India Investment Conference
Positioning Portfolios for the Turbulent Times
January 13th, 2012
The Second India Investment Conference jointly organised by CFA Institute, IAIP and NISM met with good response with more than 400 participants. Dr. Ashvin P Vibhakar, MD, APAC Operations, CFA Institute in his conference welcome note apprised the audience about CFA Institute’s emphasis on ethics and professional excellence globally and how the number of charter holder & membership in India is growing. Mr. Sunil Singhania, CFA, President IAIP, said that the local society has been actively participating in the discussion papers floated by the local regulators. Being an independent and not for profit society its views are independent and not representative of any business group. The following are the excerpts of the conference.
Mr. Upendra Kumar Sinha
In his inaugural address SEBI Chairman, U K Sinha, apprised the members of the MOU between CFA Institute, IAIP and NISM signed around 2-1/2 years ago and appreciated the efforts taken by the three in developing joint programs in the area of continuing education, sharing of knowledge & international developments which help in making decisions. He acknowledged the inputs provided by IAIP, which as an independent body does not represent any particular business group and consists of practising investment and finance professionals, into various discussion papers floated by SEBI. Likewise CFA Institute has shared work on corporate governance, risk management and standardising ratings.
The present times are difficult internationally with higher debt & unemployment levels and GDP growth rates revised downwards. The credibility, faith and trust of investors are at a risk. There are questions on the rationale of capitalism. Most of these events were not envisaged a few years ago. The public at large is expressing anger having lost money and trust. They are asking questions which many a times are difficult to answer. In such an environment the investment professionals have to be careful in discharging fiduciary duties and subject to much larger scrutiny. The industry needs to build and restore confidence and let people believe in it. In the Indian context sophisticated products are sold to uninformed people without taking into account the suitability of the products. Our job is to correct that. Its time for the mutual fund industry consolidating the investor base instead of focussing on the explosive growth, improve and refocus on risk management, build in a stronger model and follow the same.
The role of regulators is also becoming complex and they can’t tell that this is not into my jurisdiction. Independent regulators can’t say that this is my area and that one not. They have the task that the products are well regulated. However, at the same time they should not do things that are disruptive and damage the industry in the long run. All this is not possible unless people in the industry have the same feeling. It is true that the times are difficult, margins are down, and flows are down. However, do not encourage to take short term risks. At times regulators has to penalise people so as to deter others doing the same and demonstrate to the world that they are alert and such tasks and activities are avoided in the future.
In India the participation in the equity market is low comparatively. Partly this is due to lack of retirement and pension money coming to market. It expressed surprise why the pension products have not been developed by the mutual fund industry. Even in the debt market majority of the money is into short term products and that too most of it is institutional money. SEBI is working on reducing operational hassles for the investor coming into the market. These include IPO application forms, introduction of uniform KYC norms within the securities market. It is asking the mutual fund industry as well as investment bankers to provide more disclosure & information for the investing public. These include track record be it for fund managers or investment bankers. Initially there was high degree of resistance. Going forward it wants common account statement as most people would like to invest directly as information flow becomes good and they are assured that the markets are well regulated. It is risky to let any pool of money unregulated. Interests of the consumer need to be protected. On regulation of distributors, India is one of the few countries where distributors are not regulated. Hence it has asked asset managers to carry due diligence of at least 50% of the top distributors to begin with. He invited suggestions from the industry about things which may be important for the investors and industry.
Keynote Address: The Rediscovered India and the Road Ahead
Lord Meghnad Desai
Emeritus Professor of Economics, London School of Economics & Political Science
Moderated by Mr. Indranil Pan, Chief Economist, Kotak Mahindra Bank
Lord Meghnad Desai, provided wonderful insights into India’s economic and political thinking right from the Independence to the present day. Inflation has been persisting for so long. Index of industrial production has been fluctuating far too much on monthly basis. Deficit in the current fiscal will is extremely bad. Budget is likely to be generous. And if economic growth doesn’t revive than the deficit will be very bad in 2012-13. Yet he is awed to find no concern within the political system. There is an attitudinal problem in the political system and not even a single political party has shown any concerns.
