CENTRE FOR FINANCIAL MANAGEMENT
CFM QUARTERLY IN FINANCE
EDITOR: DR. PRASANNA CHANDRA
PART A: ARTICLES/ CASES
1. VARIED HUMAN WANTS
2. KINGFISHER AIRLINES
PART B: SNIPPETS
1. SOME PITFALLS OF INVESTING
2. TRADITIONAL FINANCE, BEHAVIOURAL FINANCE, AND EMOTIONAL FINANCE
3. FINANCE AND MATHEMATICS
PART C: WIT AND WISDOM
2. WISE SAWS
1. VARIED HUMAN WANTS
From all products and services (including financial products and services) we want three kinds of benefits: utilitarian, expressive, and emotional. As far as investments are concerned, the three kinds of benefits may be defined as follows:
What does the investment do to my pocketbook? Utilitarian benefits of investments are reflected mostly in wealth, augmented by high investment returns.
What does the investment say about me to others and to me? For example a stock picker may say, “I am smart. I can identify winners.” Or an option trader may say,” I can assume risk and know how to control it.”
How does it make me feel? An insurance policy may give one a sense of security, a speculative stock may provide hope, and stock trading may offer excitement.
In a fascinating book What Investors Really Want (published by McGraw- Hill in 2011), Meir Statman says: “We want high returns from our investments, but we want much more. We want to nurture hope for riches and banish fear of poverty. We want to be number 1 and beat the market. We want to feel the pride when our investments bring gains and avoid the regret that comes with losses. We want the status and esteem of hedge funds, and the patriotism of investing in our own country. We want good advice from financial advisors, magazines and the Internet. We want to be free from governmental regulations, yet be protected by regulators. We want financial markets to be fair, but search for an edge that would let us win, sometimes fair and at others times not. We want to leave a legacy for our children when we are gone. The sum of our wants and behaviours makes financial markets go up or down as we herd together or go our separate ways, sometimes inflating bubbles and at other times popping them.”
Let us elaborate on some of these wants.
We Wants Returns Higher than RisksInvestments with returns commensurate with their risks are easy to find as good lunches at fair prices. But we want free lunches and search for investments that offer superior returns or returns that are more- than- commensurate with risks.
We Want to Play and Win Although we know that earning superior returns is difficult, we want to play the game of investment and win. As Meir Statman puts it: “Playing the game makes us feel alive, in the groove, in control, and in the flow. And winning is exhilarating.”
We Join Herds and Inflate Bubbles There is a natural desire on the part of human beings to be part of a group. So we tend to herd together and create bubbles. As Meir Statman puts it: “We stampede into investments in exuberance and stampede out in fear. We inflate bubbles and deflate them. Our herding instinct also opens the doors to frauds, where early fools pull in late fools, and all turn into losers.”
We Want Self –Control and Mental Accounts We separate our money into various mental accounts and treat a rupee in one account differently from a rupee in another account because each account has a different significance to us. The concept of mental accounting was proposed by Richard Thaler. Mental accounting helps us in exercising self- control and prevent us from buying an expensive car today when we need to save for retirement.
We Want Hope for Riches and Freedom from the Fear of Poverty We nurture the twin desires of hopes for riches and freedom from the fear of poverty. So we buy risky stocks as well as safe bonds. Also, we buy lottery tickets as well as insurance.
We Have Similar Wants and Dissimilar Wants Some investors are driven by hope, while others are concerned more about freedom from fear. The tradeoff between hope and freedom is determined by our personalities, experiences, and cultures.
We Want to Avoid Losses Gains bring pride while losses cause regret. The pain of losses is greater than the pleasure of gains. As Meir Statman put it: “Realising losses is especially painful because we give up hope of recouping our losses. So we realize gains quickly and procrastinate in the realisation of losses.”
We Don’t Want to Pay Taxes While some people greet taxes with acceptance or resignation, most people don’t want to pay taxes. They consider themselves smart and savvy when they avoid taxes.
