In the second edition (first one was "My take on recession"), I would be presenting my views on hedge funds and short selling of P-notes.
A hedge fund is an investment fund, which is open to a limited range of investors that is permitted by regulators to undertake a variety of wider range of investment and pays a performance fee to the investment manager. However,unlike mutual funds, hedge funds typically take long and short positions in assets to lower portfolio risk arising from broad market movements.
A hedge fund may take a long positions in certain stocks, and short positions in ceratin other stocks such that their beta is close to zero.
A beta close to zero means that the portfolio remains unchanged due to broad market movement. Generally, investors take short term position in volatile shares and a long term view in stable counterparts.
Suppose, an investor take long term stand for stcoks of "A" and short term stand for "B".
So, if A increases by 10% and b decreases by 7%, the net profile is 3%. This way investors curb the market movement and try to have a better control over their investment.
Moving now to the P-notes(participatory notes), the obvious question is what are P-notes, why we use p-notes and what's the impact of P-notes.
As per the SEBI guidelines, foreign institutional investors should be registered with the SEBI, who wish to invest in India. P-notes are the means to bypass this procedure.
FII's who are registered with SEBI, provides access to other investors , to the Indian market who are not registered by issueing them P-notes, on the basis of stock purchased and look for all the transaction details. It's not mandatory for these FII's to disclose the name of the client unless specifically asked by SEBI for audit purpose. Hedge funds are used to issue P-notes by borrowing money from western market and invest in emerging markets.
Earlier govt. has encouraged P-notes, as it increases foreign investment but soon the market tends to be driven more by these big FII's which account for more than 35% of the investment.
Few things which concered Indian Govt. lately
1. Indian regulators are not very happy about participatory notes because they have no way to know who owns the underlying securities. Regulators fear that hedge funds acting through participatory notes will cause economic volatility in India's exchanges.
2. It's been suspected that terrorist outfits are investing and regulating the markets for raising funds.
3. Moreover, comptetors are buying the shares of ech other company behind the doors to have better control over the management.
4. To provide confidence and security to the small investors from highly volatile market.
Another question arisis, why the govt. has initially opted for allowing trading through P-notes.
Well, the answer lies if we go back in time. I remember, when I was a kid, it was a breaking news in doordarshan that India has 1billion$ of foreign reserves. Now,that was time when Indian economy was not so open and there were lots of restrictions. Before NDA govt came to rule, economic reforms had started taking place but it's a little known fact that India was borrowing short term loans from other countries and was once on the edge of being getting defaulter.
That was the time, when India required NRI's and foreign investment and provided them means to bypass these procedures and remain anonymous also.
However, lately this became a headache, as large scams started taking place under cover of these notes.
These FII's injected air into the ballon and when it's get bigger and bigger, they take away their prize leaving small investors bleeding.
To summarize, P-notes are used to increase hassle free foreign investment but it could back fire, if we loose control over its uasge and could also make your market highly volatile to the other global markets.
