Wednesday, January 28, 2009

What is 'Insider Trading'?

Promoters of companies are often charged with taking undue advantage over ordinary shareholders by selling/ buying the shares of their companies through price rigging. The issue is again hogging limelight in the aftermath of the 'Satyam' fraud. Let us try to understand the concept of 'Insider trading' and the law in place to prevent it.

Insider trading is the trading of a company's stock or other securities including stock options by individuals with potential access to non-public information about the company. The Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992, describes "insider" as any person who, is or was connected with the company, and who is reasonably expected to have access to unpublished price-sensitive information about the stock of that particular company, or who has access to such unpublished price sensitive information. Trading by corporate insiders such as officers, directors, and large shareholders may be legal, if this trading is done in a way that does not take advantage of non-public information. Information about such trading is to be published in public domain within a reasonable period of the transaction taking place.

Market regulator SEBI has put in place a comprehensive Integrated Market Surveillance System to track trading data from all the market participants: stock exchanges, depository participants, custodians as well as data of clearing houses. This system helps it detect potential and accomplished insider trading and manipulation. Recently SEBI has amended the insider trading regulations:

  • A 'deemed insider' can be anyone who has access to unpublished price sensitive information and the connection with the company has been removed.
  • All companies have to apply SEBI's model code without diluting it in any manner.
  • Directors, officers and designated employees who buy or sell shares can’t carry out a reverse transaction within six months. They are also no longer allowed to hold derivative positions.

It is common knowledge that insider trading takes place frequently, but it is very difficult to book the violators due to the difficulties in implementation of the law. As investors we need to be vigilant about extraordinary movements in stock prices and take suitable measures to safeguard our investments. Past track record of the promoters is a guiding principle for investment in a particular company.

Saturday, January 24, 2009

Who should invest in Equity?

Investors all over the world have suffered huge losses through equity investments in the year 2008. Both BSE Sensex and CNX Nifty have given a negative return of around 53% during the year, which is their worst yearly performance ever. The performance of mid cap and small cap indices has been worse. Investors who have seen their portfolios bleed have put a question mark on equity investment as a wealth creation tool. Even advisers and financial planners are finding it hard to convincingly recommend equity investments to their clients. This leads us to the important question: Whether one should invest in equity at all, and if yes who should invest in equity instruments?
Let us try to find answers to this question. Surplus cash available with an individual can be put to use in three different ways:
  1. Liquid assets: Cash in hand, Liquid bank deposits (Savings & Current accounts). This represents idle cash which is used to cover routine expenses and emergency requirements like sudden illness/ accident etc. About 4-6 times monthly expenses are sufficient to cover these exigencies.
  2. Debt instruments: These are fixed income securities (both secured & unsecured) which are designed to give stable returns over the short term, the risk increases if debt instruments are held for long term because their return is dependent upon inflation and market interest rates.
  3. Equity instruments: Equity represents the holders proportionate ownership in the invested company. One must understand that as owners of the company you have a share in the profits as well as losses generated by your company. From this angle equity investment or ownership must be taken with a long term perspective. Your horizon for equity investment should not be less than 3-5 years.

Thus, equity investment is generally rewarding in the long term and debt investment is generally rewarding for the short term. One must choose the investment option based on your goals: Short term goals maturing within 1-2 years need to be financed through debt investments and long term goals with a horizon of 5 or more years need to be financed through equity investments. Another way to look at equity investment is the 'Risk appetite' of the individual. Risk and return are directly proportional to one another, thus, you can hope for a higher return by taking a higher risk. Equity investments carry a higher risk as compared to debt instruments because they have the potential to give higher returns. Please do not enter equity markets if you are risk averse. However, the risks to equity investment can be diversified in two ways:

  • Product/portfolio diversification: By distributing the investment amongst large number of stocks/ sectors.
  • Time diversification: Buying small lots of your favourite stock through SIP (systematic investment plan), rather than in one go. Investment through Mutual Funds meets both these diversification methods.

If you had followed the above two principles, you would definitely have reduced your notional loss during 2008 (there is no loss unless you have booked it through sale of stocks at a loss). There is every likelihood of investors making profits if they remain invested for long term. Of course, one must have reasonable expectations from equity investment (The long term average is around 17-18% per annum), and one should be ready to book profits whenever these expectations are exceeded. After all it is your money and you need not blame any one else for having or loosing it.

Tuesday, January 20, 2009

Can Obama save 'laissez-faire' capitalism?