We Want to Demonstrate Our Competence Many people spend time in solving a Sunday crossword puzzle even though it imposes utilitarian costs. Why? Because they derive expressive and emotional benefits from demonstrating their competence to others and to themselves. Many investors trade frequently even though it has been demonstrated empirically that frequent trading is financially harmful. Why? Because investors want to demonstrate their competence.
We Want to Stay True to Our Values Some socially responsible investors are willing to accept a lower return to promote human rights or protect the environment as they value these things. Values of course vary from person to person. People have varying wants for utilitarian, expressive and emotional benefits.
We Want High Social Status We want high social status. Investments can help us in this respect. For example, painting and collectibles provide expressive and emotional benefits. To enjoy these benefits, some people are willing to accept lower utilitarian benefits from painting and other collectibles.
We Want Fairness While people may have different notions of fairness, the right to freedom from coercion and the right to equal power are generally considered as key ingredients of fairness.
We Want to Nurture Our Children and Families We have a natural interest in protecting and promoting the wellbeing of our children and families. So parents invest in educating their children, help them start their households, and assist them in achieving financial independence when they become adults.
People have varied wants. As Meir Statman put it: “We vary in our wants by personality traits such as conscientiousness, values such as protecting the environment, religion such as Islam, circumstances such as wealth, and culture, Asian- Americans or European- Americans, upper class or lower class.”
Our Wants as Investors and Consumers
Rational investors can separate their roles as investors from their roles as consumers. As investors they care only about production of wealth and as consumers they care about all benefits of wealth consumption, utilitarian, expressive, and emotional. The focus of standard finance is on production of wealth and its utilitarian benefits. Exploration of the expressive and emotional benefits of wealth consumption is regarded as the domain of disciplines like marketing and consumer behavior.
At times it may be possible to separate production of wealth from its consumption. But often it is not possible to separate utilitarian costs and benefits from expressive and emotional ones. For example, houses, jewellery, and art objects combine investment and consumption benefits along with expressive and emotional ones.
Our Wants and Errors
People do well when they fulfil their wants for utilitarian, expressive and emotional benefits without committing cognitive and emotional errors. Sometimes wants and errors are confused, so it is necessary to distinguish between the two.
To clarify the distinction between the two, let us consider lottery tickets. People may be lured to buy lottery tickets because they commit the cognitive error of exaggerating the odds of winning. Suppose they are provided information about the true odds of winning. If they stop buying lottery tickets, we can say that earlier they were misled by cognitive errors. If they still continue to buy lottery tickets it means that they want the expressive and emotional benefits of hope and the miniscule chance of the utilitarian benefits derived from the prize money.
The difference between wants and errors may be further illustrated with thrills and sensations. Sensation seekers (such as fast drivers and day traders) may be divided into two groups: ignorant sensation seekers and knowledgeable sensation seekers. Ignorant sensation seekers are blind to errors stemming from overconfidence in their skills as drivers or traders. They are unaware of the price they have to pay for seeking thrills and sensations. Knowledgeable sensation seekers recognise their overconfidence, but are willing to pay the price for seeking thrills and sensations.
Our Wants and Shoulds
The voice of wants says, “I want to drink this tasty aerated drink now,” but the voice of shoulds says, “You should choose the healthy fruit juice.” As Meir Statman describes, “Want are visceral, whereas shoulds are reasoned. Wants’ benefits are in the present, whereas shoulds’ benefits are usually in the future. Wants focus our attention on expressive and emotional benefits, whereas shoulds usually focus it on utilitarian ones.” While rational people are free of conflicts between “wants” and “shoulds,” normal people experience conflicts between the two. So they may require nudging.
