New sectors, old tricks

Three decades ago, when I was just starting as an investment analyst, I received some sobering advice from a Wall Street veteran who knew many of India's biggest industrialists personally. Despite his deep understanding of equity investing, he refused to hold Indian stocks for the long term. His reasoning was blunt: "If you knew businesses and businessmen as well as I do, you would never buy a single stock for keeping."

That cynical view reflected the corporate governance reality of early 1990s India, where promoters routinely milked shareholder wealth with impunity. Since then, things have improved substantially through tighter regulation, greater information flow, and the growing realisation among promoters that sustained wealth creation beats quick extraction.

Suggested read: Beating the pros | Warning signs in tiny IPOs

Yet recent events remind us that corporate governance risks never truly disappear - they merely evolve. The Gensol affair offers a textbook example of how emerging sectors can become breeding grounds for questionable practices. Renewable energy, with its compelling growth narrative and abundant funding, created perfect conditions for governance lapses to flourish beneath the glossy veneer of sustainability. Similarly, the ongoing Byju's saga illustrates how even celebrated unicorns can implode when growth-at-all-costs strategies obscure fundamental business ethics.

This pattern isn't new. Every market cycle produces sectors where money flows too easily and scrutiny arrives too late. The dot-com bubble saw companies valued on "eyeballs" rather than earnings. The infrastructure boom of the 2000s created conglomerates with opaque cross-holdings. Today's "hot" sectors - renewable energy, edtech, and various sustainability plays - aren't inherently more prone to governance issues, but the frenzied capital inflows they attract certainly create fertile ground for corner-cutting.

Suggested read: It's all about the people

What's particularly dangerous about these situations is how they expose the vulnerability in our investment psychology. When a sector becomes fashionable, our critical faculties often recede just as our enthusiasm rises. We're quick to attribute success to brilliant business models rather than favourable funding environments, and reluctant to question growth stories that align with our worldview.

For individual investors, this creates a challenging dilemma. The fundamental analysis necessary to detect governance red flags requires expertise, time, and access that most retail investors lack. Even professional analysts sometimes miss warning signs when they're caught in the gravitational pull of a compelling narrative.

So what's the solution? For those conducting their research, corporate governance must be elevated from an afterthought to a cornerstone. This means scrutinising board composition and independence, examining related-party transactions, questioning aggressive accounting practices, and being especially wary when management dismisses legitimate concerns as "misunderstandings."

However, let's be realistic - most individual investors lack the resources to conduct this level of due diligence. This is where well-managed mutual funds or systematised professional advice become invaluable. Fund managers with robust governance screening processes and the institutional muscle to demand accountability can provide a layer of protection that individual investors can't replicate on their own.

Ultimately, the lesson from Gensol, Byju's, and countless predecessors is not that we should avoid emerging sectors or innovative companies. Rather, it's that transparency and governance aren't negotiable - they're the foundation upon which sustainable returns are built. The industries and stories change, but this fundamental truth remains constant: in investing, as in life, character matters.

Suggested read: Character dheela hai

For practical application, investors should develop a governance checklist before committing capital. Look for clues that tell you about cash flow quality. Be wary of companies that frequently raise capital despite claiming robust growth. Study the backgrounds of key executives and independent directors - are they qualified or merely decorative? Watch for excessive management compensation relative to company size and performance. Pay attention to changes in auditor qualifications or changes in auditors in financial statements. Most importantly, be suspicious when management responds to legitimate questions with hostility rather than transparency.

Remember that good governance isn't just about avoiding fraud - it's about aligning management interests with yours as a shareholder. In well-governed companies, profits flow to shareholders through dividends and capital appreciation, rather than to insiders through creative accounting or related-party transactions.

And while our cynical Wall Street veteran of the 1990s might find today's Indian markets more trustworthy, his core insight remains relevant - when investing for the long term, knowing what you own is just as important as owning what you know.

Also read: Stock investing in your circle of competence