If you belong to the 98 per cent of MBA aspirants who fail to make it to a Top 10 B-school, it's not the end of the world. You have options, but you need to be careful and realistic in selecting a 'next best B-school'. Although there is no foolproof formula that can be applied to weigh one institute against another, here are some guidelines that should help you reach a rational and well-informed decision.
Placement StatisticsCurriculum, infrastructure and faculty don't count if the placement scene on campus sucks. Look up the 'placement' and 'validation' scores provided in the Cosmode-BW rankings (See page 84). Additionally, check for these signs of placement health on individual B-school websites and through informal channels (seniors, friends, friends of friends... word of mouth rules here!):
List ke peeche kya hai: Many institutes claim that X, Y and Z companies recruit their students. The important thing to ask is: do these companies come officially for campus placement? Students at lowly-ranked institutes often secure a summer or final placement at prestigious firms through their own efforts or contacts. The B-school claim may thus be technically correct but of little use to you, as you won't get a fair chance to try for the same job.
It's not over till it's over: The best institutes rarely take more than 2-3 days to place their students. The good ones will at least specify a 'placement week' or fortnight. If, months after the 2004 class has graduated, the institute cannot provide detailed placement statistics, you need to be aware that a job may come your way only through jugaad.
Open sesame: Watch out for vague statements like 'the following companies have recruited our students in the past'. (Why in the past, why not this year?) Institutes that lack proper placements usually beat around the bush on details like percentage of students placed, average salary, and so on.
The job profile: Even if a well-known company does officially visit a less-known campus, you need to check on one important fact - it might actually be offering a lower designation/package than on a premier campus. So while an IIM graduate might join the organisation as 'management trainee', you might be offered 'executive trainee'. That's not such a good thing after all!
Batch size: Even brand name B-schools find it hard to find great jobs for the tail end of the batch. Lower down, you can be sure the problem is worse. A batch size of 150 or 200-plus is definitely not a good sign, although at an individual level you can try and balance that out - aim to be in the top 10 per cent of your class!
Residential Rules!An MBA is more than a course of study. It's often described as a 'life-changing experience' with a good deal of that learning and growth taking place outside the classroom. A fully-residential programme is preferable to the day-scholar route, unless cost is an issue. The bonding in residential schools is much higher - giving you a networking advantage in the future. Besides, it's definitely a lot more fun!
The MBA caste systemThere's a definite hierarchy in the world of the MBA, and it looks suspiciously like our Indian caste system.The brahmins ('thinkers') : The consultants and investment bankers who are paid fancy sums to recite strategy mantras and perform restructuring havans. The kshatriyas ('leaders') : The managers who spearhead multinational brands, profit centres and teams in the business battlefield. The vaishyas ('traders') : The sales, systems and operations guys - those MBAs who actually oil the wheels of commerce.The shudras ('untouchables') : MBAs from little-known B-schools who take up jobs in little-known companies their more fortunate brethren would never touch!
Cost FactorLook at the input (money spent) and output (job expected) when making a decision between two B-Schools. If there's not much else which separates the two, how much you spend on your education could definitely be a deciding factor.
LocationB-Schools located in towns with hardly any industry are a no-no. Companies from other cities are unlikely to take the trouble of visiting a little-known campus. Also, you'll be handicapped by distance if you try to look for a job on your own.
LeadershipIf an institute boasts of a director who has earlier taught/ served as head of a top B-school, it's definitely a good sign. A well-connected and well-respected director can make all the difference when it comes to attracting good faculty and companies for placement.
FREQUENTLY ASKED QUESTIONS
Should I try for IIMs again?
Yes, if...
You got one or more interview calls from the Top 10 B-schools.
You scored somewhere above the 95th percentile and believe you can improve in your weak areas through due diligence.
You have two or more years of work experience. Only top B-schools will give you a chance at lateral placements. The other best bet for 'work ex' types is to take the GMAT and apply abroad, or to ISB.
No, if...
Your CAT score was pretty low - chances of it taking a quantum leap next time round are negligible.
You aren't the premier engineering school or general academic topper type who generally make it to the IIMs.
Time is not on your side (you are a girl facing pressure at home to get married - in that case better take what you get and do the MBA right after graduation).
Should I take up a job/join another institute offering admission and study for CAT side by side?Working is advisable as long as the job leaves you with some time for CAT prep. You could join another B-school and make your second CAT attempt, but keep in mind that chances of success are slim. So make sure you are reasonably satisfied with what you have in hand!
I am working. Should I do a part-time/distance-learning MBA programme?If you're taking it up in the hope of immediate professional enhancement, the short and cruel answer is no! (Unless your company is encouraging/sponsoring you to do so.) A part-time/distance-learning MBA might add to your own sense of confidence, and enhance your CV in the long run, but sadly, only a full-time MBA from a known institute gives you instant access to the corporate elevator. The rest have to huff and puff up the stairs.
