Boys need Dolls, New Dolls

Boys need Dolls, New Dolls

 

Emerging markets fascination among the investor class is nothing new. In fact the Amsterdam Stock Exchange was apparently the product of this fascination, launched as it was to facilitate the VOC, one of the first MNC, to profit from the EM story.

The difference between the 17th century adventurers and the 21st century adventurers is not in the objective, which steadfastly remains to maximize gains by riding the EM story, but in style; what is fashionably called investment style. Now people do not take out their big boats and sail around the world in pirate infested waters, fighting all kinds of diseases and worrying about the underlying logistic issues. Not to mention a few battles with the native rulers thrown in between in case there is a perceived lack of adventurism.

The second difference is the centre where the action is concentrated. Financial economy and real economy more or less progresses together like a happily married couple. That was the story of Europe for two centuries before the Great War in the 20th century and that is the story of the US of A in the 21st century.

In both cases, Innovation was at the base of the rapid economic development, in both, the real economy and the financial economy. Rapid strides were made as scientists invented or discovered new products which were then commercialized by another set of adventurists lubricated by a well functioning financial framework that promoted innovation.

Every time a successful new product is launched by Apple, God bless Steve, may his soul rest in peace, the spotlight is on the successful product. Massive reviews are written on the product itself, its advantages, it’s path breaking features; the list is endless. But rarely does the spotlight move away, and looks at the heap of the failed products that lie beneath the successful Innovation.

Why is this heap important? After all they are failed products. Did they in anyway contribute in making of that successful product. For every Apple there a thousand companies which have spent millions of dollars on ideating, innovating and failing. For every Steve, there are million entrepreneurs with stars in their eyes, and fear in the heart, who have fallen on the way side, unnoticed. Even within Apple, for every successful product launched, there are a few failures. If there is iPad, iPhone, there is also the portable Macintosh, and Apple Pippin (guess you may not have even heard of it).

What happens if there was no heap? Would the top be still there?

What applies in the real world, applies in the financial world also, as we see a range of financial innovations being attempted. The sub-prime story was an exemplary illustration of financial innovation. Human greed twisted it. Inspite of the heavy impact it had on the financial and real economy in the form of increased regulations and compliance costs, it did not deter the spirit of financial innovation.

Here is one example taken out from the heap.

NASDAQ had announced (Financial Products News #2016 -12) the launch of the NASDAQ IBIS Emerging Market Index (actually a family of indices) to track the emerging markets and provide a base for fund houses to launch their passive funds tracking the Index . It was not the first. The MSCI EM Index is the most popular in the category and has some famous ETFs, including the  IShare tracking it. 

The equal dollar weighted index began on Feb 16th 2016 at a base value of USD 1,000. The Index invested in ETFs covering emerging markets, a clear indication of the continued fascination with EMs. The selection of countries (out of 21 EMs) determined through a proprietary technology for Relative Strength. The Index tactically allocated up to five US-listed ETFs on an equal-weighted basis.  In short it was a second degree derivative product; it invested in ETFs, that invested in EM stocks.

Important thing is not why the product was launched. Or the benefits it offered. That is for the creator or the investors to answer. Simply speaking there was a felt need for the product. And in less than three months that need was no more felt. So on April 22, 2016, about 66 days later, vide Financial Product News #2016 - 22, NASDAQ discontinued the baby.

Sounds surprising. But not to most who are work in the global arena. A product that was launched after so much of research was found to be redundant, redundant enough to be discontinued. Period. 

It is in accordance with the NASDAQ philosophy.

“We continuously offer new opportunities for financial product sponsors across a wide-spectrum of investable products and for asset managers to measure risk and performance.”

The point is not the specific Index (NQIBEM) but the underlying philosophy that facilitates the introduction (de-introduction) of innovative financial products. It allows players to ideate, innovate and bring to market new products.

So which brings us to the question in the Indian context; we keep discussing the "inadequate" growth rate, which according to the RBI Guv  is a consequence of the fiscal policy, or to be fair to the Finance Minister, is a consequence of non cooperative monetary policy. Both are right but not completely. That is the big picture. 

The real story is to be found a few layers beneath, which is what the astute mind of our honourable PM realized. The economic development, even if the so called Gujarat model is debatable, of Gujarat in the past hundred years is the direct outcome of the evolved spirit of entrepreneurship that we find among Gujaratis. Business comes naturally, although innovation is generally conspicuous by its absence. Trading rules most of the time. But the underlying risk taking spirit is the key word.

The Startup India or for that matter Make in India initiatives are intended to be in the direction to ignite the spirit of risk taking and innovation among the broader population. In its most naked form, although it is not aimed at, but will create that heap, on top of which will eventually appear those successful Innovations in the real world, which shall drive the Indian economy onto the next level.

