Remember Michael Douglas as Gordon Gecko in Oliver Stone’s film, Wall Street? Remember his famous line, “Greed, for lack of a better word, is good” which was soon shortened to “Greed is good”? Well, ladies and gentlemen, after cowering under the kitchen sink and wetting his pants every hour from September 2008 right up to early March 2009, Mr. Greed has had a makeover. Back in his tailor made suits, his Tod shoes, a little leaner for to want of super-fat mid-year bonuses, he has stepped out from the dark recesses of the scullery and is strutting around Hong Kong and Singapore — picking up all the cash that as is on offer, and spinning the same old yarns, now sprinkled with words like ‘de-risking’ and ‘de-leveraging’.

I realised this in a recent trip to Hong Kong and Singapore. Thrice a year, I visit 20-odd international portfolio investors and fund managers in these two cities who want to discuss the economy and corporate issues. With this going on for several years, many have become good friends, from whom I’ve learnt a great deal about market dynamics, investment behaviour and their views of different Indian companies.

Although these investors were delighted with Congress winning 206 seats, they were worried to a man. Especially the major India-dedicated mutual fund managers in Singapore. Here’s what I learnt from them.

Forget about the recent correction that has occurred globally, and has played out in India as well. The fact is that from March 2009 the market has risen phenomenally. Why so? What had really changed? The real economy? Happiness with the elections? Hard numbers coming out of corporate earnings? Or stock prices?

Regarding the economy, nothing much had changed. The fourth quarter GDP growth was no different from the third; and the annual growth for 2008-09 was in line with the consensus estimate of 6.5-6.7 per cent. The election outcome did cause the last big spurt in the market. But the rally had begun from the second week of March — long before anyone could have credibly claimed that the Congress will be romping home. Corporate earnings were up in the fourth quarter, compared to the third. But those results came in only after the second half of April, when the bull run had already completed several fast-paced laps. There really wasn’t anything of great significance to explain why the Sensex had merrily breached 15,000 and was all set to rise even further.

The answer: stock prices. The run has been due to four factors. First, it is in part the flip side of a disproportionately sharp fall since mid-2008, which was steeper than any other emerging market. Second, India was seriously under-weight in the MSCI. When emerging markets again found favour, fund managers had to scramble to buy big dollops of Indian stock to correct this under-weighting. Third, there was liquidity sloshing around in global financial capitals, and cash was there for the punting. And fourth, a perverse incentive structure that makes fund managers behave like lemmings and grossly exaggerate accentuate both the highs and lows.

This needs explaining. The bonuses of every mutual fund manager depends upon their ability to outperform the index — be it the Sensex, the Nifty 50, or more typically the MSCI. When mutual funds start getting additional money, as they have since early March, the managers can’t say, “The underlying forces are uncertain, and I’ll stick to cash.” In an upturn, they have to invest in stocks — good, indifferent or dogs — and, in the process, show how their fund is beating the MSCI. This is what I heard everywhere: “Omkar, I know that most real estate stocks are rubbish. But they are rising the fastest. If my fund keeps getting $2 million each day, I have to invest in these stocks. Left to myself, I wouldn’t touch then with a bargepole”.

Small wonder that the developers are again hitting the financial hotspots. In a single week, Singapore saw Dewan Housing, Purvankara, Sobha, Emami, HDIL, Jaypee and GMR fishing around for private placements. Unitech had already got $350 million, and was coming for seconds. DLF had picked up $750 million. And India Bulls Real Estate has pocketed some $550 million. All loss leaders are lining up for funding. All are saying the same old bull-run story — that the sum of the parts is greater than the whole, so invest in my parts. The clever fund managers don’t buy that nonsense, but invest nevertheless. Because they have to.

So, greed is back. I worry, because the market is playing only on froth. I’m hoping for a serious correction over the next few weeks. If the market doesn’t correct now, it could be hit much harder a few months down the line. There’s too much exuberance chasing too few goods. Fuelled by greed. And perverse incentives.
 

 

Published: Business World, July 2009