'Misconceptions!' Are mutual funds relevant? Yes!

Read an opinion on the MF industry on Business Standard -- http://www.business-standard.com/article/opinion/are-mutual-funds-relevant-113063000620_1.html -- given below is my opinion on the subject.

'Misconceptions!' Are mutual funds relevant? Yes

The only reason why MFs will not succeed is because there is a huge misconception about the industry

Financial industry experts fail to understand one simple view that most people from other industries have on finance -- 'It is complicated and boring!'

There is some truth in this view and yet it can easily be classified as wrong. The truth is, its not as simple as the functioning of a savings account. You will have to fill in various forms and give signature on few documents depending upon the financial product you are buying.

The common opinion is wrong for the simple reason that not everyone knows about the intricacies of each industry. If a software expert finds finance as complicated then s/he should also understand that for most people even software is a complicated. Why is there this misconception that 'finance should be simple'?

Now coming to the response for the article 'Are mutual funds relevant?' The author has raised four points why the industry will fail. And given below is my take on each of the four points.

Benefit perception: The benefits are not clearly perceived because most people fail to do their homework. Financial products should not be considered or compared to consumable products like mobile, soap, tv etc. The most relevant comparison for it would be either doctors, architects, or engineers of a specific subject. There are many times when you think that their services are not required but that is not correct all the time.

While everyone has an opinion on what should be done when you have a fever but it is advisable to go a doctor? There are many people who would buy medicines through a pharmacist and act as a self-doctor and they live a long and healthy life, but then many people also tend to fall ill severely because they took the wrong medication.

Similarly everyone will have an opinion on how to approach investments but its best to consult a financial advisor or someone who understands the intricacies of the product. You dont like their opinion, go for a second opinion, just as you would in case of a doctor.

Also don't think that pharmacist is an equivalent to a doctor. Similarly why do people have the misconception that someone who has chosen to be a distributor or broker will understand the big picture of your finances.  (For people who think doctors and advisors are wrong comparisons, I would suggest that you check how many doctors are there in your city and if all of them have similar number of patients queuing up.)

Investments are hassles: Yes it looks difficult to invest at times and there are lots of forms to sign and they ask you with all kinds of question. But the entire idea to protect you and hence the safety measures were created. Medicines too should ideally be given only against prescription although that's not the case but convenience doesn't make the actions as correct.      

Promise vs performance: Here again the problem is that of the first one. Who made the promise?

Consistency: Another misconception. You need to understand the industry and the person. This is surely one place where I would compare it to doctors. There are successful and then there are not-so-successful. Similarly there are successful financial advisor and not to successful financial advisors.

I think most people don't get the structure right. The misconception is that Mutual Fund should be held responsible for anything wrong while this position can have some merit but it would be better to treat the Mutual Fund industry like Pharmaceutical industry. AMCs are manufacturing products, testing them. Just as the dream drug, one pill that cures all problem, that pharma companies would be chasing; mutual fund industry will try to search for its one fund that will perform in all markets in all conditions. But how can that happen?

Just as you need to find a good doctor and hope that they diagnose the illness correctly, similarly you should find the right advisor. Else in one case you might lose your health, the other will risk your wealth.

The Noon-light robbery: LIC

There is a lot of coverage to the LIC's investment in ONGC's share auction. So I thought will just explain it in the simplest possible way.

*What was reported/what happened
ONGC was auctioning its shares. Since the oil marketing company is in losses and is expected to remain in losses, so the investor community didn't show enthusiasm. The government sprang in action and called the LIC's big boss. The boss (at LIC) told his minions to buy ONGC in the auction. The minions also followed their orders.

Now the investment has been screwed: LIC bought the share around either INR 392 or INR 303.67 (this is a new controversy, I havent fig out the discreparency either), but the current price of the ONGC Share is INR 282. So either way the company LIC has made poor investment.

*Insurance?
The idea of insurance is to protect one self against an unforeseen problem. Most of the time the company takes into account that only 10-20% of the people taking out an insurance will file claim. If there is a risk of more people filing for claims then the premium amount will rise.

*Business model for an insurance company
Roughly, the insurance company invests 60-80% of the money collected in business from where it can get higher returns. Only a part of the money is kept with the insurance company so that it can give out claims and run its day-to-day activity. For this the company claims a service charge and all money made out of the investment remains with the company/shareholders.

(The exact business is more complicated but in simple terms we can state as above)

*The twist
In India LIC sells insurance product which guarantees a return at the end of the tenure. This return is linked to the performance of stock market, which is based on the number of units. So if LIC makes a bad investment then it is the policy bearer who will register the losses.