Beyond The HypeAwareness and 'brand equity' are two completely different things. An institution's reputation is silently and intangibly built over the years; weekly full-page ads do not necessarily make a good school. Many institutes that do not advertise (except for their admission notices) are definitely worth considering over and above those that blow their trumpet loudly.
Brand ExtensionsSome B-schools have branches in multiple locations. If you are attending such an institute, join in the city where the B-school was born. The 'mother brand' will generally have better placements, infrastructure et al than the rest.One last bit of advice: when the time comes to choose between three or four schools which have offered you admission, nothing can beat actually visiting these campuses to get the true picture. Spending a few thousands now is better than spending a few lakhs later on a B-school which fails to meet basic expectations. You wouldn't buy a car without a test drive, so why not take the same trouble while making a life-long investment in an MBA?
Thursday, January 17, 2008
Monday, January 7, 2008
Short Selling....
What is Short Selling
Traditionally the premise of investing is that you buy an asset and hold it
until it rises enough to make a sizable profit, it doesn't get much easier than
that. What about the times you come across a stock that you wouldn't
invest a penny in, you know that stock is doomed, a sure loser. If you
knew that the stock was going to decline wouldn't be nice to be able to
profit from its decline. Well you can profit from the decline of a stock
and although it sounds easy, there are substantial risks and pitfalls
that you need to watch out for. The mechanics of a short sale are
somewhat complicated and the investor's risks are high so it is important
that you understand the transaction before getting into it.What does it
mean to sell short?If you sell a stock you don't own, you are selling short.
(Yes, it's legal.) You are now short the stock.A short seller sells a stock
that he believes will fall in value. A short seller does not own the stock
before he sells it. Instead, he borrows it from someone who already owns it.
Later, the short seller buys back the stock he shorted and returns the
stock to close out the loan. If the stock has fallen in price since he sold
short, he can buy the stock back for less than he received for selling it.
The difference is his profit.Short selling allows investors to profit from
falling stock prices. "Buy low, sell high" is the goal of both short selling
and purchasing shares ("going long"). A short sale reverses the order
of a typical stock purchase: the stock is sold first and bought later.For
example, in March 2002, Andy thinks HLL is overvalued. He sells short
100 shares of HLL at Rs. 250 per share. The stock market crashes in
April and HLL's share price falls to Rs. 210 per share. Andy buys back
100 shares of HLL and closes out the short sale. Andy gains the difference
between the sales proceeds and the purchase costs and pockets Rs. 4,000
from the short sale, excluding transaction costs.Where Does The Broker
Get The Stock?The short answer is from other customers or the Stock
Holding Corp. of India.Short selling is a marginable transaction. In plain English,
that means you must open a margin account to sell short. This is the
same account you would use if you want to use your stocks as collateral
margin to trade in the markets.When you open a margin account, you
must sign an agreement with your broker. This agreement says you will
maintain a cash margin or pledge your stocks as margin.How Do I Sell
Short?Unlike a stock purchase transaction, which involves two parties
(the buyer and the seller), short selling involves three parties: the original owner,
the short seller, and the new buyer. The short seller borrows shares
from the original owner, and immediately sells them on the open market
to any willing buyer. To finalize ("close out") the short sale transaction,
the short seller must then go out into the stock market and buy the same
amount of shares as he sold so that the broker can return them to the
original owner.To sell short you first must set up a margin account with
your broker. A margin account allows you borrow from your brokerage
company using the value of your portfolio as collateral. The general rule is
that the value of your portfolio must equal at least 50% of the size of the
short sale transaction. In other words, If you have Rs. 100,000 worth of
stock/cash in your margin account, you can borrow Rs. 200,000 of stock
to sell short.To sell a stock short, you must borrow stock. To initiate a shor
t sale, you simply call up your broker and ask to sell short a specific number
of shares of your selected stock. Your broker then checks with the Margin
Department to see whether the shares are available or can be borrowed.
If they are available, the brokerage borrows the shares, sells them in the
open market, and puts the proceeds into your margin account. To close
out your short sale, you tell your broker that you want to buy the same
number of shares that you shorted. The broker will purchase the shares
for you using the money in your margin account, return the shares and
close out the short sale transaction.While your short sale is outstanding,
your account will be charged interest against the value of the short position.
If the stock you shorted goes up in price, or the value of the stock you are
using as collateral goes down in price, so that your collateral is less than
the "maintenance" requirement you will be required to add money to your
margin account or buy back the stock that you sold short. You must also
pay any dividends issued by the company whose stock you sold short.Why
Sell Short?The two primary reasons for selling short are opportunism and
portfolio protection. Occasionally investors see a stock that they believe
has been hyped to a ridiculously high level. They believe that the stock
price will fall when reality replaces the hype. A short sale provides the
opportunity to profit from the overpriced stock. Short sales are also used
to protect an investor's portfolio against a market downturn. By shorting
stocks that the investor believes will fall sharply when the market as a whole
falls, investors can help insulate the value of their portfolios against sudden
market drops.Short selling is also used to protect portfolios against erosion
due to a broad market decline. Short sellers make money when stock prices
fall. An investor can diversify a long portfolio by adding some short positions.
