Financial Daily from THE HINDU group of publications
Sunday, Sep 08, 2002
Corporate - Performance
How India Inc managed its investments
WITH growth opportunities hard to come by and capital expansion programmes put on hold, Indian companies have amassed large war chests of cash over the past few years. So much so that some leading Indian companies now have a larger portion of their capital deployed in investments than in fixed or current assets required for their operations (see infographic).
How a company manages its investments is often as crucial a determinant of financial performance as how it manages its operations. So how did India Inc manage its investments in 2001-02?
A study of the companies making up the S&P 500 index (banking and finance companies were excluded from the analysis) shows that companies are definitely adopting a more conservative approach to their investments than before. From investing indiscriminately in the equity market in the 1990s, companies have moved to debt and gilt investments, routed through the medium of mutual funds.
Probably due to their more conservative stance, investment returns were not too high, with only a fourth of the companies generating a return of 14 per cent or more from their investment portfolios.
A year for active management
Barring a few exceptions, active management of the investment portfolio paid off in 2001-02. In fact, high levels of portfolio churning invariably went with high returns, while passively managed portfolios registered low returns.
Tata Power, L&T, Hero Honda Motors and Indo Gulf Corporation were among the companies that traded most actively on their investment portfolios over 2001-02.
Each of these companies churned their investments more than two-fold in the course of the year. A rough computation reveals that the investment income for these companies ranged between 15 per cent and 35 per cent of their average investment balances.
Unrealised appreciation in the value of investments held is not included in investment income here.
On the other hand, Tata Engineering, Pentamedia Graphics and EIH adopted a more passive approach to managing their portfolios. These registered a portfolio turnover rate of less than 25 per cent. Investment income for these companies amounted to not more than 5 per cent of the average investment balances.
From equities to gilts
From a time in the 1990s when the cash rich corporates dabbled actively in the stock markets, companies with active treasury departments now seem to have switched to mutual funds investing in gilts and short-term debt instruments.
In March 1999, the S&P 500 companies had 60 per cent of their investment portfolios invested in group companies and just 12 per cent in mutual funds.
By March 2002, while the proportion of investments allocated to group companies fell to 54 per cent, the allocation to mutual funds doubled to 23 per cent.
However, it must be mentioned that while the strategy of active portfolio churning worked in 2001-02, in an environment of a steady downward drift in interest rates, it may not necessarily work at all times. Moreover, active churning of the investment portfolio does come with a higher degree of risk. If the treasury manager fails to get the timing of his entry or exit right, there is a possibility of losses on investment.
Though it was a year of opportunity for investment managers, not all the treasury departments worked overtime in 2001-02. In fact, there was a wide divergence in the way companies allocated and managed their investments, even between companies in the same business group and industry class.
The two Tata group companies Tata Power and Tata Engineering started the fiscal 2001-02 with investment portfolios of roughly the same size (Tata Power carried investments of Rs1,582 crore in its books in March 2001 while Telco carried Rs 1,423 crore).
But the two companies took different approaches to managing of their investments.
While Tata Power transacted investments worth Rs 19,500 crore during the year, and closed the year with an investment income of around Rs 350 crore, Telco transacted just Rs 320 crore during the year, generating investment returns of around Rs 53 crore.
Group investments: Reduced flexibility
In most cases, the composition of the investment portfolio had a bearing on how actively companies managed their investments. Companies with a large proportion of their investments locked up in subsidiary or group firms found fewer opportunities for trading actively on their portfolio and, thus, earned lower investment returns than others.
For instance, in 2001-02, Hindustan Lever's investment income was around Rs 210 crore on its investment portfolio of Rs 1,668 crore (as of December 31, 2001). Roughly half of HLL's investment portfolio was deployed in corporate or FI bonds and debt-oriented mutual funds, with another 30 per cent in government securities.
In contrast, Pentamedia Graphics, which had an investment portfolio roughly half the size of HLL's, generated an investment income of just Rs 10 crore for 2001-02. The company invested over two-thirds of its investment portfolio in group companies.
Investments in subsidiary and associate companies may often be of strategic interest and may pay off over time. However, they appear to reduce the manouverability of the portfolio and pull down returns in the initial years.
The investment portfolios of the S&P 500 companies suggest that there has been a shift in the way companies approach their investments. From investing indiscriminately in the stock market, companies have made a conscious decision to stick to safer debt investments. However, companies with a substantial portion of their surpluses invested in equity shares of group companies have borne the brunt of the steady fall in equity values over the past couple of years. By end of 2001-02, the investment portfolio of Pentamedia Graphics had a market value of Rs 303 crore, a 53 per cent erosion vis-à-vis the value at which it was carried in the books (Rs 641 crore).
Grasim showed an erosion of 33 per cent on its investment portfolio (Rs 1,432 crore at book value). Hindalco and M&M also showed an erosion of 32 per cent and 16 per cent respectively on the book value of their portfolios (Rs 1,985 crore and Rs 800 crore respectively). In contrast, ITC and L&T showed an appreciation in the value of their portfolios vis-à-vis the book value.
There were also those who, as a conscious strategy, altogether avoided the vagaries of the stock and gilt markets and adopted an extremely conservative approach to their investments, parking their cash surpluses mainly in deposits with banks.
Despite large operating cash flows of around Rs 800 crore a year, Infosys Technologies has stayed away from investments, either in the debt or stock markets. By the end of 2001-02, much of Infosys' cash surpluses were invested in deposits with banks. While Infosys closed the year with a small portfolio of Rs 44 crore, it had deposits totalling to Rs 699 crore with various banks.
Similar was the case with Dr Reddy's Labs, which carried bank deposits of close to Rs 477 crore by end of 2001-02, compared to a relatively small investment portfolio of Rs 63 crore. Both companies managed to entirely avoid the risks of the stock and the debt markets. But a risk-averse approach does involve a compromise on returns.
For both companies, investment income (mainly interest from deposits) for 2001-02 amounted to around 9 per cent of the average bank balances.
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