Barack Obama has taken over the reigns of the world's most powerful economy 'in the midst of an unprecedented crises'. His nerve-tingling oratory may have won him millions of fans around the world, but now it is the time to get down to serious work. The biggest task before him is to 'reinvent capitalism'. 'Laissez-faire capitalism' pursued by his predecessor may be as dead as the 'Soviet communism'. The entire politico-economic model of free enterprise, rugged individualism and small government on which America built its global hegemony seems to have broken down. How else can one describe a situation in which all of the country's main financial institutions and many of its biggest industrial companies are effectively bankrupt and on government life-support?
'Laissez-faire' is a term used to describe a policy of allowing events to take their own course. Laissez-faire activists support little or no state intervention on economic issues, which implies free markets, minimal taxes, minimal regulations and private ownership of property. The collapse of Communism as a political system sounded the death knell for Marxism as an ideology. The events of the past few months have proved that laissez-faire capitalism has been a monumental failure in practice. Bush administration's reliance on unregulated markets was a primary cause of ruin for the US economy.
Observers point out that US deficits have largely been financed by foreign governments who continue to pump in money into US treasuries. But many of the Arab countries who ran huge surpluses due to high oil prices may be in for tough times ahead. It is a matter of time before the money managers will have to look for safer havens as US treasuries offer near zero yields. However, with Europe also in the grip of serious depression, there is no imminent danger to the US dollar's supremacy. It is time for Obama to rewrite the principles of Capitalism. Capitalism may still survive but in a new avatar, where the state will be required to play a major role. The belief that 'markets are always right' has been shaken.
The markets have greeted the swearing in of Obama with a thumbs down, because they know that the road ahead is going to be really tough.

Wednesday, January 14, 2009

India tops Consumer Confidence Index

India has topped the recently released 'Consumer Confidence Index' for second half of 2008. The Nielsen Global Consumer Confidence Index covers internet users around the world and is conducted every six months. The latest round was conducted in September-October 2008 across 52 markets across the globe. It may not be representative of the Indian population due to the low penetration of internet users in the country. However, the important findings of this survey are:
  • India has emerged as the most optimistic nation with an index of 114 against the global average of 84.
  • Despite the economic crisis 51% of Indians believe that the country will be out of recession in the next 12 months (Asia-Pacific average 22%).
  • Indians believe in saving (58% would continue to put money into savings), they are also relatively insulated against the global financial turmoil due to the relatively nascent financial market.
  • A majority 77% Indians believe that the state of their personal finances is excellent to good for the next 12 months.
  • Indian spending is mostly directed towards new clothes, home improvement & technology products, while there has been a decline in spending for holidays and out of home entertainment.
  • The top concerns for Indians are Economy (25%), Terrorism (24%), and Work life balance (21%).

The survey may be a pointer towards the revival of the Indian Economy in the second half of 2009.

Friday, January 9, 2009

SATYAM saga: Section 388 of Companies Act invoked

7th January 2009 will hopefully go down as a special day in the history of Corporate India, just like 26th Novemeber 2008 marked a turnaround in the history of Indian politics. It was on 8th January 2008 Indian stock markets overcame 'Peak 21000' on the sensex. The clock has turned full circle since then, and exactly one year after that historic event Corporate India has woken up to the bitter reality: 'The method behind the unprecedented madness seen on our markets'. The Satyam saga continues, hopefully this would be the last time Indian investors would have been taken for a ride.

Investors across India have to unite to fight the evil designs of the unscrupulous promoters of India Inc. It is heartening to note that the Government of India has acted swiftly this time around. The govt. has used its powers under the companies act, to supersede the erstwhile Satyam Board and appointment of fresh set of directors. It is a unique case of board super cession in India under section 388 of the Companies Act, a provision which is used as a last resort. This section provides for a change of management if found guilty of fraud, malfeasance, persistent negligence or default in carrying out their obligations and functions under the law, or breach of trust. Earlier cases of CRB Capital and WH Brady had resulted in partial super cession of the board by appointment of nominee directors by the government. The govt. also enjoys powers under the companies act to amalgamate companies in national interest.

The Govt. needs to be appreciated for this timely step. It has also been followed up by the arrest of the Raju brothers under sections where bail may not be granted. Let us hope the new board will start functioning at the earliest, to restore the confidence of the vendors, shareholders and employees of Satyam Computers Ltd.

