Operation ‘Scrooge’

Published in The Hindu - Sunday Magazine on Nov 23, 2008

 

With global economy on the cusp of a slowdown, software companies have launched across the board cost-cutting initiatives. What are the ramifications?

Lately the missus has become very agitated about the happenings in the world. Even the Obama victory couldn’t bring the desired respite. For the ‘happy go lucky person’ that she usually is, her current metamorphosis into a cynic is quite startling. The worrisome thing is that I am the one facing the heat of madam’s new avatar, when the real one to blame is the economy.

Before I give you a closer perspective of the issue raging in my home, it is essential for you to know that the missus works for a leading software firm. It all began with a benign videoconference, by the CEO of the company, on a pleasant November morning that was made mandatory for all employees to attend. The agenda for the conference was “Special Initiatives for the Quarter”.  Extrapolating from the vague subject of the conference, my wife conveniently decided to skip it and focus on shopping for new curtains instead. When she turned up at the office later that day (that would mean around 1:00 p.m – she has flexi hours you see) she was in for a surprise and an unpleasant one at that. Apparently the conference was all about ‘rightsizing’ (a euphemism for ‘downsizing’) and the importance of saving a penny (for the company). To put it crudely, the CEO’s message was – “we are going to do whatever it takes to cut costs (minimum 20%) in order to maintain profitability amidst the expected slowdown in business”. The best part was that he had compared his company’s initiatives to those of the competitors and projected his list to be most employee-friendly.

Following is an extract of the minutes of the meeting (as taken down by a colleague of the missus) that outlines the MD’s multi-pronged cost saving strategy (with my comments inserted):

People

1. Bench size to be crunched – Proportion of employees on bench to be reduced to 10%, from the existing 20%. Employees who are unable to be gainfully occupied within their vertical or geographical base will have no option but to move to other domains or locations with better prospects. Wonder what happens to the much touted ‘domain knowledge’ of these employees who are suddenly made fungible? What about the employees who cannot be accommodated elsewhere?
2. Delivery Managers & Support staff to be consolidated – Anyone with an MBA would know that ‘consolidation’, just like ‘rightsizing’ or ‘rationalization’, is a synonym for ‘possible layoffs’. Under this proposal, the minimum number of employees to be billed under a Project manager will be increased. This would mean that managers, who get to keep their jobs, can’t refresh their ICICI Direct or Moneycontrol screens as often as they used to (look at the positive side- anyway the shrinking portfolio is causing enough heartburn). Similarly, the average number of employees mapped to a support staff (e.g. HR, Admin) will be increased.

Perks

1. Flexi Hours to be removed – The Company seems to have discovered that this policy (something that was closest to the missus’ heart) unnecessarily encourages staff to come late to the office and hang around well past evening. This lead to extra administration costs in terms of electricity, snacks, transport etc.  Now there would officially be only two shifts in the company- with the afternoon shift size kept as small as possible. In other words, only those employees whose project demands a late night U.S. conference call – will have the luxury of walking into the office at lunch.
2. No more air conditioning in cabs – All cabs used for employee pickup & drop (provided for those who work outside the scheduled office hours) to be made non AC. Ironically, this comes at a time when employees were demanding that the buses (provided for those attending regular office hours) be air-conditioned.

3. Mobile CUG plans to be scrapped - I guess if one employee needs to call another – he needs make the call from the office. The logic seems to be – “If you are so over enthusiastic to discuss work outside office hours, you better pay for it”.
4. Entertainment & other Support Services to be removed – The Service Desk in the office was a cool feature through which one could make reservations to movies and plays, pay telephone bills etc.. With this gone, it looks like I will be the one running these errands in the future.
5. Leave encashment to be cancelled – Not that I know of anyone who was really using this benefit – but the hard working souls will have no option but to take a vacation now.
6. Snacks, beverages to be charged – Now this is really personal. I mean software professionals thrive on such freebies. It doesn’t take much to pay, but what about the moral obligation of the company to encourage hard work and coffee counter gossip? 

 * End of minutes extract* 

The worst thing to happen after a CEO has proposed such sweeping changes and set targets for cost cutting, is that the senior managers come up with their own ‘out-of-the box’ pet schemes, wanting to exceed the target and earn a special crown of honor from the big boss.

