Thursday, April 10, 2014

Foreign Institutional Investors ( FII )

Institutional investors are organizations which pool large sums of money and invest those sums in securities, real property and other investment assets. They can also include operating companies which decide to invest their profits to some degree in these types of assets.

Typical investors include banks, insurance companies, retirement or pension funds, hedge funds, investment advisors and mutual funds. Their role in the economy is to act as highly specialized investors on behalf of others. For instance, an ordinary person will have a pension from his employer. The employer gives that person's pension contributions to a fund. The fund will buy shares in a company, or some other financial product. Funds are useful because they will hold a broad portfolio of investments in many companies. This spreads risk, so if one company fails, it will be only a small part of the whole fund's investment.

An institutional investor can have some influence in the management of corporations because it will be entitled to exercise the voting rights in a company. Thus, it can actively engage in corporate governance. Furthermore, because institutional investors have the freedom to buy and sell shares, they can play a large part in which companies stay solvent, and which go under. Influencing the conduct of listed companies, and providing them with capital are all part of the job of investment management.

FII is defined as an institution organized outside of India for the purpose of making investments into the Indian securities market under the regulations prescribed by SEBI. Positive tidings about the Indian economy combined with a fast-growing market have made India an attractive destination for foreign institutional investors.

These investment proposals by the ‘FII s’ include “Overseas pension funds, foreign corporates, individuals, mutual funds, investment trust, asset management company, nominee company, bank, institutional portfolio manager, university funds, endowments, foundations, charitable trusts, charitable societies, a trustee or power of attorney holder incorporated or established outside India proposing to make proprietary investments or investments on behalf of a broad-based fund.

FIIs can invest their own funds as well as invest on behalf of their overseas clients registered as such with SEBI. These client accounts that the FII manages are known as ‘sub-accounts’. A domestic portfolio manager can also register itself as an FII to manage the. funds of sub-accounts

In order to act as a banker to the FIIs, the RBI has designated banks that are authorised to deal with them. The biggest source through which FIIs invest is the issuance of Participatory Notes (P-Notes), which are also known as Offshore Derivatives.

Wednesday, April 9, 2014

Insider Trading

Insider Trading has been all over the news lately. First it was Enron and WorldCom. Then even the apparently squeaky clean Martha Stewart got pulled in. So just what is Insider Trading? How can you avoid problems with it, even if you are not classified as an insider?

Insider trading isn’t fraud. In most cases those prosecuted never had contact with the alleged victims on the other side of their trades. Although the victims chose to trade without prompting, the legal issue is only whether the trade was based on inside information.
 

How it occurs ?

Insider trading occurs (1) when an insider to a company, such as an officer or someone who owns a large percentage of the company, trades the company's stock. This is legal and acceptable, as long as that person is not trading based upon non-public company information.

Insider trading also occurs (2) when anyone, including employees, trades using non-public company information. This is considered illegal.

The illegal kind of Insider Trading is the trading in a security (buying or selling a stock) based on material information that is not available to the general public. It is prohibited by the US Securities and Exchange Commission (SEC) because it is unfair and would destroy the securities markets by destroying investor confidence.

The law bizarrely affects only one-half of the trading equation. People make money by not trading as well as trading. But it is virtually impossible to prove that someone chose not to buy or sell stock because of a legally improper tip. So hundreds, maybe thousands, of people get away with insider “not trading” every year. Yet it isn’t obvious that the operation of the financial markets is impaired in any way.

If there is a problem in the market about insider trading, it’s that the market is biased by imposing criminal sanctions on only one side of the transaction. Inside information should lead roughly equal numbers of people to buy, sell and do nothing. The criminal law encourages people to do nothing. Whatever the impact, it isn’t likely to be more efficient markets.

Insider-trading laws deny markets important information. The recent financial crisis was caused in large part by inadequate information. People didn’t know the true value of mortgage-backed securities, leading to a financial house of cards that crashed down on federal agencies, investment houses, commercial banks and average investors.

The distinction between public and non-public information is legally decisive but economically unimportant. Perversely, the insider-trading laws seek to prevent people from trading on the most accurate and up-to-date information. The law seeks to force everyone to make today’s decisions based on yesterday’s data. It’s a genuinely stupid thing to do.

The only plausible argument for ensuring that everyone trades on inadequate and outdated information is “fairness.” The Securities and Exchange Commission’s Enforcement Director, Robert Khuzami, says insider-trading prosecutions are aimed at restoring “the level playing field that is fundamental to our capital markets.”

That is, just because your brother-in-law works at the accounting firm, you shouldn’t be able to buy or sell based on his disclosure of a client company’s dire financial straits until everyone knows it.

