Income Inequality Will Widen, and Finance Explains Why

Can you share with us your academic and professional journey? What motivated you to specialise in finance? What has been the most rewarding aspect of your career at XLRI so far?

After completing a master’s degree in economics, I enrolled at IIM Bangalore to pursue a PhD in Quantitative Techniques (QT). At the end of the first year of my Fellow Programme in Management (FPM), I realised that I had an inherent liking for finance. Subsequently, I switched to finance in my second year. I have always liked numbers, and finance became a natural extension of that passion. For me, finance is essentially applied mathematics, which sparked my interest in the field.

My academic journey led me to TA Pai Management Institute (TAPMI) in 1997, where I spent five fruitful years before eventually joining XLRI in 2002.

Early on, I had the opportunity to adapt the renowned book Investments by Alex Kane, Alan J Marcus, and Zvi Bodie to suit the Indian context. This book is widely used in US business schools for the investments course, referred to as SAPM (Security Analysis and Portfolio Management) at XLRI. It was a golden opportunity for me. Following this, I was fortunate enough to localise another well-known finance classic — Principles of Corporate Finance by Richard Brealey and Stewart Myers. I feel extremely fortunate for both of these opportunities.

I have had the chance to teach several courses at XLRI. However, it seems that the course on Financial Modelling Using Excel (FME) resonates most with students after they graduate. Whenever I meet XLRI alumni, they often mention how they have benefited from the FME course in their careers. Interestingly, I have yet to come across a single alumnus who found courses such as Business Analysis and Valuation (BAV) or SAPM equally useful.

In your opinion, how can the principles of corporate finance be applied to solve global economic inequalities? How do you see the balance between shareholder value and social responsibility evolving in the corporate world?

In principle, the concepts of corporate finance can be applied to address global economic inequalities by promoting responsible business practices, encouraging transparency in financial transactions, and fostering inclusive growth strategies. However, I do not see that happening. In fact, corporate finance explains why income inequality is likely to widen in the future.

The principle of compounding explains why a higher investment leads to greater returns, widening the income gap between the wealthy and others over time

First, the principle of compounding explains that a person who invests a higher amount of money will receive a larger payoff compared to someone investing a lower amount, assuming both get the same return. If Ambani invests `100 crore and I invest `1 crore in a bank fixed deposit, the income disparity between us will increase over time. Second, wealthy individuals can invest in many asset classes that poorer individuals cannot even consider. So, the diversification opportunities available to the wealthy are far superior to those available to the poor. These concepts also apply to nations.

We hear a lot about the shareholder versus stakeholder debate.

Companies often pay only lip service to social responsibility. What kind of responsibility is this, when Alphabet’s significant profit increases are coupled with employee layoffs?

Alphabet, in 2023, reported a 53 per cent increase in profit and still fired 1,000 employees. Last quarter, it reported a 60 per cent increase in profit and laid off all its guys working on Python in the US. What kind of social responsibility is this? It’s not as if the company is making losses and needs to fire employees to cut costs. I do not know which shareholder wants to make an extra buck by firing employees.

Can traditional finance theories keep pace with the evolving complexities of modern financial markets, or do we need a paradigm shift?

The basic concepts in economics and finance have remained the same, although they have been made complex for various reasons, often driven by vested interests. History is full of examples demonstrating how investors lost money after forgetting the basic principles of finance.

During the dot-com boom, many analysts dismissed discounted cash flow (DCF) models, claiming they were irrelevant for internet companies. Look at what happened. Most internet companies went out of business in the early 2000s. All those who invested in them, thinking DCF is outdated, lost money. Look at Bitcoin. Why is it trading at such a high price? It reminds me of the tulip mania. Look at the housing bubble in 2007. There are vested interests who use a false narrative to keep the prices high. The game is to keep it high for as long as possible and to run away before it crashes.

People have a habit of forgetting basic finance concepts and making mistakes. Interestingly, repercussions are not immediate. Understanding their errors takes time. In this period, you often find them asking whether there is a need for finance theory adjustments.

But yes, empirical finance will undergo a major change. First, non-linear models will likely be utilised to comprehend and forecast trends in asset prices. This will not invalidate the efficient markets hypothesis; rather, it will enhance market efficiency. Second, machine learning (ML) and artificial intelligence (AI) will be increasingly employed to predict a wide range of outcomes. Third, exploratory studies will be given their due respect in finance. People will first analyse data and then develop a hypothesis.

What role do you think emotional intelligence plays in the field of finance, which is traditionally dominated by quantitative analysis?

To be honest, I am not emotionally intelligent myself. But emotional intelligence is important. First, it allows finance professionals to better understand and work with their own emotions and those of their clients. This can help prevent people from making bad decisions based on fear or greed. Second, finance teams often work in stressful, fast-moving situations where everyone needs to collaborate smoothly. A person with emotional intelligence can inspire his/her teams, handle change, and make good choices even when things are uncertain. So, while being good with numbers is still important in finance, being able to handle the human side of things is now seen as a major advantage, too.

Moreover, quantitative skills are no longer super important in finance. They used to be at one point. But not anymore. While quantitative skills may be beneficial in the early years of one’s career, other skills become more crucial for progression.

What lessons can modern corporations learn from historical financial crises to better prepare for future uncertainties? If you could make one significant change in the global financial system, what would it be and why?

Financial crises are man-made, driven by greed, poor regulation, and misguided practices. While we can’t be crisis-proof, maintaining strong balance sheets and conservative debt is crucial

Practically every financial crisis is man-made. A set of greedy bankers, foolish clients, and a clueless regulator is often all it takes to create one. We learn very little from history, so I don’t believe we can ever be completely crisis-proof. But yes, we can remain careful to minimise its impact.

