“Going fast”, said my son as he rubbed his eyes “is not a bad thing.”

Those were his first words of that day.

He must have dwelt over the discussion we had the previous night on how fast he can ride his scooter.

“Speeding”, I had cautioned, “is not a good thing. You can get hurt, break your bones, and then no more scooter-riding for a long time.”

But that is the classic clash of a generational gap: the bravery of youth versus the caution of age.

And so it is in investments. The novice enters the stock markets looking for a quick buck. Many quick bucks.

The investors who have been burnt before, approach their investment portfolios with more caution.

Yes, it is enjoyable to zip down the slopes with the wind breaking through your hair, but….where are the stones along the path? Where are the bumps that can throw you off balance? Where is the other scooter that can come zipping down from any other side and zap you?

What if…oh, so many things can go “wrong”?

A seasoned investor is a worrier. But he can still be a warrior – brave enough to head out into the battle and seek investment opportunities.

And there are many investments out there which will make investors a lot of money.

Each have their risks, each have their bumps.

Assess them yourself – or pay an advisor or mutual fund manager to assess them for you.

Of course, everyone will make mistakes as we seek returns from our investments. That is the natural order of things. But, do we learn from these past mistakes? And have fewer errors of judgements in the future? Or, are we investment managers rolling the dice based on some “I still win, no matter what happens to your money” attitude.

External morality

“Where did you park your car” I was asked by my host – a “player” in the financial markets in New York where he worked for one of the largest financial firms in the world. He was in Miami, Florida for a holiday and had invited some friends over for dinner.

“Outside the building at a parking meter – but I need to go and fill in coins later”, I replied.

“Oh, that is okay – the fine for parking illegally is only USD 15 here. In New York the fine is USD 75, so I am more careful there”, he rationalised.

A good assessment of risk-return – and a price tab on doing the correct thing.

It is okay to park illegally in Miami because the fine is “affordable”.

It is not okay to park illegally in New York because the parking fine is higher.

And so it must be with many of my colleagues in the field of investments.

The advice offered could be based on, “what can I get away with?”

Not based on: what is the right thing to do.

But, is there a place for morality in investments?

The role for morality in investments.

I heard the Chairman of ITC give a very interesting speech on how ITC is helping the farmers and local people in villages. It was fascinating how ITC was trying to change their lives.

And then there was a question from a member of the audience: Sir, how do you reconcile the fact that ITC makes profits from selling products that are known to kill and hurt people and then using some of those profits to help some farmers?

The response was: ITC is doing less of tobacco products and we are diversifying into making food and other products. If we were to stop selling tobacco items, there would be hundreds of thousands of people without a job and no means of earning any money.

In essence: ITC cannot stop doing a bad thing because it is bad and its “badness” is pretty popular.

True, there is no law that stops tobacco items from being sold. In fact, governments around the world collect taxes on tobacco products (and liquor and gambling) and, in some sense, rationalise the “sin” of producing a “bad” product.

It is a well managed bank with healthy financials. But after 119 years, it is valued at $3.6 b., less than half the valuation Ranbaxy, a private company, achieved in 47 years, which is less than half the time.

Okay, one may say it is in a different line of business. Fair comment. Compare ICICI Bank, with a market cap. of $ 22 b. with SBI, at $ 21b. Now SBI is no ordinary bank. It has a 200 year history and has an unbeaten record of uninterrupted dividend history for over 150 years, testimony to its financial strength and good management. With such a long history of success, why is it valued at one twentieth the value of China’s ICBC, with a market cap of over $ 450b. HDFC Bank, at $ 10.5b. is nearly 3 times PNB.

In oil and gas sector, Reliance Industries, also set up in 60s, has a valuation of $ 80 b., larger than that of ONGC, at $ 45b. even though ONGC has excellent financials. Take telecom. Bharti, an upstart, has a market value of $ 40 b. whilst MTNL, an erstwhile monopoly, is only $ 1.5b.

The reason is obvious to all but those in Government who are in denial of true facts. Government treats public sector companies as milch cows, irrespective of the fact that they have minority shareholders. ONGC is valued where it is because it has to bear a huge subsidy bill for petro products. Regrettably, most of this subsidy goes to people who don’t deserve to be subsidised, such as car owners for petrol, truck owners for diesel, the mafia who adulterate diesel with kerosene, for kerosene, and restaurants for LPG cylinders. ONGC, Oil India and GAIL pay the bill, but are still very profitable. IOC, HPCL and BPCL also pay the bill, and have been bankrupted.

