Vijay Kumar Gaba

Wednesday, July 22, 2020

The rise of "Retail Investor"

A multitude of data highlights that the participation of non institutional investors (and/or traders) in the Indian equity market has increased significantly in past few months. Many market observers have commented that it may in fact be a global phenomenon. Since, I do not have access to adequate authentic information about the global equity markets; I would restrict myself to Indian markets here.

As per the data available till last week, the share of non institutional volume on NSE has increased from 44.75% in February to 74.56% in July. In this period, the average daily market volume has increased from Rs51227cr to Rs59844; whereas the non institutional daily average volumes has almost doubled from Rs229bn to Rs446bn. This is unprecedented and surpasses both bubble markets (1999-2000 and 2007-2008).
Unlike the previous two episodes of bubble formation in markets, this rise in non institutional participation has coincided with sharp fall in the flows to mutual funds. Net flows into equity mutual funds tumbled 95% in June from the previous month, marking the third month of consecutive decline in the flows into equity mutual funds.
In this period the number of non institutional account with brokerages have increased materially. The largest discount brokerage in India recorded 23% rise in number of active clients in 1QFY21 period.

My enqiry indicates that the reasons for this trends are as follows:

(a) Dismal performance of asset managers (mutual funds as well as PMS). Most fund managers have disappointed the investors who were given high hopes through aggressive "Mutual Fund Sahi Hai" campaign. There have been many instances of impropriety and unethical practices, especially in case of PMS. This might have led the investors to take the things in their own hand.

(b) The socio-economic lock down due to outbreak of COVID-19 has rendered many people jobless. Besides many businesses have been working at zero or sub optimal capacity reducing the working capital requirement materially. Many of the jobless individuals and idle businessmen with cash may have started trading in equities in order to generate some income.

(c) Many young professionals who have been told to work from home, may have found spare time, which they are utilizing in trading in stocks.

The question is whether this trend is sustainable?

In my view, this trend is not sustainable. Much of this will reverse once the economy normalizes and people get to their routine work. Insofar as the conduct and performances of asset managers are concerned, the regulator might have a lot of work to do there, before the investors' confidence is restored.

Tuesday, July 21, 2020

Repayment of Debt

Continuing from last week (see How will this tiger ride end?)

As per various reports, central banks and governments worldwide have unleashed more than $15 trillion of stimulus to counter the economic slowdown caused by the outbreak of COVID-19 virus. Considering that the global economy had still not recovered fully from the global financial crisis (2008-09), this slowdown appears much more serious. It is like a cancer patient relapsing after responding to the treatment and showing some signs of recovery.

As per the estimates made by the Institute of International Finance estimates (IIF), total global debt has risen $87 trillion since 2007. Out of this government debt accounts for about $70 trillion, while the rest is private debt. The IIF estimates show that the total global debt may rise year to over 340% of the global GDP, assuming moderate recession of 3% in Global GDP. A more severe decline in economic activity will of course make the situation worse. The question is how this debt will ever be repaid, especially if the burgeoning debt keeps the fiscal bandwidth of the heavily indebted governments under check, constricting the public spending.

Traditionally, the governments have used many methods have been used to repay the public debt. For example, the following are some of the popular methods:

(a) Hiking taxes to augment revenue, so that the debt could be repaid.

(b) Rationalizing public expenditure to spare resources for debt repayment.

(d) Devaluing currency.

(e) Converting debt into equity of state owned enterprise, e.g., by issuing convertible securities of state owned enterprises; selling or divesting public assets to raise money for debt repayment; nationalizing private sector enterprises, etc

(f) Managing current account surplus to augment national reserves for repaying external debt.

(f) Replacing the existing debt with new debt bearing lower interest rate.

(g) Exponential rise in productivity

(h) Reneging on debt repayments.

(i) Changing the global monetary system, e.g., from silver standard to gold standard and from gold standard to fiat currencies etc.

Most of these methods directly or indirectly impact the savers and pensioners adversely and benefit the leveraged businesses and indebted household; inevitably resulting in further rise in socio-economic inequalities and poverty.