Over the last two weeks, the missus and her colleagues have already noticed signs of this. Here are some of the evidences:

1. The hand towels in the rest room have disappeared. So have the paper tissues.
2. The lighting in the building has reduced significantly, especially in the lobbies and corridors. On further inspection – it is evident that only alternate bulbs are lit; the others have been removed.
3. The printer runs out of paper multiple times in a day. When requesting for extra paper, one comes to know that there is a limit of 30 pages per person per day. Anything more and special approval needs to be sought from the Admin (stationery) department.
4. The thermostat setting for the central air-conditioning is up a few notches, leading to some intermittent sweaty spells during the day.

As can be expected, these surreptitious initiatives have added fuel to the fire (in this case - cost cutting) and the missus is up in arms against her company, the IT industry and me.

Why me? Well, two reasons. One, I happened to disclose to her that her company lost an entire quarter’s profit through forex losses (by the way- so have many other IT companies who loaded up on exotic derivatives in the race to hedge against the dollar). Two, as a small shareholder in her company – I said, “may be at least after all this cost cutting I would be able to recover my cost of investment”.

Now she has counted me as her enemy in this matter. Her logic is simple – employees should come first, profit and shareholders second. Her opinion is that, in the race to increase profits, IT companies are compromising on the services offered to employees. She asks – “Haven’t IT firms and their shareholders earned enough profit over the last decade to weather a slowdown, without lynching employees and their benefits?” Given the recent developments within the IT industry, she feels that the only way for the employees to get some rights is though the formation of a “Union”. 

My rebuttal is – if the same protectionist attitude prevailed in the U.S. or Europe, there would be no outsourcing in the first place.

And, so the verbal duel continues…. We welcome your comments to help settle our dispute. 

Know your Fixed Maturity Plan

Published in The Hindu - Sunday Magazine on Nov 9, 2008

Debt mutual funds including FMPs (Fixed Maturity Plans) do not always deliver on their indicative returns and may even put your principal at risk.

If the above statistic appears to you like an agricultural nutrient recipe for cultivating high yielding sugarcane, let me assure you that you are not alone. Unfortunately the data has nothing to do with crop cultivation; it represents the investment portfolio of an FMP (Fixed Maturity Plan). FMPs are a popular category of Debt mutual funds that are sold as an alternative to Fixed Deposits (FDs) for their comparative tax advantage. But, I am sure even those of you who regularly invest in FMPs may be getting a glimpse of what constitutes their investments for the first time. The portfolio listed above indicates ‘structured obligations’, otherwise called as ‘asset backed securities’ or ‘securitized loans’.

Debt mutual funds contribute to more than half of the total assets managed by mutual funds in India and FMPs (a subset of debt funds) contribute to 25% of total mutual fund assets. If you own one of these or have received a call to invest in them with claims that ‘they are same as FDs but give better returns’, then you might want to know that nearly a third of your money invested in these funds is used either to give loans to Finance companies/ Real Estate companies (in the form of debentures) or to buy out chunks of loans already disbursed by Banks/ Finance companies (in the form of ‘structured obligations’)

Let me try to clarify some the myths about FMPs and in the process highlight the risks involved in Debt mutual funds as an investment option

Myth1: FMP is same as FD
Reality: Not true. Although both lock your money for a ‘fixed’ period – the similarity ends there. FD offers ‘fixed return’ (interest rate). FMP is a Debt mutual fund that does not promise a fixed return. The offer document for the fund (distributed to prospective customers) discloses ‘indicative returns’ and ‘indicative investments’, but they are just that – ‘indicative’- which in financial parlance means ‘not true’ or ‘trust us with your money but we don’t want to tell you what exactly we are going to do with it’

Myth2: My FMP will definitely deliver at least the ‘indicative returns’
Reality: Not necessary

Myth3: Safety of principal is always given a higher importance than returns.
Reality: Common! The mutual fund manager gets his bonus based on returns. Moreover isn’t safety a ‘relative’ term? Since most of the fund managers chase returns, the meaning of ‘safety’ has morphed into – not taking too much extra risk than peers (other fund managers). You see…this attitude actually helps the peer group to collectively take-on extra risk. May be this is why the portfolio of many mutual funds actually look alike.

Myth4: My FMP invests only in high grade Government and Corporate Bonds or Bank CDs (certificate of deposit)
Reality: Not really. FMPs lend to NBFCs(finance companies) and real estate companies. They also buy out loans ranging from credit card loans to personal loans that are disbursed by finance companies to individuals. In addition, they buy out loans given to real estate companies by Banks or NBFCs.

