IPO- The promoter takes all

(This was a piece written in 2008 )

IPO’s and the merchant bankers- Takeaway for investors

Quotes from a newspaper:

“regulator’s inspection showed that the details of the promoters as mentioned in the IPO document were different from the one filed with the Reserve Bank of India.


, the merchant banker had not even verified the plant and machinery of the companies, the issues of which they had managed


one IPO, the regulator found out that the post-issue capital of the company was higher than its authorised capital —“

Above are some “omissions & commissions” by merchant bankers whilst managing IPO’s, according to a press report. The report also says that the regulator is likely to impose penalties on the merchant bankers concerned.

IPO business is funny business. Every issuer wants to sell shares at the highest possible price. Obviously, once an issuer short lists a few merchant bankers, then the actual choice would be made on who would offer the highest price. In any IPO, the fee is large. It could be a lowly 1% to as high as 5%. For an issuer, the total expenses can be in the range of 7 to 11% of the issue. Naturally, a 10% higher pricing means that the issue expenses are covered.

IPO’s, under the book building route can only proliferate in a bull market. In general, most IPO’s tend to be overpriced. All IPO pricing is based on some rosy picture of the future, so it is but natural that at least half of them will fail to live up to promises.

Once an IPO goes under water, the IPO investor feels cheated. Once many go, the noise levels increase. Investor forums start shouting and ask for action against lead managers etc.,

Firstly, no investor is forced by anyone to invest. He makes a conscious choice. He is being misled by the noise surrounding an IPO. He has no access to the prospectus or has no expertise to understand the same. So, he goes by his broker/friend/media views and plonks his money. Most investors I know want to keep flipping each IPO on allotment and move on to the next. One group just keeps piling up the IPO allotments. Over time, they sell where they see gains and hold on to the ones under water. In many cases, the reasons for holding on are psychological. Further, in each issue, the amounts involved are small (though it all adds up to a tidy sum) so there is a tendency to hang on. Over time, some of them become worthless and move on to the “vanishing companies” list.

What about the lead manager? To my mind, the lead manager/s should be punished only if there are compliance issues. If there are mis-statements, suppression of facts (which any due diligence should have thrown up) or any other act/omission which could have materially altered the story, then they should be punished. Here, the punishment should be severe and not nominal. I would say that suspending all the business of the entity for six months to a year plus a financial penalty which is at least four to five times the total fees involved in the issue should be levied. The penalty should hurt. A few lakhs does not make a difference to most merchant banks. Suspension of activities (all business done by the entity/group) in capital markets is a must. Only then would it hurt.

There would be instances where the lead manager is taken for a ride by the company. Such cases would be complex in nature. For instance, one of the cases cited above relates to the company filing some return with the RBI. It is very unlikely that the merchant banker would be able to verify this and to my knowledge, would not fall in the check list for due diligence. However, non-existence of plant and machinery is something that is amazing. So is the case of the authorised capital not being adequate. These are elementary errors and the punishment should be very severe. In fact, taking away the capital markets business licence would be a fit action in these cases. When a merchant banker takes on an IPO mandate, his responsibilities are huge. He may not have all the expertise himself, so he has to hire the right people to help him in this. On pricing, it is what the traffic can bear, so no issues with them. I would not blame a merchant banker on this. If he does this frequently, the market place would judge him over time.

Pricing is something we all like to hold the merchant banker responsible for. If an issue lists at a huge premium, then the issuer has lost. Similarly, if the issue lists at a discount, the investors get hurt. There is no answer to this. The merchant banker gets paid by the issuer. Naturally, his first loyalty lies there. As far as the investor is concerned, he has to take his call. There is no point in saying that if institutional investors put in money, they would have done their homework. World-over, there is an unholy nexus between institutional investors and merchant bankers (who also are brokers). The institutional investor can move more quickly, he has access to much more information than the retail investor would have.

The retail investor is all alone in this. The IPO grading system has been discussed in our magazine. Whilst it is a useful tool, it gives no help on pricing. This brings home the lesson that equity investments are fraught with risk. IPO investing is perhaps more risky than a secondary market investment. In the secondary market, you would have access to more information, research and price history. Further, in most IPO’s one has no idea about the management quality and capabilities. You may end up with a multi-bagger or end up with tissue paper. It is best to be cautious. In IPO’s, the advantage is typically with the issuer. He comes in at a time and price convenient to him. It need not coincide with what is good for an investor.

