GalaTime

NSE Circular: Change in Index computation methodology of S&P CNX Nifty

With effect from June 26, 2009, the S&P CNX Nifty Index will be calculated using free float market capitalization methodology.

The free float factor (Investible Weight Factor – IWF) for each company in the  index will be determined based on the public shareholding of the companies as disclosed in the shareholding pattern submitted to the stock exchanges by these companies. Further, the following categories would also be excluded from the free float factor where identifiable separately:

• Government holding in the capacity of strategic investor
• Shares held by promoters through ADR/GDRs.
• Strategic stakes by corporate bodies
• Investments under FDI category
• Equity held by associate/group companies (cross-holdings)

The same applies for the S&P CNX Defty and the CNX 100 indices.

Note that theBSE did this for the Sensex way back in September 2003.

“Though in the short-term fund managers would have to incur additional costs to realign their portfolios with the index, a free-float method is considered the best practice in index construction globally.”

Also, a free-float index reflects market movements better and supports passive investment styles because it is easily replicable. Further, it also avoids the undue influence of any closely-held large-capitalisation stock on the index movements.

Will this further improve the prospects of index ETFs such as those offered by Benchmark?

Will it also provide short-term trading opportunities as instituitional investors re-align their index funds to match the ‘free float’ weightages?

Will it significantly reduce the chances of manipulation and volatility in some stocks?

Will it shift the sectoral composition of the indices?

Will it result in short-term capital gains  and hence tax liabilities - for the index funds?

Last, but not the least - will it make historical index data meaningless? If the NSE does not provide a re-computed historical dataset using the ‘free float’ methodology, should we backtest trading systems for the Nifty?

• Nature: Do nations go to war over water?

Yet the myth of water wars persists. Climate change, we are told, will cause water shortages. The Intergovernmental Panel on Climate Change estimates that up to 2 billion people may be at risk from increasing water stress by the 2050s, and that this number could rise to 3.2 billion by the 2080s⁷.

Water management will need to adapt. But the mechanisms of trade, international agreements and economic development that currently ease water shortages will persist. Researchers, such as Aaron Wolf at Oregon State University, Corvallis, and Nils Petter Gleditsch at the International Peace Research Institute in Oslo, point out that predictions of armed conflict come from the media and from popular, non-peer-reviewed work.

Nations may not, but communities definitely will.

• Capital Ideas: Uncertainty principle in the market (HT: Arjun)

Soros: Heisen­berg’s Uncertainty Principle is concerned with statistical probability. It cannot determine the behavior of specific particles, but it has pro­duced remarkably reliable estimates of the probability of certain kinds of behavior. By contrast, my interest is in the course of specific events. As an investor, I find statistical probability of limited value; what matters is what happens in a particular case. The same applies with even greater force to historic events. I cannot make reliable pre­dictions about them; all I can do is formulate scenarios. I can then compare the actual course of events with the hypothetical ones. Such hypotheses have no scientific validity, but they have considerable practical utility. They provide a basis for real-life decisions. I am not able to predict the course of events in accordance with uni­versally valid generalizations, but I can devise a general framework that helps me to anticipate and adjust my expectations in the light of experience.

• The Chronicle Review: The Roar of the Crowd

Marx was wrong: The opiate of the masses isn’t religion, but spectator sports. What else explains the astounding fact that millions of seemingly intelligent human beings feel that the athletic exertions of total strangers are somehow consequential for themselves?

Maybe it is time to rework Andy Warhol’s observation that in the future, everyone will be famous for 15 minutes: Thanks to spectator sports, each of us can know fame for most of our lives, so long as we are satisfied with the ever-shifting, warmed-over shadow of someone else’s.

Spectator sports offer quick and easy entree into an instant community. Never mind that it is ersatz. It is there for the joining; no need to “make the team.” Instead, just buy a ticket, a T-shirt, or turn on the television or radio.

Thus the popularity of IPL.

This quote from a DNA article sums up the situation well: “Like in politics, there are no permanent enemies or permanent friends in the stock exchange business.”

The fight between NSE and Financial Technologies (FT) has been public for quite a while: in brief, the NSE put FT on its watch-list claiming issues with FT’s software; while FT claimed that this was just NSE’s way to deal with competition from MCX (in which FT owns a big stake).

With that background, consider these two recent developments:

DNA: Next: BOLT from BSE on NSE NOW!

