Stocks are for the wealthy

(This was written ten years ago. I had met a wonderful bunch of people at a seminar. It was an eye opener. These folks understood equities best. Not the average person, who ‘saves’ and is seeking to build his wealth from a single asset class. )

A Class ApartR Balakrishnan on saving  and  investing prudently
29 June 2010 0

Finally, I met a group of investors who were playing the market not to maximise their wealth, driven by greed—they were in it just to diversify their wealth portfolio

At most seminars on stock markets, I am struck by the fact that investor expectations always seem to border on greed. An interactive session on broader issues degenerates into stock-specific questions. However, a recent seminar I was privileged to address was a refreshing change. The crowd had a large number of active stock-market players and this was a gathering of what I would term as ‘wealthy’ people. All of them (barring the organisers, who were dressed in suits) were in casual attire. Clearly, comfort was more important than appearance.

Everyone in the crowd (which was more than 500 strong) had spare cash to invest. They had substantial wealth in real estate, gold, diamonds, fixed-income investments and shares. A few of them had chosen the mutual fund route as an additional avenue, but not as a first choice. They all seemed to prefer buying stocks. Questions did veer on to specific stocks, but they were aimed more at provoking the men on the dais who included a couple of ‘talking heads’ on business channels.

The older among the crowd had seen ups and downs, so they were more sensible about losing money in stocks. Many of them had large core holdings in frontline stocks plus speculative ones. Yes, they were all businessmen from the trading community. Some of them had also put money into the market through portfolio management schemes (PMS) and had mixed reactions to the route.

I did a straw poll of the audience and found that none of them had ever entrusted his/her wealth to a financial planner or a ‘wealth manager’. Financial assets are secrets which people do not wish to discuss with others. They were also upset by the fact that someone in the bank, other than the branch manager or the relationship manager, is privy to their financial data. They have learnt how to avoid these pests; a few of them have gone to the extent of just keeping an account alive with the bank in question, while moving most of the money to other banks.

A majority of them was into mid-caps. They focused on industries they had good knowledge about. For instance, a steel trader would look at his customers and their financial behaviour; their off-take of material, etc, would be a good base for him. There were a couple of people who focused very sharply on acquisition targets. Most of them spend a couple of hours or so every day on their portfolio.

They talk to more than one broker and keep track of their views. They have a list of favourite brokers as well as ‘contra’ indicators (brokers whose views have consistently been wrong).

Also, almost each one of them stayed away from derivatives. In fact, a younger member responded that derivatives trading was stressful and also said that it demanded deeper study and constant monitoring.

For me, all this was revealing. Here was a group of people for whom equity is another asset class; not the only one. None of them seemed to be unduly worried or impacted by the volatility in the market. More important, they got in prepared that they could lose their money. One of them was a late entrant into equities, having got in at the peak of 2008, but still active and working his way through 2009 and 2010 to recoup his losses.

The interesting thing was that someone tried to explain to them the merits of ‘Systemic Investment’ in equities. They brushed it aside, saying that it may have its merits for someone who keeps worrying about wealth. For them, equities were clearly beyond asset allocation. It was one more way to try and experiment with money. Equities were not their first line of defence in their wealth basket. Well, we may choose to disagree with their approach on the grounds that it may not be the optimum strategy to ‘maximise’ wealth, but they are a class apart; they do not need to keep score. As someone said, if you have to count your assets, you are not rich enough!

Inheritance- WILL is only part ONE

(This is a plug for an essential service. The wealth you accumulate for passing on to your heirs is at risk of running in to process risks, document deficiencies and lots more. Make sure that there is NO SLIP BETWEEN THE CUP AND THE LIP. Writing a WILL is only part ONE.

Property. Wealth. Assets. Loans. Receivables. Insurance policies. Demat accounts. Physical share certificates. Partnership interest. Gold. Jewelry. Bank Accounts. Single accounts. Joint Accounts. Foreign bank accounts. Foreign shares. Mutual funds. Fixed Deposits. Bonds. PPF account. Office provident fund. Gratuities Annuities. Life insurance. Nominations. Power of Attorney.

The mind gets numb enumerating what all we accumulate in our life time. If we were to exit the world tonight, we would leave behind a lot of chaos for our family members. And many times, we would also leave behind bitterness that will spoil relationship, spill blood and enrich lawyers and consultants.

When my father passed away, he did not even have a bank account to his name. When my father in law passed away, he had three company fixed deposits to his name, jointly with his wife. There was no accumulation. The rituals were done and life went on for the others as before.

Unfortunately, these kind of people are a rarity.

Most of us will end up life accumulating a lot of things.

MOST OF US WILL BUY SOMETHING and then move on to the next thing. We will be happy so long as we can enjoy unfettered ownership of our assets during our life time. Our worries stop with that and often, stop gap solutions are put in place. So what if there is not “Chitta” for the land? I am not going to sell it. And so on. We will keep rationalizing.

Once we stop breathing, we do not care what happens to our properties. Or do we? Do you want to give it to someone? Or let the legal heirs fight it out? Sometimes, properties can hang in limbo for more than two generations, because the documentation was not proper. And the documentation, title etc HAS TO BE SORTED OUT BEFORE YOU BREATHE YOUR LAST.

Writing a WILL is a good beginning. But then, you are not guaranteed a seamless transmission of your assets to your chosen beneficiaries, if the paperwork is not in order.

I would like to introduce to you, Rajat Dutta. We were colleagues at CRISIL, many years ago. He runs a company “Inheritance Needs Services Private Limited (“INSPL”). INSPL is guided by an eminent Board of Advisors – Mrs. Kishori Udeshi (Former Dy. Governor – RBI), Mr. Berjis Desai (Private Lawyer), Mr. Sanjay Kumar Bhattacharya (Former MD – SBI), Mr. P H Ravikumar (Founder CEO – NCDEX), Mr. Bobby Parikh (Former Head E &Y India) and Mr. Kenneth Andrade (Founder Oldbridge Capital) and able Mentors – Mr. Radhakrishnan Nair (Former Member Board SEBI & IRDA) , Mr. Tamal Bandyopadhyay ( Author and Financial Columnist) and Mr. Ashok Barat (Former MD of Forbes & Co. Ltd.).