But Wall Street is built on metaphorical hillsides. The market is suffused with this sort of unfairness. Professional investors make money because of asymmetries of information. Someone working on Wall Street is almost always going to be better versed on financial issues than a casual investor. People make careers picking up hints and suggestions to use in trading.

However unfair it might seem to trade on inside information, it is unfair to no particular person.

Unless you committed fraud as part of the transaction, the person who bought your shares or sold his did so because he wanted to do so based on his information. Your “inside” information had no impact on his decision, especially in the impersonal markets through which most security transactions occur.

Acting on new information moves the market toward the right or “honest” price, as economist Donald J. Boudreaux puts it. Prosecuting people for insider trading slows the price-adjustment process. That means the price shock when the relevant news hits the market will be more abrupt and the losses will be greater for some people.

In some insider-trading cases there is a genuine victim: individuals or companies whose proprietary information was improperly disclosed. That should be punished, but as a civil offense based on the relevant contractual or fiduciary relationship. This kind of disclosure shouldn’t be of concern to the feds, let alone be an offense serious enough to justify wiretaps and mass arrests.

Yet the SEC employs sophisticated computer software to identify a few “suspicious” trades out of hundreds of millions of transactions. Agency enforcement chief Khuzami wants greater access to grand-jury information and greater power to pressure defendants to turn in their confederates.

Insider trading shouldn’t be a crime. There typically is no victim. To the contrary, most of us benefit when prices move more rapidly to the right level.

Unfortunately, prosecutors, regulators and politicians alike periodically demonize insider trading to justify their offices and budgets. But there is no reason to punish investors who trade on accurate information. In fact, that is precisely what the financial markets should encourage.

An Insider

A company insider is someone who has access to the important information about a company that affects its stock price or might influence investors decisions. This is called material information.

The company executives obviously have material information. The Vice President of Sales, for example, knows how much the company has sold and whether it will meet the estimates it has provided to investors. Others within the company also have material information. The accountant who prepares the sales forecast spreadsheet and the administrative assistant who types up the press release also are insiders.

A public company, if it is smart, limits the number of people who have access to material information and, therefore, are considered insiders. This is done for a couple of reasons. First, they want to limit the likelihood that anyone will "leak" the information. Second, being an insider means being subject to severe limits on when you can trade in the company stock, usually only the middle month of each quarter.

The company's senior management are insiders. So are some of the financial analysts. The top sales people usually also are insiders, although a regional sales manager who only sees his or her own region's results may not be one. The individuals in Investor Relations and/or Public Relations who prepare the public announcements also are insiders.

If the company is developing a new product that could be a big seller, the key people in the Research & Development team would also be considered insiders, provided the information they have is material, as defined above.

Other individuals who are not employees, but with whom the company needs to share material information, are also insiders. This list could include brokers, bankers, lawyers, etc.

Not An Insider

So does that mean you are not an insider unless you are on the company's management team, financial or development teams, or someone hired to handle the material information? In a word, "No".

The SEC includes in its definition of insiders those who have "temporary" or "constructive" access to the material information. If the President of a company tells you that the company's best hope for a breakthrough product isn't going to get regulatory approval, you are now every bit as much an insider as he is, with respect to that information. It is illegal for him to trade based on that knowledge before it becomes public knowledge. It is equally illegal for you to do so because you are now a "temporary insider". This remains true regardless of how many times the information is passed. If the president tells his barber, who tells her baby sitter, who tells her doctor, who tells you, the barber, baby sitter, doctor and you are all "temporary insiders".

Anyone who has material information is prohibited from trading, based on that knowledge, until the information is available to the general public. The US Supreme Court ruled recently, that this even applies to someone with no ties to the company. Possession of material information makes you an insider, even if you stole the information.

Employees Stock Option Plan

ESOP means Employee Stock Options. As the term signifies, ESOP is about ‘options’. Employee Stock Options or ESOP are generally given by most of the big companies in India, especially IT companies which are listed outside India to their employees

ESOP’s are Employee Stock Option Plans under which employees receive the right to purchase a certain number of shares in the company at a predetermined price, as a reward for their performance and also as motivation for employees to keep increasing their performance. Employees typically have to wait for a certain duration known as vesting period before they can exercise the right to purchase the shares. The main aim of giving such a plan to its employees is to give shares of the company to its employees at a discounted price to the market price at the time of exercise. Many companies (especially in the startup phase) have now started giving Employee Stock Options as this is beneficial to both the employer as well as the employee. ... read more on yourstory.com

If the market price of the stock is above the procurement price, the employee stands to gain by selling it off immediately. If however the price is below the agreed price level, the employee has the option to set aside his option and not exercise it.

