Retail investors should stick to ethical investing

Mango people’s indignation over the DLF-Robert Vadra controversy prove how much they despise the businessmen-bureaucrat-politician nexus. The nexus hurts the common man in more ways than one.

However, if the common man, who is also a retail investor, directly gives money to a businessman with political connections, he is deliberately jumping into a deep well. Greed overcomes fear leading to losses and this can be avoided if one embraces an ethical investment policy.

DLF stock has fallen over 11% post the controversy and the stock has fallen 80% from its peak in 2008. DLF is highly leveraged with debt levels of Rs 22,680 crore as of June 2012 against annual sales of around Rs 10,000 crores.[caption id=“attachment_489351” align=“alignleft” width=“380”]  In a soup. Reuters[/caption]

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The company’s debt-equity ratio is just below 1. It is clear that DLF will have to sell assets to reduce debt as its sales are just half of the total debt and this will not help it service the debt.

DLF may not be able to sell its assets if the current controversy drags on. If the company cannot sell its assets, then its lenders get affected. The lenders will include banks, insurance companies and other players such as mutual funds, real estate funds and private equity.

Hence, the common man on the street will be affected indirectly if the bank in which he owns shares or has fixed deposits makes provisions for DLF’s loans.

The share price of the bank will fall or the rating agency will downgrade the credit rating of the bank if it makes provisions for DLF loans. Similarly an insurance company making provisions for loans will face deterioration in its financials and this could affect the policy holder.

Holders of debt of DLF, including mutual funds, real estate funds and private equity, will see their net asset values fall. Investors in these funds will lose money on the back of the fall in net asset values.

DLF at this point of time is not likely to default on its loans but if it does default then the above issues will hurt the investor.

It is a well known fact that companies using natural resources to make profits have to deal with politicians and bureaucrats. Some sectors such as oil and gas have a stronger regulatory framework than other sectors such as real estate and mining.

The recent mining and land grab scams have exposed the weak regulatory framework that enables businessmen, politicians and bureaucrats to make huge profits at the cost of the public exchequer.

The loss in revenues to the government will result in higher taxes, fiscal deficit, inflation and interest rates, which in turn hit the mango people.

Institutions do not have ethics when it comes to investments thus resulting in indirect exposure to tainted sectors. A banker or a fund manager will tend to overlook any possibilities of scams down the line as they are focused on returns.

It is not their money they are dealing with. However, after the scams have surfaced, bankers and fund managers will clamp down on investing in tainted companies or sectors leading to debt defaults and fall in equity prices.

Scams always surface after the businessman, bureaucrat and politician have made their money. Ultimately, it is the average man on the street who gets affected.

The only way the retail investor can avoid getting directly hit by tainted sectors or companies is by following strict principles when making investments.

India has many listed companies that try and deliver shareholder value by making and delivering the right products and services at a competitive price and these companies deserve more support than companies that exploit natural resources through crony capitalism to make money.

Arjun Parthasarathy is the Editor of www.investorsareidiots.com a web site for investors.