Social Investing - An Idea whose Time has come

Author: Madusudanan Ramani,NMIMS,MBA-Capital Markets

Social Entrepreneurship – Exploring Newer Frontiers 

Social investing refers to investing in the firms that are in operation to bring about a social change in the society and such firms are called as social enterprises. The ultimate objective of these social enterprises gets reflected more in the empowerment of underprivileged than in just profit statements. Most of avenues available for development and upliftment are available in forms of charitable donations and grants. Sustaining the operations for a long period of time with donations is difficult on account of lack of adequate funds. Unlike public causes, social enterprises require knowledge support other than just funds.

The huge opportunities for social entrepreneurship stem from the inefficient government schemes to uplift poor and to improve their standard of living. Some of the examples of successful social enterprises in India are Ela Bhatt’s SEWA Bank, Dr. Verghese Kurien’s AMUL and Nand Kishore Chuadhary’s Jaipur Rugs. Given the nature of India, most of such opportunities lie in rural areas.

Most of the Social Enterprises can be classified into these broad areas –

1. Agriculture, Food and Rural Business – Firms that are involved in enhancing productivity in rural areas with an innovative practice. Some of the firms operating in this segment are Masuta Producers Company Limited, Star Agri, Champion Agro, Grameen Infra, Janani Foods, Native Conbac Bamboo Products, Drishtree and KNIDS Green.

2. Education – Enterprises committed to provide affordable education to the underprivileged. Some of the firms operating in this segment Levelfield Schools, Bookbox, Sudiksha Knowledge Solutions and Edaxis Systems India.

3.Clean Energy – Firms who provide solutions to reduce the carbon footprint. Some of the firms operating in this segment are d.light design, Husk Power Systems, SBA Hydro and Renewable Energy (SHREY) and ORB Energy.

4.Technology – Enterprises that have leveraged technology to enable development. Some of the firms operating in this segment are FINO, Gradeim, Embrace Global, B2R Technologies, Comat Technologies, SMV Wheels and Forus Health. 

5.Housing, Health & Sanitation – Enterprises that have provided affordable healthcare and sanitation to enhance the quality of living. Some of the firms operating in this segment are AyurVAID, Environment Planning Group limited, Ziqitza Healthcare, WaterHealth International (WHI), VisionSpring, PVRI, LifeSpring and Neurosynaptics.

      

The concept of social investing has started only in the last 5 years and is slowly evolving, whereas it has been in developed nations since a long time. Some of the Funds that provide funding to such enterprises in India are Lok Capital, Rural Innovation Networks, Acumen Fund, Aavishkaar Fund, VenturEast, Oasis Fund, Song, Elevar Equity II and Grey Matters Capital. Social Enterprises have attracted more than $ 140 million and has also been attracting some mainstream VC firms such as Nexus Ventures, IndoUS Ventures, Seedfund and Draper Fisher Jurvetson (DFJ). This segment is expected to receive almost $ 1 billion in the next five years from the VC/PE investors.    

Prospects for future

In a country like India, such enterprises benefit from the demographic nature of the country. Profitability in such enterprises increases significantly with vast scale. Given the population and the income profile of the country, such firms would be able scale up significantly and be attractive to investors.

Household Income Profile in India

More than half of the households in the country earn less than 1,12,000 per annum. There is a huge opportunity to provide basic services like Health & Sanitation, Education, Housing and Food at affordable prices.

Most of the segments other than Micro Finance have not been exploited. Of the total of $ 140 million received by such enterprises, an estimated $ 50 million has been received by the Micro Finance segment.  

Challenges for Social Enterprise

1. Finding the Right Kind of Investor – The funding for such business is big issue that the entrepreneur deals with. The entrepreneur faces a huge challenge of convincing the investor about the idea as a sustainable business proposition. Generally, Venture Capitalist and Private Equity investors have a investment horizon of 3-5 years. But given the nature of business (Profitability and Scalability), an exit in social enterprises could range from 5 to 8 years. It is imperative on the part of entrepreneurs to find an investor with larger time horizon. Predicting the future cash flows in the case of such business is not predictable and makes the valuation of start-ups difficult.

