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'Retail investors have learnt a lesson'

Suspensions, restrictions, evidence, tape, transcripts… The stock market has witnessed all this and much much more in March 2001.

In this drama that has engulfed the market, the retail investor has lost the most. Having entered the year 2000 stock market euphoria late, the retail investor has ended up losing a lot of money.

John Band, CEO, ASK Raymond James spoke to Kanchana Suggu about his views on the stock market collapse, Sebi's steps and the fate of the retail investor. As an investment banker to two recent takeover bids -- Abhishek Dalmia's bid for Gesco Corporation and Radhakisan Damani's bid for VST Industries -- he also elucidiated his views on the increasing M&A activity.

The Sensex soared 177 points on the day of the Budget. How long do you think a Budget like that would have been able to sustain the excitement?

Well, I think it was a good Budget. But like most government announcements since liberalisation began, what really matters is whether the government delivers on its Budget speech.

There's been a lot of panic in the market. But I think the real problem continues to be uncertainty about Indian information technology stocks. And the fact that IT stocks happened to break while the Budget was going on is actually a coincidence.

The problem is that politicians, because they are very conspiratorial in nature, believe in conspiracy theories in everything including the share market. I don't believe there was any conspiracy or a bear cartel. I don't think there was significant wickedness in the counsel of the Bombay Stock Exchange.

So you think a big deal is being made out of the transcripts?

I think all these transcripts, suspensions, inquiries and so on is total nonsense. I think it is witch-hunting. They are trying to find somebody to blame. I think Anand Rathi is being made a scapegoat.

I think the real problem is that we've never attempted to construct a margin system that protects investors. Our margin system only protects the exchanges. What I'm suggesting is that we should move to a margin system that protects both the exchanges and the investors.

We need a margin system that protects people against their own foolishness. That is the single biggest lesson we should learn. If we fix that, then I don't think there is that much else wrong with the market.

Do you think Sebi's move to ban short sales is a harsh one?

I think it's nonsense. All these artificial restrictions on trading just tend to defer problems or in some cases even exaggerate them.

Sebi should basically have said that the market should find its own level. They should've studied the long-term requirements of the market.

The other thing Sebi has to do is to impose some sort of discipline on the brokers and their clients. In the US, brokers permit gearing above 50 per cent only in real blue chip stocks and no leverage is permitted on junk stocks.

And Sebi's restriction on member brokers. What do you think of that?

You have to understand the sequence of events that I believe occurred after the Budget. The finance minister made as good a Budget as he could have done. But he did it against a background of further major slides in the Nasdaq.

There were, therefore, three sorts of investors who were committed to selling in the market. Not because of the Budget, but for very good reasons of their own. There are those who believe that the current woes of the Nasdaq and to a lesser extent of the Dow are the early symptoms of a major downward revision in share prices across the globe and the most prominent advocate of that view is Shankar Sharma of First Global.

So he has consistently protected some sort of global meltdown for a long time. He would take the moves that were going on in the US markets at the time of the Budget as further justification of that view. That does not make him a part of a bear cartel or a market manipulator. That's just a particularly pessimistic view that he has.

There is also a problem that many brokerage firms within India have been pointing out that the sustainability of earnings growth in many of our IT companies is a problem and that people should both reduce their exposure to IT companies and concentrate on quality stocks. By no stretch of imagination could Himachal Futuristic or Global Tele-Systems be called quality stocks.

Himachal Futuristic has a management with quite a shocking reputation. Global Tele-Systems has built its historic revenue growth on the basis of a cosy relationship with the government of Maharashtra, which is now bust.

As far as Himachal Futuristic is concerned, no investor with a memory longer than four-five years would ever touch the stock. As far as Global is concerned, the valuations to which it was propelled earlier in the year, were out of line with reality because although the management team of Global is good and they have some very exciting plans, their historic profitability has been much enhanced because of their relationship with the government of Maharashtra.

Global is not a bad company, it just happens to be in the spotlight, because a lot of people were owning it earlier. At one time, it was the most speculative stock on the stock exchange. And it's one stock whose share price would've been dramatically capped by the sorts of limit on the carry forward that I've been suggesting.

There are other companies which I believe lack transparency, have dubious accounting and so on. There was a trend going on during the Budget. I've identified the 'global meltdown' people as being expected to sell in the market. I've identified the 'tech nervous' people as being likely to sell in this market.

