Archive for September 11th, 2015

Amtek Auto and Mutual Funds: Use Side Pockets, not Gates

September 11, 2015

Prof JR Varma has an interesting solution for the ongoing trouble between JP Morgan Mututal Fund and Amtek Auto. Just for the starters,the fund had invested in the paper of Amtek Auto. As Amtek Auto got into trouble, so did the fund. It stopped redemptions from the funds.

Prof Varma says instead of closing the gate (i.e. redemptions), one should allow the side pockets to work:

JPMorgan Mutual Fund has gated (restricted redemptions from) two of its debt funds which have large exposure to Amtek Auto which is in distress. A gate is better than nothing, but it is inferior to a side pocket. I would like to quote from a proposal that I made in a blog post that I wrote in October 2008 when the NAVs of many debt oriented mutual funds were not very credible:

At the very least what is required today is a partial redemption freeze to ensure that nobody is able to redeem units of mutual funds at above the true NAV of the fund. Anybody who wants to redeem should be paid 70% or 80% of the published NAV under the assumption that the true NAV would not be below this. The balance should be paid only after the true NAV is credibly determined through asset sales.

Unlike the generalized distress of 2008, what JPMorgan funds are facing today is distress limited to a single large exposure. According the July portfolio statement, Amtek Auto was about 15% of the NAV of the Short Term Income Fund. Even if this is valued at zero, the fund can pay out 85% of the NAV to everybody. (For the India Treasury Fund, Amtek is only 5% of NAV, so the fund can pay out 95%). Essentially, my proposal is what is known in the hedge fund world as a side pocket: the holding in Amtek Auto should go into a separate side pocket until it is liquidated and the value is realized. The rest of the money would remain in the normal mutual fund which would be open for unrestricted redemption (as well as for fresh investment).

The gate has two big disadvantages:

  1. The gate is not total: redemptions are not stopped, they are only restricted to 1%. This means that some redemptions are taking place at a wrong value. The money that is being paid out to this 1% is money that is partly money stolen from the remaining investors.
  2. The gate rewards the mutual fund for its own incompetence. A fund which has made a bad investment choice would be punished in the market place by a wave of redemptions. That is the competitive dynamic that encourages mutual funds to perform due diligence for their investment. A gate stops the redemption and shields the fund from this punishment.

It is possible that the mutual fund offer document might not contain a provision for a side pocket. But the Securities and Exchange Board of India (SEBI) as the regulator certainly has the power to issue directions to the fund to use this method. Let us see whether it acts and acts quickly.

Hmm..Side pockets vs gates..nice way to explain complex ideas..

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How growing cereals instead of tuber led to certain countries getting better institutions? (some parallels with Sholay..)

September 11, 2015

This idea of what leads certain regions to have higher incomes than others is as old a question as it can get. Within this, quality of institutions has emerged as one of the strongest reasons for high and low growth. Within this, the questions remains what leads to better institutions? Many explanations have been given like law, politics, finance and so on.

Joram Mayshar, Omer Moav, Zvika Neeman and Luigi Pascali have this interesting piece looking at geography and agriculture as a source for institutional differences. They build from Jared Diamond’s idea on why geography matters but have a different take.

The authors say that regions that grew things like tuber etc could not really store these agri items. Hence they had to be consumed right away. There was no case for appropriation by robbers and so on.

However, those who grew things like cereals etc which could be stored, there was a case for appropriation by robbers (Hindi Movie fans will remember Sholay :-)). Hence, the need for hierarchy and institutions to minimise these robberies.

That simple really..

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Economists vs economics (and a call for more pluralistic economic thinking)..

September 11, 2015

Prof Dani Rodrik sums up the issues with the subject and suggests way forward. He says the idea is again not to search for that elusive single model but allow multiple models, multiple thinking..

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