Dealing with people’s perception with is a huge challenge in this sector. The receptiveness to buy a product or consume the services of a social enterprise is generally low.

2. Profitability - Balancing Social-benefit versus Financial-return remains a key challenge for such entrepreneur. The entrepreneur has to build a asset light model to reduce the requirement of capital and improve the return on capital employed. Narayana Hrudayalaya saved money by asking the vendor to park the machine there and charge money by selling the reagents required for the test rather than buying the device.  

3. Scalability - The opportunities for such business in India are in plenty but they are scattered over a large catchment area. The businesses have to invest in technology to enable flow of information and better administration. The key to success of such firms lies in the reaching the consumer by right implementation and reaching a certain degree of scale.

Some renowned business models are profiled below

Narayana Hrudayalaya

Narayana Hrudayalaya was established in 2001 by Dr. Devi Shetty as a cardiac facility in Bangalore and it has become Asia’s largest Cardiac Care center with around 1,000 beds and performing 30 heart surgeries in the day. They have reduced cost of surgeries by altering processes, hard bargains with medical devices companies and creative partnerships. The heart surgeries in Narayana Hrudayalaya cost less than $ 3,000 as against $ 5,000 - $ 7,000 in other hospitals in the country and the hospital has one of the lowest levels of mortality rates. It initiated a scheme of micro insurance for the farmers of Karnataka, where in farmers are insured against heart surgeries at a monthly premium of Rs. 10.

Even though more than 15 percent of the patients have are charged a subsidized rate, the hospital makes healthy profit margin of 7.7 percent (post tax). JP Morgan and PineBridge investments have investments in the hospital and own close to 25 percent

.

Vortex Engineering

Vortex Engineering has innovated to produce low cost ATMs to enable banks to penetrate into unviable locations. The portfolio of Vortex includes Gramateller Indi ATM and Gramateller Duo ATM. The cost of vending machine and the power consumption is lower, factors that would help the banks to set up ATMs in unbanked areas. It has received funding from organizations like Oasis Fund, Raymond Stata, VenturEast, Aavishkaar and Vishal Bharat Comnet.      

SEWA Bank

Shri Mahila SEWA Sahakari Bank (SEWA Bank), a SEWA Group affiliate, has raised $ 10 million from International Finance Corporation (IFC) in January 2011. In 1974, SEWA bank was registered as a co-operative bank and is under the purview of RBI and the State Government of Gujarat. It generally lends to economically active low-income women. The bank has used mobile van and a team of field-workers to promote “Doorstep Banking”. SEWA Bank provided loans to 25,000 borrowers and has mobilized deposits from 348,000.

Greenway Grameen Infra

Established in 2010, after four years of ground work and research, Greenway Grameen Infra sells portable metallic chulas (stove), which is four times more fuel efficient that the traditional mud chulas. All the households not using a LPG form the market for Grameen Infra. The company sells the metallic chulas at Rs 950 and estimates the total market demand to be Rs. 10,000 crores.  

Husk Power Systems

Husk Power Systems (HPS) operates in the clean tech space, which uses to produce electricity using rice husk rather than diesel. It has set up such 60 mini power plants, each of them produce enough electricity for four villages. Each power plant has saved 42,000 liters of kerosene and 18,000 liters of diesel. HPS has received funding from Shell Foundation and Acumen Fund.  

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The Falling Rupee

Authors:  Bharat Mulchandani , NMIMS Capital Markets and Himanshu Bhutani , NMIMS Capital Markets

On the morning of 31^st May 2012, after reading the headlines “Rupee falls to a new low”, my father exclaimed, “I wish you were in the US right now, sending Dollars home”^{. [1]} Ironically, the “expensive” dollar was the reason my father refused to send me to the US to complete my post graduate education after I graduated in June 2010 (The exchange rate at that time was 1USD= Rs. 46.50). That was my first brush with the greenback and the affair has continued since.

Today, as a student of the capital markets, I wish to put my learning into practice and see how the economic theories I learnt in class apply to the current heartache caused by the dollar. Let us look at these theories in greater detail. 

