Whose side is SEBI on ?

My latest blog on SEBI's recent directives on Mutual Funds is here.  The post follows:

Assume we are living at a time when we still used boats to travel long distances. Imagine a large, leaky boat about to set out on a stormy sea. Imagine that this boat is about to make a journey that in the normal course will last over a year. Additionally, the boat has had a history of capsizing a few times in the past, often taking with it the passengers. However, each time, the owners are able to pull the boat out from the sea put up a few patches and declare it seaworthy. It would seem obvious that tickets for the trip would be hard to sell especially to people staying in the vicinity of the port of launch.

Now imagine that there is a regulator whose job is to protect the passengers. The regulator is charged with certifying the sea-worthiness of the boat so that the passengers have a safe journey. Over the years, seeing that the boat has not proven to be particularly safe, the regulator declares that all passengers have to decide for themselves what the journey is worth to them. Sellers of tickets are to be paid for their services directly by the passengers not by the boat owners. Meanwhile, the seas become stormier, and ticket sales fall.

The boat owners now demand that the ticket prices should be raised (They obviously form a cartel if you want to use the boats, you have to deal with them). This extra money is to be used partially for rewarding those who sell tickets to passengers. Importantly, more money is to be paid to those sellers who sell tickets to unsuspecting passengers, who live far away, and are therefore less likely to have heard of the experience of earlier passengers. Even more intriguingly, passengers who have already bought the tickets should be charged extra every time a "new" passenger from afar agrees to board the leaky boat. What should the regulator do?

It could of course ignore the lobbying of the boat owners, and insist that they spend money building a more robust boat. It could insist that boat owners pay more to cartographers who can help determine a less risky path to the destination. It could insist that buyers have a right to know that that besides the boat, there were other less dangerous paths to the destination as well. It could mandate the creation of boats that are safer. It could insist in fact, that their primary mandate was to protect the passenger, and not the well being of the boat owners.

What would you say of a regulator that instead, agrees whole heartedly with the boat owners, caps the payment to the cartographers, increases the price of the tickets and increases incentives for those getting unsuspecting passengers to the boat even forcing existing passengers to pay more. Who am I talking about replace "boat owners" with "Mutual Funds" and you have your answer.

Undoing its own logic

In 2009, SEBI decided to ban entry loads for mutual funds the argument then was that investors should determine for themselves what services of "fund advisors" people who sold them funds was worth to them. Investors could decide how much they would pay. A laudable objective.

This change effectively killed a whole range of distributors where clearly, the investor did not feel that enough value was being added to be worth paying. Inflows into equity mutual funds fell as well.

The moot point is whether the inflows fell as a result of poor market and fund performance or because of a lower distributor base.

A look at the graph above shows that the problem is not that the assets did not increase. Just that equity fund assets did not grow. Most equity funds in the period post the ban of entry load (August 2009) have delivered poor returns to investors (category average for 3 years for equity large cap has been 4.5% per annum while even liquid debt funds have delivered 7% per annum). Since the equity markets have performed poorly, long-only funds too have performed poorly some more so than others. Long-only refers to a situation where fund managers are only allowed to buy before they can sell. An alternative would be to sell first and then buy back at a lower price if the market were falling. Almost all mutual funds are "long-only". In such an environment, would it be expected that there would be a rush of investors into equity funds? Not in the view of this writer.

What therefore was the rationale to re-impose the entry load which is what SEBI has mandated as per its latest guidelines? Under the guise of increasing investor participation, SEBI has made the following changes (a) entry load has been increased if mutual funds were to raise money from centres other than the top 15. 

Astonishingly, it has allowed mutual funds to charge the extra load to other investors of the fund as well not only the far-away ones (b) it has passed on the service tax that was earlier paid by the asset management company to the investor (c) it has capped the brokerage that can be paid to the broker who provides research and trade execution to the fund house and incidentally provides the fund manager the inputs to enable him or her to make investment decisions after considering multiple view points.

The product is faulty, not the sales effort

First and foremost, SEBI could have allowed mutual funds to have investment styles which are not only "long-only". The market offers enough instruments today to allow a skilful fund manager to trade both ways and generate "alpha". By allowing manager to only buy, the ability to sensibly exploit shorting opportunities is unavailable to managers. The recent Alternative investment fund guideline is a step in direction of allowing shorting as well, but the large ticket size per investor (currently Rs 1 crore is the minimum per investor) is a big entry barrier.