Faced with a threat from Financial Technologies and its upcoming stock exchange, the two leading stock exchanges in the country — the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) — have decided to join hands.

Call it the NBA-NSE-BSE Alliance. To begin with, BSE’s online trading platform (BOLT) will soon be available on NSE’s in-house software Neat-on-Web (NOW). Traders using this platform will get access to over 7,000 stocks listed on the BSE.

Mint: BSE, MCX in alliance talks; may consider cross-holding

The Bombay Stock Exchange Ltd (BSE), Asia’s oldest bourse, is discussing a possible alliance with Multi Commodity Exchange of India Ltd (MCX) to boost its declining market share and sharpen its competitive edge.

India’s largest commodity exchange MCX and its promoter Financial Technologies India Ltd will help the 133 year-old BSE-run equity futures and options trading and the recently introduced currency derivatives. The two exchanges may even consider taking equity stakes in each other.

What gives? The BSE & NSE team up to compete with FT & MCX. But then, the BSE and FT are supposedly warming up to each other. Is this all media speculation? Imagine a third announcement saying that the NSE and FT have settled their differences amicably and will jointly boost the corporate debt market in India.

Are they in fact one big, happy family looking to create/retain a near-monopoly in Indian capital markets? After all, the exchanges pay their management well - why get into mudslinging when you have a lucrative game going? As someone said - ‘the house always wins’.

There’s no shortage of commentary on the ridiculous bailouts of banks, the obscene bonuses handed out in the financial industry and the moral / ethical bankruptcy in Wall Street, excuse the pun.

Umair Haque adds his two cents to the topic: The Bailout We Need

“Have they no shame, have they no sense of responsibility to American taxpayers? . . . Have they no sense of decency?”

Oh, the humanity. Of course they don’t; if they did, they would have found “banking” repugnant in the first place.

Today’s banks and businesses have given rise to a kind of adverse mega-selection: they select and empower the worst and dumbest among us.

Yes, you read that right. No, investment banks quants weren’t the brightest. As Nassim Taleb has pointed out, the models they built relied on statistics flawed at the most basic logical level.

The worst and dumbest. And, what’s perhaps worse, the guys supposed to be reining them in are drinking the banking lobby’s snake oil, hook, line, and sinker.

No punches pulled, thank you very much.

But that is how today’s financial industry is - like it or not. Whether it’s New York, London or Mumbai - when the downsides are limited (non-existent?) and the upside huge, all it takes is a slightly loose moral code and off you go into the money ‘management’ business.

From there on, it’s a vicious cycle of 2 and 20 -> AUM / OPM -> Big bonuses & expensive lifestyles -> 2 and 20, … Meanwhile, the regulators are ‘managed’, as is the government, the media and the public.

As for India, look no further than the latest piece from Le Grand Fromage @ First Global: The Azhar Syndrome

Exposure to real estate alone was 175% of Net Worth for ICICI Bank, 180% for Axis Bank and 88% for HDFC Bank…and this was after the serial fund-raisings by all of them..…plus there was significant exposure to other cyclicals like steel, textiles, et al.

Unsecured loans were (and probably still are) are between 112-165% of tangible networth.

Total Sensitive Sector exposure + Unsecured lending, of these banks is: 305% of Tangible Net Worth for ICICI Bank; Axis Bank has the same ratio at 316% of Tangible Net Worth; and HDFC Bank, 292% of Tangible Net Worth.

Whoa. Anyone still think the credit crisis and bad lending practices won’t affect India?

What happened? Just a case of MBAs, private bankers & promoters gone wild. Growth at any cost. NPAs - what’s that? Overvalued - of course not. Leverage - now that’s a beautiful thing. Profitability - haha!

It’s all about the Indian growth story, baby. (And how much I can milk it for.)

• Business Standard: 59% stocks on BSE are illiquid

Over 59 per cent of stocks traded on the Bombay Stock Exchange (BSE) and 22 per cent of stocks traded on the National Stock Exchange (NSE) have been identified as illiquid by the exchanges based on their trading activity during June 2008.

The monthly turnover on BSE and NSE in these stocks has plummeted sharply from over Rs 6,000 crore in January 2008 to Rs 2,950 crore in March 2008 and to Rs 562 crore in June 2008.

This is a head-ache for brokers, hedge funds and system traders (like us)!

• BCA Research: U.S. Dollar: Next Carry Trade Financing Vehicle?

