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'The real worry is the character of entities not the conduct of market players'

By N Mahalakshmi
Last updated on: June 27, 2005 12:52 IST
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As the Sensex crossed the 7000-mark there is exuberance in the market, though there is a sense of nervousness about the new highs in some quarters.

It looks like fundamentals are strong, corporate earnings are growing at a healthy pace and, barring a few islands of overvaluation, there is no cause for worry. But then, all of us know that stock prices are not driven by fundamental realities alone.

Fund flows are important to ensure that prices are what they should be. And in the past two years, Indian equities have got re-rated on the back of an unprecedented flow of portfolio investments.

Notably, there has been a sizeable chunk of foreign inflows from hedge funds which are gaining popularity all around the world. The sustained rise in interest rates in the US and the buzz that certain hedge funds are reporting losses are sure keeping markets wonder how long this rally could continue.

Even as market analysts try to figure it all out, Business Standard bring you an exclusive interview with Sebi chairman, M Damodaran. Excerpts:

Is there anything that makes you nervous about the state of the markets today?

First of all, I should tell you that regulators do not worry! They are only concerned! Having said that, the level does not disturb us. It is the pace at which the market moves that we are concerned about. If it is in one direction over a period of time then there has to be some fundamental strength or positive factors around it.

Our job is to watch closely if the movements are erratic, and to see if there is too much volatility or sudden movements that are not driven by events or developments that are reasonably justifiable. For now, there is nothing very disturbing.

What is your concern about hedge funds?

There is a traditional belief that hedge funds take more risks in pursuit of high rewards, enter and exit faster compared to other category of investors. Therefore, if they have a disproportionately large presence in any market, there could be attendant volatility.

Of course, all this is predicated on whether there is a herd mentality or not which may not be the case at all. So the conventional economic worry is about the sudden flight of capital.

But if there are enough investors, then withdrawals by some investors could be countered by some others who might find the market attractive enough to stay.

For instance, if you look at FIIs, April and May were negative but the market went up.

Our real concern, as also for all the regulators in the world, is the quality and character of money. Whose money is it? If you are not able to get beyond the various layers, then it is a cause for concern.

If somebody wants to come and register here and comply with FII guidelines which require compliance with KYC (know your client) norms, it is fine.

Our regulations stipulate that those who invest here should also be registered overseas. The fact that these entities are governed by the regulators in their respective home countries provides some level of comfort.

Having said that, the next level of concern is where these entities are registered - whether the regulators there also adhere to the level of governance we expect.

So the real worry is the character of entities not the conduct of market players. 

What is your assessment of the magnitude of hedge funds in our system?

I can't give exact numbers. But our assessment is that about 22-25 per cent of the total money coming in through foreign institutional investors are hedge funds.

Since last year when the liquidity tightening began in the US, analysts have been predicting that money will flow out of emerging markets back to the US. But that has not quite happened. Do you see the impending capital flight as a threat to markets?

Often we have seen that conventional theories have exploded. For instance, there is this theory that fund managers get their bonus and go for holidays towards year-end and hence markets tank.

Many a time it has not panned out that way. So these pet theories do not always work. Ultimately, it is each investor's call on which are the best countries or stocks to invest in. On a relative basis, emerging markets have done better than developed markets.

Within the emerging markets group, India has done fairly well with just a couple of countries having beaten us.

Today, India is a preferred destination. Apart from the flows, what is more comforting is growing FII registrations. There are now about 700-odd FIIs registered with Sebi and they are coming from a variety of countries.

For instance, there is a lot of fund flows from Japan. There are FIIs coming in from countries such as Norway and Sweden. Indications are that India is as good if not better. If the economy remains strong and corporate earnings grow, inflows should be strong.

If some FIIs decide to withdraw, it is their individual call and that need not mean capital flight. Herd mentality is a market phenomena which we can't avoid.

Are you contemplating any additional market stabilisation measures?

I do not subscribe to the idea of having an institution or fund for investor protection/market stabilisation. We should not have any artificial support systems. More money and more stocks - that will the market's own contribution to itself.

You have expressed concerns about mutual funds…

Yes. When a new fund is launched, distributors get more money to sell the new offering. So they tend to sell these products more aggressively. If you see, a lot of money has moved from existing funds to new funds.

Net accretion to unit capital is moving sideways, not up. My point is that why not mutual funds reward investors, instead of distributors. Though mutual funds may argue that what they pay to distributors is not always paid by the investors - they bear the costs themselves - it does push up the cost of managing funds, overall.

If AMCs bear the issue expenses and pay distributors from their pocket, they are under pressure to recover their costs, for which they need to charge higher fee and ultimately the investor bears the burden. I think what is going as reward to distributors should get passed on to the customers by way of lower fees.

Are you concerned about the kind of funds being launched - too many sector- or segment-focused funds…

So long as disclosures are adequate, and the investment objective is clear and is communicated to the investor, there should be no problem. There is a segment of informed investors who would like to invest in these specialty funds.

Also, since most of these funds are open-ended, investors do have the liberty to exit anytime.

What do you see as your biggest challenges now?

We have a lot of liquidity in terms of foreign investors and even domestic investors. But we need to see more issues. We need to see more repeat issues which are now going overseas.

In essence, we need to make sure that Indian markets are a more friendly place for Indian companies to list without diluting on entry level requirements or even continuous disclosures.

An even bigger issue is how to ensure that we have more investors. We need more retail investors in the market whether directly or through the mutual fund route.

The Indian markets are today better than 10 years ago in terms of regulations and, therefore, the fact that there is more comfort for investors to invest in equity markets is something we need to effectively communicate.

Towards that end we need to have more investor associations which will become our interface with investors. Currently, we have eight registered associations with Sebi though there are a number of associations across the country.

For now, very few of them have taken up investor concerns as their main activity. We need to have more organised groups which do this as their major activity and comply with the regulations charted out by Sebi. We can also assist them in some way.

On the regulatory side, you have been talking about making delisting guidelines friendlier. Any progress on that?

We want to make delisting simpler. Today, there are thousands of companies which are listed but lots of them are not traded. Many of these companies got listed because there was a tax incentive for getting listed.

These are small companies with limited shareholders, no trades in the market and do not comply with regulations. Many are suspended. Since they are suspended the exchanges are not earning anything from them.

We have to recognise that so long as we remain in this state, the small investor does not have any exist. So we need to create a climate where companies which are listed are compliant. We have a team working on this right now and we will probably see changes soon. 

What about public holding in listed companies? There are different companies at different levels of public holding primarily because they got listed at different time-period when regulatory requirements differed. Because of this, there are certain anomalies that arise when it comes to take-over code, for instance...

In the long-run we need to get all companies to the same level of public holding.

But this has to be done in a non-disruptive manner. We have to frame regulations realising that not all companies can get there immediately.

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N Mahalakshmi
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