The portfolio will then have positions that make money both when prices rise
and when they fall. This reduces the volatility in the portfolio's returns and
helps protect the value of the portfolio when prices are falling.By shorting
carefully selected stocks that are priced near their peak but that will fall sharply
if the market falls, an investor can use the profits from the short sales to help
offset losses in his long position to protect the value of his portfolio.Short
selling just like long buying is essential for proper functioning of the stock
market. It provides essential liquidity which in turn leads to proper price discovery.
Traditionally the premise of investing is that you buy an asset and hold it
until it rises enough to make a sizable profit, it doesn't get much easier than
that. What about the times you come across a stock that you wouldn't
invest a penny in, you know that stock is doomed, a sure loser. If you
knew that the stock was going to decline wouldn't be nice to be able to
profit from its decline. Well you can profit from the decline of a stock
and although it sounds easy, there are substantial risks and pitfalls
that you need to watch out for. The mechanics of a short sale are
somewhat complicated and the investor's risks are high so it is important
that you understand the transaction before getting into it.What does it
mean to sell short?If you sell a stock you don't own, you are selling short.
(Yes, it's legal.) You are now short the stock.A short seller sells a stock
that he believes will fall in value. A short seller does not own the stock
before he sells it. Instead, he borrows it from someone who already owns it.
Later, the short seller buys back the stock he shorted and returns the
stock to close out the loan. If the stock has fallen in price since he sold
short, he can buy the stock back for less than he received for selling it.
The difference is his profit.Short selling allows investors to profit from
falling stock prices. "Buy low, sell high" is the goal of both short selling
and purchasing shares ("going long"). A short sale reverses the order
of a typical stock purchase: the stock is sold first and bought later.For
example, in March 2002, Andy thinks HLL is overvalued. He sells short
100 shares of HLL at Rs. 250 per share. The stock market crashes in
April and HLL's share price falls to Rs. 210 per share. Andy buys back
100 shares of HLL and closes out the short sale. Andy gains the difference
between the sales proceeds and the purchase costs and pockets Rs. 4,000
from the short sale, excluding transaction costs.Where Does The Broker
Get The Stock?The short answer is from other customers or the Stock
Holding Corp. of India.Short selling is a marginable transaction. In plain English,
that means you must open a margin account to sell short. This is the
same account you would use if you want to use your stocks as collateral
margin to trade in the markets.When you open a margin account, you
must sign an agreement with your broker. This agreement says you will
maintain a cash margin or pledge your stocks as margin.How Do I Sell
Short?Unlike a stock purchase transaction, which involves two parties
(the buyer and the seller), short selling involves three parties: the original owner,
the short seller, and the new buyer. The short seller borrows shares
from the original owner, and immediately sells them on the open market
to any willing buyer. To finalize ("close out") the short sale transaction,
the short seller must then go out into the stock market and buy the same
amount of shares as he sold so that the broker can return them to the
original owner.To sell short you first must set up a margin account with
your broker. A margin account allows you borrow from your brokerage
company using the value of your portfolio as collateral. The general rule is
that the value of your portfolio must equal at least 50% of the size of the
short sale transaction. In other words, If you have Rs. 100,000 worth of
stock/cash in your margin account, you can borrow Rs. 200,000 of stock
to sell short.To sell a stock short, you must borrow stock. To initiate a shor
t sale, you simply call up your broker and ask to sell short a specific number
of shares of your selected stock. Your broker then checks with the Margin
Department to see whether the shares are available or can be borrowed.
If they are available, the brokerage borrows the shares, sells them in the
open market, and puts the proceeds into your margin account. To close
out your short sale, you tell your broker that you want to buy the same
number of shares that you shorted. The broker will purchase the shares
for you using the money in your margin account, return the shares and
close out the short sale transaction.While your short sale is outstanding,
your account will be charged interest against the value of the short position.
If the stock you shorted goes up in price, or the value of the stock you are
using as collateral goes down in price, so that your collateral is less than
the "maintenance" requirement you will be required to add money to your
margin account or buy back the stock that you sold short. You must also
pay any dividends issued by the company whose stock you sold short.Why
Sell Short?The two primary reasons for selling short are opportunism and
portfolio protection. Occasionally investors see a stock that they believe
has been hyped to a ridiculously high level. They believe that the stock
price will fall when reality replaces the hype. A short sale provides the
opportunity to profit from the overpriced stock. Short sales are also used
to protect an investor's portfolio against a market downturn. By shorting
stocks that the investor believes will fall sharply when the market as a whole
falls, investors can help insulate the value of their portfolios against sudden
market drops.Short selling is also used to protect portfolios against erosion
due to a broad market decline. Short sellers make money when stock prices
fall. An investor can diversify a long portfolio by adding some short positions.