The Demand Side

Current Account captures the difference between the imports and exports of goods and services in dollar terms. Here, we consider two commodities that account for most of our imports and drive the demand for the Dollar.

1. Oil

Let us analyze the consumption of oil, one of the most essential commodities and the chief driver for the demand of dollar in India. Even though the rupee depreciated from Rs 48 to Rs 56 in the blink of an eye and the price of crude stayed put close to a US$100 a barrel during the quarter ended 31^st December 2011, the demand for crude was not affected, as India imported nearly 3.45 million barrels of crude a day during FY 12. In value terms, crude imports rose 41% to US$141 billion. This, despite the volume imported remaining the same. 

Any undergraduate text book will explain that when currency weakens, imports become more expensive and people consume less. It's a way the currency and demand adjust themselves. In India, it doesn't work that way. Here, the currency slips, imports become more expensive but consumption does not fall.

What happens then? The currency further slides and slowly you find yourself in the midst of a vicious cycle. That's when a flexible exchange rate loses its significance. It's a point where economics ends and politics begins.The subsidy provided by the government artificially kept the demand high and also caused the government finances to take a severe hit. Moreover, the severe shortage of Dollars because of fund outflows by foreign investors resulted in the government hiking the price of fuel sharply. This further stoked inflation, already at dizzying levels because of supply side constraints, which affected the common man in the most extreme way possible. The prices of essential commodities such as food and milk went up drastically. The cost of travelling by public buses, once considered to be the most economical form of transport, increased by nearly 50%. The household budgets went for a toss. And coupled with a slowing economy ahead, it spelt difficult times for the man on the street.    

2. Gold

Let us consider the case of gold now. India’s been fascinated by gold since time immemorial and consider it to be the safest form of investment. This is reflected in the fact that India is the largest importer of gold in the world and accounts for one-third of the world’s demand. The gold import bill has risen from US$4.1 billion in 2001-02 to US$33.8 billion in 2010-11. As per the data released by ASSOCHAM India,gold’s share in the total import bill of the country has gone up from 8.1% in 2001-02 to 9.6% in 2010-2011. This accounts for the major outflow of the Dollars from the country and has a major impact on Fiscal Deficit. The table shown below gives us an overview of the demand for gold.

However due to the depreciation in local currency and rising fiscal deficit figures government has been taking some strict measures in order to curb the demand of gold. This is being done by imposing 1% excise duty on unbranded jewellery and doubling the customs duty on gold to 4%. The outcome of such measures is quite evident. India’s gold imports slowed to 200 tonnes (-30% YOY) in 1Q12. ^[3]

The Supply Side

Capital account records the flow of money in and out of the country. For a currency to be stable, the Dollar inflows in the capital account should match the deficit in the current account and vice versa. 

1.Capital Account Flows

In order to finance the gaps created in the current account by oil and gold, India needed to finance it by attracting Dollars for investment. And Dollars flowed in thick and fast due to the high returns on investment and the higher interest rate on offer. Using the interest rate parity theorem , we realize that the interest rates need to be high in order to ensure that there are sufficient capital inflows in order to finance the deficit, as is the case today, where the interest rates on offer in India are nearly 8% and near zero everywhere else around the world. So this should not be a problem right? But as it turned out, things have not quite been so smooth for India. Let us now look at the details. 

FII:

Foreign institutional investors have been a great source of dollar inflows for India. They invest in the India in order to capitalize on the higher interests on offer apart from trying to milk then security markets which features a number of high growth companies.

But, things have changed considerably. FII Inflows have dropped from US$30 billion in 2009-10 to US$18 billion in 20110-12. IN FY 13 also, FII have been net sellers, pulling out nearly US$327 million from the Indian Markets. 

This has caused severe shortage of Dollars and has led to a freefall in the rupee. And given that these flows move in and out of the country frequently, this has caused major volatility in the Rupee. This is demonstrated by the fact that the Rupee went from being the worst performing currency in Asia to the best performing and back to worst in a span of 6 months from December 2011- June 2012 as the FII inflows poured in at the start of the year and have been withdrawn after the budget session.

