Tuesday, December 27, 2016

The Magic of Bamboo

Co-Author: Saumya Rastogi

Bamboo, one of the oldest plantations in India is not as well tapped in India as compared to the other countries. This is very strange as it’s a native of India, yet, we do not realize its importance and right usage. Prashant and Aruna set out to revive the bamboo usage in India. Prashant is a Post Graduate in Management from Osmania University and Aruna is a Post Graduate in Science from Nagpur University. During their search for furniture, they realized that the market was dominated by iron, steel, plastic and wooden furniture. Bamboo was nowhere to be seen. Their search for eco-friendly furniture led to the emergence of Bamboo House.

Here is the story of Bamboo House from its founders Prashant and Aruna.

Bamboo House is a social venture focused on incorporating bamboo to provide sustainable livelihood. Would you like to talk about your ‘green’ startup and its emergence?
Bamboo House is a “Social Enterprise” utilizing bamboo as an economic driver for providing sustainable livelihood opportunities through business models designed to work at the base of the economic pyramid and promote bamboo as an eco-friendly substitute to wood, steel, iron and plastic.

On a sunny evening we were shopping around to buy a sofa set for our home but noticed that market was inundated with routine wood, steel, iron and plastic furniture. We searched around and noticed that overseas markets offered numerous bamboo product opportunities but Indian markets offered no simple solution.

Our search for bamboo furniture landed us up in a small village called “Katlamara” in the state of Tripura on the India – Bangladesh International border. “Katlamara” is a sleepy little village, one of the many bamboo and skill rich locations of our country. Village “Katlamara” is politically India but geographically Bangladesh (during Independence, King of Katlamara decided to merge with India). We decided to understand Indian bamboo sector and went for a “study tour” as we sensed Triple bottom-line impact bamboo could create. We had no specific Entrepreneurial motive since we had no idea what bamboo was all about. 

Family and friends were surprised at our decision, we were less than a year into our marriage, and left our respective careers. I was in my established imports business and Aruna dropped her plans of pursuing her Ph.D. We knew it was a big risk but were prepared. I handled half of country's forest and Aruna handled the other half and finally in May 2008 our study tour led to the evolution of our Social Enterprise “Bamboo House” in Hyderabad.

Any particular reason for choosing “Bamboo”? Do you have any expert team for choosing the bamboo appropriate for product development?
We chose Bamboo for Triple Bottom-line Results:
  1. Social: Bamboo can help more than 5 million of our population cross the poverty line
  2. Environmental: Bamboo minimizes emission of CO2 gases and generates up to 35% more oxygen than equivalent stand of trees.
  3. Financial: Indian Bamboo Market is estimated at Rs. 26,000 Crores by the year 2015 which provides strong growth opportunities

What are the pricing strategy/ methodology adopted at Bamboo House for product pricing?
We have no defined strategy for pricing as we are not operating under fair market conditions.

Bamboo based products are eco-friendly but the fear of termites, pest attacks always prevail. How do you ensure effective monitoring to avoid damage?
Treatment and seasoning of bamboo is done over a period of 12 -15 months and all required technical precautions are taken to ensure products / projects lasts a lifetime, and in any case not less than 30 years.

What are the major challenges faced by you in developing this venture?
We did face several challenges in developing this venture. Bamboo is under Regulatory constraints as per the Forest Act 1927. Harvesting & Transportation of bamboo is not permitted under the Act. Another problem is that Forest Act does not provide any right to choose the bamboo. We have to buy what is sold but while making products we make the right selection from available stock. There are various other challenges like:
·         There is no benchmark to follow in this industry
·         Raw material available through forest auction is not suitable for commercial applications
·         Every state has its own laws on bamboo for forests being in the concurrent list of the constitution
·         Bamboo traps both air and moisture, making it a difficult raw material to work with
·         Most of the tribal forest areas are inhabited by Naxalites
·         Learning the concept and mapping Raw Material species and Resource base is a challenge as well
·         Development of Logistics, supply chain, distribution, operations and Business modeling
·         Scaling and building volumes in this business is not easy
·         Lack of communication and transportation facilities at the production level

All of these make the business quite difficult operationally.

What according to you is the unique selling proposition (USP) for Bamboo House?
Domain expertise, passion and our ability to play well in this sector. We have very high domain knowledge which helps us.

Has bamboo house received any funding in the past? Are you seeking more funds in the future?
We decided to fund/ support our social venture through borrowings from friends and family apart from very little personal savings we had. We knew that no bank/ financial institution would come forward to support us initially.

We raised our first bank loan from Bank of Baroda under PMEGP Scheme under Credit Guarantee Scheme and are now looking to raise funds again to scale our initiative.