Given the scale of the debt and conditions of the global economy, I believe that the present situation is unprecedented and we may not have a solution template available to the governments. Since the global financial crisis in 2008-09, the central banks and governments have applied a variety of innovations to the conventional monetary and fiscal solutions. It would therefore be not totally inappropriate to believe that the solution to the problem of burgeoning debt will also be innovative. It may be a cocktail of the above cited conventional methods with or without suitable modifications. Two things though I am confident about is that (i) this debt will not be paid in cash as an honest borrower pays to the lender; and (ii) the global monetary system will not be the same 10years from now, as it exists today.

Friday, July 17, 2020

Random thoughts on RIL

Mukesh Dhirubhai Ambani becoming the sixth richest person on the planet earth has been adequately highlighted in Indian media, much more than his younger sibling Anil Dhirubhai Ambani pleading state of total penury in a UK court few weeks ago.

Twenty years ago, Wipro Chairman Azim Hasham Premji was rated as the fifth richest person on Earth and the Richest in India. At that time, he could have exchanged his 75% holding in Wipro worth US$47bn, for 100% ownership each in Reliance Industry, Hindustan lever and Infosys Technologies, and still keep enough change to survive for two generations. Having committed most of his wealth to charity, today Prem Ji is known for his generosity and philanthropic pursuits and not for his wealth.

This is however not the point of discussion here. Many readers have asked for my views on Reliance Industries, especially in light of the impressive growth agenda presented in a grand digital show, watched by millions. I would like to share my thoughts on Reliance Industries with the readers. It is however pertinent to note that these thoughts are of a tiny investor, who has plenty of investment options and unlike the fund managers benchmarked to Nifty, is under no compulsion to invest in an Index heavyweight stock.

At the outset, I may say that RIL does not fit into my investment strategy; hence I would continue to avoid it even after the impressive futuristic business plan.

Insofar as the grand AGM show is concerned, my views are as follows:

(a) Section 96 of the Companies Act 2013 requires every company, other than a One Person Company, to convene a general meeting of its member every year, and specifically call it Annual General Meeting in the notices calling such meeting.

As per circular of Ministry of Corporate Affairs, vide F. No. 21412020-CL-V dated 5 May 2020, this year the companies could be permitted to hold their AGM in digital mode, e.g., through video conferencing. However, "In such meetings, other than ordinary business, only those items of special business, which are considered to be unavoidable by the Board, may be transacted."

As per section 102 (2), the following business is specified to be ordinary business of AGM -

(i) the consideration of financial statements and the reports of the Board of Directors and auditors;

(ii) the declaration of any dividend;

(iii) the appointment of directors in place of those retiring;

(iv) the appointment of, and the fixing of the remuneration of, the auditors.

This essentially means that (1) An AGM must conduct the ordinary business specified under section 102(1); and (2) digitally held AGM should not conduct any special business unless it is considered unavoidable by the board.

I am no legal expert, and Reliance Management has access to the best legal resources in the country. Therefore, it would be ridiculous for me to challenge the legal validity of the grand digital show hosted by the Ambani family. But within my heart I refuse to accept this as AGM.

The point here being that, the promoters of the company find the law of the land "manageable", an attitude which as an Investor I do not like.

(b) Reliance Industries is now one of the largest 60 firms in the world. But the AGM of the company appeared like a Mom and Pop show with the four family members presenting the products and strategies. Personally I would have liked an array of top class professionals holding the fort.

(c) The Chairman proudly presented Sundar Pichai, CEO of Alphabet and Google, as strategic partner. He however demonstrated no inclination to introduce the leadership roadmap for the employees of the company. Like the Congress Party, Reliance Industry is also presented as a dynasty.

That is however not the point. The point is that Reliance Industries has decided to follow the model adopted by the erstwhile global giant General Electric and not the current global leader Google and Facebook. They want to do all the businesses themselves, rather than becoming investor in new businesses and let the best professional brains run that business independently.