IN SHORT, INSPL helps you with the dirty but most important leg of making sure that your ASSETS ARE SEAMLESSLY TRANSFERRED TO YOUR LEGAL HEIRS. You have to engage them professionally.  They will essentially make sure that all documentation, title deeds, tax papers etc are in order. They do not sell you any product. They can help you one time, or you can engage them till the transmission is completed. I think this is an extremely useful service that needs more mention and more push. Even when we are alive, we have to fight red tapes to get transfers done, taxes paid etc.

To use their language, they will assess the RISK in transferability of assets to your beneficiaries. They can guide you at each step, including pointing you to the right service provider for the right task. In case you have not written your will yet, it is probably the best time to connect with them, as they can guide you with the process, find you a lawyer, make sure that the creases in documents are removed etc. To borrow a phrase from LIC, they will be with you “Zindagi ke Saath and Zindagi ke Baad”.  (With you in your lifetime and also after your lifetime).

I have no personal stakes or interest in this business. However, this service is something that is absolutely a must in these days of fast paced life (lock down exempted) and the rat race where people keep accumulating things. And in this race, they forget that they are mortal.

You can check out their website at https://inheritanceneeds.com/  .  

Mutual Funds & DEBT(Spelt R ISK)

(This appeared in Moneylife in the issue of 16 April 2019. Sometimes, we ring a bell. It is lost in the noise. )

The World of Debt: How Unsafe Are Mutual Fund Schemes?R Balakrishnan
16 April 2019 14

Our mutual fund (MF) industry is a lazy one. Competition is driven by distributors who force the industry to compare daily returns on long-term products and forget the existence of ‘credit’ risk in debt products. We had faced such issues once during the 2008 crisis, when one fund house had to virtually close down because of the presence of ‘real estate’ commercial paper (CP) in its liquid schemes.

Liquid schemes lost their sanctity and, now, no one knows what a liquid scheme is.  The general expectation, until Lehman Brothers 2009, was that a liquid scheme will never result in a loss on the principal. It was made possible by investing in the ‘highest’ quality paper.

The madness in 2008 was such that many fund houses violated this norm. The endless chase for higher returns led to compromise on quality. And rating agencies also helped along, with their liberal approach.

In 2009, banks stepped in and a lot of rescue operations were undertaken. A few funds had to shut down its business in India and some fund houses lived in the shadows, for some time. However, most big losses were borne by ‘corporate’ investors where all the losses, ultimately, get passed on to the shareholders in the wash; so, the professionals who manage the treasury carried on life as if nothing had happened.

The same thing happened with the MF industry. After some early fears, the callous approach to risk, because they manage ‘other peoples’ money’, is back with a vengeance. Debt MF schemes are investing in ‘short-term’ paper of companies where the only hope is for ‘renewal’ of the debt. In other words, eternal debt is being shown as ‘short-term’ paper and being held in liquid schemes and short-term schemes. 

The regulator is hopelessly inadequate and we cannot expect too much from that office. Globally, the liquid schemes have a 5% cap per exposure (to a group) except for sovereign paper. Here, we relaxed it to 10%! And the bulk of the investments would be in NBFCs (non-banking finance companies), investment companies and holding companies.

Sadly, many MFs invest in ‘structured’ paper with less than Triple A rating. For instance, one of the defaulting papers that is held in many FMPs (fixed maturity plans) had a Single A(SO) rating! It is my strong belief that structured paper should not be permitted in ANY scheme for retail investors. And ‘Structured Ratings’ have no basis; they are just opinions based on past behavioural patterns. So, going for anything less than a Triple A is foolish. And that, too, surely not in any short-term or liquid scheme. And if a mutual fund has to invest in a structured paper, the only rating acceptable should be the highest one, from a minimum of two agencies. It is common knowledge that the differences between rating agencies are actually well known to the investing community. In spite of that, they compromise on quality.  

The main problem with credit risk is that the fund manager, fund house or the rating agency faces no material negative impact. Everything gets passed on to the sucker whose money is invested in these papers. As long as this does not change, we are unlikely to see any return to sanity that is of an enduring nature. Their goal is to increase the size of their assets under management (AUM). The distributor sells on the basis of immediate ranking and selling commission. ‘Direct’ investors go by past performance in terms of rates of return, etc. So, the whole thing is skewed in favour of the fund manager chasing returns by ignoring risk. 

FMPs were created to overcome the barriers placed on inter-corporate loans by the government. MFs act as the intermediary between the borrower and the lender, by creating a vehicle for this. The unfortunate part is that some bystanders (HNIs and other investors) get caught in this. Maybe the regulator can consider scrapping this altogether or restrict the scheme to corporate investors.  

There is need for a fix for this industry. Some thoughts come to mind:

1. Liquid Schemes – Should not hold less than Triple A rated securities, from the best of the credit rating agencies (there is a clear knowledge in the marketplace about the best and the worst); 

2. Ceiling per group exposure should be limited to 5% of AUM; 

3. No exceptions to the 5% rule except for Central government paper or T-Bills. State government papers should not be permitted in liquid schemes; 

4. A penalty system should be evolved – When there is a credit default and loss to the NAV (net asset value), a fixed percentage should be passed on to the AMC (asset management company). Maybe a minimum of Rs5 crore and a maximum of Rs100 crore should be fixed. This itself will make fund managers become credit experts overnight; 

5. No structured finance paper should be permitted in any scheme where there are retail investors. And, even where they are permitted, the minimum investment ticket should be Rs10 crore; 

6. Sector exposure should be capped at 5%;  

7. If there is any loss of NAV in a debt scheme, the AMC should be prohibited from accepting new assets in debt schemes for at least two years; 

8. ‘Unrated’ paper, or debt instruments without a credit rating, should not be permitted in ANY scheme.  