The portfolio will then have positions that make money both when prices rise
and when they fall. This reduces the volatility in the portfolio's returns and
helps protect the value of the portfolio when prices are falling.By shorting
carefully selected stocks that are priced near their peak but that will fall sharply
if the market falls, an investor can use the profits from the short sales to help
offset losses in his long position to protect the value of his portfolio.Short
selling just like long buying is essential for proper functioning of the stock
market. It provides essential liquidity which in turn leads to proper price discovery.
P
Why Participatory Notes are dangerous ?
Participatory Notes (PN), a general name used for the investment
by Foreign Institutional Investors (FIIs) through Offshore Derivative
Instruments (ODIs) such as Participatory Notes, Equity-Linked Notes,
Capped Return Notes and Participating Return Notes, have created
a storm in the stock market, with SEBI coming out with a draft
for discussion to regulate them, the RBI suggesting that they be
phased out, and the Finance Minister assuring that the Government
is not going to phase them out. First things first. Let us clearly
understand the fundamental issues. The PNs are a slap on the face
of every citizen who is an investor. For a person to invest even in
one share, several KYC (know your customer) forms have to be
filled up, and PAN numbers and proof of address, etc., provided.
For the PN investor, the system is totally silent on even elementary
information. The FIIs issue PNs to funds/companies whose identity
is not known to the Indian authorities. Hence, the PN system is
blatantly discriminatory and seems to favour ghost investors.
Any self-respecting market, if it discriminates at all, does so
against outsiders. But we have done the unthinkable. We should
recognise and internalise the fact that funds are in search of
markets, and not the other way. Given the demographic shift
in the developed markets (where pension funds have to locate
markets to get returns for longer periods) and the lack of huge
opportunities in long-term projects, it is natural that global funds
are in search of markets. The PN route, through which a section
of investors is participating in our markets, is a mystery wrapped
in a puzzle, crammed inside a conundrum and delivered through a riddle.
These are address-less funds that could be from dubious sources and the
clamour for it is intriguing, if not outright suspicious. Current Scenario
According
to the SEBI Web site, the current positio According to the SEBI Web site,
the current position of these instruments is as follows: “Currently,
34 FIIs / Sub-accounts issue ODIs. This number was 14 in March 2004.
The notional value of PNs outstanding, which was at Rs 31, 875 crore
(20 per cent of Assets Under Custody of all FIIs/Sub-Accounts) in
March 2004, increased to Rs 3,53,484 crore (51.6 per cent of AUC)
by August 2007. The value of outstanding ODIs, with underlying as
derivatives, currently stands at Rs 1,17,071 crores, which is approximately
30 per cent of total PNs outstanding. The notional value of outstanding
PNs, excluding derivatives as underlying as a percentage of AUC is 34.5
per cent at the end of August 2007.” (SEBI - Paper for Discussion on ODIs).
This implies that more than 50 per cent of the funds are flowing through
this anonymous route which needs a re-think on this entire issue.
This brings us to the question about who are the investors interested in
Indian Papers. Who uses the PN route? The first category is the regular
funds whose twin objectives are returns and more returns on a
21*7*365 basis. They are interested in India since the India story
is very good and returns are attractive compared to developed markets.
The second category is prodigal money returning. It is not a secret that
a large number of politicians/bureaucrats/business-persons have
accumulated wealth abroad. This has been accumulated by
under-invoicing/over-invoicing, by corruption in contracts and gifts
from abroad; and by not bringing in legitimate receipts. The third
category is those foreign governments/entities who would like to
acquire/control Indian entities by taking them over. The fourth
category is the terror financiers who could find this route attractive
and simple. The first category does not have any reason to use the
“anonymous” route since the aim is to earn returns /repatriate and
benefit out of interest rate and currency value arbitrage. They enter
and exit as per these calculations and are not shy ab..
First, what are PNs?
Investopedia.com defines participatory notes as “Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities.”
Brokerages buy India-based securities and then issue participatory notes to foreign investors, it adds. “Any dividends or capital gains collected from the underlying securities go back to the investors.” The kind of people/institutions that can invest in PNs can be found at http://investor.sebi.gov. in/faq.
What is key in the PN definition?
The most important part that needs to be observed in the investopedia.com definition is “investors or hedge funds that are not registered with the Securities and Exchange Board of India”. This is a big deal.
Why?
Imagine you or I try to open a demat or trading account with any firm. When anyone in India tries to open a demat or trading account, they have to give ID proof and address proof. In business it’s known as KYC, or ‘know your client’.
In essence, it means that companies, especially financial entities, should know the ‘character’ of their client. What it means is that they should know whether their client is real or someone with questionable credentials.
How does that apply to PNs?