The UB Group of India, headed by Vijay Mallya, launched the Kingfisher Airlines (KFA) in 2005. After having earned the reputation of liquor baron, Vijay Mallya diversified into the totally unrelated business of airlines. He entered the airline industry when the buzzword was ‘low cost’ and the aviation industry in India was booming. Vijay Mallya, a colourful and flamboyant person, is known for his fondness for “good things in life” such as IPL teams, cars, horses, private jets, yachts, and exotic villas. According to some sources, Vijay Mallya set up KFA in 2005 as a birthday gift for his son, Siddharth Mallya, on his 18th birthday.
The UB Group, under the leadership of Vijay Mallya, built a successful liquor business and Mallya took great pride in building several powerful liquor brands. Fond of good things in life, Vijay Mallya conceived of KFA as a five star airline. He took special interest in building KFA as a premium airlines brand. KFA offered exotic cuisine, provided choice in-flight entertainment, and employed model-like air hostesses. KFA won several awards. Among the more notables of them are: India’s Second Buzziest Brand in 2008 by The Brand Reporter, Asia Pacific’s Top Airline Brand, India’s No. 1 Airline in customer satisfaction by Business World, Best Airline in India/Central Asia, at the Spytrax World Airline Awards 2010.
The image that it created enabled it to get the KFA brand valued by Grant Thorton at ` 4,100 crore in 2011-12, even though the company was incurring losses. In March, 2016, this valuation was being probed by the Serious Fraud Investigation Office (SFIO). A Grant Thorton spokesperson said the firm fully stood by its brand valuation report on Kingfisher. He said, “We believe it was appropriate in the context of when it was done and the purpose for which it was done.” By the way, RBSA Advisors, a global valuation and transaction advisory firm, carried out two valuation exercises of KFA brand in 2013 and 2015. In 2013, the KFA brand was valued at ` 200 crore and in 2015 it was valued at ` 100 crore.
To the surprise of many, KFA which prided itself as a provider of premium services, acquired Air Deccan, a low cost carrier in 2007, changed its name to Simplify Deccan and subsequently to Kingfisher Red. Perhaps this acquisition was motivated by a desire to cross the legal hurdles of flying internationally quickly. KFA started its international operations in September 2008. On September 2011, Vijay Mallya announced that KFA would soon stop operations of Kingfisher Red as it did not believe in low-cost operation any longer.
Since its inception KFA never made money. It accumulated losses and debt. Even after two rounds of debt restructuring, it defaulted on its debt and other obligations. In September 2011, KFA made following disclosure to the Bombay Stock Exchange (BSE): “The company has incurred substantial losses and its net worth has been eroded. However, having regard to improvement in the economic sentiment, rationalisation measures adopted by the Company, fleet recovery and the implementation of the debt recast package with the lenders and promoters including conversion of debt into share capital, these interim financial statements have been prepared on the basis that the Company is a going concern and that no adjustments are required to the carrying value of assets and liabilities.” KFA lenders later stated that they regarded the company as viable.
On 15 November 2011, KFA released poor financial results indicating that the company was “drowning in high-interest debt and losing money.” Mallya suggested that the solution was for the government to reduce fuel and other taxes. In 2012, the Directorate General of Civil Aviation suspended KFA’s operator permit and KFA was grounded.
In 2013, lenders began to recall loans. In 2014, KFA loan was treated as an NPA by lenders and United Bank of India declared KFA as a ‘willful defaulter.’ According to the 2014-15 annual report of the group’s holding company, United Breweries Limited, the consortium of bankers had invoked the company’s corporate guarantee. In 2015, lenders began the recovery process. In 2016, SBI, the lead banker in a consortium of 17 banks that have loans worth ` 9000 crore to KFA, said that they were trying to do everything possible to find a solution.
1. Discuss the behavioural factors that may have led to the creation and destruction of KFA.
1. SOME PITFALLS OF INVESTING
Here are some pitfalls that investors should guard against:
· Green pasture effect
Marketitis Traders feel compelled to play the market all the time for a variety of reasons. As Martin J. Pring said: “Some crave the excitement.. Others see it as a crutch to prop up their hopes….When everything else in your life results in disappointment, the trade or investment serves as something on which you can pin your hopes.” J.H. Wolf calls this phenomenon “marketitis.” Since the motivations for trading are flawed, it is not surprising that the results usually are bad.
