Niveshak Dec14

Niveshak THE INVESTOR

VOLUME 7 ISSUE 12

December 2014

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VII ISSUE XII December 2014 Faculty Chairman

Prof. P. Saravanan

THE TEAM Abhishek Bansal Akanksha Gupta Apoorva Sharma Bhawana Saraf Gaurav Bhardwaj Jatin Sethi Kocherlakota Tarun Maha Singh Gulati Mohit Gupta Mohnish Khiani Palash jain Prakhar Nagori Priyadarshi Agarwal Ramesh Jaiswal Rahul Bajaj Sandeep Sharma S C Chakravarthi V Vishal Khare All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

With this issue of Niveshak, we bid farewell to an eventful year of 2014. The month of December saw foreign investors pouring in $2 billion in the Indian capital markets in December, taking this year’s total inflows to a whopping $42 billion since January. Foreign Portfolio Investors have invested heavily into the debt market with an exposure of $26.4 billion, while $16.4 billion have been poured into the equities market. The year 2014 was not very good for IPO market as the funds raised via IPOs in 2014 was lowest in more than a decade, despite the benchmark indices hitting new highs during the year. The five IPOs that hit the markets this year raised a combined Rs 1,201 crore, the lowest since 2001, when 13 companies had raised Rs 296 crore. Major headlines of this month were - Walmart announcing the opening of new cash and carry store in Agra after a gap of two years. RBI in its fifth bi-monthly monetary policy kept the policy rates unchanged. Jyotsna Suri elected as the President of Federation of Indian Chambers of Commerce and Industry (FICCI) and she will succeed Sidharth Birla. The mid-year economic review projected the 2014-15 growth to be at 5.5%. The Finance Ministry ratified 8.75% interest on PF for 2014-15. Japanese Prime Minister Shinzo Abe was re-elected for another four year term. Ebola fighters were named as Time magazine’s 2014 ‘Person of the Year’ for their tireless acts of courage and mercy and for risking, persisting, sacrificing and saving. India’s Kailash Satyarthi received the Nobel Peace Prize for 2014, sharing it with Pakistan’s Malala Yousafzai, the youngest ever Nobel laureate, for their work on promoting child rights in the troubled sub-continent, where millions are deprived of their childhood and education. The UN’s annual economic report predicted the global economy growth to be 3.1% in 2015 and 3.3% growth in 2016. The report also said the India is estimated to record a 5.4% economic growth this year and its GDP will improve to 5.9% next year and to 6.3% in 2016. The State Bank of India has launched two indices namely SBI Monthly Composite Index and the SBI Yearly Composite Index that will primarily track manufacturing activity and offer a forward-looking economic trends. The highlight of this year’s budget was Real Estate Investment Trust (REIT) and our Article of the Month describes everything you need to know about REIT’s. Startup ecosystem is maturing in India and 2014 has seen a phenomenal traction in this space, our coverstory discusses how Private Equity, Hedge fund and VC’s investments have impacted start-ups in India. The year 2014 was also about FDI investments, our FinGyaan section covers FDI investments and how they help the economy. It also covers both the bright and dark side of the story. And our FinLife section covers the Corporate Social Responsibility aspect of the corporates and how it is helpful to the Indian economy and people. This year was about blazing stock markets and our FinSight section covers that in detail by describing the SENSEX movement this year and the steps taken by Modi government that helped the markets. To end this brief note, it’s important that we thank you, our readers, for your constant support and appreciation. Please continue to motivate us so that we can come out with more insightful reads in the issues to come. Keep pouring in your suggestions and feedback to niveshak.iims@gmail.com and as always. Stay Invested! Team Niveshak

Disclaimer: The views presented are the opinion/work of the individual author and The Finance Club of IIM Shillong bears no responsibility whatsoever.

CONTENTS Cover Story Niveshak Times

04 The Year That Was

Article of the month

14 Start-up and Private Equity

Real Estate Investment Investments in India Trusts : A look into the need and benefit of real estate investment trusts in India

FinGyaan 18 FDI- a harbinger of economic growth?

Finsight

The sudden improvement in stock markets: Will it sustain?

FinLife

FinView

22 Socially Responsible Corpo- 29 Interview with Prof. Natesan rates Ramesh, Professor â&#x20AC;&#x201C; SJMSOM, IIT Bombay

Classroom

31 DuPont Analysis

The Year That Was

NIVESHAK

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The Niveshak Times Team NIVESHAK

IIM Shillong PM launched Make In India Campaign to make India a manufacturing hub Prime Minister Narendra Modi on 25 September 2014 launched Make In India Campaign at Vigyan Bhawan in New Delhi to make India a manufacturing hub. The campaign is aimed to attract foreign companies to set up their manufacturing units in India and to seek greater foreign investment. The objective of the campaign is to get manufacturing sector to grow over 10% on a sustainable basis over a long run. The campaign is aimed to transform the economy from the services-driven growth model to labour-intensive manufacturing-driven growth. This will help in creating jobs for over 10 million people, who join the workforce every year. Union government de-regulated diesel and hiked natural gas rates Union government on 19 October 2014 deregulated the price of diesel and hiked the rates of domestically produced natural gas. The price of diesel will be market-linked without any government intervention and retail rates reflecting price changes in the global market. Now the government will no longer provide subsidy on diesel. This is the first reduction in diesel rates from 2009. The diesel price was reduced by 2 rupees a litre to 30.86 rupees in January 2009. After the deregulation of diesel, the rates of diesel will bring down rates by 3.37 rupees per litre. Besides, the natural gas tariff was hiked by 46 percent and will go up from current 4.2 per million British thermal units (mmBtu) to 6.17 per mmBtu from 1 November 2014. The increase of natural gas price will push up fertiliser, power, CNG and PNG rates. The natural gas price increase will result in CNG prices going up by 4.25 rupees per kg and piped cooking gas by 2.6 rupees. Besides, tariff for power produced from gas will go up by about 90 paisa per unit and fertilizer production cost by almost 2720 rupees per ton. Relief in Inflation

SEPTEMBER 2014

Inflation has been one of Indiaâ&#x20AC;&#x2122;s biggest problems. It remained elevated for a long period of time, often growing at a rate over 10%. This year brought cheer on this end too. Inflation fell the entire year to new multi-year lows. Wholesale price inflation grew 0% in November, while retail inflation grew 4.4%, as per the latest data. This has been predominantly because of a fall in global oil prices. Food inflation, which grew 15.4% in November 2013, is down to 3.1% in the same month in 2014. This is good news, as high inflation eats into the value of money. A continuous fall in inflation also could open doors for a cut in interest rates by the Reserve Bank of India. This could help spur growth. Quantitative Easing comes to an end In May 2013, the US Federal Reserve announced its intentions to cut down its bond purchases, called the Quantitative Easing programme. The US central bank infused money into the US markets through this programme. This money found its way into riskier emerging markets like India. The announcement led to market crashes around the world. The Indian market was the most affected. 2014 has seen a reversal of this effect. The US central bank slowly reduced its bond purchases to finally end the programme in October this year. Despite that, foreign investors continued investing in India as the underlying economy and fundamentals improved. The US central bank also indicated it may hike interest rates next year. Mergers & Acquisitions in the year 2014 On February 13, Comcast Corporation announced its proposed acquisition of Time Warner Cable for a whopping $69.8 bn. It was only first of the many such handshakes to cheer up World Inc this year. Some of the major international Mergers & Acquisition (M&A) deals this year include those between Holcim (acquirer) & Lafarge (target) for $46.8 bn, Facebook & WhatsApp ($19.4 bn), General Electric & Alstom ($17.1 bn) and Novartis & GlaxoSmithKline ($16 bn). The Indian landscape was also flush with such announcements. Flipkart- Myntra joined hands in a deal reportedly

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worth Rs 2,000 cr. Other important deals include RILNetwork 18 Media and Investments (Rs 4,000 cr), Asian Paints- Ess Bathroom Products, Kotak Mahindra Bank - ING Vysya Bank (all stock amalgamation), Merck- Sigma (for $17 bn in cash), Ranbaxy - Sun Pharmaceuticals ($4 bn), Tata Consultancy Services (TCS) and CMC and Tech Mahindra Ltd - Lightbridge Communications Corp ($240 m). FDI in Insurance, Railways, Defence etc. Moving ahead with the economic reforms, the Cabinet cleared the proposal for raising FDI limit in defence to 49 per cent and fully opened up the railway infrastructure segment, like high-speed trains, for foreign investment.

valuable tech companies in the world after raising $25 billion from its U.S. IPO. World Economy Snapshot It’s been a mixed year for the world’s economic indicators. • On Dec 31 last year, oil prices were hovering around $98 per barrel. In a twist of fortune, the prices have dropped 22 percent per year to around $76 in November. • The US meanwhile, is stepping up its way back as a vibrant economy. • The US stock market, as measured by the S&P 500, is up over 11% so far in 2014.

The decisions taken at the Cabinet meeting headed by Prime Minister Narendra Modi here came barely two weeks after the one to raise the cap of FDI in insurance sector from 26 per cent to 49 per cent.