I find it amusing that banks invest in MF schemes. Their customers reduce their borrowings from the bank when they issue commercial paper. Then the bank goes and invests in an MF scheme which buys these commercial papers. So much of credit risk is hidden and the systemic risk multiplies. I do not know why banks should invest in lower yielding debt of the companies that game the system? If they have too much liquidity, they should pass on the benefits to borrowers rather than to the MF industry.  

Coming to the glamorous cases of fund houses that invested in debt papers of IL&FS (Infrastructure Leasing and Financial Services) entities, Zee promoter funding and several others (I am sure there are many more skeletons that have not tumbled out so far), there are two issues that disturb me. If the collateral was going down in value, why did they not pull the trigger and sell off all the shares? Under whose authority did they negotiate a default to be pushed as a ‘reschedule-ment’? There is a good scope for a class action suit against these fund houses who took the call on their own, without involving the investors.

The fund houses MUST pay a price. Letting them get away scot-free is denial of justice to the investors and sets a very bad precedent. Will SEBI act? Now, as an investor, think carefully. Is the extra 1% or 2% worth the risk? Even if the public sector banks (PSBs) are terrible, they are owned by a promoter who can use the printing press to honour commitments. Use fund houses for index funds or exchange traded funds (ETFs). Maybe liquid schemes. Beyond that, I do not see the need for MFs. I can do without any of their ‘Income’ or ‘Bond’ or ‘Balanced’ schemes. 

And one last point. One fund house has closed the scheme by paying out the proceeds of the scheme, except for the defaulted paper. IF the defaulted paper fetches anything, the proceeds will be given to the investors on realisation. I agree with this approach. I do not approve of a blanket extension of maturity. It gives me the feeling that there are more cockroaches in the kitchen. 

VALUATIONS TODAY

As I kept struggling to understand valuations, whether it be TESLA or whether it be Flipkart or Uber, I realised that it is not something new. Joseph Heller had seen this coming when he wrote Catch-22. He also must have inspired so much of accounting practices, that he deserves a place of merit in the Hall of Fame of Accounting Standards.

One of my favourites from Catch-22:

Yossarian was riding besides [Milo] in the co-pilot’s seat. ‘I don’t understand why you buy eggs for seven cents apiece in Malta and sell them for five cents’
‘I do it to make a profit’
‘But how can you make a profit? You lose two cents an egg.’
‘But I make a profit of three and a quarter cents an egg by selling them for four and a quarter cents an egg to the people in Malta I buy them for seven cents an egg. Of course, I don’t make a profit. The syndicate makes the profit. And everybody has a share.’
Yossarian felt he was beginning to understand. ‘And the people you sell the eggs to at four and a quarter cents apiece make a profit of two and three quarter cents apiece when they sell them back to you at seven cents apiece. Is that right? Why don’t you sell the eggs directly to you to eliminate the people you buy them from?’
‘Because I’m the people I buy them from’, Milo explained. ‘I make a profit of three and a quarter cents apiece when I sell them to me and a profit of two and three quarter cents apiece when I buy them back from me. That’s a total profit of six cents an egg. I lose only two cents an egg when I sell them to the mess halls at five cents apiece, and that’s how I can make a profit buying eggs for seven cents apiece and selling them for five cents apiece. I pay only once cent apiece when I buy them at the hen in Sicily.”In Malta’, Yossarian corrected. ‘You buy your eggs in Malta, not Sicily.
Milo chortled proudly. ‘I don’t buy eggs in Malta,’ he confessed, with an air of slight and clandestine amusement that was the only departure from industrious sobriety Yossarian had ever seen him make. ‘I buy them in Sicily for one cent apiece and transfer them to Malta secretly at four and a half cents apiece in order to get the price of eggs up to seven cents apiece when people come to Malta looking for them.’
‘Why do people come to Malta for eggs when they’re so expensive there?’
‘Because they’ve always done it that way.’
‘Why don’t they look for eggs in Sicily?’
Because they’ve never done it that way.’
‘Now I really don’t understand. Why don’t you sell your mess halls the eggs for seven cents apiece instead of for five cents apiece?’
‘Because my mess halls would have no need for me then. Anyone can buy seven-cents-apiece eggs for seven cents apiece.’
‘Why don’t they bypass you and buy the eggs directly from you in Malta at four and a quarter cents apiece?’
‘Because I wouldn’t sell it to them.’
‘Why wouldn’t you sell it to them?’
‘Because then there woudn’t be as much room for profit. At least this way I can make a bit for myself as a middleman.’
‘Then you do make a profit for yourself,’ Yossarian declared.
Of course I do. But it all goes to the syndicate. And everybody has a share. Don’t you understand? It’s exactly what happens with those plumb tomatoes I sell to Colonel Cathcart.’
‘Buy,‘ Yossarian corrected him. ‘You don’t sell plumb tomatoes to Colonel Cathcart and Colonel Korn. You buy plumb tomatoes from them.’
‘No, sell,’ Milo corrected Yossarian. ‘I distributed my plumb tomatoes in markets all over Pianosa under an assumed name so that Colonel Cathcart and Colonel Korn can buy them up from me under their assumed names at four cents apiece and then sell them back to me the next day for the syndicate at five cents apiece. They make a profit of one cent apiece, I make a profit of three and a half cents apiece, and everybody comes out ahead.’
‘Everybody but the syndicate,’ said Yossarian with a snort. ‘The syndicate is paying five cents apiece for plumb tomatoes that cost you only half a cent apiece. How does the syndicate benefit?’
‘The syndicate benefits when I benefit’, Milo explained, ‘because everybody has a share. And the syndicate gets Colonel Cathcart’s and Colonel Korn’s support so that they’ll let me go out on trips like this one. You’ll see how much profit that can mean in about fifteen minutes when we land in Palermo.’
‘Malta,’ Yossarian corrected him. ‘We’re flying to Malta now, not Palermo.’
‘No, we’re flying to Palermo,’ Milo answered. ‘There’s an endive exporter in Palmero I have to see for a minute about a shipment of mushrooms to Bern that were damaged by mold.’
‘Milo, how do you do it?’ Yossarian inquired with laughing amazement and admiration. ‘You fill out a flight plane for one place and then you go to another. Don’t the people in the control towers ever raise hell?’
‘They all belong to the syndicate.’ Milo said. ‘And they know that what’s good for the syndicate is good for the country, because that’s what makes Sammy run. The men in the control towers have a share, too, and that’s why they always have to do whatever they can to help the syndicate.’
‘Do I have a share?’
‘Everybody has a share.’
‘Does Orr have a share?’
‘Everybody has a share.’
‘And Hungry Joe? He has a share, too?’
‘Everybody has a share.’
‘Well, I’ll be damned,’ mused Yossarian, deeply impressed with the idea of a share for the very first time.