What are your future plans? How do you see ‘green architect’ evolving in the future?
We will persist in our endeavor to create sustainable livelihood models and ensure larger involvement at the grass root level. We understood that our country cannot grow and develop if our villages don't grow and we believe that bamboo can serve as one of the growth engines for the country. Some of our new initiatives are: Bamboo Bicycle, Recycled Tyre Furniture, Recycled Tyre Planters, Recycled Tyre Bags, Recycled Tyre Footwear, Bio-Degradable Sanitary Pads, Incinerator for Disposal of Used Sanitary Pads, Recycled Drum Furniture, Street Dust Bins – With Scrap Drums, Low Cost Bamboo Based Toilets for Rural India.

What has been your Eureka! Moments in the journey so far?
Had it not been for the media support, we wouldn’t have travelled this far in our bamboo journey. Nearly 25 of country's leading news channels and 150 newspapers and magazines including BBC helped us in taking our work ahead, as we were very clear from the beginning that community model should be media supported and market driven only then livelihoods can be sustained at the base level.

2013 – March-April: Our Bamboo Initiative received further support, through “International Visitor Leadership Programme (IVLP)” - A 4 week programme of the US State Department.

Monday, December 5, 2016

How India Grapples with Cyber Threats

This article was first published by the Global Association for Risk Professionals on December 01, 2016;

On October 21, the National Payments Council of India confirmed one of the country’s biggest data breaches: a compromise of 3.2 million debit cards issued by leading banks including the State Bank of India, ICICI Bank, HDFC Bank and Axis Bank. It was a reminder that even as the Narendra Modi government has embarked on the Digital India campaign, cyber vulnerabilities and their costs to both the private and public sectors are significant and increasing.

Various studies show that the number of cybercrimes has been increasing substantially. As per data from the National Crime Records Bureau, it grew by 23 times over the 2005-2015 period. 

ASSOCHAM-Mahindra SSG put the compound annual growth rate at 107% from 2011 to 2015.
An Ernst & Young report said that 40% of respondents from India highlighted an increasing level of concern around cyber breaches or insider threats over the last two years. In March 2016, Ravi Shankar Prasad, then Communications and IT minister of India, reported to the upper house of parliament that in the year 2014, cybercrime cases in India went up by 69%.

Countermeasures in Progress
The government has stepped up efforts to combat cybercrime. Programs include public education to spread awareness, and there is a proposal to set up a cybersecurity and e-surveillance agency. In addition, the Reserve Bank of India, Securities Exchange Board of India and other regulators have issue cybersecurity guidelines and are expected to beef them up.

Microsoft Corp. has launched a Cyber Security Engagement Center (CSEC) in the National Capital Region. Microsoft India Chairman Bhaskar Pramanik said that “CSEC’s mission is to help build a trusted and secure computing environment, a critical enabler for India’s digital transformation. It will work towards fostering deeper cybersecurity collaborations with public- and private-sector organizations.”

In announcing the commitment, Pramanik said, “Cybersecurity is crucial for Digital India. A data driven economy can flourish only when governments, businesses and individuals have access to hyper scale and hyper flexible cloud computing with the confidence that their data is secure.”

Even as such initiatives become more critical, the National Cyber Security Policy of 2013 has not yet been implemented. Coordination is essential to tackle the menace of cybercrime. During the recently concluded CyFy 2016, the India conference on Internet Governance and Cyber Security, organized by the Observer Research Foundation, in Delhi, Carl Bildt, former Prime Minister of Sweden and head of the Global Commission on Internet Governance (GCIG), told the Times of India that “as an emerging cyber power, India needs to engage seriously on issues of Internet governance.”

Liability Insurance
While it is taking time to devise and implement policies at the national level, there is a solution that businesses can consider immediately: cyber liability insurance. The product has been available in the Indian market for some time, and companies in the IT, IT-enabled services and health care industries are showing interest. Most banks, however, have not gone beyond buying the mandatory bankers’ indemnity coverage.

“Cyber liability insurance is becoming very important nowadays, especially in the backdrop of the rising number of instances of cybercrime and data breaches,” says Sushant Sarin, senior vice president–commercial lines, Tata AIG General Insurance Co. Ltd.

“We see that more and more companies are buying them,” he says. “Those companies which were the first movers are buying more cover, and those that have not bought it yet are starting to explore it.”

The “limit of liability” for which companies need to buy insurance depends upon various factors, such as the type and volume of data, origin of data, location where the data resides, sensitivity of the data, data security protocols, peer group benchmarking, etc.

“If the data originates from Europe or the U.S., the data privacy laws are stricter there, so more Insurance will be required,” Sarin explains. “Similarly, if the data is personally sensitive or creates financial vulnerabilities, the amount of Insurance required will be much more.”

Possible Payouts
Sarin says that the amount payable by an insurance company when a cybercrime or data breach occurs would depend upon such factors as how the data got out; costs of notifying customers about the breach; fines or penalties imposed by regulatory bodies; damages awarded by courts to affected customers; reputational damage, etc.

