A senior manager in a reputed mutual fund recently dropped a bombshell within the investing community. Speaking at a prominent (financial) investment conference, he said that the country’s stock market has entered a new phase in this century. Unlike the 1980s, 1990s, 2000s, and 2010s, the entire set of risks are borne by the investors, both retail and institutional, and not by the financial entities. This is because the latter, which include development financial institutions, and banks, avoid stocks and equities for varying reasons. Thus, there are no safety valves for the direct investors. They are on their own, and they need to deal with their risks. There is no one to save them, and no one to make them aware of the anchoring, and other cognitive biases. “The risk-taking for the entire country today lies with the investors,” said Sankaran Naren, ICICI Prudential AMC’s chief investment officer.
During the 1980s, when the stock market boomed for various reasons, including the role played by the cash-rich Unit Trust of India, a host of state-owned development institutions such as IDBI, ICICI (now a privatised bank), and IFCI were invested in shares. Apart from giving loans for the nation’s progress, especially in heavy industries and infrastructure, these entities held significant equity holdings in the companies. It was possibly to secure the large loans, or have a say in nation-building. In fact, their voting rights were so significant that they could sway decisions against the promoters, if the need arose. In several sensitive situations, like takeovers, they would play major roles, especially as they were puppets of the ruling regimes. For example, they stalled the late Swraj Paul’s desire, which was initially aided by politics, to take over iconic Indian firms. They did the opposite by preventing the Ambani takeover of L&T.
Simultaneously, and during the 1990s, the banks took over from the development agencies, whose role declined, and almost-vanished due to the economic reforms. As the financial sector opened, the Government diluted a part of its stake in state-owned banks, and allegedly gave more autonomy, the banks became more excited about equities. According to Naren, this was more so in the 2000s, especially “in the 2007-08 cycle.” Over time, as the banks were saddled with chunks of bad loans, including by willful defaulters, they became risk-averse. Despite goading by the finance ministry, they remained aloof to both lending, and equities. They were more interested in recovering any portion of the non-performing assets. This is reflected in the existing shareholding patterns of the listed firms, where Life Insurance Corporation (LIC), mutual funds, foreign investors, and retail investors together hold major percentages. This is especially true of firms, where the promoters’ stakes are low.
What has happened in the last decade or so is the phenomenal cash flows with LIC, and unbelievable inflows into mutual funds. The foreign pipeline, which spurted during the 1990s, continued to pump hundreds of billions of dollars into Indian equities. There were major differences. Being state-owned, LIC was nudged and pushed by the Government. Recently, it was embroiled in a controversy over investment in a large group, which it denied. Foreign investors remained fickle, with sudden inflows and outflows to manage risks, hedge uncertainties, and cater to quarterly returns. Thus, mutual funds, by default, became the champions of Indian investments. In the recent past, despite huge withdrawals by the foreigners, the domestic fund flows via mutual funds have not only resuscitated the markets, but grown the indices to induce attractive returns. Conversely, felt Naren, fund managers, plush with funds, are pushed to invest in expensive stocks, irrespective of their valuations.
Although the mutual funds have created multiple, almost confusing, options for the investors, this has had the opposite effect. It has impeded the decision-making of the fund managers. As Naren explained, thanks to the specialised vehicles, if the retail investors root for small-cap, midcap, or large-cap categories, the fund managers have no choice. “If SIPs come in costly midcaps, the midcap manager will invest in costly midcap issues,” he said. This creates a non-virtuous cycle of hyped valuations since the inflows keep growing, and there is an urgency to be invested in specific categories. So, while private equity and foreigners sell to benefit from high valuations, and knowledgeable ones exit at the right time, the retail investors keep buying because the fund managers have no option but to keep the money busy. In addition, the small investors are keen to invest in equities, and avoid debt and balanced-advantage funds, which distort their portfolios, and continuously enhance risks.
The trick, according to Naren, is two-fold. First, retail investors need to understand that the long-term implies long-term. According to him, investors pay lip-service to long-term goals; they may say they wish to be invested for 20 years, but very few stay for 10 years. In addition, their portfolios, as mentioned earlier, are lopsided. “Do not put everything in one asset class. Asset allocation is the only way to stay safe,” warns Naren. Thus, financial advice, financial knowledge, due diligence, and reading the fine print is essential to understand risks, take appropriate decisions, and increase the asset basket. No one, apart from the investors themselves, can save them. The policy-makers and regulators will constantly be a few steps behind the risks, and act once the horses have bolted the stables.