Made in China

Once again, a nationalistic fervour all around us. “Don’t buy Chinese”. The latest one after the skirmishes at the border. Let us look at the trade statistics.

India exports mostly a basket of primary goods to China, including cotton, yarn, organic chemicals, ores, natural pearls, precious stones, and fabrics. Chinese imports into India include electric machinery, electronic equipment, nuclear reactors, boilers, solar energy components and APIs (active pharmaceutical ingredients), plastics, etc. (https://www.hindustantimes.com/india-news/mapping-china-s-large-trade-footprint-in-india/story-3fIpfOfG1BAN6JMRIboKoI.html)

The annual ‘trade’ deficit with China is over $50 billion. Of course it will be lower this year due to lower industrial activity.

It is in this context that we have to see what we are up against. Look at our exports to China. Just commodity exports. And imports? High technology, capital intensive, speciality chemicals, bulk drugs for pharmaceuticals etc. We, as domestic consumers are vulnerable like never before, should trade wars begin. It is easy to be dismissive and say that we only get ‘cheap’ and poor quality products from China. In many cases, we have ceased making things as the industries ran out of steam in competing on price.

I look at Japan. From a humiliated nation in 1948, they gradually built up capabilities to make everything and also sell it to the world. When the world started putting quotas on their exports, they went in to those nations and set up factories there. And they also managed all this as the Yen was strengthening from over 250 yen to the dollar to under 125 Yen to the dollar. There was political will and Long Term thinking. The MITI (Ministry of International Trade and Industry) of Japan is credited with the rise of Japanese industry from the ashes to clocking a compound growth of near ten percent from 1952 to 1971. There is also another perspective that can be found here https://www.econlib.org/library/Enc1/JapanandtheMythofMITI.html

It was possible only because business and government worked in tandem. China’s success story is also amazing. Japan achieved their growth with a democracy. China falls short on that. They have probably used economic conquest of the world as a way to territorial growth. Today, they are investing globally and owning so many businesses and infrastructure across the globe. China investors own so many companies in India now! So the boycott of China is not all that easy. Will you shut down these companies?

We are yet to get to our starting block. Infrastructure, capital, cost of money and work ethic. These are the hurdles to be overcome. Impossible? We will not know unless we put our shoulder to the wheel. Focus on the next fifty years. Subsidies can be meaningfully structured like China did or Japan did.

We need a think tank approach. One of the important things is that the policies should be firm for the fifty years. Not changed every year. The biggest confidence that business need to commit more capital is continuity of policy. A taxation policy that is fair and simple. A taxation law that can be hypothetically put in to ten or twenty pages. And a lot of integrity from businesses, service providers and the government officials is called for.

We can debate till the cows come home. The important thing is to bring manufacturing to India. We need inputs and infrastructure that is comparable to China.

It is useful to share a Whatsapp forward here . I do not know if it is true or false. But it gives us an idea of what we are up against:

EXPERIENCE OF INDIAN MANAGEMENT IN CHINA

I am the Vice President of a medium sized Indian corporate . We are one of the largest manufacturers of Drum Closures in the world. These are a closing devices used in the manufacture of 200 litres Steel drums. It is a very high precision engineering product. We are also one of the largest manufacturers and exporters of scaffolding system out of India. These are also highly engineered precision products.

It is a common practice in these days in the business circles to compare India and China in almost all spheres . In every forum or platform the discussion inevitably veered around China – India comparison. In this article, I want to share the experience of starting and operating business in China . You may make your own comparison with the conditions in India based on your own experience . I am a patriot to the core and am no fan of China . However the business and economic considerations compelled our group to consider putting up a factory in China for producing drum closures and scaffolding for Chinese and international markets. We considered the availability of cheaper raw material, highly productive labour, very low logistic cost and good sized domestic market in China as the reasons enough to invest in a factory in China.

We were aware about volatile Indo-Chinese relations and the risk involved in operating in China. They have some typical laws and their legal system tend to favour Chinese . We had developed high level of indigenous manufacturing technology which is economic and competitive. There was also fear of Chinese learning and copying our technology. In spite of all these fears we decided to go ahead by taking reasonable precautions. We decided not to take any Chinese partner. Apart from the fear of loss of technology there is also a law in China that Chinese citizen holding minority interest also has a veto power in the company. Hence we decided to go on our own.

In 2006 we started searching for a suitable location. We wanted to be close to East Coast but in a location where the labour was cheaper than the developed eastern provinces and the laws permitted generation and disposal of effluent.