FDI:

Foreign Direct Investment was seen as critical to India’s development as the money was badly needed to build infrastructure in order to support economic growth. Thus the policies were liberalized and money came in.  But, due to unfavorable government policies such as GAAR and failure of government to take tough decisions rolling back its decision to allow FDI in multi brand retail due to pressure from coalition parties, FDIs inflows have dipped recently to US$1.32 billion in May 2012 compared to US$4.66 billion a year ago. And this has had a direct impact on the rupee.

NRI deposits:

In order to create newer avenues for dollar inflows, RI deregulated the interest rates for NRI deposits. As a result, Non-Resident Indian (NRI) fund inflow into Non-Resident External (NRE) deposits in the month of January 2012 touched US$1.6 billion, the highest in the last ten years. But this had little impact as this could not cover up the fall in inflows from FIIs and FDIs. 

 The Results

Balance of Payments is defined as a record of all transactions made between one particular country and all other countries during a specified period of time. One might argue that this fall must help exporters and reduce imports and that the situation will correct automatically. But what we fail to realize is that our imports are far greater than our exports and that the demand for oil is nearly inelastic due to the subsidies provided. It is precisely this imbalance between the current account and capital account in the current scenario has led to a Balance of Payments crisis. What it simply means is that we are using up our foreign reserves rather than adding to it and it is going to be very difficult expect the RBI to intervene directly to stem the fall. This can be illustrated by the fact that our forex reserves fell US$12.8 billion Dollars in Q3 and US$5.7 billion Dollars in Q4 of FY12 respectively.[3] RBI has used various measures such as limiting the banks open position in contracts and providing Dollars directly to the oil marketing companies. But this has simply helped in reducing volatility, and has not prevented the Rupee from falling. Moreover, even though there have been more remittances, they have not been able to compensate for the outflows on current account and reduced inflows on the capital account. RBI just does not have enough firepower in order to do anything due to limited forex reserves.

The onus is on the government now to put its act together and stop using monetary policy to correct structural problems in an economy. Strong measures have to be taken on the fiscal policy front such as removing fuel subsidies and reducing fiscal deficit. Government needs to come out of its slumber and take decisive political decisions such as FDI in retail to attract Dollars and help recover. I know that increasing fuel prices would harm the economy, but I sincerely believe that Indian must bear the pain through this correction as this will result in a far superior recovery and will ensure that we will reach a solution rather than postpone the problem.   

It is amazing the manner in which a common Indian household, which may have never seen the dollar, is being ruled by it.

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COMMODITY PRICE DYNAMICS

Authors:Pallav Kumar, NMIMS ; Ashish Agrawal, NMIMS

In spite of the consistent attempts being made for stabilizing the commodities market, it still remains to be the most volatile one. Several steps are being taken in order to overcome the volatility. In the agricultural commodities for example, commodity buffer stock scheme has been used, the idea behind this is to store a part of the production in the years when there is good harvest, thus increasing the price from what it would have been and sell the stored goods in the years when there is less production, thus reducing the price from what it would have been.

While the neo classical commodity market models (which promotes efficient markets hypothesis) believe the rational speculators to be a key element in the price stability in the commodities market, the speculators are proving themselves to be a major cause of price instability. As per the chartists and fundamental approach, the interaction between heterogeneous agents, chartists and fundamentalists, may cause a skewed movement of asset prices. As per simulations, whenever the govt. imposes a minimum price to support the producers, the volatility decreases, however the average price of the commodities declines too. Likewise, when the government imposes a maximum price to support the consumers, the volatility decreases, but the average price which consumers pay, increases. This puzzling outcome is because of the dynamic lock in effect.

When the price of the commodities has crossed a critical upper limit the bull market turns into a bearish one. When the govt. intervenes to inhibit this shift it puts a cap on the price of the commodity. As a result, the average price becomes higher than what it would have been without the cap. Moreover, since the price is fluctuating at a high level, it reaches the price cap repeatedly so that the buffer stock is likely to finish rather quickly. Alternating between a lower and an upper price boundary can be seen as one of the ways to counter this problem. The price volatility thus gets decreased but the market still remains distorted. This process of changing the level of price limiters and on-off switching however leads to severe bubbles, crashes or volatility clusters. Hence commodity markets are extremely volatile and regularly display severe bubbles and crashes.  Such price dynamics may, of course, be triggered by demand and supply shocks.