One issue relates to pricing disclosure. Whilst giving the mandate to a merchant banker, all issuers insist on a “price range” at which the merchant banker can place the shares. Without this, no issuer will give a mandate. However, the public get to know of a price only when the issue is about to open. All offer documents have a blank in the price disclosure. I understand that pricing can change, in tune with market conditions. However, why not give the indicative price band whilst filing the red herring or the draft prospectus with SEBI? This would give time to analysts to give their views on the issue. Today, most analysts do not get time to do this efficiently, because the price band fixation and the issue opening happens with a gap of a few days. This is something for the regulator to consider. Let the issuer be free to fix a totally different price when actually opening the issue. By giving the indicative price range up front, it would help the investor to take a better view and lead to more analysis and information to the potential investor.

The funny thing is that we all get introspective and rational when the markets are down. When a bull market resumes, all of us forget our lessons and plunge headlong in to putting our money back in to the markets, hoping to make a quick killing. By and large, IPO’s do give an opportunity to make money, depending on whose greed is greater at a point in time. In a bull market, the issuer takes advantage of the investor greed. In a bear market, unless the issuer is desperate, he waits it out.


August 23, 2008.


MIDCAPS- The story of emerging microcaps..

(this is published in Today’s editions of Deccan Chronicle. The hot favourite of the markets is the mid cap segment.)


If you are the person who is a keen investor in small and mid cap stocks,  be aware that you are entering a twilight zone. The mid cap stocks drama is nearing completion of another cycle, notwithstanding the money that is pouring in to the markets.

As this bull run started, somewhere around 2014, the mid cap space looked interesting.  Smart investors jumped in early. Valuations for mid caps, that were at discount to large caps, shot up higher and higher. Earnings growth seemed to exist only in the mid cap space. As earnings expectations were met, the next round of forecasting jumped even higher, prompting push in prices higher and higher.

Currently, the BSE mid cap index trades at a thirty times earnings and the small cap index at a healthier 74 times earnings. Of course, the BSE Sensex is at a measly 24 times earnings. Let us see how the indices behaved post the change in government:


Apr-14  22,418  7,323  7,490
Dec-14 23%  27,499 42%  10,373 48%  11,087
Jun-15 24%  27,781 46%  10,680 48%  11,075
Dec-15 17%  26,118 52%  11,143 58%  11,837
Jun-16 20%  27,000 60%  11,717 58%  11,801
Dec-16 19%  26,626 64%  12,031 61%  12,046
Jun-17 38%  30,922 100%  14,644 106%  15,411
LATEST 42%  31,798 107%  15,157 109%  15,635


(These are month end closing indices of the BSE for the Sensex, Midcap Index and the Small Cap index )

These are amazing returns and for those who stayed invested, the journey must have been exciting. However, there are many who keep buying and selling and it is very unlikely that the returns would have been so much if measured for their money, over this period. Yes, one may have had great returns if there was concentrated investing in one or two stocks that multiplied many times, in this bull run.

However, it does look clear that the party is about to slow down dramatically, if not end. And the latecomers are the ones who will take longest to recover from the hangover.  As I am writing this (10th August, 2017) the markets seem worried. Of course, as an investor, I have to keep awake at these times. If there is some irrational correction AND I can spot some value buying WITH margin of safety, I am ready. I think that time where we can get ‘margin of safety’ is still to come.

The worst hit will be those who joined the bandwagon late. The sweet spot in the last three years seem to have been the first calendar half of 2017. In other words, if you joined the party by end December 2016, you probably had a good ride. The indices hide individual stock movements and thus the story would be different for different investors. If you are in pharma and IT, you probably are staring at losses whereas if you are in to cyclicals like steel, you had a good ride.

However, none of these periods offered ANY margin of safety to the investor. We had to bank on crowd behaviour and money flows.

For those in the mid cap stocks, my advise would be to stick to high quality stocks (those with ROEs in excess of twenty percent) and exit the rest, even if it means a loss. Very often, when the exits get crowded, no one gets out. So, I would opt for a conservative approach, cashing out on the speculatives and the ‘hope’ driven small companies.  The cash can be useful in the days to come.

Once a sector gets impacted, many people try to buy the stocks on decline. It is not a good strategy, always. Just look at the pharmaceutical sector. The stream of bad news has brought down the prices, but still the multiples are nowhere close to giving the buyer any margin of safety. So, if you just look at the High/Low and keep buying stocks, it is unlikely to work in this bull market. Pharma stocks have just become ‘expensive’ from being ‘very expensive’. Prices are still not related to earnings and are driven by hopes that are getting dashed as events unfold.

