Niveshak Spetember 2013

Niveshak THE INVESTOR

VOLUME 6 ISSUE 8

September 2013

VULTURE FUNDS

Is there any end to their prowling ??

FOOTBALL FIELD: NOW IN VALUATION, PG. 16

WISH YOU A MERRY CRISIS: THE BUBBLE BOMB PG. 81

FROM EDITOR’S DESK Dear Niveshaks,

Niveshak Volume VI ISSUE IX September 2013 Faculty Chairman

Prof. P. Saravanan

THE TEAM Editorial Team Anchal Khaneja Anushri Bansal Gourav Sachdeva Himanshu Arora Ishaan Mohan Kaushal Kumar Ghai Kritika Nema Neha Misra Nirmit Mohan

All images, design and artwork are copyright of IIM Shillong Finance Club ©Finance Club Indian Institute of Management Shillong www.iims-niveshak.com

The month of September saw a deep dip in rupee which went to its all-time low of INR 68.80 per dollar. But after the appointment of the new RBI Governor, things seems to be improving. The rupee and bond rates surged to onemonth highs on 19 September 2013. The rupee traded at 61.88 per dollar and the benchmark 10-year bond yield traded at 8.18%, after dropping to 8.14%, it’s lowest since August 8, 2013. Corporates will find dealing with this volatility a challenge as several forecasters are now changing their 2013 projections for the domestic currency.

Equity Markets also welcomed the new RBI governor by remaining highly volatile with a net upward movement of more than 2000 points (SENSEX) in the past one month. Of course, the US fed decisions, China growth figures and RBI monetary policy had its own share of movements and fluctuations.

The Article of the Month for September discusses about the need of privatizing banks in India. It analyses the pros and cons of the government ownership in banking sector in India and suggests a suitable way forward for the reforms in banking sector. The cover Story for the Month of September takes a step to throw some lights on “Vulture Funds” and how they have ruined many nations. It also tries to analyze how vulture funds are hunting Indian economy. Niveshak also brings some more good reads for you in this issue – the FinGyaan of the issue brings to you how an investment banker puts all his valuation results into the football field before pitching his valuation to the client. Fin-Sight of the issue talks about how financial bubbles in an economy are a trap. It throws light on some of the major crisis that have happened in the world economy & ends by wishing the reader for being prepared for the crisis to come. Then there is the story of late 1970s about Chinese economy, which talks about a series of reforms known as “Secondary Revolution” which transformed China from a planned economy to an open market economy. The issue also explains the most talked about plans in the Mutual Fund Industry i.e. SIP, STP & SWP through our much cherished Classroom Section.

To end this brief note, it’s important that we thank you, our readers, for your constant support and appreciation. Thank you! It is your endless encouragement and enthusiasm that keeps us going. Kindly 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 Month That Was

Article of the month

08 Privatization of Banks: Need of the hours

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Vulture Funds: Is there any end to their prowling?

FinGyaan

16 Football Field: Now in

Valuation

Finsight

23 Wish you a Merry Crisis: The Bubble Bomb

Finistory

20 Chinese Second Revolution 27 Mutual Funds

CLASSROOM

The Month That Was

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www.iims-niveshak.com

The Niveshak Times Team NIVESHAK

IIM Shillong Raghuram Rajan seen switching to consumer price inflation at RBI Raghuram Rajan, the newly appointed governor of RBI, is set to use the consumer-price inflation for the first time. The use of CPI over WPI has been one of the much debated topic in the recent times. This comes after his last week’s surprise move of raising repo rates by 25 basis points. These steps are in line with what he said during his first speech as a RBI governor earlier this month. Dr. Rajan underscored the fact that the primary role of the governor is to stabilize the purchasing power of the currency which signals to curtail inflation even if it comes at the expense of growth. The shift from WPI to CPI signals further increase in the benchmark interest rates.

India’s consumer price index rose 9.52% in August from a year earlier, the fastest pace in a basket of 17 Asia-pacific economies as per Bloomberg. Core consumer prices climbed about 8.2% for the same period. The rupee had slumped by over 14% versus dollar in past one year amidst the persisting high inflation.

Allcargo Logistics buys US firm Econocaribe Consolidators Allcargo Logistics Ltd. on Sept. 27 announced that it has acquired US-based Company Econocaribe Consolidators Inc. in a $50 million deal. Econocaribe, founded in 1968, is the third largest non-vessel operating carrier in the US. Both the companies have been working together in US from the last few years.

Allcargo completed the deal through its Belgiumbased subsidiary ECU line in which it acquired a 33 percent stake in 2005 and remaining shares in 2006. The acquisition will help ECU line to increase its foothold in North America. Allcargo Logistics had already developed a strong presence in the mutlimodal transport operating (MTO) business through the wide network of ECU Line and had gained a strong hold on the domestic MTO business. The shares of the company had closed 11.42 percent

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higher on BSE on Sept. 27 amid the announcement of the acquisition on a day when SENSEX lost 0.84 percent or 166.58 points. The company is also looking to grow in Australia and Europe through increased merger and acquisition activity in the future. This came amid the concerns raised by the company’s customers who do want to do business with it because of limited presence of the company in these geographies.

SC allows voters to reject all candidates in the election In the pursuit of benchmarking best practices for Elections, SC this month came up with a landmark judgment. It held that voters will have a right to cast negative vote, rejecting all candidates contesting elections. This decision is expected to push eligible voters, who are not satisfied with contestants, to turn up for voting. The court directed the apex body for elections (Election Commission of India) to enable “none of the above options” at the end of the list of contestants in all Ballot papers as well as EVM (Electronic Voting Machines).

This move is expected to foster purity and vibrancy in upcoming elections and ensure increased participation, ultimately leading to cleaner politics.

Telecom Regulator orders pan-India number portability within six months Going beyond the January 2011 regulation of inter circle mobile number portability, the telecom regulator (TRAI) has now mandated the Department of Telecom to implement pan-India mobile number portability. The Indian Mobile phone users will be then allowed to continue with the same number while permanently shifting to a different circle.

The pan-India MNP presents an opportunity for leading mobile phone companies like Airtel, Idea and Vodafone that have benefitted from circle level MNP in the past, to consolidate customer base of the Industry further, while keeping check on operational effectiveness and oligopolistic environment. This will also help the smaller players to take up this chance to acquire corporate customers that bring in more revenue.

DIPP proposes 100% FDI in railway projects

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NIVESHAK

The Department of Industrial Policy and Promotion has circulated a cabinet note proposing 100% FDI in Indian Railways. This move of GoI is likely to revive the iconic Indian Railways, which is currently resource-starved, by allowing foreign investment in development of rail lines between project sites and existing network. The business model that will be followed is that the DIPP will create a Special Purpose Vehicle (SPV) in which the foreign companies will be allowed to pick up 100% stake. To ensure smooth excavation and flow of raw-materials, the emphasis is on first-to-last mile connectivity as this SPV will construct and maintain rail lines which would connect mines, ports & industrial hubs with the existing rail network. The operations side will remain with the Indian Railways. The current financial crunch has led to atleast Rs. 2 lakh crore in throw-forward projects which in turn led to the delay of infrastructure development. This proposal is expected to give fillip to Indian Railways’ target of raising Rs. 1 lakh crore through PPP for the 12th five-year plan.