In the process, India may be missing a tremendous opportunity. An article by Vibhu Arya published in Business Word titled "The Sale-And-Leaseback Of India's Internet Economy", is an interesting read in this context. This article aptly highlights my concerns.

(d) I find the business growth plan presented by the Ambani family frightening. If successful, Reliance Industries will own almost all the personal data about more than 50% Indians. This should have worried most people, especially those who opposed UIDAI (Adhaar) being made mandatory. But so far I have not heard any voice raising any concern. This business plan is in total contempt of the core principles of Anti Trust regulations. This makes RIL a misfit in my investment strategy.

(e) Notwithstanding the unsubstantiated claims of 37% CAGR since 1977, the stock of RIL has underperformed the value creators like Asian Paints, Dr Reddy, HUL, etc by huge margin. If we factor in the losses made by the investors in RPL-1, RPL-2, stocks hived to ADAG etc., the return will be dismal.

(f) There is no clarity as to how the value being created in digital, retail and renewable businesses will be assigned to the shareholders of RIL. If instead of demerging these businesses (mirroring the shareholding) the management decides to list these businesses as subsidiaries of RIL, the RIL shareholders will realize little value, like it was in the case of L&T.

(g) Last but not the least, I believe that for few more years, the new age businesses will continue to be cross subsidized by the cash generating Pethem and Refining businesses. If the current down cycle gets elongated structurally due changes in the way people travel & work and consumption patterns, the current level of profitability may not be sustained in the medium term.

I may reiterate that these views are strictly from my personal investment strategy standpoint. Given that I am a tiny investor, it is natural that larger investors may not be in agreement with these views. Therefore, I would not like to indulge in any argument over these views.

To the question "whether RIL share price can rise further?, my categorical answer is yes it can certainly rise higher from the current levels.

Thursday, July 16, 2020

Cart leading the horse

Recently the SEBI chief was quoted saying that exempting companies from declaring 1QFY21 results by allowing them to combine 1QFY21 and 2QFY21 will be detrimental to the interest of investors. He reportedly said that "Without companies declaring their results for a quarter, investors, financial analysts and media might make their own estimates about companies' earnings, which could be less reliable and speculative".

If this is really the thought process of regulator than it must be a cause of worry for all, especially investors. A regulator laying so much emphasis on quarterly earnings of companies highlights the adhoc nature of our regulatory framework for the market.

It is pertinent to note that financial analysts and media do make their own estimates much before companies declare their results. The companies' performance is widely reported and evaluated by analysts and media in comparison to these estimates. The tone of the reporting is always that the company "missed" or "beat" the estimates of analysts or media. I have never seen an analyst or TV channel admitting that their estimates about companies' earnings or monthly sales data were wide off the target.

There is enough empirical evidence to guide the regulator that the practice of releasing the estimates of quarterly earnings and monthly sales numbers causes undue volatility in stock markets and often leads to mispricing of stocks. Despite many representations, the regulator has not considered making it compulsory for analysts and media reporters to explain the divergences between their estimates and the actual performance of the company besides incorporating the historical divergences in their reports. It would help the investors in determining how much reliance they may place in these estimates.

In recent years, with the advent of numerous professional "investor relation" service providers, a large number of companies have started the practice of scheduling analyst presentations, conference calls and media interactions after announcing quarterly results. These calls and presentations are attended by a large number of people. My interaction with many analysts and investors indicates that the statements and projections made by the companies' managements in these interactions usually influences the analysts' forecasts and investors' decisions. While the regulation requires the companies to intimate the stock exchanges about all such scheduled interactions in advance; there is no regulation that requires the management of companies to explain the divergences between their forecasts and actual performance. Consequently, in a buoyant market environment like the present one, it is common to see managements of poorly managed companies to make wild forecasts palpably to influence the prices of shares of their respective companies.