In 2008 after many discussions and considerations we located an Industrial Zone Quanjiao in a small town about 50 km west of Nanjing which met most of our requirements. After obtaining initial information about the zone, we decided to meet zone authorities personally and to see the area . I and one of my colleagues reached the zone office in the morning at about 10.00 AM. To our surprise we found that the zone authorities had made elaborate arrangements to welcome us. Local party chief and few other senior officials were also present . We felt awed and nervous. We told the zone head that we had visited only for a survey and do not have a plan to sign any deal. The zone chief informed very politely that they were sure that we would be satisfied with the land and the conditions.

They then explained their proposals and showed various sites in the zone. After we showed our interest in a piece of land they made a final offer which was substantially more attractive than the offer made in the mail earlier. We asked for few more facilities which they readily agreed and after about 4 hours the deal was signed. We were amazed at their helpful and cordial approach all through the discussions and their determination to get first foreigner to invest in their industrial zone.

After signing a short MOU , we informed them that we need to go to Nanjing and speak to a lawyer to form a company. The zone chief mentioned that if we have trust in them they would form the company with all approvals free of cost. By this time we had already started trusting them and agreed to their proposal. They had also got a local Bank Manager with all the necessary forms for opening the bank account. All this in a day’s work!

Within a week we got company registration with the name and registration number and the company documents were given to us within 2 weeks. The bank account was opened within one week thereafter. Hence within less than one month we were able to buy the land with all the registration and approvals and also open the bank account.

One officer in the zone was nominated to give us all the required assistance. We mentioned about the need for an architect. Promptly he gave us names of about 5 architects who were already active in the zone. After some discussions with architects we finalized one from Nanjing and gave him details of the building requirements. We once again approached the officer of the zone for help to find some contractors for construction. Within one day he give list of 8 or 9 civil contractors who were doing construction activities in the zone. We floated the enquiry to all the contractors and finalized one of them.

The building was constructed in about 4 months and in 6 months time we were able to start the production. In my last 30 years of experience in India I have yet to see a factory starting within 6 months.

We have been in production for last 10 years and are quite satisfied with our working in China. I would now like to share some of my experiences of operation in China.

1) Even though the labor wages are higher than India, the cost per piece works out to be cheaper because of high productivity of the labor.

2) The zone we selected is located in a small town with a population only about 1,50,000. The zone was also one of the most ordinary typical industrial zone of China. In spite of this the internal road of the zone are wide, concreted with shady trees on both sides, good landscaping and very clean and organized. The zone offer 5 basic services of providing electricity, water and sewerage connections at the factory gate, levelled land and road connectivity. I have yet to see an industrial estate of similar quality and services anywhere in India.

3) The workers are provided free lunch every day by the company. This is the common practice in China.

4) Every year during Chinese New Year all the business in China remain closed for 10 days. Apart from these there are few holidays during Labour day in May ,National Day in October , Dragon boat festival in June. There is no PL,CL system.

5) The factory laws in China is very well defined and there is no room for any discretion. The 5 star Insurance is compulsory for each and every employee which covers Endowment , Accident ,Unemployment , maternity/paternity and hospitalization . For the compensation for injury during working is well confined depending on the nature of injury. The compliance of factory rules are done once at the time completion of construction and then there is no further inspection. In fact during our more than 10 years operations we do not have any inspector visiting our factory for any reason.

6) We submit VAT returns online every month and every month our VAT refund due is credited. There is no human interaction or any failure. In fact no one can issue Invoice which they call Fapio with their own logo or style . Each and every seller has to by pre-printed Invoice/Fapio from the Sales Tax department and can issue only those Invoices to their customers. Seller has to buy one devise from tax department which gets connected between computer and printer and data gets transferred to tax department automatically.

7) There is a very high degree of safety and security and there is no theft.

8) There are no aggressive unions. In fact the wages and benefits are well defined and there are no negotiations. The working is peaceful. There is no political or bureaucratic intervention. After every Chinese New year, our area’s Mayor visits our factory with entire HOD of departments like Electricity ,Labour,Zone etc. to discuss on any issues if faced by us.This is amazing.

9) All the government offices are fully accountable. If any application for any license or permit is not settled in 30 days then the same is deemed to be approved.

10) In spite of Indo-Chinese tensions from time to time due to situation in the borders the Chinese workers and staff are very cordial and friendly. They are all aware about the tensions but it has not affected our or any other Indian establishment.

11) There are no other taxes or dues except VAT, Income Tax, Custom Duty and local taxes. These are all well-defined and there is no room for disputes. All assessments are done online.

12) The government of China response very quickly to changing international situation. For example when President Trump slapped 10% Custom Duty on Chinese products, within one week government of China increased the VAT rebate by 4% and also devalued their currency . Thereby nullifying the custom duty in US and at the same time making Chinese goods more competitive in the rest of the world. This is their usual speed of response.

These are some of cuff observations of operating in China. Clearly China has unmatched ease of starting business as well as ease of doing business. It is because of this combination that the invisible transaction cost are almost NIL in China. This propagates downstream and upstream giving over all competitiveness to the Chinese products.

If the Government of India follow the China model of ease of starting business and doing business then I am sure India can overtake China as world manufacturing hub because intrinsically Indian entrepreneur is more seasoned, matured and experienced than Chinese counterpart.

JAI HIND !!!


Best Regards,

xxxxxxx nnnnnnn Vice – President
cvxxxxxx Industries (India) Ltd.”s

Boycotting China is not a solution. That is accepting defeat. We have to begin an Industrial revolution that will win a trade war with China in fifty years. Fifty years is y a short time in the history of a nation.

Corporate Governance? What is it?

(This was written in 2008 to celebrate Satyam)

A VIEW FROM THE SCEPTIC TANK

Corporate governance is an oxymoron. Business is done with a view to acquiring power and wealth and if short cuts have to be taken, they will be. This is true not just of Indian companies, but of companies worldwide. It is all a question of degree and not one of principle.

