how to ensure that, were a similar tragedy to occur again, there is an appropriate system to deal with recompense issues. Au contraire, the Government was thinking of watering down the liability in case of a nuclear accident!

In general news of interest, the Direct Tax Code has been revised. The good news is that it will be simplified and that the tax brackets will be friendlier. The lowest rate of 10% will apply for incomes between Rs 1.6 to Rs 10 lacs (instead of 5) per annum, the next bracket of 20% will apply for incomes between Rs 10-25 lacs (instead of 5-8), and the highest, 30% will be for incomes over Rs 25 lacs, up from Rs 8 lacs.

However, long term capital gains, for holding of shares over one year, will now be treated the same as short term, and taxed as income, at the marginal rate. This will lead to a churn in stockmarkets as investors would, but naturally, sell amongst their family members, stocks held for over a year, only to buy them back simultaneously, thus raising the cost of acquisition. Brokers will benefit.

The harebrained idea of imposing MAT (minimum alternative tax on book profits of companies) on assets instead of on profits, has been thankfully shelved. The person who thought of it should also be shelved, preferably with duct tape over his mouth.

Advance tax collections for the first quarter to June are expected to be 20% higher. The CMIE has estimated GDP growth at 9.2% for 2010-11, compared to 7.4% in 2009-10. This can lead to even more FII inflows, since Japan and the Eurozone are anaemic in their growth.

Having said that, the Eurozone, especially, is vulnerable, with risks of sovereign defaults continuing to loom. Since there is a lot of inter se lending in the Zone, one country's problems can easily spill over to another. One can expect crisis to pop like bubbles, from time to time, and of ensuing volatility. The dips would provide buying opportunities.

Last week the BSE-Sensex rose 506 points to end at 17570 and the NSE-Nifty rose 143 to end at 5262. The sensex is likely to bounce its head against 18,000. Any dip on a Eurozone crisis would be a buying opportunity.

J Mulraj is a stock market columnist and observer of long standing. His weekly column on stock markets has run for over 27 years. An MBA from IIM Calcutta, he has been a member of the BSE. He is Conference Head - India, for Euromoney. A keen observer of events and trends, he writes in a lucid yet readable style and takes up issues on behalf of the individual investor. Nothing pleases him more than a reader who confesses having no interest in stock markets yet being a reader of his columns. His other interests include reading, both fiction and non-fiction, bridge, snooker and chess.

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4 Responses to "A question of balance"


Jun 20, 2010

re- the issue of watering down of the liability of equipment suppliers of nuclear plants-is there a campaign in progress against such a move? this pernicious thought should be nipped in the bud.



Jun 19, 2010

Straight from Hip- Very informative and interesting articles every saturday. good work Mr Mulraj


Rajan Nireshwalia

Jun 19, 2010

Dear Jawahir

Always enjoy reading "STRAIGHT FROM THE HIP ".
Short and full of sense!!!!!!!!! Keep it up.

Rajan Nireshwalia


Anupam Garg

Jun 19, 2010

your views on the effects of shareholder capitalism are superb. But one must understand that it is shareholder capitalism has played a pivotal role in wealth creation. It cannot be blamed for financial crisis as i believe it was purely a result of poor regulation & stupidity of credit rating agencies.

The oil spill and other environmental hazards can be attributed to the greediness associated with shareholder capitalism but again the regulators have done a poor job.

DTC's revision is welcome and i hope there r no further changes

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