There was a joke about the Chairman of a company asking his finance manager why their company’s share price was half that of their competitors when their performance and profitability was the same. A month later it had caught up, so he called in the finance manager, complimented him and asked him how he had achieved it. The manager said he had just spread a rumour…that the Chairman had resigned!

One thinks that if the Government were to resign from these companies they would be doing the companies and themselves a favour. But the disinvestment process is stuck, like a lot of other necessary and sensible reforms, in the quagmire of a failed politics.

The Government did not take the necessary and sensible decisions to hike petro product prices in line with rising oil prices, to sell companies which they have demonstrably failed to manage (look at the valuation differentials), and a whole host of other things, because of politics. The argument was that taking tough but necessary decisions would cost it votes in the next election.

Well, election time is near. Do they now think that subsidised petro product consumers are going to vote for them en masse? Why, then, have they spent Rs 200,000 crores a year subsidising them when a better targeting of subsidies to the needy would have probably cost less than a fifth of the amount?

Do they think farmers are going to vote for them when they continue to reel under inadequate financing, lack of fertiliser and unfair product pricing? Unlikely. Why, then, did they incur some Rs 100,000 crores on subsidising one bit of fertiliser, viz. urea. How much of this has gone to absentee farmers from Punjab and Haryana enjoying tax free income in Canada?

It is easy to spend money, but the spend must result in a gain in productivity. For example if a Government employs, say, 1 lac people, paying them Rs 100 to dig a hole, and another 1 lac, paying them Rs 100 to fill it, GDP will grow by Rs 2 crores without any increase in the nation’s productivity. Such spending thus results in increasing money supply, hence inflation, without increasing the economy’s ability to compete. Inflation has now hit 11%.

Not that the PM and his officials do not know all this; they have been hobbled by survival politics subjugating revival economics.

Investors know all this too, and react to it by selling shares. FIIs continued their selling last week, except on Tuesday, causing the market, which seemed to be rallying till Tuesday, to collapse. The BSE sensex ended the week at 14571, down 618 points. The NIFTY ended the week at 4347, down 170 points.

The market is at a crucial level. If it goes significantly below 14500, the sensex would then look for support at around 12,500. What are the factors that investors need to look out for.

Basically it is how domestic politics shapes up; next week there is a crucial meeting between the Government and its Left allies (is that the correct word?) over the nuclear deal with the US. There is no more time for waffling over this. If the Left continues to be obdurate and prefers to withdraw support, the 14,500 level can crack. Investors do not like political uncertainty and the withdrawal would lead to early elections. If, however, Mulayam supports the Government, it can survive and the nuclear deal can make progress. The market will rally sharply.

Added to this is the likelihood of a fall in global oil prices. A lot of the price rise in oil is now speculative with too much money chasing it. It is not a mismatch of demand and supply; in fact there are a lot of full oil tankers whose cargo cannot find buyers.

In USA consumption of petrol is likely to fall for the first time in 17 years, simply because prices of petrol have been raised. South East Asian countries like Indonesia, Thailand and Malaysia have raised prices 30-40%. They are not, perhaps, hobbled by ‘allies’ or maybe their political leaders have the necessary anatomical parts ours don’t.

So the next week is crucial. Since it involves trying to predict political behaviour it is anybody’s guess.

Source: Stark Contrasts in Creation of Value

Their erudition and their education, would, it was felt, help them steer a coalition Government hobbled by Left parties with antediluvian ideas of economic growth, on a sensible path. For four years, it seemed things were going well, with the Indian economy growing at 8% and pouring enormous amounts of tax revenues to the Government. The triumvirate, alas, forgot what they had learnt in economics classes and succumbed to the politics of survival. We will now pay the price of neglect to plan for the future.

Poor governance matters. Look at Vietnam, till now one of the tiger economies, whose fast economic growth attracted a lot of foreign capital and created a stockmarket boom. The growth was not managed. The stockmarket has fallen 70% from its peak and every single day in April was a downtick! Look at Zimbabwe, where Robert Mugabe’s neglect has turned a country once the rice bowl of Africa, feeding other nations, into one that has to beg for food as it is bankrupt. Look at North Korea where upward of 1 m. people will die of famine as the great leader chases his nuclear nightmare.

Luckily India has democracy, and democratic institutions. But economic realities must be faced, such as rising crude oil prices unable to sustain untargeted subsidies, without fully prostrating to political compulsions. The triumverate ought to have been protected from political interference, much as Narasimha Rao did when Manmohan was the Prime Minister!

