Riding on retail sentiment

If that were to go down, mid- and small-caps may take a bigger hit

Retail sentiment, which has driven the market for the last two years, has started looking weaker. The first signs were the narrowing of the market. Breadth declined, as the ratio of advancing shares to declining shares went down. 

A second related signal was the underperformance of small-cap and mid-cap indices compared to large-cap indices.  While large-caps have been net gainers with the Nifty up 9.5 per cent and the NSE 500 (which includes the top 500 stocks in the market) up 3.5 per cent since January, the Nifty small-caps 250 is down 17 per cent and the mid-caps 250 is trading at its early January levels. 

Since retail investors focus on smaller stocks, these data suggest that retail investors who directly buy stocks have lost some enthusiasm, at least temporarily. The data from mutual funds is less volatile, but it is an important and more stable indicator of retail attitude. 

Retail investors now own over 50 per cent of all fund assets and retail investors are overwhelmingly focussed on equity and balanced funds with over 90 per cent of retail assets going into these segments. (Retail includes the high networth individual category where fund data are concerned). 

Mutual fund data over the past three months indicate that the enthusiasm of mutual fund investors is easing off. May, June and July have seen successive month-on-month declines in equity fund inflows. This is the first three-month period since Feb-Mar-April 2016 when such a declining trend has been noticed. 

Equity inflows in July at Rs85 billion (bn), were lower than inflows of Rs89 bn in June, which in turn, were lower than Rs104 bn in May, which was lower than Rs119 bn in April 2018.  Among other segments with equity exposure, ETFs saw an outflow of Rs39 bn in July, compared to an inflow of Rs83 bn in June and inflows of Rs27 bn in May. Balanced funds (which have equity exposure) saw inflows of Rs2.9 bn in July versus much higher inflows of Rs14.8 bn in June.  

It isn't only equity. There have been declines across several fund categories and a huge outflow from the income category. Income funds are generally backed by corporate treasuries. Across May to July, income funds saw redemptions of over Rs50 bn across the three months - no surprise given the RBI's worries about higher inflation.

In the meantime, the liquid / Money market segment has seen massive volatility in terms of inflows. April saw huge inflows of Rs1.16 trillion, followed by outflows of Rs467 bn in May, inflows of Rs521 bn in June and outflows of Rs311 bn in July. This could reflect a consensus that, while the RBI is now firmly committed to raising rates, there will be periodic pauses.  

Total assets under management (AUM) has risen, mainly due to capital gains in the stock market.  It may also be noted that equity inflows remain substantial even if there is a declining trend. Indeed, compared to May-June-July 2017 when total inflows to equity funds were Rs265 bn, inflows in April-June 2018 of Rs300 bn were appreciably higher.  

Equity Inflows will remain high, until September at least and funds will continue buying equity, probably with a focus on large-caps, until that time. A large proportion of equity inflows come via systematic investment plans (SIPs). SIPs are a very sensible way to invest: Identify the funds you wish to buy and allocate a sum every month to average the acquisition price, reducing the impact of price volatility. 

Most SIPS have a minimum tenure of six months and the average retail investor usually commits to the minimum period (many commit for longer periods). What's more, many people do their investment planning at the beginning of the fiscal and launch their SIPs in April. 

After September, a substantial number of retail customers will be reviewing their SIPs and taking a call on whether to continue with those plans. If retail sentiment does recover and strengthen, most of them will carry on. If sentiment is seriously impacted, there will be a drop in October over September. In the meantime, we'll have to see if August and September see a continuing trend of lower inflows. If retail sentiment stays down, small-caps and mid-caps will lose more ground for sure.