Let us take the beginnings of any company that is family founded. If you try and go back to the beginnings of how the promoter got to build up his capital, subscribe to rights issues and keep up his lifestyle when the directors’ salaries were restricted by Companies Act to a measly sum, it will tell you stories about how companies’ wealth got diverted to promoters and professionals in power. So, do not delve too deep. You will not invest at all. In today’s context, the call you have to take as an investor is about whether the promoter will leave anything on the plate for you. In good times there is enough gravy to go around, so you will not feel the pinch as “shareholder”. It is when the bad times roll, when promoters are compelled to maintain their lifestyles that you end with the short end of the stick.

Family owned companies undertake corporate restructuring to accommodate family members. Professionally managed companies with no distinct owner, often use the company as a tool to attain personal ambitions. There is no structure that guarantees “corporate governance”.

Whether it is something as small as using the office telephone for personal use or taking commissions on purchases, there is only a question of degree of “dishonesty”. Or like making the companies buy a private aircraft for use by the top echelon at shareholder expense. It is established that corporate governance in its pure form cannot exist anywhere in the world. Sometimes, the extent of transgression can be as subtle as a banker denying a loan to a friend’s competitor or something as brazen as a set of “professionals” hi-jacking the company from its shareholders. I have often seen cases of unrelated diversifications, which have been undertaken, merely to cater to some personal fancies of the promoter.

Therefore, it is best that one accepts as a fact that corporate jiggerypokery is a way of life and every one is snow white, unless caught with his hand in the cookie jar.

Practices such as quarterly earnings and stock options have contributed a lot for encouraging corporate dishonesty,. Pressure to deliver quarterly results makes the management sacrifice longer term interests. Stock options are a very deceptive form of stealing from the shareholders, whatever is the legal position. In good times, the stock options always get exercised and in bad times it does not. A lose-lose for the shareholder in either case. You have only to see the recent annual report of a media company, where the notional “cost” of stock options exceeds the operating profits! The ideal situation is that stock options must be granted before the company goes public. Having gone public, there should be no dilutions on this front. The way out would be for the company to create a separate trust which can buy from the secondary market and then grant ESOP’s out of that. This way, the costs are also truly reflected and the shareholder is not surprised.

One important fact that encourages corporate dishonesty is the total lack of punishment for white collar crimes. Apart from the delays and the lack of professional competence required to establish the crime, the penalties are too tiny. Often, the penalty is on the company and not on the directors/managers! Recently, there was an announcement that any company that makes losses for more than three years would get de-listed! Why penalize the shareholder?

Similarly, there is this whole game of “preferential offers” and issuance of warrants to promoters which the law permits but hurts the minority shareholders. A fair way to go about the preferential offers would be to resort to a ‘rights’ issue and if the minority shareholder does not take it on, then go to the private placement route. If the government is serious about Corporate Governance, then the first thing to do would be to stop this shareholder abuse.

I see seminars on corporate governance being sponsored by companies that do not practice it; I see high corporate governance ratings for companies that are extremely low on the same. Perhaps the rating agencies are being practical. So long as you are leaving something for the shareholder and the creditor, everything is hunky-dory!

In a raging bull market, fund managers and investors tend to ignore the factor of “honesty” whilst investing. Companies that they had avoided in bear markets due to management issues, become hot favourites in bull markets. The answer is simple. These managements are more interested in rigging up the share price, so now they become the desired investments for a fund manager.

World over, white collar crime is tolerated by regulators, with punishments being very mild. So, it is really a matter of “cost-benefit” analysis whilst doing a white collar crime and nothing more. One only has to go through cases like Enron and the list of entities involved includes the so called “best” names in the financial services industry. The western world also has something interesting called “compounding”. Frequently, we come across the term “xyz paid an amount to the Securities Exchange Commission, without admitting or denying guilt’. How wonderful! Or does it mean that there are some “offences” which carry a price tag in dollar terms and nothing more? No wonder, we have also adopted this in our legislation of capital markets! Or we have scores of American Companies “restating earnings”. This is but another way of saying “we lied to you”! Now there is a raging debate on whether the Sarbanes Oxley guidelines need to be diluted to bring more business to USA. This by itself shows that governance is secondary to commerce!

There is also this new fad for “independent” directors having to be appointed on the Boards of companies. Do you think that any promoter will appoint someone on the Board who he thinks will be a nuisance? Let us get real. No director can be truly independent. And if the law imposes too much burden and liability on the independent director, no one would want to be one. Business is about networking and relationships. In this space, there is no tolerance for anyone trying to act “inconvenient”. At best, an independent director can protest against “daylight” robbery. We have yet not seen any “independent” director coming out and blowing a whistle.

How do we use this in our investment philosophy? If you want to stay long term with a company, then focus on its Management quality. However, for short term speculative opportunities look for managements with a “past” and gamble on them. Maybe you will lose your shirt, but there is also a chance that you could hit the jackpot. Also, if you at all want to invest in equities, do not worry too much about this aspect. After all, the promoter also has a vested interest in the stock price. Maybe the ride quality for him and the investor are different, but the destination ought to be the same!

In the recent Satyam case, institutional shareholders have forced the management to give up its ghost. I hope that there is similar fervor when it comes to mightier companies. Maybe the legal framework will get more protective of the non-promoter shareholder. However, as the old saying goes, “Wall Street writes the rules”. It is very difficult to envisage a legislation that can hurt promoters getting cleared.

Remember, it pays to be a skeptic, so that you never get disappointed.

Lessons from Warren Buffet on Investing in Equities

Warren Buffett is truly a great teacher. He has simplified investing for everyone. Alas, we never learn. We read, get energised and then straight away shoot for something without thinking. Courtesy an internet forward, here is the essence of his approach

A checklist for the stock selector; the Warren Buffett criteria:

Is the business simple and understandable?

“An investor needs to do very few things right as long as he or she avoids big mistakes.” Above-average returns are often produced by doing ordinary things exceptionally well.

