IPO investors: Why the rush to sell might be a missed opportunity

IPOs are structured to showcase the long-term prospects of a stock. But the majority of investors seem to be chasing short-term gains. (Image: Pixabay)
IPOs are structured to showcase the long-term prospects of a stock. But the majority of investors seem to be chasing short-term gains. (Image: Pixabay)

Summary

  • While IPO investors are rushing to lock in quick gains, they may be overlooking the potential for long-term wealth creation. A Sebi study reveals that behavioural biases are driving this short-term thinking, leading to missed opportunities for sustained growth.

Attractive assets typically command higher prices as investors prefer to hold them. However, the landscape of India’s initial public offerings (IPOs) is beginning to reflect a troubling divergence from this age-old wisdom. 

A recent study by the Securities and Exchange Board of India (Sebi) reveals that investors are increasingly driven by behavioural biases, with many choosing quick exits over long-term holds. The study analysed 144 IPOs listed between April 2021 and December 2023, uncovering a striking trend: 54% of IPO shares (by value) were sold within a week of listing, and 70% within a year.

This behaviour runs counter to the typical design of IPOs, which are structured to showcase the long-term prospects of a stock. But as the data shows, the majority of investors seem to be chasing short-term gains. 

Read this | Swiggy IPO: How investors justify risky pre-listing trading

For IPOs delivering strong listing gains, the trend is even more pronounced. IPOs that gained more than 20% within the first week saw 67.6% of their shares sold by value within seven days. In contrast, IPOs with negative returns saw only 23.3% of shares sold, highlighting the tendency to "lock in" profits early to avoid the fear of losing gains.

The disposition effect: A costly behavioural bias

At the core of this behaviour is the 'Disposition Effect,' where investors are quick to sell winners while holding on to losers. 

Behavioural finance experts caution that this bias stems from emotional rather than rational decision-making, often leading to suboptimal outcomes. While the temptation to take quick profits is strong, investors risk missing out on significant long-term gains. This has been particularly true for several technology companies, where IPOs experienced short-term volatility but delivered substantial growth over time. By selling early, many investors forfeited the potential upside.

"Cashing in on listing gains early may seem enticing, but IPO investors risk missing out on long-term wealth creation," explains Tarun Singh, founder and managing director of Highbrow Securities.

Behavioural biases and market dynamics

Broader market dynamics have fuelled behavioural biases among investors.

During the period in question, a surge in IPOs saw nearly 75% of offerings delivering positive returns, amplifying the Disposition Effect amid high optimism. Driven by the desire for quick profits and the fear of missing out (FOMO) on the next big IPO, many investors sold shares with significant gains and reinvested in new offerings. Instead of offloading underperforming shares to generate liquidity, they prioritized selling high-gain stocks. 

Ans this | Why history tells us to beware the IPO frenzy

Notably, nearly half of all demat accounts participating in IPOs during this time were opened post-pandemic, pointing to an influx of less experienced market participants. These investors are more vulnerable to behavioural biases like 'regret aversion' and 'herd mentality.' The comfort of locking in profits quickly, especially in a volatile market, can be tempting for such investors. Interestingly, the study revealed that 63% of retail IPO investors were concentrated in Rajasthan, Gujarat, and Maharashtra, with 39% hailing from Gujarat alone.

“The post-COVID era has seen a massive surge in retail trading, driven by a confluence of high liquidity and strong IPO returns. This has cultivated a quick-profit mentality among investors, where they are more focused on short-term gains than on assessing the true long-term potential of the companies, they're investing in," notes Prashanth Tapse, senior vice president of research at Mehta Equities Ltd.

Policy interventions: Addressing the behavioural shift

Emotional investing, left unchecked, can contribute to market bubbles that eventually burst, as seen during the Dotcom Bubble in 2001 and the Global Financial Crisis in 2008. 

Recognizing the risks, the Sebi and the Reserve Bank of India (RBI) have introduced measures to curb speculative behaviour. Policy changes like the switch from a pro-rata basis to a lottery system for NII (Non-Institutional Investor) share allotments, and caps on IPO funding by non-banking financial companies (NBFCs), are already making an impact. 

Also read | The IPO roulette has more spinners and fewer winners, what's your fate?

Oversubscription rates have fallen, and applications from "big ticket" NII investors—those applying for more than 1 crore—have seen a sharp decline.

These interventions aim to temper emotional investing and encourage a more rational, sustained approach in the market, reducing the prevalence of the Disposition Effect.

Simarjeet Singh is an assistant professor of Accounting and Finance, and V.P. Singh, is professor and director of PGDM in Managerial Economics and Statistics, both at the Great Lakes Institute of Management, Gurgaon.

 

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