Government withdraws export incentives for cotton, yarn The Commerce Ministry has withdrawn the 4% export incentives for cotton yarn and cotton.

According to Confederation of Indian Textile Industry (CITI), benefits of GoI’s Focus Market Scheme and Incremental Export Incentivization Scheme put together result in 4% of the FOB value of exports.

The annulling of this incentive has drawn a sharp reaction from textile industry and fiber traders in times of subdued shipments and increasing CAD. Currently there is no export restriction or export duty on cotton yarn. But there is only a requirement of registering the export contracts with the Directorate General of Foreign Trade (DGFT). The chairman of CITI argues that withdrawing the export incentives on the ground that there is restriction on export is incorrect. The withdrawal of incentives for overseas sales could cut exporters’ margins. Despite this move, the buoyant demand for cotton yarn would offset any fall in export margins. Trade commitments for cotton yarn exports rose more than 26% in August from a year earlier mainly due to rising demand from India’s biggest client, China.

Sebi set to overhaul listing, M&A norms The Securities and Exchange Board of India is set to fine-tune the various norms related to listing in

stock-exchange, securities issuance, mergers and takeovers. The step will align the norms with the new Companies Act which was recently passed on August 8. The recent step is aimed at improving transparency and giving minority shareholders a bigger say in the business transactions. Moreover, these will have farreaching implications encompassing the duties of the Board of Directors, management and administration structures, accounts and audit rules followed by the Indian Companies. When a company goes public through IPO, it needs to disclose its objectives for raising money and it can change the objectives only with the approval of shareholders. The companies Act says that even if a single shareholder disagrees with the change, he/she has the right to revoke the management decision. Regulations related to IPOs is one of the most critical areas that is set to change owing to the step taken by SEBI. Currently, a high court’s approval is a must in mergers and acquisitions decisions. Once the new law is enforced, approval from National Company Law Tribunal will prevail over that of high court.

New gas pricing policy will apply uniformly to all: Moily Amidst talk of Reliance Industries Ltd (RIL) being denied a higher price for gas due to output from KGD6 not matching targets, Oil Minister Mr. Veerappa Moily on Sept. 26 said that the new gas pricing policy will apply uniformly to all. The new policy is based on the recommendations of Rangarajan committee.

The current rate is 4.2 mmBtu for gas produced from D1 and D3 fields as per the current term which is set to expire on 31 March 2014. Mr. Moily is mulling on whether to apply these current rates or 8.4 mmBtu, the price recommended under the new gas policy. The point of contention for the oil minister is because D1 and D3, Reliance Industries Limited (RIL) has produced much less than the targets. According to Directorate General of Hydrocarbons (DGH), the output at D1 and D3 fields have falled to 10 million standard cubic meters per day (mmscmd) from 5354 mmscmd achieved in March 2010 because RIL did not drill its committed number of wells. RIL, on the other hand, blames unforeseen geological complexities for the fall in output and believes the reserves in D1 & D3 are actually less than one-third of 10.03 trillion cubic feet predicted two years before the field began output in April 2009.

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The Month That Was

The Niveshak Times

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Article ofSnapshot the Month Market Cover Story

Market Snapshot

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

MARKET CAP (IN RS. CR) BSE Mkt. Cap Index Full Mkt. Cap Index Free Float Mkt. Cap

6467320.15 3,298,771 1,696,202

LENDING / DEPOSIT RATES Base rate Deposit rate

9.70%-10.25% 8.00% - 9.00%

Source: www.bseindia.com

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

61.18 83.42 62.66 99.49

CURRENCY MOVEMENTS

RESERVE RATIOS CRR SLR

4.00% 23%

POLICY RATES Bank Rate Repo rate Reverse Repo rate

9.50% 7.50% 6.50%

Source: www.bseindia.com 25th July to 27th September 2013 Data as on 27th September 2013

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NIVESHAK

BSE Index Sensex

Open 20090.68

Close 19893.85

% change -0.98%

MIDCAP Smallcap AUTO BANKEX CD CG FMCG Healthcare IT METAL OIL&GAS POWER PSU REALTY TECK

5889.83 5601.87 10698.38 12237.89 6364.7 8566.81 7521.21 9316.57 7255.36 7360.63 9016.73 1610.32 5855.45 1449.89 4199.23

5627.58 5479.62 11192.48 11494.65 5890.02 8052.67 6896.44 9475.89 7829.4 8720.76 8349.93 1565.00 5586.99 1213.23 4471.09

-4.45% -2.18% 4.62% -6.07% -7.46% -6.00% -8.31% 1.71% 7.91% 18.48% -7.40% -2.81% -4.58% -16.32% 6.47%

% CHANGE

IT

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Article Market of Snapshot the Month Cover Story

Market Snapshot

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Article of the Month Cover Story

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Privatization of Divyesh Pai & Yogendra Sarfare

TAPMI In August, 2013 RBI published a paper that called for reduction of government ownership in public sector banks (PSB).The paper titled “Banking Structure in India – The Way Forward”, focussed on reforms in banking with special focus on consolidation in banking, giving licences to new banks and reduction of government stake in banking sector. One of the recommendations was that government should dilute its stake for the betterment of the economy. This article will analyse the pros and cons of the government ownership in banking sector in India and will suggest a suitable way forward for the reforms in banking sector.

BANKING SECTOR: THE PAST The government presence in the banking sector started with the nationalization of banks in 1960. The importance of the Indian banking system was seen as the significant driving force for economic development of the country. Indian government passed Banking Companies (Acquisition and transfer of undertakings) Ordinance and nationalized 14 commercial banks in the year 1969.

These banks accounted for 85% of the total deposits of the country. The second phase of nationalization was carried out in 1980.

The reasons cited for nationalization were efficiency, monetization, integration and socialization. However, post liberalization, the government started diluting its stake

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in the public sector banks in order to raise capital. Following are the current shareholding pattern by the government in some of the public sector banks: - Dena Bank: 55.24%, - State Bank of India: 62.31%, - Allahabad Bank: 55.24%, - Bank of Baroda: 55.41%, - Bank of India: 64.11%, - Union Bank of India: 57.89%.

The need for reforms and the consequences of the government ownership in the banking sector • Politicization and Bureaucracy Existence of private banks and development is preferred by various nations across the globe. The reason may be because the public ownership of the banks comes with certain challenges of politicization and bureaucracy. Politicization means politics playing a major role in the management of these banks. It can be in the form of credit favours to the rich and wealthy or lending to a certain strata of the society. This leads to more disparity among the citizens. The pressure of lending to the groups for vote banks leads to substantial NPAs since proper credit evaluation of the process is avoided or ignored in such scenarios.

• Conflict of Interests The government as a major stakeholder, sits as a board member in the public sector

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Article of the Month Cover Story

Fig 1: Public shareholding in Public Sector Banks

banks. Thus, when government frames policies that are more in favour of PSBs, it is essentially allowing them to have unfair advantage compared to private sector banks.

Thus, the level playing field is absent.

• Technology The public sector banks are not technologically advanced compared to its peers. Majority of the Indian population is in the age of 25-35 years who are tech savvy. They are service seekers rather than credit seekers. Technology can provide better customer service with quick response time. In this regard private sector banks are better equipped in technology terms than the public sector banks and having better infrastructure to support it.

