Are Indian Investors smarter?

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Aside real estate and gold, Indian investors save largely in safe, low-risk, capital-guarantee financial instruments. Let us look at the corpus accumulated in some of these instruments.
  • Bank Term deposits - 85 Lac Crores (Rs.1 Lac Crore is Rs.1 Trillion)
  • LIC policies - 15 Lac Crores
  • EPF - 6 Lac Crores
  • PPF/NSC - 8 Lac Crores
  • Mutual Funds - 7.6 Lac Crores
The total well surpasses India's GDP ($1.873 Trillion ~ Rs.104 Trillion). Bank deposits provide inflation-adjusted real rate of returns @ <1%, most LIC policies offer a paltry 3-5% return, Post-office/Small savings and EPF offer returns similar to bank deposits. Select mutual funds have offered 15-20% returns over 10 year time frame (shorter time frames have offered negative returns). Next, let us look at some published statistics on capital markets (Equities/Mutual Funds).
  • Total market cap of Sensex is Rs.72 Lac Cr (top 100 firms m-cap @ Rs.51 Lac Cr)
  • From 2006 to mid-2013 FIIs bought Rs.46 Lac Cr of equities and sold Rs.45 Lac Cr
  • In the same period, DIIs bought Rs.18 Lac Cr of equities and sold Rs.17.5 Lac Cr
  • Everytime the net FII becomes < 1% of m-cap, the market has dipped 20%
  • To get a return of 10%, FII inflows need to be around $10-15 billion in a year
  • FIIs can hold upto 24% publicly listed companies, presently they own about 22%
  • Stocks bought by FIIs have provided returns in the range of 5x-7x while stock sold by FIIs have dropped by 15-50%
Examining the asset classes "preferred" by Indians reveals few critical investment characteristics. These assets are:
  • Predominantly bought/sold by individual investors
  • Profit/loss stays in India
  • Demand/supply is a domestic factor
  • Relatively stable returns (look around your family/friends, hard to spot a loser)
Examining the not-so-favored asset classes belonging to the capital markets basket reveals characteristics that are in direct conflict with the preferred assets:
  • Predominantly bought/sold by institutional investors (FIIs and DIIs)
  • Profit leaves India
  • Demand/supply is a global factor (eg. QE, return chasing hedge funds, foreign pension funds, rating agencies)
  • Highly volatile returns (look around your family/friends, hard to spot a winner)
  • Most retail investors have lost anywhere between 20-80% of their portfolio by investing in stocks and mutual funds
The Indian stock market is very volatile due to the nature of FII flows, infusion of promoters' foreign funds and governance issues. It may still not be very difficult to encourage the Indian households to move to equities & mutual funds provided the market offers them with  transparency. After all, there were 20 million retail participants in 1990, down to 12 million in 1999 and 8 million in 2009 (in sharp contract to increase in investor households in the same 20 years).

Saving an additional 10% (~Rs.1 Lac Crore ~$17.4 bn p.a) and investing this savings in Equity/MFs is only an incremental target for Indian households. Such an inflow could greatly reduce the dependence on FII flows and progressively capital market instruments could gain investor's trust. At this point, capital market would begin to reflect the investment characteristics of the retail investor's "preferred" asset class and could be embraced at large. This move could not only be assertive on the ownership of Indian capital market but also help to stabilize the Rupee and Current Account Deficit (CAD).

This analysis finds that unless serious measures are taken by policy makers to make the capital market retail-investor friendly and limit the speculative aspect of FII participation, Indian investors may remain risk-averse. And this leaves him/her with little choice except to invest in low-return financial assets rather than risking loss of capital (whether this approach is the best to adequately cover all of his future financial needs is a different issue altogether). Do you think otherwise, post your thoughts..

Today's hedge funds and leading fund managers are advising investors not to chase returns, but to accept lower returns in a new low-growth world order. This leads one to infer that the Indian investor is perhaps acting smarter by refraining from investing in financial assets with unclear returns. Now it is the turn of the policy makers to offer an Eco-system that could leverage the massive domestic savings into capital market flows.

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