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Hedge funds worry India
By Indrajit Basu
KOLKATA - As if a typical
monsoon had struck India, the sky over the Mumbai head
office of Mastek Ltd, which claims to be the first IT
solutions company in the world to be assessed at top
levels for its software processes, was dull and gray on
the morning of July 15. Inside, it was equally gloomy,
for different reasons.
Mastek's stock price had
fallen 33 percent immediately on the opening of the
market, following disappointing results the previous
evening. Fourth-quarter profits and revenues had plunged
by 81 percent and 7 percent respectively, and the
company had issued an equally grim profit warning. But,
while Mastek senior officials huddled in their offices
that afternoon, unavailable to the media, stock market
sources smelt a rat - hedge funds.
There is no
direct evidence that hedge funds were involved in the
dramatic fall in Mastek's share price. Indeed, the
company's steep slide was partly justified on the basis
of its results and the profit warning. However, global
hedge funds, with their quick forays in and out of
markets in search of total returns, have been at play in
India over the past several months, to dramatic effect.
Girish Nadkarni of TAIB Securities and other
equities brokers and analysts said they suspect that
somebody large was trying to tip the market against
Mastek and Indian tech stocks in general, "and that
force could be well be a hedge fund. After all, hedge
funds applied similar tactics on Infosys four months
back and succeeded," said Nilangshu Joshi, an
independent operator.
Even as a surge of inflows
from foreign institutional investors (FIIs) are helping
Indian stock markets touch new highs almost every day, a
certain nervousness is looming over the country's
capital markets.
"Although big FIIs have been
investing in India actively this year, hedge funds have
also been active. What makes the market nervous is the
prospect of these hedge funds booking profits before the
earnings season kicks off," said S Sreesankar, a
prominent stock market analyst.
Hedge funds are
increasingly emerging as India as well as globally as
investment playthings for the super-rich (see Hedge funds beat the odds - for some
as significant forces in recent months.
They have become a cause for concern not only for the
country’s stock markets but also the Securities and
Exchange Board of India, (SEBI), the regulating
authority. Of the Rs 101 billion (US$2.2 billion) of FII
money that had flowed into India this year by July – the
highest inflow in recent times - over $1 billion is from
hedge funds, stockbrokers say.
"Around 40 to 50
percent of the overseas money flowing into the Indian
market is through participatory notes and most of it is
coming from hedge funds," said Dharmesh Mehta, head of
equities with Enam Securities.
Hedge funds make
their money by identifying imperfections around the
globe in the price of financial assets - equities, bonds
or currencies. They typically require a minimum
investment of US$500,000, making them available only to
institutional investors and the very wealthy. They
typically have lock-in periods ranging up to five years.
Most require net worth on the part of investors ranging
from $1 million to $5 million.
Unlike
traditional mutual funds, they rarely buy and hold.
Their basic goal is to zip in and out of positions,
often powered by borrowed money. They could, for
instance, go long on a company in the US (like Infosys)
and short it in India. If the strategy works, then they
make money both ways. They will go aggressively after
anything and everything that moves.
India has
emerged an ideal operating ground following SEBI's
permission in December last year to allow foreign
institutional investors to invest in equity derivatives,
a nascent market in which local punters have not
developed the skills to take full advantage. The
market's immaturity thus offers skilled traders
opportunities to book quick, short-term gains, and
market imperfections and arbitrage opportunities are
essentially what hedge funds look for to make a killing.
It is this nature of hedge funds that keep
regulators and stock markets around the world worried;
it is almost impossible to keep them in check. They tend
to increase market volatility. Occasionally they can
even cause an entire economy to crack under the weight
of their selling. That is the biggest reason behind
SEBI's discomfort. Experts say emerging markets and
India in particular, are hot and hedge funds are going
full out to capture returns. Over the last 18 months,
hedge funds have gone on overdrive across the world,
delivering average returns of 12 percent.
Emerging markets hedge funds have done even
better, delivering two-year and three-year returns of 20
percent and 14 percent respectively while the S&P
500 - the benchmark index in the United States - has
fallen by 27 percent and 38 percent respectively. The
last 18 months have also seen a spate of new hedge fund
start-ups entering the market. There are now at least 55
hedge funds focusing purely on Asia and hundreds of
funds that have allocations to Asian stocks, debt or
currencies.
Global hedge fund capital under
management now totals $650 billion - up from just $50
billion in 1990. The exponential growth has been driven
by investors who have grown tired of giving their
savings to mutual funds, which are happy if they
outperform their benchmark indices even on the way down.
Some US$7 trillion in market capitalization was wiped
out in the market collapse that began 2000. Secondly,
interest rates have also steadily declined across the
world, thus making investors who preferred debt to look
for new parking places.
Hedge funds, with their
focus on absolute positive returns, thus emerge as
favorites because unlike mutual funds, they make money
only if investors do. They usually aren't paid unless
they generate returns. Third, and more importantly,
developments in the US are also making the new US hedge
funds look outwards at alternate investment
destinations. The most compelling one is a registration
requirement late last year that requires US offshore
funds to register with the US Treasury Department's
Financial Crimes Enforcement Network. The new norms
apply to hedge funds with US clients, are organized
and/or sponsored by US citizens and have investments
exceeding $1 million.
This essentially means
that the new norms apply to all large hedge funds
promoted by US nationals. It also means that US offshore
funds, which have been routing investments through known
tax havens like Mauritius to invest in India and other
emerging markets, would now be subject to the US
Treasury's scrutiny. All hedge funds, according to
brokers, have chosen to operate in India indirectly
(using an instrument called participatory notes which is
are nothing but contracts issued by foreign and Indian
broker outfits that are registered with SEBI), because
SEBI has always frowned on the prospect of hedge funds
entering the Indian market and has refused to register
them.
Equity investors believe that almost all
the large foreign brokerages like Credit Lyonnais,
Merrill Lynch, Morgan Stanley and Salomon Smith Barney
issue participatory notes. Sources add that other
institutions (non-FIIs) and Indian brokers also offer
this service to hedge funds. Which is why, although
hedge funds have scared many, many Indian and foreign
brokerage houses have started lobbying with SEBI and the
Finance Ministry to officially open doors to pure US
hedge funds.
"India has set itself a target of
US$5 billion of foreign investment inflows during the
fiscal year 2003-04," said Arvind Mahajan, a
Kolkata-based broker. "And to achieve that, the country
will have to open up to newer sources, hedge funds
included."
(Copyright 2003 Asia Times Online Co,
Ltd. All rights reserved. Please contact content@atimes.com
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