Money betting on a risky financial instrument caused them to lose over Rs. 100 crore
Kumar Mangalam Birla was upset. The news he had received in late September 2010 from the 18th Floor of the Indiabulls Centre in Mumbai was distinctly downbeat. The Mumbai-headquartered Aditya Birla Money had lost Rs. 103 crore on its Options Maxima strategy.
Babuji, as Kumar Mangalam is called inside the group, had two choices. He could let the loss trickle down to the investors, or he could pay investors back.
Apart from high-net worth individuals, the word was out that the scheme that had lost money also had some big names from the financial services industry, including a CEO of one of the largest private sector banks in the country.
A spokesperson of Birla said that these rumours are baseless and refused to talk on this due to the client confidentiality clause with their investors. Birla bit the bullet and Aditya Birla Nuvo (ABN), the parent company of Aditya Birla Money, paid the investors. The loss was recorded on ABN’s books.
Missing the Beat
This wasn’t in the Aditya Birla Money script. In 2008, Kumar Mangalam Birla had told Economic Times that he should be either in the top three slots in every business or he should be very profitable. The financial business has three main divisions: Insurance, mutual funds and broking.
Nuvo also plans to infuse Rs. 300 crore into Aditya Birla Finance, a non-banking financial company (NBFC), to increase its net worth and expansion plans. The Aditya Birla group (Birla group) wants to enter the banking sector through this NBFC. And perhaps this too must have played a part in investor’s losses being made good. Such an event reflects badly on a group seeking a banking license.
These losses are significant for Aditya Birla Money.
The firm had posted an income of Rs. 38 crore for the July-September quarter of the year ending March 2011 and a net profit of Rs. 1.5 crore. For March 2010, Aditya Birla Money had a total income of Rs. 112.37 crore with net profits of Rs. 12.68 crore.
The Rs. 103 crore hit that ABN has taken is equivalent to more than two years of Aditya Birla Money’s profits. Incurring such a large capital loss in a financially conservative Aditya Birla Group is almost akin to getting hit for a last ball six in a match against Pakistan.
Ajay Srinivasan, who heads Birla’s financial services foray, and his second-in-command, Pankaj Razdan, found out the true extent of Kumar Birla’s feelings. Soon after the loss, they tried to meet him to explain what had happened. Word has it that Birla didn’t grant them an audience. Instead, they had to meet Santrupt Mishra, the director for group HR for a major dressing down, says an insider.
The jury is now out on whether this setback will lead to more shake-up inside Birla’s financial arm. Insiders say that even before this current setback, Kumar Birla had begun making senior-level reshuffles across various parts of his financial empire, preferring to replace the current incumbents with old Birla loyalists.
In 2007, Birla handpicked Ajay Srinivasan, who was then with Prudential Corporation Asia in Singapore, to head the financial businesses of the Aditya Birla Group. Since 2002, Birla’s financial services business had lost momentum. In 2002, its star fund manager Bharat Shah had moved on to ASK Raymond James and charge for all of financial services went to S.K. Mitra. Then on July 7, 2007, S.K. Mitra was told that his performance was not up to the mark and he was given a hefty severance pack and asked to move on. Birla finance business employees say that before Mitra was out of the building, they were told that Ajay Srinivasan was taking charge of the financial services group.
When Srinivasan took over in 2007, he had to build a business that was losing market share both in the insurance as well as the asset management side. Insurance had a market share of 5 percent and the assets under management (AUM) of Birla Sun Life Mutual Fund stood at Rs. 23,000 crore, making it the seventh largest mutual fund. There was no broking arm and Srinivasan felt that this was one piece that was lacking, so he had to scout for an existing company that could give him access to this business. Since Kumar Birla wanted to be among the top three players in these segments, Srinivasan had a very tough task at hand.
Srinivasan and his second-in-command Pankaj Razdan brought new vigour to the operations, primarily by introducing the go-getting culture of the ICICI group. Insiders say that close to 70 people who had at some point worked with the ICICI group joined Srinivasan and Razdan’s team. Their dynamism and aggression didn’t quite go down well with many of the old-timers inside the Birla finance business though.
To be fair, Srinivasan did get things moving. Between 2008 and 2010, the insurance business has grown by 15 percent annually. It generated profits of Rs. 20 crore for the first time for the July-September quarter of the year ending March 2011, but new business premium has fallen by 12 percent. Chances are that growth may not come through for the year ending March 2011, as the Securities and Exchange Board of India (SEBI) and the Insurance Regulatory and Development Authority (IRDA) have changed the way insurance schemes or unit-linked insurance plans (ULIPS) work — and that will dent profitability severely.
