• MacroScan: More Space for Speculation

. . . both in terms of the price earnings ratio and the nature of the surge in markets the current situation is either similar to or even more dodgy than that which prevailed in early 2001. Of course, it could be argued that the FIIs responsible for the recent surge are not pigmies of the kind that Ketan Parekh was, reliant on illegally acquired capital for their investments.

But because these entities are cash rich and include highly leveraged, speculation-prone institutions like hedge funds and private equity firms looking for abnormal returns, some among them might choose to use the short selling option when markets are high in the hope that the market can be maneuvered downwards to ensure large profits.

• Chicago Tribune: Hedge fund returns in ‘07 ‘disparate’

The average hedge fund gained 10.4% last year, including 0.7% in December, according to data released Tuesday by Chicago-based Hedge Fund Research Inc.

Seven of the 10 largest firms fell short of the annual average, said people with knowledge of their returns. Six were quantitative managers, who use mathematical models for some or all of their trades.

The highest returns were reported by managers who, unlike quants, use fundamental research to make investment decisions.

• DNA: FMP returns can be negative, too
  

. . . investors would do well to understand that, by virtue of being market-linked, there is a possibility of debt investments going negative intermittently. There could be phases when investors could find the net asset value (NAV) of their FMP investments dipping over a day or a week.

Debt instruments, and by extension debt funds and FMPs, are prone to a downturn, particularly when there is pessimistic news on the economic front (i.e. inflation, interest rates among other factors).

• Morgan Stanley Global Economic Forum: Food Inflation Risks Rising Again
  

After remaining stable for a period of five months, the CRB foodstuff index has shot up again. The index has increased by 4.5% in the last six weeks, taking the pace of year-on-year rise to 23.7% as of December 2007. Global wheat, rice and soybean prices have increased to new highs.

Except edible oil for most other major agricultural items, India is largely self-sufficient, though it has again started importing wheat. However, healthy buffer stock and the government’s efforts to restrict exports have helped in keeping domestic food prices (especially of grains and pulses) insulated so far. Despite this, we believe that, with a lag, some amount of pass-through of higher international prices in domestic food prices would be inevitable.

• Ajay Shah: Combating fees and expenses in fund management

In some situations, Indian customers are incredibly price sensitive. But when it comes to fund management, customers seem to be willing to tolerate very high charges, and accept astonishing levels of non-transparency.

The distributors have a tremendous stranglehold on customers; there is a race to the bottom taking place where the mutual funds which squander the most customer money on the distributor gain market share.

One symptom of the idiocy of what is going on is the bias in favour of churning (customer switching from one scheme to another since the distributor earns a fee at every fresh investment) and the bias in favour of `new fund offerings’ at which point distributors make a killing.

Become a customer of the New Pension System, which is phenomenally low cost, when you get the opportunity.

Amen!

• Bloomberg: India’s Future May Depend on Eggs and Condoms

. . . the cost of reaching out to 80 million children and 10 million pregnant and breast-feeding women with daycare centers, medicines, counseling and nutrition — including eggs for a protein-rich diet — at 300 billion rupees ($7.6 billion) a year. That’s 1 1/2 months of taxes that the government collects from levies on personal incomes and corporate profits.

The fertility rate, which stands at 2.7 children per woman, is likely to miss the government’s target of 2.1 by 2010. And after India hits that rate, the population will still take another 35 years to stabilize.

• Economic Times: Experts forecast $20 bn investment in 2008

The year 2007 is clearly the year that saw the rise of private equity funds. According to those tracking the industry, $13 billion (which is approximately Rs 55,000 crore) was invested in Indian markets in 2007.

“The current momentum would continue and would get bettered. We forecast 2008 to see $20 billion worth investment.”

New sectors like commodity, mining and corporate farming could be looked into by investors. With valuation in sectors like textile and auto components at near bottom, a strong case for bottom fishing in these sectors is not ruled out.

• Sucheta Dalal: Stock-price manipulation, false media and reports on corporate denials

Every listed company now knows that if it refuses to respond to media queries, it leads to a wrong or misleading report in the public domain, which causes needless volatility in stock prices. The management also knows that media reports based on information that is not reported to stock exchanges immediately leads to a verification query from the bourses. Why then is the senior management of these companies “not available for comment”, especially when they respond to official queries with a fair amount of alacrity?

