Sunday, February 26, 2006

Investment Advice or Gobbledygook

Over the years the one point that I have heard finance ministers across party lines make is “Investing in equity markets is a risky proposition. Investors who do not have the requisite expertise are advised to leave it to the experts. If you want to participate in the India growth story you would be much better off using mutual funds to do so….”

Fair enough. Coming from ministers with such impeccable educational backgrounds I thought it sensible to take their advice. I promptly signed up for this newsletter that sent me research reports on the prospects of different companies.

I must say the reports were very impressive. Industry analysis. Comparative analysis of various players in the industry. Ratio analysis. The reports had it all. And what’s more, they also gave me a clear idea as to what I should do in the form of a “Buy” or “Sell” advice.

I few weeks later I was completely confused. At the end of a rather comprehensive analysis of a software company “A” they put a “Hold” advice on the stock. I read further to figure out what this exactly meant

“By this recommendation of HOLD, what we mean is that existing shareholders would be better off holding onto the stock with a long-term perspective. However, if an investor would like to BUY this stock, then the upside from the current levels is about 14% CAGR. Investors could take the investment decision based on this premise.”
“Hang On”, I tell myself. “What are they really saying?”

Are they telling me that my decision to own the stock tomorrow depends on whether I own it today or not. That was definitely contrary to what my B-School management accounting professor told me. Remember, sunk costs and all that.

In essence what they were telling me is that if I already own company “A”, I should be happy with an annualised return of 14 %. However if I don’t own it, I can buy into a company “B”, (which they recommended last week) and expect an annualised return of 25%!!!

And this is in a tax regime where the costs of shifting from Stock A to Stock B are negligible for a long- term investor.

I decide to research this further. I search through their archives and come across a report on Company “A” published more than a year back. I notice that they had recommended a buy on the company in that report.

An interesting consequence of all this is that an investor owns a stock because they suggested that he buys it, and now that he owns it they suggest he continues holding it. Despite the fact that in their opinion he would make higher returns going forward if he instead owns stock B.!!! A person who subscribed to the newsletter last week would outperform a subscriber who took their advice on company A last year.

And all this is when they are RIGHT with the predictions on stock performance. God save us in the rare event that they go wrong.

Authored by Sameer Nair

Tuesday, February 21, 2006

The Mutual Fund merry go round

Which MF scheme should you invest in?

a) A Fund launched five years ago at Rs. 10 that has a NAV of Rs. 50 or
b) A New offering from the same fund at an entry price of Rs.10

To make your decision more “informed” assume that the new scheme will have the same investment pattern as the existing one, albeit packaged under a new name keeping with the latest flavour of the stock market.

In fact a “rational” investor should be totally indifferent between the two. The current NAV of the scheme is totally irrelevant!! If two funds have the same investment portfolio their performance will be no different.

Going by the enthusiastic responses to New Fund Offers (NFO) of various funds it seems that a large number of people believe otherwise. In fact a quick glance of the portfolios of some well known funds will tell you that they have multiple funds launched at different times, that have largely invested in the same set of companies.

Many mutual fund analysts have noted that despite the large funds garnered by New Fund Offerings the total amount invested in mutual funds has not increased significantly.

Clearly a number of investors are actually selling their investments in the fund quoting at a Rs 50 NAV to invest in the new fund offering at Rs. 10 because they believe the new fund is cheaper and therefore has more upside potential!!!

Who benefits?

The fund - because it is allowed to recover the marketing expenses from a new offering to the extent of 6% of the initial moneys garnered. To make matters worse this money is recovered over a five- year period effectively benefiting those who exit early and penalize those who stay with the fund.

Mutual Fund Distributors (in many cases banks) who make huge commissions by selling mutual funds.

The savvy large investor who “shares” the commission with his Agent

Who loses?

The poor retail “long term” investor who has not only incurred transaction costs for nothing, but has also effectively subsidized the Mutual Fund’s marketing expenses.

To put it bluntly this is nothing but a scam. Exploiting human irrationality and lack of appreciation of basic financial concepts amongst the masses to enrich themselves cannot be called anything else.
Authored by Sameer Nair

Monday, February 20, 2006

India V/s China: The Google Test

Over the past few years there has been a lot of discussion on the India v/s China story. I was following the same on and off in my own desultory fashion and trying to figure out which country was more economically important to MNCs. No particular reason, just idle thoughts of an idle mind. Unfortunately I found it rather confusing.
Why? Well, look at the usual suspects discussed, FDI and Infrastructure.

Some claim that the FDI figures that China releases is highly puffed up and that India on the other hand under reports its FDI as it does not take into account the reinvestment of capital and overseas corporate borrowings as is the normal practice. Therefore the FDI gap is much closer than one feels. Then again there are those who compare India's FDI inflows very unfavourably with the Chinese FDI based on actual numbers.