The revenue of the financial services business has increased by 45 percent in the last one year. Yet, Srinivasan isn’t anywhere close to achieving Birla’s targets. Birla hasn’t reached the top three positions in any of the businesses and profitability isn’t very robust either. Also, close to 80 percent of the assets of the Birla Mutual Fund are related to liquid, cash or debt-related funds. These schemes earn a meagre 15 basis points (0.15 percent) as asset management fees. Other funds that have substantial assets in equity earn around 1 percent as management fees.
So, to get a piece of the equity action, in September 2008 Srinivasan recruited Vivek Kanwar from ICICI Bank to head Birla Sun Life Distribution. Kanwar had been a general manager at ICICI Bank, with the retail liability group, and his responsibilities included handling high net worth individuals and institutional clients. In September 2009, Kanwar became the head of Aditya Birla Money, the broking arm of Birla Financials.
Actually, it was Birla’s second attempt at broking. The group had a broking company called Birla Sun Life Securities, which was sold to BRIC Securities in 2003 at a small sum of Rs. 18 crore. By the time Srinivasan took charge, the financial services sector had taken off and broking was a critical part of the financial services play. In a way, it was the missing piece in the asset management and insurance business.
ABN bought Apollo Sindhoori Capital investments, a broking firm from Chennai, from the Apollo group. The relatively high acquisition price of Rs. 350 crore was largely because of its retail client base of 250,000.
In November 2009, Apollo Sindhoori was rechristened as Aditya Birla Money and Vivek Kanwar was given a free hand and a salary that is believed to exceed Rs. 2 crore. It was now important to show results. The erstwhile Apollo Sindhoori had an interesting product in its stable called Options Maxima, which used risky options strategies to make money for its investors. The senior management of Aditya Birla Money was impressed by this product as they thought that they could sell it to high net worth individuals as a safe product. It is believed that it also carried a fee element that was charged to the investor to the extent of 1 percent, something that generally large asset management companies charge to their investors. Generally, the industry norms for trading options work to around 0.05 percent to 0.075 percent. Furthermore, investors were told that there will be a one rupee broking charge on every transaction. Though Kanwar had no prior experience in the derivatives business, selling this product became very critical for the Aditya Birla Money management.
There was nothing wrong per se in selling such a risky product. What was a little odd was that it was sold to some people whose age and risk profile were not suitable for this product. A spokesman from Birla Financial Services makes it clear that the investors were aware about the risks in the strategy, while investors argue that the risks were casually mentioned.
Old Man & the Short Strangle
Seventy-six-year-old N.R. Ramaprasad is one such person who ended up buying the Options Maxima product. Since 1970, Ramaprasad had only invested for the long term. For years he has been holding stocks of Infosys, ITC and Gujarat Ambuja. He never really sold his equity investments. Either by pure luck or absolute genius, Ramaprasad had made a fortune, allowing him to take early retirement from his job as a cement technologist because of fading eyesight and a glaucoma operation that had gone wrong. In July 2010 he got a call that changed his life.
The call was from Vinay Madhavan from Aditya Birla Money. Pretty soon he ended up investing Rs. 2.5 crore into the Options Maxima scheme. Except that this wasn’t a cash investment. N.R. Ramaprasad would have to offer a portfolio of shares worth Rs. 2.5 crore to Aditya Birla Money. Ramaprasad was told that the shares would be used as collateral for the options strategy that Aditya Birla Money planned to use.
According to a power point presentation of the strategy provided to investors, “good returns of around 24 percent can be expected on investments and surplus of the initial investments may be claimed as payout by the clients on monthly basis, around 10th of every month”. Ramaprasad was verbally assured a 1.5 percent return every month. The presentation says that Aditya Birla Money did not expect the market index to move more than 25 percent from the level it was then. The presentation is silent on one aspect though: It does not talk about how the option premium could increase drastically, if the market volatility increased. The premium is what really shot through the roof.
Didn’t Ramaprasad even for a moment think that something was amiss? After all, he didn’t quite understand the methods of the Aditya Birla Money staff. “I had advised Aditya Birla for their cement plant near Raipur and had a lot of faith in this group. Thus I invested blindly in whatever they were selling me,” says Ramaprasad.
He was shocked when two months later he was told that he would have to pay Rs. 39 lakh if he wanted his shares back! “I never knew I was committing the greatest mistake of my life,” he says. Ramaprasad still doesn’t understand it fully, but Kanwar and his team were using a highly risky strategy called the Short Strangle to deliver returns in a stock market that was stagnant. This strategy would work well in a range bound market. It would mean that Aditya Birla Money would keep collecting driblets of steady money from the people who expected the market to rise. A fair thought in June 2010, because most market experts believed the markets would remain in a band.
