Low brokerage alone will not bring investors

My interview in Business Line yesterday. Since this is based on a face-to-face interaction, I have been quoted in brief. I am reproducing the article with some additions to clarify what I mean:

The regulator has made a major disservice by making exchanges ‘for profit’ organisations. — Anand Tandon, CEO, JRG Securities 

The Government and capital market regulator SEBI’s effort to attract retail investment in equities has had little impact. Retail investors have incurred huge losses in the last few months. Even as broking firms are trying to woo retail investors with low brokerages, exclusive research reports and stock recommendations, the wild swing in the stock market has scared retail investors. The capital market is dominated by foreign institutional investors and domestic institutions, and needs a major overhaul to gain investors’ trust, says Anand Tandon, CEO, JRG Securities, in an interview with Business Line.  

Excerpts:

Why are retail investors shying away from market?

It is actually a simple problem, but also extremely complex. It is simple, because an investor will invest if there is a chance of making money. If eight out of 10 times he makes money, the possibility of losing twice is acceptable. On the other hand, if you loses eight times and make money just twice it is not acceptable, even if you hit a jackpot twice and cover up all the losses. Essentially, retail investors have not made money.

What has changed dramatically for small investors in the market?

Intense competition. In fact, the regulator has made a major disservice by making exchanges ‘for profit’ organisations. The original function of exchanges was to provide people access to capital. As opposed to that, today, as a ‘for profit’ organisation, exchanges provide liquidity pools. In the process, they create their own transaction charges. With new exchanges coming in, there is no proportionate increase in liquidity. The liquidity pool is getting divided. So, there is more and more illiquidity.

What is the impact on market intermediaries?

The competition among exchanges will have a trickle-down effect on market intermediaries. Some 20 years ago, one had to shell out Rs 4.5 crore to become a BSE member. Today, you do not even need Rs 45 lakh. An investment of Rs 4.5 crore would have become Rs 20 crore, even if it was invested in a safe product. But by bring in more exchanges, you have to pay Rs 10 lakh deposit, and become a trading member. Essentially, my investment of Rs 4.5 crore 20 years back, is equivalent to Rs 45 lakh today.The entry barriers are lower, resulting in poorer quality of new members

But competition is good for investors …

It is true to a certain extent. However, If there is such a plethora of intermediaries in the market, clients will be induced to trade more. Effectively, the market will become more short-term in nature. Providing a quality service will become a big challenge. If my competitor is willing to provide a trading account for free, I will need to match it. Of course, the compliance cost has gone to the roof.

We have to provide the infrastructure, dealing terminals, telecom backbone, and watch through every trade and keep records for eight years. The return I get is decided by the next door mom-and-shop competitor. I feel we have got into this vicious trap of over capacity. Consequently, brokerages have gone to the suboptimal level. There is no incentive for providing advisory services which will benefit investors.

What is the remedy?

In the interest of banks, the RBI can restrict banks from competing on certain services offered by them. Public insurance companies are not allowed to under cut. The Aviation Ministry, which has no business of regulating tariff, can express its concern to airlines about under cutting prices. Why does SEBI not monitor the fees charged by intermediaries, so that service quality is maintained?

Lower charges are beneficial for investors. Isn’t it?

No, not always. Take the case of the power sector. All the companies have bid the lowest price at which they can supply the power. Now, they are struggling to fulfil their commitment. Lowering brokerage charges alone will not bring retail investors back. There was a time when you could not charge more than 2.5 per cent.Now, even 2.5basis points is difficult to retain. Development of the market cannot be done in the absence of intermediaries.

A homage

Today is a sad day in India’s history. A young girl lost her life having faced the bestiality of a group of animals in the form of Man. Unfortunately, she was not alone – it is an all too frequent issue in our country. Action needs to be taken against all who were responsible, including those in power. But that can wait for another day. Ghalib wrote a poem when his cousin Arif died young. I take his words to pay my homage to the one who died. 

Aaye ho kal aur aaj hi kahte ho ki jaaun mana ki hamesha nahi acchha koi din aur Jaate hue kahte ho qayamat ko milenge kya khub! qayamat kaa hai goya koi din aur Tum kaun se the aise khare dad-o-sitad ke kartaa maluk ul-maut taqaaza koi din aur Haan ay falak-e-piir, jawan tha abhi arif kya tera bigarta jo na marta koi din aur

आये हो कल और आज ही कहते हो कि जाऊं माना कि हमेशह नहीं अचछा कोई दिन और जाते हुए कहते हो क़ियामत को मिलेंगे कया ख़ूब क़ियामत का है गोया कोई दिन और तुम कौन-से थे ऐसे खरे दाद-ओ-सितद के करता मलक उल-मौत तक़ाज़ा कोई दिन और हां अय फ़लक-ए पीर जवां था अभी `आरिफ़ कया तेरा बिगड़ता जो न मरता कोई दिन और

How much time has passed since you came into the world? It's as if you came only yesterday, and today you're saying that you're going. I agree that you won't stay forever, but stay a few days more. Why are you in such a hurry to die?