ESOPs are nothing but “OPTIONS”, which are also in stock market in India (remember Future & Options?)

Let me tell you what Stock Options are in general. If a person has a Stock Option, he actually has a right to BUY a stock in future at a pre-decided price agreed at the time of giving those stock options. So in future whatever is the market price does not matter, you always have an option to buy it at the price which was agreed upon. In this case if market price of the stock is above the pre-decided price, then you can just exercise your options of buying the stock and instantly you will be in profit. If however, the current market price is less than the pre-decided price, then you choose not to exercise the stock option at all and nothing happens.

Let me give you an example. Let’s say that an employee joins a company on 1st Jan 2013. His company gives him 500 ESOPs with vesting period of 3 yrs and at the vesting price of Rs 200. What this means is that his vesting date is 1st Jan 2016 (after 3 yrs) , On that date, he has a OPTION to buy 500 stocks of the company at Rs 200 if he wishes. Now lets say on 1st Jan 2016 …

Case 1 – The stock price is Rs 800

In this case, the employee can exercise his option and he can get 500 stocks at only Rs 200 . At this moment, the employee will make a clean profit of Rs 600 each shares and a cool Rs 3,00,000 . Note that he does not have to pay anything here, when he exercises his option, he will automatically get his profit without putting anything from his pocket. It makes sense to exercise his option in this case, because vesting price is less than market price.

Case 2 – The stock price is Rs 130

In this case, it does not make any sense to exercise, because you will be in loss, because the price you have to pay is less than market price, so you let this option go.

Note : In case of stock options, you can never make any loss, it will always be some profit only.

Tuesday, April 8, 2014

Red Herring prospectus

The term red herring originates from the tradition whereby young hunting dogs in Britain were trained to follow a scent with the use of a "red" (salted and smoked) herring (see kipper). This pungent fish would be dragged across a trail until the puppy learned to follow the scent.

The reason it is called a red herring is due to a disclosure statement printed in red ink on the cover which explicitly states that the issuing company is not attempting to sell its shares. e.g. "A Registration Statement relating to these securities has been filed with the Securities and Exchange Commission but has not yet become effective. Information contained herein is subject to completion or amendment. These securities may not be sold nor may offers to buy be accepted prior to the time the Registration Statement becomes effective."

When a company decides to go public the company appoints underwriters and registrars of issue, it first involve one or more investment banks known as underwriters. The company and the investment bank first discuss some aspects like the amount of money a company will raise, the type of securities to be issued and all the details in the underwriting agreement. After the company secures an underwriter, it files a draft offer prospectus SEBI for review. 


This document contains information about the offering and company’s information like financial statements, management background, legal issues (if any), use of proceeds and risk factors. Once the draft document cleared by SEBI, it becomes offer document. Offer document is then submitted to registrar of the issue and stock exchange. Once offer document gets clearance from stock exchange, Issuer company makes it available to the public. The issue prospectus is now called as ‘Red Herring Prospectus’.

It means a prospectus which does not have complete details as regards the price at which the securities are being offered and the quantity of securities. When the offer of securities gets closed, then the company has to file a final prospectus stating therein the total capital or quantity of securities raised and the price of the securities or any other details which were not given in the red-herring prospectus. This final prospectus, in case of a listed public company, is necessary to be filed with the Securities and Exchange Board of India (SEBI) and the Registrar of Companies but if the company is not a listed one then the company has to file the final prospectus only with the Registrar of companies.

Red Herring Prospectus is a prospectus which does not have details of either price or number of shares being offered or the amount of issue. This means that in case price is not disclosed, the number of shares and the upper and lower price bands are disclosed.

On the other hand, an issuer can state the issue size and the number of shares are determined later. An RHP for and FPO can be filed with the RoC without the price band and the issuer, in such a case will notify the floor price or a price band by way of an advertisement one day prior to the opening of the issue. In the case of book-built issues, it is a process of price discovery and the price cannot be determined until the bidding process is completed.

Hence, such details are not shown in the Red Herring prospectus filed with ROC. Only on completion of the bidding process, the details of the final price are included in the offer document. The offer document filed thereafter with ROC is called a prospectus.

Monday, April 7, 2014

Moat of an Indian Stock

The moat was used as a defence mechanism for castles. Usually, they were filled with water to reduce the risk of fires and create a barrier for horses and their riders. The moats were created very deep, which made them harder to cross.

Most are familiar with the sight of a moat, traditionally dug around castles, and frequently filled with water. When the moat was first employed, it was meant to provide an additional defense of castles, towns, or large installments of people. A water filled moat made extremely difficult to storm a castle and or gain access to the walls of a fortress. Attacking armies could not simply climb the walls, and attempt to bring them down, because the moat proved a formidable obstruction. Further, attempts to fill in the moat or provide a crossing was often met with a volley of arrows, to discourage such attempts.

