Column : The great global equity famine

Written by Shobhana Subramanian | Updated: Dec 14 2011, 08:18am hrs
Its bad news. A McKinsey report says that, by 2020, investors around the world may allocate just 22% of their financial assets to equities, down from 28% today. That could stymie plans of corporates: a study across 10 mature and eight emerging economies reveals they would need to mop up an estimated $37.4 trillion of additional capital to support growth, an amount that would exceed investor demand by $12.3 trillion. Whats worse is that most of this estimated shortfall would be seen in developing nations. There could be a way out: its possible, the report observes, that emerging market investors may acquire a bigger appetite for equities, and were they, over the next decade, to raise their equity allocations to levels currently seen in the US, demand and supply would match. Thats a long shot though and, as the report says, such a sudden shift in investor preferences would be unprecedented, requiring a bunch of initiatives designed to make the markets attractive to individuals. Only a tripling of allocations to equity would raise demand sufficiently, given that households, in most emerging markets, today prefer to put away their money in deposits; on average, they allocate less than 15% of financial assets to equities compared with 42% for US households.

The report is a well-timed wake-up call; 2011 has been a rather disastrous year for equities globally but more so for India, which will probably end up one of the worst performers. Of course, households today hardly play a role in the Indian market; foreign institutional investors have been the dominant players, for the most part, since they were allowed into the country in 1992. And although they are the largest investor class with 42% of all financial assets, equities accounted for just 8% of these assets in 2010. It wouldnt be surprising if that share drops in 2011. While the government has attempted to develop an equity cult, and persuade small investors to park some of their savings in equities, it clearly hasnt been enough. Indeed, the McKinsey report notes that while the wealth of Indian households is expected to grow rapidly in the coming decade, the prospects for India to develop a significant equity investing culture are unclear. In particular, the report cites the instance of the Securities and Exchange Board of India (Sebi) banning upfront sales charges, or loads, on mutual funds in 2009, which has caused distributors to pull back. Such regulations, perversely, may temper Indian investor demand for equities, it observes.

McKinsey is right. Things have gone horribly wrong for mutual funds with money moving out in most months since August 2009. The timing couldnt have been worse. The Indian market saw one of its biggest rallies after that with the Sensex hitting 21,000, but it was the foreign investors who made money while Indias retail investors missed an opportunity of a lifetime. Had more small investors participated in that rally, their confidence is equities would have been renewed. Commissions are not such a bad thing when charged in moderation; its a fact that life insurance firms did charge very high commissions for ULIPs, which was

unjustified. The trick lies in checking malpractices of fund houses; for instance, if theyre churning portfolios too aggressively or not giving customers the net asset value (NAV) that theyre eligible for or launching meaningless schemes simply to mop up money. Sebi must also check misselling but disincentivising intermediaries cannot be the answer because mutual funds, like insurance, are still a push product. The other piece that retail investors like is the IPO space. But the track record here has been abysmal with most IPOs that hit the market in the last couple of years trading well below their issue price.

Sebi has said it is looking into the high levels of volatility on the day of listing and has also mandated that prospectuses should document the track records of merchant bankers. But IPOs, especially of smaller companies, are being priced aggressively and while the investor must do his homework before he parts with his money, perhaps Sebi could also tighten the criteria without going back to the Controller of Capital Issues days. One does not expect stocks to outperform their respective benchmark indices at all times but the fact that two-thirds of the IPOs are way out of the money means there is an issue somewhere. Investors have made pots of money over the years as the government disinvested its stakes in PSUsthe Coal India IPO, for instance, was a thundering success. But, in general, the smaller private sector firms have fared very poorly. McKinsey suggests remedies for beefing up the markets: strengthen listing requirements, ensure that securities regulations require full transparency by issuers and provide meaningful protections to minority shareholders. Sebi has been attempting to check price manipulation, circular trading and even insider trading but much more regulation is needed. The larger issue, however, in India today is that of corporate governance or the near lack of it. Investors can deal with business cycles but will tire of poor corporate governance standards. Today, the advantages of investing in listed equities are being questioned in light of corporate scandals and a perception that the markets may no longer serve the interests of ordinary investors, notes the Mckinsey report. So, if companies want to access the savings lying with pension funds and insurance companies, they need to be cleaner and more transparent. Otherwise, theyre going to be short of equity.