For corporates: maintain a strong balance sheet, ensure adequate cash reserves, and keep debt levels conservative. High cash reserves and low debt will help a company survive during periods of crisis. Additionally, diversifying risks across geographies, sectors, and customer bases can mitigate the impacts of localised crises.

For investors: don’t listen to your broker or financial adviser. They have their own interests to look after. Instead, follow the time-tested financial advice: invest in a diversified portfolio. Its value may drop during a financial crisis, but it will bounce back soon. If you are a long-term investor, then do not invest anywhere else.

If I could suggest one change, it would be to ensure that financial advisers and consultants also have “skin in the game.” I know this is impractical, and vested interests would likely prevent it from ever being implemented, but it could align their interests with those of their clients.

What drives your passion for finance, and how has your personal philosophy shaped your professional journey?

As I mentioned earlier, I have a weakness for numbers, which initially attracted me to finance. More recently, I’ve realised that I also have a growing interest in computer programming, which has led me to explore AI and machine learning and their applications in finance. There is no other personal philosophy here. 

In a rapidly changing world, what core values do you believe should remain constant for finance professionals?

First and foremost, integrity should be at the heart of every finance professional’s work. Be honest, transparent, and ethical in all dealings. Maintain the highest standards of professional conduct.

Closely related to this is the value of a strong sense of fiduciary duty. Finance professionals have a legal and moral obligation to act in the best interests of their clients, putting their clients’ needs ahead of their own.

Whenever you are tempted to do something wrong, just think of your parents — would they be happy if you did it? If not, then don’t do it.

In addition to these foundational principles, finance professionals should also embrace a commitment to continuous learning and adaptability. The financial world is always evolving, with new technologies, regulations, and market conditions constantly emerging.

How do you approach teaching complex financial concepts to students who may not have a strong background in finance?

It’s simple. Finance can be taught to anyone who is willing to learn. It’s a very intuitive subject. The basic concepts can be grasped by anyone who knows basic high school maths. So, the only background you need is an open mind and a lack of fear when it comes to numbers. I like to quote Peter Lynch here:

“Everyone has the brainpower to follow the stock market. If you made it through fifth-grade math, you can do it.”

This applies to everything we teach in finance, not just the stock market.

What role do you see artificial intelligence and machine learning playing in the future of finance?

My responses may be a bit biased because I’m currently working in this field. But my assessment is that AI and ML will play a big role.

AI and machine learning will significantly impact finance, providing enhanced accuracy in predictions and risk management

I see two trends emerging. First, AI and ML will be used (are already being used) extensively in finance to predict practically everything. Their impact will only grow exponentially in the coming years. Second, there will be a significant rise in the use of alternative data (in addition to traditional data). This includes social media data, satellite imagery, IoT data, text, images, audio, and video. Tools now exist to extract and analyse such data. Fintech companies are already determining creditworthiness using Google Maps data, and insurance companies are setting premiums based on smartwatch data.

Imagine this: as a financial analyst, you’re trying to make sense of a massive amount of data, looking for patterns and insights that could give you an edge in the market. With AI and machine learning, you can crunch those numbers in a fraction of the time it would take a human — and with far greater accuracy. It’s like having a superhuman assistant by your side, helping you make smarter, more informed decisions.

But there’s more to it than just speed and accuracy. AI and machine learning are creating new opportunities in areas like risk management. Picture being able to examine large volumes of data from various sources — financial transactions, market patterns, customer behaviours — and using that data to spot potential risks and opportunities. It’s like having a crystal ball assisting you in the complex world.

Overall, I’m incredibly excited about the future of finance with AI and machine learning. These technologies have the potential to revolutionise how we manage money, assess risk, and serve customers.

In your view, what is the role of finance professionals in promoting sustainability and ethical business practices?

Every business decision has an impact — whether on the environment, society, or the economy. As finance professionals, we often advise and influence those decisions. We have a unique opportunity to steer companies towards more sustainable and ethical practices, and help them balance short-term profits with long-term value creation. By analysing data and trends, we can help businesses understand the potential impacts of climate change, resource scarcity, and other environmental and social issues on their bottom line. Moreover, we can work with them to develop strategies and investment plans that mitigate those risks while capitalising on opportunities.

I also believe AI will prove useful in this regard. For instance, AI can help aggregate and analyse ESG data from various sources, providing deeper insights into a company’s sustainability performance. AI tools can also provide real-time monitoring and reporting on sustainability metrics, allowing for more proactive and responsive management.

What advice would you give to students and young professionals aspiring to make a mark in the field of finance?

Keep an open mind when studying finance. It’s one of the most beautiful subjects that explain certain types of human behaviour really well. Even if you’re not into finance, study it well. It will pay off when you make personal investment decisions in the future.

Focus on linear algebra, statistics, and data analysis. These skills are critical in many finance roles. Being proficient with spreadsheets is equally important.

Even though ChatGPT can write Python code, you must know what questions to ask and how to use the generated code. Gaining some experience in computer programming will be immensely beneficial.

Network actively. When I joined XLRI, a senior colleague who was a successful trainer told me, “You work. But I network.”

Don’t rely solely on the XLRI brand. It may help you initially, but after five years, no one will care where you graduated from. Your work is all that matters.

Lastly, do not ignore your health or family for a job promotion. That promotion can wait. None of us knows what happens after death, so take care of your health.