Who is blocking new investors

Updated: Jun 2 2014, 10:02am hrs
Retail investors have been quitting the capital markets for a long period. It is misleading to assume that they have disappeared post the last market crash in 2008. In fact, even during the bull market of 2004-07, the net addition of new retail investors into the market was far from the desired levels. When the markets crashed in 2008, the hollowness of our secondary market was much visible as mid-cap and small-cap companies suffered heavily due to a lack of liquidity.

In an active secondary market, the retail investors actively participate in trading. However, it doesn't mean that new investors enter the market just

because the secondary market

is vibrant.

The steps taken to promote the entry of new investors, like the Rajiv Gandhi Equity Savings Scheme (RGESS), failed miserably, due to design failures. No amount of monetary incentives, like what was offered by RGESS in the secondary market, could make any significant increase in the number of new investors, due to the policy makers' failure to understand the evolution of the 'retail investor' in the market. The policy makers need to have clarity on how and when new investors enter the market.

Most often, the first participation of a retail investor in the secondary market is through the IPOs, as has been in the past, and not through the secondary market purchases. A new investor first starts his investment in IPOs as a baby step and learns the tricks of the markets and risk-taking very slowly, until he gains confidence to play in the secondary market.

My view is that post the so-called liberalisation of the primary market, in the form of free pricing, retail investors shied away from IPOs and consequently from the secondary market, too. It is not absolutely right to say that free pricing of IPOs is the only reason for investors apathy in IPOs. I am sure that many will say that several IPOs were very successful in the primary market even after free pricing was introduced. But the most relevant question is, why did issues fail to attract new investors even though they were successful in the market at times

Why IPOs are avoided

After free pricing and reforms were introduced in the primary market in the mid-90s, the commissions payable to sub-brokers and brokers were reduced to a fraction of what it used to be. A broker/sub-broker used to get at least 2.5% commission for IPOs on an allotment basis, as against the current level of 0.1% to 0.5%. Before such reduction of commission, the sub-brokers and brokers used to visit new investors to explain the IPO in detail, assist them in filling up the forms, collect the application money, etc.

Today, with an average 0.25% commission, no sub-broker or broker will take any effort to sell IPOs to new investors. They are not even sending application forms to clients, wary of the postage cost, which is more than the commission received from IPOs.

Unless intermediation in the primary market is recognised as a useful economic activity and compensated for sufficiently, new investors will not enter the IPO market and hence the secondary market, too.

How to attract investors

The investment bankers have only looked at the cost of intermediation and hence have merely concentrated on speculators in the IPO market for the success of IPOs. When a good IPO opens, it is the same group of active IPO investors that invest and then sell after the first few days of listing. This class of primary market investors, called 'flippers', cannot save India's capital market from the problems of depth, as they appear only when the market is active.

The investment bankers, in their anxiety to get mandates from issuers, always offer them very aggressive pricing, which sets the imagination, and greed, of the promoters flying and they ask for a very high valuation. When the secondary market is active, this class of 'flippers' in the primary market also become active and issues get subscribed. When the secondary market is dull, neither the 'flippers' are interested in IPOs nor are the investment bankers able to get mandates from issuers, thus, making the economy weak in terms of capital availability.

In the name of the fashionable 'cost reduction of IPOs', we have come to a stage where we get new investors neither into the primary market nor to the secondary market, resulting in a total surrender of the markets to the FIIs.

To increase the retail participation in the market, we need to bring back to the IPO market the thousands of intermediaries who have disappeared over a period. Only a remunerative commission structure for such advisors can bring new investors into the IPO market and consequently the secondary market.

Retail participation in secondary market

New investors have not started entering the stock market and only a small fraction of the current retail investor population of around 1.5 crore has become active in the secondary market. Both mutual fund and secondary market data reveal that investors have been exiting the market. It is particularly notable that 2013 was the year with the lowest volume of delivery transactions in the last nine years. This was primarily due to the lack of confidence in the markets, as from 2009 onwards the markets have been delivering negative returns when the fixed income products were delivering close to 10% returns. If the annual inflation rate of 10% is applied, the real value of the BSE Sensex is around 13,000 points for an investor who invested during the market peak of 2008.

When the market liked the proposition that Narendra Modi is the BJP candidate for prime ministership, a slow return of HNI investors into the market started, along with the FIIs. Investor confidence in Narendra Modi was on account that a three-term chief minister with a proven track record will set governance right. When the BJP got an absolute majority, the investor confidence went up. However, it is interesting to note that most of the retail investors have been exiting when the market peaked mid-May, while HNIs and institutions started buying aggressively. This is more because a lot of investors who have been waiting for the last five to six years started selling to book notional profit after a long waiting period, whereas they are actually still booking losses due to inflation.

The retail investors are the last to gain courage and the first to fear the markets due to the 'greed and fear' factor in the market. Only when the Nifty crosses the 10,000 points will they start gaining courage to aggressively return to invest. When the market peaks, the retail investor will be fully invested because of greed, and lose a lot of money. This is seen all over the world and hence retail investors must learn from past mistakes and must start taking risk when a bull market is beginning instead of waiting for the peak of the market. Finally, to bring the investors to Indias capital market on a sustainable basis, we need to fix the IPO market and the IPO market only.

CJ George

The author is MD, Geojit BNP Paribas Financial Services