*The noon robbery
LIC is making poor investment knowingly because the Govt has directed its Chairman to do so. This hurts the company from a business sense but also because it is doing against the best interest of its policy investors.

*The biggest problem
Years ago, there was a mammoth company called UTI which used to collect money and invest. But it failed because it came out with a product with guaranteed return and it invested in stocks but around the same time stock market collapsed and hence it didnt had enough money to meet its obligation.

LIC may not have to share the fate of a govt bail-out now but if its decision making is not give the due freedom then it will go the Air India way and face the prospect of being bankrupt.

A policy error on Maruti's part

There is continuous problem that has been cropping up at the Maruti's plant. Every now and then they are shutting it down for fairly long period.

But no one, it seems is actually trying to solve the underlying problems they are just playing the immediate game.

To start with the main problem is that temporary workers are paid less and have less amenities but companies prefer them because its easy to issue them pink slips (in other words fire them) when there is a slow down.

This is definitely a skewed system.

The solution would be to pay higher wages (i.e. cash in hand) to temporary workers.

The easiest I could think of was to pay 20% more to temporary workers than the permanent workers. That should even out the playing field between temporary and permanent workers.

Permanent workers get less cash in hand and more benefits plus firing them would be difficult. Meanwhile temporary workers will be paid more because they will have more risk, the risk of losing the job.

Why is the state government not suggesting such simple solution or coming up with a solution that is (a) practical (b) solves the real problem?  A policy problem cannot be solved by signing agreement and playing strikes and suspension.

False tone

I am sure; some of your friends must have bought a Tata Indicom or Docomo at some point. Do you remember their complaints? If you don’t remember then just call up your friend who had used any of the Tata’s telecom offering and ask them, if they would like to use or let’s say rely on the service (Indicom or Docomo or Virgin) again for their office or their personal work? Also try and recall if you have you ever heard any corporate connection with the services of Tata telecom? My memory fails on any such information.

During college days (like two years back), I remember many of my friends having a reliance connection to talk to their parents, as their parents also had reliance at home. And they would keep a second mobile to call up friends and use locally. This second service would be one of the major three: Airtel, Vodafone (former Hutch) or Idea (then it used to be Spice in Karnataka and Punjab).

Only one friend took Tata Indicom for calling home since it had a better offer. Two months later, the mobile and the service found its way to the dustbin, and the easiest way to infuriate my friend during those days was to ask "How’s the service of Indicom?"

The second time I heard about their service quality was when one of my friends bought Tata Photon, the USB dongle. Well this particular customer was satisfied with the service initially. Till he reached Jamshedpur, also sometimes called as the Tata Steel's city. Apparently the USB didn’t work in the region, I meant in Tata Steel’s city.

So, the simplest way to check out a loser or a winner in the service sector is to crosscheck with about three questions. How good is your service? And how fast can you adapt to technology? Are they using technology to enhance the experience of the customer? And is it worth the cost?

The recent article by Forbes on Tata's telecom business was good. There were lots of information in the article, how the telecom business is run and what Ratan Tata may be thinking. They even tried giving some suggestion of what could happen.

The most interesting part I found was now it plans to merge all of its telecom businesses under a single umbrella. Its still better to be late than never. 

The second interesting information was: "Customers will normally switch to market leaders or if the network has exceptional voice clarity. Tata has neither the leadership nor the right type of network. It has the 1,800 MHz frequency band, which isn't the best for voice clarity and competing on that front will be hard."

And "Worse, it has to pay other operators for carrying traffic for it in some very key markets." This certainly was information for me.

Somehow I felt the conclusion was over dramatised, "Srinath may be an insider but some of these tasks are so tricky that even for someone of his experience, tying up all loose ends may just take too much time. And that's a commodity that might run out for the Tatas even if their money doesn't."

When was the last time when Tata's have closed down a company after investing so much? If you can’t get an answer to that then keep watching.

"Bonus"

It funny the way American media and the politicians are shouting over the AIG executives being paid the bonus.

There are some who want the bonus to be either returned or capped for "xyz complicated reasons."

Then there are those who are fighting that it should be paid if not, "we should consider it, the end of capitalism. And that without 'bonus' senior management will not feel motivated to work and show performance. Therefore, the company (AIG) should pay them (the management) bonus and kick them out."

I checked up on answer.com for its meaning and their business dictionary said -

1. Compensation paid to an employee or employees for achieving a particular sales goal or organizational objective. This is above and beyond either a Commission or a Salary. A corporation achieving a 10% increase in profits may distribute part of the earnings as a bonus to its employees.