India had since Independence a vast division in philosophy amongst its politicians. In the earlier 40 years after Independence it never trusted the market, private business and foreign capital. Instead its policies relied on government enterprises, civil servants etc. It will come as surprise to many people that India was one of the largest colonies with many entrepreneurs at the time of Independence. On the world industrial map it was ranked 7th. Indians had capitalism imbibed into themselves. This could be corroborated by the success Indians had overseas. Even an auto-rickshaw driver wants his son to study in private schools as he doesn’t have faith in the public schools. Then there was a complete change in stance in the 1990s and an era of liberalisation was brought in due to weak financial situation. It encouraged private sectors participation and foreign capital. However, the early 40 year philosophy threatens to come back every time at present through UPA2. There are debates on Food Security Bills. While everybody appreciates the social protection schemes, it is debatable if it could work. Whether cash transfer and government intervention is superior. The question is on the efficiency of re-distribution of government spending. Likewise there are noise and efforts to control social media like facebook and Google. These companies have resisted being bullied. India should avoid following China on this front. The very Prime Minister who brought in reforms is unable to hold onto the progress as he does not have many friends in the cabinet.
The developed world is into recession or depression and the pre-Lehman crisis or 2008 levels of GDP in the US and Europe is not likely to be reached at least till 2015. There is a growth gap of 7 to 10 years. And India could capitalise on this. There are questions on capitalism too. While the west has forgotten the basic virtues of capitalism like working hard, saving, and reinvesting, the same is thriving well in Asia. Capitalism has passed from West to the East. Throughout the economic and political history of the last 200 years, capitalism has gone through crisis. It is a cycle of growth boom and bust. Crisis builds up due to overspending and over indulgence and this leads to cleansing acts. It recovers by its own bootstrap. They are perfect because of cycle. IMF needs to be restructured as its borrowers are the debtor nations. India’s problem is not growth, it’s the challenge to grow at 9% plus. Its crisis of governance and politics. India can be a champion country if given a proper platform & system and constraints are removed.
On the question of inclusive growth, he thinks the labour is too expensive in the country and there is no manufacturing base in the country. Unlike countries like Malaysia, Bangladesh and China which initially concentrated on low tech low labour cost industries, India focussed on medium to hi-tech industries and missed on major part of manufacturing growth witnessed in other countries. Besides schemes like NREGA and Food Security Bills as form of subsidy have pushed costs up and removed the incentive to work or cultivate. Subsidies have ensured that people remain poor. India needs ambitious manufacturing policy and strategy to remove urban-rural divide. It is tried and tested way in many countries.
Outlook for the World Economy and Major Financial Markets
Dr. Michael Ivanotich
President, MSI Global Inc.
Moderated by Mr. Indranil Pan, Chief Economist, Kotak Mahindra Bank
Dr. Michael Ivanotich, gave detailed presentation on the world economy and major financial markets. To summarise the huge stimulus has reduced the impact of sub-prime crisis given in the developed market. Developing markets have on the other hand better domestic market.
The recent ISM indicators have been positive in the US. This include service sector index which is expanding at slower pace, manufacturing sector which is witnessing new orders, expanding production and lower inventories. However, for the unemployment rate to drop to levels of 5-6%, the GDP has to grow of 3% or above. Even then the 8.0mn jobs lost post the Lehman crisis are not likely to be recovered fully. Till date around 2.0mn jobs have been recovered. Consumption is holding out despite declining wages indicating that people are drawing from their savings balances. The Fed’s crisis management provided ample liquidity. The US banking system’s borrowed reserves which average $200mn per month under normal circumstances went at the peak to $698.8bn in Nov-08. Last month ending Dec-11 it dropped to $9.3bn (as against $45bn a year ago). The Excess reserves (lendable funds) which average $1.5bn on monthly basis in normal times were at $1.5trn on Dec 28, 2011. However, not all of this is going to consumer loans. Yield on 10 year bond is less than 2.0% as against CPI of 3.5%. The Fed’s monetary base is up 30% which is tripled from the pre-crisis level. The target Fed rate is 0.25% whereas effective is 0.07%. In Nov-12 US goes for Presidential Election which will lead to cleansing.
Most of the macro data in the Euro zone is better than those in the US and Japan. The nominal budget balances in the Euro zone is estimated at -4.0% during 2011 versus -10.0% in the US and -8.9% in Japan. The structural budget balance of the Euro zone is likely to be -2.8% during 2011 as against -7.9% in the US and -8.0% in Japan. The public debt in Euro zone is 95.6% in 2011 versus 97.8% in the US and 211.7% in Japan. The government in Euro zone has to run primary budget balance of 0.0% whereas US faces -6.8% and Japan -5.1%. As can be seen all of the above numbers are better in Euro zone than in the US or Japan. So why is there such a big hue and cry all about? The reasons could be that ECB policies are too late to resolve the crisis. Also ECB cannot do what the Fed can do i.e. buy bonds directly from the government.