• Financial Inclusion The government’s main focus is growth across all strata and sector of the economy.

Hence it is imperative for the government to lend to priority sectors such as agriculture.

Therefore, the responsibility of financial inclusion lies with the central government to ensure delivery of financial services at affordable costs to vast sections of disadvantaged and low income groups.

Private sector banks don’t open more branches in rural areas than minimum stipulated since quality of assets are better in urban areas. As per statistics from International Institute for Strategic Studies (IISS, 2007), only 14 % of agricultural wage labourers had a bank account, whereas the number was over 85 % for self-employed professionals. While agricultural wage labour does have access to informal savings schemes, that is a second-best solution (in the economic parlance) rather than the firstbest. Given such a lack of financial inclusion in rural India, comprising over 75% of India‘s population by most estimates, there is both an economic and a political case for improving access to finance.

Thus, it is suggested by experts that having more private banks will increase the geographic spread of the banking sector.

This will increase access to credit in the rural areas. It will also increase competition amongst the banks and will indirectly lead to better service for the poor.

However, there is a counterview to all these arguments. If data is analysed from pre-1969 i.e. pre nationalization era and compared

Majority stake of government in banking sector is acting as a hindrance to the growth of the economy

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Article of the Month Cover Story

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with post m a r k e t , nationalization, n a m e l y then the banking, results show insurance, that corporate etc.

To exclusion and remove these government barriers it ownership recommended is crucial that the for financial government inclusion. This should reduce data questions its stake from the validity all financial of the above firms including arguments for banks to entry of private 26% by the Fig 1: Difference between Private and Public banks in terms of the network size ownership in 2010. It states banks.

The that though returns from these rural areas are generally government of India is a stakeholder and it low and cost for doing business is high. is perfectly logical to protect its shareholding The PSBs are able to do business in such interest, it must give up its stake for the environments because of the government betterment of India’s growth. goal of “good for all”. The private banks Raghuram Rajan Committee whose sole aim is to maximize shareholder Raghuram Rajan’s report “A Hundred Small value won’t be able to sustain low or Steps” – Report on Financial sector reforms negative returns for long periods and will states the advantages that the state enjoys eventually shut shop. because of its ownership. It observes that public sector banks enjoy guaranteed AN ANALYSIS OF VARIOUS PAPERS BY support from government, favours by THE RESEARCH COMMITTEES ON THE regulatory authorities, lesser costs of GIVEN TOPIC banking compared to peers. It also points Percy Mistry Committee out to that public sector banks have lesser This committee has observed that high skills and poorer incentives compared to ownership of government in banking sector private sector banks. It recommended that is acting as a hindrance to the growth of the the way forward is to make institutions economy. It states that “the persistence and ownership neutral. For the public sector, pervasiveness of direct rather than indirect this means removing the overlay of costs forms of public intervention in the financial and benefits imposed by government system (from ownership to directed lending) ownership. One way is bank privatization, has compromised the early and smooth or reducing the government’s majority stake development of various financial markets so that even if the government has de facto and concomitant institutional structures control, the bank is not ‘public sector’. It in different financial sub segments. It also goes on to state the advantages of entry of states that barriers have been erected foreign banks in India may lead to reduced between different segments of financial costs and increased competition. It would Raghuram Rajan Committee recommended that the way forward is to make Banking Institutions ownership neutral

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NIVESHAK

the framework of purposive, rule bound, nondiscretionary prudential regulation and supervision. Autonomy is a prerequisite for operational flexibility and for critical decision making whether in terms of strategy or day to day operations. There is also the question whether full autonomy with accountability is consistent and compatible with public ownership.” Thus, it recommended the government ownership to reduce to 33% in all public sector banks. By reducing the ownership, the government will play the role of minority stakeholder and would not play a significant role in the policies and appointment of boards of the bank.

In conclusion, it can be easily inferred that government stakes in public banks shall be reduced. By reducing its stake in the banking and allowing more foreign players, the government can focus more attention on other activities that lead to growth. It must forego its stake and try to be neutral and independent observer in this sector. If India aims to achieve the advanced state of financial markets that countries like US have, the government must plan its exit from this sector gracefully and early.

Narasimhan Committe - II recommended the government ownership to reduce to 33% in all public sector banks

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Article of the Month Cover Story

also bring skills that are needed in Indian economy. It compares the profitability of public sector banks with its peers in other countries and shows that they contribute very low to the growth of GDP. Thus, it incurs that • Additional rural branching is not very profitable, and when given a choice, everyone stays away from it— public sector banks and private sector banks alike.

• When in a rural area, differences in bank ownership do not significantly affect the kind of clientele that is served.

• Efficiency and innovation are critical to reaching the underserved profitably. The relatively low productivity of public sector banks is an important impediment in using the public sector banks as the primary instrument to achieve inclusion.

With respect to credit, it gives data that support the theory that public sector banks generally lend more to priority sectors such as agriculture. The public sector banks also have higher NPAs when it lends to agriculture sector than private sector banks. Since the public sector banks are under pressure from the government to help the deprived sector of economy, many loans are either waived or not recovered fully. It then highlights the fact that public sector with its aim of growth for all employs significantly higher people than private sector banks. This results in stagnation and inability of banks to retain talent. It, therefore states that government ownership does not increase the efficiency with which state owned banks carry out their functions, and probably imposes constraints.

Narasimhan Committee-II Narasimhan Committee made some important recommendations regarding the issue of government ownership. It clearly states that -“It attaches the greatest importance to the issue of functional autonomy with accountability within

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VULTURE FUNDS Is there any end to their Prowling ??

Anushri Bansal & Neha Misra

Team Niveshak investors that specialize in distressed debt. As the name suggests, these funds are like circling vultures patiently waiting to pick over the remains of a rapidly weakening economy. Poor nations that are eligible for debt cancellation are highly vulnerable. These funds have been known to chase the debt relief process and then to buy the debt of nations who are about to get debt relief.

A POOR NATION’S DISTRESS: OPPORTUNITY FOR VULTURES Vulture funds’ chances to make money rise as problem hits an economy - the more the people of the distressed nation gets affected, the better it is for the vultures. As it is usually mentioned, distressed debt opportunities are counter-cyclical in nature. This is particularly the case when economic slowdown follows a period in which large debt was taken. In a scenario where a destitute nation has outstanding debt owed to a government or a commercial creditor Fig 1: A Vulture Fund’s Cycle of Profits

PICTURE THIS Imagine a destitute nation, clambering under debt & poverty, which can no longer make its monthly loan payments. When this nation admits its inability to pay back the debt, the lender, which is usually another nation or a bank, makes a last ditch attempt to make some profit. It sells the hapless nation under debt to a private creditor for pennies on the dollar. Here enter the vultures. The private creditor who bought the wretched nation’s debt is called a vulture Fund. A vulture fund purchases debt claims as a secondary lender. These are niche

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NIVESHAK

IS THERE ANY HUMAN COST INVOLVED? In 1999 and 2005, the G8 declared commitments to call off over US$ 100 billion and US$ 55 billion respectively in debt owed by the heavily indebted poor nations to major multilateral institutions such as the World Bank and the IMF. This was followed by sustained campaigns by anti-debt groups around the entire world who debated that rather than wasting a poor nations’ scarce resources on external debt service to wealthy creditor nations & institutions, those could be better spent on the welfare of their citizens. Thus, debt relief was aimed towards freeing-up funds for investments in poverty reduction and providing health & education to people of the nation. The actions of vulture funds are capturing international attention, primarily because the policymakers and the wider public outrage that payouts to vultures transfer the benefits of debt relief efforts from their intended beneficiaries, i.e. the citizens of poor nations, to speculators in sovereign debt. Litigation is also a costly affair for the poor nation’s government administrations. The cost is not only in terms of dollars spent but also in the dedication of scarce human resources & capacities to fight against speculative litigators.