There is a special category of foreign institutional investors who may also have been selling in this market and that is the participatory note holder. FIIs can invest as FIIs, but the people who have not registered as FIIs and want exposure to Indian shares, can actually purchase through this participatory note route, where a foreign brokerage which has an affiliated FII buys the share for the FII and then issues a note which gives many of the benefits of ownership share to somebody who is not a registered FII.

Since CSFB is, as far as I'm aware, the biggest issuer of participatory notes, it is no surprise that CSFB was identified as a substantial seller at the time of the Budget.

You also get a vicious circle going on, where if you have people nervous about tech stocks, you have participatory notes being redeemed, you have low-quality tech stocks being sold disproportionately and those particular tech stocks (Himachal and Global) have very big carry forward positions, then you start triggering false sales of those stocks.

The meltdown in Himachal and Global was long overdue. It was unfortunate for our FM that it happened the day after the Budget. But it was nothing to do with the Budget specifically. It was nothing to do with any nonsense about a bear cartel and it was nothing specifically to do with the action of CSFB.

But if you look at it from the government's perspective, suddenly there is selling in the market. So there must be a conspiracy. There is no scam. There are great many investors who had very good reasons for selling.

What kind of restrictions, according to you, should be imposed on the broker-director?

I think it's very difficult, because in many other member-run exchanges, the elected broker-directors do have access to market sensitive information. But, by and large. they use it for the good of the market and not to go out and make profits.

But if there is evidence that the members have misused it, then obviously they should be punished and it would call into question the viability of broker-directors in future. The experience in other countries is that such abuse is relatively rare and one of the great benefits we've had for the last five-six years has been the competition between the BSE and NSE to drive down trading costs and improve transparency.

Everyone is now talking about the evil promoter-broker nexus that exists in the markets…

I don't believe this either. I'm sure that we should have tighter rules on insider trading. I am sure if we catch promoters manipulating shares, they should go to jail, just as if we see the chairman of parliamentary parties accepting notes across the table.

I don't want one law for the stock exchange and a different law for the politicians.

In today's times, what significance do words like investor confidence and investor protection really hold?

I think there are two or three things that matter. The first is that in India, we have a gambling mentality in the stock market and this is not just the fault of brokers. If you look at the number of clients who are begging brokers to let them trade on margin, there is a gambling mentality which in other countries is catered for by betting in dog races, horse races or other more colourful spectacles than share prices.

The problem is that our markets, like all global markets have become very much more volatile. Very big amounts of money can move in particular directions in a short notice. The amount of risk that a broker or his clients are allowed to take in ordinary times is far too high.

We allow people to trade in carry forward with a margin of only 15 per cent. US firms will allow margin trading of only 50 per cent and that too in absolute blue chip stocks. The degree of danger of something speculative happening and going wrong is very much greater in the Indian markets than it is in other markets.

The problem also for both our politicians and to some extent our market regulators and brokers is that when the market is going up like a rocket, very few people say, 'Oh, this is not good. What about investor protection? Are they buying something that they shouldn't be buying'? And when it goes down, everybody cries foul and talks about a bear cartel and other things.

I think retail investors have learnt a lesson. When retail investors got caught in the 1992 scam, they stayed away from the market for some time. They have come back into the market at the tail-end of the IT boom and got caught again. This is really sad because if investors really want to achieve long-term capital appreciation, the stock market is a very good place to do it. But that involves buying consistently over time, not buying at the top and selling at the bottom. That's only a good way to destroy wealth.

So I think retail investors should be buying in bad times as well as good so as to average out their costs. They should buy stocks with sound fundamentals, not rubbish. But retail investors persist on following what the latest fashionable big bull is doing. So they are guaranteed to only lose money by doing that.

And what role do you think Sebi should be essaying here?

There is a huge limit to how much you can protect people from their own greed and stupidity. If people are determined to throw their money away by buying shares of Himachal Futuristic at over Rs 2000, that is the road to self-destruction.

Any investor who bought Himachal Futuristic at a four-figure price had obviously not done any homework. Himachal Futuristic at any price in excess of Rs 1000 was complete nonsense and yet the whole of Calcutta seems to have earned it at a price over Rs 2000. There's a limit to how much you can protect people from their own foolishness.

I think the system could be revised to actually reduce the scope of both ramping stock prices on the upside and artificially depressing prices on the downside. That's because our margin system, at the moment, takes increasing amounts of margin from people when stock prices are moving dramatically rather than when speculative pressure is building up.