• Prudent Bear: Voodoo Banking

Clients often sought “alignment” of interests requiring banks to take risk positions in transactions. This evolved into the “principal” business as banks increasingly made high risk investment in transactions. In some banks, this evolved into a model where the bank acted purely as “principal” rolling back the clock to the days of J.P. Morgan. Banks convinced themselves of the strategy on the basis that the risks were acceptable (it was their deal after all!), the risk could be always sold off at a price (market were liquid) and (the real reason) high returns.

Banks have sold risky assets where the seller has provided the buyer with favourable terms. Banks have sold leveraged loans on the basis that the bank lends the buyers 75-80% of the price at below market rates. Sellers have given undertakings that if future asset sales are at lower prices than that paid by the buyer then the seller will compensate the purchaser. These provisions have allowed banks to sell assets at prices that avoid the need to further mark down its positions. This creates uncertainty about the value of bank assets. Further write-downs in asset values cannot be discounted.

• Economic Times: PSEs free to park funds in any MFs

The government has allowed CPSEs to park 30% of their cash surplus either in equity or debt instruments or money market mutual funds.

Taken together these companies own about Rs 4 lakh crore in surplus funds. This means with proper investment plans about Rs 1.33 lakh crore can come in to the kitty of mutual funds soon. Companies like ONGC and BSNL have shown their interest in investing their money in mutual funds and have already submitted the plans to the nodal ministries.

• Financial Express: MFs accumulate Rs 20,000 cr cash for deployment

MFs are sitting on Rs 23,545 crore of cash that is waiting to be deployed in the market. Of this Rs 19,214 crore lies with existing MFs, while the remaining Rs 4,331 crore has been mobilised through the NFOs.

Out of the entire mutual funds industry, diversified equity funds were having cash of Rs 7,859 crore (8.64 per cent of the total assets) at the end of March against Rs 4,773 crore (4.46 per cent of total assets) in January 2008.

• NY Times: Debt Collection Done From India Appeals to U.S. Agencies

Americans are used to receiving calls from India for insurance claims and credit card sales. But debt collection represents a growing business for outsourcing companies, especially as the American economy slows and its consumers struggle to pay for their purchases.

Encore pays its collectors in India an average base salary of 17,000 rupees ($425) a month, and they earn bonuses — sometimes more than $1,000 a month — for getting customers to pay. In contrast, collectors in the United States, make about $6,500 a month.

• Business Standard: Time for a U-turn

Public sector banks, which were quoting in the range of 1.5-2.5 times one-year forward price-to-book value before the market mayhem, are now quoting between 1-1.5 times. Similarly, for private banks, the valuation has fallen from 4.5-6 times to 2.5-3.5 times.

Credit growth has slowed down from over 30 per cent last year to about 22 per cent as on March 28 – below RBI’s expectations of 24-25 per cent in FY08.

The March 2008 quarter is expected to be comparatively weak, due to a host of issues like slowing credit growth, higher deposit rates, mark-to-market hit on bond portfolio affecting trading profits among others. The net interest income and operating profit of public sector banks is expected to grow in single digits year-on-year; the best case scenario is a 15 per cent growth while some banks may also see a decline. Net profit is likely to grow in the same range.

• Mint: Institutional investors expect a slow start to short-selling
  

Short-selling for institutional investors as well as a securities lending and borrowing (SLB) mechanism becomes operational this week, but experts say institutional investors will be preoccupied with the other measure that will be implemented on Monday—the imposition of margins for all institutional trades in the cash market.

The capital market regulator has now stipulated that even cash trades by institutional investors will be margined, just as they are in the case of retail participants. To start with, margins would have to be paid a day after the trade, and from 16 June, margins would have to be paid up front like by any other investor. These requirements are likely to take centre-stage this week.

• Hindu Business Line: Volatile equity markets make structured products attractive

Structured products are good for customers unwilling to take high risks. The minimum amount for investing in such structured products is about Rs 10 lakh and the maturity period is usually three to five years.

These are in the form of non-convertible debentures and listed on the NSE, governed by SEBI guidelines.

Assuming that the product is linked to Nifty, the issuer may promise that if the Nifty gives 100 per cent returns, then the structured product will give 105 per cent. To ensure this, the issuer invests part of the money in risk-free fixed deposit.

The balance will be invested in equities or other high-return instruments. The capital can be protected from the portion invested in the fixed deposit, even if the market falls. In the normal circumstances, the investor in any case will get higher returns — the interest from the fixed deposit plus returns from the equity.