ROOTS OF THE VULTURE FUNDS One of the leading vulture funds that has captured headlines for long and has been instrumental in shaping the notorious image of vulture funds is the investment firm Elliot Management. Putting down roots in 1995, it purchased US$ 20 million in Peruvian bank debt in the form of bonds at approximately half the original value. Post-

Fig 2: Countries classified worldwide under HIPC Initiative

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Cover Story

that has not been cancelled or restructured, there is a probability that a private financial organization will seek to buy that debt, and that too at a steep discount and take legal action to seek repayment of the original amount. This is referred to as capitalizing by firms but in the terms of debt campaigners, this is considered as vulture activity.

ATTACK OF THE VULTURE Taking the above mentioned example further, when the poor nations obtain newly freed-up resources from debt cancellation, the vulture funds pounces in to take over the money. It hires an elite law firm to sue the country in French, British, or U.S. courts, because the law systems of these countries usually help the creditor and not the debtor. They sue the nation for much more than what they had paid to buy the debt, often suing for the original worth of the debt as well as a very high interest and legal fees. These funds often win these lawsuits because there is nothing illegal about their activity in U.S., French and British law. What they do is that they undermine the opportunity at a new start for millions in the impoverished nation and get rich off money meant to help the world’s poorest people. IMF published a report in 2007 on Vulture Funds which showed that 11 out of 24 poor countries mentioned that they were involved in legal cases with vulture funds and other creditors not participating in debt relief worth a total of $1.8 billion. These have been described by the worst of terms. Some people name these funds as something that pounce on a state like a vulture on a rotting carcass. These funds are exploitative in nature as a private creditor buys up this cheap foreign debt and sells it at a much higher cost.

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Fig 3: African nations classified as HIPC countries

acquisition, Elliot sued the country and won US$ 56 million. However, with limited funds to disburse for debt repayment, Peru preferred ignoring its obligation to Elliot management. Eventually, it was in a court in Brussels that ruled that Peru was violating the principle of equal treatment (pari passu clause) and thus, was obligated to pay the debt to Elliot. This was truly a pioneer case that opened the door to the infamous Vulture Funds who went on to pose a huge threat to the sovereign secondary debt market and the poor indebted nations worldwide.

FAILURE OF HIPC INITIATIVE This first of the vulture fund cases also brought to light the risk that the world debt market faced and it was during this time that IMF and World Bank laid down the framework for ground work for a program to assist in debt relief for poor nations. Heavily Indebted Poor Country Initiative, launched in 1996, was aimed at directing funds normally retained for debt service payments towards social development programs. These programs would aid in reducing poverty and increasing long term developmental infrastructure projects. However, HIPC turned out to be a big failure when Elliot case got publicized and similar conglomerates followed suits by exploiting the secondary sovereign debt market. By many standards, Elliot case was a landmark case as it had helped lay down the ground rules on how

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to achieve massive gains at the cost of some extremely poor and indebted countries.

VULTURE FUND ABUSE IN AFRICA And talking about poor and indebted countries, one can’t fail to mention the African continent. It has been one of the regions to be majorly affected by vulture funds due to its poor and indebted status.

African nations till two years back, i.e. mid 2011, dominated the HIPC list thus making it to the top of the list of most vulture fund firms. With nearly 33 out of 40 HIPCs, about 80% of the countries in the African continent were eligible for debt relief and many were contending to become eligible under the joint IMF and World Bank initiative. However, two particular cases that have had devastating impact on the development of the African nations owing to the huge vulture fund litigations are:

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Sick units in satellite towns like Ghaziabad and Faridabad in the North as well as far suburbs of Mumbai and other industrial areas were being increasingly eyed by these funds for the property attached to them.

A blatant example in this case is Standard Chartered Bank acquiring loans of Golden Falcon, a steel unit, from State Bank of India at Rs. 39 crore. This was a clear indication of the foreign banks’ developing interest in buying out of bad loans. The main attraction for Standard Chartered in this transaction had been the properties at Vashi and Wadala in Mumbai. Another, rather controversial purchase was the bonds issued by Apple Finance by Kotak Mahindra Primus for Rs. 80 crore. The multistoried office of Apple Finance located in Bandra Kurla Complex being the main lure.

Even more recently in January, 2013 AION, a special fund ( read vulture funds) jointly owned

by ICICI Ventures and promoted by ICICI Bank and American PE firm Apollo Global had raised US$325 million to invest in distressed Indian companies.

By attempting to raise the corpus to US$ 500 million, they are clearly signaling the increasing opportunities for such funds in a somewhat slowing economy.

Thus, it’s time India also become aware and more cautious of the circling vultures overhead. Vulture funds conforming to the name connote capitalist greed in the poorest forms. Preying on the weakest players across the globe purely for financial gains has jeopardized development like never before. Their approaches of masking ownership, functioning in offshore tax havens while establishing themselves as fly-by-night operatives undoubtedly show that they themselves find their work less than clothed.

In addition to this, they are known to steal from tax payers of donor countries by not paying taxes and instead compelling the developing nations to pay from their development funds.

The need of the hour, thus, is to limit the profits made by these vultures, increase transparency, introduce an international bankruptcy framework and prevent sale of HIPC claims to entities that will not provide debt relief. This requires commitment by the creditors. Europe and the US, home to a majority of these vulture funds should lead the pack in thwarting such activity at least within their borders. Vulture funds are an impending threat to not only the Indian sub-continent but to the world at large and it’s high time that efforts are merged to avert any harm to other adolescent economies.

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Republic of Congo Flying high on the success of Peru, Paul Singer of Elliot Management purchased US$ 30 million of debt at an undisclosed price. The debt was owed by the Republic of Congo since 1980. Post purchase, Elliot sued the country for repayment of the full debt plus the interest. Elliot won the litigation and was awarded more than US$ 100 million in 2002.

Zambia Government of Zambia had bought agricultural equipment on credit from Romania in 1979. Soon it was apparent that Zambia would be unable to pay off its debt and the two countries mutually agreed to liquidate the debt in 1999, by being part of the debt relief program. Yet, at the last moment, Donegal International, a third party investment firm purchased the debt with a vulture’s eye. Donegal acquired the debt for US$ 3 million whose original value stood at US$ 15 million. Donegal didn’t waste any time in suing Zambia to finally settle at US$ 55 million. Zambia was forced to pay US$ 15.4 million to Donegal in 2006 by the British High Court. The money amounted to nearly 65% of its total relief fund, an enhancement of the HIPC Initiative. Thus, a large slice of the funds entitled for poverty reduction strategies was paid off to a capitalistic investment entity.