One reason why some companies have not yet bought cyber liability coverage could be lack of awareness about the products, or a misguided belief that their organizations are secure. Given the current level of cyber risks and the likelihood that they will only get worse, the ready availability of insurance provides a practical option.

Saturday, November 19, 2016

India’s Lesson in Demonetization

This article was first published by the Global Association for Risk Professionals on November 18, 2016.

The victory of Donald J. Trump in the U.S. presidential election was not the only surprise in the global news on November 8, 2016. That evening, Indian Prime Minister Narendra Modi addressed the nation and announced that Rs500 and Rs1000 currency notes would “cease to be legal tender,” effective at midnight. “This step will strengthen the hands of the common man in the fight against corruption, black money and fake currency,” he said.

The announcement shocked the nation. Technically speaking, the move was not unprecedented. But the demonetization was in 1978, and given that 65% of India’s population is under 35, memories of it are limited. According to news reports, http://www.business-standard.com/article/economy-policy/demonetisation-in-the-works-for-6-months-10-people-in-the-loop-including-raghuram-rajan-116111000009_1.html preparations were under way for six months and shrouded in secrecy. Only about 10 senior people in the prime minister’s office, Finance Ministry and Reserve Bank of India were aware.

The scheme in 1978 was not deemed to be very effective, as “the element of intended surprise and secrecy was also not well maintained and thousand rupees notes were already out of circulation one week before the demonetization. Reportedly large amounts of high denomination notes were sent to Gulf countries, especially to Dubai and Kuwait, a few days before the ordinance was announced.” (Kishore C. Samal, Chasing Black Money in India) http://www.ispepune.org.in/PDF%20ISSUE/1992/JISPE2/Chasing-Black-Money-in-India.pdf

So secrecy became an absolutely necessary condition. Any leaks would have rendered the entire exercise futile by tipping off the black-money hoarders.

In a 1976 paper, On Black Money, http://www.jstor.org/stable/pdf/42657322.pdf K. Sundaram and V. Pandit wrote, “Since it is infeasible to demonetize currencies of all denominations, the success of this policy [demonetization] turns on the extent to which black liquidity is in the shape of currency of the denominations to be demonetized.”

Data from the Reserve Bank of India show that 86% of all currency in circulation is in the Rs500 and Rs1000 denominations, amounting to Rs14.2 trillion, or $212 billion.

Sundaram and Pandit added: “. . . insofar as the measure is anticipated in advance by some and conversion of currency in the relevant denominations takes place, success of this measure is further eroded.”

The policy did not take care of black money in the form of real estate or gold or other non-currency  assets. There are expectations and rumors of crackdowns in the near future on those who have bought real estate and gold through black money.

Impetus to Go Cashless
While the Rs500 and Rs1000 notes were to be removed, Rs2000 notes have been introduced. People were given a window of 50 days to deposit and/or convert the 500 and 1,000 denominations at banks and post offices – a deposit bonanza for the banks that lowered bond yields. http://www.bloomberg.com/news/articles/2016-11-15/black-money-purge-drives-world-s-only-bond-gain-amid-trump-rout  There were limits on the amount of money that could be converted on a daily basis.

Those who got Rs500 and Rs1000 notes converted were handed Rs2000 notes by the banks; Rs100 notes were available at automated teller machines (ATMs). The long queues at ATMs, and out-of-order ATMs, indicated that many people were either without cash or, with Rs2000 notes, were unable to complete small-value transactions because retailers, unequipped with smaller-denomination notes, were not willing to accept the Rs2000 notes.

As a result, many people who had never used debit cards began to do so. Many small retailers and suppliers of daily provisions started asking people to pay by card, cheque or digital wallets – cashless modes of transactions that will bring greater transparency and help curb the creation of black money in the future.

Inflation and Taxation
Dr. Arvind Panagariya, vice chairman of NITI Aayog, http://niti.gov.in/ told the Economic Editors’ Conference—2016 that “as the black money goes out of the system, the money supply will shrink to some degree. This will reduce inflation rate in the absence of any open market interventions by the Reserve Bank of India.”

A drop in inflation, coupled with banks deposit flows, will give the RBI room to lower interest rates in the future.

The scheme is designed in such a way that people hoarding large amounts of undeclared income in cash will find it difficult to dispose of that cash. There are no limits to deposits of Rs500 and Rs1000 denominations, but it has been made clear that deposits above Rs250,000 would be scrutinized and matched with the account holders’ income tax returns. Mismatches could lead to penalties of 200% of the tax payable, along with the payment of the tax payable.

Modi Initiatives
One of the reasons for the Narendra Modi government’s coming to power was public reaction to scams and corruption. Modi promised to fight corruption and bring good governance and in his November 8 address listed previous measures taken:
·         A law passed in 2015 requiring disclosure of foreign black money.
·         Agreements with many countries, including the U.S., for sharing banking information.
·         A strict law in force from August 2016 to curb benami (nameless or fake-name) transactions.
·         A voluntary income-disclosure scheme for declaring black money after paying a stiff penalty.