• The country’s currency continued its brilliant comeback, racing past the Euro, Yen and other major currencies. The US Dollar has seen one of its best rallies since the nineties.

The move is aimed at boosting domestic industry of a country which imports up to 70 per cent of its military hardware.

• The US economy grew at 3.5% in the third quarter, inflation remained steady and the country’s unemployment rate hit a six-year low in October.

The Cabinet also approved a proposal to open up cash-strapped railways to foreign investment by allowing 100 per cent FDI in areas such as highspeed train systems, suburban corridors and dedicated freight line projects implemented in PPP mode. The FDI liberalisation in the sector would help in modernisation and expansion of the railway projects.

• The International Monetary Fund has trimmed the growth forecast for Latin American and Caribbean region to 1.3% in 2014 and 2.2% in 2015.

Alibaba IPO 2014 marked the world’s record-breaking initial public offering. Alibaba Group, a Chinese e-commerce company, witnessed an overwhelming response for the biggest US-listed IPO. By raising $25 billion, Alibaba surpassed the 2010 offering of Agricultural Bank of China which had recorded $22.1 billion. On its first trading day, Alibaba shares soared 38 percent as investors grabbed their chance to create the largest global IPO. Reuters reported that according to its prospectus, Alibaba had agreed to sell $26.1 million additional shares under the option, and Yahoo Inc an additional 18.3 million, netting the two companies an extra $1.8 billion and $1.2 billion respectively. Alibaba, one of the world’s biggest online e-commerce stores, is now ranked among the most

• Things are not looking up for the 28-member Euro Zone either. Growth is expected to be 1.3 percent in the bloc this year, instead of the 1.6 percent predicted in the spring, according to the European Commission, EU’s executive arm. • During Q3, Japan slipped into recession after the nation’s gross domestic product fell for the second consecutive quarter this year. Signs are scary. According to The Economist, the “Japanese government debt is now above 240% of GDP and the government continues to run deficits of around 8% of GDP per year.” • China’s economic growth has slowed to 7.3 percent in the third quarter and the country’s government and central banks might slash interest rates over fears of deflation and rise in unemployment. According to Reuters, “Fullyear growth is on track to undershoot the government’s 7.5 percent target and mark the weakest expansion in 24 years.”

The Year That Was

The Niveshak Times

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Market Snapshot 35000.00

6,000

30000.00

5,000 4,000

25000.00

3,000

20000.00

2,000

15000.00

1,000

10000.00

BSE

FII, DII Net turnover (in Rs. Crores)

Article ofSnapshot the Month Market Cover Story

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-1,000

5000.00

-2,000

0.00

BSE

-5000.00

DII

-3,000

FII

-4,000 26/12/14

25/12/14

24/12/14

23/12/14

22/12/14

21/12/14

20/12/14

19/12/14

18/12/14

17/12/14

16/12/14

15/12/14

14/12/14

13/12/14

12/12/14

11/12/14

10/12/14

09/12/14

08/12/14

07/12/14

06/12/14

05/12/14

04/12/14

03/12/14

02/12/14

01/12/14

30/11/14

29/11/14

28/11/14

27/11/14

Source: www.bseindia.com www.nseindia.com

MARKET CAP (IN RS. CR) BSE Mkt. Cap

LENDING / DEPOSIT RATES

9675058.58 Source: www.bseindia.com

Base rate Deposit rate

CURRENCY RATES INR / 1 USD INR / 1 Euro INR / 100 Jap. YEN INR / 1 Pound Sterling INR/1 USD

Euro/1 USD

RESERVE RATIOS 63.64 77.74 52.93 98.98

GBP/1 USD

10.00%-10.25% 8.00% - 9.05%

JPY/1 USD

CRR SLR

4.00% 22.00%

SGD/1 USD

3.50%

3.00%

2.50%

2.00%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.00% 8.00% 7.00%

1.50%

1.00%

Source: www.bseindia.com 26th Nov 2014 to 26th Dec 2014

0.50%

Data as on 26th Dec 2014 0.00%

DECEMBER 2014

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Article Market of Snapshot the Month Cover Story

Market Snapshot BSE Index Sensex MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

Open

% change

28386.19 10119.95 11180.24 18787.14 20586.35 9630.87 16236.26 7696.85 14809.67 11094.24 11274.31 10874.72 2135.26 8228.54 1660.73 6125.31

27241.78 10115.85 10894.89 18455.13 21253.3 9359.5 15113.05 7686.06 14409.51 10422.16 10562.54 9878.81 2032.64 8121.33 1533.94 5762.49

-4.03% -0.04% -2.55% -1.77% 3.24% -2.82% -6.92% -0.14% -2.70% -6.06% -6.31% -9.16% -4.81% -1.30% -7.63% -5.92%

% CHANGE TECK

-5.92%

REALTY

-7.63% PSU POWER

-1.30% -4.81%

OIL&GAS

-9.16% METAL

-6.31%

-6.06% Healthcare

-2.70% FMCG

-0.14% -6.92%

-2.82% BANKEX AUTO

Smallcap

-1.77% -2.55%

MIDCAP Sensex

3.24%

-0.04% -4.03%

Niveshak Investment Fund Information Technology

Cons Non Durable (6.60%)

HCL Tech.

GODREJ CONSUMER Wg:6.60% Gain:8.69%

(15.12%)

Infosys

Wg: 4.40% Gain : 20.27%

Britannia Wg:5.25% Gain: 71.94%

Wg: 5.29% Gain : 04.55%

TCS

Wg: 5.42% Gain : 1.65%

FMCG (24.34%) Colgate HUL

Wg:7.18% Gain: 15.29%

Wg:5.20% Gain: 6.55%

Banking (7.40%) Wg:6.69% Gain: 7.07%

Auto (12.04%)

Pharmaceuticals (13.36%)

Dr Reddyâ&#x20AC;&#x2122;s Labs Wg:5.43% Gain:8.53%

Lupin Wg:7.92% Gain : 21.87%

HDFC Bank

Wg: 7.40% Gain : 2.91%

Chemicals (8.19%) Amara Raja Batt Wg:5.31% Gain : 13.95%

Tata Motors Wg:6.73% Gain : 8.18%

ITC

Asian Paints Wg:8.19% Gain:15.62%

Misc. (5.57%)

Manufacturing (7.33%)

Titan Company Wg:5.57% Gain:-2.09%

Page Industries Wg:7.33% Gain:15.20%

Performance Evaluation

Opening Portfolio Value : 10,00,000 Current Portfolio Value : 13,88,872.0 % Change in Portfolio Value : 1.90% Change in Sensex : 4.61%

Risk Measures: Standard Deviation : 13.73%(Sensex : 13.11%) Sharpe Ratio : 2.54 (Sensex : 2.20) Cash Remaining:2,67,689

Comments on NIFâ&#x20AC;&#x2122;s Performance & Way Ahead: In the month of December (till 26th December), owing to market entering into consolidation over the performance month of November, the BSE Sensex witnessed a change of (4.61%) where as the NIF recorded (1.90 %) change. This month the NIF portfolio again witnessed a reshuffle in terms of value and composition. Since its launch, NIF has made a return of 38.88% compared to the returns of the Sensex at 32.89%. This has been through the profit booking strategy whenever the market was overvalued. The recent fall in the markets have held us in a good stead as the conserved cash has cushioned the fall and has enabled us to take an advantage of the lower prices. The recent drop in oil prices leading to soft commodity prices is also a net positive factor for the Indian economy. This coupled with our basic philosophy to conservatively invest in high quality companies, has led us to introduce Page Industries, HDFC Bank & Godrej Consumer Ltd. into our portfolio and at the same time about 17% of our portfolio is still in cash. We expect some more reforms and rate cut as the important driver for the fundamentals of the companies in the first quarter of the new near 2015 and we would continue to lookout for maximizing returns by taking as-least-as-possible risk.

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REAL ESTATE INVESTMENT TRUSTS A look into the need and benefit of real estate investment trusts in India Dylan Jude Fernandes

IIM Bangalore REAL ESTATE INVESTMENTS Real estate investments entail the ownership and management of both commercial real estate and home ownership. Real estate investment could be ‘direct’ or ‘indirect’. Direct investing refers to owning and managing physical real estate (land, buildings etc). Indirect investing refers to owning securities of entities that own and manage real estate. In case of home ownership, real estate most likely comprises the single largest investment of a typical retail investor. However, the dynamics of commercial real estate investing are significantly different. The primary motive of commercial real estate investing is to generate return through lease rentals and capital appreciation. Following are some basic yet typical characteristics of real estate investments :

DECEMBER 2014

Indivisibility By virtue of their physical characteristics, real estate investments are indivisible. For example, it is not possible for an investor to buy only the living room of a flat and expect another investor to buy the bedroom. Big ticket investments A derivative of indivisibility is large lot size. A typical real estate investment entails significant capital investment. Difficult price discovery Real estate values are not easily determinable as in the case of stocks. This is because the assets are heterogeneous, have significant idiosyncratic risks and are illiquid. Therefore, real estate prices are generally determined through appraisals, which are infrequent.

