Understanding Investing Risk is More Than Qualitative Assessment

I love to interact with readers when they write a good thought based message. I like their questions, specifically, when they would like to discuss investing related questions. One of TIPBlog’s reader, Jagadees, wanted to know my thoughts on generalized qualitative risk assessment in the context of my buying Reliance Capital shares. Below is his mail message.

I would like to know about your thought process regarding your position in reliance capital (because this position was not discussed in detail as other companies you normally do. the only place i could see about this company is in the post regarding holding companies).

Based on my readings so far, I understand that this company is poised in the good position to tap massive consumer savings with its vast retail distribution &marketing strategy in mutual fund and insurance business. Whatever the new scheme it launches, it does in a big way and currently its mutual fund is top in AUM. It is also a likely candidate to get banking license.

 

But my concern is quality of the management i.e. ADAG. when i analyzed i found the following things to be very disturbing.

  1. It’s a well known fact that due to the greediness of the management to debut in the SENSEX soon after IPO, it connived with investment bankers and priced steeply. Ultimately, it ripped retail investors.
  2. SEBI barred Anil Ambani and leading official of Reliance Infra and RNRL from investing in secondary market until 2012, besides imposing a charge of Rs 50 crore for settling a probe into alleged unfair market dealings by the two firms.
  3. Recently I read an article on Tekelha about the wheely dealing of Reliance Com in Swan Telecom regarding 2G and really taken aback on the involvement of ADAG
  4. A Reliance health insurance premium has been priced very cheap before 3 years to garner large customers. And suddenly this year they hiked the premium by 400%. In India, until recently there was no health insurance portability and hence it would be a disincentive for clients not to renew. I found this one to be bait system to lure customers.
  5. It’s well known fact that all of ADAG companies are running short of cash flows. Even Reliance Com is looking to restructure its loan it took for 3G from various entities all over the world and finally he got funds from china development bank.

In all the above cases the management tries to cheat investors or customers, regulators, govt etc. My doubt is even if Reliance Capital does well and generates cash by disinvestment of its insurance business & other things; will management share with minority shareholders. Wont they look for other illegal ways to siphon out the money from this entity to other group companies which is sinking with mountains of debts? How can retail investors entrust their money to this management? or am I missing out something?

 

Jagadees, has great set questions about ADAG. All these concerns points to one issue, which is, management’s past history demonstrates it is not going to share profits with small retail investors. I am with you on your concerns. A simple answer to these concerns is, that’s the risk one takes.

 

Give me one example where company management thinks about retail investors? Where before making a decision any company will think of small retail investors like you and me. I do not believe there is any! So either you be part of it or avoid it. I choose to be part of it and swim carefully.

 

Having said that, I think we as retail investors need to understand what risk means to them. It is my view that risk is something that is very subjective. To me, it’s interpretations vary like finger prints. They are never same. I do not interpret risk as a qualitative matrix. That way of interpreting risk is blind. The issues about ADAG mentioned in this message regarding quality of management; is qualitative. It does not tell me anything about risk to me. It does not tell you how it will affect your wallet? Saying, there is risk because of bad quality of management; is meaningless.  That’s why I say, it is blind for decision making.

 

My interpretation of risk is in conjunction with the price you pay for buying your stocks. Same question, how does it affect my wallet? So, while I agree with these concerns about bad management, I tend to take one step further and understand them in numbers. This translation is, again, subjective. But at least it gives something to measure. Let us take Reliance Capital as an example.

When I pay 400 or less for Reliance Capital, I think my risk-to-returns are reduced considerably over long term. As long as my price is more than zero, risk will always exist. But when I pay more, i.e. 500 or 600 or more, I am increasing my risk-to-returns. And hence, I should not buy at 500+. Now, if I believe Reliance Capital is junk company, I would not even think of buying any shares. But I know for sure, Reliance Capital is not a junk company. But it is neither a good or great company. It is one of many.

 

Coming to you concerns as listed above…

  • On item number (1) I do not think there is anything wrong with it. Any business owner will do what ADAG did. Get maximum possible price in a given market conditions! If I were business owner, then I would do the same. Retail investors were not forced buy into his IPO. I wrote about it in valuation of new IPO.

  • On item number (2) and number (3) Well, I do not think I expect integrity or ethics from Ambani clans. My personal view is poor guy Anil is getting killed. While almost every major business family is doing these things. e.g. His elder brother is master of such willy nillys. The recent RIL-BP deal is likely to be orchestrated by his cronies in oil ministry. There are many such examples with other industrialists also… NOT that I am a fan of such behavior. Like all retail investors, I certainly despise such business dealings. But Anil Ambani he is not the only one! So I do not take that, exclusively, as a part of decision making.

  • On item number (4) Don’t you see sudden jump in gas prices? Don’t you see sudden jump in food items? Don’t you see jump in real estate prices? All are completely blatant?  Again, why target Reliance Health insurance premium? The point being I try not to mix ethical business practices with my investing goals.

  • On item number (5) Bunching all ADAG companies together is, again, a folly w.r.t. investing. ADAG is not a company in itself. It does not trade in equity markets. I only picked Reliance Capital because; I think it passes my equity selection metrics. Cash flow is one of them, but not the only metrics. Now, what price to pay is a different discussion. I had held Reliance Infra for a while, but I removed that one.

 

I am not justifying ADAG, Reliance Capital’s, or any other business’ practices. I am not qualified to do that. On the other hand, if I start making decision on ethical practices, there would be no company left in India or I will not be able to live my life. Question that I need to answer is, whether I as retail investor will make money by buying shares of this company – and depending upon what price I buy shares, I take that risk. Another example of interpreting risk in empirical numbers is here on expected returns of NIFTY index.




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