GDP growth is expected to slow down this year, though we should still be over 8%. If services, which account for 55% of the economy, continue growing at above 10%, that provides 5.5% GDP growth; industry, which accounts for 28%, growing at 7% (as in April), would provide another 2% and agriculture, accounting for 18% would, with a 3% growth, chip in with 0.5%, adding up to 8%. Or more, with higher growth in any sector.

The irony is that the resources generated during the past four years in terms of tax revenues, have not been spent in ensuring the future. Most of it has been wasted in political gestures, such as the subsidy on petroleum products. Only a small fraction, perhaps not even a tenth, goes to the truly deserving, who would need subsidised kerosene and LPG as fuel for cooking.

This population could provided the subsidy in a more effective way, using technology, without needing a blanket low price for all. The kerosene mafia, which adulterates diesel with subsidised kerosene, is a beneficiary of this largesse, as are car owners who are not discouraged from buying fuel guzzling cars. (Belatedly, the Government has woken up to its responsibility and levied a special excise of upto Rs 20,000 on fuel guzzlers; too little, too late). Contrast this with Indonesia, where the Government had the cajones to hike petrol prices by 30% last year. Demand for oil has fallen 10% since.

The BJP Government had, when in power, hiked petrol and diesel prices by an equal amount, even though the underlying crude oil price growth was much less. However, it did it in 34 small increases, without attracting public fury, instead of one large one, leading to protests. (Ironically the protestors were the very people who prevented the small hikes). So even when politics comes into economics, management of it becomes important.

Kerosene coupons, much like food coupons in America, would be one way of better targeting subsidies to reach only the intended beneficiaries. Modern day technologies like smart cards embedded with chips to distribute products can also be used. The Government could, and should, have used buoyant tax revenues to develop resources using floating turbines to generate wind power and wave power technology to generate power from waves is now advanced enough to make it equivalent to nuclear power, which would give the Government an alternative. India, with its huge coastline, would be able to develop this, had the priorities of nation building been determine by strategic thinking and economics instead of populism and accommodative politics!

Because prices of petrol and diesel have been subsidised, there is no price effect on its consumption, resulting in a ballooning import bill for crude oil. This leads to a current account deficit, taken care of by capital inflows. To attract which, and to control inflation (which in the last week of May touched a 7 year high of 8.75%), interest rates would need to be raised. RBI did just that, raising the repo rate (the one at which it lends to banks) by a quarter percentage, to 8%. The interest rate cycle is turning up, globally, which would negatively affect equity markets.

With all these untargeted, hence largely wasteful, subsidies on oil, on fertilizers, with the increase in salary after the pay commission hike and with the farm loan waiver, the Government’s fiscal position is atrocious, which is why foreign investors have been selling in spades. Which is also why the Government approved a procurement price of Rs 850/quintal for wheat, lower than the Rs 1000 recommended by CAC.

There was a lot of interesting corporate news. The promoters of Ranbaxy, India’s largest pharma company, agreed to sell their 34% stake to Japanese Dai Ichi Sankyo at a price significantly higher than market price, which consequently shot up. Dai Ichi will make an open offer for 20% at the same price, of Rs 737 per share.

Reliance Communication, which is planning a merger with MTN of South Africa which would be the largest deal from India, will have to face another complication. (The cap on foreign investment in telecom is a major complication which calls for a convoluted route to takeover). Reliance Industries has claimed that it has the right of first refusal if R Com is sold.

Idea Cellular is taking over Spice, in which Telekom Malaysia has a 39.5% stake. Post merger and preferential allotment, it would end up with 20%.

The India story is still good, largely due to the demographic dividend, with a young, well educated population who are free to pursue dreams. At a recent analyst meet of NIIT it was pointed out that India will have an addition of some 47 m. educated people in the 19-25 age group. The rest of the world (including China) will have a reduction of some 53 m. in this age group. Given proper governance, and a polity that cares for the future of the country more than for its longevity, there is no reason why the boom should not continue for years. Given good governance!

Last week the sensex fell sharply by 506 points on opening day (high oil prices, weak Dow), rallied thereafter, then fell again, to close down 382 points at 15181. The Nifty fell 110 points to end at 4517.

It is possible that the sensex can rally to over 16,000 level. One could exit if it does, for thereafter, at some point, early elections may be called. Oil prices are likely to fall, which would help control inflation. The inflationary environment would probably be most benign in Nov and Dec. An election then may probably be seen to be in the best interest of the ruling Government.

Source: Investing in India – What They Didn’t Teach Them at Harvard!