The Strategy Unravels
Many broking firms created similar options strategies for their customers. But when the
market started to move up by mid-September, most of these brokers booked some losses and moved on. Nobody attempted complex strategies for their investors. Those who did, knew that heavy FII flows would take the market higher in September itself. Aditya Birla Money was managing something around Rs. 600 crore through this strategy and was not ready to lose the fee income.
No one is quite sure about the exact reason why the strategy unravelled. From the first week of September, the market became volatile. From September 2, within a span of 20 days, the volatility index (VIX), which measures the volatility of the market, moved from 16 to 24, while the Nifty moved by 9 percent. Since the market shot up, the premium on the calls also moved up and that is how the losses accumulated. The premium on the Nifty which was around Rs. 6 in the first week of September, began trading at around Rs. 200 and thus call writers had to suffer heavy losses. Investors in Options Maxima, which used a short strangle strategy, made some money by writing simultaneous put options, but that income was not enough to compensate the huge losses incurred by writing call options. It isn’t clear why Aditya Birla Money’s risk management didn’t throw up warning signs even though the VIX indicator had already turned red.
“Investors need to understand that options premium is not only sensitive to the price of underlying [asset] but also to the volatility. It can display huge percentage swings in value as volatility moves, even if the underlying itself has not moved. Movement in underlying compounds the risk. Short strangle strategies can prove very risky if a range bound market turns volatile,” says Johnny Bhatkar, a derivative expert who runs Pyxis Systems, a derivatives risk management company.
When Ramaprasad came to know that some investors had actually got their money back, he contacted the Birla Money office. “I asked them if other investors were refunded their money and Aditya Birla Money told me that was not the case. I have been reading in the newspapers that some investors were paid back. So why not me?” he says. “We only acted as a broker to the transactions of their clients,” says a spokesperson from the Aditya Birla Financial services group. “Aditya Birla Money officials told me that it was I who had given instructions to Aditya Birla Money to trade this complex derivative strategy. And I had given my shares as a collateral,” says Ramaprasad. Aditya Birla Money maintains that this was “not a portfolio management scheme (PMS) which needs to be registered with SEBI”.
Ramaprasad may not have any legal recourse. “Section 11 of the Securities Act, 1933 of the United States provides a private right of action to take action in matters related to material misrepresentations and omissions related to securities. There is no similar direct Indian law which provides an investor with such rights against a broker, unless SEBI decides to take action,” says Diljeet Titus of Titus and Company advocates.
Inside the office of Aditya Birla Money, stress levels have begun to rise. Kanwar has put in his papers and has taken the entire blame on his shoulders.
Yet that hasn’t stopped the blame game inside ABN. Old timers are blaming the former ICICI pros for the entire setback. And the knives are out for them. The fact that the Birla group is invariably very bottom-line driven compared to the ICICI culture of driving top-line, is widening the chasm between the old camps. This has also proved to be the perfect opportunity to hit back at the incumbents. “Earlier we were told that there will be only five-six top guys that will be in the top and middle level management inside Aditya Birla Money, Mutual Fund and Insurance firm. But then we saw this place full of ICICI people and obviously we did not like it,” says a former Birla employee who had seen the changing culture inside the Birla offices and left the place.
So far, the Birla group’s tryst with outsiders to head its financial services forays hasn’t paid off. Not too many folks have lasted beyond three years. The mutual fund business itself has seen eight CEOs within a span of 15 years. The present CEO is the third one during Ajay Srinivasan’s tenure as the business head, Financial Services, Aditya Birla Nuvo.
There will be Changes
The winds of change are slowly being witnessed inside the company. “It seems that Birla wants to get back to his old culture of high profitability over growth at any cost and that is why he is slowly trying to reposition his people at the top in most of his businesses,” says a Birla employee.
For instance, he has given a free hand to A. Balasubramanian, a Birla loyalist who has been with the firm for a long time and has been made CEO of Birla Mutual fund. The insurance business will not have the aggressiveness of the ICICI culture and Jayant Dua, another old Birla hand has been made the CEO and managing director of the company. That leaves Aditya Birla Money, which is handled by Pankaj Razdan, after the ouster of Vivek Kanwar.
If Kumar Birla chooses to make any more senior level changes for the next few months, it will simply mean the Rs. 103 crore derivatives mess has proven to be the final straw on the camel’s back.
(Additional reporting by Rohin Dharmakumar)