The prime minister told the citizens that almost Rs1.25 trillion was uncovered due to these efforts in the last two and a half years. He vowed that many more measures will come in the future.
Acknowledging the inconveniences, Modi implored the citizens to be patient and support the fight against corruption – to accept temporary hardships in the interest of a better India.

Political Reaction
Although the national mood seems generally positive, there was strong opposition from other political parties. Indeed, many political activities in the country are funded with black money.
Then there are cynics. To them, I would suggest an analogy: Corruption and black money is like cancer. A patient might prefer to withhold information from doctors in order to avoid painful treatments, or might want to avoid treatments without 100% assurance of a cure, which is unrealistic.

Tackling black money is important and should not be avoided. No amount of preparation will be enough in a country of 1.2 billion people, and there is always room for improvement.

Singapore’s The Independent hailed the demonetization, saying, “Modi does a Lee Kuan Yew to stamp out corruption in India,” a reference to that country’s transformational leader.

Time will tell if the policy will contribute towards making India a fairer, transparent and corruption-free economy. Black money and corruption are so deep-rooted that they cannot be completely eliminated. More efforts and persistence will be required. To paraphrase Robert Frost, there are miles to go before we sleep.

Wednesday, November 16, 2016

In Global Competitiveness, India Is Trending Higher

This article was first published by the Global Association for Risk Professionals on November 11, 2016;

China is 29th, India 39th in the World Economic Forum’s annual index, which is led by Switzerland, Singapore and the U.S.

India ranked 39th in the 2016-’17 Global Competitiveness Report, recently published by the World Economic Forum. The South Asian nation is 16 places higher than it was the previous year, and 32 above its 2014-’15 rank, and now most of those ahead of India are developed countries in terms of income or other parameters. (See illustration below for factors that go into the WEF analysis.)
In the competitiveness ranking topped by Switzerland, Singapore and the United States (unchanged in that order from a year earlier), followed by the Netherlands and Germany (switching places 4 and 5), China was 28th, unchanged since 2014-’15. Brazil has slipped to 81st (from 75 in 2015’-16 and 57 in 2014’-15). Russia improved to 43 from 45, and South Africa to 47 from 49.
In its region, India was best-performing in areas such as infrastructure, goods market efficiency, financial market development, market size, business sophistication and innovation. India still has a long way to go in health, primary education and labor markets — despite significant improvements health and education over the last decade.
What is behind the rise of India in the world competitiveness ranking?
Market size — India’s huge domestic market worked in its favor. Johan C. Aurik, chairman and global managing partner of strategy consulting firm A.T. Kearney, in an interview with Livemint, said that India, with an economy trailing only those of the U.S. and China, “is lucky that it is so big that it does not need the world.”
Financial market development — After being marred by scams in the 1990s and early 2000s, India’s stock markets have advanced in terms of modernization and technology, with the regulator (Securities and Exchange Board of India) backing efforts to bring them up to international standards.
Figure 1