Confusion: How can loans granted by one bank/finance company be sold to a mutual fund?
Explanation: Not only can loans originated by one bank/ finance company be sold to mutual funds, they can also be sold to other banks. In fact such packaging of home loans and selling them to multiple investors and financial institutions around the world is one of the reasons why the collapse of the U.S. housing bubble has had a global impact. You might remember that I had covered this in detail, using the example of CDOs in the article ‘When the Bubble Burst’ (Oct 5, The Hindu, Sunday Magazine). A similar process of creating ‘structured obligations’ (packaging and selling of loans) is also prevalent in our country. Here is how it works:

Step 1: Finance company issues ‘sub-prime’ (high risk) personal loan to pan-wala at 35% annual interest rate to be repaid over 2 years s
Step 2: Finance company has issued 500 crores of such loans and needs more money so that it can issue more of these lucrative loans
Step 3: Finance company Treasury Head calls Debt fund manager and enquires – “are you interested in making 20%-25% p.a return on your investment by buying personal loans from us?”
Step 4: Debt Fund Manager: “of course I am interested - are you kidding me, I can barely get 8% p.a. from Government bonds. Can you also throw in some other loans like vehicle loans, credit card loans etc. so that I can buy a diversified portfolio? Make sure you give me ‘prime’ (lower risk) loans too, although they may yield lower interest rate. Also, a couple of my colleagues managing other Debt funds may be interested.”
Step 5: Treasury Head: Great! What I will do is create a SPV -Special Purpose Vehicle (a Trust account) into which I will transfer an assorted pool of loans (two wheeler, credit card, personal loan, prime and sub-prime) worth 1000 crores. You and your friends can pay me 1150 crores upfront (15% profit on 1000 crores) and buy the SPV. I will keep crediting the EMIs collected every month from customers of these loans, into the SPV, and you can withdraw at your convenience. Although I am charging a 15% markup on the loans, you will still make better returns than you would on Government Bonds because the average interest rate inbuilt in the customer EMIs is 20%.
Step 6: Debt Fund Manager: Okay. But what if the customers default in paying EMI’s? Will you compensate me?
Step 7: Treasury Head: We have paid lots of money to a leading credit rating agency to evaluate our loans. They have said that only 5% of these loans will experience customer default, so what I will do is compensate you for loss up to 5%. With my loss guarantee, the rating agency will give AA grade to the ‘loan package’- meaning high quality investment.
Step 8: Debt Fund Manager: If you have paid lots of money to the rating agency, their rating must be very accurate. The deal seems fair. My friends and I will pay you 1150 crores upfront and buy the assorted loan package (otherwise called ‘structured obligations’) between the three Debt funds that we manage.
Step 9: Finance company uses the payment received by selling its loans at a profit (even before their tenure is over), to give out more loans

Similar packaging and selling of loans is also done for large loans given to real estate projects. Today, most of the Debt mutual funds in the country have loaded themselves with such loans purchased from finance companies and banks through the ‘structured obligation’ route.

Principal Risk

So what is the problem you may ask? What if my Debt mutual fund/ FMP invests in packaged loans, as long as I get my high returns? The answer is ‘risk’. To be more specific – the risk of losing your principal.

Loans, particularly personal loans have witnessed very high default rates in the past few months. One reason is that customers took too much of these loans that were aggressively marketed at high interest rates and are now not able to repay. Similar pattern has been observed in other segments such as credit card and two wheeler loans.

Now, many debt mutual funds that purchased these loans are stuck with paper on which default rates have become much higher than what was guaranteed by the finance companies. Unfortunately there is no standard market like the stock market for selling these ‘structured obligations’. This means the mutual funds that own these loans will have to retain them until all loans mature, even if the risk of loss increases.

To worsen the situation, large investors and companies that parked their savings in such funds have pressed the ‘sell button’ even before the redemption date is reached, despite the high penalty (around 2%) involved in doing so. FMPs and other Debt funds that are unable to meet the redemption pressure have approached banks to lend them money to tide over the crisis. Mirae Asset Management Company is a case in point.

The recent turn of events has brought out the uncertainty involved in achieving the ‘stated’ returns in Debt Mutual Funds/ FMPs and has exposed the inherent risk of losing a portion of your principal. The winner in this chaos – seems to be FD (fixed deposit), which has emerged once again as the safer alternative, untouched by the vagaries of financial engineering.

You too can check if your fund has invested in ‘structured obligations’ by logging on to http://www.valueresearchonline.com/ and clicking the portfolio details of your fund. You can also find out the % of money allocated to these instruments, by your fund.