NIVESHAK

Article of the Month Cover Story

Search, information and diligence costs Real estate investments require significant time, effort and cost to obtain adequate information about price, ownership and title and economic viability. Similarly, gathering required information requires professional due diligence, which is major source of inefficiency as regards overheads and time. Need for active management Investors who own the traditional bond and stock portfolio may not be required to actively manage their investment. However, owners of real estate assets are required to continuously involve themselves in maintenance, negotiating contracts, collecting leases, paying taxes among other activities. Idiosyncratic risks Properties are generally fraught with idiosyncratic risks i.e. risks which are peculiar only to that specific property. In most cases, it is difficult to minimize this risk using the traditional portfolio theory. NEED FOR CAPITAL One of the major problems plaguing real estate owners is the availability and cost of capital. Though real estate investments are highly levered and are characterized by high loan-tovalue ratios (LTVs), equity investment is the Achilles heel of this asset class. Stable and long term ownership capital is quintessential to ensure efficiency of any asset class and real estate is no exception. THE WAY OUT As a logical deduction of the discussion this far, one plausible way out is allow those investment products to flourish which widen investor base, provide efficient tax treatment to investors and provide liquidity to the asset class. WHAT ARE REAL ESTATE INVESTMENT TRUSTS? Real estate investment trusts (REITs) are securities created by pooling real estate assets. These securities make disbursements to holders from cash generated via lease rentals and capital appreciation (at the time of asset sale). REITs are analogous to mutual funds, a mutual fund is a pool of investment from investors who mandate the fund manager to invest their money appropriately and earn the desired return. The fund manager in an investment professional who stands in a fiduciary position and uses his expertise and knowledge to invest these funds

for the benefit of the investors in exchange for management fees. Whereas mutual funds pool together stock and bonds, REITs pool together physical real estate assets. Benefits of REITs for potential investors: Diversification and inflation hedge Real estate, as an asset class, provides significant diversification benefit to a traditional bond and stock portfolio. For example the FTSE NAREIT All Equity REITs Index was 0.58 correlated with the S&P 500 . Contrastingly, the NCREIF Property Index, which measures appraised value of commercial real estate quarterly, was only 0.09 correlated with the S&P 500 during the same period . Superior return performance The performance of US REITs is summarized in the table below . It is evident that real estate has consistently outperformed other asset classes over the long term US REITs S&P 500

BAML* Corp

BAML High Yield

Returns (% ) 5 years

28.3

21.3

5.2

18.3

10 years

8.3

6.9

4.4

8.7

15 years

11.5

5.3

5.4

7.6

*Bank of America- Merrill Lynch Lower minimum investment By creating securities and offering them to a large pool of investors, REITs considerably reduce the minimum investment size. This allows retail

ÂŠ FINANCE CLUB, INDIAN INSTITUTE Of MANAGEMENT SHILLONG

Article of the Month Cover Story

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investors and smaller institutional investors to participate in the real estate sector. Eliminates need for active management Like any commingled investment in trust, REITs transfer the asset management role to the trust. So long as investors believe that the management fees and other establishment expenses of the REIT justify the saving in time and effort from their end, REITs offer an attractive value proposition. It would be worthwhile to note that in near efficient markets, most investment returns trail the benchmark by active management costs. Price discovery REITs are listed on stock exchanges and traded real time. Consequently, the prices of these securities are determined through an unbiased demand-supply mechanism, since most secondary markets are reasonably efficient. High current income Since REITs distribute nearly 80% to 90% of their earnings as dividends, investors who desire high current income from their investments are faced with an attractive proposition. Eliminating search and diligence costs It is safe to assume that the assets pooled by the REIT would have performed adequate due diligence before including the asset in the pool. Further, REITs benefit from economies of scale and need to invest incremental effort for performing the due diligence of every additional property. Benefits of REITs for asset holders: Liquidity The single largest benefit of REITs to asset holders is the liquidity it provides. Owners who hold a portfolio of real estate assets can easily monetize these holding without ceding control of these assets. Similarly, asset holders can expect to receive full value of their holding without significant time loss. Equity investments REITs facilitate equity investment into real estate assets which lends stability. Further, real estate developers and other asset holders can hold more assets since they are in a position to raise more debt. Exit options REITs provide an excellent exit option to asset holders, who otherwise were required to go through the agony of an outright sale.

DECEMBER 2014

Benefits of REITs from standpoint of the asset class In addition to the above-mentioned benefits, REITs also provide the following benefits to the asset class as a whole: Lowering transaction costs As is the case with capital market instrument vis-à-vis the underlying, the transaction costs are significantly lower. The rationale for this lies in economic theory of competitive markets. A capital market is a structure that reduces information asymmetry for a large number of buyers and sellers. The end result is a favourable reduction in transaction costs. Efficient taxation REITs provide a tax-efficient investment vehicle. The nuances of this, from the Indian context, has been explored in detail in a subsequent section. THE CASE FOR REITS IN INDIA The India real estate sector has been characterized by developers being cash strapped due to upfront investment whose payback was lengthy. This led developers to lever their balance sheets and also drop prices in anticipation of capital appreciation. As the economy took a turn for the worse at the start of this decade, many developers came under pressure to liquidate some of their prime holdings in distress. The last 2-3 years have been replete with cases where investors who underwrote properties with minimal deposits withdrew their support, leaving developers in the lurch. However, as the market has matured and rebounded, commercial real estate has made a strong case for itself as a viable alternative asset class. The Xander Group opines that the real estate market has adequately matured to look beyond real estate development as the only means of exposure to the asset class . Currently, of the estimated 350 million square feet of ‘Grade A’ office space concentrated in the major urban centres in India — valued at around $65-70 billion —, about 80-100 million square feet is estimated to be eligible for REITs in the next 2-3 years, valued at about $15-20 billion, according to KPMG. According to an estimate by Cushman and Wakefield, the assets that may qualify to be included in REITs may reach $20 billion by 2020. In the first three to five years, as much as $12 billion could be raised.

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RISK-RETURN CHARACTERISTICS As per a study conducted by Stern University, mortgage REITs have generated excess returns of 2.20% over the broad-based stock market index between 1972 and 2013 . Further, the MSCI US REIT Index generated compounded annual return of 8.40% over the past 10 years whereas the S&P 500 generated compounded annual return of around 7.40% for the same period . Between 1994 and 2007, REITs have returned 3.55% per quarter with a Sharpe Ratio of 0.37 vis-à-vis the S&P 500 which returned 3.08% with a Sharpe ratio of 0.27 . It should be noted that REITs are suited to risk-averse investors desiring high income yield. Around 60% of total REIT returns can be explained by current income. A report by Lazard has proven that REIT dividend growth (8.40%) over the past 30 years consistently exceeds US inflation (CPI = 2.40%) . In the Indian context, the near term attractiveness of REITs is hazy. Yields on commercial assets top out at around 9-10%. After adjusting for expenses, an REIT can offer to the investor can be at best 7-8% . However, as the expense ratio reduces in line with global standards returns are expected to improve. Further, given high relatively inflation in India, it may be unreasonable for REIT dividend growth to consistently outpace inflation. As a word of caution, it would be naïve on our part to forget the inflation hedge provided by real estate and therefore REITs. CONCLUSION From the argument posited through this article, it can be reasonably concluded that REITs are an attractive proposition since they remedy many ills plaguing the real estate sector as an investable asset class. In the current Indian scenario, the risk-return characteristics may not appear tantalizing. However, with an uptick in the economy and increase in rentals, the returns from REITs, on a risk-adjusted basis will improve.

Article of the Month Cover Story

Since REITs would be similar to other publicly traded securities, these instruments are open to foreign investors. As such, REITs are inherently capable of improving foreign exchange inflows and therefore help in correcting the current account deficit. LEGAL & REGULATORY FRAMEWORK Real Estate (Regulation & Development) Bill In 2013, the UPA government introduced the Real Estate (Regulation and Development) Bill which sought to regulate the sector, protect buyers from erring developers and usher in transparency . As the asset quality improves and stakeholders have adequate legal remedies, monetization real estate assets in the capital markets will be easier. The only drawback of the proposed legislation is that it does not extend its claws to commercial real estate. Securities Exchange Board of India (SEBI) norms In the 2014 budget, Finance Minister Arun Jaitley accorded “pass through” status to REITs. Therefore, transfer of real estate to an SPV or an REIT would not attract capital gains tax. Similarly, sale of REIT units from one member to the other would not be a taxable event for the REIT. In summary, the pass through structure eliminates double taxation and ensures that each income and/or gain is taxed only once. Similarly, losses incurred by investors through an REIT holding can be offset against other capital gains. Following up on the impetus from South Block, SEBI notified rules governing REITs. Following are some features of the norms : • REITs can invest in commercial real estate either directly or through SPVs. • REITs can raise funds only through an IPO, which will be listed on an exchange. • An REIT will have to hold assets worth at least Rs.500 crore at the time of an initial offer and the minimum issue size has to be Rs.250 crore. • The minimum subscription size is Rs.2.00 lakh, whereas the minimum trading lot size is Rs.1.00 lakh. • Not less than 80% of the assets should be invested in completed and revenue generating properties. • Sponsors must hold 25% of the issued units for first three years and 15% thereafter to ensure commitment.

