Sunday, September 16, 2012

Value Investment Climate in India

The future of an economy is determined by how efficiently it uses the limited available capital. Value Investors take a long term view and reward enterprises that are efficient users of the capital by investing in them. With a national Savings rate of 30% plus (which is likely to sustain for a long time despite the recent hiccups), one would expect a much more vibrant investment climate for equities in the country.This leads us to ask the following question:

What is holding back Value investments in India?

1. Real estate: Because of the heterogeneity, it is very difficult to make a general statement about real estate in India. But some parts like National Capital Region and Mumbai are well known to be expensive compared to their global peers.There has never been a well known bubble burst in the real estate in India. A large segment of the population thinks that in the long term, real estate, particularly land, is the most productive asset class and does not diversify away from it.

2.Gold: Indians have had a fascination with Gold from time immemorial which has its own merits. Gold can at best be an insurance against hard times when family Gold can be sold to start afresh.But the magnitude of Gold currently held by us is a bit much and tremendous Indian wealth will be lost if gold loses its glitter.To put into perspective, the current value of Gold held by Indians exceed the total market capitalization of BSE. If this capital was invested in similar enterprises, the size of our economy will double. The world's most successful investor is not very fond of Gold

3.Underdeveloped Mutual Funds Market: The market for Mutual Fund is highly underdeveloped in India and most of it is limited to large cities with 85% of the flows coming from top 15 cities. It might be due to the relatively short history that Indian Asset Management sector has had but there has not been any spectacular or iconic Fund Manager like a John Templeton or a Peter Lynch. Nothing sells like success. Yes, there have been some smart Managers like Madhusudan Kela who shone for some time before the great recession eclipsed them but the fact remains that there has not been a single Mutual Fund in India whom investors can trust with unflinching faith. We are yet to get a Magellan Fund.

4.Weak Regulatory environment: Far too many crooked promoters have gone unpunished for investors to have faith in the Indian regulatory environment. Scams and bankruptcies happen almost everywhere but probably only China can rival India in the number of people going unpunished. Even in case of China, the punishment meted out are severe and ruthless. The recent IPO scams where investors lost upto 90% of their wealth immediately after listing and recent Deccan Chronicle drama where 3 fellows looted 30+ Banks and NBFCs making a mockery of all regulations and continue to walk free are but some examples.

5.Small surplus capital: At at an aggregate level, our savings are very high as a percentage of GDP, but in absolute terms they are rather small. The complexity involved in capital allocation are quite different at different ticket sizes. At a smaller scale, return on capital is higher if a person invests in his own enterprise and returns generated by methodical asset management are comparatively less attractive. Also, for professional Asset Management to bloom, the surplus capital needs to be large enough to be deployed for long periods of time without having to be redeemed for meeting short term exigencies.

6.No Giant Value Investors: Though Warren Buffet and Ben Graham are known worldwide for their investment acumen, very limited number of people outside US can relate with them. We do have had some successful investors in India but there has not been a single investor who believes in buying and owning a  business wholly forever. The power of such people goes much beyond the economic value they add directly. Warren Buffet is like the head priest of a church whose membership keeps on increasing. We do have some tribes in India that follow value investment principles similar to Buffet but not an established church yet.

What are the future prospects?

1.Real Estate: Like all overvalued assets get corrected in time, real estate in India is also bound to get corrected and valued as per its true economic value. Real estate prices are high primarily because low supply of quality real estate. A major cause of the overvalued real estate is inadequate infrastructure. Investment in infrastructure,Roads e.g., has a disproportionate impact on real estate prices by hugely increasing supply. If India were to achieve the target of constructing 20km new roads every day, supposing the road affects 100sq m area in its vicinity, 2sq m of develop-able area will be made available for every Indian every day. If that were to happen, both sides of these new roads would be lined up with houses end-to-end and every Indian would have a 700sq m home on a highway.The upcoming correction in Real estate, whenever it happens will first jolt the economy, then release substantial surplus capital to be either consumed or productively invested.

2.Gold: Gold demand is a function of human psychology as well as availability of, and risk return considerations in other alternative asset classes.While the former cannot change overnight, later is bound to e negative for Gold as an asset class. Historically, Gold has kept pace with inflation. When the world comes out of the recession and the uncertainty subsides, risk premium on Gold will subside, making doubly unattractive. The relative share of Gold as an asset class will eventually decline but the absolute demand might not because of increased affluence. Because of the harmful effects to the Indian economy, policymakers will make an effort to dissuade people away from Gold as an investment.

3.Mutual Funds: Though policymakers and industry participants are trying to increase the penetration, these efforts will pay off only when investors see consistently superior performance. The eventual end of current recession may structurally and presence of large number of schemes may statistically aid this but the consistent superior returns is a serendipitous phenomenon and cannot be predicted.

4.Regulatory Environment is a function of the intelligence of the personnel manning these bodies as also the integrity of the government of the day. From the current state of affairs, it does not seem like things can get any worse than what they are.So, they can only get better. Having a good regulatory environment is also in the interest of the financial industry participants. The increased international competition with international Stock exchanges like Singapore and domestic ones like MCX might accelerate the evolution of regulatory environment.

5.Surplus Capital: By all indications, Indian economy is likely to grow at a relatively high rate for a long period of time to come.The stock of investible surplus capital will keep growing with the resultant increase in per capita income.

6.Giant Value Investors: We might not see a Warren Buffet in India any time soon but we might see some highly successful Value Investors of Indian origin. Prew Watsa's Fairfax financial has recently bought Thomas Cook by taking a controlling stake in this company. If Watsa continues his track record and acquires more Indian companies and make a success out of them, he might get a cult following in India. Even otherwise, there are a lot of individuals who have been following value investing principles and have succeeded in a small way. Some of them might snowball into legends ten, twenty or thirty years later.

To sum up the prospects of Value investing are cautiously optimistic in India. There are online forums and blogs that are vibrant with activities and are actively promoting Value investment. Some of them that I find interesting and helpful are listed below:




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  2. Absolutely right, for long term investment, investing in real estate is the most profitable option than any other. But everyone can't invest in real estate as amount need in real estate investment is too big. So choose investment option according to fund you have,.

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