Tickeritis Henry Howard Harper in his excellent book called The Psychology of Speculation written in 1926 described the constant need to watch the market as ‘tickeritis.” He argued that a person suffering from tickeritis “is no more capable of reasoned and self- composed action than one who is in the delirium of typhoid fever.” Constant watching of the tape results in some kind of mental intoxication that “foreshortens the vision by involuntary submissiveness to momentary influences.”
The Green Pastures Effect A psychological snare that traps all of us from time to time is the false assumption that we are floundering while others are flourishing. The grass looks greener on the other side of the fence. So we abandon our strategy and unthinkingly imitate what others are doing.
Enteritis Most people enter the market because they think it is easier to make money. There seem to be two reasons for this. First, not much cost and effort are required to begin trading. Hardly any other form of business activity provides such ease of entry. Second, playing the market appears easy and uncomplicated. All that one has to do is “buy low” and “sell high.”
2. TRADITIONAL FINANCE, BEHAVIOURAL FINANCE, AND EMOTIONAL FINANCE
Emotional finance provides a new perspective in the domain of finance. In contrast to traditional finance and behavioural finance, it explicitly recognises the critical role of emotions in all thinking and experience and examines how emotions drive investment decisions and financial activity. Traditional finance assumes that economic agents are rational decision makers. Behavioural finance examines the implications of cognitive heuristics and biases and affect heuristic (a specific quality of positiveness/ negativeness felt rapidly and automatically in decision making). Emotional finance focuses on financial decision making from the perspective that the outcomes of decisions are not known in advance. As someone put it: “Outcomes can be guessed or imagined but never known, which necessarily stimulates emotion conceived as an ongoing and dynamic (changing) influence on thought. Emotional finance seeks to incorporate such understanding within a formal theoretical framework that has direct practical relevance to all financial market participants and is close to their personal experience.”
3. FINANCE AND MATHEMATICS
Finance is a systematic and disciplined study of the financial transactions of money. It may be defined as follows:
Mathematics + Money = Finance
Of course, from the above equation, don’t deduce that Finance without Money is Mathematics!
When we say mathematics, we are talking about a wide range of mathematics from the extremely pedestrian and obvious to the extraordinarily complex and profound as shown below.
Simple Arithmetic and High School Algebra Partial Differential Equations
Warren Buffett, the eminent investor and businessman, uses high school arithmetic. At the other end of the spectrum James Simons a well- known mathematics professor setup Renaissance Technologies, a hedge fund in late 1980s. Probably the most successful hedge fund in history, this find uses advanced quantitative investment strategies and employs many PhDs in Mathematics and Physics.
PART C: WIT AND WIDSOM
· A very difficult businessman was approached by a famous charity organization for donation.
The businessman didn’t give anything. He said, “First my mother is sick and dying in the hospital and does not have a health insurance. Second, I have six children from three divorced marriages. Third, my sister’s husband died and she has no one to support her four children.” The man from the charity organization said, “I am sorry. I feel bad about asking for donation.”
The businessman responded, “Yeah, well if I’m not giving them anything, how can you expect anything from me.”
· Sherlock Homes and Dr. Watson were camping on their trek. They pitched their tent under the stars and slept off. In the middle of the night, Holmes woke Watson up and said. “Watson, look up and tell me what you see.” Watson said, “I see a sky filled with millions and millions of stars.” Holmes asked, “What do you infer from that?” Watson said, “If there are millions of stars, and if even a few of them have planets, it is likely that one them would have a biosphere that sustains life.” Holmes rapped Watson and said, “Idiot, what it means is that somebody has stolen our tent.”
2. WISE SAWS
· The discovery of few notes of sympathy is the secret of all good conversation.
· There is no subject, however complex, which if studied with patience and intelligence- will not become more complex.