Another could have been the ability to manage a multi-asset fund. Here of course the plethora of regulators offers an impediment. So we have the strange conundrum that each individual can be a "multi asset class hedge fund" by himself there is no bar for an individual to trade in equity, commodity, currency, gold or real-estate, but no investment professional or fund house can offer such an investment vehicle to investors. A mutual fund cannot invest in commodities for example an asset class that has done well in the same years that equity has performed poorly. But if this is the problem, should it not have been addressed?

Clearly this is a case where the wrong question has been posed and answered. Many representatives of mutual funds and distributors would have presented their view points to SEBI. I wonder how many investor associations did. 

The views expressed are the personal views of the author.

Seeking visionary leadership

My column of Wealth Insight released online on 28th July is here. Reproduced below

While it is wrong to blame democracy for slow growth, what India needs is a policy framework that creates a transparent environment

By Anand Tandon | Jul 28, 2012

A recent report by Kotak Institutional research serves to remind us of the need for growth. Basing his numbers on average income growth rates, the analyst concludes that 100mn additional households (i.e. half billion people) will remain in the “survivor” category by 2025 if GDP grows at 5% rather than at 9%. In other words, a growth rate slower by 4% per annum will consign approximately 7% of the world’s population to poverty over the next 13 years. Poverty that could have been avoided! High growth is incontrovertibly a desirable objective for any government.

Is democracy a hurdle?
Our erudite prime minister included, the current political class and “chatterati” blame India’s democracy for slower economic growth compared to China. This is without basis.

Yasheng Huang, a professor of Political economy at MIT delivered an excellent lecture at TED last year which I strongly urge the reader to listen to (http://www.ted.com/talks/yasheng_huang. html). Huang compares India’s growth with China and concludes that the growth differential arises less out of political structure and more out of differences in education and health parameters.

One of the interesting points that Huang makes is that India, during the period 1961-1991, had a dominant single party rule (less democracy, more autocracy – the Emergency being a case in point). During this period, the economy averaged a growth rate of 1.8%. Post 1991, with the first “minority” government, and under subsequent coalition governments, average growth for the next two decades has exceeded 5%. In itself, this should silence those who blame “fractious democracy” for slower growth as the data suggests exactly the opposite.

Data given in the below table is worth thinking about. In 1981, India had better rail coverage (a proxy for infrastructure) than China. However, India lagged significantly when it came to human indicators. Literacy in China (1985) was significantly higher – with women literacy more than two times that of Indian women. Perhaps that explains the higher life expectancy of the Chinese by more than a decade. Indian women had a life expectancy lower than that of men – in itself an unnatural situation. Post this decade, the difference in growth rate of China and India diverged significantly. If no other data is presented, would it not be logical to conclude that growth rate differentials are driven more by human capital, and less by the ability to set up infrastructure? Huang, in fact, concludes that infrastructure development is a result of economic development and not its cause. As the economy develops and generates savings, infrastructure improves.

Does “reform” only equal “FDI in retail”?
Indian “reform” started in the decade of the 90s with lower licensing requirements – allowing the Indian entrepreneur to use his talents as he sees fit. Trade barriers were lowered with lower import tariffs, forcing Indian industry to become more competitive.

Capital restrictions were reduced. This led to an increase in foreign inflows within the country – and, of late, overseas investments by Indian corporations. Another factor of production, i.e. “capital”, was unshackled.

Human Development vs Infrastructure Development  India  China Infrastructure   Railways (1981) Km 61,240 53,900 Electrified Railways (1981) Km 5,345 1,700 Human Capital   Adult Literacy Rate(1991) 48.20% 77.80% Women Literacy (1991) 33.70% 68% Life Expectancy Men (1985) (yrs) 57 68 Life Expectancy Women (1985) (yrs) 56 70 Source: Presentation of Y Huang

Two other economic factors of production – “land” (which, in economic terms, includes all natural resources) and “labour”, have, however, escaped any significant “reform”. We therefore have a situationwhere, though consumption demand in India remains strong, supply is restricted. In fact, the country has to rely on imports to meet its demand. Supply increase, which should act as automatic stabiliser to increased demand and fuel growth, is restricted by land and labour laws that are cumbersome and archaic.