Vivimed Labs responded to a report in a financial daily that it may acquire a firm in Europe saying, “it has nothing to comment on the news item and will make the disclosures to the Exchange as and when things materialise.” Well, as first-level regulators, the stock exchanges are expected to at least write to Vivimed to say that their verification process cannot be dismissed with such an off-hand response bordering on arrogance. But in most cases the exchanges are acting as a post office and false media reports gain currency as the truth.

• Zeal LLC: CRB False Witness

The reason CRB charts are bearing false witness today is because this index’s new custodians radically changed its composition back in July 2005. The CRB’s traditional equal weighting and geometric averaging among its component commodities were trashed. This tenth revision of the CRB created a new version of this index unlike any before in history. I wrote an essay back then explaining all of this.

The unprecedented tenth-revision CRB, or CRBr10, is utterly dominated by energy. Energy comprises 39.0% of this new index compared to 17.6% in the ninth-rev CRB, the CRBr9.

The CCI is really the traditional CRBr9 we are all used to. It was created to preserve the historical ninth-rev CRB interpretation of commodities’ performance in this new CRBr10 era.

• Reuters: RBI approves short selling by foreign funds

The Reserve Bank of India (RBI) on Tuesday said it had given approval to foreign funds to short sell, lend and borrow shares of Indian companies, although domestic stock markets are yet to set a starting date for the new measures.

The central bank said borrowing of shares by FIIs would only be for delivery for short sales, and margins or collateral could only be held in cash.

• SEBI: Waiver of load for direct applications

. . . it has now been decided that no entry load shall be charged for direct applications received by the Asset Management Company (AMC) i.e. applications received through internet, submitted to AMC or collection centre/ Investor Service Centre that are not routed through any distributor/agent/broker.

Yay!

• Business Standard: Chhota-Sensex pitted against mini-Nifty

It’s going to be a battle between ‘Chhota-Sensex’ and mini-Nifty as the country’s two premier stock exchanges, the Bombay Stock Exchange and the National Stock Exchange, introduce mini-contracts on their key equity indices in the derivatives (futures & options) segment from Jan 1, 2008.

. . . at the current level of Nifty, the value of one contract (where the lot size is 50) is above Rs 3 lakh. On a mini-Nifty, it will be Rs 1.22 lakh as the minimum lot size on the new contract is set at 20 by NSE.

Similarly, an investor on the Sensex contract currently pays about Rs 40,000-45,000 as margin per contract (market lot is 25). For mini-Sensex, it will be about Rs 8,000-9,000 (market lot is 5).

• Economist: The uncomfortable rise of the rupee

The RBI already circumscribes the freedom of firms to raise money abroad, and in October the regulator put a freeze on “participatory notes”, an indirect way for foreigners to play the Indian stockmarket.

Might it go further? In the 1990s Chile threw some “sand in the wheels” of international finance by forcing foreign investors to deposit a fraction of their money directed toward the country in an interest-free account. The encaje, as it was called, remains the most fashionable and widely studied experiment in capital controls. It probably helped to deter short-term investments. But the overall volume of inflows did not slow and Chile’s real exchange rate continued to appreciate.

The other Chilean lesson from that period is more orthodox and thus less talked about. The government showed admirable fiscal restraint, which relieved some of the upward pressure on domestic prices, and also left the exchequer with enough money and credibility to cushion the economic downturn when foreign capital eventually turned tail in 1998.

• NY Post: A Gas House Gang
  

Hedge fund billionaire Paul Tudor Jones has partnered with several big Wall Street firms and The New York Mercantile Exchange to form a new electronic venue for trading carbon greenhouse gases and other emissions.

The global carbon market is already about $30 billion and some analysts estimate that it could grow into a $3 trillion market over the next 20 years.

• Always On: The AO Top Dealmakers ‘07

Institutional Public Investors
Asset management firms of all stripes (mutual funds, hedge funds, etc.) fall into this category. Besides investing in technology stocks, they may also become limited partners in private equity firm funds.
1 Fidelity Management & Research
2 T. Rowe Price Associates, Inc.
3 Wellington Management Co. LLP
4 Capital Research & Management Co.
5 AllianceBernstein LP
6 Capital Guardian Trust Co.
7 Vanguard Group, Inc.
8 Gilder, Gagnon, Howe & Co. LLC
9 Goldman Sachs Asset Management LP (US)
10 Wells Capital Management, Inc.

