The Hindu Business Line : Rated futile

It is interesting that the Securities and Exchange Board of India should ask that all Initial Public Offers of equity shares be rated. But what value will rating bring to investors? There is no precedent in the developed markets of IPOs being rated. The success of this move will depend on the rating agencies and the ways investors interpret the ratings. Since the major regulatory push in early 1998 to have fixed deposit schemes of companies compulsorily rated, rating agencies have been evaluating a variety of sophisticated debt instruments. Investors have also come to realise the value of the exercise, how for example an investment grade rating for a particular scheme should be seen as a trade off between high safety and relatively low yield.

The acceptance by the investors and the reliability of the rating exercise for debt instruments have paved the way for a more efficient intermediation between savings and investment. Small investors have a readymade guide in the rating symbol and choose investment avenues appropriate to their risk appetite. In the process of rating, the agencies have acquired considerable industry-specific expertise and this would no doubt be of immense value when they get to rating equities. However there are fundamental differences between equity and debt. Debt instruments are more amenable to rating. Safety of the money invested in a particular scheme and the company's ability to repay the rated debt are the key factors in a rating exercise. As a rule, the rating does not change very quickly nor often in the case of debt instruments. In the case of equities too, business fundamentals may not change, but valuation is influenced by both investor expectations about future earnings of the company and their assessment of how other investors would look at this prospect. Assessments therefore are liable to change and constantly. Equities, by definition, are risk capital. An investor seeks not just dividend, but capital appreciation too. Rather than just the safety of the funds invested, it is the attractiveness of the price of a particular stock that would guide investors. The problem with rating is that it will not warrant anything about the price; and there will be no straight advice on whether the stock is worth investing in.

Yet the exercise may not be altogether without value. In theory, a prudent investor can get all he or she needs by a diligent scrutiny of the offer document and the disclosures therein. But the argument that an ordinary investor is not really equipped to see through the clutter is not without merit. As a supplemental piece of information to the existing process by which investors arrive at decisions, an independent grading assessment will not hurt.