China’s GDP is looking for moderation of growth to 8-9% range. Its policy is to restore price stability and switch from exports to domestic consumption. How much will China help the rest of the world? It is major importer of food, energy, raw material and dual use technologies (where US is trying to bring restrictions). It is importing at a rate of more than 10%. India’s GDP is slowing down. Inflation has been way above RBI’s comfort zone of 4-6% band. The current account deficit and the government deficit run high at 3.5% and 9-10% respectively. Russia doing well. Brazil’s GDP slowing a post-election cleanup.
Dr. Michael gave a very good perspective on why the Europe is not likely to break up. It was a Franco-German creation. France and Germany have seen two world wars in the nineteenth century. So they decided to never fight again. For reference purpose the Elysee treaty, signed in 1963, achieved a lot in initiating European integration and a stronger Franco-German co-position in transatlantic relations. The Schuman declarationof 1950 is regarded by some as the founding of Franco-German cooperation, as well as that of the European Coal and Steel Community of 1951, which also included Italy, Belgium, the Netherlands and Luxembourg. The Maastricht Treaty also called the Treaty of European Union was finally signed in 1992 by the members of European Union. That the Euro will break is the creation of the press. European Commission will provide money to support growth.
What investors really want?
Dr. Meir Statman
Glenn Klimek Professor of Finance, Leavey School of Business, Santa Clara University
Moderated by Mr. Parag Parikh, Founder and Chairman, Parag Parikh Financial Advisory Services Ltd.
Meir started the presentation with an example of a Rose trying to deduce the utilitarian, expressive and emotional value versus the $10. Likewise with the costly mechanical Swiss watches, socially responsible investments, hedge funds and paintings. He differentiated between standard finance and behavioural finance with the former assuming finance with rational, computer like people in it and latter dealing with finance with normal people in it who sometimes are smart and sometimes stupid. We act irrationally as we fall victim to cognitive errors and misleading emotions on our way to what we want. Our wants are like locomotives carrying status, family, fear of poverty, regret of losses, hope for riches, beat the market game and so on. It’s like the watching movies which are unreal and one comes to reality at the end versus investment illusions where lights never turn on. He highlighted the benefits to active investors – utilitarian being high returns, expressive being feeling of smartness compared to mediocre index fund and emotional being exhilaration of investing.
To cope with these behavioural traits Statman says you should know yourself, your clients, their wants, goals, cognitive errors & emotions. We need to teach clients the science of financial markets and human behaviour. With correlations between US and international stocks increasing does diversification really help? Is Markowitz wrong? Does market timing help? What are the cognitive errors in market timing? Some of them being framing errors, overconfidence, finding patterns in foresights and hindsight, those that confirm your claims and beliefs, herding etc.
Meir also highlighted the risk tolerance of people in different countries. It is high is poor countries as there is they have nothing much to loose anyway. Also these are collective societies. People are integrated into strong, cohesive groups. While countries like US are more individualists and ties between individuals are loose. Hence they have lower risk tolerance and have higher uncertainty avoidance. On how these concepts could be applied in real life situation is to encourage admission and cutting of losses, soliciting de-confirmatory evidence, reasoning in favour and against etc.
Asset & Risk Allocation in a Turbulent World
Mr. Brian D. Singer, CFA
Head of Global Macro Strategies, William Blair & Company
Moderated by Mr. Suresh A Mahadevan, CFA, MD and Head of India Equities, UBS
The only way the market could remain efficient is to have many active managers trying to exploit inefficiencies within it. Capitalism is not in crisis it is the state governance. Brian divided the primary drivers in the market in these turbulent times into two broad categories with demographics, innovation and social welfare trajectory falling under the economic and fundamental drivers and new world order, illiquidity & solvency and integration & connectedness falling under the broad capital market considerations. His focus stayed on the latter category and generated good attention span of the audience. Brian emphasised on the importance of game theory particularly Nash Equilibrium, where multiple players are in the games with their own strengths, strategies and knowledge of the optimal strategies of other players. The theory is helpful right from wars to present political regimes. During the cold war era from 1950s to Nov 1989 there were two dominant players viz. USA and USSR the portfolios were mostly stable though not optimal. The post cold war till present day has been unstable and not optimal. There are two spheres of influence one in orbit consisting of North America and Eurozone and out of orbit consisting of LATAM, former Soviet bloc, Asia (China and India). In such a situation just fundamental analysis will be insufficient for asset allocation and risk management.
