CIRCUIT BREAKER. The stock market’s problem of riches

For three years now, the Indian stock market has been giving cautious investors the runaround, defying both gravity and explanation. The bellwether Nifty50 saw its price-earnings multiple cross 26 times recently but has shown no inclination to correct despite elusive earnings growth. Despite bubble warnings, IPOs demanding three-digit multiples have attracted enthusiastic market response.

Stock prices have proved immune to dismal economic news too, vaulting over barriers such as the note ban and GST like PT Usha in her prime. So what’s giving the Indian market this Duracell-like resilience? It seems to be a case of too much money chasing too few opportunities. While the domestic money seeking out stocks has grown by leaps and bounds lately, the investment universe hasn’t expanded to keep pace.

In short supply

In recent years, even as foreign investors have continued their flirtation with Indian stocks, domestic retail investors have begun an all-new romance. Retail savings pouring into mutual funds, the National Pension System (NPS) and insurance plans have seen a manifold surge in the money earmarked for equity with the domestic institutions.

In the last five years, domestic mutual funds have seen their equity assets vault from ₹2 lakh crore to about ₹8 lakh crore. With the EPFO’s equity foray, exchange traded funds have grown from under ₹1,000 crore to over ₹60,000 crore. The NPS has gone from a non-entity to a ₹2 lakh crore fund looking to allocate a larger pie to stocks. Insurers have another ₹6 lakh crore of equity assets under their belt.

Fund managers argue that even with all this, domestic institutions make up just ₹15 lakh crore of the ₹146 lakh crore market capitalisation in India. But the devil really lies in the details.

Half of that market cap is not available for trading at all as it is held by promoters. And while the market cap of listed stocks has no doubt ballooned due to soaring valuations, the number of investible stocks has actually shrunk. Data from the BSE tells us that of the 5150 companies with listed equity, 1191 have been suspended for trading. Of the available 3956, on any given day about a third aren’t traded. As a result, the traded universe has actually contracted from over 2900 to 2800 in the last five years. And this is after accounting for the 300-odd IPO stocks that have listed on the main board in this period.

Filtered out

Then there’s the fact that only a fraction of this universe meets the basic filters on financials, market capitalisation and liquidity that long-term investors look for. Only about 150 stocks feature a market cap of over ₹10,000 crore, offering room for significant institutional participation. About 330 make the market cap bar of ₹2,500 crore. The number has expanded from 219 to 330 in the last five years, but clearly hasn’t kept up with the three-fourfold expansion in the money chasing it.

All this explains quite clearly why, as a high tide of new money floods into equities, it is contributing to super-charged valuations for the investment-worthy names. Given that this problem isn’t solving itself, it may be essential for SEBI to intervene to expand the pool of investible opportunities in the market. Failing this, the retail investors’ recent romance with equities may well end in grief.

Expanding the pool

There are four ideas that the market regulator can consider to expand the stagnant pool of investment-worthy stocks.

Primary market boost : The world over it is a thriving primary market that expands the listed universe and keeps it vibrant and contemporary. But in India, IPO activity has been at a low ebb for the last 10 years after a frenzied fund-raising from 2006 to 2008 that ended badly for investors. Bull phases in India are usually the cue for dubious promoters to launch pricey IPOs only to vanish later. This prompted SEBI to raise the quality bar for new issuers in the last five years. While SEBI certainly cannot afford to lower its quality bar, it can consider other tweaks. Doing away with the quota system in IPOs to create more headroom for institutions is a live possibility.

Market depth : A key reason why many institutional investors stick to the safety of the top 200 stocks is the lack of research, liquidity and market depth. This poses a chicken-and-egg problem as it is institutional interest that drives sell-side research. To improve market depth, SEBI should first rethink its recent move to restrict large and mid-cap MFs to a rigid laundry list of 250 stocks. A floating market cap range which slices the universe into large, mid and small-cap portions based on the percentage contributions (70, 20, 10 is the global norm) will be more conducive to market expansion. SEBI and the stock exchanges can also sponsor independent research into the hundreds of under-the-radar mid and small-cap names. This can be funded by the ample coffers of the investor protection and awareness funds. NSE and CRISIL had earlier collaborated on such a research effort, it can be taken forward.

More mid-cap/micro-cap vehicles : There’s avid interest in mid and micro-cap investing from a rising segment of informed and affluent investors who have a high-risk appetite. This has led to brisk business for stock subscription services, portfolio management services, stock advisory services and stock discussion boards on social media. Instead of cracking down on such activity, SEBI should look for ways to promote its orderly growth on a buyer-beware basis. AMCs should also be allowed to offer a larger menu of mid-cap and micro-cap MFs (minimum subscription limits can be set high) to cater to this segment. From a market development point of view, SEBI’s recent rules on consolidation requiring AMCs to run just one scheme in the mid- and micro-cap categories is an avoidable step.

More free float : A final idea, already said to be under SEBI’s consideration, is to expand the free float of the market by nudging promoters of India Inc to further dilute their stakes in listed companies. The last round of dilution to ensure 25 per cent free float, did deliver a significant increase in the institutional ownership of listed stocks. Public sector companies remain the serial offenders on this aspect and it is time SEBI pressured them to comply.

With disinvestment topping the to-do list of the finance ministry, such a move can pay off for the markets in two ways. SEBI need not worry about the promoter credentials of PSU firms tapping the market. The markets will have a larger pool of quality businesses to invest in and can also gain oversight over government-run businesses that gobble up taxpayer money.

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