When PNs are first sold, they are sold to someone SEBI ‘knows’ but then they are sold in the market and they can be, and are, purchased by people/institutions that SEBI does not know about. These people, who can trade them, do not have to register with SEBI or anyone. They can participate in the Indian bourses, using FIIs (foreign institutional investors) as intermediaries; but they are essentially faceless and SEBI will never know who these investors are.
Does that create any problems?
Yes, a problem for the integrity of the Indian bourses. Integrity here not only means honesty but also structural integrity.
Hypothetically, people who are against the success of India can invest large sums in the Indian market and then pull them out all of a sudden, causing mass panic.
Now, this is not to suggest that all the investments coming in through the PN route are ‘shady’ but it does certainly give us food for thought.
Are PNs massive enough to be of concern?
PNs have been exploding in India. SEBI estimates that the total foreign stake in Indian companies in August 2007 was around Rs 6.9 lakh crore, of which Rs 3.53 lakh crore (51.6 per cent of the AUC or ‘assets under custody’) is through PNs. Compared to the outstanding PNs of Rs 31,875 crore (20 per cent of total AUC) in March 2004, this is an amazing 11 times growth.
What accounts for the fast growth of PNs in recent times?
One of the reasons why PNs have grown so rapidly in India is because of the regulations that SEBI has imposed on those who can register as FIIs.
The regulations also exclude hedge funds from becoming FIIs. This means that hedge funds see PNs as a perfect conduit to investing in India. As of now there are 34 FIIs that issue PNs.
Another obvious reason for routing money through PNs is the anonymity it affords. Both the above issues have conspired to drive the massive rise in PNs.
Are there different types of PNs?
There are two kinds of PNs — spot-based, and derivatives/futures-based (also known as ODIs, offshore derivative instruments), meaning that they are based on other underlying instruments. The latter accounts for around 32-33 per cent of all total outstanding PNs.
Why did SEBI have to do what it did?
Now everyone knows that SEBI placed regulations on PNs. But it must also be stated that it resisted doing so for a while.
What happened, in essence, was that it was under considerable pressure from both the RBI (Reserve Bank of India) as well as the Finance Ministry.
Pressure!
The RBI was and is deeply concerned about the rapid appreciation of the rupee caused by huge net FII inflows. The net FII investment in India in 2007 stands at over $12 billion currently. The Finance Ministry was concerned about the galloping stock market. The Sensex went from 18,000 to 19,000 in four trading sessions and the Finance Minister expressed concern over that.
He cautioned that if there was a break in the stock market bubble, it could and would have catastrophic effects on the real economy. Obviously both were justified in forcing SEBI’s hand.
So, the market regulator brought in controls?
That’s right. The changed regulations that SEBI put in place, as you may be aware, were:
FIIs and their sub-accounts shall not issue/renew ODIs with underlying as derivatives with immediate effect. They are required to wind up the current position over 18 months.
Further issuance of ODIs by the sub-accounts of FIIs will be discontinued with immediate effect.
FIIs which are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40 per cent shall be allowed to issue further ODIs only at the incremental rate of 5 per cent of their AUC in India.
Those FIIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40 per cent shall issue PNs only against cancellation/redemption/closing out of the existing PNs of at least equivalent amount.
What next?
That’s the ‘$64,000 question’! We have already seen what will or could have happened. The markets tanked sharply and then rebounded again.
What has fundamentally changed is that it is very unlikely we will see FII inflows the way we have seen them in the past few months. That’s a near given considering that outstanding PNs account for over 51 per cent of foreign money in India. The other fact is that FIIs control most of the floating stock in the bourses.
Do they?
There have been estimates made that show FIIs, including PN-holders, owning around 15-20 per cent of stock of the top 1,000 companies in the bourses. Now consider the promoters; they own over 50 per cent but those shares rarely ever come into the market. That means that the FIIs have had a near ruling of the market. In effect, they control the market because they not only own a chunk of floating shares; they are also the most active.
If you look at the correlation between net FII flows and the market indices, there is a near-perfect positive correlation, suggesting very strongly that FIIs have a tight control on the market, if not a stranglehold.
Will the 18-month Damocles’ sword impact the markets?
Now that PNs with underlying derivatives have to be withdrawn in 18 months, it is likely that there may be some choppy sessions ahead but the volatility should pan out very soon. The volatility should reduce because derivative-based PNs are highly leveraged — something that contributes to volatility.
It should also mean that the hedge funds, which have been fairly responsible for this steep rise in the market, might exit the market because SEBI will never let them register as FIIs.
The RBI can then heave a sigh of relief because the appreciation pressure on the rupee will slacken to a large extent. The Finance Ministry too will heave a sigh of relief because the danger of a full-scale bubble bursting has reduced to a good extent, if not fully.
We had a damage-control exercise a few days ago…?
On October 21, SEBI said that sub-accounts (the mechanism through which FIIs issue PNs) could stay, provided they registered and, in effect, surrendered their anonymity. This is, however, a smart move by SEBI that will likely amount to nothing.
Why so?