So, the way I'd like to see it go is that the base margin is increased from 15-25 per cent. Even in good times, nobody should be leveraging more than three times.

It's just crazy because they are not in a position to withstand a substantial downward shock. I would put the base up to 25 per cent.

The advantage of it is that the more speculative a stock becomes, the harder it gets to propel it further. So that's John Band's suggestion for protecting investors in future.

But when will investors' confidence be restored in the markets again?

I hope it will never be restored to a foolish level that was prevailing prior to the market crash. If investors have confidence to buy shares like Global Tele-Systems at Rs 3000 or Himachal Futuristic at Rs 2500, then that is not confidence. That is sheer foolishness.

So I hope that investor exuberance never returns to the level that it was showing in March last year. If that happens, they will surely lose their shirts again. We don't want investors who rush to the market blindly believing that they are guaranteed to make money. We want investors who accept that markets will go down as well as up and the best way to make money from the market is to be a long-term investor, who doesn't commit money he can't afford to the market.

If other sorts of investors have been driven out of the market, then it's not necessary a bad thing.

Well, I don't have any interest in seeing people jump to their death from a building in Calcutta. Those sorts of people should not be in the market. It's a tragedy that young people actually believe that the market is such a route to riches that they can mortgage their lives on it. Such people should not be in the market.

The stock markets are also gripped with fears of how badly the US economy slowdown will affect India? What is your view?

I believe that different economies have different drivers. Those with growing ratio of children to adults in work (a measure of consumption pressure), have a growth dynamic which enables them to bounce back quite quickly from recessions.

Examples of those sorts of economies would be most of the emerging markets, the US and to some extent UK, France and Australia as opposed to Germany or Japan.

So a recession in Japan or Germany is always a much worse thing than a recession in the UK or the US.

People have drawn very false parallels between the Japan of the late 1980s and the US of the late 1990s. The parallels are false because Japan has no domestic demand pressure.

I think there will be a recession because confidence is not enough to get the economy back on track by the third quarter.

And its effects on India?

In terms of what it means to India, general purpose body shoppers are definitely going to suffer. There are a lot of H1-B visas being surrendered. Companies with good relations with old economy US companies will not particularly affected by the slowdown.

The slowdown is going to be very focused on the consumer sensitive areas and the tech sectors. So dotcoms will continue to go bust, car companies will continue to struggle for two-three quarters, but companies which make aeroplanes with five year order books, companies which make weapons for mass destruction, companies which basically supply the industrial economy, will not suffer to that extent.

Obviously, the Indian tech sector is vulnerable to the extent that Indian companies are suppliers to dotcoms etc., they are definitely going to experience significant pain.

The ones with least pain are those who have major projects with old economy companies like Satyam. Some of the medium-sized firms like DSQ Software and Silverline are the most affected.

DSQ has been a problem stock in the meltdown just like some of the others. I think companies that have niches, like Polaris in financial services shouldn't have too much problem.

But the question is, will more US companies outsource to India? Yes, absolutely. There is no undermining of the long-term case for investment in Indian technology.

Which stocks are you bullish on?

I think the Indian pharma sector is looking good. For example, Dr Reddy's. It's a great company. We have been recommending it consistently for as long as I can remember and it seems stuck in a trading range of 1250-1400.

When the rest of the markets collapsed or zoomed up on the froth of the tech boom, Dr Reddy's continues to be Dr Reddy's.

In power, there is BHEL. Since we are incapable of attracting foreign investment to build power stations on terms that make sense, it is likely that India's power shortage in future will be addressed by local projects. If we are going to solve our power shortage by domestic investment, BHEL will be a huge winner. Boring, but great.

Hindustan Lever surprised everybody nicely with its quarterly results. HLL has come such a long way, it's attractive to my mind.

What role do hostile takeovers play in the Indian economy?

A small number of hostile takeovers is very good therapy for the market because it causes people to focus attention on non-performing managements. I think some increase in takeover activity would be good in terms of improving corporate sensitivity to shareholder requirements.

There is a need for more M&A activity in India even though it may not all be hostile takeovers. Hostile takeovers for sleepy companies is a good thing.

On balance, I think not every takeover works, but the ability to try is what makes the US economy and other western economies successful.

Finally, how have your corporate finance activities been affected since March 2?

We have had people approaching us suggesting that investment in our sort of corporate activity might be more exciting than buying second-rate IT stocks. They're learning.

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