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January 26, 2009
Should public resources be auctioned? On which parameter?
Background: In India sale/access to natural resources like oil & natural gas, spectrum(in the telecom sector) has often been auctioned. At times, auctions have also been combined with revenue sharing agreements i.e. the private entity which wins the right to access the particular natural resource also has to share a portion of its revenues.
These auctions often cause controversies.
Unitech sold its 60 per cent stake in the telecom venture to Telenor, for Rs 4,470 crore. Swan Telecom sold 45 per cent stake to the UAE-based Etisalat for Rs 4,100 crore ($900 million). This was Rs 2,450 crore more than what its promoters paid to acquire the licences in February. Unitech also had acquired licences for 22 circles by paying Rs 1,650 crore to the Government. The valuations received by these Indian companies are unprecedented as neither of them has a single subscriber nor any infrastructure........
.........(Source:
Hindu Businessline, 7 January 2009)
The debate in the Indian media seems to be biased in favour of getting the highest possible price for every publicly owned natural resource.
I would like to argue otherwise.
To my mind, the Government should be trying to get for its citizens goods & services at the lowest possible sustainable prices. Thus, selections of private managers should be carried out by defining an auction on the correct financial parameter. Let me elaborate.
Scenario: A billionaire offers to allow you to deploy a very large amount of his funds—a sufficiently large amount which could influence prices in pockets of the financial market.
Question: would you expect the billionaire to pay you a part of the returns you may earn on deploying these funds? Or, would you be happy to do it for free, if you have already manage a significant amount of money and you hope that your existing funds will be able gain substantially from your enormously increased influence in the financial markets? Or would you be willing to pay the billionaire for allowing you to acquire this new influence in the financial markets?
As on 31st March 2007, the Employees’ Provident Fund Organisation(EPFO) had investments of Rs 1,69,939 crores (US$ 34bn approx.) under Employees’ Provident Fund; Rs80,766 crores (US$ 16bn approx.) under Employees Pension Fund( Securities & Public Account); and another Rs5,533 crores (approx. US$ 1bn) under Employees’ Deposit Linked Insurance Fund( Securities & Public Account).
As per a Press Trust of India report dated 29th July, The Central Board of Trustees (of the Employees Provident Fund Organisation) have decided to allow three private sector firms and one public sector firm to manage provident fund of employees. The lowest bidder quoted an asset management fee of 0.0063%. Another private sector firm quoted 0.0075%, while the public sector firm(which is also the existing manager for the EPFO funds) and a third private sector firm quoted 0.01% each.(Note: Two bidders, both from the private sector, who bid zero were actually disqualified. However, the disqualification was a technical legality)
An expert estimate of the average cost to company of a fund manager for managing a large fund is of the order of Rs 2.5 crores(US$ 0.5mn approx.). Thus, for the three private firms the cost of the fund manager could be of the order of Rs 7.5 crores (US$ 1.5mn approx.). Considering the infrastructure costs as well as the costs of other key employees, these firms may barely be able to recover their cost. Why? Because the total asset management fee earned by the three private firms in managing the EPFO fund would total to around Rs 10 crores (US$ 2mn approx.)! Maybe, the three private sector firms are quoting these rates out of some new Corporate Social Responsibility(CSR) initiative! Maybe the private players will not deploy their best talent. Or may be the will keep the staff for the fund really small. Maybe they will use the same staff which manages other funds, and which manages the EPFO funds as if it were part of their secondary or tertiary work stack! Or maybe the asset management fee would be renegotiated (revised upwards) at a later date!
Why bother as long as the returns on the EPFO funds managed by the private firms are close to the average returns on the rest of their(private firms’) funds! In fact, all we should do is monitor the EPFO fund performance.
I believe the auction conducted by EPFO was conducted on the wrong parameter. The auction should not have been conducted on asset management fees. Rather, the technical bids evaluation process should have shortlisted those private firms which have a track record which satisfies the EPFO. Then, the asset management fees(in %) should have been negotiated with the shortlisted firms to arrive at a single number. Last and most importantly, the financial bids should have been on the basis of a multiple of the average future returns earned by that entity in all its other(existing and future) assets under management. As an example consider that ABC, PQR and XYZ are among the shortlisted firms. Then, they should submit their multiples. Say, ABC promises a minimum return of 1.05 times that of the average future return in its other funds. The bids by PQR and XYZ could be multiples of 0.90 and 0.95 respectively. Then, the most favourable bid is that of ABC, followed by the one made by XYZ.
What if the promised return is not earned? The difference should be credited to the EPFO fund managed by the private firm, from the private firm’s own pocket. And as a risk mitigating factor the EPFO should take good collateral as a security against the private player not fulfilling its promise.
If the private players cannot promise even something close to its own performance for its other assets under management, we can be sure that EPFO is being shortchanged!
WHAT DO YOU THINK? WHAT MIGHT BE A BETTER SOLUTION?
Posted by amgodbole at January 26, 2009 11:27 AM
Your article is very very interesting.
But I am afraid that your suggestion of choosing fund managers is not completely realistic.
Firstly, the asset management is like gambling in many ways. A fund manager buys different instruments on behalf of different funds he works with. He cannot guarantee equal results because different stakes obviously bring different gains. By the way, he has no mechanism to make profits of his different funds equal.
Secondly, volumes of assets under management of companies are often seriously more than their own assets. That is why, the asset management company can rare guarantee any profitability. Certainly, it can proclaim it in advertisements, but fails to meet in reality.
Thirdly, different funds even being managed by a particular company can have different investment declarations or rules. That is why, they cannot be compared.
Sorry for my primitive arguments which was told above, but I suggest choosing a fund managers in according with:
1) reliability of managers (ratings, respectability, and so on),
2) their ability to meet requirements (follow investment declaration, provide reporting and service)
3) (the most important) the history of their previous effectiveness (profitability of operation after asset management fees).
Posted by: Gregory Gorobetz at March 20, 2009 05:37 PM
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