Though the equity market is scaling new highs, retail investor participation has fallen
There is a lot of optimism in the air with inflows into equity mutual funds picking up, resulting in higher participation by retail investors in recent months. The bigger picture is different though. According to a report by brokerage firm CLSA, Indian households have sold $8 billion in equities directly or indirectly over the past five years, which has brought the household equity exposure near an all-time low at 2%.
The recent flows have tilted the ratio positively a bit, but there is scope for much more. This begs the question, where are the domestic investors?
Is it enough for them to just follow the market mood? In contrast, foreign institutional investors (FIIs) have gone from net investments of around $6.7 billion in Indian equities in 2003 to around $20 billion in 2013. Year-to-date for 2014, net flows from FIIs have been slightly over $12 billion.
The S&P BSE Sensex has given a return of 17% compounded annually from August 2004 till August 2014. This shows that markets have rallied in the past decade even without retail investors.
However, experts are convinced that they can’t be disregarded because individual investors bring the much needed depth and stability to equity markets.
Household investment in equity was at a peak in 2008 when annual inflows reached around $30 billion, according to the CLSA India Strategy Report. In FY08, FII inflows into Indian equities was at $232 billion. However, FIIs are known for being fair weather friends; although they brought in a lot of money, they also took most of it out, making the net investment around $13 billion.
FII flows are driven by many reasons and they are nimble footed, moving in and out of markets quickly. “FIIs look at the relative attractiveness of a market (compared to other markets across the globe) and after analyzing the risk-return premium of a particular geography, they allocate funds. There is a perception that they tend to exit soon. But on a net basis for India, FII investments have improved in the past 6-7 years," said Rajesh Cheruvu, chief investment officer, RBS Private Banking India.
This explains to a large extent why our markets have held fort so far despite the absense of domestic investors.
According to Sundeep Sikka, chief executive officer, Reliance Capital Asset Management Ltd, “Markets can’t be too dependent on institutional funds as retail investors bring depth and stability."
Participation by FIIs is largely concentrated in the futures and options (F&O) market, which by their very nature are short-lived. Only about 7% of the equity market transactions happen in the cash market, and the rest in the F&O or derivatives market. Satish Menon, executive director Geojit BNP Paribas Financial Services Ltd, a retail focused brokerage, said, “For us, nearly 25% of trades happen in the cash market." This indicates the slightly longer-term investment behaviour of retail investors.
Higher retail participation will result in more transactions across market capitalization and this can aid in better price discovery. Moreover, a bigger base of widespread investors can help in reducing sharp and sudden swings in individual stocks.
“During periods of global risk aversion, retail investors can give support to markets so that the fall is not too sharp. Moreover, domestic institutional investors tend to look at such times as buying opportunities. Therefore, the overall curve can be smoothened," said Cheruvu.
According to the CLSA report, direct investments by retail investors (as compared to FIIs) are more concentrated in stocks with a market capitalization of less than $0.5 billion (16% stake versus 13% for FIIs). This proportion changes completely when it comes to large-caps—26% stake for FIIs in stocks with a market capitalization of more than $5 billion, and 7% by retail investors. So, domestic retail investor participation can help broaden market transactions and increase penetration of investors across a higher number of stocks.
But there is a long way to go till that happens. “Data on the NSE (National Stock Exchange) website shows that the exchange has only 4.7 million active clients through all brokers registered with it. “For a country of 1.2 billion people, that’s an insignificant number," said Menon.
...and you need the market
“In our country, most people don’t have access to social security or government sponsored pension to cater for retirement. Yet, at the same time, we refuse to understand that investment in fixed deposit (fixed deposits) at 9-10% return per annum doesn’t add much to the kitty. When inflation is high, the value of money itself decreases by roughly that percentage every year. In the end, investing only in FDs earns us nothing," said Sikka, adding that equity is the only historically proven asset which consistently gives long-term returns that beat inflation.
However, this kind of disciplined long-term investing is easier said than done. “Many retail investors carry with them the memory of bad times and bad choices. While they don’t like to sell at a loss, as soon as prices recover to breakeven, they exit and don’t want to take that risk again. Many even consider this kind of an experience similar to gambling," said Menon.
If you aren’t certain that you can directly make good stock selections, pick equity mutual funds with proven track records of performance. In India, we have funds that have a proven track record of at least 20 years and have managed to consistently beat their benchmark in that period. That’s a great return and it has come through investing in a benchmark index.
Selecting a good quality equity mutual fund can help you make even higher returns thanks to fund managers’ alpha. Alpha refers to the excess returns that fund managers are able to generate through active investing techniques.
Secondly, investing in equity is akin to gambling only if you invest based on unsubstantiated tips that brokers and friends give you, and then jump ship out of fear.
If you do some basic research and follow good quality companies, you are unlikely to lose money in the long run. Reliance Industries Ltd, Larsen and Toubro Ltd, Grasim Industries Ltd, Maruti Suzuki India Ltd, ITC Ltd, Bharti Airtel Ltd and Infosys Ltd are only a handful of examples in the large-cap space which have made considerable long-term wealth for investors. Wealth creation in the equity market can be directly equated to the growth of the underlying company.
Mint Money take
The CLSA report points out that retail investors are selling equities through all modes— directly, through mutual funds and via insurance.
The waning confidence is a matter of great concern, given the potential of the asset class to give consistent long-term returns, and the depth that this class of investors can bring to the market.
Experts suggest targeted and specific tax breaks for equity investors. This could help attract investors more towards equity. Secondly, inflation has a role to play; during periods of high inflation there are limited opportunities to generate returns and focus inevitably shifts to physical assets such as real estate and gold.
Lastly, awareness needs to increase manifold. While individually brokerages and mutual funds are promoting investor awareness and highlighting the merits of long-term investments in equity, there has to be a bigger push from the government as well.
Products such as the Rajiv Gandhi Equity Savings Scheme are well intentioned but may be too complicated for the average investor.
In the meantime, easy access, tax-saving pull and repeated discourse on the benefits of long-term and stable investments in equity might boost the proportion of household savings invested in this rewarding asset class.