During the early Middle Ages, a moat might not be filled with water. It was still a trench deep enough to render it difficult for attackers to breach the walls of a building. A moat not filled with water is a dry moat. Later, most moats were filled with water. However, they were not, as some suppose, filled with alligators or sharks. It would have been virtually impossible to keep sharks alive in moat conditions; it’s very hard to keep them living even in today’s aquariums. Keeping alligators would also have proven impractical.

Most early versions of the moat did not have drawbridges, as one most often thinks. They did have bridges that could be removed easily at the approach of an enemy. In most cases, drawbridges were not employed until the late Middle Ages.

Though we commonly think of the moat in association with European Castles, Medieval Japan and China had impressive moat systems guarding cities and castles. Some Japanese cities would have not one but several moats. Some buildings might be built between some of the moats, but the vital parts of the city could be protected by as many as three moats. Sometimes these moats were the dry moat variety. Today, a few moats remain, like the one surrounding the Japanese Imperial Palace.

Some Native American tribes also built moats around central living areas, at least as far back as the 16th century. These provided some protection against raiding tribes or raiding Europeans. However, the introduction of the rifle to American Indians did render some moats useless, unless they were very wide.

Trenches dug during many wars work on the principal of the moat, though these are dry moats. Even today, a military force may dig large trenches to slow down an enemy, make motor transport impossible, or to keep tanks from crossing. A moat or trench can also be a useful place to hide during long battles.

Moats also frequently are used in zoos to keep animals in. These normally span a large, unjumpable distance, and are fairly deep. Fans of the computer game Zoo Tycoon, know digging a moat around dinosaur installments is an excellent way to keep large predators from escaping and eating the scientists.

ITC's low-tax cigarette launch has helped boost margins.
 

Investment Thesis

ITC, India’s largest cigarette manufacturer by revenue, has garnered leading market share through its popular brands. It's not without its share of challenges, which include competitive pressures from cheaper substitutes such as chewing tobacco and leaf-rolled tobacco, and the potential for further government intervention (like the passage of higher taxes). Even so, ITC has defended its turf for several years by investing in product innovation, and in marketing its core brands. In addition, ITC has also recently expanded its product set to include lower-priced products (which are subject to a lower tax rate) to expand its customer reach. This has allowed it to post solid sales growth and expand operating margins in its cigarette business, despite rising taxes. We believe ITC will continue to hold a dominant position in the Indian cigarette market for over a decade, and we think Indian smokers will trade up to more premium brands as the prevalence of smoking increases (unlike in developed economies, where smoking is declining).

We believe ITC Limited enjoys a narrow economic moat, owing to its brand strength, pricing power, and the addictive nature of its core product. Large competitors, including Godfrey Philips and VST Industries, combined, hold approximately 20% share of the Indian cigarette market. Less than 5% of the total market by value, but 48% by volume, is served by over 300 unorganized cigarette and leaf-rolled tobacco manufacturers, which pose a low-price substitute to branded cigarettes. By launching branded products at lower price points, ITC has been able to effectively compete with these unbranded tobacco producers, and improve its market share over time.

ITC holds a greater-than-majority share of India's organized cigarette market, and has been able to raise prices while maintaining volume growth. Given that most smokers remain brand loyal for a long time, and are addicted not only to smoking but also to the taste of their particular brand, we believe that ITC has a narrow economic moat and will sustain its leadership in the Indian cigarette market, despite competitive and regulatory pressures.
 

Risk

The major risks facing ITC stem from potential changes in government regulations related to taxation, manufacturing licenses, and advertising or distribution bans. More specifically, if the government drastically increases the excise tax rate on cigarettes (similar to past actions), the company's production volumes and profitability could suffer. Apart from regulatory risks, we also believe there is a risk that ITC management may expand further into less profitable businesses--and away from its core competencies in cigarettes--which would not be in the best interest of its shareholders. Overall, we rate ITC as having medium uncertainty, reflecting that the firm derives more than half of its sales from the cigarette business, which in itself is a non-cyclical business that operates with minimal financial leverage.
 

Company Profile

ITC Limited is the largest cigarette manufacturer by revenue in India, with more than INR 300 billion in annual revenues and only 10% of its sales coming from outside India. ITC’s major business segments include cigarettes (56.2% of net sales), consumer products (14.6%), agricultural produce (14.9%), paper-related products (9.3%), hotels (2.4%) and other (2.6%). The company started as a subsidiary of Imperial Tobacco IMT in 1910, but today is 31% owned by the global cigarette giant, British American Tobacco BTI.