Cover Story

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Start-up and Private Equity Investments in India

Rahul Bajaj & Sandeep Sharma

IIM Shillong Introduction Dreams of Indian youth have been gradually shifting from being corporate leaders to being business owners over the last few years. More and more college students are getting inspired by Mark Zuckerberg and the Bansals. Startup ecosystem is maturing in India and 2014 has seen a phenomenal traction in this space. Raising Funds in a private company is a very complex and overwhelming exercise. It depends on the stage in which business is operating, capital requirement of the business and how prepared are the owners to part with some control and equity of the company. Friends & Family, Angel Investors, Venture Capital (VC), Private Equity, Banks, Government, Accelerator programs and Incubation houses are the major source of financing for the private companies in India. Let us look at the various financing options for private companies. Bootstrapping: Personal savings, loans and investments from Family and Friends are the primary source of financing during bootstrapping. It is the phase in which the business model of the company is put to test and it lays the ground for future investments in the company. Also during this phase the company has minimum interference from outside world and revenues are driven by the execution capability of founders of the company. As the investments are sourced from personal savings the concept of frugality in the culture of the company gets

DECEMBER 2014

embedded during bootstrapping. Seed Financing: It is a type of equity financing in which a relatively small amount is invested in the concept stage of the startup. Companies during this stage need small capital infusion to cover for expenses and research & development costs as they start to make revenue or prototypes. Angel Investors, Seed accelerators, Incubation houses are the primary source of such funding in India. Seed Accelerators: Seed Accelerators are programs that provide the startups with money, mentoring and contacts. It is said that meeting the right people at the right time can be the best launchpad for a startup. It is during this phase that maximum startups fail. Accelerator programs help the startup overcome this stage and pitch to VCs and angel investors. Generally such programs charge the startups 6-12% of the equity. Y-Combinator is the first and the most famous American seed accelerator program. Till date four Indian Startups HackerRank (previously Interviewstreet), TapToLearn, Plivo & Markupwand has been funded by Y-Combinator. Prominent Indian seed accelerators are TheMorpheus, Tlabs, Iaccelerator, Gsf, Microsoft, Target, Ryerson Accelerator program, Freemont Partners, Kyron, Catalyzer etc. Incubation House: Incubation Centres are similar to seed accelerator programs. They provide

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support and guidance to the new generation of entrepreneurs and help them stay afloat during the initial turbulent times. With the backing of the Indian government all the major institutions in India have an in-house incubation centre, and currently there are more than 75 centres supported by ISBA (Indian STEPs and Business incubator’s Association). Prominent Incubation centres in India are CIIE - IIM Ahmedabad, SIDBI Innovation and Incubation Centre - IIT Kanpur, Society for Innovation and Entrepreneurship - IIT Bombay, TREC-STEP – NIT Trichy etc. Angel Investors: These are a network of high net worth individuals who invest in the initial stages of the company to provide seed funding. As this investments happen in the early stage of the companies they bear high investment risks and are subject to dilution in the future. Angel investors usually are more founder friendly in comparison to VC or PE but they are carful to invest in companies that have high growth potential (10x or more returns). They demand less of premium in equity as they have other means of making money and may not be looking for a specific level of returns. Also autonomy of decision making is more for the founders with an angel investor than VC or PE funding. However a company might need multiple investors to receive enough money to support its growth which will result in founders having to manage multiple investor relationships. Indian Angels Network, Mumbai angels etc. are the prominent angel investors in India. Venture Capital: VCs invest in high growth potential companies like Angel Investors with a distinction that the amount invested is higher and so is the amount of equity and control with VCs. They also bring expertise and other resources to the company. In India over the last few years VC investment was seen only in the established companies who have tested their business models and are in need of funding to fuel their

growth, however 2014 has been a year where early stage investment was also a prominent phenomenon. Series of funding happens from the early stage, expansion capital to late-stage capital, e.g. Series A for Early stage –> Series B –> Series C etc. for later stages. PE and Hedge fund investments in private companies work in a similar way. Generally they fund companies in the growth or later stage. Prominent VC funds in India are Accel Partners, Blume Venture Advisors, Canaan Partners, Helion Venture Partners, IDG Ventures India, Inventus Capital Partners, Nexus Venture Partners, Sequoia Capital India, SAIF Partners etc. Crowd Funding: 2014 also has been the year of discovery for this method of financing. Startups, regulators, broadcasting channels or the ecosystem developers are the players who contribute to the success or failure of a startup. Crowd Funding as the name suggests sources it’s funding from all the stakeholders in the startup ecosystem & the people. They leverage the power of the crowd through communities who contribute to ideas, technology and financing. Crowdfunding contributors comprise of family and friends, fellow Indians and it could further extend to Non-Resident Indians (NRIs) and even founders of Indian startups who may want to give back to the community by supporting fresh startup ideas. Investments in 2014 More than 300 investment deals in Start-ups were completed in 2014. The year saw a huge amount of funding even to companies with little revenue as long as the Industry in which they operated had huge growth potential. Venture Capital funding in Indian startups reached ~USD 5.1 Billion in 2014 (YoY growth of over 380%) in comparison to ~USD 1.06 Billion in 2013. This was led by a billion dollar funding round of Flipkart. Bangalore topped the list of funding with over 30% of the deals and approx. USD 2.5 Billion of

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investments in Bangalore based startups. Angel investments grew 160% from a mere 56 deals in 2013 to over 145 deals in 2014, accounting for nearly 56% of all deals however they bagged only USD 210 million in 2014. Demographics, huge population (implying huge market), Political stability & government promotions, constantly improving internet connectivity and ever growing number of internet users are the major drivers for rapid growth in private equity and start-up investments in India. Travel portals were the pioneers of E-commerce in India, however slowly they are being overtaken by the online physical goods companies. Flipkart, market leader in the E-commerce companies in 2014 became the first company in India to have a billion dollar funding round. Tiger Global, Accel Partners, Morgan Stanley Investment Management & Singapore sovereign-wealth fund GIC led the USD 1 billion funding in July, which was preceded by another round of funding just two months earlier from DST Global, Tiger Global, Naspers and Iconiq Capital of USD 210 million. Also it rounded off the year with another USD 700 million from new investors Qatar Investment Authority, Baillie Gifford, Greenoaks Capital, Steadview Capital along with a few existing investors. Part of the funds went into acquiring leading fashion portal Myntra. Tiger Global and Accel were the leading investors in both Flipkart and Myntra, and are believed to have pushed for the merger to shore up the battlefront against Amazon and Snapdeal. After having invested huge money into these companies what would be exit route for these investors? Success story of Flipkart has changed the way investors and entrepreneurs look at a business. Focus is shifting from profit margins to revenue growth,

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market share and market potential. Once the company becomes the market leader, it further consolidates its position through horizontal and vertical mergers and acquisitions and finally it goes for an IPO. Exit strategy for these investors would be through sale of their holdings to another VC or PE firm (when their holdings are small) whereas for investors like Tiger Global with higher holdings the only route would be an IPO. The latest rounds of funding in Flipkart has raised its valuation to around USD 11 billion and delayed its route to an IPO. Amazon announced a USD 2 billion investment in India to expand business, a day after its largest Indian rival Flipkart announced of having raised USD 1 billion in funding. To spice up the fight Snapdeal in October 2014 raised USD 627 million from Softbank Group, which was followed by fourth and fifth round of funding of USD 133 million and USD 105 million respectively. Another Lifestyle and fashion ecommerce portal Jabong raised US$27.5 million from Britainâ&#x20AC;&#x2122;s CDC Group. The Real Estate sector also saw a rising interest, with seven companies successfully raising investments. Housing.com raised three rounds amounting to USD 137 million (Last round of funding of USD 90 million which was cleared by Softbank in October) and pushing the total for the real estate sector to nearly USD 240 million. Housing.com has been a leader among Indian real estate portals, pioneering the use of mapbased mobile technology to make house-hunting in a disorganized market easier. It was followed by Indian homes which is another real estate portal that raised big money this year, approx. USD 75 million dollars in 2 rounds of funding. Another real estate portal Commonfloor.com

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clear exit yet for these companies. Conclusion Venture capital investors have raised over three times more capital so far this year in comparison to last year, highlighting intense investor interest in India’s booming startup sector and indicating greater deal activity in the months ahead. However this has also driven up the valuations and ambitions of various start-ups. Technology startups with Intellectual Property have been the primary beneficiaries of early stage VC investments, whereas others have to go through an acid test of their business model before they receive funding. The increased fund flow is coming at a time when the dynamics are shifting in the Indian venture capital market and VC funds are increasingly backing early stage startups which was not seen until last year. Increasing VC investments provide exit route to angels which has improved the profitability of the Angel Investors. Startup atmosphere in India is currently at a high and this will promote disruptive innovation in the country. Startups are highly competitive and focus on customer satisfaction and process simplification. This will bring efficiency in the system and promote optimum utilisation of resources. Startups during the growth phase are the real job creators for the country. Maturing E-commerce Industry this year has been one of the largest recruiters from major Engineering colleges and B-schools across India. Currently farming employs more than 50% of the working population, but contributes only approx. 14 percent of the GDP. Services sector contributes nearly 60 per cent to the GDP, but employs just around 27 per cent of working population. In order to balance this equation India will have to not only accommodate the youth who are joining the workforce every year but also support the transition of the workforce from agriculture to manufacturing and services sector. Make in India and other policies of Indian government to promote manufacturing and services Industry along with the creation of startups will help creation of 10-20 lakh jobs every year. Therefore it is very important not only for investors but also for the country that these investments reap out companies like Google, TCS, Reliance and Flipkart for the next generation of India.

