‘Financial Markets are the Ones With Least Integrity’

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In his new book, stock market guru Parag Parikh argues that investors should not seek returns in bearish markets. Shantanu Guha Ray finds out why

Fair Warning Parag Parikh feels that irrationality is an inherent characteristic of the stock market
Fair Warning Parag Parikh feels that irrationality is an inherent characteristic of the stock market
Photo: Deepak Salvi

You wrote that the financial services industry is a jungledevoid of ethics and all about money. Is that the reason you wrote the book?
Of all the professions or businesses the financial markets are the ones with least integrity, where the ruling ethos is how to make money from the other guy at any cost. That’s why we have so many scams. When it comes to money, greed dominates and this is what we saw in the last two years — different financial firms and banks went bankrupt and evaporated. Lehman Brothers, AIG, Merrill Lynch no longer exist today. It was greed which became their graveyard.

wrote the book to share my knowledge and experience of the capital and financial markets from the last 25 years, to empower the investor to make guided rational decisions. Investors need to be made aware that the so-called innovations of the financial markets are always against their interest. Take the case of derivatives – they are good hedging instruments but have been structured in ways people cannot understand. They are thus used as speculative instruments. The credit card, a great financial innovation for convenience, has been turned into a product which gets people into debts as they spend beyond their means and the issuers charge hefty interest, making themselves richer at the cost of their clients. Margin trading, loans against shares and IPO subscription make investors trade more than their capacity, ultimately violating the basic principle of investing – that investment has to be made from one’s own money and not borrowed money, or else it is speculation. It is important for us to teach the right things to our youth. The current environment of competition and mad craze for money is teaching them to speculate – they are under the illusion that money can be made by taking shortcuts.

You have often found bonds and other fixed-rate financial instruments riskier than equity investing. This is surprising because many in India consider the stock market risky and bonds very safe.
On an average from 1979 till date, equities have returned around 17-18 percent. However, we find that investors have lost money and the stock markets are riskier than bonds. Is it not a paradox that investments have done well but the investors have done poorly? The problem is not the equities per se, the problem is the investors themselves who sway between greed and fear on the slightest change in a particular level of comfort. This is the reason that the title of my book talks about “behavioral finance.” I have tried to make the reader aware of the different types of behavioral anomalies that affect us and in turn distort our decision making.

We must always look at return on investment; however, when fear grips us when the markets are in a bear phase we are looking at return of our investment. With stock market losses around us we want to see our capital intact and that’s how we find bonds more attractive and less risky. If we buy a bond which matures after five years or keep a fixed deposit with the same maturity we find solace in that our money is intact after the five year maturity period and our getting a steady interest return. However, if one were to calculate the vagaries of inflation and the fast depletion of our purchasing power, bonds are also risky. After five years your principal amount may be intact but its purchasing power would have detoriated. That is the reason stocks are known to be the best hedge against inflation. At different times both have their role to play and we cannot call one more or less risky over the other.

Value Investing and Behavioral Finance
Value Investing and Behavioral Finance
Parag Parikh
Tata Mcgraw Hill
325 pp; Rs 395

The market is still not growing. Is that a matter of concern?
The markets grew from an index of 3,000 in 2003 to 21,000 in 2007– a seven-fold increase in four years. Can you expect it to just go one way up? We have just seen a year of bear times and we want it to go up again. It’s only bad times that offer great investment opportunities as we saw in the later part of 2008 and beginning 2009. Values were available at a song and I am sure value investors were smiling their way to the bank.

Would you agree that all bull and bear runs are natural? In fact, you mention it in your book that it’s a cycle. Does greed make the runs dramatic?
Anything that goes up must come down and vice versa. Bull markets are followed by bear markets and then again by bull markets. It’s the behavior of its participants that makes it dramatic. Participants include investors, government, mutual funds, financial institutions, stock brokers, the regulator, the banks etc. They are swayed by fear and greed and so are their decisions. This leads to irrational behavior. It is this irrationality which makes markets interesting and difficult to understand.

I found a recent comment by you intriguing: “All the things done in the market — these so-called innovations — are designed to make money for these traders against the interest of investors. It’s an unnecessary web of complexity.”
I have already discussed some of the innovations. Initial Public Offering is one such innovation which is against the interest of the same investors who apply for the offer. I have devoted a full chapter on the same; I’ll give you a gist. IPOs always come in bull markets. Why? Because the investors are willing to pay any price for the stock. They never come in bear markets because the management is not willing to give the shares to the public cheap as they believe that the shares are more valuable. That is the reason we saw no IPOs in end 2008 and beginning 2009. The company appoints an investment banker whose fees are dependent on the maximum value he can get for the shares from the public. The investors read the research report and listen to all the good talk about the company from the same investment banker appointed by the company. Moreover, today IPOs are market priced and if one is paying a market price one has a choice of over 6,000 stocks in the market. Why is there so much hulabaloo about an IPO? Because they spend money on advertisements, the media creates hype, people fall for it and end up paying a fancy price.

I just read today that Oil India is revising its price band of Rs 750–850 to Rs 1,250–1,450 for its upcoming IPO as it saw the overwhelming response and the success of the recently launched NHPC IPO. How can investors earn if no money is left on the table?

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