This was by far the most glaring example of how vulture funds can with no difficulties wipe off any progress made by HIPC VULTURES HUNTING INDIA India hasn’t been spared by these incessantly hunting vultures either. The year 2007 saw the economy becoming aware of this term for the first time. Added to that, many were stating that atleast half-a-dozen US based buyout funds were looking around to acquire bad assets in India In India, the main targets of these ruthless investment arms had been loan accounts with property collateral attached to it. Thanks to the Securitization Act, buy out of bad loans with underlying assets as real estate had become possible. Most foreign funds and foreign banks were found approaching the country’s top lenders to buy out assets of companies that had gone belly-up.

These firms had been pretty nonchalant about their intentions as well. They were not attempting to turnaround the fortunes of the production units, rather, they had wanted to develop the real estate market, hawk it and then rifle for further prospects.

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FOOTBALL FIELD FinGyaan

FinGyaan

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NOW IN VALUATION Lokeshwar Sinha

IFMR, Chennai

A company can be valued according to different methodologies like Discounted Cash Flow (DCF) model, Enterprise value Multiples (e.g. EV/EBITDA), 52 weeks high/ low stock price levels of the company etc.

None of the methods can be called perfectly right or wrong, as they provide an indicative figure for valuation. Once various valuation analyses have been performed, it is important to evaluate the valuation ranges derived from various methods and use that information to triangulate a valuation range for the company. Investment bankers often summarize the result by creating a page called “football field” to graphically depict the valuation ranges derived using different

methods of valuation. A “football field”, so named for its resemblance to a U.S football playing field, is a summary which enables bankers to establish a valuation range for a company that is the subject of a merger and acquisition (M&A) transaction. For public companies, the football field also includes the target’s 52-week trading range in line with the precedent transactions in the specified sector (e.g. 30-40%). A football field may also reference the valuation implied by a range of target prices from equity research reports.

Getting into a Football Field In general, a football field will show that the valuation range from comparable company

Fig 1: An example of a Valuation Football Field

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Fig 2: A contrary example to the above Valuation Football Field

analysis is lower than that of comparable transaction analysis because a control premium is included in the comparable transaction analysis. However, this is not always the case, especially when there has not been any M&A activity in the industry for a long time. A DCF analysis normally creates a valuation range that is similar to the range for a comparable company analysis, although there are cases when it’s not so. Typically, a company’s current acquisition value falls above the overlapping ranges given by the comparable company analysis and the DCF analysis, although again there are cases when it’s not so. This is because an acquirer should pay a control premium, which is not included in either of the above methods of valuation. A Leveraged Buyout (LBO) analysis generally provides a floor value for a company, as it represents a price that a financial buyer would be willing to pay, based on their required internal rate of return (IRR).

Generally, strategic buyers are able to pay more than the financial buyers, since they can take the advantage of synergies with their own company. But, if the market allows high leverage (as was the case from 2006 to mid-2007), which results into higher IRRs, or if there are specific operating strategies that a financial buyer brings to the transaction, then it is possible for financial buyers to surpass strategic buyers, despite the lack of synergy benefits. If there are multiple lines of businesses within a company, then a break-up analysis can be included in the football field. Depending on the industry and the company, other valuation methodologies can also be included in the summary.

Understanding with an Example An example of football field can be found in Figure 1.

As shown in Figure 1, the current stock price of $40 is within the comparable company

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analysis range of $36 to $44. The comparable company analysis range is less than the comparable transaction analysis range of $42 to $51. This is generally expected since comparable transaction multiples include a control premium whereas trading comparable (from comparable company analysis) do not. A DCF analysis might show a valuation range of $38 to $45, unless synergies are added, where the range might increase to $43 to $50, assuming cost synergies of $5. In this football field, it is inferred that financial buyers might be interested in the target company based on its strong cash flow, low leverage, and small capital expenditure requirements, and so an LBO valuation was completed, which shows a valuation range of $39 to $45, based on an assumed 20% IRR requirement. A breakup analysis was completed, because there are several different business lines run by the company, and the valuation range based on this analysis is $41 to $51, which is the widest range due to uncertainty regarding different business line values after allocating debt and considering tax issues. Based on this football field, investment bankers might determine that the appropriate triangulated value for the target company is $50 (which might be expressed as a range of $48 to $52), that represents a 25% premium to the current share price of $40. However, $50 could be adjusted up or down based on the acquisition consideration (shares or cash), probability of completion, and other factors.

Analysis & Interpretations The comparable company analysis range is generally in line with the DCF analysis range,

which means that, currently, investors are properly valuing the company in the public markets relative to its intrinsic value. The breakup analysis range in Figure 1.1 is wider than some of the other methods. This is not uncommon because there is less certainty in the values of several component pieces compared to a single company because there is execution risk involved with each of the individuals sale transactions and also because there may be uncertainty as to the range of values for some of the component pieces.

If the company in Figure 1 were for sale and a buyer were to offer $50 per share, the offer is likely to be considered “fair” from a financial point of view due to the fact that – 1. $50 represents a $10 per share or 25% premium to the current share price of $40.

2. $50 is on the high end of the comparable transaction analysis range of $42 to $51.

3. $50 is greater by $5 per share than the high end of the DCF analysis or “intrinsic” value range of $38 to $45.

This means that, assuming markets were to properly value this company based on a DCF valuation, the highest value a public investor should be willing to pay for a noncontrolling interest is $45 per share. If the financial buyer were to offer $50 per share, the offer price would exceed the standalone intrinsic value of the company. The only reason a potential buyer should be willing to pay $50 per share for a company that is, at most worth $45 on a standalone basis is because the potential buyer can create more than $5 per share of synergy value (such that a price of $50 per share is still a value

A Leveraged Buyout (LBO) analysis generally provides a floor value for a company, as it represents a price that a financial buyer would be willing to pay, based on their required IRR.

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NIVESHAK

1) % which would give three different final values. Thus, the discounted cash flow (DCF) method will give a range of values for the company being valued. This applies to all valuation methods. The football field graph shows the different mean valuations and multiples for the different methodologies and allows the person conducting the valuation to decide which method to use primarily to achieve the best possible valuation. Straight away an investment banker can see the share price given by the average of all of the valuation methods and argue its range of valuation. The valuation range is finally tested and analysed within the context of merger consequence analysis in order to determine the ultimate bid price.

Companies are generally valued using a combination of multiples and future cash flows, and each of which can be taken in a best, worst and median case scenario. For example with a discounted cash flow, it can be assumed that the company will have a terminal growth rate of x%, (x+1) % or (x-

A DCF analysis normally creates a valuation range that is similar to the range for a comparable company analysis, although there are cases when it’s not so.

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FinGyaan Article of the Month Cover Story

enhancing transaction for buyer even after paying away $5 in synergy value in order to gain control of the target company).