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which began as a community platform for houseowners, property seekers, leaseholders and tenants to connect, interact and solve everyday problems has raised two rounds of funding this year to raise USD 40 million. Mobile startups witnessed a newfound interest and accounted for almost 11% of all deals. Ola a leading local player received a massive USD 210 million dollars in October from Softbank, on top of USD 41 million dollars it received earlier. Total funding for Ola in 2014 was over USD 250 million dollars making it third largest startup funding in 2014. Taxi for sure raised US$30 million in series C funding and tied up with Tata Motors to launch a Nano line, probably the world’s smallest taxis which will cost less than three-wheelers (auto-rickshaws) in India. Recent debacle with Uber has also put significant pressure from the government on the functioning of online taxi services and is affecting the functioning of these companies. These investments will take some time to mature before the investors can look at their exit options, however investors looking to exit now will have to do it at discounted valuations. Zomato is leading by example, showing Indian internet companies how to go global. This restaurant discovery and rating company is going global fast, expanding to 20 countries. Its appetite for growth led to five acquisitions in New Zealand, the Czech Republic, Slovakia, Poland, and Italy. It has raised USD $60 million funding late in the year. Going global is the best strategy for Zomato, to increase its customer base by leverage their expertise developed over the years and then investors can exit through an IPO. Also Practo which started out in Bangalore - a doctor discovery and booking platform for patients, lists more than 100,000 doctors in India and Singapore, has raised USD 20 million in the current year. There are huge investments coming in the healthcare industry and investors can look to exit as it gets acquired by another company. Gaming & Media are the new participants in 2014 and have seen significant growth since then, largely driven by the big ticket fundings of NewsHunt, ScoopWhoop & News in Shorts. Hungama, a digital entertainment company which has become the repository of Bollywood movies and music has raised USD 40 million dollars in 2014. They are still in a nascent stage and unless an acquisition happens there is no

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FinGyaan

FDI- a harbinger of economic growth? Sainath Zunjurwad

SIMSRE

Introduction There exists near unanimity among economists and policymakers that foreign direct investment (FDI) can positively and substantially influence the economic growth of the recipient country. FDI is conservatively understood to be relatively more stable, permanent foreign capital that brings along with it advanced technology, managerial knowhow, and skills versus the flighty portfolio funds. Although, the recipient economies experience short term pain, a host of long term benefits accrue to such countries. Infusion of new capital results in expansion of production base, increased employment, and lower prices for domestic consumers due to increased competition. FDI typically results in efficient allocation of resources, increase in efficiency and productivity, and access to technology locally unavailable. Increased competition forces local firms to upgrade. Empirical studies

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suggests that FDI has positive impact on domestic investments growth and technological progress resulting from the spillovers from the affiliates of Multi-National Corporations (MNCs). Improvements in corporate governance, deepening of capital markets are palpable. FDI becomes a self-sustaining mechanism of rapid economic growth, with trickle down benefits to even the weakest sections. Forward and backward linkages develop from the MNCs, boosting domestic investments and growth further. However, misguided attempts at inviting FDI can wreak havoc in host countries. Numerous issues like the threat of foreign control of strategically critical resources, overdependence on foreign money for growth are being debated in the public domain. FDI in an environment with weak technological capabilities, lack of absorptive capacities, feeble regulatory institutions and

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rudimentary infrastructure will cause more damage than good. The benefits of FDI may sometimes be not demonstrable, and where present may not be equitable. Adjustment costs such as short term job losses, closure of local firms may be too heavy to be incurred. The devastating impacts on poor countries which opened their economies prematurely are a sobering lesson. The net flow of FDI has been from the industrialized countries to Emerging Market economies (EMEs). In the 1960’s, this FDI flow was directed due to the abundance of natural resources in the EMEs. This inflow was independent of the macroeconomic conditions of the host country. However, recent flows have been more of the export-oriented kind, which place tremendous importance on macro factors. FDI flows rose manifold in the nineties. This burgeoning FDI was seen because of an attitudinal shift in the policies of the EMEs, which clearly recognized the potential of FDI as the harbinger of growth. Where blanket bans on FDI were the norm in the past, today most EMEs have liberalized their policies to the extent that MNCs have

unfettered access to local businesses and markets. Bilateral Investment agreements have mushroomed, multilateral fora like the World Trade organization have pushed for legislations in the parliaments of member countries, offering protection of foreign investment, safety of intellectual property rights. Global FDI flows skyrocketed during 2003 and 2007, growing 4 times, while the flows to the EMEs rose 3 times. From the apogee of 2007 which saw FDI flows mushrooming to $ 2.1 trillion, it had shrunk to $ 1.1 trillion in the aftermath of the financial crisis. FDI flows rose by 9% to $ 1.45 trillion in 2013.UNCTAD forecasts these to rise to $ 1.8 trillion by 2016. The optimism stems from the fact that the flows are directed towards the EMEs, and at $ 778 billion they constitute 54%, while the developed countries constitute 39% at $ 566 billion. On the outflow front also, the EMEs are faring better, with $ 553 billion outflows constituting 39 % of global outflows, up from a meager 12% in early 2000’s. Fewer barriers exist today to the flow of FDI. Why has this come to pass?

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Interplay between FDI and Growth EMEs lack financial resources and are therefore hampered from achieving optimal growth. Inflow of FDI can bridge this gap and result in total factor productivity (TFP) growth (stemming from technological innovation). Endogenous growth model states ‘knowledge accumulation’ drives growth. FDI is the most efficient channel of dissemination of technology from the developed to the developing countries. Linkages develop between MNCs and local firms, aiding diffusion of foreign technology. This results in increase in domestic investments, which are termed as spillover benefits accruing to the host economy. In the short run, as the stock of capital rises, output expands directly, while in the long run it expands because of indirect factors like the increased disembodied knowledge in the host due to spillover and diffusion effects. The uncertainty lies in the fact whether FDI will stimulate domestic investment (as allied industries take root) –the complementary effect or will simply drive out local firms and replace them to form a monopoly-the substitution effect. If FDI crowds out domestic firms, result would be a decrease in output. The former is what the proponents aim for, while the latter is the proverbial bogeyman for the naysayers. FDI results in growth because of higher TFP in industrial nations which are technology leaders, and through capital accumulation in the EMEs which are laggards.

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FDI does not automatically result in growth. Certain pre-conditions have to be met. • Host economy must have a threshold level of human capital accumulation. Absorptive capacity must reside in the host to capture the positive externalities generated by FDI. E.g. skilled domestic labor force, high educational attainments among native managers. • The technology gap must not be too wide that overcoming this bridge should prove too much for the domestic industry. Competition will force the locals to upgrade, but a lack of capability would simply force them to shut down. • The capability of local firms to take upon complementary activities generated by FDI. In a moderately developing economy, this is a countervailing force to the distress caused by the displacement of local firms. • Financial markets (FMs) are critical in determining the positive or negative externalities of FDI. Developed FMs help in mobilizing savings efficiently and aid in screening investment projects, fostering the growth of recipient and allied industries. Underdeveloped FMs tend to punish the domestic firms more than the MNCs, hindering the ability of domestic firms to invest and thereby prevent them from enjoying spillover benefits. An analysis concerning the causal relationship between FDI and growth cannot be compete without touching upon the mechanism by which dissemination takes place. That is what we turn

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continue to be imported from the home country, enunciating the complementary effect of FDI. • In fact, affiliates can serve as export platform to a third country. Host countries offer concessions on import duties for export oriented FDI. Conclusion Trade and fiscal policies adopted by governments have a bearing on FDI flows. These policies could be enabling or serve as impediments. Governments in EMEs need to address concerns relating to intellectual property rights, and property security. MNCs are reluctant to set up or expand their R&D bases to EMEs due to these concerns. Only when these concerns have been alleviated, can the host economy truly enjoy the fruits of liberalization. FDI really took off in a big way that stimulated growth in the 1960s and continues to be the driver of development process in much of the world, particularly so the emerging one. For FDI to succeed, host countries need to do their homework. For a country like India, it entails the deepening of financial markets- reforms including reduction in entry barriers, establishment of investment promotion organizations, enactment and implementation of good, consistent governance policies, strengthened and able regulatory environment, with executive powers devolved upon SEBI, FMC, RBI and others, doing away with relics of the past such as FIPB, and better risk management. Rapid strides in the fields of education and technology should enhance absorptive capacities of the host economy. However, the horrific experiences of LDCs are a cautionary tale and such countries shouldn’t become the fools to rush in, where angels fear to tread.