Cash is king in these markets. And there is no need to rush in at the sign of first correction. I am not referring to any levels in the indices, but keep your eye on the ‘margin of safety’. Buying closer to that is what will give you better investment returns. Being conservative at this juncture, will ensure that you are around in the markets for a long time.  I am sure that one investor named Warren Buffet must not have even averaged three buys in a year. He spends all his waking time on the stock markets and buys and sells far lesser number of stocks than we do, by spending a few hours in a week.  And he has not done too badly.


(http://epaper.deccanchronicle.com/articledetailpage.aspx?id=8778359  )



The lament of a Senior Citizen

(This came to me as a ‘forward’. It makes great sense and is a genuine plaint. A senior citizen has no hope that someone is looking out for him. As jobs get scarcer and medicines become stronger, we are condemned to longer and longer lives. And the rulers, do not seem to care enough. What is particularly telling is the comment that the legislators have the right to fix their own pay, so they are not worried at all.)

A Senior citizen posted the following on the facebook page of PM Mr. Narendra Modi and sent an email to FM Mr. Arun Jaitley. For information of all my friends.

Respected Prime Minister Shri Narendra Modi ji,
Respected Finance Minister Shri Arun Jaitely ji,

First of all I extend my sincere thanks in anticipation that you will spare a few minutes of your valuable time to read and take suitable action in the matter.

I am a senior citizen and on 01.08.2012, I put Rs 40 lakhs in a nationalized Bank for 5 years. I was being paid an amount of Rs. 35,352/- every month (of course subject to income tax) enabling me to lead a worry free life financially. Now on maturity I have reinvested the amount in the same Bank and I will be paid Rs. 26,489/-; a shortfall of Rs. 8863/- i.e. 25% over the previous return, per month. Can you please advise me from where I should make good the loss or sacrifice consumption of medicines or atta or dals or vegetables or fruit or milk or what?

Practically your government after taking over in 2014 has done nothing for senior citizens. No additional facilities extended but withdrawal of what existed in 2014. No commodity or provision item is available at the price of 2014. Yes you have been able to bring down the figures of inflation and indices but not the actual prices. Every off and on the prices of some essential daily use items go rocket high like dals, chana/besan, salt, onion and now the tomatoes. At that time we cannot even dare see those items.

I know you have political and the theoretical replies for these issues like interest on deposits and advances in banks depend on demand and supply. The prices of daily use items vary with seasons being agricultural products. But the straight upward shoot of prices cannot be justified by these reasons. If the government wants to provide cheaper credits to the trades and industries, it should not be at the cost of depositors. Banks are sitting over volcanoes of NPAs and all good money is being diverted for bad money. On the other hand banks have exponentially increased service charges on anything and every thing.

In desperation we look for investments in equity or mutual funds. There also over scrupulous elements outsmart us and hardly give us any returns. Your NPS scheme is of no use to us at this stage.

But is it not the duty of the government to enable the senior citizens to lead a respectable life who have spent their golden years in serving various organizations and finally the nation? Government cannot see the other way. I am at a loss to understand from where this deficit of 25% be met.

It may not be appropriate for me to question lije this but i am compelled to. Is any of the minister/MP/MLA is ready to cut his salary and allowances by this percentage? If not, then why the public especially the senior citizens?
Perhaps it is because that, like you, we do not have the power to fix our own salaries, allowances and perqs and getting everything for full year, for sessions of total of 3 months and that too attending sessions at their sweet will. When the matter of increasing your salaries comes, you pass the same just in 2 minutes with no discussion, with all heads together be it from ruling or opposition benches. For this increase, you totally over look the cost to the exchequer, deficit, economics and any other factor.

The government had started a scheme for deposits of senior citizens and the rate was 9.20% but In July, 14 it was reduced to 8.3%; the amount limited to Rs 15 lakhs. This is totally unjustified. The rate should be a minimum of 12% and the amount limit should be equal to what a person gets as terminal benefits. The government should ensure financial respectability to the senior citizens to walk with their heads straight.

I am sure you will understand the plight of the people whose good part of expenses comes from the interest of their savings of life time.
Sorry if I have offended you in any way.
Thanks and Regards

D. P. Bhateja 2246 sector 48C Chandigarh
Mobile : 9417819504

GST- Reason to Invest in India

(This appears in the Deccan Chronicle of yesterday/today in various editions. GST transition has been smooth, contrary to the noise around it. There are problems, but the opportunities it throws up are big.  The fiscal reforms that have kicked in are primarily aimed at ensuring a high level of information control and management by the government. Irrespective of our criticism, the moves have a positive spin on the corporate sector as well as on the fiscal situation)

GST is now a reality. I doubt if there are any direct winners or losers merely due to a lower or higher rate of effective taxation. There will be a transition period of eighteen to twenty-four months till the dust settles. These are yet early days. Numbers will not tell us the story for some more time.  The panic situation to clear inventory that was produced before June 30th,  seems to have been a blessing in disguise for many. Inventory has been cleared and cash freed. There will be some inventory losses as well as some inventory write offs. A cleansing, so as to say.