The second angle is illiquidity and insolvency which are into a mutually reinforcing vicious cycle. One will have to evaluate the issues and the impact. For example in Eurozone Merkel wants forced fiscal prudence by the PIIGS nations, PIIGS want money now and Sarkozy wants to protect his banks which are exposed to PIIGS. So France and Germany combine on the one hand and PIIGS on the other and each will try to pressurise each other by forming a coalition. A new equilibrium will be reached. Evaluating default risk or the tail risk in such a situation is difficult. And we may not necessarily have appropriate skills. Taking reference from Centre of Strategic and International Studies, Brian shared the fiscal sustainability index and Income Adaptability Index. On the former countries like India who have not made much fiscal commitments like pension liability etc score high at 130+ while those like Spain are at the bottom with scores less than -30. On the latter index countries like India are at the bottom with scores less than 20 and countries like Netherland does better with scores above 160. Based on these parameters he charts countries with limited solvency threat and those with significant solvency threat.
Likewise integration (brought through innovation & inventions) and connectedness (like free trade agreements between nations & regions) has to be taken into consideration for asset & risk allocation. Overall conclusion – just fundamental analysis may not be sufficient in managing assets & risks. One will have to take into consideration geo-politics, government structures & responses, change in regime, leadership and the games they play.
Global & India Demographics: Implications for Investment Portfolios
Dr. Clint Laurent
General Manager, Global Demographics Ltd.
Moderated by Mr. Anirudha Dutta, Head of Research, CLSA India
In the recent past every economist in the world was positive about the favourable demographic change that is likely to happen in India over the next 10 to 20 years. Dr. Clint not only gave in numerical details the current population, its age group, income, education, labour participation rate, some of the numbers state-wise, he also throws similar numbers for other nations and warns of how demographic dividend could turn into a demographic liability if we do not improve education and engage labour productively.
Currently India fares poorly on the education front and the situation doesn’t seem to change significantly over coming decades. The percentage of population which completes secondary education is at present 13% compared to say China where the same number stands at 60%. The percentage of population having no education is an alarming 30% compared to 7% in China. The worst part is the ratios are not likely to change much over coming two decades. Education is very critical for improving the productivity of the labour force. It is found that whenever a country crosses 200 in Education Index there is sudden lift in productivity.
China and India form bulk of the global labour force at 32% and 17%. However both the male and female labour participation rates for India at 75% and 38% are lower than those of China at 86% and 73%. The female participation rate is lowest in North Africa and Middle East at 31%. The cost per worker too is lowest in India at $2655 pa versus $4295 in China. The cost is likely to increase by only $996 over current decade compared to rise of $5116 in case of China. Despite this for the every dollar you pay one gets $1.36 in returns in India compared to $1.83 in China. The returns converge in 2031 at $1.47.
The upper middle income group with household income between $25,000 to $100,000 forms the major component (45-47%) of the global population. At present this group majorly resides in Western Europe (32%) and N America (22%). China and India form 6% and 1%. Hence the strategy of the Tata group who bought JLR having presence in these geographies. But by the end of the current decade China is estimated to become the largest with 22% of the population while India is expected to remain at a mere 2%. Hence Indians might want to look for exporting to Chinese population. Again by 2031 China is expected to have 47mn households with income of $50,000 or above.
The population in the age group of 40 to 64 years is best one for consumption. Here India is likely to add 68mn people over the coming 10 years and another 59mn the following decade (2021-31). This group usually have most of the consumer durables. The demand shifts to lifestyle products like dietary supplements, healthcare, travel & tourism. In Hong Kong 10 years ago there were few gyms. Now you find it at every street. An average tourist spends $1000 in non-travel related expenditure. So these are the areas where Indian organisation could look forward to.
Deploying Quantitative Methods to Position Portfolios for Turbulent Times
Mr. Pranay Gupta
CIO, Asia, Lombard Odier
Moderated by Mr. Prashanth Y. Narayan, VP and Head of PMS Team, ING Investment Management
There is increase in volatility, risk, asset correlation, dispersion in forecast estimates as well as manager returns worldwide. In such turbulent times even quantitative strategies have come for criticism by the investors. Hence Pranay’s presentation has been timely. He started with explaining which strategies work better at what point in the market cycle, how to select good managers, what are the different risk factors one need to evaluate most importantly draw down risks in between the horizons, the impact of leverage, change in allocation as the market evolves and so on.
