DOES SENSEX REFLECT A TRUE PICTURE OF THE STOCK MARKET?

For most common Indian, the BSE Sensex is equivalent to the Indian stock market, and for experts it is the nerve of Dalal Street. But, since the day I started understanding stock market and its functions, the biggest question that kept haunting me was, when we have a huge pool of listed (public limited) companies in the country (as many as 81,926 as on December 31, 2010), how correct are we by following a benchmark indicator that consists of just 30 companies selected on the basis of a single parameter - market capitalisation?

As a finance professional, I often get to see many presentations which compare BSE Sensex with NYSE Composite to prove a point. But I just want to ask a simple question to those sophisticated presenters; the comparison that they showcase, is it between two equals? Certainly not! While the Sensex presents an ultra-narrow view point by indicating stock movement of 30 companies of an exchange that houses the world’s largest number of listed companies, NYSE Composite, on the other hand, presents a broad and global view by showing market movements of 1867 stock (1530 US companies and 337 non-US companies).

Moreover, while the top global indices, be it NYSE Composite or Nasdaq Composite, provide comprehensive sector coverage by including stocks from all the 10 industries defined by the Industry Classification Benchmark, the Sensex does not even pay a heed to the same. On the contrary, the Indian benchmark index is heavily skewed towards just 3 sectors - Oil & Gas, Financial Services and Information Technology - as combined together they control over 50% of the total weight in the index at any point of time – whereas some other key sectors like aviation and gems and jewellery are either completely ignored or get a paltry weight of 1%-2% like the healthcare sector (Cipla is the only healthcare company in the Sensex with a weight of 1.1% as on April 21, 2011).

But possibly, what makes Sensex the worst possible indicator from India’s point of view is the fact that the index does not even represent 30 stocks in true sense. Thanks to sole selection criteria of market capitalisation, it’s just a representative of the top 10 stocks which have a combined weight of 67.25% (as on April 21, 2011) in the index, whereas, the top 10 in NYSE Composite holds a total weight of less than 15% at any point of time. What’s laughable in the Indian context is the fact that any strong movement in the top 2 index constituents, Reliance Industries (11.78% weight) and Infosys (9.43% weight), alone is good enough to rig the Sensex much more than what the bottom 5 (combined weight of just 3.69%) can do together.

For an average common man, who does not understand what the Sensex at 20,000 actually means, the index is also an indicator of the country’s economic growth. But as the past records suggest (in 2008, the economy grew at 9% when the Sensex dropped over 52%; on the other hand, Sensex gained 81% in 2009 when the economy only managed a 7.4% GDP growth) the Sensex is on a completely different tangent as compared to the economy. And the reason, for sure, is the narrow base that it represents. So it’s high time that we actually should either abandon looking at the Sensex as a benchmark of any sort and move one to some other index like BSE 500 or perhaps BSE 1500, or change the existing selection criteria of Sensex to present a comprehensive and wider indicator that also shows the real picture of the economy. BSE has already lost the stock market war to NSE in 2009. It might also lose the index war in 2011...

THE BRILLIANT CONSPIRATORS OF THE INDIAN CORPORATE BOND MARKET

It’s unfortunate, but true! The strangest thing about the Indian capital market is its retail investing community. While they have already mastered the art of losing money in the equities market almost on a daily basis, they have no clue about a safe heaven called the corporate bond market. They are ready to bet their net worth for a 12-15% return on the tips given by the so called market pundits, but they are not ready to learn about how to earn 8-9% ‘risk-free’ returns by investing in corporate bonds. And the result? While the key nations across the world have a well balanced capital market with the bond segment complimenting the equities segment, India on the other hand has a capital market wildly tilted towards the equities – conspiratorially so, because of the lobbying power of the equity powerhouse FIIs. Between 1996 and 2008, the ratio of equity market capitalization to GDP has more than trebled to 108%, while that of the bond market has less than doubled to just 40%. The worst issue is that only 3.3% of this is contributed by the corporate bonds. Why should it be like this, I ask? Why is the Indian corporate bond market at such a dismal state despite having such a large number of listed companies?

Well, the major reasons are, one, a lack of interest on the part of India Inc., and two, as I mentioned before, a well managed calumnious tactic to never motivate retail investors in the bond market. So far, India Inc. has walked out of this responsibility by conveniently blaming the lack of demand for corporate bonds in India. But the truth underneath depicts an ugly picture of vested interests. While the corporate sector pays around 9-11% for raising long-term funds in form of bank loans or issue of bonds, in the latter case, the companies need to maintain a level of transparency for the whole world – they can do away with the same in case of loans from banks. Moreover, while raising funds through bonds, companies need to face the acid test of investors due to the due diligence process. At the same time, in a country like India, which ranks 87 in the world (Transparency International’s Corruption Perception Index 2010), paying a little bribe to get a loan clearance is not a big hassle and Indian companies know it quite well since the license raj days. While there is a lot that can be discussed, the LIC Housing Finance bribery scam, where the CEO got arrested, is the pristine example with which I shall rest my case.

But then, why blame the corporate sector alone? Has the government shown any determination to develop the market? None whatsoever. There is no doubt that the intent was there always (remember the 2005 R. H. Patil committee report, which is now biting dust somewhere on bureaucratic shelves), but the interest was always missing. While governments the world over have encouraged their bond markets with various tax incentive models, India is yet to formulate anything in this direction. At the same time, equity investors are enjoying a fair deal of tax free provisions. If that is not enough proof of some deliberate connivance between the government and the equity players, then what is? Despite the Prime Minister requesting his finance ministry for developing a ‘vibrant’ corporate bond market in India, the chapter was again missing in the latest Union Budget. Not that we were too surprised by such a ramshackle act of ignoring.

Keeping in mind that the country now needs a massive $1 trillion investment in the infrastructure sector to keep up with a near double-digit growth rate, the best way at the moment is to rev-up the corporate bond market. And when do I personally expect this to happen? 2015; no sooner...