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to now. Is FDI a mere substitute for cross border trade? One of the noticeable trends has been the phenomenon of FDI increasingly replacing trade. Let us take a simple example. A firm which wants to expand to a foreign market, typically starts by exporting its products. Gradually, it expands the range of activities it performs in the recipient country-marketing, representative offices, after sales centers, etc. Once it has a solid footing, it starts a production base. The former constitutes international trade among open economies, while the latter is FDI. In this example, FDI seemingly replaced trade. Is FDI complementary or substitutionary vis-à-vis trade? Recent decades show a surge in FDI, while trade has more or less been stagnant. FDI could be substituting trade, but engendering a world economy growth that is beyond the scope of mere trade flows. MNCs choose between exports or FDI based on relative incentives and costs (Standard trade theory). • MNCs possess intangible assets that are harnessed by strategically placing production facilities in different locations with a view for profit maximization. In this endeavor, they choose between affiliates and exports. This choice is influenced by host country policies (tax holidays, concessions, and easy credit) that encourages FDI. • Imports are discouraged via high tariffs and duties. In the late 1980s, a substantial part of Japanese FDI in Europe was because of antidumping duties imposed by the European Commission. • Currency exchange rates are a major determinant in FDI vs. trade decision. An appreciating yen against the rupee will discourage Japanese trade to India, resulting in increased FDI flows. • Horizontal FDI- moving the production facility to the host country has demand enhancing effects. Local goodwill, customer loyalty, spillover effects on other products for a multi products firm contribute to increase demand both for the base and allied products. • Vertical FDI sees the transfer of only a part of the production facility to overseas market, typically the assembly function. Components

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SOCIALLY RESPONSIBLE CORPORATES

Bhawana

IIM Shillong

The implementation of the Companies Act 2013 has created a lot of buzz by incorporating clause 135 which deals with Corporate Social Responsibility (CSR) in both the industry and the academia. In simple terms, CSR means the responsibilities that the business should discharge towards society. It has been branded as a new concept; however, it could be very well traced back to the philanthropies of industry captains Tata’s, Birla’s, Modi’s etc. all in the 19th century. Since long time, these socially benevolent activities were revolving around nation building and socio-economic emancipation, ultimately focusing on labour and environmental laws in independent India, with PSU’s given the responsibility to take the lead. The shift in the focus of responsibilities of the Corporates from the overall development of nation to promoting the sustenance of the ecological environment, can be attributed

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to the degradation of environment to alarming levels. The business community was considered to be solely responsible for the imbalance in the environment. By mandating CSR, Corporates have been called to owe up to their responsibilities and work for sustainable living. CSR would require the companies to focus on a balanced approach of economic progress, social progress and environmental stewardship (Triple-Bottom-Line Approach). World Business Council for Sustainable Development very aptly defines CSR as the continuing commitment by business to contribute to economic development while improving the quality of life of the workforce and their families, as well as of the community and society at large. With the implementation of CSR there would be a paradigm shift in the practice of the same – from the ‘philanthropies’, i.e. focusing more on the means of earning profits than on the application of profits.

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Through CSR, the firm also earns the opportunity to add to its brand value in it’s strive to give back to the society. The firm earns a greater bargaining power and competitive edge over the competing brands in the market and attracts, retains and motivates quality employees. The Government, being the custodians of public welfare, with its policies and regulations are supporting these ‘Socially Responsible Corporates’ with concessions. The Corporate Giants leverage upon such advantages for financial security. The Corporates are expected to balance three P’s: “People, Planet and Profit” by devising unique business models, the focus of which would be on community development. Conglomerates such as Hindustan Unilever (HUL) has launched Project Shakti in 2002 which trained and inducted rural women (‘Shakti Ammas’) from very low-income households to become direct-to-home sellers, selling basket of HUL products, door-to-door in their villages. It also came up with the Shaktimaan programme which was launched in 2010 and empowered unemployed/ underemployed youths (Shaktimaans) in the Shakti entrepreneur’s family to dwell deeper into the villages with HUL products. These programmes enabled HUL to grow its rural footprint immeasurably and strengthen its distribution reach with parallel contribution to the economic welfare and social upliftment of the participants. Nestle India ltd. (NIL) came up with Village Women Dairy Development Programme that provides training to women on dairy farming and entrepreneurship to make them financially stable and independent. The programme led to the development of the communities in and around NIL factories, thereby transforming them from extremely backward, poverty-ridden hamlets completely

lacking in infrastructural facilities into vibrant, upcoming settlements. Reiterating its premise of ‘Shared Value’, NIL has ensured a steady supply chain of stipulated quality raw materials, trust and devotion. The e-Choupal model of ITC leverages upon digital technology to accustom the small and marginal farmers with services on know-how, best practices, timely weather information, transparent discovery of commodity prices etc. e-Choupals have enhanced productivity, increased incomes, enlarged capacity for farmer risk management and so on. ITC takes advantage of the model by securing raw materials for its personal care products and packaged foods. IBM, Tata Group, Infosys, Wipro, Coca Cola, Britannia Industries, Bajaj Auto, MRF Ltd, Maruti, ONGC etc. are other major players in the spectrum of CSR. CSR has been mandatorily applied in contrast to the earlier voluntary applications like Corporate Responsibility for Environmental Protection, 2003, or the National Voluntary Guidelines for Social, Environmental and Economic Responsibilities of Business issued by the Ministry of Corporate Affairs in 2011. The Principle eight relating to inclusive development in the above mentioned guidelines incorporate many aspects which are included in the CSR clause of the Companies Act, 2013. The current CSR provisions is mandatorily applicable to companies with an annual turnover of Rs. 1,000 crore and more, or a net worth of Rs. 500 crore and more, or a net profit of Rs. 5 crore and more. The clause mandates it for such companies to spend at least 2% of their average net profit in the previous three years on CSR activities. It has also included indicative activities under Schedule VII which would be covered under CSR activities.

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As per the report of the Indian Institute of Corporate Affairs, at least 6000 companies in India (including several first-timers) will be required to undertake CSR projects in order to follow the Companies Act, 2013 and their CSR commitments can be as high as Rs. 20,000 crore. Adequate disclosures of such activities should be given through reports and company website. CSR has continued to be a topic of debate among scholars and practitioners for quite some time. Still there is a lot of speculation with respect to the proposition as to whether there exists any role for business in social upliftment. With the growing stress on CSR a number of investors incorporate environmental and social considerations into their investment decisions. This growing attention on Corporate Social Responsibility (CSR) from investors has raised questions on the financial impact it would have. Taking a theoretical perspective a good CSR performance would have an impact on the firms’ market value. It may increase the productivity and financial performance as it implies a good relation with the key firm’s stakeholders. Also Scholars to the likes of Hart Porter and Van der Linde and Russo and Fouts explain that a good CSR performance can provide a competitive advantage increasing the innovation capacity. Through incorporation of CSR the firms meet stakeholders’ expectations which again is induced by the increasing awareness about CSR firms generate a reputational capital and enhance their social legitimacy which in turn contribute to increase sales and customers’ loyalty. There have been many empirical studies to test whether CSR performance matters for stock market investors. In the American context it has been observed that the firms with a good CSR performance tend to have higher market-to-

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book ratio. Several researches have concluded that the firms deleted from the Dow Jones Sustainability Index because of their bad CSR performance exhibit negative cumulative abnormal returns. Also it has been found out that a good CSR performance reduces the cost of capital, because of a reduction of a firm’s risk and a larger firm’s investor base. The firms with a good CSR performance reduces information asymmetry. If we are to consider that CSR performance has a negative impact on cost of equity and decreases information asymmetry, socially responsible firms would have more advantages than others to issue equity and thereby would be less leveraged. Hence, the question that needs to be answered is that as to whether the firms adapt their financing decisions according to the CSR performance they propagate. Firms with a good CSR performance tend to prefer equity over debt when they finance their activities and exhibit lower leverage as they have lower cost of capital and lower information asymmetry. Firms with high CSR ratings issue larger equity volume than others to exploit a low asymmetry information situation. As per the market timing theory managers issue larger equity volume when information asymmetry is low as information asymmetry makes equity issuance more costly. Thus there exists a positive relation between CSR performance and size of equity issues. Firms with good CSR performances are less dependent on market conditions when issuing equity. The determination of financing choice is dominated by two competing theories which are the trade-off theory and the pecking order theory. The trade-off theory establishes the existence of an optimal capital structure. The optimal capital structure suggests a tradeoff between the costs and benefits which are associated with debt and equity. The pecking

