Mumbai: Stung by large losses in 2008 and with the direction of equity markets still uncertain, retail investors in the past year have turned day traders instead of building long-term portfolios.

At the height of the bull run in 2007, delivery-based trades were at an average of 42%, which means for every Rs100 of traded value, Rs42 was from deliveries.

For the fiscal year ended 31 March, however, that figure fell to around 22% of total traded volume of Rs48 trillion, according to a McKinsey and Co. report commissioned by industry lobby group Federation of Indian Chambers of Commerce and Industry.

At least 90% of the 25.92 trillion trades transacted by retail investors are intraday, where investors sell what they buy on a particular day before trading closes, according to McKinsey.

In other words, retail investors, who account for at least half of the total turnover, took home less than 10% of the shares they traded.

Graphic: Yogesh Kumar / Mint

“As long as this (uncertainty) persists, retail investors’ interest will remain low," said Dharmesh Mehta, head of broking at Enam Securities Pvt. Ltd.

The trend is less of a “casino mentality" and more a lack of conviction to start building portfolios, said Ashu Madan, chief operating officer of Religare Securities Ltd. “People still feel the market situation is not very conducive for long-term portfolio building; that is why they indulge in short-term trading. This is a natural phenomenon after a big crash."

After reaching a record high of 21,206 in January 2008, the Sensex lost 61.52% to drop to 8,160.4 points in March 2009, after an unprecedented liquidity crunch hit the global financial system in the wake of the collapse of US investment bank Lehman Brothers Holdings Inc.

Foreign institutional investors, the main drivers of the Indian equity market, sold Indian stocks and sent money home to meet local redemption pressure.

Of the 22% delivery-based trades of the total volume, institutions contribute around 17% of the total traded volume in cash segment, “leaving approximately 5% delivery-based turnover between retail and proprietary", the report said.

Thus, 78% of the cash segment volumes of Rs48 trillion, or around Rs37.44 trillion, is intra-day trade, which does not go towards capital formation.

In addition, Rs145.3 trillion of traded volume comes from equity derivatives, which are settled in cash. Futures and options contribute approximately 75% of the trading volume in India, significantly more than in developed markets. Since these instruments are settled in cash, they make a minimal contribution towards capital formation. And here, too, retail investors transacted around 40%, or around Rs58 trillion, of the volume.

“The population of retail investors in capital market is low and of this most of the investors, who have knowledge about markets, opt for day trading," said Sudip Bandyopadhyay, managing director and chief executive officer of Convexity Solutions, a Mumbai-based investment advisory.

“Many investors who have burnt their fingers due to adverse market movements have moved out. So, despite having a world-class market infrastructure in India, many retail investors lack confidence," he said, adding that confidence would only increase gradually.

Enam Securities’ Mehta said retail investors typically enter the market during public sale of shares of state-owned firms. “But right now the interest has not been good because people did not make money in the recent public issues by the government," he said.

The revenue structure of brokerages is also a reason for high rate of churn. Since brokerages pay their dealers and relationship managers based on trade volumes, churn is often encouraged.

“But typically, the brokerage on delivery-based trades is 10 times that of intraday trades," said Religare Securities’ Madan. “So to say all brokers prefer churning is not correct because continuous churning affects the shelf life of a client."

To increase long-term retail participation, incentives should be offered for direct investments in markets, say some industry experts.

“This could be in the form of some tax exemption. The investment pattern in many equity-oriented instruments has improved a lot over the years due to the incentives offered," Bandyopadhyay said, referring to equity-related instruments such as mutual funds and equity-linked insurance plans.