Does the business have a consistent operating history?

Buffett’s experience has been that the best returns are achieved by companies that have been producing the same product or service for several years.

Does the business have favourable long-term prospects?

Buffett sees the economic world as being divided into franchises and commodity businesses. He defines a franchise as a company providing a product or service that is

(1) needed or desired,

(2) has no close substitute, and

(3) is not regulated. Look for the franchise business.

Is the management rational with its capital?

A company that provides average or below-average investment returns but generates cash in excess of its needs has three options:

(1) It can ignore the problem and continue to reinvest at below average rates,

(2) it can buy growth, or

(3) it can return the money to shareholders. It is here that management will behave rationally or irrationally. In Buffett’s mind, the only reasonable and responsible course is to return that money to shareholders by raising the dividend, or buying back shares.

Is management candid with the shareholders?

Buffett says, “What needs to be reported is data – whether GAAP, non-GAAP, or extra-GAAP – that helps the financially literate readers answer three key questions:

(1) Approximately how much is this company worth?

(2) What is the likelihood that it can meet its future obligations? and

(3) How good a job are its managers doing, given the hand they have been dealt?”

“The CEO who misleads others in public may eventually mislead himself in private.” Does management resist the institutional imperative?

According to Buffett, the institutional imperative exists when “

(1) an institution resists any change in its current direction;

(2) just as work expands to fill available time, corporate projects or acquisitions will materialize to soak up available funds;

(3) any business craving of the leader, however foolish, will quickly be supported by detailed rate-of-return and strategic studies prepared by his troops; and

(4) the behaviour of peer companies, whether they are expanding, acquiring, setting executive compensation or whatever, will be mindlessly imitated.”

Is the focus on Return On Equity?

“The primary test of managerial economic performance is the achievement of a high earnings rate on equity capital employed (without undue leverage, accounting gimmickry, etc.) and not the consistent gains in earnings per share.”

What is the rate of “owner earnings”?

Buffett prefers to modify the cash flow ratio to what he calls “owner earnings” – a company’s net income plus depreciation, depletion and amortization, less the amount of capital expenditures and any additional working capital that might be needed. Owner earnings are not precise and calculating future capital expenditures requires rough estimates.

Is there a high profit margin?

In Buffett’s experience, managers of high-cost operations continually add to overhead, whereas managers of low-cost operations are always finding ways to cut expenses. Berkshire Hathaway is a low-cost operation with after-tax overhead corporate expense of less than 1 percent of operating earnings, compared to other companies with similar earnings but 10 percent corporate expenses.

Has the company created at least one dollar of market value, for every dollar retained?

Buffett explains, “Within this gigantic (stock market) auction arena, it is our job to select a business with economic characteristics allowing each dollar of retained earnings to be translated into at least a dollar of market value.” What is the value of the business?

Price is established by the stock market. Buffett tells us the value of a business is determined by the net cash flows expected to occur over the life of the business, discounted at an appropriate interest rate, and he uses the rate of the long-term U.S. government bond.

Can it be purchased at a significant discount to its value?

Having put a value on the business, Buffett then builds in a margin of safety and buys at prices far below their indicated value.

We will do well to revisit the basics, form our checklist for picking up stocks

MID CAPS- The bitter sweet segment

(An article on mid-caps- from 2014. This may be the time for some risk-reward games)

HIGH RISK HIGH REWARD GAMES

People often ask me about what is wrong in investing in small company stocks? By small, I mean ‘small’ in terms of market capitalisation. Market capitalisation is the price of each share multiplied by the number of shares issued. For example, as of close of 22nd July 2014, the Bombay Stock Exchange had 3,232 scrips that were ‘traded’ (or where a price was available). The total market capitalisation of these companies was Rs.91,02,473 crores if we used the closing prices of that date. Interestingly, the 100 largest companies accounted for Rs.67,81,963 crores. In other words, three percent of the number of companies accounted for nearly three fourths of the size of the market!

Why does liquidity in a stock matter? Liquidity has a direct impact on the tradable prices of a share. You may assume that once you see a price on the exchange, you can buy or sell reasonable quantity of the stock at that price. Nothing could be farther from the truth, if the stock is not liquid. Less than a hundred stocks will meet that qualification.

What would be a reasonable quantity? For a FII it could be a million dollars ( or Rs.6 crores), for a domestic mutual fund it could be around Rs.50 lakh and for an individual it could be, say, a lakh of rupees.  So, can one buy or sell ‘reasonable’ quantity of a stock at the indicated price? If the answer is positive, then you could say that the stock is ‘liquid’.  Most often, if you exclude the top fifty stocks, the price you pay/receive will not be what is quoted on the screen. You will end up paying a higher price if you are a buyer and get a lower price if you are a seller. That is the ‘impact’ cost of your trade. The poorer the liquidity, the higher the impact cost of your trade.

So, if you are trading for a few rupees, this hurts you badly. So you will see that the day traders generally flock to the large liquid scrips. Poor liquidity is also the reason why it is easier to manipulate prices in smaller company stocks. A large buying by a group of seemingly unconnected people is sufficient to drive prices higher and higher, when the stock is illiquid. Often, the smart operator first accumulates a stock, then issues a recommendation to buy and provides supplies at gradually increasing prices. Once someone creates a buzz in a stock, the price of such a stock moves with huge jumps making each buy more and more expensive.

The negative side is that when the sentiment turns against the stock, the bottom seems to fall out of the stock. The stock keeps hitting the lower circuits with not much volume and we could get stuck with a stock where stop losses and sells do not work. All theories go out of the window, when such a fall happens.

Thus, if you decide to buy or sell a stock that is not liquid, you have to plan for properly. You cannot invest or trade in this for a small return like ten percent. The impact cost of buying and selling could easily take away ten percent! Probably you will have to buy early and sell early also. You cannot wait to sell at the highest possible price because if the selling starts, you will be unable to execute a trade except at a huge disadvantage.