Gradually, as the dust settles, there will be good tidings for the organized sector. The entire GST system levels the playing field. This means that the unorganized sector will not have any price advantage. Advantages of scale will be a competitive advantage, as it ought to be. The largest companies will be the biggest winners. Further, companies in sectors that face competition from unorganized players, will also gain. I can see textile industry regrouping. As will automobile ancillaries. The organized sector will insist on buying inputs only from registered players in order to get their GST credits. Logically, this means that the smaller players will be forced in to registration and paying GST.


In the initial phase, a lot of companies will be shy of passing on the full extent of the inputs credit as they deal with a new system. In about a year or so, as the system stabilizes, there will be further competition based on this fact. So, in the short term, some consumer products could face some price hikes, but will level off over time. Consequently, we may see some consumer companies report a spike in short term earnings over the next couple of quarters, but it would level off.


One thing to remember is that a broad increase or decrease that is universal, is unlikely to change the demand supply equation in an industry. For instance, increase in the effective service tax rate from fourteen to eighteen will not reduce the total services being provided. Similarly, an across the board reduction in automobile prices is unlikely to dramatically increase the sale of automobiles.


The BIG question is whether GST will result in a better compliance and consequently a higher collection of expenditure taxes. My answer is YES. Firstly, the service tax hike is a huge boost to the collection. And the compliance net will spread wider.  The key thing to see is whether there will be a spin off on the government finances. I would think that there would be a consolidation of our finances leading to lower deficit. Now, the government could share some of the spoils by way of lower income tax rates.


Lower income tax rates is something that ‘appears’ more tangible and real. Even if it gets taken away by higher taxes on expenditure, the human mind always reacts more positively to a higher cash in hand. This illusion helps build confidence in the system and also the economy.


GST is probably the single biggest fiscal reform that India is seeing. Yes, we can always moan about the absence of a single rate and procedural issues, but after one year, the results will be on the ground for all. Just one factor of Octroi being abolished helps boost our economy, as goods move faster and efficiency improves.


Let us not look at GST in isolation. Demonetisation was also an important step in the whole process. This administration is extremely focused on data integration. Demonetisation, Aadhaar, GST are all pieces of a jigsaw which will complete the data integration. As every transaction becomes traceable and linkable, tax compliances would improve. Ultimately good compliance would help in lowering the effective tax rates. How the administration redistributes the gains is something that only time will tell.


Over the next two years, I can see corporate India becoming big beneficiaries of the GST system. Market leaders stand to benefit as scale becomes an important component. Compliance costs are unlikely to be high on a recurring basis, though there would be high transition costs. However, transition costs are unlikely to break the backs of any of the companies.


It is important to close our ears to the noise and look at each of the moves by this administration for its impact. The power of the information age is being harnessed to benefit government as well as business. Only those who have gained by evading compliance will be losers in this game.


As an investor, I think that we are headed for good times. Focus on quality, size and potential. Overall, one can expect better efficiency of capital. To use a much-abused phrase, “opportunities are always there”. We all need some luck to back the right horses.


R Balakrishnan




MARGIN OF SAFETY- (A rude WTF reminder)

(This appears in some editions of Deccan Chronicle today and in some, will appear tomorrow. Stock markets give us a rush of blood at some times and some times suffocate us. Logic and reasons are strange in the market)

If you understood a business perfectly and the future of the business, you would need very little in the way of a margin of safety. So, the more vulnerable the business is, assuming you still want to invest in it, the larger margin of safety you’d need. If you’re driving a truck across a bridge that says it holds 10,000 pounds and you’ve got a 9,800 pound vehicle, if the bridge is 6 inches above the crevice it covers, you may feel okay; but if it’s over the Grand Canyon, you may feel you want a little larger margin of safety…

Warren Buffett

Stock markets make us human beings behave in strange ways. When things are quiet and stocks are inexpensive, we do not enter the arena. Once things warm up and there is a lot of noise, including anecdotal evidences of fortunes being made by others, we start looking at it. Finally, we succumb. Either though a SIP route (if we convince ourselves that we cannot manage the risks associated with stock picking) or a brave plunge in to the markets, all by ourselves, with friendly tips from media and experts.


Most of us go through our lives without bothering to understand ‘valuation’. And given that over time, stock prices tend to rise, we attribute our investment performance to our skills and ‘information’ network. And when the performance of what we pick happens to be disastrous, we attribute it to lousy experts.