2. An unexpected benefit occurring as the result of making a particular action.

That sounds simple. Doesn't it? Maybe the simple reason for not paying the business is for failing to make any profit. So why not just state the simple reason rather than fuming and writing 1000 of words when you can finish it in less than 200.

And if some are still advocating that it (bonus) should be paid then just ask them, why? And, how do they define 'Bonus'? Also which private company pays bonus for failing?

I think these questions will be enough to get the desired results.

The logic of "Cycle"

Well to put in simple terms economic cycles can have two simple comparisons. And its applies to not just economic cycle but to business cycle as well.

The first cycle can be called is the non-market way, or a life’s way. To make it more comparable consider the life cycle of plant, animal or top of the food pyramid humans too. We live a certain number of years and then we die, this is the ultimate statistics. To put it to brutal terms there is no cycle in it; it’s a one way path which ends with death. Ok you need a bigger example then consider communist Russia, or you can look up any monarchs. They all survive for some years or few hundred years max and then get settled in the dust.

Then there is a second type of cycle - the market cycle – which is the natural cycle. Very much like the nature or a complete cycle; the reason mentioning it this way is because it is repetitive in nature, the patterns will be repeated though the time frame may not necessarily be exact. There will be summer, autumn/ monsoon, winter and spring. A country and its economy will have to see it, doesn’t matter if they want to or not.

So the current financial meltdown should not be surprising, since we all are part of this market cycle. The new millennium witnessed financial engineering on an unprecedented level. Complicated financial models were developed to make people reach in short span of time. Then should it be surprising that we have been hit by the draught of credit and flood of pink slips?

This is similar to the excess done by us humans; too much of deforestation or building big dams without considering the biosphere then there will be calamity like massive flood, draught and according to most recent problems that we (humans) have created global warming.

Escaping it is impossible; unless you can figure out a way to escape death, don’t count on getting out of this mess so fast. We all read in school or if not in school then by way of experience we should learn – “You reap what you sow”

Unfortunately public memory is very short. when the time is good rather than taking some of the tough decisions we get greedy; then we tend to forget the lessons learnt a bit too fast.

What Recession ?

A friend of mine asked me to write something on recession; although I am not an authority on it but then this is just a blog so I will write.

- - - - - - - - - - - - - - - - -

On using Google and reading many different sites, if one has to explain what is recession then it would be this -

"A true economic recession can only be confirmed or announced if GDP (Gross Domestic Product) growth is negative for a period of two more consecutive quarters."

What are the causes for recession? When did it start? What was the exact point is difficult to ascertain. According to one website, ‘the true starting point actually rest in the several quarters of positive but slowing growth before the recession cycle really begins. Often in a mild recession the first quarter of negative growth is followed by slight positive growth, then negative growth returns and the recession trend continues.' (recession.org)

Although the truth is there is no pattern, look at the graph given on the right. Or if the above statement is right, in that scenario the worst is not over.

Also though the two quarter theory is generally accepted but most experts do not agree on it.

Just for information, so that there is no misunderstanding. In the US it's the National Bureau of Economic Research (NBER), which announces if the country is in recession. And they use a multitude of factors before announcing that the country is in recession like unemployment, industrial output etc.

Now in India's case there is no defined authority, at least not to my knowledge.

If you are to ask me then I would say, probably RBI will announce, if there is ever such a situation. Then stock markets will crash, therefore, the Finance Minister would cry foul. So, the governor of RBI will file a case and the law ministry will give its own interpretation. I think after the first announcement and the denial it will be another quarter when the Supreme Court will give the verdict, "WE ARE IN RECESSION".

Now no need to panic that was just a scenario "if" there is a recession in India.

India is not in recession. Our growth has just slowed down and from IMF to the individual experts are all saying that India will see growth although a small one which can range from 2 percent to 5 per cent for the calender year 2009. Although I personally would put it between 1.5 per cent to 4 per cent at best. If it goes more than 4 we should celebrate, that we managed more than 4 when the world shrank .5 percent or more.

The last Laugh

Although I have already mentioned in my previous blog "The Satyam Misconception", that nothing will happen to Raju because the elected representatives will protect him. B will move at snails pace and there will be many roadblocks on the way. The roadblocks which our dear politicians will make.

Look at Satyam now, the company will be sold in few weeks time and government will not be responsible for it. Till then the state government will do its best to protect Raju; so far it has managed to do it. With some scolding and backing from supreme court SEBI and SFIO will manage to get some some preliminary work done. But it will not be to book the guilty or deliver justice but to show the people that work has been achieved.