At the time of taking leave of me, you promise to meet on Doomsday. From your saying this it seems that Doomsday has not come today, but will come some other time. For me, the day of your death itself is Doomsday

if the Angel of Death presented his claim on your life, so what? It was only the first reminder. You didn't have to pay him at once, that very instant! Since when were you so scrupulous about such things? Why did you show an appalling (and uncharacteristic!) degree of scrupulousness-- all too quickly you accepted his claim, and gave your life into his power.

O ancient Sky the one dying was young, he hadn't reached his natural lifespan. If he had remained alive for some days more, what harm would it have done you?

Global warming - still confusing

The climate change and global warming debate continues to remain confusing. Depending on what you read, the evidence on both sides seems overwhelming. Goes to show that when we are dealing with long data series which is itself derived out of various assumptions, the outcome will be what you want it to be.

An interesting article on the issues of calculating a "base temperature" to start with - and possible manipulation by the pro lobby.

A year later (well almost)

After my last post in Aug 2011, I fell silent. Besides the excuse of not finding time (only partially true), the more important one was a complete state of disgust with the affairs of the nation. I thought that rather than venting, I should take some time off and let things settle.

Well, things have settled. It is now settled that the momentum of the economy has run aground. Its settled that the incumbent policy makers suffer from serious nostalgia - they are trying their atmost to return us to the "mai baap" sarkar of the decades of the seventies - when most of them must have been in their "youth". The "inspector" raj is back in full force.The difference is that a activist judiciary has decided it needs to decide where you can dig up mud from (almost - there is a court imposed bar on mining sand in the state of AP!)

The only writing I have done in the past few months has been to contribute a monthly column to "Wealth Insight" - a magazine targetting the equity investor, and being published by Dhiraj Kumar of Value Research. I started writing in Jan 2012 and have contributed 5 columns to date. The next few posts will carry these columns. From now on, I hope to start writing again, and I look forward to seeing you readers back !

Moral Relativism

Last evening I had occasion to meet a very senior finance sector executive from the US –now involved in equity investments. He invests serious amounts of money in India, his own as well as that of others –in private equity and public markets.

While commenting on investment opportunities in India, he mentioned that valuations in India do not mean much since corporate reporting is suspect. To use his words – “why should I pay for the expenses of the promoter”? The implication was that all companies “cook” books and therefore investors were seriously disadvantaged.

I mentioned that while it may be true that many company founders tended to take some money out of the business, it appeared to me that this was not significantly different from the behavior of professional managers, especially in the US, who paid themselves disproportionately. I mentioned that I would tend to rate the behavior of Mr. Vikram Pandit of Citicorp in the same category. In my book, taking $165m (out of an estimated $800m) for selling a lemon of a fund to Citi (subsequently shut down one year after it was taken over) and then offering to manage the company for a salary of $1 smacks of extreme cynicism. The response was that this was legal and above board – and more a mistake made by Mr. Prince the earlier CEO of Citi (who, incidentally, received $138m for his efforts at Citi over 4 years).

This is correct. However, the question I ask is – if something is legal is it necessarily morally acceptable? Should society not expect a higher level of ethical behavior from its leaders – political and corporate? In other words – is there a case for expecting moral absolutism rather than accepting behavior because “others do it too”. If the latter, why should society not make such behavior legal – thereby making it “acceptable”.

The shenanigans of corporate America are too well known to bear repeating. Enron through Madoff, the story continues. What is however, only now attracting comment, is the excesses that corporate America has resorted to – well within the law, but way over the top of what one should classify as acceptable behaviour. John Thain’s $35,000 commode is symptomatic. When the senior executives of the top 3 American car companies went to Congress for a bail-out package, they went by private luxury jets.

If Satyam’s Raju is accused (correctly) if siphoning of large sums of money, the story of Merrill is interesting in that it is legal! In a letter dated Feb 10, 2009, the Office of the Attorney General, State of New York, points out that Merrill, with the apparent complicity of Bank of America, paid out $3.6bn of performance bonus on Dec8, 2008 – well before the due date, and after having lost $15.31bn in the last quarter of the year alone. This necessitated a take-over by Bank of America, and a subsequent bail out by the US tax payer. Does the fact that this is legal make the shareholder’s risk lower? I think not!

It would be well to remember that it is not the case of “poor corporate governance in India” vs “rule of law” in the US. It is simply a case of human greed tilting the scales. At the current moment, it can be safely argued that the level of greed exhibited in the West far outstrips that in other other part of the world – perhaps in human history.