Source: World Economic Forum
Similarly, the Reserve Bank of India (RBI) has taken steps to improve the bond markets, bring transparency to non-performing assets and bring inflation under control. The image of the central bank went up many notches under its 23rd governor, Raghuram Govind Rajan, who was succeeded in September by Urjit Patel.
Institutions — Policy paralysis, misuse of public money and infrastructure were among the reasons that people lost trust in public institutions and administration in the last few years of the United Progressive Alliance (UPA) government. In 2014, when the National Democratic Alliance (NDA) came to power, the Narendra Modi-led government has lifted public confidence.
Goods market efficiency — Although India is the best-performing country in South Asia in goods market efficiency, it has actually declined in this measure over the last decade. With passage of the goods and services tax (GST) by the parliament earlier this year, and efforts ongoing for an April 1 implementation, there may be significant improvement in overall market efficiency. “GST was a miracle, I thought it would never happen,” Aurik said.
Infrastructure — The key infrastructure ministries are seen as having done their job well over the past couple of years. The government has designated infrastructure as a top priority, and there has been significant, perceptible progress in power, roads and shipping, and railways. Besides planning to spend billions of dollars on infrastructure, the government has relaxed regulations to attract foreign direct investments (FDI) in the sector.
Labor market efficiency — India ranks lowest in this pillar (112th out of 138 countries). The current labor laws are outmoded and rigid. Although labor law reform is on the government’s agenda, it is a politically sensitive issue, and small steps meets with resistance. The proposed reforms would make hiring and firing easier for the large public sector undertakings.
Macroeconomic environment — The Indian economy is poised for further growth. Per capita income has almost doubled in the last six to seven years. The foreign exchange reserves of more than $360 billion help in maintaining confidence in monetary and exchange rate policies and enhance the capacity of the central bank to intervene in forex markets. The economy is well placed for meeting external obligations, and maintaining investor confidence helps to attract much-needed FDI.
Although fund managers are parking money in India due to the advantage they get from the positive interest rate differential, a lot of these funds, just as in other Asian economies, are seeking a more permanent destination. India is now the top FDI destination for the world. Prime Minister Modi sends out the right signals about the commitment of the government to providing the right environment for development.
Technology readiness — India has not done well in technology readiness despite its success in IT outsourcing. Regulators must keep up with the sophistication in market technology and new market structure. Enforcement cases will become more complicated as market manipulation and other misconduct are now also conducted on the Internet, where they are difficult to detect.
Cybercrime surveillance should be updated periodically. Also, whether a demutualized exchange should be regulated as any other listed company, or as a utility, will be a challenge for the regulators.
Health and primary education — Jim O'Neill, the British economist and former chairman of Goldman Sachs Asset Management credited with coining the term BRICs (Brazil, Russia, India and China), wrote on Bloomberg View about 10 things that India must do to achieve its potential. Two of those 10 were related to education — primary and secondary as well as colleges and universities. (Liberalizing financial markets and building more infrastructure were among the others.) Education is essential if the population of India is to be a true asset for development.
On the health front, the average growth in total health care spending is lower than the average GDP growth rate and lower, as a percentage of GDP, than that of even low-income countries, as classified by the World Bank. (India is classified as low-middle income.) It is estimated that nearly one million Indians die every year due to inadequate health care facilities, and close to 700 million have no access to specialist care.
Higher education and training — The country is home to the Indian Institute of Technology and the Indian Institute of Management, yet many graduates in India are unemployable. The quality of faculty and infrastructure and the number of institutions of higher education need beefing up.
Business sophistication and Innovation — There has been significant improvement in both business sophistication and innovation owing to increased research and development activities and the ecosystem for promoting start-ups.
Although many indicators are favorable, Prime Minister Lee Hsien Loong of Singapore, on a recent visit to India, said the country remains a difficult place to do business. Gaps in the regulatory framework and other crucial areas need to be addressed. India’s competitiveness ranking is an endorsement of the steps that have been taken and a reminder that there are still “miles to go.”

Tuesday, October 4, 2016

Value Investing: The Line from Graham to Buffett

This article was first published by the Global Association for Risk Professionals on September 30, 2016;

The Oracle of Omaha has not strayed from basic principles but adjusts to changing conditions

The stock of Berkshire Hathaway has historically outperformed S&P500 benchmark. As pointed out in the, Wall Street Journal (http://blogs.wsj.com/moneybeat/2016/05/02/warren-buffetts-epic-rant-against-wall-street/), “From 1965 through the end of last year [2015], Berkshire shares have risen 1,598,284%, compared to the 11,355% return on the S&P 500.”

Warren Buffett, the chairman of Berkshire Hathaway, was a student of Benjamin Graham, the foremost guru of value investing, at Columbia Business School. Buffett is Graham’s most famous disciple and has attracted many to adopt value investing.

“Intrinsic value” and “margin of safety” are the two keys to value investing.

When shares are bought at a price cheaper than what the market values them at, and sold at a higher price later, value is extracted through this transaction.

Sanjay Bakshi, managing partner of Value Quest Capital, a value investor, professor, and ardent fan of Warren Buffett and Charlie Munger, said in an interview, “There are times when the markets are extremely inefficient, and at that time you should take advantage of the market. If ‘Mr. Market’ is buying you out at crazy valuation, give him your shares, and if he is willing to offer his stake very cheap, take it. This fundamental principle of value investing has never been compromised by Buffett or any successful value investor.”

Margin of Safety

Graham’s margin of safety is one principle that has had a profound influence on Buffett. It is the difference between a stock’s market price and its intrinsic value. For example, if the market price is much below intrinsic value, the margin of safety is large enough to protect the investor against future uncertainty and market downturns.

“If you were to distill the secret of sound investment into three words”, Graham wrote in his book The Intelligent Investor, “we venture the motto, margin of safety.”

Firms which trade at a high margin of safety dramatically reduce the risk of a permanent loss of capital.

Sanjay Bakshi offers an explanation: “You need a gap between value and price because value might drop, or your valuation might be wrong. Great businesses get destroyed because of many reasons including technological obsolescence, change in regulations, natural calamity or management hubris. Value investors don’t buy dollars for 95 cents because that leaves little margin of safety. They buy at 50 or 60 cents or even lower. This principle too has not been compromised by any successful value investor.”

‘Great Companies’ and Book Value

While Graham advocated buying stocks that are underpriced relative to their intrinsic value and can earn more than what the market expects – that is, stocks with very high margin of safety or those trading at large discounts – Buffett does not shy away from buying at reasonable prices what he deems a “great company.”