• Economic Times: Cos cut new forex deals to hide derivative losses

Many firms, which have taken a hit as euro and yen rose against the dollar, are today entering into offsetting transactions in an attempt to neutralise the original deals.

These original deals, as ET had recently reported, were derivatives contacts with banks where corporates had bet that euro will weaken (or, at least not rise too quickly) against the dollar.

. . . it’s the mark-to-market (m2m) clause that swings the fortunes in a derivatives trade.a

Hmm. So it’s like buying a stock, finding that it dropped a lot & you have unbooked losses, and deciding to short it so you can offset paper profits against real losses. New corporate finance policy: ‘hope & pray’.

• Mint: New company law regime may put M&As on fast track
  

The extent of the activity can be gauged from the fact that there were 339 M&A deals with a total value of about Rs1.76 trillion during the first six months of 2007 against 480 deals of about Rs80,000 crore in all of 2006.

One of the important dimensions on M&A is the intent to have the merger applications heard by the National Company Law Tribunal (NCLT), as distinct from the high court, which is the position today.

Ah, to be an I-Banker in India!

• Business Standard: Building blocks

Infrastructure is the biggest opportunity today in India backed by the monetary allocation of about $500 billion in current Five Year Plan. This opportunity will cascade down to every player operating in infrastructure space, which will further require a lot of ancillary activities to support the main infrastructure activity.

• Bloomberg: JPMorgan, Deutsche Bank Keep Mum on Indian Intellectual Capital
  

Wall Street’s plight is India’s opportunity, just as software companies, computer service providers and generic drug makers have discovered in their industries.

Amba, which is based in New York and has about half of its 550 employees in Bangalore, says it’s even testing strategies and models for quantitative hedge funds. For other hedge fund clients, Amba does everything except give advice on the size and timing of an investment.

• Prudent Bear: Regulatory Debauchery, by Satyajit Das

The US central bank’s strategy is clear. The current credit problems require a substantial reduction in the level of borrowings and leverage in the global financial system. Asset prices ramped up by excessive debt need to adjust. The adjustment can take place via a “crash”. This would be de-stabilizing and would wreak further havoc on already weakened banks. Alternatively, the de-leveraging and price adjustment can be achieved by creating inflation through loose monetary policy. If asset prices remain at current levels, higher inflation allows values to fall in real terms. Higher inflation also reduces the value of the borrowings that must be paid back allowing the required reduction in leverage.

• Economic Times: Flexible models help PMS cos beat mutual funds

PMS providers follow the more advanced models such as CPPI (constant proportion portfolio insurance) or DPI (dynamic portfolio insurance), while regulations require mutual funds to follow the basic ‘static-hedge’ model.

In the static hedge model, the fund manager allocates a pre-determined percentage of the portfolio to debt instruments to the extent that their value is equal to the investor’s capital. The rest of the portfolio is invested in the riskier equity instruments for boosting returns.

The CPPI model, which most PMS providers follow, is based on the static model, but allows rebalancing of portfolios with higher percentage of equity allocation, as per pre-determined metrics. Accordingly, PMS providers invest most of the money in shares and move swiftly to debt instruments, when markets fall and the value of the portfolio falls below a pre-determined level.

• Business Standard: Good for capital gains

Most of these companies have an order book to sales ratio in the range of 2.5-4 times FY07 revenue. This implies that for the next two-to-three years, even if the companies do not get fresh orders, they can still maintain revenue growth of 30-40 per cent.

Capital formation, which was about 25 per cent of GDP in year 2000, has now gone to over 30 per cent. And if the economy keeps this pace, capital formation has to grow faster to support the growth. In the case of China, capital formation was just 23 per cent to the GDP in 1990, and is over 45 per cent, at present.