We all have different interpretations of “Value”. To some, it is price. They look at historical highs/lows and seek their comfort. Some look at P/E multiples and buy it. Some look at P/E relative to growth. Some look at the overall market mood and are happy to look at ‘relative’ P/E multiples. Some are happy to chase what they read or hear that some ‘ace’ investor is buying. Sometimes it is ‘story’ based buying. Like we suddenly get bullish on ‘solar’ power or ‘electric fuel’ or ‘retail’ or ‘banking’ etc. Or we have stories like PSU companies going to be managed better. Of course there may be more theories and strategies. However, unless one spends a lot of time in understanding business and financials, you are leaving your investment to chance and luck.


You should make attempts to improve your odds.  One thing we should understand is that we are buying in to future expectations on a company, stock, or economy. Buying the past is the most common thing that everyone does. Even when choosing a mutual fund to invest, we are happy to go by ‘independent’ ranking that is purely based on past performance.


At each stage, when we buy a stock, we are buying in to ‘prospective’ returns. And that means one has to buy at valuations that give us a level of comfort. Stock prices never move according to our expectations. It rarely gives you the ‘speed’ of price movement that you want. Sometimes, even the direction can go wrong. After all, there are thousands of people out there forming a view on a stock, every moment. When you are buying or selling, you are in effect not just impacted by a price but also by expectations.  The prime assumption that one makes is that sooner or later, price will reflect the quality of a company with respect to its earnings and business.


I would urge all of you to read or re-read the chapter on “margin of safety” in the book “Intelligent Investor” by Benjamin Graham. Essentially, it is buying a business at a price that is lower than what it is worth. Yes, we all think times have changed.


Everyone tells me that I will never be able to buy stocks, given my conservative approach. I will miss out on stocks and be stranded with bank deposits and liquid funds. There is so much money flowing in to the markets that downside is ruled out. Everyone wants to buy Indian stocks. Reforms are happening at rapid pace. We are growing rapidly. Banks are getting cleaned up. Transparency in governance. Aadhaar has helped eliminate so much of waste. Oil prices are low. Inflation is low. And GST will multiply the profitability. Low oil prices across the globe. Fastest growing economy in the world.

I prefer to not change my thinking or rules for valuation. Everything will obey the law of gravity. Excesses happen at both ends. I am happy at one end and unhappy at another. Why should I voluntarily choose unhappiness?


I am not going just by the stock market indices. Given that we have a market with over 450 companies that deliver a ROCE of over 15% on an annualized basis, there are enough companies to invest. However, when I scan each of them under a lens, I do not seem to find a ‘margin of safety’ anywhere. One has to have an exaggerated view of future performance and also pray that nothing will go wrong, in order to make even a 15% annualized return. Yes, there is tremendous volatility and there are huge price swings that will lure us to quick returns. However, given growth, interest rates, inflation and valuation, I will be happy to sit this one out. I will be happy to watch the action around me, keeping an eye on any opportunity that will come when the crowd becomes quiet. Sometimes, it pays to hunt alone.





Dilip Pendse, RIP

To those who did not know him, he was in a financial scam involving Tata Finance.

I first met Dilip in 1984, when he was working in a secretarial function in one of the Tata Companies, perhaps Indian Hotels. He helped me and my friends with a lot of introductions within the group and help us win some business. With Dilip, it was business first. He was fiercely loyal to his employers. I doubt if that loyalty every wavered, till two days ago.

During all the times we knew, he never asked us for anything in return. He was happy to see his friends get business on merit. Yes, probably we got some preference because he pushed, but never did he let us do a second best deal.

I lost active touch with him somewhere in the early nineties. I have followed the stories, with scepticism and grief. Grief because a man who devoted his entire life to one employer, was soon hounded by the same employer.

Dilip takes with him many secrets to the grave. Secrets that would hurt some people, who are possibly relieved at his unfortunate end.  Maybe he will be in a story telling mood when we meet him on the other side. He may have done something wrong and reckless. But I doubt he did it for any personal gains. Those who knew him and his lifestyle, will vouch for that.

Whatever he was, he remains, to me, a good man and a good friend.  It is unfortunate that he ended his life in despair and fear. Surely, the Gods above owe some answers for treating him the way they did.

There may be stories and debates about his alleged wrongs. I am happy to ignore them and say a prayer for his soul. Dilip, RIP.

Save or Invest?