As per the cobweb model, complicated price movements can be attributed to nonlinearities. However, apart from this there exists an additional source of market instability. As most of the commodities are traded at stock exchanges, speculators can also prove to be the deciding factor in commodity markets. Surprisingly, this aspect has received only little attention so far. In a market basically three types of agents interact i.e. the consumers, the producers and the speculators. Speculators are considered to be the heterogeneous one since they are used to both technical and fundamental trading strategies, and, at the inception of each trading period, they choose one of the two strategies as their own trading strategy for that given trading period. Their behavior can be regarded to be rational since they decide between these two strategies depending upon the market.

We are assuming that the price adjustment on the commodity markets may be given by a log-linear price function.

Hence, the log of price S at time t + 1 is 

                                              S_t+1 = S_t + a (D^t + W^tC D^t + W^tF D^t )

Here ‘a’ corresponds to the positive scaling coefficient in order to calibrate the price adjustment speed; D^t corresponds to the excess demand of the real economy, the technical and the

fundamentalist analysts respectively at time t.

The weight of the chartists at time t is given as W^tC, whereas the weight of the fundamentalists is given as W^tF

  

 To illustrate the demand and supply decisions for the real economy we are introducing a reduced form assuming that the supply schedules of both the consumers and the producers are log-linear. The excess of demand for the real economy can be expressed as

                                                     D^t = m (F − S_t),

Here ‘m’ refers to the slopes of the supply and demand curves and F corresponds to the long-run equilibrium price (also called the fundamental price).  When the value of the price is equal to the value of the long-run equilibrium price F, the excess demand of the real economy turns out to be zero. We can then assume that the economic structure is quite stable and there are no or very few permanent demand and supply shocks. As a result, the value of F remains constant over time. In the absence of speculators,

                                                   W^tC = W^tF = 0,

In this case law of motion of the commodity’s log price has a unique fixed point at S_t =F, Such a state is obviously efficient. Speculators are familiar with both technical and fundamental analysis.

Now, to model the excess demand generated by chartists or the technical analyst we formulate:

                                                    D^t = b (S_t - F)

Where ‘b’ is a positive reaction coefficient and F is the long-run equilibrium price (also called the fundamental price). The technical analysts believe typically in bear and bull markets. As long as the price is above the fundamental value, chartists regard the market to be bullish. Since a further price increase is expected, chartists believe in buying the commodity.  However, if the price drops below the fundamental value then the chartists tend to lose faith in the stock.  In a bear market, chartists sell the commodity.  Since changes in excess demand are positively correlated with changes in price, it is in a broader sense consistent with positive feedback trading.

Fundamental analysts believe that prices tend to revert back to their fundamental value. If the price is above its equilibrium value, lower prices are expected and fundamental analysts tend to sell the commodity. In the same way if the price is below its equilibrium value, higher prices are expected and fundamental analysts tend to buy the commodity. The excess of demand generated by fundamental analysts can be given as

                                                            D^t = c(F − S_t).                                              

Here c is the reaction coefficient.

The Speculators tend to exploit interchangeably the bull and the bear market situations. However, when the price deviates more from its fundamental value, speculators perceive more risk for the bull or bear market to collapse. As a result, an increasing number of speculators tend to go for fundamental trading. The market share of speculators who tend to apply technical analysis may thus be given as

                                                          t   =1/ 1+d (F−S_t) ².

The higher the switching parameter d is greater than 0, faster the speculators tend to switch to fundamental analysis.

The weight of fundamentalists is       

                                                           W^tF = 1 − W^tC

Although producers and consumers are the two primary participating agents in the commodity markets, there are also other participants, such as speculators, who may have a definite effect on the degree of price variability and on the success of any commodity price stabilization scheme.