We also need to ignite similar projects in the financial space too, where innovation is looked down upon not because of the inability of our finance wizards to ideate, but for the fear of these WMDs. Incidentally in a research paper done by Rajan, our central bank Guv (in collaboration with Luigi Zingales) way back in 1998, he had concluded that "financial development can enhance innovation, and thus enhance growth in indirect ways."  So where is the innovation, the driver for growth.

A brief review of the occupants of North Block reveals a succession of leaders with leftist leanings or with economic background; the current incumbent being a lawyer by training, with a visible lack of experience in risk taking skills for facilitating the same. Increased controls, which end up stifling the free spirit, seems to be the order of the day.

A similar review of the leaders of various regulatory/financial bodies like SEBI, LIC, GIC, UTI, reveal a succession of civil servants, who worked in the overall framework of continuity and risk avoidance. A few years back when I had an opportunity to interact with some of the regulators, for the launch of a “revolutionary product” in India, I heard some rather interesting reasons behind the reluctance.  By the way at that time, there was actually nothing revolutionary about the planned product; it was a pretty standard template tried and tested in the developed markets.

I always believe that people at heart come with honest intentions. So if the bureaucracy is not in favor of innovation, they have their own genuine reasons which comes from centuries of conditioning.

First and foremost, as a society, India is a patriarchal protected society, where anyone with any authority takes it upon himself to protect the innocent from the evils. Whether it is the Film Censor Board that determines the duration for which James Bond can kiss on Indian screens  or the Police Department that will spend enormous resources on moral policing, or for that matter the Government that would decide what is good to eat or drink, everyone wants to be protective. And for those who do not intentionally come with the protective paternal instincts, the vigilance agencies like CBI, CAG, ensure risk avoidance.

Another reason for risk avoidance amongst the regulatory leadership is the genuine fear of the unknown. People who work in the regulatory bodies are mostly drawn from the civil services; a body of know-all people, whose experience and expertise on cutting edge is highly limited. And since they are Know-All, the inclination to learn something new is limited. Those rare campus hires taken by the semi government bodies, are too small in number to make an impact, on the overall strategic thinking.

Probably the biggest financial innovation was the US-64 in a very wrong way, when a MF was disguised as a fixed income product and mass sold. Rest is history. Or for that matter insurance sold across the country by LIC and many others even today, as an investment product.  The only innovation we have seen so far in the mutual fund space is on incentivizing the distribution channel to mobilize funds for clones. The concept of a Product Manager in the mutual fund industry who can work out the real product level profits made by the Fund House is still rare. There are some early signs, but we have miles to go. Most MF CEOs would fail to identify/act on their cash cows or dogs in their Product matrix of the AMC P&L. Most of the time  the product with the largest assets ends up bleeding the fund house.

For decades the old stock brokers club ruled the only worthwhile stock exchange in the country, until the civil servant managed NSE came into the picture. The Exchange scored heavily (and rapidly) on transparency and reducing transaction costs, resulting in exponential volume growth. It had learned from BSE on what NOT to do. Did they learn on what to do? Did it help promote financial innovation? After a few decades of existence?  It definitely did good as a platform for transaction, but its record on improving the quality (innovativeness) of products transacted is debatable.

While Exchanges themselves are just a platform for innovators to make innovations available, they also encourage innovators in developing new products that can be distributed at a mass scale.

A quick research of ETFs available on NSE reveals a rather interrupted development. Again it may be debated that ETF record is not the only parameter. After all ETF is not the Holy Grail. But the findings would not change much on any other product either.

There are about fifty odd ETFs traded on the Exchange most of which are plain vanilla passive products tracking either NIFTY or one of the sector indices of NSE. There are two international products, one on the Hangseng and the other on the Nasdaq 100, again plain passive ETFs, which was launched sometime in 2011. And then, am still searching for anything innovative done by NSE or by any finance powerhouse.

But the story on NASDAQ is sharply different as illustrated by the short lived NQIBEM. Regulators let the boys create new things, new toys, play with them, let them break it, bury it, and make another set, afresh. The story of these indices is essentially the story of these broken toys, discarded toys, which form the heap, that helps make the peak.

It is time for the Mint Street and the North Block to provide strategic vision to the boys on the Street to get innovative with their toys instead of peddling the same old toys that has been around for the last few decades. We need to work actively to broad base innovation in the financial product space. In a way we need to have that heap. The accelerator for the economic growth will come from innovation in the financial space as it become an effective intermediary to funnel funds in a broad range of causes. Something that is being done in the rather clouded world of VC, Angels, (and other shades of investors) needs to be opened up, and broad based, so that a thousand flowers (toys) bloom.

We need to have products that die regularly, so that they continue to live, for the economy to prosper.