SEBI knows that PNs are held by hedge funds and SEBI will not register hedge funds even if they wanted to register. (For starters, Encarta defines ‘hedge fund’ as risk-taking investment company; “an investment company that is organised as a limited partnership and uses high-risk techniques in the hope of making large profits.”)
Is the move against PNs right?
Whether SEBI’s decision to ban PNs was correct or not is a very tricky question. However, at the end of the day, the guiding principle should be whether the decision taken prevented a blow-up of the economy. Everyone will have his or her views but my view is that the decision taken was right. The question is a very philosophical one…
Philosophical? Yes, because it comes right down to the heart of the issue of capital controls. Should the Government ban certain type of flows or should there be no capital controls? On a personal level, I believe that there should be no capital controls but that this ideal should not be placed on such a high pedestal that everything else becomes subservient to it. The only thing that should be placed on a pedestal is the macroeconomic well-being of the economy and everything else should become subservient to it.
Is this what you believe weighed the most, in the PN issue?
Yes. SEBI didn't want to ban PNs for several reasons and this let the markets stretch a bit too far. Economic graveyards are littered with the dead bodies of countries that let their stock markets enter a `bubble zone'; a zone where valuations couldn't possibly be justified by fundamentals. The funny thing about bubbles is that they always burst.
What makes PNs capable of hurting the markets?
The main issue or danger regarding PNs is that they are fairly dominated by hedge funds. These funds have only one objective in mind and that is to make lots of money in a short time. I'm not saying that it's a bad objective because the lord knows everyone of us has that objective. However, the key difference is that hedge funds can move a market to their whims while small investors cannot, so there are times that their objective can run opposite to what the regulators would like.
Does India fit in the scheme of hedge fund thinking? How?
Yes, perfectly. A country like India is ideal for hedge funds. Indian bourses are fairly shallow compared to other bigger bourses and that means a relatively less amount of money can move the market. When FIIs come into India with all guns blazing, it generally means that the markets will swing upward and vice-versa causing a lot of volatility. They are not called hot money for nothing. On a comparative basis, India has a very volatile stock market.
So, should India ban FII money?
I am not suggesting for a second that India should ban FII money. They should be let in but there should also be a leash placed on them. The only thing that should matter to regulators should be the well-being of the economy. And an over-inflated market is not conducive to that ideal.
D. MURALI
http://InterviewsInsights.blogspot.com
Bio: Mr Sunil Rongala, a PhD in economics, is the co-author of `Asia in the Global Economy: Finance, Trade and Investment' (along with Mr Ramkishen S Rajan of George Mason University, US), a book to be released in 2008 (www.worldscibooks.com). Previously the Group Economist in the Chennai-based Murugappa Group, Mr Rongala is currently a research manager in an international partnership firm, in
Participatory Notes (PN), a general name used for the investment
by Foreign Institutional Investors (FIIs) through Offshore Derivative
Instruments (ODIs) such as Participatory Notes, Equity-Linked Notes,
Capped Return Notes and Participating Return Notes, have created
a storm in the stock market, with SEBI coming out with a draft
for discussion to regulate them, the RBI suggesting that they be
phased out, and the Finance Minister assuring that the Government
is not going to phase them out. First things first. Let us clearly
understand the fundamental issues. The PNs are a slap on the face
of every citizen who is an investor. For a person to invest even in
one share, several KYC (know your customer) forms have to be
filled up, and PAN numbers and proof of address, etc., provided.
For the PN investor, the system is totally silent on even elementary
information. The FIIs issue PNs to funds/companies whose identity
is not known to the Indian authorities. Hence, the PN system is
blatantly discriminatory and seems to favour ghost investors.
Any self-respecting market, if it discriminates at all, does so
against outsiders. But we have done the unthinkable. We should
recognise and internalise the fact that funds are in search of
markets, and not the other way. Given the demographic shift
in the developed markets (where pension funds have to locate
markets to get returns for longer periods) and the lack of huge
opportunities in long-term projects, it is natural that global funds
are in search of markets. The PN route, through which a section
of investors is participating in our markets, is a mystery wrapped
in a puzzle, crammed inside a conundrum and delivered through a riddle.
These are address-less funds that could be from dubious sources and the
clamour for it is intriguing, if not outright suspicious. Current Scenario
According
to the SEBI Web site, the current positio According to the SEBI Web site,
the current position of these instruments is as follows: “Currently,
34 FIIs / Sub-accounts issue ODIs. This number was 14 in March 2004.
The notional value of PNs outstanding, which was at Rs 31, 875 crore
(20 per cent of Assets Under Custody of all FIIs/Sub-Accounts) in
March 2004, increased to Rs 3,53,484 crore (51.6 per cent of AUC)
by August 2007. The value of outstanding ODIs, with underlying as
derivatives, currently stands at Rs 1,17,071 crores, which is approximately
30 per cent of total PNs outstanding. The notional value of outstanding
PNs, excluding derivatives as underlying as a percentage of AUC is 34.5
per cent at the end of August 2007.” (SEBI - Paper for Discussion on ODIs).