According to Pranay, quant/systematic strategies perform well at the start of the trending bull market while fundamental strategies essentially consisting of stock selection work well at the peak of the market cycle. Fundamental strategies look for turning points while quantitative strategies look for continuity. During volatile period identifying opportunity sectors and stocks become critical as the cross sectional variance of the stocks and divergence in returns in them increases.
Selecting good managers can lead to dramatically different investment results. Assuming that one had a neutral portfolio with returns of roughly 8% then removing 60% of worst managers could have enhanced returns by more than 200bps and inversely removing 60% of the best managers could have depressed yields by nearly 200bps. Investors need to go inside the managers to understand their investment philosophy and processes. Likewise one needs to evaluate whether the out performance has been due to one huge right bet, whether it is due to a few star or iconic fund managers and so on.
Coming to define risk different people perceive it in different way. Pranay finds Draw-down risk more important than volatility. It is a well known fact that some of the large hedge funds had to close down as they could not manage draw down even if their calls were right in the long run. While investment results are to be seen in the long run, the intra-horizon fluctuations could be huge. In such periods changing style or risk allocation could be more damaging. When volatility went up in 2008 investors who held on to same accounts and risk profiles came out much better than those who brought down their portfolio risk in 2009-10! Apart from draw-down risks, one needs to look into tail, event, macro and regime risk for example sudden spike in oil prices or interest rates or changes in currencies or governments.
Executive Panel: India Investment Outlook
Mr. Abheek Barua, Chief Economist and SVP, HDFC Bank
Mr. Ashutosh Bishnoi, Acting CEO, L&T Mutual Fund
Mr. Manish Chokhani, MD and CEO, Enam Securities Pvt. Ltd.
Mr. Navneet Munot, CFA, CIO, SBI Funds Management Pvt. Ltd.
Mr. Shankar Sharma, Head Quantitative Trading Strategy Group, First Global
Moderated by Mr. Vivek Law, Editor, Bloomberg UTV
Keeping with the tradition of last year, India Investment Conference had power packed panel discussion on the investment outlook for the coming year. Vivek Law of Bloomberg UTV moderated the session, which was relayed live to this business channel, and had Abheek Barua, Ashutosh Bishnoi, Manish Chokhani, Navneet Munot and Shankar Sharma on the dias. The broad views are summarised below.
Abheek Barua: With data like IIP prone to errors and volatile on monthly basis it is difficult to make an assessment. However, macro indicators point to slowdown. BoP do not justify currency rate of Rs54 against the USD. The interest rates are likely to come off but not as dramatically. RBI could start easing monetary policy in a calibrated fashion with a cut in CRR.
Ashutosh Bishnoi: Split the argument into two. One was whether there are enough opportunities to make returns of 13% plus. On this front high quality assets which were priced expensively are becoming slightly attractive. On the other hand are there people who will come for investment. As of now most of them will spend on consumption rather than into savings or investments where real returns have been negative.
Manish Chokhani: The Indian equities may be going into a cyclical decline as against structural down turn in most of the developed market. The rate of change of downward trend is slowing. Almost 80% of the stocks are near 2008-09 lows many of which could turn much higher three years down the line. The interest rate hikes which stopped the bull market have sown the seeds for the next bull market.
Navneet Munot: The developed markets are going through balance sheet recession, while India is going through the P/L recession and not structural. Last year preservation of capital was the major theme. This time around you will have to equally worry about hedging the upside risk. For most of corporations, capital may not be a constraint especially if the returns of 14% are guaranteed like in the case of power generation. However, factors like land acquisition, availability of coal and evacuation have cropped up.
Shankar Sharma: Last time we were unduly negative due to what was happening on political front, corruption and Anna movement. However, the developed markets too face similar issues. RBI was carried away by success of 2007-08 policy and increased rates thereby sacrificing growth. Once the growth momentum is broken it is difficult to revive the same. RBI will have to cut rates really big time or provide higher stimulus. Though 2008 peaks are not likely to reach for years to come, FDI investors may be seeing opportunities which we are missing.
Contribution by: Chetan Shah, CFA, IAIP Volunteer