If, in this example, the DCF analysis range were $46 to $53, as shown in Figure 2, as opposed to $38 to $45 as shown in Figure 1, the target company might not want to accept an offer of $50 per share. If the company believes in the integrity of its strategic plan and its projections, it might not want to try and realize its strategic plan and then allow time for the market to reward it with a higher stock price. Assuming, the market ultimately does recognize the intrinsic value of the company (assumed here to be the DCF analysis range of $46 to $53); it is possible that this company could be worth more in the public markets than the $50 per share offered by the buyer.

Applications 1. It helps to graphically depict the valuation ranges derived using different methods of valuation.

2. This approach also helps in using one method to “sanitize” the other!

3. A football field summarizes the various metrics and assumptions used to determine the valuation of a company or business segment.

Conclusion

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Article of the Month Finistory Cover Story

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Chinese “Second Revolution” Kaushal Ghai

People often debate one name, the country which is world’s biggest superpower today – China or the United States. Some economists are of the opinion that the dragon has already left USA behind but many argue that US economy is much bigger than that of China when we compare them on a per capita basis. Whoever tops the list, the evolution of China in last 35 years cannot be ignored. According to the World Bank, GDP growth in China has averaged more than 9 percent since 1989 and crossed even 14 percent a couple of times during the same period. Exports increased from USD 10 Billion a year to almost USD 1 Trillion between 1980s and 2000s. Savings increased by 14000 percent and at least 400 million people have been lifted out of poverty. Table 1.1 shows China’s GDP as a percentage of GDP of other large nations. It can be seen how fast China has grown; especially after 1978 when it opened up for the world.

Currently, China’s GDP is around 220 percent of that of Japan while this figure stood at only 39 percent back in 1978. . China has managed to achieve all this and more through a series of reforms generally known as “Second Revolution” which started in late 1970s. This transformed

United States Japan Germany India

1952 9.5 78.5 NA 63.9

1978 13.6 38.5 50.8 78.0

IIM Shillong

China from a planned economy to an open market economy.

China before the start of economic reforms The People’s Republic of China, established in 1949, adopted a planned economic system similar to what followed by Soviet Union. Some of the features were state run industries and substantial authority vested in the hands of bureaucracy. The period between 1949 and late 1970s saw mixed results. On one hand, rising rates of savings and investments helped economy to grow while on the other, there were some short term disruptions like Great Leap Forward of the 1950s and Cultural Revolution of the 1960s which impacted the Chinese economy negatively. In this planned system of economy, emphasis was given to quantity and not quality and focus was majorly on investment goods rather than consumer products; innovation remained entirely neglected. The planned system was hostile towards entrepreneurship.

In an open market system, individuals and organizations can modify volumes of sale and

1990 27.9 70.5 113.3 122.2

2000 51.7 165.9 244.8 190.6

Table 1: China’s GDP as a percent of GDP of other large nations

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2004 64.0 219.2 322.1 203.1

NIVESHAK

which could subsequently give them better incentives. With better incentives, farm output jumped quickly. Figure 1 shows the agriculture output of China in Billions of Yuan. It can be seen that the output in years before 1978 was stagnated around 160 Billion Yuan, but the output increased consistently after the introduction of agricultural reforms in 1978 and almost doubled in eight years from 1978 to 1986. The positive impact of reforms spread beyond agriculture to areas such as rural industries followed by urban industries.

After the initial success in agriculture, aim was set to (a) revive rural and urban industries, and (b) increase market awareness and efficiency by encouraging the producers. In order to do so, a unique and innovative dual pricing strategy was adopted. As per the new strategy, the transactions corresponding to most of the commodities were split into a plan component and a market component. Once the producer had fulfilled the plan requirement, he could sell the remaining goods in market at the price he wished. The new pricing scheme took care of two major shortcomings of the planned system.

One, the rigidness in prices was controlled, as the producers could charge flexible prices after fulfilling plan requirement, and two, it brought innovation. In the planned system there was no incentive for innovation but in the new scheme, producers could use innovative means to increase their profitability by properly pricing the above-plan output.

The positive impact of change in economic policies in China could be seen soon as companies which could not enter Chinese market earlier started changing their minds and seeing China as a potential demand center. It started in 1979 when Boeing announced the sale of its 747 aircrafts to various Chinese airlines.

Soon after, beverage company Coca-Cola too showed an interest to open production unit in China. The reforms marked the beginning of international trade in China.

Opening of South China Before 1978 China was almost isolated from International trade. Deng’s economic reforms gave a lot of emphasis on the establishment of Special Economic Zones (SEZs) along the coastline of South China. Industries establishing there could make huge profits and avail many

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Article of the Month Finistory Cover Story

price to improve customer relationships and hence improve profits, but in a planned system, everything is controlled by the state. Neither is there an opportunity to expand nor the fear of being succumbed by the competitors, which subsequently removes the pressure of improvement. Although China had performed well compared to other developing nations, China’s position was weak compared to other East Asian countries such as Japan and South Korea. There was a need for economic reforms if China had to compete.

The Beginning of Reforms Following Mao’s death in 1976, Deng Xiaoping emerged as the leader of China. Deng along with Zhao, the third premier of the Republic of China, initiated the series of much needed economic reforms. It was not easy for China to adopt the reforms and change from a planned economy to open market as whenever there were talks of forming relationship with foreigners a sense of fear of being exploited arose amongst the citizens. The collapse of Soviet Union acted as the catalyst which made Deng think to go for change in market style. Deng’s economic reforms were summed up by the “Four Modernizations” – agriculture, industry, science & technology and military, with the first reforms coming in agriculture.

The reforms, also referred as the “Second Revolution”, started in a small village in east Anhui province where some farmers signed an agreement to divide the communally owned land amongst themselves into small sections called ‘household contracts’. Collective farming in communes was abandoned and was replaced by household cultivation. At that time, this act would have been considered a serious crime otherwise but Deng supported the experiment and tried the same model throughout the country. This became the first major breakthrough for the economic reforms of China. The privatization experiment rapidly won support of a lot of people throughout the country as the Chinese farmers were already frustrated by the commune system. The shift to ‘Household cultivation’ meant that the farmers could grow extra fruits and make profit out of them rather than get a tiny share from the old collective system of farming. This scheme motivated the farmers to put in more energy

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Fig 2: Agriculture Output in China

incentives in the form of low taxes, cheap land and low-cost labor, so the first SEZ was established in Shenzhen in South China.

During the late 1970s and early 1980s, Hong Kong and Taiwan, the Southern neighboring countries of China, were also experiencing a shift in their industries from light manufacturing to more high tech manufacturing. The businesses were looking for cheap labor and cheap land. The combination of Chinese venues, low-cost Chinese labor with the entrepreneurial capabilities and market knowledge of foreign business people slowly developed China into an export hub and took China forward to where it stands today, towards its current state of economic globalization.

After witnessing the initial success of SEZs, the number of SEZs and open cities in South China increased. This was because of easy availability of commodities, information and trade opportunities with the International market.

Apart from a few sectors which were shielded from the external markets, almost all the other sectors saw the entry of producers from countries such as Japan, America, Italy, Bangladesh etc.

Because of this the competition level increased which pushed the Chinese suppliers to reduce the cost of production and increase the quality to match global standards. The opening of economy was responsible for accelerating the shift of Chinese labor from farm sector to manufacturing

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sector, and has today made China, a country whose biggest asset is its labor.