(This appears in today’s Deccan Chronicle. Is there a difference between “Savings” and “Investment”? Maybe yes, maybe no. Drawing a distinction, helps you plan your finances better) Here is a link to the article http://epaper.deccanchronicle.com/articledetailpage.aspx?id=8421037 )

Many readers write in, asking for guidance on investing in to shares. Many want a short list of stocks that can be bought for the ‘long term’ or want some names for investing without any time scale in reference. A smaller number ask for names of mutual funds where one could invest. And of course, there are some who want to share the names of stocks they have invested and want a view on each.

Investing is a very personal choice. And everyone has his own risk appetite as well as knowledge of where they want to invest in to. Some of us know and understand the concept of equity mutual funds, some of us can talk about companies and stocks and some can even talk ratios and analyses.  Each one is bound to take a different path to investing his/her savings. For me, more important than the return, is to understand what I am investing in to. And personally, I will never invest in to a product that I cannot understand. For instance, while I may like to trade in shares, I will not touch the derivatives segment in the markets. I used to like the ancient ‘badla’ system on the BSE, but am extremely uncomfortable with the F&O segment. I do not understand it and hence will not risk any money in it.

All of us will either save or invest, so long as we have money to spare after meeting all our expenses. The object behind savings & investment is to keep aside our money till it is either needed by us for some future spend or we want to leave behind some wealth. We can save and invest during our ‘earning’ years.

My distinction between “savings” and ‘investment” is simple. Savings is that money which I keep aside for some emergency needs or unforeseen needs AND some known obligations that will be due in a period of five to ten years.  “Investment” is that money that is left over after my “Savings”. In other words, unless there is some emergency, I am never going to need that money.  Yes, once my investment grows to a sizeable sum, I may have plans to use some of it. However, this money is invested after providing for all my known cash outflows.

When I am putting away money for ‘savings’ I am conservative and will not risk my capital. I will keep my money in what is commonly known as ‘debt’ instruments (Fixed Deposits, Bonds, Liquid Funds etc). Here I have fixed commitments on anticipated dates. If I put it in stocks or derivatives or anything that is subject to market movements, my commitments could be in jeopardy. As an example, if I have a commitment of, say, Rs. One lakh payable in five years, I will start to put aside around Rs.1500 away each month in to a liquid fund. This will ensure that I have the lakh of rupees around the due date or before it. I cannot put 30K in a share today and calculate that at the end of three years, it will be 3X and so on. It is possible that it could be far higher than 3X or even lower. The company may do well, but the  stock market mood could be wrong. Or some economic factors would have changed and so on.

Thus, anything that is subject to fluctuation (shares, real estate, gold, diamonds etc) that cannot be predicted, cannot be in a basket of ‘savings’. It will be considered as ‘investment in my diary. This group is the one that causes most grief to folks out there. Many use the ‘investment’ option for short term play, including leveraged play and come to grief. When you are buying something with a view to selling at a gain in a short period, you are essentially trading in prices. In a short time frame, the earning power or the value of an underlying asset is not going to change fundamentally. What changes are just expectations. Thus, when you make a ‘trade’ you are expecting that you have boarded the train that still has some way to go. When your trade starts ‘working’ in a liquidity driven bull market, you feel that your investment IQ is high. The level of risk taking increases. Often, without knowing the product.

Thus, understanding risk is an important need. The other important thing is to identify our own wants. How long can we spare the money? What are our known commitments? Sustainability and longevity of our ‘earning’ is also equally important. All these will help you deal with Savings & Investments in an appropriate manner.


ANNUITY- In search of Income after work

(This was written in Moneylife, some time ago. Since the noise of the insurance salesman is never ending, I think you may like to form your views on annuity products.)

Annuity: Dead Investment?

