Realism Creeping Into The Markets

John Band has worked in the financial services industry for the last 27 years. His first involvement with the Indian securities markets was in 1985, when the initial discussions of foreign portfolio investment took place. He has been a director of ASK-Raymond James since 1997. He was recently appointed chief executive of ASK-Raymond James & Associates, the Group's stock-broking and merchant banking company. He is also a member of the BSE's Derivatives Committee. Excerpts from an interview with Thomas J Priju.

What criteria do you adopt while making an investment selection? How do you determine the fair price?

The broad parameters we look at while making our investment selection are business, management and valuation.

 

We prefer businesses that are simple to understand and have favourable long-term prospects. A natural corollary to our investment processing process is that we concentrate on companies with strong brands. Historically, we have preferred managements with a strong focus on core competencies, a high level of quality consciousness, and those which are cost competitive. As a stakeholder we would definitely be looking at a high degree of fairness in dealings.

As regards valuation, we try our best to bring a high element of objectiveness. We broadly look at companies that offer `GARP' (Growth at Reasonable Price) i.e. we will buy companies that are growing faster than their peers, but only at a price that we consider fair. The stock must also offer liquidity.

This bottom-up approach involves selecting from a mass of 6,000-odd companies a portfolio of roughly 30 stocks.

How do you view the state of the Indian markets?

In a broad sense, the Indian markets are going through a correction phase, which is similar to what has been happening on the Nasdaq. At these levels, old economy stocks look reasonably valued. With several ICE stocks showing a fall of more than 50 per cent from their highs, realism is slowly creeping in. As a result, investors are relooking at valuations, which had reached irrationally high levels.

Though the dotcom mania has subsided in the United States, there are some important lessons to learn from the same.

First and foremost, we have the interesting case of Morning Star (a mutual fund monitoring company) which took a decision 5 years back to move to the Net. Though most of the first round of B-to-B portals were pure net plays, Morning Star is a good example of a traditional brick and mortar company which moved to the Net early on.

In the Indian context I have not been greatly impressed by any of the Internet sites, since a large number of them are `me-too' sites. The major lacunae with a vast number of dotcom sites is the absence of a robust revenue model in place.

How do you think the capital markets will benefit from the introduction of derivatives?

Derivatives will improve the maturity of the capital markets in several ways.

Index futures will enable large investors _ particularly foreign and domestic institutions _ to increase or reduce their overall exposure to Indian equities quickly and efficiently. They can then buy or sell individual securities at a rate that avoids pushing prices up or down as large orders currently do. This flexibility will make the market more attractive and encourage more investment in equities.

Additionally, index futures will provide a suitable vehicle for speculators who hope to profit from an overall market move rather than anticipated moves in individual share prices. The logical next step is the introduction of traded options on individual securities. This will appeal to speculators who anticipate price movements in particular securities. They have the benefit of the leverage inherent in an option.

Brokers and the market experienced reduced risk in comparison with account trading, since the option is bought or sold for immediate settlement. There is also a benefit for institutional investors, which can earn an extra return on their equity holdings by writing options.

How do you evaluate the current environment of corporate governance?

Corporate governance has already improved substantially in recent years, partly because of increased regulation, but also because of increased awareness of these issues by investors.

The market has punished companies whose promoters engage in related party transactions or fail to demonstrate transparency in their accounting. Companies like Infosys, which are committed to the highest standards of corporate governance, are given a premium rating by the market.

The main areas still in need of improvement are accounts and audit. Consolidated accounts _ in which unearned profits from transactions with group companies are eliminated and which include the profits and losses of subsidiaries _ are long overdue. The lack of a deferred tax accounting requirement can also result in overstated profits.

Auditors need to be more vigilant in their role as shareholders' protectors. Too often, related party transactions are inadequately disclosed or explained. Further, even large organisations seem to get away with misleading statements in their directors reports - as ICICI did in 1999 - without an auditor comment.