In a short span of just thirty years, China has transformed a lot. Even today, China is passing through massive transformation; from an economy based on agriculture to one based on services and manufacturing, from a command to a market economy, and from a totally closed economy to an economy which is much more open than most countries at the same level of income. The reforms adopted by China in the last thirty years have moved China to the top trading nations in the world. The World Bank has estimated that if China continues to grow with the same pace, it will become the world’s largest economy during the first half of 21st century itself. It has also been estimated that by 2020 China would become the world’s second largest importer and exporter of goods. It is the same country, which some thirty-five years ago was unable to compete even with its neighbors such as Hong Kong and Taiwan, and was nowhere in the global economy as a whole, but since the beginning of reforms China has changed its image amongst its people and also globally by emerging as one of the today’s superpowers.

NIVESHAK

Finsight Cover Story

The Bubble Bomb

Akshay Gupta

IBS, Hyderabad East is “East”, all the action lies in the West.

Some might say this phrase is a thing of the past now, others might say the G4 economies are bouncing back. The truth is, in long term, we are all in debt. Look closer, you will see the elephant in the room – Soaring Global Debt. From the tiny state of Cyprus racing to secure a bailout to stave off bankruptcy, which looks like a dot in the larger financial picture, to Detroit bankruptcy to the emerging markets losing their mojo. We are all part of it now. Banks, government and consumers, we are moving money around in circles. The deficit crisis and the financial bubble busts are sweeping the economies away. With Total World Debt standing at $190 trillion (See figure 1 for a distribution of this debt across economies), even all the World Bank Deposits can’t pay it off. Conclusion – Financial Bubbles are good for economy’s health? Think about it - It’s a TRAP! What is a bubble? When the prices of securities or other assets rise so sharply and at such a sustained rate that they exceed valuations justified by fundamentals, it is said to form a bubble. However, in today’s

era , the term bubble for me, is a situation in which asset prices appear to be based on implausible or inconsistent views about the future that carries the potential to desolate the financial structure of the world.

It all began in 1637 when, speculation of Dutch Tulip Bulbs, popularly known as the “Tulip Mania”, peaked at today’s equivalent of more than $1000 per bulb and the market collapsed under its own weight, presenting financially wrenching crisis speculators and their backers. Then came the South Sea Bubble of 1720 - this was a time of lavishness and opulence in Britain, with many wealthy speculators desperate to invest in a company that wildly promised astronomical returns, trading wool and fleece for piles of jewels and gold. Shares in the company quickly reached 10 times their value, but when the bubble burst, many of the country’s elite were left destitute.

Railway Mania, another British phenomenon, grew throughout the early 1840s, peaking in 1846 when a staggering 9,500 miles of new railway lines were authorized, around a third of which were never actually built.

As the price of railway shares increased,

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Fig1: National Debt by Countries

more money poured in, largely from the new, affluent middle classes that had arisen from the smoke of the industrial revolution.

As few had predicted, it ultimately became clear that building railway lines was not as lucrative and easy as investors had been told by wily entrepreneurs. The collapse was unavoidable, and many middle-class families lost their life savings as a result.

The predominant factor of the USA’s Great Depression known as “The Black Tuesday” of 1930 was over-indebtedness and deflation; loose credit to over-indebted, which fuelled speculation and asset bubbles. Talking about bubbles, how can one forget the “The Dot-Com Bubble” of 1997, one of the historic ‘speculative’ bubbles of all time that left behind many vacant buildings and many more failed dreams. Low interest rates by the Fed’s and subsequent availability of cheap credit led to over investment which was the main cause of the downfall. This was the time when growth was preferred over profits and the market collapsed yet again.

A classic example of low interest rates demolition is of the Housing Bubble Crisis (Sub-Prime Mortgage Crisis) where the US Fed made more mistakes than yogi bear reciting Shakespeare. This bubble also led to the Eurozone Debt Crisis - a complex network of financial derivative products (Which according to Warren Buffet are nothing but

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WMD’s - Weapons of Mass Destruction) held globally. However, this was just the tip of the iceberg. The solvency of some EU banks was strained by significant exposures to domestic sovereign debt. The market value drop of government bonds led to liquidity strains, as these bonds were widely used as collateral in interbank markets and in some instances, EU governments had to provide funding to vulnerable domestic banks, at the expense of their countries’ debt.

It seems like everyone is on a suicide mission with an option to blame their kill on someone else but the beauty of deal is that no one is responsible, because everyone is drinking the same cool-aid. The Federal Reserve Quantitative Easing (QE) measures (a fancy term for easy money policy!) are responsible for blowing these bubbles.

However, the reality is that a pin lies in wait for every bubble and when the two eventually meet, a new wave of investors learn some very old lessons: First, many in Wall Street (a community in which quality control is not prized) will sell investors anything they will buy. Second, Speculation“The Mother of all Evil” is most dangerous when it looks easiest.

So are we doomed to be in financial bubbles forever? There’s a lot of bubble talk out there right now. Much of it is about an alleged Bond Bubble that is supposedly keeping bond prices unrealistically high and

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interest rates – which move in the opposite direction from bond prices – unrealistically low. Ever since the market mayhem after the US Federal Reserve chairman Ben Bernanke introduced QE measures, global investors have been pulling money out of the emerging markets. What these measures do is that they overheat the emerging markets (BRICS) causing protectionism and competitive devaluation as the currency of these economies are pegged versus Dollar.

Brazil’s GDP grew by only 1% and may not grow by more than 2% this year, with its potential growth barely above 3%. Same is the case with Russia, despite oil prices being around $100 a barrel. South Africa, a developed market wrapped around an emerging market, grew by only 2.5% and with currency depreciation, it would not grow faster than 2% this year. When it comes to India, the economy seems to be in denial. The GDP growth rate is at a 10 year low (around 5%) but the government still is optimistic to achieve breakthrough results by the next quarter. The Rupee touched its all-time low - 1$=Rs.68.8 which clearly states how vulnerable the economy is to any sort of policy measures.

We need to focus on Commerce, and not only on Finance. People get all hunky dory when it comes to investing in China, however the

best way to approach the growth figures of China is by ignoring their GDP rate. Even if we take into account the 7.5% growth rate at face value, its components suggest a more ominous scenario. What’s really the issue in the country is this unhealthy obsession with GDP numbers. Even in the best of times, China’s data can be about as accurate as tossing a dart at a chart on the wall. It’s a structurally imbalanced economy distorted by top down policies and considerable “grey” activities that are hard to measure, not the least of which is the sprawling shadow banking sector which is suffering from the predicament of over investment , seeds of which were planted way back in the housing bubble crisis of 2008, where China appeared to dodge the global financial meltdown by implementing a huge half a trillion dollar stimulus misdirected towards wasteful projects such as unneeded steel and aluminium plants.

So the sudden rush for the exits quite conclusively proves that rising asset prices across the world were being supported by easy liquidity. QE measures coupled with huge dollar holdings transcend the financial strength and it is about time that emerging market devised an escape. Why not dollar holdings? Loading up on dollars helps Asia’s exporters by holding down local currencies,

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Finsight Article of the Month Cover Story

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but it causes economic control problems.