Last week, I bought a retirement policy. All I need to do is keep up the payments for 15 years and my agent can retire
There is a lot of noise about annuities. And I am sure, you will be bombarded with agents and media who try to tell you how this product is great for you. Please understand what the product does and how it works, before you plunge headlong. An annuity is a long-term investment that is issued by an insurance company designed to help protect you from the risk of outliving your income. Through annuitisation, your contributions (what you pay) are converted into periodic repayments to you that can last for life. You could invest a lump-sum or invest over a period of time and start receiving payments immediately or at some later date.
Why should it matter whether we choose an annuity from an insurer or whether we directly invest the money ourselves and keep withdrawing monthly amounts? Here, the insurance company plays on your fear—that if you do it yourself, at some point, the money will get over, if you live too long. Or what you can get as income is not guaranteed forever, something that an annuity does. For example, if we keep a fixed deposit (FD) of Rs1 lakh, we can permanently keep getting an interest of, say, Rs8,000 every year. However, the uncertainty is that bank deposits are for a certain period, say, five or even 10 years. At the end, we will have to renew it at the rate of interest prevailing then. It could be higher than 8% or lower than 8%. So, we have to take a view. Human beings hate uncertainties. How about 6% forever? Or 5%? Insurance companies give you a lower rate on annuities, playing on this uncertainty in your mind. Plus they guarantee that the contracted amount will be paid to you for life.
In an FD, you can keep withdrawing the annual or monthly accruals and protect the principal which can go to your nominee. In an annuity, you generally do not have anything residuary, unless you choose a product that has a return of capital to the nominee on your death. In such cases, the annual payouts are also lowered by nearly 20% compared to an annuity that does not return any money on your death. And annuities are taxed in the hands of the recipients as income.
When we compare the option of no return of capital, there is no reason why we should go and seek an insurance company to pay us a fixed amount as annuity. We can simply keep it in an FD or a liquid mutual fund (MF) scheme and get far better returns. And, after three years, the withdrawals can be tax-efficient too in case of a liquid scheme. So, there is no way I will go and buy an annuity today. I am willing to live with the risk of falling interest rates. In fact, if you are short of your retirement date, you should aggressively put at least half the corpus into a ‘balanced’ MF scheme and half into a liquid scheme. Once you need to withdraw, you could work out a systemic withdrawal plan (SWP). Depending on your corpus, you could plan to just take away a part of the growth. Of course, if your corpus is small, and you are the worrying type, you may not have the luxury of taking the risk and it may actually make sense to buy an insurance annuity with no return of capital. That will ensure that you have some amount coming your way.
The ideal way to build up for your annuity is to keep investing in equities up to a year or two before the actual retirement date. By retirement, I mean the time where you stop receiving income other than investment income. If you must buy an annuity product, buy it a year or two closer to your retirement. Do not start investing in annuity products early in life. That is because you can make your money work better than any insurance company can.
If you have to buy annuities, buy it in doses. Start with the first dose after your earning cycle is over. This is because the older you are, the higher are the annuity payouts, since the expectation is that you are closer to death with each passing year. Thus, the annuity is structured in a way where the older you are, the higher is the payout. Just check out this page:
Notice the annuity payouts given on this page. They keep increasing with age. In other words, the later you buy the product, the higher is the annual payout.
There is enough evidence to show why we must save and why we should start saving early. My simple advice is that, when you start early, put larger amounts into equities. Whether you use the mutual fund route, or the direct equity route, is dependent on your temperament. Of course, I am presuming that each of us would be in a position to plan everything precisely. But, in real life, many do not plan and each person’s situation is different from those of others. If you save and invest well, most probably, you will end up with enough cushion. At the other extreme will be those whose circumstances push them to selling whatever assets they own and be at the mercy of their children.

Do ‘No Return of Principal’ Annuities Make Sense?

In cases where there is NO return of your principal, the annual payouts are less than 8%. It is like keeping a FD in a bank and you forfeit the FD to the bank, when you die. However, let us look at it differently. If you opt to keep a corpus in a mutual fund product like liquid schemes that gives a 5% annual compounded return, you can do a SWP (equal withdrawals each year, to exhaust the principal and accumulated growth over a specific period) which will give returns as under:
20 years—7.92 %pa (per annum) of your invested amount withdrawn in EMI style;
15 years—9.49%pa of your invested amount withdrawn in EMI style;
25 years—6.02%pa of your invested amount withdrawn in EMI style.
The LIC table shows an annuity for life equivalent at 9.35% if you are aged 60, and over 12%pa, if you are aged 70. So, here is a situation where an annuity gives a better pre-tax return. As of now, annuities are fully taxable. Whereas, in SWP of MF schemes, we do pay a very low tax on withdrawals after the third year, if we plan well. Also, if your liquid schemes pay higher, their returns are better than annuities.
Thus, I would not totally write off annuity products. For instance, if I am 70, the annuity is a good product, on the assumption that I will live beyond 80 or so. Of course, if I die in a year, the principal is gone. There is a trade-off on the uncertainty of life. For example, with the same corpus, an MF scheme will not give you 12%; but there is comfort that your heirs will get back the principal that you did not live to enjoy. The deeper you get into financial planning, it gets beyond numbers. A lot has to do with your temperament and comfort. However, temperament and comfort must be taken into account after financial literacy, not before. Financial choices make sense only after you fully understand all the product choices before you.

NPAs- ONE way to treat them

NPA. A very vexatious issue. What is terrible is that loans get written off or there is some Crony Debt Restructuring (CDR) and it is business as usual again. There are companies like Indo Count Industries etc where the banks have made sacrifices and all the upside after the loan waiver has been to the promoters.

