APPRAISAL VALUE. Art and science of portfolio management

Indian stock markets are on a bull run, which is attracting the attention of all and sundry. It is time to encourage investors and intermediaries of the capital market, including fund managers, to persuade people with surplus monies to multiply their wealth on the back of the India growth story.

The favourable demographics and reform-oriented progressive outlook of the current political executives make the India growth story sustainable over medium- to long-term. However, as the adage goes, “discretion is the better part of the valour”; the investors and more so the fund managers should exercise discretion in the decision making.

When investing in the capital market becomes a procession, prudence (discretion in investment management terminology) becomes the safeguard against the hubris. That prudence is the art and craft of investment management, a top up on the science of management to create optimality of a mixture of liquidity, safety and returns.

As chairman of the National Pension System Trust Board, in one of the review meetings, I had asked a fund manager whose investment into the commercial paper of a company gone bust had become an NPA, as to why did he invest in that instrument at all. He said, “When the investment call was taken, the debt paper enjoyed the highest rating”. Though the reply of the investment manager was valid in the crucible of science, it had dropped off into the ditch of NPA while treading on the platform of art and craft of management.

Whereas, the fund manager being questioned had utilised all of the above and more by selecting a highest rated paper, he had completely overlooked the art and craft of management.

The examination of the NPAs in the banking system would reveal a number of cases where well above the investment grade rated paper having joined the rank of the default category within a period of less than two years.

Similarly, investment in equities demands a constant watch over the investee company because there is nothing called immortal magnificence in the case of a corporate. A number of yesterday’s blue chips have become underperformers. In fact, the composition of both Nifty and Sensexis completely different from what it was just about five years ago. In the case of some weightage has gone down very significantly, while some others have been moved out.

On May 23 and 24, on account of couple of factors, in particular hint of stress on the border some of the mid and small cap stocks had fallen ranging from 5 to 25 per cent though the index had corrected only marginally.

While both the Sensex and Nifty more than recovered on May 25 and climbed to a new peak, those stocks pulled back only marginally. In the case of quite a few equity scripts, the price and volume are artificially built through the concerted and coordinated trades by of a set of brokers, while rumour-mongering is disguised as authentic news and spread selectively. The froth in the valuation can be deciphered while looking at them through a microscopic lens.

I always advocated during my days as the overseer of LIC’s investment management on the art and craft beyond the science of management. The art and craft begin with reading the numbers on the balance sheet of the borrowers as to what do these reveal and/or hide. Aggregate and disaggregate, slice and dice those numbers and then put it on a canvas to evaluate how does the painting look like. Also, gather, read and make sense of the information about the management — vision, values, cultures and skills and the enterprise as a whole — performance, transparency, perspectives and value creation. And the data sources have got to be different, complete and credible.

The testing of investment options on the firmament of science and art and craft should be validated further by relating the unrelated and imagining a connection. The investment manager has to be a storehouse of information. The information of the team has to be aggregated to create the integer. It is important for the fund manager to learn to weave events and then ask his heart — the artist and the mind — the scientist, what should be the decision. The colour and canvas by itself do not make a painting. It is the craftsman in the fund manager who puts the colour of science on the canvas of art to create a propensity of investment decision making.

When confronted about the culture and value system of the managers of that enterprise as also correlating some of the unread stories in the balance sheets of the associated companies, it was very clear that the science of management alone was used while investing in that instrument. The evaluation of the management and the performance of the group would have revealed that loss making enterprises of the group and extravaganza were being financed albeit stealthily by the enterprise with the highest rated paper through imaginative financial engineering.

It is also important to profile the people behind the enterprises; their lifestyle, value system, credibility and relationship frames with a variety of stakeholders etc. The fluidity of the environment challenges the investment managers to keep a constant vigil on the transforming shades of the profiles.

In case of intermediation, it is important to separate peddlers from skilled and professional investment bankers. The peddlers’ conduct and technique often border on inefficacies. It is believed that some of the NPAs of the PSUs were peddled very well. The eventuality of default or loss in investment value is forgone, if at the point of decision making the artist in investment manager is conspicuously absent.

The opportunities for investment in Indian capital market are wide and varied, both in debt and equity; individuals and, most importantly, fund managers as trustees of public monies have to realise that investment management is a conscious call where “promise to be financially and intellectually honest” is the fundamental underpinning.

The writer is former chairman of SEBI and LIC

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