The tough part is that if you are seeking big winners, they are hidden within this group. The large well known names may offer you average to above average returns, but if you want a kicker, it would be from this universe of illiquid stocks. Thus, I would not ignore this space. However, I will also not put all my money in this space. And keep looking for longer term buy and hold stocks.

In a bear market, this illiquid segment becomes very illiquid and as sentiments keep improving, volumes in this segment keep getting better. As a contrarian, it makes sense to buy illiquid stocks when the bottom is falling off the market and sell when everyone wants to buy. As far as I am concerned, it is a good time to get rid of some of these stocks.

(This article appears in today’s Asian Age/Deccan Chronicle)

SAFEGUARDING THE RETAIL MF INVESTOR

The mutual fund industry has a deep structural flaw. The participation of institutions and corporates as investors in the fund is a disaster. They are quick movers and are disruptors of the entire investor community in mutual funds.

A retail investor, typically stays invested for long. If a fund were to be packed with retail investors ONLY, it would typically keep growing in size as more and more individuals pour their savings in to mutual funds.

Letting corporate investors in has also led to a lot of ‘investment’ banking activities in the Mutual Fund. They have become pass-through vehicles for inter-corporate loans, by-passing ‘related party’ transactions, promoter funding, builder funding etc.

I would urge SEBI to ensure that Retail and non-retail are segregated. There is no way the companies can be kept out given their lobbying power. However, the retail can be ring fenced. Make sure that there is no inter scheme nonsense between retail and non-retail.

In debt funds, the non-retail can smell trouble. They will be first in the redemption queue. To meet this, the fund will sell the most liquid and the one that fetches the value as per book. So what will be left would be less liquid assets and assets that will not fetch the ‘book’ value. The non-retail benefits at the EXPENSE of the retail.

The distributors and IFAs should put pressure on the MFs to start this immediately. SEBI can do this at a day’s notice. MAKE SURE THAT ASSETS ARE SEPARATE AND NOT CO-MINGLED.

It is not too late. DO IT NOW.

Non-retail money is HOT money. Keep them in a separate basket. Give respect to the retail investor who is the sticky customer

When days have 24 hours and time is suspended

(this was on my blog a few years ago. Seems more relevant in these days of lockdown..)

Time and the Machine, by Aldous Huxley

(Nick’s Notes: Taken from here. This brief writing by Huxley is not explicitly anti-work but it has some useful and interesting commentary on how work and time cooperate with each other to reinforce a lack of interest in anything else.)

Aldous Huxley

 

Time, as we know it, is a very recent invention. The modern time-sense is hardly older than the United States. It is a by-product of industrialism – a sort of psychological analogue of synthetic perfumes and aniline dyes.

Time is our tyrant. We are chronically aware of the moving minute hand, even of the moving second hand. We have to be. There are trains to be caught, clocks to be punched, tasks to be done in specified periods, records to be broken by fractions of a second, machines that set the pace and have to be kept up with. Our consciousness of the smallest units of time is now acute. To us, for example, the moment 8:17 A.M. means something—something very important, if it happens to be the starting time of our daily train. To our ancestors, such an odd eccentric instant was without significance  –  did not even exist. In inventing the locomotive, Watt and Stevenson were part inventors of time.1 [emphasis mine]

Another time-emphasizing entity is the factory and its dependent, the office. Factories exist for the purpose of getting certain quantities of goods made in a certain time. The old artisan worked as it suited him with the result that consumers generally had to wait for the goods they had ordered from him. The factory is a device for making workmen hurry. The machine revolves so often each minute; so many movements have to be made, so many pieces produced each hour. Result: the factory worker (and the same is true, mutatis mutandis, of the office worker) is compelled to know time in its smallest fractions. In the hand-work age there was no such compulsion to be aware of minutes and seconds.

Our awareness of time has reached such a pitch of intensity that we suffer acutely whenever our travels take us into some corner of the world where people are not interested in minutes and seconds. The unpunctuality of the Orient, for example, is appalling to those who come freshly from a land of fixed meal-times and regular train services. For a modern American or Englishman, waiting is a psychological torture. An Indian accepts the blank hours with resignation, even with satisfaction. He has not lost the fine art of doing nothing. Our notion of time as a collection of minutes, each of which must be filled with some business or amusement, is wholly alien to the Oriental, just as it was wholly alien to the Greek. For the man who lives in a pre-industrial world, time moves at a slow and easy pace; he does not care about each minute, for the good reason that he has not been made conscious of the existence of minutes.3

This brings us to a seeming paradox.2 Acutely aware of the smallest constituent particles of time – of time, as measured by clock-work and train arrivals and the revolutions of machines – industrialized man has to a great extent lost the old awareness of time in its larger divisions. The time of which we have knowledge is artificial, machine-made time. Of natural, cosmic time, as it is measured out by sun and moon, we are for the most part almost wholly unconscious. Pre-industrial people know time in its daily, monthly and seasonal rhythms. They are aware of sunrise, noon and sunset, of the full moon and the new; of equinox and solstice; of spring and summer, autumn and winter. All the old religions, including Catholic Christianity, have insisted on this daily and seasonal rhythm. Pre-industrial man was never allowed to forget the majestic movement of cosmic time.

Industrialism and urbanism have changed all this. One can live and work in a town without being aware of the daily march of the sun across the sky; without ever seeing the moon and stars. Broadway and Piccadilly are our Milky Way; out constellations are outlined in neon tubes. Even changes of season affect the townsman very little. He is the inhabitant of an artificial universe that is, to a great extent, walled off from the world of nature. Outside the walls, time is cosmic and moves with the motion of sun and stars. Within, it is an affair of revolving wheels and is measured in seconds and minutes – at its longest, in eight-hour days and six-day weeks. We have a new consciousness; but it has been purchased at the expense of the old consciousness.