My suggestion is that whenever there is a loan waiver, the banks should be issued a mix of Preference Shares and Equity Share Options at par equal in value to the amount sacrificed. The options could have a ten year expiry.  All these options can be pooled in to a separate investment vehicle that is managed by professionals in an SPV that belongs to the GOI. This will ensure that the the banks also get some share in the upside.

The preference shares can have a put option at the end of 3 years or so and banks can get it back. The preference shares should carry a dividend  and there should be a condition that preference dividend will get priority over equity dividend and the rate cannot be lower than the equity dividend. Similarly, if there are any stock splits or bonuses, or any other dilution, the bank must be compensated.

It is tragic to see the promoters laughing their way to riches after looting the public money from banks. As it is the public bear the brunt of farm loan waivers. While one could probably attribute that to socialism, this corporate debt write offs has a rich mix of fraud and corruption.

I know my suggestion will not be liked by the business community, but I am sure that any rational human being would support it.

Now, which side of the coin do the politicians, the PMO, the RBI fall? Are they on the side of the businessmen or are they rational?

Yes when there are genuine business failures, there is no impact. But this scheme would work like a pooled insurance. I recall the old days when the development institutions had a compulsory conversion clause for a part of the loan. This kept institutions like IDBI/IFCI alive for years beyond their practical death


(This appears in today’s Deccan Chronicle-  http://epaper.deccanchronicle.com/articledetailpage.aspx?id=8319913

We generally take it for granted that in good times, we can buy a rupee worth of tomorrow’s products, by paying more than a rupee today. As the noise escalates, so does our imaginary gains.. Then …)


Markets have reached a stage where nothing seems to deter a buying idea. Neither a dubious past, not dubious promoter seem to matter. The momentum in the small and mid cap space is so great, that a mere mention of a stock name on the social media is enough to set fire to its price. Everyone is a hero. And some serious investors too do not mind going along, as there is a big fear of ‘being left out’.


If I am an ultra HNI, with no financial worries, I can speculate on the thinnest of reasons. Losing some part of my money is not material to me. The excitement of always having to make a trade is sufficient compensation.


In this market, most of the ideas or recommendations that are now popping up, have the one or more of the following traits:


  1. Absurd valuations being justified by optimistic expectations;
  2. Poor quality of promoters overlooked and justified on price;
  • Commodity stocks getting valuations like pharmaceuticals used to get;
  1. Forgetting the debt on the balance sheets;



In general, the nature of trades that are being done now, put your capital at risk. You have to be absolutely swift in taking money off the table. In investing, there is something that is called as ‘potential’ rewards.  It generally is an inverse of popular sentiments. In other words, when I am buying at a high valuation in a bull market, my return depends on the same conditions persisting or improving when my stock has to be sold. Should sentiments turn, then price can be dented severely and even the recovery of principal can be a big issue.


Thus, it all boils down to risk management at a personal level. At this juncture in the stock markets, the risk reward is clearly unfavourable. It does not mean that you sell everything and go. Keep high quality in to your investment portfolio and treat the not so high quality as opportunistic trades. Play the market according to what you can afford. Also, remember, in the midcap space, buying is a lot easier than selling. When a small stock trades a couple of hundred shares a day, the price moves up rapidly when a few buyers emerge. On the flip side, when people want to sell, you will see the Lower Circuits in operation for many days.


So, how does one address the issue of investment risk in these uncertain times?


For the mutual fund investors, I would think that this is a good time to be in to Balanced Funds. The automatic cap on the equities will ensure better risk management. It will give you some upside of a raging bull market, while protecting you from a big fall. And I am not even betting on a decline in interest rates. If you are having to invest a large amount, I would urge caution. You may not always be lucky in the midcap stock that you buy. One way to check your risk in a new idea, is to see how the price of a stock has behaved over the last couple of years. If most of the rise has been in the last one year or so, then your potential upside is low. Most of the jump COULD have already happened. Yes, of course, there would be some exceptions, but I would still err on the side of caution.


Fundamentals of investment do not change. Valuations are a function of market moods and momentum. As an investor, I like to buy when things are to my advantage. I have yet to see any market that has run away forever. In the late 1980s, the Japanese stock markets ran away as if there was no tomorrow. The Nikkei (an index of Japanese stocks, like our Sensex) was in shouting distance of 40,000. Just have a look at where it is now. In nearly four decades, the index is nowhere near that peak. Of course, not every stock would have done it. But the odds are that most of the stocks would have followed a similar fate.


People tell me that I am too negative on the markets. I am simply paranoid. I see risk at every corner. I am happy to preserve my capital and put money when I am happy with MY assessment of risk and reward. Remember that if something loses half its value, it would have to double from there, to come to status quo (not to mention time value of money).