A survey conducted by McKinsey & Co. many years ago, suggested that there is no clear consensus on contribution of the practice of issuing frequent earnings guidance to the value of companies; though they did feel that their company’s coverage by analysts and hence its visibility would decrease if they stop giving earnings guidance. A majority of participants responded that most managements issue earnings guidance largely at the insistence of brokerage house analysts, particularly the sell side analysts. A majority of respondents believed that issuance of earnings guidance does help in maintaining a channel of communication with investors and intensifying the management's focus on achieving financial targets. Though many participants did also feel that it causes share price volatility and excessive trading. The practice is also found to be leading the companies to focus more on short term goals.

The regulator should have felt relieved on receiving request from companies for not issuing quarterly numbers, rather than getting perturbed and denying the markets a much needed breather.

Wednesday, July 15, 2020

How will this tiger ride end?

A large part of global economic and financial research these days is focused on the burgeoning debt at all levels - government, business and household. The global government debt is now estimated to be 105% of global GDP and is still rising briskly. In the year 2020 itself the global government and private debt burden may increase by US$200trn, approximately 35% of global GDP. According to Bank of International Settlements, the percentage of companies with less than one interest coverage ratio has exploded since the global financial crisis (GFC). This number is witnessing sharp rise in the wake of COVID-19 led economic crisis.

In Indian context also, we have seen sharp rise in fiscal deficit (rise in government debt); corporate debt and household debt. Also, the quality of debt has deteriorated materially at all levels. The ratio of India’s public debt to GDP is expected to scale a new high at the end of FY21 due to record borrowing by the central and state governments and an expected contraction in the country’s gross domestic product (GDP) during the fiscal year.

According to RBI, the combined liabilities of the Centre and the state governments were around Rs 147 trillion or 72.1% of GDP at the end of March 2020. The revenue (and hence the debt servicing capability) of the government has deteriorated as the economic slowdown has led to material fall in tax revenue as well non tax revenue. The lower interest rate for fresh borrowing is helpful, but higher social sector spending is more than neutralizing that benefit.

Indian households had debts worth nearly Rs 43.5 trillion at the end of March this year, up from Rs 6.6 trillion at the end of March 2008 and Rs 19.3 trillion five years ago at the end of FY15. Outstanding retail loans are now equivalent to 21.3 per cent of India’s GDP in FY20, up from 13.2 per cent at the end of March 2008 and 15.5 per cent at the end of March 2015.

Wide spread job losses, wage reduction and poor employment outlook in organized sector has led to higher household debt, at a time when debt servicing capabilities are worsening fast. The fact that personal loans have not seen much reduction in interest rates, makes the situation even worse. In unorganized sector the conditions are much worse. The informal debt is much more expensive and difficult to service. The chain effect of the informal debt is much deeper and wider as compared to the formal debt. (see here)

The credit quality of Indian companies has materially deteriorated in FY20. As per the rating agency ICRA, The value of debt downgraded has more than doubled, according to ICRA Ratings Ltd. The disruption from the Covid-19 pandemic is likely to make the things worse. (see here)

In the study of indebtedness, the Japanese model is considered prominently. Japan government is the biggest debtor in the world. It owes more than 230% of GDP of debt. To save the economy from sinking Japan started to balloon its public debt many decades ago, at the expense of economic growth. For past many decades, Japanese economy has failed to register any meaningful growth or inflation. European Union, BoE and USA have also taken the same path in past one decade.

The question that are begging answers are therefore: (a) How this debt will ever be repaid? (b) If the global growth continues to remain low, how the poor and developing economies will bridge the development gap with developed countries and come out of poverty? (c) How the perpetually slow growth will impact the demography, i.e., whether the world will follow the demographic trends of Japan and grow old? (d) What will happen to the commodities based economies and populations in case the global demand for commodities continue to shrink for longer than expected? and (e) Will the digital highways make the geographical boundaries and hence the present concept of "Nationalism" redundant?

I am not an expert on any of these matters and mostly incompetent to satisfy these inquisitions. Nonetheless, since the questions have come to my mind, I will certainly try to seek some answers. I will be happy to share my thoughts with the readers in later posts.