Graham advocated that a defensive investor should look for companies with current ratio of at least 2, long-term debt not more than net working capital, positive earnings for each of the past 10 years, uninterrupted dividends for the past 20 years, 33% increase in earnings per share for the last 10 years using a three-year moving average, price not more than 15 times past three-year-average earnings, etc. Some of these were based on the then prevailing market conditions in the U.S. and can be easily modified to suit the changed conditions, different risk appetites and different countries.

Graham also suggested that conservative investors buy stocks at prices close to their book value per share, and no more than one-third above that figure. However, this criterion alone may not indicate a sound investment, and investors must verify that the company has a sufficiently strong financial position and its stock is selling at a suitable ratio of earnings to price.

Due to the emphasis on book value, which excludes intangibles, the criteria will tend to exclude firms that have considerable assets in the form of goodwill, patents, software, franchises, etc. While Buffett did invest largely in traditional stocks like General Motors and Coca-Cola in the initial days, his portfolio has changed over the years to include the likes of Verisk Analytics and IBM, which have considerable intangibles.

Financial Sector

A common refrain among Graham watchers and followers is to stay away from financial services. These stocks have a very different model, especially when it comes to deposit-taking institutions where the assets are essentially leveraged products and the liabilities can never be truly paid-off, as that would lead to a collapse.

However, according to The Intelligent Investor, “We have no very helpful remarks to offer in this broad area of investment other than to counsel that the same arithmetical standards for price in relation to earnings and book value be applied to the choice of companies in these groups as we have suggested for industrial and public-utility investments.”

The financial services sector as a whole is very diverse, with numerous banking, brokering and asset financing services coming under the umbrella. Buffett has over the years invested in such companies as American Express, Bank of New York Mellon, Goldman Sachs and Wells Fargo.

Although Buffett has himself said in the past that he is “85% Graham,” it is safe to say that his investment style has evolved over the years and adapted to changing business scenarios. As Bakshi puts it, “Buffett did not change any basic principle of Graham. He just applied them in a different manner.”

Thursday, September 29, 2016

Concentration: the case for putting all your eggs in one basket

This article was first published in the Financial Times, FTfm, on September 30, 2013; Co-author: Khemchand Sakaldeepi


Is diversification the best way to invest in the market today? Not really. The portfolios of major investors worldwide make the case for another, often-ignored, strategy: concentration. Business schools need to refrain from pushing the merits of diversification without highlighting the efficacy of concentration.

“Do not put all your eggs in one basket. Diversify.” In 1952, investment aspirants received this clarion call from Harry Markowitz, a US economist and Nobel laureate. Peter Lynch, the famous US businessman and stock investor, “never saw a stock he didn’t like” and was a great proponent of portfolio diversification. While managing the Magellan fund, at the peak of his career, Mr Lynch’s portfolio had more than 1,000 stocks. To date, portfolio diversification remains the most important lesson taught to students of investment and risk management. The concept is a common thread in the investment approach of most fund managers and investors.

However, if we look at the portfolios of the rich and famous, they are, surprisingly, mostly concentrated. Several great investors, spread across geographies, have very concentrated portfolios. Warren Buffett, George Soros, Rakesh Jhunjhunwala and many others are renowned proponents of portfolio concentration. To Mr. Buffett, over-diversification presented a “low-hazard, low-return” situation and thus he dismissed it. A concentrated portfolio pivots on the absolute conviction of the investor in his or her stocks and his or her risk appetite.

A diversified portfolio, on the other hand, works well if the investor is optimistic about the stock, but wary of the associated risk. Investors like the first billion-dollar Indian investor, Mr. Jhunjhunwala, walk a fine line between the two.

John Maynard Keynes, the influential British economist, was another staunch supporter of concentration. “As time goes on, I get more and more convinced that the right method in investment is to put fairly large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes,” he once said.

Mr. Buffett, echoing Benjamin Graham, the father of “value” investing, says he does not just buy an insignificant thing that bounces by a small percentage every day on the stock market. He buys part of a real business and thinks like the owner of a business would.

Mr. Buffett says: “Wide diversification is only required when investors do not understand what they are doing.” Bruce Berkowitz, founder of Fairholme Capital and a leading “value” proponent, adds that just a handful of significant positions are enough to do unbelievably well in a lifetime.

In 2012, the results of a study from the Paul Woolley Centre for the Study of Capital Market Dysfunctionality, University of Technology Sydney, showed that if skilled fund managers invested in concentrated portfolios, they would improve their performance markedly as compared with the portfolios that they would build under the compulsion to diversify. Despite mitigating stock-specific risks, the method of diversification cannot fortify the portfolio against market risks.

Advocates of concentration also opine that building or creating wealth with a diversified portfolio is difficult, unless the entire market is experiencing a bull phase and all the stocks in the portfolio are performing well. Even then, you may not get the full advantage of a multi-bagger as your investment in that particular stock would be just a fraction of your entire portfolio. The anti-diversification camp proposes that to generate wealth some concentration is required, provided people know how to assess their risk appetites and simultaneously pick winning stocks.