This implies that more than 50 per cent of the funds are flowing through
this anonymous route which needs a re-think on this entire issue.
This brings us to the question about who are the investors interested in
Indian Papers. Who uses the PN route? The first category is the regular
funds whose twin objectives are returns and more returns on a
21*7*365 basis. They are interested in India since the India story
is very good and returns are attractive compared to developed markets.
The second category is prodigal money returning. It is not a secret that
a large number of politicians/bureaucrats/business-persons have
accumulated wealth abroad. This has been accumulated by
under-invoicing/over-invoicing, by corruption in contracts and gifts
from abroad; and by not bringing in legitimate receipts. The third
category is those foreign governments/entities who would like to
acquire/control Indian entities by taking them over. The fourth
category is the terror financiers who could find this route attractive
and simple. The first category does not have any reason to use the
“anonymous” route since the aim is to earn returns /repatriate and
benefit out of interest rate and currency value arbitrage. They enter
and exit as per these calculations and are not shy ab..
First, what are PNs?
Investopedia.com defines participatory notes as “Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities.”
Brokerages buy India-based securities and then issue participatory notes to foreign investors, it adds. “Any dividends or capital gains collected from the underlying securities go back to the investors.” The kind of people/institutions that can invest in PNs can be found at http://investor.sebi.gov. in/faq.
What is key in the PN definition?
The most important part that needs to be observed in the investopedia.com definition is “investors or hedge funds that are not registered with the Securities and Exchange Board of India”. This is a big deal.
Why?
Imagine you or I try to open a demat or trading account with any firm. When anyone in India tries to open a demat or trading account, they have to give ID proof and address proof. In business it’s known as KYC, or ‘know your client’.
In essence, it means that companies, especially financial entities, should know the ‘character’ of their client. What it means is that they should know whether their client is real or someone with questionable credentials.
How does that apply to PNs?
When PNs are first sold, they are sold to someone SEBI ‘knows’ but then they are sold in the market and they can be, and are, purchased by people/institutions that SEBI does not know about. These people, who can trade them, do not have to register with SEBI or anyone. They can participate in the Indian bourses, using FIIs (foreign institutional investors) as intermediaries; but they are essentially faceless and SEBI will never know who these investors are.
Does that create any problems?
Yes, a problem for the integrity of the Indian bourses. Integrity here not only means honesty but also structural integrity.
Hypothetically, people who are against the success of India can invest large sums in the Indian market and then pull them out all of a sudden, causing mass panic.
Now, this is not to suggest that all the investments coming in through the PN route are ‘shady’ but it does certainly give us food for thought.
Are PNs massive enough to be of concern?
PNs have been exploding in India. SEBI estimates that the total foreign stake in Indian companies in August 2007 was around Rs 6.9 lakh crore, of which Rs 3.53 lakh crore (51.6 per cent of the AUC or ‘assets under custody’) is through PNs. Compared to the outstanding PNs of Rs 31,875 crore (20 per cent of total AUC) in March 2004, this is an amazing 11 times growth.
What accounts for the fast growth of PNs in recent times?
One of the reasons why PNs have grown so rapidly in India is because of the regulations that SEBI has imposed on those who can register as FIIs.
The regulations also exclude hedge funds from becoming FIIs. This means that hedge funds see PNs as a perfect conduit to investing in India. As of now there are 34 FIIs that issue PNs.
Another obvious reason for routing money through PNs is the anonymity it affords. Both the above issues have conspired to drive the massive rise in PNs.
Are there different types of PNs?
There are two kinds of PNs — spot-based, and derivatives/futures-based (also known as ODIs, offshore derivative instruments), meaning that they are based on other underlying instruments. The latter accounts for around 32-33 per cent of all total outstanding PNs.
Why did SEBI have to do what it did?
Now everyone knows that SEBI placed regulations on PNs. But it must also be stated that it resisted doing so for a while.
What happened, in essence, was that it was under considerable pressure from both the RBI (Reserve Bank of India) as well as the Finance Ministry.
Pressure!
The RBI was and is deeply concerned about the rapid appreciation of the rupee caused by huge net FII inflows. The net FII investment in India in 2007 stands at over $12 billion currently. The Finance Ministry was concerned about the galloping stock market. The Sensex went from 18,000 to 19,000 in four trading sessions and the Finance Minister expressed concern over that.
He cautioned that if there was a break in the stock market bubble, it could and would have catastrophic effects on the real economy. Obviously both were justified in forcing SEBI’s hand.
So, the market regulator brought in controls?
That’s right. The changed regulations that SEBI put in place, as you may be aware, were:
FIIs and their sub-accounts shall not issue/renew ODIs with underlying as derivatives with immediate effect. They are required to wind up the current position over 18 months.
Further issuance of ODIs by the sub-accounts of FIIs will be discontinued with immediate effect.