When central bank buys dollars, they need to sell local currency, increasing its availability and boosting the money supply and inflation, so they sell bonds to mop up excess money. It’s an imprecise science made more complicated by the US Fed’s QE policies which could sink the emerging markets. So does one get a déjà vu of the Asian Financial Crisis 1997? We should not forget the example of Japan, where bets against government bonds (similar to today’s QE policies) ended in grief so often that the whole trade came to be known as the “widow-maker” which was a catalyst in the ’97 crisis.

However, every crisis contains within itself the seeds of success and the roots of failure.

Finding, cultivating and harvesting that potential success is the essence of crisis management but it seems insurmountable in today’s era of greed, where banks, investors are going bonkers over cheap credit and are ready to repeat the same mistakes again.

From the Tulip Mania to Great Depression, to the stagflation of the seventies, to the economic crisis caused by the housing bubble and Eurozone and now the bond bubble, every economic downturn suffered by the developed and the emerging markets can be traced to Federal Reserve policy.

The Fed has followed a consistent policy of flooding the economy with easy money, leading to a misallocation of resources and an artificial so called ‘boom’ followed by a

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recession or depression.

What’s the definition of insanity if not doing the same thing over and over and expecting a different result every time? Can nature endure more and more people going insane at the same time? It becomes, as Buffet says “systemic” like cancer - it’s global and malignant. Greed is good, but not God. We take a buck, we shoot it full of steroids and we have a bubble, which are nothing but an in diffusible time bomb. The months ahead will be choppy. There will be moments of panic when the markets will have to be calmed. Most of us don’t know it yet but we are the ninja generation - no jobs, no incomes, no assets, we got a lot to look forward to! So brace yourselves ladies and gentleman, I wish you a merry crisis.

NIVESHAK

Mutual Funds nirmit mohan IIM Shillong

Sir, yesterday there was an expert talk being telecasted on the TV discussing SIP, STP and SWP in Mutual Funds. What are these plans all about?

As you all know, a mutual fund is a professionally managed type of collective investment scheme that pools money from many investors and invests it in stocks, bonds, short-term money market instrument and other securities. Mutual funds have a fund manager who invests the money on behalf of the investors by buying/selling market securities.

Sir, how SIPs can help us in reducing risk associated with price movements in the market?

As net asset value fluctuates throughout the year, there is no way the investor can anticipate the maxima or minima. In case of SIP (Systematic Investment Plan), the investor, by deciding to invest say Rs. 3000 regularly each month automatically gets the benefit of the swings. He gets least number of units in the months of high NAVs, whereas he accumulates higher number of units during low NAVs. Thus, SIP helps in averaging cost of acquiring units.

Sir, what is STP then?

In STP (Systematic Transfer Plan), we invest a lump sum amount in Debt Mutual Fund and then a fixed sum is transferred from this fund to an Equity Mutual fund on mutually agreed dates of a month and denominations. These plans outperform when markets are very volatile and one doesn’t want to take risk with his money in a short span of time. If one invests through STP and markets falls or goes volatile, then this situation is way better than the

one time investment option. For that matter, it is still better than keeping money in Bank or a SIP, because at least the money is earning some returns on debt part in STP. In a way it offers all the advantages of a SIP along with other advantages like growth of money and liquidity.

Sir, is there any situation wherein SIP is more advantageous than STP? Yes a situation does exist. Let’s say, in case market is already at the end of a bear market and it can start its upward movement anytime. In that case STP will not deliver the best returns like SIP, because at that time a one-shot investment is a good choice.

Sir, can we can say that STP is suited to investors who want to invest lump sum into debt funds and at the same time want some equity exposure in order to gain higher returns on their investment.

A big YES!! But vice versa is true as well. STP can also work as a tool to transfer from equity fund to debt scheme giving you the dual advantage of earning profits from your equity investment and preserving capital by moving it into debt.

Sir, they also mentioned about SWP. What is that?

SWP stands for Systematic Withdrawal Plan. Here the investor invests a lump sum amount and withdraws some money regularly over a period of time. This results in a steady income for the investor while at the same time his principal also gets drawn down gradually. These plans are very well suited for retired people who get a lump sum amount of gratuity after their retirement and want a regular source of income.

Sir, thank you for explaining the concepts so clearly.

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Article of the Month Classroom Cover Story Cover Story

CLASSROOM FinFunda of the Month

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FIN-Q 1. X is a financial organization in India and is the only investment firm to be created through Parliament Act. X remained the sole vehicle of investment in the capital market until regulator SEBI was established in 1988. Identify X? 2. Indian partner of a joint venture (north and east operations) with the world’s leading fast food restaurant has petitioned to the Company Law Board for his removal as the Managing Director of the JV. Name the JV 3. X, an Indian company, floated an issue of a controversial financial instrument, Y, in 2008.

It collected a sum of around Rs. 19000 crores by 2011. X claims that this issue was a private placement and not a public offer. Identify X and Y. 4. The Organization in Question has been awarded with numerous prestigious awards in the travel industry, a few prominent ones being Genius of the Web Award by CNBC, National Award for E-Governance for being the Best Citizen Centric Application, Most Innovative Product in Travel & Tourism of India etc. September 2, 2013 was a new high in the history of the firm. Identify the organization and the high it achieved on September 2, 2013.

5. A rule permits market makers to trade outside quoted ranges, when it is determined by an exchange that the movements in the market are so sharp that quotes cannot be kept current. What is this rule called?

6. GoI moved from a defined benefit plan to a defined contribution plan by making it mandatory for its new workforce (except armed forces) with effect from 1st January, 2004. This lead to formation of regulatory institution X to regulate and develop the sector. Identify X. 7. Which Multinational National has bought Daewoo ENTEC, a leading Korean sewage treatment service providers, and is looking at more M&As to become the leading water treatment company globally?

8. Movie X, an American drama film spans over the 36 hour period at a reputed Investment bank and depicts the pre-stages of the financial crisis 2008. Identify X.

All entries should be mailed at niveshak.iims@gmail.com by 10h October, 2013 23:59 hrs One lucky winner will receive cash prize of Rs. 500/-

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WINNERS Article of the Month

Prize - INR 1000/-

Divyesh Pai & Yogendra Sarfare TAPMI

FIN - Q

Prize - INR 500/-

Soumya Sharma IMI, Delhi

ANNOUNCEMENTS ALL ARE INVITED Team Niveshak invites articles from B-Schools all across India. We are looking for original articles related to finance & economics. Students can also contribute puzzles and jokes related to finance & economics. References should be cited wherever necessary. The best article will be featured as the “Article of the Month” and would be awarded cash prize of Rs.1000/- along with a certificate.

Instructions »» Please send your articles before 10th October, 2013 to niveshak.iims@gmail.com »» The subject line of the mail must be “Article for Niveshak_<Article Title>” »» Do mention your name, institute name and batch with your article »» Please ensure that the entire document has a wordcount between 1200 - 1500 »» Format: Microsoft WORD File, Font: - Times New Roman, Size: - 12, Line spacing: 1.5 »» Please do NOT send PDF files and kindly stick to the format »» Number of authors is limited to 2 at maximum »» Mention your e-mail id/ blog if you want the readers to contact you for further discussion »» Also certain entries which could not make the cut to the Niveshak will get figured on our Blog in the ‘Specials’ section

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