Despite this, calls for economic reform restrict themselves to allowing “FDI in retail” as a magic formula to erase all ills that afflict the economy. This can partially be put down to vested interests of analysts – most employed by “sell side” brokerages – who mouth what their clients want them to – i.e., greater market access. However, one wonders about the compulsions of the writers of the Economic Survey, who also repeatedly dish out the same formula, while remaining silent on the market destroying features of the proposed “land reform” bill, or the lack of clear policy in handling out natural resources for use by industry.

Needed: A focus on factors other than capital
Running a government is complex. More so, in a large, diversified country like India. Any leader can get overwhelmed by the enormity of the task. But, as I stated in the beginning, slow growth destroys opportunities for 7% of the humanity. A visionary leader would focus on one or two issues in a term of 5 years – issues that can unleash the potential of millions of his countrymen and women. Education and health are two such issues. Natural resource is another.

True reform would be to provide a policy framework, and create a transparent environment where the Indian entrepreneur can use these factors of production to further the goal of economic growth – and generate employment. Providing “entitlements” to people without empowering them to reach their own potential is the hallmark of bureaucracy, not leadership.

What to expect from the new CEA

I have a new blogpost on CNN-IBN's India Blog site. The link is here. I am also copying the blogpost below:

Last week, the Indian government appointed Dr Raghuram Rajan, a distinguished economist, as its chief economic adviser (CEA). The CEA advises the government on possible policy options and priorities. There are no executive responsibilities other than to prepare the various economic reports that are presented to Parliament - including the Economic Survey. In this context, it may be useful to look at the policy preferences of the new CEA.

In April, Rajan made a speech in New Delhi in the presence of the PM where he signed off with "I have been frank as an academic, that is the only value I bring". This suggests that perhaps he thought that his speech would not be to the liking of his listeners. But was it really that radical?

The speech (along with my somewhat liberal translation for the non-economists) identifies some issues with recent economic policy:

"Rent, patronage, or entitlement enhancing measures have sailed through."

"Private consumption, especially in rural areas, is growing strongly on the back of rising incomes, strong credit growth and continuing government transfers and subsidies. The result: The gap between our spending and our saving is making us dependent on short term foreign inflows to a dangerously high extent."

My translation:

Policy paralysis led to bureaucratic/political adhocism, encouraging corruption. India's unwashed masses have been satisfied through hand-outs in the form of subsidies for which there is no apparent way to fund.

The Government has raised minimum support prices for agri commodities at much higher rates than the rate of inflation. Along with free hand-outs (referred above), and forced lending to rural sector through compulsory priority sector lending, we are consuming well over what we save. Soon we will need China to fund us!

So far, I see no problems with the diagnosis. The problem starts now!

Rajan says: "We need a common minimum programme across all sensible political parties to ensure that we stabilise the economy and foreign investor perceptions quickly."

Here we have it. By implication, democracy in India is a problem. If you don't agree with policy wonks of the government, you are not "sensible", and foreign investors are more important than local.

In reality, democracy is good for the economy as are policy disagreements. Enough data exists to prove it. One example is that India's growth rate has gone UP significantly in the period since we have had coalitions ruling the country.

Additionally, most large Indian houses have been investing overseas (perhaps in quanta at least as large as inflows) over the past few years. That should cause policy makers to pause and see why domestic industry does not see the potential in India while we are supposed to invite foreigners.

Rajan goes on to suggest that by 2000's, "powerful elements of the political class which had never been fully convinced about giving up rents from the License Raj ..., had by then formed an unholy coalition with aggressive business people ..... The new post-License Raj equilibrium became the Resource Raj."

The statement is misleading seeming as it does to suggest that the unholy politician/industry alliance is new. When did India ever have a strategy to offer national resources in a transparent manner? It was always through licensing which is by its nature open to corruption. Only difference this time the scale of corruption is unprecedented under the current dispensation.

So what is the solution that Rajan prescribes? He says, "simply moving our millions from low productivity agriculture to rural industry or services will give us growth for years to come, provided we are willing to do the minimum necessary to collect the low hanging fruit."

