Mumbai: Small investors are allocating an increasing portion of their savings to stocks, but their holdings as a proportion of the market are being dwarfed by those of company promoters and foreign institutional investors (FIIs).

Still, buoyed by an increase in investment options such as mutual funds and insurance products, retail investors will keep increasing their stock market allocation. This amount will rise from about Rs1 trillion in fiscal 2008 to between Rs3 trillion and Rs5 trillion by 2020, two recent reports by international brokerages said. The reports projected that Indian households will triple their allocation in stocks to 15% of savings by the end of the next decade, from 5% now.

Stock taking: The Bombay Stock Exchange. Indian households will triple their allocation in stocks to 15% of savings by the end of the next decade, from 5% now, two recent reports by international brokerages say. Abhijit Bhatlekar / Mint

The rise of India’s bellwether equity index, the Sensex, about six times—from 3,400 points to 20,200 between 2003 and 2007—that expanded shareholders’ wealth to $1.8 trillion also played a role in attracting retail investors.

But the equity allocation rate dipped to around 5% of household savings in the fiscal year ended March 2009 as the market slumped following the collapse of US investment bank Lehman Brothers Holdings Inc. in September 2008, leading to an unprecedented credit crunch.

The Sensex lost some 53% in 2008 as FIIs pulled out money to meet redemption demands in their home countries.

Both CLSA and Noble now suggest that the flow will increase though overall retail exposure to the markets is declining despite individuals allocating higher sums for investment in stocks.

The share of individual holdings in India’s market capitalization, which was some 17% in 2001, has come down to around 10% as promoters and institutions increased their share.

“The market has grown faster than individual savings rate (in equities)," said Saurabh Mukherjee, head of research at Noble in India. “Retail investors don’t have enough wealth to outshoot the market."

However, some analysts such as Dhirendra Kumar, chief executive of ValueResearch, a New Delhi-based mutual fund industry tracker, reckon that the more important fact is that promoters are increasing their holdings even as the market moved from being a clutch of mom-and-pop run companies to ones that are more professionally managed.

“In 2001, there was still a hangover of surrogate holdings," said Kumar. “Promoters believed that institutional shareholders would do their bidding and not destabilize them. That has changed."

Promoter shareholding, which was around 50% in 2001, has increased to nearly 56-58%, according to various estimates, with promoters increasing?their?holdings?through various ways including share buybacks and warrants.

Be that as it may, following precedents set in developed countries such as the US and the UK, increasingly complex and volatile markets are paving the way for institutionalization, experts say. In other words, most of the fresh money from retail investors will find its way to the markets through mutual funds or insurance products

Indirect retail holdings

The trend has indeed started. Retail investors’ direct share in market capitalization has come down to 10% in 2009, but if indirect holdings or their exposure to mutual funds and insurance firms, which in turn invest in equities, are included, a back-of-the-envelope calculation shows that the number would go up to about 15% of current market capitalisation.

Here’s how: Mutual funds’ share of market capitalization is 3.6% now and a third of this money comes from retail investors. On the other hand, 90% of the money invested by insurance companies comes from small investors. These companies’ share in market capitalization is 4.16%.

Even then, the retail pie in the overall market is shrinking as the comparable number for 2001 would be close to 20%. In that year, insurance companies had some 1.6-2% share of India’s market capitalization and mutual funds some 5%.

While retail direct holding has declined, there is evidence that investors are routing a greater share through intermediaries, especially through insurances products such as unit-linked insurance products, or Ulips. Ulips provide life cover and invest part of the premium in stocks and bonds.

“Institutionalization of markets will happen," said Ullal Ravindra Bhat, managing director of Dalton Strategic Partnership Llp, an FII. “People don’t have the capacity all the time to figure out the right shares."

Typically, as household savings increase, there is greater intermediation from the financial sector, said a September note from Noble.

“However, while the share of long-term equity investments is high (approximately 20%) in developed countries, the share of equity investments to total wealth in India is only 5% of financial savings of households," it said. “This suggests that there is enormous scope in India for growth in equity investments as share of total savings."

The insurance and mutual fund sectors are expected to drive a significant part of this growth. The insurance sector was opened up to private firms in 2000. Since then new products such as Ulips had seen the equity assets of insurers go up seven times to Rs2.8 trillion as of July 2009.

Similarly, the mutual fund industry, too, has grown in size and its equity assets are now valued at around Rs1.7 trillion. The assets under management of the Indian mutual fund industry, which has 40 asset management firms, are Rs7.4 trillion. According to industry estimates, 70% of this money comes from other firms and not small investors.

To be sure, in the past decade, measures such as dematerialization of shares, or conversion of paper shares to electronic records, tax benefits on equity investments and online trading have made it easier for the small investor to own equity or equity-linked instruments.

But traditionally, Indians have always been conservative and risk-averse. “The older generation considered equity investments very risky and almost akin to gambling," the CLSA note says.

Further, market frauds such as the one in 1992 when investor Harshad Mehta engineered a dizzying bull run, or in the beginning of this decade when Ketan Parekh rigged the price of several scrips, made small investors lose faith in stocks as a means of savings.

The peak rate of equity investments as a proportion of household savings was 20% in the early 1990s; a lot of investors burned their fingers then and lost trust.

Nearly two decades after liberalization, bank deposits continue to be the preferred mode of savings. Going by CLSA estimates, about 42% of Indian households’ gross financial assets were in bank deposits at the end of fiscal 2009. Another 13% rests in provident and pension funds and a further 12% in non-banking deposits.

For many investors, the stock market is an unknown beast and very volatile. For instance, an investor who had entered the markets in March 2001 would have to wait for four and half years till September 2005 to get her money doubled but another, who entered the market in March 2009, would have doubled it in only six months.

Ashwin Ramarathinam contributed to this story.