Stocks: New players, old behaviour

Here are two sets of bare facts. One, private mutual funds were permitted to be set up in 1993 and in the next 21 years, until the end of 2014, their equity investment had gradually touched Rs 2 trillion, spread across pure equity funds, balanced funds, and equity-linked savings schemes. At the current rate of growth, by March 2024, equity assets held by mutual funds are expected to touch an astounding Rs 24 trillion. This implies a stunning 12 times growth rate the past decade, a compound annual growth rate of 28.2 per cent. This is the story of institutionalisation or aggregation of Indian savings directed at equity markets. Fact number two. Compulsory dematerialisation was introduced in 1996. Over the next 24 years, the number of demat accounts went up to 40 million. Then, in just three and a half years, that jumped over 3.25 times to 130 million. This means that 90 million new investors, 2.25 times the total demat population developed over 24 years, entered the market in the past three years or so. This is the story of the direct entry of retail savings into the Indian equity market.

What do these two sets of facts imply? That the growth that happens in decades has happened in less than four years. Or, to paraphrase Vladimir Ilyich Lenin: “There are decades where nothing happens, and there are weeks where decades happen.” It shows that the dominant players in the Indian market have changed from foreign investors to local institutions and retail investors. This makes the Indian market less susceptible to purely global factors that tend to influence foreign investors. As evidence, during the entire period of US interest rate hikes, foreigners, in line with their usual playbook, sold Indian stocks, but Indian markets continued to rise due to the influx of local money. However, as our markets continue to scale new heights, a sense of gold rush has taken over. At times like these, it pays to remember lessons from history when smart foreign investors were gripped by a similar sentiment.

Since 1992, when foreign institutional investors (FIIs) were allowed to enter India, they have determined the fate of Indian stocks. From the late 1980s the key objective of Indian companies was relentless resource raising to fund asset growth. The buzzwords were “diversification”, “public issues”, “term loans”, and “capital-intensive projects”. For investors, the key investment criterion was asset growth and pedigree. Equity research was non-existent. Few understood the terms “return on capital employed”, “return on net worth” or “free cash flows”. Insider trading and price rigging were rife and until the early 1990s, the main institutional investors were the public sector Unit Trust of India (UTI), government insurers, and development finance institutions.
 

FIIs entered the Indian market in two ways: One, by buying directly on the stock exchanges, which started with a trickle in 1993 and turned into a flood in 1994; two, by subscribing to overseas issues of Indian companies through global depository receipts (GDRs). By 1994, emerging markets were in flavour and India was seen as the next Asian tiger. In 1994, our gross domestic product (GDP) growth hit a stunning 7.4 per cent. A statutory market regulator was in place and a new, nationwide electronic exchange had been set up. Business houses were dreaming big and capital providers were desperate to bankroll them. In March 1994, when the markets touched a new high, the Oppenheimer fund easily raised $550 million, which was then the highest subscription to an India-dedicated offshore fund. FIIs were so dominant that the head of a financial institution had told me: “The reverence for FIIs has now metamorphosed into the mixed feelings of fear and awe.” But March 1994 would turn out to be the market’s highest point for the next five years except for a brief upsurge in September! Foreigners invested at the peak — much like you and I do. They made the same mistake in the dotcom boom of 1999-2000 and again before the global financial crash of 2008.

I am not for a moment suggesting that the market is about to crash or will go on a long decline. Indeed, I remain bullish because of a combination of two factors: Massive government expenditure and the resilience of Indian consumers. Then again, markets overshoot the fundamental thesis due to a set of behavioural factors that affect even institutional investors: Greed, short-termism, relying on “greater fool” theory, herd mentality, trying to be trendy, etc. In the immortal quote of Chuck Prince, former chief executive officer of Citibank: “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing.” You might be mistaken if you were to assume that Indian mutual funds were different from their global counterparts, who burnt their fingers thrice during the market excesses due to such behaviour. Moreover, this time around we have millions of newbie investors who are clueless about how to handle sudden and severe adverse market reactions, which arrive from time to time. We have a new market structure where Indian investors have become dominant. But will they act any differently from foreign investors of the past?

The writer is editor of www.moneylife.in and a  trustee of the Moneylife Foundation; @Moneylifers