The state of infrastructure in both the countries obviously has to crop up. And people always always start with the airports. The squalor of Mumbai pitted against the spanking new Pudong airport at Shanghai. While China is indeed far ahead in terms of physical infrastructure, of late MNCs have begun to talk in glowing terms of India's "soft" infrastructure i.e. a free press, an independent judiciary and our democratic institutions - such as they are!!!

So as I said in the beginning it has been a slightly confusing time for me.
Which do MNCs prefer? India or China?
Now I know.
China China China and China once again.
Why so?

Well look at the reaction of dear old Google – the world leader in search and a very important player in the Internet arena – to the "requests" of Chinese authorities to censor their search results. It has voluntarily decided to censor search results on topics such as " Independence for Taiwan" and the "Tiananmen Square massacre" among other things.

And as justification for this despicable conduct Google has come out with a totally self serving crap which read as, "While removing search results is inconsistent with Google's mission, providing no information... is more inconsistent with our mission." Ooo la la.

Now look at the reaction of Google to concerns of the Indian Government over Google Maps, "Google takes governmental concerns about Google Earth and Google Maps very seriously. Google welcomes dialogue with governments, and we will be happy to talk to Indian authorities about any concerns they may have."
That is it. Nothing beyond this bromide dished out by the company spokesperson. I wonder if they would have been so blase if it was the Chinese Government that wanted some change.

This difference in reaction says it all does it not?
China wins hands down.

Friday, February 10, 2006

(Ir)Rationality and Corporate Madness

The only course that I managed to get an A grade in my illustrious career at B-School was Cost and Management accounting.

And here I am in the danger of losing my annual performance incentive. My sin? I have been vehemently arguing in favour of putting into practice something I learnt in Cost and Management accounting.

Serves me right for deviating from my general philosophy of not taking academics too seriously. I sometimes wonder if performance at work and grades at an MBA are negatively correlated. But more of that later.

In my years spent in the corporate world (and in life in general) one of the concepts I have found most appealing and yet the one concept that I find most difficult to put into practice is the notion of sunk costs.

Very broadly, while evaluating the pros and cons or more mathematically the costs and benefits of a decision I should only consider future costs and benefits. Costs that have already been incurred and benefits already reaped should not enter the equation at all. It will unnecessarily cloud my decisions.

Intuitively the most rational of us make this mistake. I make this mistake often, but am puzzled that on a few occasions that I don’t; my bosses in fact mock me.

Some common examples are

1) Let’s say there are two stocks that I own,
a) I own 1 Share in Company A, Purchase price = 50, Current Market Price = 75
b) I Own 1 share in Company B, Purchase price = 100,Current Market Price = 75

If I need 75 urgently and I want to sell only one of these then which one should I sell?


1) Total Revenues from Project A = $ 10 Million, Costs = $ 8 Million, Should I fight a battle with my customer to make an additional 1 million in revenues in the process incurring a cost of 3/4 a million?
2) Total Revenues from the same Project A = $ 8 million, costs = $ 10 million, should I fight a battle to make an additional 1 million in revenues incurring a cost of 3/4 a million?

The key to making the correct decision, I was told by my professor back in B-School, is to ensure that we only take into account future costs and benefits. One million in additional revenue vs. three fourth of a million in costs.

Put simply our decision to go ahead and contest the case or not should not be clouded by the costs already incurred.

I can bet my bottom dollar that all the bosses in the 10 companies I worked for will be more inclined to say “No” in case 1 and “Yes” in case 2

They would have certainly flunked Cost and Management accounting. But does it really matter? They decide my annual performance incentive, rationality be damned.
Authored by Sameer Nair

Wednesday, February 08, 2006

Adventure at Midnight

I just have to share this adventure at midnight that I had recently. It was an out and out “Famous Five” kind of stuff. Or as a friend pointed out, “At least make it Hardy boys, sounds less childish.” Anyway Famous Five/Secret Seven/Hardy Boys/Shikari Shambhu whatever, an adventure is an adventure.

Here it goes.

Dark was the night and all was still save the ………….oh! What the hell. I have no clue. I was fast asleep. And past midnight into my sleep numbed brain floated the persistent, irritating ring of my blasted cell phone. I reached my hand out and was about to be rather curt with the caller when a man’s soft whisper came through.

Now I am not accustomed to receiving calls at midnight. I am definitely not accustomed to men cooing to me softly at midnight (or at any other time I might add).

But my mild state of confusion changed when I could hear the caller. “Gautam” it said, “I am X from Flat 101. There is a gang of robbers on my terrace and my family and I have locked ourselves up in one of the rooms. What do you think we should do? What can you do?”