• Economic Times: Frenzy in capital goods stocks baffles experts

According to analysts, L&T is trading at over 45 times 2008-09 estimated earnings, BHEL at over 30 times 2008-09 estimated earnings and ABB at roughly 34 times 2008-09 estimated earnings. The 30-share Sensex trades at 20-21 times 2008-09 estimated earnings.

Also, no fund manager can afford not to have these stocks in their portfolio, which have risen 125-250% in the past year.

This time, it’s different!

• Sucheta Dalal: True lies

On 12th October, The Financial Express carried a front-page report saying that Jai Corp Limited, whose stock is on fire, plans to “raise Rs 40,000 crore through its wholly-owned subsidiary, Urban Infrastructure Venture Capital (Pvt) Ltd.” In a report packed with details, it also said that Rs22,000 crore of this sum was committed for investment in 12 cities. There was a rare quote from the reclusive director Anand Jain saying: “The UIVCPL is Indian advisor to Urban Infrastructure Real Estate Fund (UIREF), a Mauritius-based offshore fund for investing in the Indian real estate sector.” Yet, when the bourses verified the report, Jai Corp said, “The contents of the aforesaid article are categorically denied by us. As on date, Jai Corp has invested Rs0.50 crore in Urban Infrastructure Venture Capital Pvt. Ltd and not in any individual city as is made out in the article.”

• IHT: When risk becomes a shell game

American made subprime loans and sold them to special purpose entities it set up. Those entities, in turn, financed themselves by borrowing, mostly through the short-term commercial paper market.

To reassure investors, the special purpose entities entered into swap agreements with Bank of America and other big banks, in which the banks promised to make up the difference if the loans had to be sold and fetched less than par value. The chances of such a sale presumably seemed slight when the deal was made in 2004, but lots of unexpected things are cropping up these days.

Packages of mortgages that were classified as performing - meaning the homeowner is mailing in a check every month - sold for as little as 80 percent of face value, and none went for more than 92 percent. The nonperforming loans sold in a range of 54 percent to 59 percent.

• FT: The pseudo-science hurting markets

We learn from crisis to crisis that MPT (Modern Portfolio Theory) has the empirical and scientific validity of astrology (without the aesthetics), yet the lessons are ignored in what is taught to 150,000 business school students worldwide.

The environment in financial economics is reminiscent of medieval medicine, which refused to incorporate the observations and experiences of the plebeian barbers and surgeons. Medicine used to kill more patients than it saved – just as financial economics endangers the system by creating, not reducing, risk.

• Merrill Lynch: 1980s Redux?

The late 1980s was a cycle characterized by a synchronized global expansion, but in the context of a fatigued US economy and strength back then in Europe and Asia. Back then, the Asian stock market that caught everyone’s attention was Japan – today it is China.

If the lesson of the last housing cycle is any indication, it could be years before the next housing bull market takes hold. If bargain hunters have anything on their side, it’s time.

• Bloomberg: Smart Money in India Rides on Small Companies

For those who want to benefit from a decade or two of India’s rapid economic transformation, it might be far more rewarding to invest in 10 unknown companies and see one of them make it to the benchmark in 10 years.

. . . combing the universe of 22,000 for-profit organizations — companies, partnerships and family- owned businesses — out of which at least 5,500 are “diamonds in the rough” . . .

• Economic Times: RBI calls for curbs on PN, PE inflows

RBI has called for a ban on incremental or fresh issuance of participatory notes (PNs) to overseas investors by foreign institutional investors (FIIs), tightening of due diligence norms for issuance of PNs, and some controls on other forms of capital such as private equity . . .

The share of PNs in overall portfolio inflows as a percentage of total foreign portfolio flows rose from 32% late last year to 42% at the end of March ‘07, according to data maintained by the regulators. One estimate is that incremental PNs in July and August could aggregate to 70% of total inflows.

Killing the golden goose?

• Hindu Business Line: Registration must for investment advisers: SEBI draft

SEBI has suggested that registration be mandatory for all investment advisers, in its draft norms. It has framed draft SEBI (Investment Advisers) Regulations, 2007, which is placed in public domain for comments and suggestions.

The SEBI draft is here. Besides what Deepak said, all I would add is that in my posts on portfolio management services, I’ve constantly lamented the lack of performance disclosure on their part. If investors get access to this one thing, the SEBI proposal will have paid off.