Fund managers today are caught in a catch-22 situation. Is wealth generated first by diversification and then maintained through concentration or vice versa? Knowing that concentration has been the mantra for success for most investment gurus, is it savvy to jump on the “diversification bandwagon” by adhering to popular belief? Awareness of such dilemmas and seeking clarity on them is essential for future managers.

It is, thus, time for business schools to introduce concentration as an important strategy in wealth creation, management and enhancement. Special attention needs to be given to this in business pedagogy, as the training of financial advisers and finance students will remain incomplete if it is restricted to the hallowed realm of diversification as the only plausible investment strategy.

Monday, September 12, 2016

Mobilizing Data and Analytics in Malaysia

The interview was first published by the Global Association for Risk Professionals on September 09th 2016

Insurers turn to predictive and anomaly-detection techniques as fraud losses cut into profitability and cause regulatory concerns.

Mounting motor insurance claims have been a source of worry for general insurers in Malaysia. They suffered a net loss ratio for Motor Act business of 219.6% in 2015, and an above-100% combined ratio for the total motor portfolio. The losses are attributable to high frequency of third-party bodily injuries, rising accident rates and medical costs, as well as fraudulent claims (Source: ISM Insurance Services Malaysia’s Statistical Yearbook.) Industrywide efforts are being made to control the fraudulent claims payout. A fraud detection and prevention system of Insurance Services Malaysia (ISM) is part of the industrywide effort to control payouts of fraudulent claims.

ISM was conceptualized in 1998 by the General Insurance Association of Malaysia (PIAM), initially to establish the Malaysian Insurance Rating Organization. In 2003, MIRO and the MIS department were merged to form the ISM department, and the scope of the project was expanded to include anti-fraud and IT-related services. ISM Berhad was incorporated in 2005 and today provides an infrastructure of databases and analytics that allows members to make informed decisions and support a liberalized pricing environment, build competencies in quantitative underwriting and technical pricing, and increase efficiencies in operations. The shared information and capabilities are accessible online to enhance fraud detection.

Mahendran (Mahen) Samiappan, the chief executive officer of ISM, discusses in this interview with Dr. Nupur Pavan Bang the general insurance industry in Malaysia and efforts by the organization to curtail fraud.

What is the state of the general insurance market in Southeast Asia, and particularly Malaysia?
Motor Insurance is the largest portfolio in the region, followed by property. Health insurance is generally sold as a rider with life insurance policies. So in comparison to the life segment, health is not a very big business for the general insurance market. Health is also sold as unit linked policies by the life insurers.

In terms of technology and distribution, Singapore would be the leader, followed by maybe Malaysia and Thailand. Everyone acknowledges that Malaysia has good regulations due to the active role played by Bank Negara Malaysia as the regulator of this industry. We have averaged a growth rate of 6% to 8% in general insurance consistently. In 2015 the industry experienced much lower growth, 2.7%, and 2016 is expected to have a low growth rate as well.

What are some of the major challenges in Malaysian insurance?
The biggest challenge is pertaining to the motor portfolio. Motor comprises 47% of the total portfolio. It is still under the tariff regime, for both the third party (act or mandatory) as well as the own damage (non-act) cover. The act business endures heavy losses as a result of rising claims-cost bleeding. The current tariff was set out in 1978 and has not been revised since then.

Bank Negara Malaysia has put in place a road map for gradual liberalization of motor insurance tariffs. By July 2017, non-act business will be de-tariffed, and gradually the act business may also see certain adjustments in prices. The flexibility to price is important for the Insurers, but it may lead to price wars, as has been witnessed in some other countries. That may still mean that the portfolio remains loss making.

Is the market ready to price?
The larger players, who have backing from their foreign partners with considerable underwriting and technical know-how, are ready for risk-based pricing. The largest insurer would have about 15% of the market share and, with that kind of data, coupled with their capabilities, can do the pricing.

The smaller companies may not have adequate data, and this is where ISM comes in. ISM was established to support the industry in the de-tariffed environment. So we will definitely play our role and carry out our responsibility to support the industry in this transition. The regulator has also been aggressively going around and assessing the readiness of the insurers.

Does Malaysia face the uninsured-vehicle challenge that some markets do? Uninsured vehicles not only result in loss of premiums for the insurers, they also have huge economic impact on the uninsured vehicle owners and victims of accidents.
Not really. The Road Transport Department and insurance databases are linked. So if a vehicle does not have the mandatory third-party policy, road tax will not be issued by the department. Road tax in Malaysia is annual, and almost all vehicles would have at least the act policy.

For the victims of road accidents, ISM provides a Vehicle Information Exchange service – if the vehicle registration number is captured, the details of the insurer of the vehicle can be obtained.

How is the industry tackling its leakage problems?
It is true that leakages from premiums as well as claims are plaguing the insurers. It is plain fraud. In its road map, the regulator has clearly stated that they want to control and manage fraud. They don’t want the insurers to be lax on claims and then keep adjusting (increasing) the premiums to cover the losses. The focus is on fraud and data quality.