How do we do this? "We need to liberalise sectors like education, retail and the press, freeing entry and improving customer choice. We need to transform more government-owned firms into well-managed publicly owned firms which are free from political influence or government support. And we need to evolve transparent means of pricing and allocating the bountiful natural resources in our country."

Get the connection? Huh? Well I don't too. How does letting foreign investment in the press, retail or higher education (he speaks of higher education, not primary, when he speaks of liberalisation somewhere else in the speech) help in increasing rural industry or services? Privatisation of government-owned companies has already been ruled out of the policy tool box of the current government and is unlikely to find its way back.

Unfortunately, the rest of the prescriptions too don't offer anything new: increase fuel prices (instead of curtailing wasteful government expenditure), find a policy for allocation of natural resources (non contestable except that no format has been suggested, so this is a motherhood statement and no more) and look out for foreign investors (I fail to see why it is not necessary to be kind to Indian investors as well).

So far, what one sees of the new CEA seems to be only old wine in new bottle. Worse, it does not seem to be based on fact or cogency of argument. Hopefully the reality will be better for India's economic future.

A surreal experience

An early morning ballon flight over rose valley Cappadocia, Turkey. You can see from the colors of the mountains why it is so named. This is as close to gnome valley as one can get - have not seen this kind of landscape ever before. I broke my long-held self-imposed rule of never riding any vehicle or animal that did not have an ENGINE - can't say I have any regrets. Not going to make it a habit though - markets are behaving in an engine-less manner anyway.

After 5 days in Istanbul, awaiting the flight to Cappadocia.

Istanbul is all it is made out to be - great historical monuments, wonderful energy, and a very modern outlook.

Watch out for weak air conditioning (even in the best hotels), and nasty taxi drivers.

Language is interesting - many common words with Hindi. Kofta, kebabs, shorba (I'm using hindi spellings, though the turkish words are the same with the same meaning). Shakkar(sugar) shakarpara are other examples. Dikkat (danger), and meydani (maidan) are close - and this is only a sample. The slave dynasty left more than a few monuments in India. 

Latest market obsession - reforms post Presidential elections

Post the announcement that Pranab Mukherjee was standing down as the finance minister, the equity markets again started factoring in "reform initiatives" by the PM. That this would imply the PM's inability to push his senior colleagues to accept  his recommendations vis a vis their ministries, does not seem to bother the markets. In this context, Swaminathan Anklesaria's column

Don’t expect major reforms from Manmohan as FM

is worth a read.

For those interested in the context of the "reforms" initiated by Dr. Singh in 1991, the video below is a must-watch. Though it features the finance minister of the "other" side, it does give a ring side view of what the situation was in those days. When will the market participants learn? Being bullish is great, but ignoring history ensures that errors are repeated

Congratulations President Mukherjee

First, heartiest congratulations to Mr. Pranab Mukherjee on his appointment as the 13th President of India. Compared to the incumbent, whose nomination had raised many an eyebrow given the somewhat less than salubrious past of her immediate family, Mr Mukherjee's accession to the Presidency is likely to be welcomed by most.

 

I visited the website of the new President elect just a few moment ago. The link is below - but since it is likely to get updated (hopefully soon), I have cut and paste a small part of the right column. The election results are updated, so the site is live and the webmaster is awake. However, he seems to see no contradiction on sending a message thanking the electorate for their support - while continuing to request the electorate to vote for the Congress. 

 

Results

Shri Pranab Mukherjee has defeated his opponent by128252votes
We are immensely grateful to all the people who directly & indirectly supported us.

JAI HO INDIA JAYAHE JAN GAN MAN-SUPPORT CONGRESS FOR A STABLE INDIA

I hope that Pranab da will quickly forget that he was a part of the Congress over the past few decades - and accept the role of a President who represents the Constitution - and not some political affiliation. The President's post is meant to be above party affiliations. The President is NOT a member of any party. As chance would have it, one of India's most senior politician now occupies that post.

The Prime Minister's post on the other hand, IS the most important Political post in the executive - and is meant to be held by the most senior politician with the ability to lead his party to power in an election. Here, we have someone who has not won ANY election where the people have voted directly - nor would he have been able to win a party election if one were to be held.  Instead, he holds his position as a nominee. I hope, for the sake of India, that this changes quickly too. Jai Ho.