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order theory make an assumption that information asymmetry between investors and managers is the most important driver for firms’ financing decisions. Market timing theory is an extension of this theory which states that firms issue more equity when information asymmetry is low and market conditions are favorable. Theoretically a number of models have been developed like the equilibrium model where there exists two types of investor’s i.e. green and non-green investors and three types of firms i.e. non-polluting, neutral and polluting firms coexist. The boycott of polluting firms’ securities from green investors limited provided opportunities for risk sharing. As a result of which the securities of these firms have lower prices and higher cost of capital. In the capital market equilibrium model the investors only buy stock if they have information on it. Thus it implies that because of the reduction of investors’ base, firms for which information is incomplete have a higher cost of capital. The KLD scores are used to confirm that companies with high CSR ratings have a lower cost of equity. Specifically this theory is applicable for companies that improve their employee relations and their environmental policies. Also companies in tobacco and nuclear power industries have a higher cost of equity. It is claimed that the environmental performance signals to the market that the firm is a less risky investment and hence the investors claim a lower premium in return for lower risk. Many authors have found a negative relationship between CSR performance and financial risk which are in line with a lower cost

of equity for firms with high CSR performance. Sin Stocks i.e. firms involved in controversial activities like tobacco, gaming and alcohol, faces higher litigation risks because of social norms. A good CSR performance gives confidence to investors that the firm considers stakeholders’ expectations and generates a moral capital for firms. CSR performance improves market liquidity and decreases bidask spreads. CSR performance can also reduce agency costs. Firms with well-established CSR norms are more engage with their stakeholders which limits the likelihood of opportunistic behaviour and reduce overall contracting costs. Aristotle had once proposed “one has to think of oneself as a member of the larger community and endeavour to excel to bring out what is best for him and humanity’s shared enterprise.” There is an integrating force between the corporates and the larger community; there is really no ambiguity between one’s self-interest and the greater public good. It, therefore, is imperative that a Corporate whose identity is socially defined would never perform actions that are wholly immoral and anti-social. Companies should take this opportunity and treat CSR as a core business strategy like that of marketing and finance.

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The sudden improvement in stock markets: Will it sustain? Jayraj Dabral

IIM Udaipur

“Sensex breached 40000 mark, Nifty at alltime high,” stated a headline in a leading business daily dated 31st Dec 2015. It seems fascinating and improbable at first sight, but analyzing recent bull run makes these figures reasonable. Since May 2014, S&P BSE Sensex rose approximately 17.5 %, while CNX Nifty has grown by 15 %. Extrapolating from similar trends, we can expect 40 % rise till Dec 2015 in Sensex, which amounts to possibility of Sensex breaching 40000 mark. In recent six months, we have seen the stock market reaching new heights quite often. Though there were intermittent losses but overall trends were a bull run further into untested territories. Factors that fueled this rise must be scrutinized. General elections in May 2014 proved to be a watershed event. From May 2013 to Feb 2014, Sensex hovered in a narrow range while after March stock market saw a bull run clearly observable in a sharply inclined curve, driven by anticipation of a strong, stable BJP led NDA government. Bull Run continued further after election results, riding high on optimism. Modi factor has been able to lift the prevailing mood of disappointment about Indian economy. Bull markets, stable currency,

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softening inflation figures, stable, cohesive government at the center further boosted people’s confidence. It augurs well for the policies that can’t find their way out of parliament due to the coalition government. In the previous regime, economy has witnessed plummeting investor confidence. Policy paralysis and fiscal slippage fear brought the economy to the lowest growth figures in a decade. Recent rise was primarily due to the money poured by foreign institutional investors (FII) into equity and debt market in expectations of better returns and a hope that the new government will take concrete steps to upturn the economy. FII bought Rs.1.02-lakh crores of debt instruments and Rs.78, 400 crores of debt in the first eight months of financial year 2014. This has been a primary driver of the stock market. But FII can never be trusted for a sustained higher level of stock as they can leave the market quickly in the hope of higher returns elsewhere. Government’s aim should be to attract FDI and the Central Government rightfully has taken some initiatives to march on this path. Recently, Narendra Modi launched ‘Make in India’ campaign aimed at transforming India into

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a manufacturing destination. This will facilitate investment, foster innovation and enhance skill development. This has created positive investor sentiments, which further added to the optimism about Indian economy. This optimism manifested itself in the recent rally in the stock market. But certainly its significant impact will be observable in the longer duration. Recent surge in markets is more a result of future expectations rather than current ground level development. So it is possible to see market corrections if policy hurdles continue and the government doesn’t perform much on the ground level. In its bid to promote India as world investment destination and manufacturing hub government has taken steps to simplify trade. New schemes as promised will put the onus of compliance with regulatory norms on the citizens. Also, there are some significant developments to curb the inspector Raj making business inspections more transparent. These developments are certainly helpful in adding to the investor confidence as well as if taken in the right spirit these steps will pave the way for a sustained bull run in the market. In the short period, the government in the power has taken steps to deregulate diesel prices, bring transparency to the coal mine auctions, remove bottlenecks in investment environment, and has also taken initial steps towards labor and land reforms. Government has started marching forward to end policy logjam that was strangling Indian economy in the past. Recent deregulation of diesel prices gave a significant boost to the oil firms

and related stocks such as Banks and PSU’s. This step will also reduce the subsidy burden on government, which eats up a significant chunk of our earnings, thus making way for more investments. This sent a wave of optimism across various international financial institutions. The Sensex soared over 350 points, tracking the reform measures after this announcement happened. Recent macroeconomic data has shown improvements. India’s GDP advanced at 5.7% in the second quarter of 2014, and it is the highest growth rate reported since the fourth quarter of 2011. In Sept 2014, S&P raised outlook on India’s sovereign rating to stable from negative. “Our outlook revision reflects our view that India’s improved political setting offers a conducive environment for reforms, which could boost growth prospects and improve fiscal management,” S&P said. On the same day market witnessed strong FII inflow, pushing stocks higher. Government’s look east policy and recent tie-ups especially with China, Japan, and Singapore has further helped sentiments go high. In the longer run, Japan will be an important ingredient in successful Indian economy. It will play a major role in developing infrastructure. Government has opened up economy for various sectors, and there is much hope that other important sectors like defense will be soon welcoming foreign players. This move by government will help in improving economic prospects as well as strengthening our defense capabilities. At present India is one of the largest importers of defense products.

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Moodyâ&#x20AC;&#x2122;s Investors Service has shown faith that if India successfully implement economic, financial and fiscal measures, it will be able to achieve sustainable growth. This will be manifested in sustained bullish trends in the market. India: Recent Policy changes to support Growth Acceleration, a recent report by rating agency analyzed impact of recent policy measures taken by government to improve the investment climate. It rightfully asserts that MAKE IN INDIA campaign, infrastructure development initiatives, financial inclusion measures, clearer inflation targets, as well as promised reforms in banking and energy sectors, should be the first step. Sensex that comprises big banking names Axis Bank, HDFC Bank, ICICI bank, State Bank will need banking reforms in the longer term to keep up the momentum going. PSUs that form a big chunk of stock markets need to be revitalized by implementing efficient and transparent policies. Recent initiative of rationalizing coal allocation has helped investorsâ&#x20AC;&#x2122; confidence of probable rise in these stocks. IT companies such Infosys, TCS, Wipro has continuously increased their profits as business activity in the United States, a prime market for IT companies showed modest performance. There is a risk of triple dip recession as no improvement signs are visible in Eurozone in the near term. Also, Chinese economy has shown muted growth. The current rally in Indian stocks comes in the backdrop of struggling economy of Russia and Brazil. Indian fundamental needs to be strong to continuously fuel the market run. As per European commission, GDP in the 18-nation Eurozone is forecasted to rise by 0.8 percent this year and 1.1 percent in 2015, which is lower from earlier projections, a stronger dollar may cause some hot money to flow to the U.S.A. In near term we can see some investors taking their money off the market as the U.S.A job data and key economic figures improve. On the other hand, we can also find lesser liquidity coming to the stock market as it rollbacks its Quantitative Easing program. This will have direct bearing on the market, though recently announced Japanâ&#x20AC;&#x2122;s cheap money may find its way to Indian market that will further drive Indian market in the near term. Riding high on optimism, investors are putting their money into Indian markets, but there is a component that is more governed by

DECEMBER 2014

sentiment rather than rational considerations. Certainly there have been some positive developments and government has taken preliminary steps to improve the economy and clear policy logjam but still there is a long way for these steps to give a significant boost to the economy. What we are observing today in markets is more a result of expectations rather than something happening at ground level. Investors have shown much faith in Modi Government, which is continuously fueling stock markets. We need to keep in mind that sentiments can be ephemeral, and FIIs are hot money that might leave our boundaries as quickly as they entered. So one should be cautious about real development in the economy. Whether these developments in the stock market will endure or see bearish trend will largely depend on the seriousness of the government in reviving the economy. In the end, several domestic and external factors are Critical to the recent recordbreaking streak. But certainly new BJP led NDA government comes as one of the top factors. Markets have flourished even during inefficient congress rules so upturn will sustain or not will be an interesting thing to watch in the longer term. Government has done some groundwork for essential reforms such as GST, fuel price deregulations, approvals, labor, and land reforms. These have boosted investor sentiments that have caused recent rally in the market. But sustainability of such level of optimism and resulting higher level of stocks will be dependent on the implementation of these initiatives.