Thursday, January 8, 2009

Satyam: Let the Truth Prevail

The ‘Satyam’ saga has turned out to be far away from ‘Satya. The moral of the story is 'riding the tiger and getting eaten too'. Confessional statement by Ramalinga Raju has sent shock waves through the entire investor community. Raju's story seems to be half truth only, there's more to it than meets the eye. It is the story of a CEO trying to become a landlord and a politician overnight. Raju seems to have swindled Satyam shareholder's money to buy land for his family members and to bribe the politicians to fulfill his evil design.
Whatever has happened is history, law of the land will take its due course in the time to come. However, the new board of Satyam has a task cut out before them, in order to restore the confidence of vendors, shareholders and employees of the beleaguered company. Here is what they need to do swiftly:
1. Initiate criminal proceedings against Raju, to recover the swindled money. Try to get the accounts and assets of the Raju's freezed by enforcement agencies.
2. Recast the balance sheet, by hiring an independent firm, to instill confidence in the stakeholders.
3. No company will be able to takeover Satyam at this juncture due to the takeover code. Invite interested parties like L&T, M&M to nominate members on the board to lend it a semblance of legitimacy.
4. Take immediate steps to cut costs to keep the company as a going concern. Convince all employees to accept a 25% wage cut for the next 6 months at least. The directors should take the lead by announcing a 50% cut in their own remuneration. Manage efficient management of premises, rent out some space from company owned premises. The survival of the company is the main issue.
This issue is much bigger than a mere 'Corporate Governance' issue, as the image of India as a nation is at stake. Of course, it is bad news for the investors, as this may have laid the foundation of a prolonged bear phase ahead!

Saturday, January 3, 2009

Interest Rate Mechanism

Interest rates reflect the price of money/credit in the economy. Banks have two main sources of income - the net interest income (i.e. income earned on loans minus payout on deposits) and the incomes they make on their investment portfolios. Since bond prices move inversely with interest rates and the bulk of banks' portfolios is in bonds, treasury incomes rise with a fall in interest rates and vice versa. However, the bank profits largely depend on their net interest incomes.

The key interest rate indicator, also known as the REPO rate has recently been lowered by 100 basis points by RBI. Repo rate is the annualised interest rate at which banks borrow money from the Reserve Bank of India (RBI) over a short term. At the same time RBI has lowered the reverse repo rate by 100 basis points, signalling the banks to cut their lending/ deposit rates. Falling interest rates are a boon for the borrowers in the long run, as they help sustain the profitability of the companies.
The recent rally in the global/Indian markets is a reflection of the fact that the markets believe that the profitability of the companies is going to improve with the steps taken by the monetary authorities recently. But we need to consider the under noted facts:
  • Are these measures enough to revive the economic activity and the consequent demand for companies' products. The falling incomes and the uncertain environment are forcing the consumers to postpone their purchases.
  • Are banks in a position to pass on the benefits to the end users. Unfortunately banks in India cannot lower the interest rates drastically, because of the administered interest rates of the small savings schemes which directly compete with bank deposits.

Keeping in view the above factors the falling interest rates may not have a significance on the revival of company fortunes for at least the next two quarters. This fact makes me believe that the rally in global markets may not sustain long enough.

Thursday, January 1, 2009

India Inc.: Challenges ahead in 2009

The recession in the Global Economy that started in 2008 is likely to continue deep into 2009, causing a severe contraction in economic activity. Severe recession is likely to grip US, Europe, Japan and other advanced economies, even emerging markets will face a severe slowdown. The situation is grim and is leading the global economy towards 'Stagflation', a situation which combines the ill effects of economic stagnation and deflation, where aggregate demand falls short of aggregate supply.
India Inc. will have to grapple with this grim global situation for at least the first half of 2009. The internal signals available are not encouraging at all. Even as inflation is hurtling towards a five year low (it is expected to slide to a level of 2-3% by March 2009), domestic demand seems to be contracting at a rapid pace. The credit crunch has started hurting the growth plans of companies, uncertainty of employment is responsible for the decline in consumption levels. The stimulus package by the government is going to have a limited effect.
India's industrial production was down 0.4% in October '08, exports have declined by 10% in November '08 for the second consecutive month. There is a case for further rate cuts by the RBI in the wake of decelerating inflation, but the banks may not be able pass on the benefits to the end users unless administered deposit rates are cut by the Government. Banks will not be able to reduce deposit rates further as the interest offered on Govt. schemes (PPF, NSC, Post Office deposits) range between 8-8.5%. Prudence calls for a 0.5-1% cut in these rates but the govt. in an election year may not be able to bite the bullet.
The situation is alarming, the government is trying to boost consumer spending by 'Demand pull' factors, but to sustain the momentum supply side factors need to be augmented in the right earnest. Infrastructure spending needs to be boosted to remove bottlenecks in supply. This can be done by cutting costs through efficient management of resources. India Inc. would also have to cut costs to stay afloat in these challenging times. As far as investors are concerned, they can go for selective investment in cash rich companies which thrive on domestic consumption. However, keeping in view the turbulence in global markets, a 'buy on decline' strategy may be prudent.