When I heard those words I, for a person of my age and fitness level, acted with reckless courage. And displaying acrobatic skills I did not know I possessed was under the bed in a jiffy. I do not know what the existing world record for getting under a bed from on it is but I am sure I lowered it a few notches.

I also shut off all lines of communication. Lest there be another telephone call.

Problems however persisted. My trip under the bed turned out to be a congregation/communion with an assortment of old newspapers, used envelopes, dust balls, a sock, an apple core and other such items necessarily found (according to the latest Municipal rules) underneath beds in a bachelor pad.

Prompted by this and to a smaller extent by the fact that there already appeared to be a smallish, noisy crowd of do-gooders who had assembled to rescue the Xs, I got out from under the bed and after securely locking my flat walked down.

As I walked down I saw that the junta was clustered around the main door which was to be opened by X. As we heard X’s footsteps quite a few of us, with an ill assumed ease, tried to melt into the background or at the very least behind one's fellow rescuer.
The door opened and we all burst into the house.

Meaning, the most daring of us peeped into the house and then tip toed in. With the knowledge by and by that no one was around we decided to calm the nerves of the children and a wide eyed Mrs. X.

P.G. Wodehouse had once famously remarked that milkmen as a species are the least marrying sort as they see women too early in the morning. I am now convinced that brave rescuers, like all of us, who see women at midnight don’t fare much better. Anyway I digress.

All of us then assembled on their terrace and speculated on the route taken by the desperadoes to escape.

At this critical juncture appeared good old S, their neighbour who was clearly surprised by the commotion. When told of the reason he was even more surprised. Pointing out that he was on his terrace not 10 minutes ago removing clothes off his clothes line. I was beginning to put 2 and 2 together but decided to ignore the old man.

After a few minutes all of us dutifully trooped out.

When I reached home I peeped out of my window and found the Ss and the Xs exchanging a few embarrassed laughs.

The reason.

A recent rather novel idea of the Navi Mumbai Municipal Corporation to install street lights had meant that when dear Mr. S was picking his clothes off the clothes line (at midnight, I might point out) he had perforce to walk up and down the side of his terrace. As a result of this, the shadows created by the street lights fell on the Xs window and made them feel that there was this huge gang out loose on their terrace.

Ah! Well. I had a good laugh too. But talk of bad timing. I came to know of the Mr. S angle barely minutes after I had breathlessly SMSed a friend telling her of my “heroics” and promising to reveal all when we met. Tch tch.

That's the way the cookie crumbles.

Sunday, February 05, 2006

Don’t Tax my Salary, Mr. FM

Its that time of the year again!!! A whole host of industry associations, tax-experts, finance managers and their aunts have crawled out of the woodwork once again with their wish lists for the finance minister.

Cut excise duties on cars – It would be a great employment generator.
Cut Tax Rates, Tax Collections will rise? Laffer, the famous economist dude said so.
Do not raise taxes on essential commodities; we are already overburdened with an increase in Oil prices.
Blah blah blaaah and some more blah.

I am a simple man with a very simple wish.
Out with taxes on Salary.
Do I hear “Yeah right, might as well ask Aishwarya Rai out”?

Well I think it is not as crazy an idea as it sounds at first. This could actually be a Win-Win situation. Unlike my date with Aishwarya, I might add. :-)

What if we replace Income tax on salaries with a “Salary Distribution Tax”?

The way it would work would be by shifting the burden of paying the tax entirely on to the Employer in the form of a tax on the wage payout. Say a 10% Tax on the total wage bill of the employer.

The idea is to make the whole process simpler for the employee while ensuring the exchequer does not lose out.

For the employee the immediate benefit is WYSIYG. His take home salary converges to the salary mentioned in the employment letter. (Of course the salary mentioned in the employment letter would now be more realistic, read a bit less than before.) No need to run to the CA to file tax returns. No medical bills to be “arranged” for, no rent receipts to be forged, no Form 16s to be obtained. The tax authorities do not have to deal with the mountains of returns that they do every year.

Moreover the employee feels deliriously happy under the mistaken belief that there is no tax to be paid at all.

Can the tax authorities do it? Sure they can. After all they have done the same with dividends, when all that the government did was to shift the burden on to the company in the form of a dividend distribution tax. The result of this distribution tax was lower dividend for the shareholders (to the extent of the tax). But who looks so deep?

With this one stroke of the bureaucratic pen the then BJP government convinced a large number of retail investors that dividends distributed by companies are tax-free. Retail investors “felt good” that they no longer had to pay a tax on dividends.

Why not make the salaried employees “feel good” in the same manner, this budget?
Authored by Sameer Nair