ISM’s Central No Claims Discount (NCD) database is already being used by the insurers to plug leakages at the application stage. Over the years, the NCD database has evolved into a system called Claims & Underwriting Exchange (CUE), which provides alerts to the insurers based on certain business rules. For example when an old vehicle moves from act only policy to a comprehensive policy, it is unusual, and hence an alert is sent to the insurer. These initiatives have helped to some extent.

Can you elaborate on fraud at the application stage?
Fraud at the application stage can be perpetrated by a customer providing a bogus identity or falsifying records like the driving license, use of the vehicle, incorrect claims history, etc. There is a strong linkage between claims fraud and fraud committed at the application stage. Reducing application fraud can significantly decrease the exposure to certain types of claims fraud. Stopping fraud at the application stage saves investigation, claim adjudication, litigation and recovery expenses.

How is the industry planning to deal with such fraud?
ISM is working on a platform with an objective for comprehensive fraud detection and prevention. Using analytics techniques such as predictive modeling, link analysis, anomaly detection and text mining, claims will be scored, and certain claims with high potential of fraud will be highlighted based on business rules and analytics. The insurers can allocate resources to investigate the highlighted claims and thereby make more effective use of available resources.

However, analytics and models are only as good as the data. So a right mix of analytics with prudence, diligence and judgment should be applied by the insurers while processing applications and claims.

Monday, August 29, 2016

The RBI after Rajan

This article was first published by the Global Association for Risk Professionals on August 25, 2016;

Continuity, but a contrast in style, at India’s central bank

On September 4, 2013, the internationally prominent economist Raghuram Govind Rajan took charge as the 23rd governor of the Reserve Bank of India. He decided in June to depart at the end of his politically tumultuous three-year term, and with the August 20 announcement of his successor, deputy governor Urjit Patel, the book on Rajan is officially closing.

A former International Monetary Fund chief economist and University of Chicago finance professor, Rajan came in with a “rock star” image, a contrast to his predecessor, Duvvuri Subbarao, whose performance was the worst ever by an RBI governor, according to Arvind Panagariya, then professor of economics at Columbia University and now vice chairman of the government think tank NITI Aayog. Subbarao had kept the Indian economy relatively stable during the global crisis period. By the time he entered into the second phase of his tenure, in 2012, the economy was marred by nearly 10% inflation, a depreciating currency and low GDP growth.

Rajan dazzled with degrees from IIT (Indian Institute of Technology), IIM (Indian Institute of Management) and MIT (Massachusetts Institute of Technology) and a reputation for speaking his mind, was widely credited with predicting the 2008 crisis, and key economic indicators seemed to respond immediately to his moves.

Anticipated Criticism
When Rajan addressed the media after assuming office, he said, “Some of the actions I take will not be popular. The governorship of the central bank is not meant to win one votes or Facebook ‘likes.’” He said he sought “to do the right thing, no matter what the criticism, even while looking to learn from the criticism” — words that turned out to be prophetic.

Over the three years that ended September 4, 2016, Rajan did mostly the right things. He brought inflation down, stabilized the rupee, and GDP was going in the right direction. Yet he could not escape criticism.

There was really no end to the tug of war between him and the government over interest rate cuts. The government continually pushed for greater cuts, while Rajan refused until inflation fell within the targeted range. But even when inflation was within the targeted range, Rajan did not cut the rates as much as the government would have liked, citing risks in the global economy, rising crude oil prices and uncertain monsoons.

Rajan was also quite vocal about issues that did not directly come under his purview. That did not sit well with the government, which needed to tread carefully due to Rajan’s positive image amongst industry, the media and general public.

Return to Academia
Subramanian Swamy, a Harvard University PhD in economics and member of the Upper House of the Parliament of India, stepped up as the central banker’s vocal public critic. He was allowed to rant against Rajan for a long time before Prime Minister Narendra Modi made his unhappiness over the entire issue known, subtly, in a television interview. By then, Rajan had already issued a statement saying that he would not be seeking another term and would return to Chicago’s Booth School of Business, from which he was on leave.

There was outrage. There were letters of support for Rajan, speculations about who would succeed him and how he or she would measure up to Rajan in stature, independence and ability to complete policy and regulatory changes in progress.

Modi’s choice of Urjit Patel was seen as a safe one. Patel has a doctorate in economics from Yale University, along with degrees from the University of Oxford and London School of Economics. He has done stints at the International Monetary Fund, World Bank, Brookings Institution, Reliance Industries and Boston Consulting Group, and has been associated with various central and state government task forces and committees.

Patel is known to be the architect of the current monetary policy framework of RBI, which focuses on inflation targeting. He is quieter and lower-profile than Rajan. The consensus is that continuity in policies will be maintained and that the government did well in appointing an “insider” to succeed Rajan.