Does this mean that Indian corporate governance standards should not be raised? Or, investors should blindly trust the numbers that companies put out – either in India or anywhere else in the world? The answer, clearly, has to be in the negative. As investors, the cardinal rule has to be “buyer beware”. But this is true as much in India as any other part of the world.

The repeated failures of credit rating companies to predict credit defaults, and audit firms to collude with managements point to the acceptance of moral relativism that has, unfortunately, become a norm in corporate behavior.

John Bogle’s recent book “Enough” (an apt book for current times) quotes Henry Kaufman as saying –

“Trust is the cornerstone of most relationships in life. Financial institutions and markets must rest on a foundation of trust… Unfettered financial entrepreneurship can become excessive and damaging as well – leading to serious abuses and the trampling of basic laws and morals of the financial system. … Only by improving the balance between entrepreneurial innovation and more traditional values can we improve the ratio of benefits to costs in our economic system”

An “us vs them” debate at this stage is futile. We all need to look within to see that we act in a manner that can truly be called “professional”.

Caesar's wife should be above suspicion - or perhaps not ?

The story so far - The election commissioner, Mr. Navin Chawla, attracted opposition from 205 members of Parliament when appointed. It was alleged that he could not be non-partisan. The Times of India carried a report:

A Times Now investigation has... found that two trusts floated by Navin Chawla, a member of the Election Commission, received funding of lakhs of rupees under MPLADS from various Congress MPs.

A petition, seeking his removal, addressed to the then President APJ Abdul Kalam, was not acted on. This led to the petitioners approaching the Supreme Court seeking a direction that the petition be forwarded to the CEC. This petition was subsequently withdrawn on the basis of an affidavit filed by the Chief Election Commissioner (CEC) in the Supreme Court. In the affidavit, the CEC claimed that he had authority to, suo moto, recommend the removal of the election commissioner. He quoted the unanimous decision of a Constitution Bench of the Supreme Court of 14th July 1995 (4 SCC 611) where the Judges stated :

That the Election Commissioners could be removed on the recommendation of the Chief Election Commissioner did not make them subordinate to him but only ensured their independence of the political Executive. The Chief Election Commissioner, in any case, could not recommend their removal out of whim or caprice and had to exercise his power with reason and responsibility.

At that time, the Additional Solicitor-General had objected to the statement of the CEC and contended that only the Centre could take action against the election commissioner. The Supreme court reserved judgement on the correctness of the CEC's position. A report on the events is here.

The CEC has, after due process, now recommended the removal of the election commissioner. The government has rejected the recommendation. This now leads to a constitutional impasse. Clearly, this needs to be referred to another Constitution Bench. This goes against the earlier order which seemed to indicate an interpretation favouring the reverse.

At a time like this, when serious efforts need to be made to protect the integrity of the constitutional intent, we have the leading English newspaper in the country worried about the "timing" of the action of the CEC. Ignoring its own coverage, and missing the point of constitutional impropriety - the editorial does not once refer to validity or otherwise of the arguments made by the CEC for the recommendations - the editorial laments the timing of the report in the light of the forthcoming elections.

It seems that a society gets not only the politicians it deserves, but also the newspapers it deserves.

The price of courage and the cost of cowardice

A friend send me a link to a letter made more poignant because it was published posthumously. Lasantha Wickrematunge, the author, and editor of The Sunday Reader, was shot on his way to work on Jan 8, 2009 in Sri Lanka. It describes his resolve to express his opinion on the politics of Sri Lanka, while being aware of the risks to his life. His death, establishes once again the cost that "freedom" often demands from men - the supreme sacrifice. It is men like him that the rest of us have to thank for our freedom, the existence of which we often take for granted.

In contrast, our feckless prime minister and spineless bureaucracy have scored a self-goal with regard to the handling of the post-mumbai-attack situation. Pakistan has now won the game, set and match. From being on the run, they have turned the tables completely - with the latest "umpire" of India's choice (remember, we have chosen to outsource our defence to other countries) David Miliband, the British foreign secretary, hectoring our PM and foreign minister on the need to resolve the "core issues" of Kashmir - a connection which even the Pakistanis have not insisted on making with any degree of conviction. Two interesting view points emerge - one where the UK position is sought to be explained in terms of their own domestic compulsions  and another, which takes a more robust view of how India (mis) handles its strategic goals.

In any case, with the new US president having signalled his willingness to interecede in Kashmir, we can only hope that we have an early election. At least there will be a chance that the democratic process will result in giving the "old bones" some rest. 

Two minutes of silence

More than fifty thousand families directly, and perhaps almost as many indirectly (Maytas group, other persons involved in Hyderabad real-estate, head hunters and placement agencies) need that silence – as a requiem for their dreams – atleast temporarily. These are the real losers in the scam at Satyam.