To make it attractive, Govt. will pressure PSUs to give work to Satyam. Government assurance will work with some clients too and they wont desert it. The company that buys Satyam will bear the trouble form there on.

By June, election will be over, the new govt will have to deal with the recessionary or slow growth faced by others. It will be far too busy to bother, Satyam Will be a headache for some one else. The media will be busy hounding the new govt and the meltdown affect on India will claim some more business.

Raju will either get bail or will make some deal and leave India on a temporary basis at least. Since, public memory is weak, he will come back when people would have forgotten him.

So who will have the last laugh here, not the Govt, not the shareholder or any one else but our man Raju!!!

The Satyam Misconception

'Satyam Computer Services limited,’ this was a famous company. Rather it is still famous albeit in the wrong sense. Ever since the CEO of Satyam, Ramalinga Raju confessed to falsifying accounts on January 7, 2009; it has gained more publicity (a negative one). An active media is doing a good job by asking some very correct questions like how he managed to do so for several years. Definitely the big auditing firm was involved. Without Price Waterhouse Coopers involvement this would not have been possible.

Where most people are getting it wrong is by calling it the "Indian Enron." Even I thought the same comparison on hearing about the confession the first time. And I think we were all wrong in it. When Enron scandal was investigated the CEO, Kenneth Lay was the one who went on fighting the case and the CFO, Andrew Fastow testified and pointed at all culprits including Lay. The accounting firm Arthur Andersen was one of the big five in auditing business. Both Enron and Arthur Andersen were forced to shut down.

Enron was trapped after investigations showed the whole scam. Where as in Satyam's case, the CEO surrendered before he can be caught. Securities Exchange Board of India (SEBI) had started inquiry in to the affairs of the company after it had to abort plans for Maytas acquisition. Surely given time they would have caught him. Merrill Lynch (now Bank of America) must have sniffed something wrong to back off from reviewing the company and has stayed away from media light. The CFO, Srinivas Vadlamani is blaming everyone but himself.

What Might Happen?

Well this is the biggest questions which everyone would want to know. Raju was the blue eyed boy of the State and of the different ruling parties be it the present Congress or the previous Telgu Desam (TDP). The stage has been set for compassionate hearing because of his confession and his health. When a politician gets indicted instead of going to jail they often fall sick and then end up in hospitals (wouldn't say this is true for all but definitely the big ones). One would expect few cases in which some thing like this would happen but then its the other way round. This is amusing but a hard fact. So it will not be surprising if Raju too falls ill and then is shifted to a hospital. Since he has surrendered the lawyers will do their job. If the political masters’ don’t disown Raju then this case will be stalled like Bofors, Fodder, or the way Gujarat genocide has never been solved properly despite media attention. This case too has the potential too join this junk list.

Now comes the part to deal with Price Waterhouse Coopers (PWC), well their associate firm in India. There are many legal angles to it. But most importantly what has come up in the past few days is about the disclaimer that PWC has on its contract. Also that it has sent a letter to the new board that its auditing cannot be relied up on as the data it had received were false. Weren't auditors supposed to make sure that owners are not falsifying data? It is not that PWC (i.e. their Indian associate or the main company in US) will go unpunished, from current reports it seems that ICAI will cancel the license of those accountants associated to PWC in India. Considering Satyam was listed in US PWC will not have to face some wrath there too.

Will it be a jolt to Investments?

Perhaps in the short run. But with global recession looming, it will be difficult pin point the Satyam debacle as the reason why FIIs are not coming. This may contribute to some extent but not to a very large extent. The reason being India is evolving just like the rest of the countries and it’s cheaper compared to the developed nation with lots of talent. Besides if Madoff can run a ponzi scheme so can Raju.

Corporate governance laws will improve with this incident. As far as justice is concerned, that will have to be done by the market or let’s call it the free market. Shareholders of all companies will have to make sure they don’t get audited by PWC be it in India or in any other country. This measure will ensure psychological safety. It will also leave a strong message for the auditor community.

On investors part they would have to deal with Satyam the way they think is the best. The good part is that the company was not being run on loss nor did the founder walk away with the money. Profits are there though not as much as stated earlier. Therefore, the potential is there to still keep its image as a major player in IT industry. Although the government has intervened to set things right or rather a bail-out from the sidelines but that may not be the best thing to do. Many would say what cant he government do from the sidelines? well for starters provide liquidity from PSU banks, maybe hand over some of its contract. But these things will not help in the long run. Rather let the investors sit together and come to a unanimous decision. Ultimately it will be the market that will provide the business, then let the other half called investors take the decisions.