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At Yahoo: Too Few Investors


I speak about the lack of active investors over at Yahoo: Too Few Investors.

A question [1] was asked in the Rajya Sabha of the Namo Narain Meena, MoS in the Finance Ministry about how turnover was distributed in the National Stock Exchange (NSE) among different classes of investors. The answer was enlightening – 30.9 lakh different entities traded in the cash segment of the NSE in the first quarter (April to June) of this financial year.

But this is top heavy; of the entire turnover in this period, just 451 entities were responsible 50% of the total. Of these, around 156 were “proprietary” traders, meaning members trading on their own behalf, rather than for clients. In the Futures and Options segment, about 557,000 entities traded in this period, with just 106 accounting for 50% of the turnover – again, 58 of this was prop-trading.

The minister’s response to yet another question [2] revealed that more than 60% of both cash and derivative markets are “intraday” trades – that is, both the buy and sell are executed on the same day.

This triggered angry reactions from parts of the media, some saying that the market is really a casino for concentrating volume in the hands of a few. And that the rampant speculation, evident by high intraday trading, is benefiting only a few people.

In my view this is outrage at the wrong issue. That our markets are top-heavy isn’t a surprise. Of the 1,400 stocks traded on the NSE, just the top 50 account for more than half of the total market capitalization – the Nifty 50 market cap is Rs. 34 trillion (lakh crore) of the total NSE market capitalization of 64 trillion. Just the top 15 stocks account for 1/3rd of the NSE market capitalization. (All data from the NSE web site) In terms of traded volumes too, most of the trades happen in the largest stocks, both from the data on NSE and from the Minister’s replies. Our markets are top-heavy and will be for the foreseeable future.

Being top-heavy isn’t a big deal; that investors chase the same stocks is a story played over and over in all international markets. To get exposure to the Indian indices, institutional money will flow into index stocks than any other.

Prop-trading isn’t the issue either. Brokers trading their own accounts will always be a good chunk of income – with the lowest costs, you can expect brokers to set up large arbitrage operations, both between exchanges and between segments (like cash versus futures arbitrage). This results in low delivery ratios and heavy churning, and is entirely acceptable; arbitrage is a well understood profession, and in India today generates a number of jobs – behind each prop-account may be hundreds of arbitrageurs. There are unacceptable operations which I’ll talk about later.

What’s the problem then? The absolute numbers. Just 30.9 lakh investors that have made a trade in three months? Three months when we are at one or two-year highs, the retail population just doesn’t care enough to invest directly? Sure, the three month period is perhaps too small – but the real number isn’t much bigger, going by the Swaroop committee report, which says 8 million (80 lakh) investors invest in direct equity, mutual funds and insurance. I’ll take a guess there are about 40 lakh individual equity investors. (Figures here are not easily available)

There are more than 20 crore mobile phones in the country. There are about 28 crore “middle-class” and growing so fast you’re outdated the minute you have a number. According to the National Council of Applied Economic Research (NCAER), India has46.7 million (4.67 crore) high income households, that is, earning more than 1.8 lakh per year. That’s households, not people. Yet, less than 10% of them choose to participate in the Indian equity markets directly.

NSE’s July market newsletter reveals that of the total shareholding of companies in the country as of March 31, 2010, promoters owned 56% of the total market value of the shares. Institutions owned 25%, of which 13.64% was with Foreign Institutional Investors (FIIs) – just 9% was with insurers/mutual funds. Retail individuals own about 8.7% directly. This, again, is indicative – foreign investors are the largest collective entity after promoters in market value share, with direct retail coming in a distant third.

As an economy we have too few direct investors; and while there’s enormous opportunity, there have to be lessons learnt from hearing this kind of data after nearly 10 years of constant economic growth. This is what I hear when I ask people why they don’t buy stocks.

Markets are a manipulated casino.Investors, burnt time and time again after getting into overheated markets, complain that only a few “insiders” know anything of value in the markets, and that the power brokers move stocks around with money. That is, in my opinion, true. Insider trading is rampant, and stocks are manipulated, sometimes brazenly. It’s not that this doesn’t happen elsewhere – it’s that when it happens here, despite the Securities and Exchange Board of India (SEBI) conducting impressive investigations, the miscreants walk away scot-free. The complaints against “proprietary” trading must focus on such manipulation and trading. We need strong regulators and appropriate powers of action – until that happens, and a few culprits get thrown into jail and their ill-gotten wealth appropriated, the markets will continue to feel like loaded dice.

Markets are full of cheats and frauds. There used to be a time when, to buy a share, you had to call a broker and he would send someone on to a “trading floor” making strange hand gestures in order to execute the order. You would always seem to get the highest price of the day when you bought, and the lowest when you sold. It was that bad, and brokers loved it. The NSE went electronic and instituted norms to control such blatant fraud, and today it is indeed extremely safe to buy stocks on the exchanges; you can now see the prices in the exchange as you buy or sell, and watch as your order gets executed at the price you dictate. You no longer have to worry about brokers running away with your money – your money and shares are electronically ring-fenced at large clearing institutions.

Still, the frauds haven’t gone away – they continue to lead investors astray through complex structured products or mis-selling shady portfolio management practices. Yet others take blanket “powers-of-attorney” and misuse client shares. While some of these are being addressed, the would-be investor gets that creepy-crawly-feeling of the financial crowd waiting to con them out of their money.

It’s too complicated. Investor education is important. The less people know, the more they are likely to feel it’s a casino. But education doesn’t happen overnight, and the idea should be to create a sustained education mechanism, not a sudden brouhaha. Potential investors need to know what stocks are, and how to buy or sell them. About the steady investing techniques, diversifying into equity, and how to do this without needing a Ph.D. About how to avoid the jerks that the industry is filled with, who tell you to buy insurance policies “for only three years” and then run away with hefty commission checks.

The process needs to be refined as well. For example, If I bought a stock today, and sold it in two days, why did I get charged a 10% fine? While many brokers allow you to buy today and sell tomorrow, the settlement cycle of the exchange means shares take two days to reach you; sometimes, the person you bought the shares from fails to deliver the shares – this is a “short delivery”, which goes through an auction process where the seller pays the exc
hange a penalty and you get your shares only after four days. That means you don’t have the shares to pass on to the person you sold them to the next day, hence you are on the wrong side of that “short delivery” and get penalized. The answer is to fix the process and tighten the delivery mechanism.

Ill-defined products are another issue. The NSE has allowed shareholders to “lend” their shares out and earn some interest on them – arbitrageurs can borrow such shares and use them for trading, and return them after some time. The problem? If you lend shares, you still need to place money as “margin” with the exchange – this defies logic. I lend my shares so where, really, is the requirement for further margin money? It’s not like the share price can go negative. Products like these are utterly useless in their current form.

Lastly, there’s not enough transparency. Companies must reveal consolidated financial information every quarter, including balance sheets and cash flow statements, along with what they do right now – standalone profit-and-loss statements. Plus, they must immediately declare all material financial information, and no selective distribution (to analysts or FIIs) must be permitted. That way the retail investing public has a better chance of getting information useful for longer term investing.

Bringing more investors on board should be the take-away. Of all the numbers the honourable minister quoted, just one stays with me: Only Thirty Lakh Active Investors.

[1] Unstarred #1669 – Search here

[2] Unstarred #1692, Search here.


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