By UR Bhat
Investor myopia looms as a major threat to India's growth story. This is because we are relying increasingly on public-private partnerships to invest in long-gestation infrastructure projects, but returns on such projects fall short of capital market expectations.
Till about a decade ago, investments in public infrastructure like roads, airports, bridges and utilities were the preserve of the government, both for political and economic reasons. Recent changes in policies have rightly given more scope for public-private partnerships in providing public services to speed up the process of investment and meet rising expectations.
However, these new opportunities for entrepreneurs have come at a time when there is enough evidence to suggest that the time horizons of most investors are shrinking, not just in India, but abroad.
A recent study by Andy Haldane and Richard Davies of the Bank of England clearly establishes this fact across all sectors. The study highlights the irrationality of investors in ascribing very low values to long-term cash flows - which is the hallmark of major infrastructure projects.
Under rational discounting - a method of trying to figure out the current value of future incomes - cash flows even 50 years ahead contribute around 1% of the present value of a long-term project, but myopic investors in the developed markets expect this discounting for cash flows in just 25 years.
The study shows that in the US and the UK, cash flows five years ahead are discounted at rates more appropriate to eight or more years hence. Ten-year cash flows are discounted as if occurring 16 years hence and cash flows beyond 30 years ahead are given almost zero value.
The life insurance companies, typically, should be natural investors in long-term projects, as their liabilities - life covers, etc - often extend to 20 years or more. But in India they have been even more myopic. Most of their policies are unit-linked insurance plans (Ulips) which are essentially short-term in nature.
But investor myopia is not restricted only to the long-gestation infrastructure projects. Every corporate chief knows that sustaining stock prices involves humouring the market by outperforming the expected quarterly growth numbers and rising dividend payouts, even if it means taking your eye off long-term opportunities.
Given the general short-term orientation of the investor, a project is to be financed by the public markets to fund. For example, a water-powered car that can help conserve fast-depleting energy resources, requiring large investments with a long-term return profile, is unlikely to find favour.
It is only the very large companies that can afford to allocate a small portion of their profits to such long-term projects without impacting investor and market expectations in terms of profit growth and payouts.
However, there is enough evidence at hand to show that the biggest innovations in the world have come from the smaller companies and start-ups. There is a strong case, therefore, for policy action to encourage long-term investing in the public markets.
There is not much to distinguish between individual investors, speculators and institutional investors in terms of investment horizons in India because short-term 'crowd-think' seems to be the common guiding spirit among them.
Channellising long-term retirement funds to the capital market by promoting individual retirement accounts, contributions to which are fiscally incentivised if held till retirement, should therefore be seen as a priority. Other measures could include structuring compensation packages for company managements that are backloaded. That is, their incentives should be deferred and paid over long periods of time in order to encourage long-term thinking, and incentives should be clawed back if the performance is not up to the mark over long periods of time.
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Companies can also be encouraged to access long-term capital providers through differential voting right for shares, with long-term investors getting higher voting rights and dividends.
The bulwark of the capital market is the long-term investor and public policy needs to be tweaked to encourage long-term investing through fiscal incentives and changes in company law. While quarterly results are important, market analysts look for information in these earnings that may have long-term implications for the valuation of a company.
Sustainability of earnings is pivotal for the valuation of a company in as much as almost three-fourths of the value of a company rests on the expected cash flows after the first 3-4 years. Company communications to the financial community should, therefore, highlight the extent of impact that short-term results could have on the long-term sustainability of its earnings.
In addition, companies need to be proactive in honestly influencing the build-up of market expectations to prevent them from going overboard and leading to undue volatility in stock prices at the time of quarterly results.
An efficient capital market serves as a conduit to channelise domestic savings to value-enhancing investments that should ideally lead to economic growth and social welfare. Traditionally, most of the public infrastructure assets in India have been built and managed by the government, partly because of the policy framework, as also because of the low returns from such investments.
With improving living standards in India, public expectations in terms of the adequacy and quality of public infrastructure services have been showing a dramatic increase over the last two decades. It is well known that government finances are not in a great shape and it is increasingly becoming difficult for the government to bridge the huge infrastructure deficit in the country by investing its own resources.
Moreover, citizens are increasingly willing to pay for good quality infrastructure services, apart from what they pay by way of direct and indirect taxes to the government, thanks to improving living standards.
The inability of public markets to fund long-term projects at reasonable rates of return has consequences for public welfare. This market failure needs to be urgently addressed because if such investments do not happen or consistently fail to produce adequate returns, there is likely to be less of an incentive to save. This could, in turn, stunt economic growth and ultimately impede social welfare.
(UR Bhat is currently Managing Director of Dalton Capital Advisors (India) Pvt Ltd, part of the Dalton Group, UK, advising foreign institutional investors investing in India. He speaks for CorporateGovernance both in his writing and speaking engagements, as also as amember of the Corporate Governance Committee of the Indian MerchantsChamber. He has been invited to the boards of several companies in India as an independent Director.
Published Date: Jun 18, 2011 02:50 pm | Updated Date: Dec 20, 2014 03:52 am