Interview with Prof. Natesan Ramesh , Professor – SJMSOM, IIT Bombay

In the phase 2011-2013, in India, we saw a decline in Private Equity investments. Some say it was due to the loss of investors’ confidence while some say it was due to government policies. Now with a new government in place and investors’ confidence returning, how will the PE scenario change? As an emerging market, India has got great potential, especially with the population. Subsequently, you will have to expect that there will be some seasonality and fluctuations in terms of investments. You have to look at the global situations along with the local situations. As a PE investor, you are looking at the company’s prospects plus the market scenarios. Also you look at the global trends. We are no longer an isolated country like we were in 1992. Therefore you see what impact the global scenario will have on markets and companies and whether the company will be able to sustain itself if there is a global meltdown. Global downturns may not always be bad as it gives us time to pause and take a quick look to see where the valuations are in comparison to when we made the investment. This is the financial aspect of these investments. But we have to understand that PE investments are just like others where you look at geo-political aspects. In the period 2011-13 India was not politically robust. There were a lot of negative news which drained investor’s confidence. Even though people might not be concerned about the political side of these events, they are still concerned about the economic impact of this. But PE will always continue looking at our billion dollar market and those trends may not change. Of course change in government which is pro-development will help in infusing more investments.

only more scrutiny but also requires a lot of experience. In your experience, what do you think these VC firms see while evaluating future investments into an entrepreneurship venture? VCs are classic early stage investments. PE comes at larger quantum at later stages but VCs are at a much earlier stage. So their risk factors vary as you don’t know how these ventures will evolve. So they look at how these ventures will do in the markets and if it is sustainable or not. So you weigh a whole bunch of ideas in terms of valuations. You also do your market research and background checks. VCs is not only about type of technologies or products or solutions. VCs are the one who gauge people. VC investments is not only dependent on the novelty or attractiveness of ideas. They also look at the team in terms of their execution capabilities. They bet on people more than ventures and ideas. One of the most important things is the team’s confidence in executing their plan. VCs are generally stricter in terms of adherence to plans. That does not mean that if execution is not according to plans then everything will break down. VCs have multiple screening processes. Any project which reaches the final stage but founders do not exhibit confidence in themselves then funding becomes more difficult for them. Most of the literature on venture capital says that it’s the team that matters because the ideas are plentiful and they have only limited funds. They also look at the risk and reward ratio. They see if they are putting the right amount of money in the plan and what multiples would they get for the higher risk they assume. So they expect greater returns for their investors.

India is becoming an attractive market due to its increasing number of Between VC and PE investments, VCs are millionaires and billionaires. To satisfy more risky due to their stage of financing their return appetite VCs and PEs are in the business cycle. So VCs require not taking more and more risks. So do you see © FINANCE CLUB, INDIAN INSTITUTE OF MANAGEMENT SHILLONG

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an alarming rate over here or this is the general industry standards or norms? When venture capital started, it started in small amounts. The quantum of money was also very small and risks were taken in proportion to the investments. But as markets grow, confidence builds in the markets, so the valuations will grow. So I always said “If you can’t stand in the heat, get out of the kitchen”. So this will always be an issue and in India valuations are considered in two ways. There is a science of valuation and then there is an art of valuation. If the investors are many and deals are less the valuations will always be high. But there are many ideas in the markets which again brings us to see the team and leadership. This is how the industry has evolved and it will continue doing so. Again I am bringing your attention to the fact that India is a very large market. If you see the consumer space especially B2C sector, there is still a lot of potential especially in the lower classes. Tier-3 and Tier-4 cities still are untapped. There is a lot of room and opportunities. So it is an evolving business where there will be ups and downs. No VC can say all his projects has bagged multiples. For every successful project there could be ten projects which have made losses for them. That’s just the nature of the business. VCs will always have more risk but they also have higher returns.

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But historically we have seen that 30% of the investments that PE makes have generated negative returns. What do you think are the possible reasons for this? There are many factors behind negative returns. One of the reason is that sometimes it happens that these investment firms’ ends up chasing the deals which make them overpay for these deals. So basically they are already locked in negative returns in such scenarios. You have to be a bit savvy as an investor because the quantum is much larger in the PE world than the VC world. Therefore in my opinion, prudence dictates. Also one thing you can never predict is the uncertainties in the external environment. You can gauge the local markets, put in the what-if scenarios but you can’t predict events which are endemic across the world like the 2008 financial crisis. That was a seismic event which could not be predicted. There were warning and alerts but since everything was going well so people didn’t really pay attention. These kind of effects also reflect on the performance of the companies. So

DECEMBER 2014

negative returns are quite possible. PEs are also not very far away from VCs in terms of risks. They also make bets and hope that they are the right ones. And since quantum is bigger, the returns are bigger. A $500 million may bag a PE investor $2.5 billion! That’s 5 times the investment. Since these investments are large, any external shocks from the environment will create problems. In my opinion, the main reason for this 30% deals with negative returns is due to the fact that there are too few deals and too many investors. What would be your advice to management students or any other person looking to make a career in this sector and how is the career prospects for them? The VCs are hunting campuses because they need talent. This is a vibrant industry and will continue to grow. VCs always look to recruit MBAs from top B-schools, as they want to recruit the best. It is not just about knowing the industry and how it works, it is also about the ability to structure things because VC is not just about money, it is also about structuring deals in the right way. So they need talent. My advice to the students studying in B-schools would be to brush up their finance skills. You will need it more than you ever think. You are always expected to know things while working in VC and PE firms so you have to be savvy and astute because you will be pitched by many people. Your ability to separate a good deal from a bad one will take you a long way ahead in the industry. It doesn’t mean you have to be shrewd, you just have to be quick, smart and come up with a win-win situation for the firm. At your level you will not be able to gauge the management and the team because that will come only with experience as it is an art. So it will be all about finance for you. Your spark will attract the VC firms towards you.

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DuPont Analysis

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Apoorva Sharma IIM Shillong

Sir, I came across a performance measurement called DuPont Analysis in an article. I have never heard that term before. What is it? It is a measure of performance that was started by DuPont Corporation. It is also called DuPont identity. It breaks down the ROE i.e. Return on equity into three different elements. ROE is a measure of the value created by the management of a company for its shareholders. The more the ROE, the better is the company’s performance. However its value can be misleading. A good ROE might suggest a risky stock. DuPont analysis helps the investor understand the cause for the movement and hence take informed decisions. Sir, how is the ROE calculated? Please give an example as to how a greater ROE can be suggestive of a risky stock? Good! That is an intelligent question. ROE= Net Income/ Shareholder’s equity. If it is more, it is a sign that returns on shareholder’s equity is going up and hence the company is worth investing. If the company’s capital structure is such that it takes more of debt and less of equity, then the net income generated would be mostly because of the debt taken, however the ROE would go up as shareholder’s equity has reduced. The leverage of the company has increased, the stock evidently is more prone to risk as the company might default on its debt payment obligations. What are the components that ROE is broken into while performing DuPont Analysis? There are three components each of which measures different parameters and help

in determining the cause of movement in ROE and whether ROE has increased for the right reasons: a) Net Profit Margin which measures Operating Efficiency b) Total Asset Turnover which measures Asset use efficiency c) Equity multiplier which measures the Financial Leverage ROE= Net Income/ Shareholder’s equity = (Net Income/ Sales) * (Sales/Assets) * (Assets/ Shareholder’s Equity) = (Net Profit Margin) * (Asset Turnover) * (Equity Multiplier) Sir could you please explain the implications of these components on the movement of ROE? Yes, Sure. If the company’s ROE increases due to the Net Profit Margin or Total Asset Turnover, it is good for the company indicating that the company is performing well and is therefore a good investment option. Equity multiplier is a measure of company’s assets per rupee of stockholder’s equity. The more the equity multiplier, higher is the financial leverage which implies that more debt is being used to finance the assets of the company. If the increase in ROE is due to rise in Equity multiplier then it is a matter of concern as the stocks of an over leveraged firm are risky because of the chances of default on debt payment obligations. However if the company is under leveraged (lower debt component), and equity multiplier rises, it is a positive sign suggesting that the company is managing its funds better. DuPont is therefore a performance measure which analysts use to understand returns and compare different companies in similar industries to determine the best investment option. Isn’t that its use? Excellent!

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WINNERS Article of the Month Prize - INR 1500/Dylan Jude Fernandes IIM Bangalore December FinQ Winners 1 st Prize - INR 1000/Aman Singh FMS Delhi

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