Thus we can say that the chartists are a source of market

instability.  Also weak reaction of the speculators (either the fundamentalists or the chartists) can push the market to be either a bull or a bear market and strong reaction of the speculators causes market prices to fluctuate irregularly between bull and bear markets. 

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Niveshgyaan 2012 Begins! : Lecture 1

Kick-starting our fornightly corporate talk series with a lecture on modelling and valuation by an associate director of CRISIL!

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Pledging of Shares –A boon or a curse???

Author: Pratik Jain

Pledging of share is a simple mechanism where promoters, in order to raise funds for either personal or company needs, pledge their holding shares to any financial institution, it is a phenomenon in which the promoter of an entity keeps his own stake as collateral for the borrowed funds; the debt can be for personal purposes or for the companies’ sake.

Generally the loans provided is about 25-40 % of the collateral value depending upon the liquidity in the market and the profile of the company and the promoter. Due to restriction on the part of banks to provide such funding, the Non Banking Financial Institutions (NBFC’s) are more active in providing such kind of loans.

So what does it mean for retail investors?

If an entity has raised funds by pledging their shares it means that the company has exhausted all other options of raising capital from the markets. Usually, pledging is used by the promoters as a last resort to raise capital.

If the promoters have raised the capital for the betterment for the business, investors need not worry, but if it has been raised for personal needs it sends a negative signal to the investor. 

The risk for the promoters

The real problems begin when the share prices tumble for any reason, shares worth 200 crores are suddenly worth only 120cr. The lenders would as for ask for more shares as collateral. If the promoter cannot provide more shares than the lender has the right to sell these shares in the market.

The risk for retail investors.

After the SATYAM fiasco, where it was found that most of the shares held by the promoters were pledged, SEBI has made it mandatory to disclose details about pledging of shares. Unfortunately, some of the critical information as to why the shares have been pledged (for personal or corporate reasons) which can change your view about the stock have still not been made mandatory.

The Indian Angle

As discussed above pledging can be risky for a promoter and can even make him lose his stake in the company. Yet more than 800 companies have taken this route to raise capital. As discussed above it is generally the last resort for funding. But promoters still prefer it because it does not lead to dilution of their holdings.

Another pitfall is that financiers have hardly taken a stern view against defaulting promoters. Often imprudent lending leads to the promoter going bust and the retail investors witnesses a loss of wealth.

List of Indian companies as that have pledged shares as a percentage of their holding

% of Promoters holding pledged	Number of Companies	Major Companies
90%+	More than 60	Ansal Properties, United Spirits, Gujarat Pipapav Port
75-90 %	Around 70	Wockhardt, Essar Oil, Orchid Chemicals, S Kumar Nations
More than 50 %	More than 100	Alok Industries, Suzlon, JP Power, Everonn
Less than 50 %	More than 500	Network 18, Tata Tele, Hero MotoCorp

Margin Call - Triggers

In the week ending July 27^th 2012, there was a lot of selling pressures on mid-cap stock like Tulip Telecom, Pipapav Defence, Parsvnath Developers etc. These companies had a very high level of promoters holding being pledged. Shares of Tulip Telecom plunged up to 40 % on a intraday basis on fears that margin calls had been triggered and a large operator was selling these shares before rising and closing at 25 % down. Pipapav Defence was down 12.5 % and 10% on consecutive days .

The companies eventually gave press releases that no margin calls had been triggered and it was business as usual at these companies. So as you can see, even rumors of margin call triggers by finance companies can send the stock tumbling down as everybody presses the panic button and sells. After the events of this week SEBI has swung into action asked BSE and NSE to put these stocks in 5 % circuit filter bracket.

 

 PIC: Drop In price of Tulip Telecom on July 26th, 2012 due to fear of margin call triggers 

Course of Actions for Retail Investors

Pledging of shares by companies’ promoters does not necessarily mean that the company should be avoided totally, but certain prudence should be shown while investing in such companies. Companies with large debt on their books and a large percentage of pledged shares should be avoided. A few exceptions to this can be some large cap companies like Hero MotorCorp. But as Warren Buffett number one rule says “Never Lose Money” one should approach these stocks with a certain level of caution and investors with relatively low risk appetite should certainly avoid them.

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