FIIs which are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of less than 40 per cent shall be allowed to issue further ODIs only at the incremental rate of 5 per cent of their AUC in India.
Those FIIs with notional value of PNs outstanding (excluding derivatives) as a percentage of their AUC in India of more than 40 per cent shall issue PNs only against cancellation/redemption/closing out of the existing PNs of at least equivalent amount.
What next?
That’s the ‘$64,000 question’! We have already seen what will or could have happened. The markets tanked sharply and then rebounded again.
What has fundamentally changed is that it is very unlikely we will see FII inflows the way we have seen them in the past few months. That’s a near given considering that outstanding PNs account for over 51 per cent of foreign money in India. The other fact is that FIIs control most of the floating stock in the bourses.
Do they?
There have been estimates made that show FIIs, including PN-holders, owning around 15-20 per cent of stock of the top 1,000 companies in the bourses. Now consider the promoters; they own over 50 per cent but those shares rarely ever come into the market. That means that the FIIs have had a near ruling of the market. In effect, they control the market because they not only own a chunk of floating shares; they are also the most active.
If you look at the correlation between net FII flows and the market indices, there is a near-perfect positive correlation, suggesting very strongly that FIIs have a tight control on the market, if not a stranglehold.
Will the 18-month Damocles’ sword impact the markets?
Now that PNs with underlying derivatives have to be withdrawn in 18 months, it is likely that there may be some choppy sessions ahead but the volatility should pan out very soon. The volatility should reduce because derivative-based PNs are highly leveraged — something that contributes to volatility.
It should also mean that the hedge funds, which have been fairly responsible for this steep rise in the market, might exit the market because SEBI will never let them register as FIIs.
The RBI can then heave a sigh of relief because the appreciation pressure on the rupee will slacken to a large extent. The Finance Ministry too will heave a sigh of relief because the danger of a full-scale bubble bursting has reduced to a good extent, if not fully.
We had a damage-control exercise a few days ago…?
On October 21, SEBI said that sub-accounts (the mechanism through which FIIs issue PNs) could stay, provided they registered and, in effect, surrendered their anonymity. This is, however, a smart move by SEBI that will likely amount to nothing.
Why so?
SEBI knows that PNs are held by hedge funds and SEBI will not register hedge funds even if they wanted to register. (For starters, Encarta defines ‘hedge fund’ as risk-taking investment company; “an investment company that is organised as a limited partnership and uses high-risk techniques in the hope of making large profits.”)
Is the move against PNs right?
Whether SEBI’s decision to ban PNs was correct or not is a very tricky question. However, at the end of the day, the guiding principle should be whether the decision taken prevented a blow-up of the economy. Everyone will have his or her views but my view is that the decision taken was right. The question is a very philosophical one…
Philosophical? Yes, because it comes right down to the heart of the issue of capital controls. Should the Government ban certain type of flows or should there be no capital controls? On a personal level, I believe that there should be no capital controls but that this ideal should not be placed on such a high pedestal that everything else becomes subservient to it. The only thing that should be placed on a pedestal is the macroeconomic well-being of the economy and everything else should become subservient to it.
Is this what you believe weighed the most, in the PN issue?
Yes. SEBI didn't want to ban PNs for several reasons and this let the markets stretch a bit too far. Economic graveyards are littered with the dead bodies of countries that let their stock markets enter a `bubble zone'; a zone where valuations couldn't possibly be justified by fundamentals. The funny thing about bubbles is that they always burst.
What makes PNs capable of hurting the markets?
The main issue or danger regarding PNs is that they are fairly dominated by hedge funds. These funds have only one objective in mind and that is to make lots of money in a short time. I'm not saying that it's a bad objective because the lord knows everyone of us has that objective. However, the key difference is that hedge funds can move a market to their whims while small investors cannot, so there are times that their objective can run opposite to what the regulators would like.
Does India fit in the scheme of hedge fund thinking? How?
Yes, perfectly. A country like India is ideal for hedge funds. Indian bourses are fairly shallow compared to other bigger bourses and that means a relatively less amount of money can move the market. When FIIs come into India with all guns blazing, it generally means that the markets will swing upward and vice-versa causing a lot of volatility. They are not called hot money for nothing. On a comparative basis, India has a very volatile stock market.
So, should India ban FII money?
I am not suggesting for a second that India should ban FII money. They should be let in but there should also be a leash placed on them. The only thing that should matter to regulators should be the well-being of the economy. And an over-inflated market is not conducive to that ideal.
D. MURALI
http://InterviewsInsights.blogspot.com
Bio: Mr Sunil Rongala, a PhD in economics, is the co-author of `Asia in the Global Economy: Finance, Trade and Investment' (along with Mr Ramkishen S Rajan of George Mason University, US), a book to be released in 2008 (www.worldscibooks.com). Previously the Group Economist in the Chennai-based Murugappa Group, Mr Rongala is currently a research manager in an international partnership firm, in
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