For the non-institutional shareholders, my sympathies, for having being on-board at the time when the story blew-up. They are collateral damage. For the rest, institutional investors in particular, it’s an occupational hazard. Investing in companies that adopt dubious practices (exploiting governmental contacts being one among them) is a regular provider of the elusive “alpha”. Much “wealth” has been created at the hands of such dubious managements to provide any long-lasting aversion to such practices.

The Madoff case in the US is an example. A complainant to the SEC two years before the ponzi scheme finally crashed, pointed out several “red flags”. Some related to the behaviour of fund of funds – that are meant to conduct a proper due diligence on funds they invest in. Here are some excerpts

Red Flag #14: Madoff subsidizes down months! Hard to believe (and I don’t believe this) but I’ve heard two FOF’s tell me that they don’t believe Madoff can make money in big down months either. They tell me that Madoff “subsidizes” their investors in down months, so that they will be able to show a low volatility of returns. These types of stories are commonly found around Ponzi Schemes. These investors tell me that Madoff only books winning tickets in their accounts and “eats the losses” during months when the market sells off hard. The problem with this is that it’s securities fraud to misstate either returns or the volatility of those returns. These FOF professionals who heard BM tell them that he subsidizes losses were professionally negligent in not turning BM into the SEC, FSA and other regulators for securities fraud.

Red Flag #15: Why would a fund of funds investor believe any broker-dealer that commits fraud in a few important areas – such as misstating returns and misstating volatility of returns – yet believe him in other areas? I’d really like to believe in the tooth fairy, but I don’t after catching my mother putting a quarter underneath my pillow one night.

Can you spot the similarities?

Many business leaders have appeared on TV expressing surprise, dismay and shock. I wonder why. Indian companies have been consistently ranked amongst the most prone to bribery. “Public works” ranks on top as the area most corrupt. Satyam promoters had a background in construction. Can it be that companies that are willing to bribe others, are going to be the epitome of probity when it comes to their own operations? Surely, we cannot rank amongst the world's worst without large companies in the country being a party to this practice. This combined venting to consternation seems to me to smack of the same hubris – the search of which brought Satyam to its demise.

Instead of repeatedly denouncing Satyam, we need to do some soul searching here. Can society ever create the incentive structure that balances what is needed for survival against the greed for wealth. Till then, people in glass houses….

Common man, uncommon expectations

Rab ne bana de jodi – Aditya Chopra latest directorial venture, is the story of a “common man”, a Clarke Kent, who seeks to induce his wife-by-accident to love him. In the process, he creates a persona of a boisterous and flashy, yet sensitive, Raj who almost wins his wife’s heart – but loses out in the end.

Aside from an excruciating three hour length, gaping improbabilities in the plot (a moustache can hide the identity of a man from the woman he lives with?!) and a Shahrukh Khan who thinks that an “ordinary man” has drooping shoulders and simpers, the story throws up an interesting view point. 

If Sahni – the “ordinary man” has it in him to be dashing, and amusing, why does he go through life as a repressed soul. Indeed, why is it important that the girl love his boring personality and ignore the advances of his attractive alter ego?

Some years back, I had the opportunity to consult with Mrs Rama Bijapurkar – a leading marketing consultant. We were, at the time, doing some research on the economics of film making and I asked Mrs Bijapurkar if it were possible to use market forecasting tools to select a script for a movie. Her insight, which I think is extremely meaningful, was that successful movies were a lead indicator to consumer behaviour and could be used to forecast shifts in consumer preferences – and not the other way around.

If RNBDJ – the alphabet soup the movie name resolves to – becomes successful, is there a message in it for marketers and society? That too a perverse one – that hard working, ordinary people, had best retain their anonymity. That aspiring for greater success and recognition is best left to others – perhaps even a hint, that with a bit of piety thrown in, you may even achieve the “impossible” – in the movie, the love of the protagonist’s otherwise uneventful life – if you do not aspire for more?

Over the weekend, the newpapers carried articles suggesting that Mr Ratan Tata was annoyed that a police officer who had risked his life for 6 hours in the Taj while waiting for the commandos to arrive, had released a CCTV recording to the media which showed him in action. Usually, most societies celebrate bravery. More so, when a poorly armed officer faced up to the challenge of heavily armed and well trained terrorists – and risked his life in the process. If it were a set-up, or the action pre-meditated, one could understand the reason for displeasure. With neither being the case, what can be the reason for feeling that the recording was “misused”? Though I am perhaps being uncharitable here – does it reflect the bias of society leaders that an “ordinary man” has attempted to reach beyond his station in life. It appears that stories of extraordinary courage of ordinary people, can be celebrated only in death, and if still alive, such persons should rapidly recede back into anonymity. Life imitating art?