Much money, but few investment options

On August 22, financial newspapers reported SEBI’s announcement of bringing more companies under Additional Surveillance Mechanism (ASM), over and above the sizeable number that is currently being tracked closely.

While ASM affects the market sentiment about a company and its stock price, it is a logical initiative to protect investors’ interest. Such measures are commonly taken by the regulators globally in the interest of the investors whenever a significant misconduct and/or fraud is perceived to be brewing and/or the prices of scrips are being manipulated.

Post demonetisation, with improvements in the fundamentals of the economy, clean-up of quite a few of the corporate balance-sheets and revival of investors’ interest, a significant amount of households savings have been transiting to financial instruments; although growth of bank deposits and state administered savings schemes, which provide lower or negligible real rate return, has been retreating.

This has given rise to strong inflows into the capital market — directly into equities and also through mutual funds — in search of higher returns.

The recently released RBI Annual Report reveals a jump in gross financial savings to 11.1 per cent of national disposal income in 2017-18 up from 9.1 per cent in 2016-17. It also comments on shifting of household savings from banks. Currently, SIP folios are growing at an average monthly rate of 9.92 lakh.

The number of equity folios has grown to 6.31 crore. There has been a more than three-fold rise in AUM of mutual funds in just five years. In the absence of adequate supply of quality paper either through IPOs, FPOs, or rights issues, the monies have been chasing the available securities. The demand-supply mismatch raises the price of the scrips, makes the valuation expensive, reduces the return and creates a froth. This also opens opportunities for unscrupulous elements to manipulate the prices of less worthy scrips and create a bubble.

SEBI’s efficacious surveillance mechanism may have revealed a froth as also evidence of disproportionate price rises of some of the scrips. Anecdotal evidence suggests that returns of 25-75 per cent on wealth management portfolios were delivered during 2016-17 on the back of a sharp rise in the valuation of quite a few scrips from amongst mid- and small-cap segments.

A significant correction in the price of those scrips and less-than-expected recovery following some of the pragmatic actions taken by SEBI have led to low and negative returns delivered by many of the same wealth managers. The flood of new monies to wealth managers has receded significantly.

Such events are common in all capital markets. While preventing these completely may not be possible, addressing the disease coupled with treating the symptoms can significantly reduce the potential of such events. And if these still occur, the adverse impact on investors’ economic interests is minimal.

Demand-supply mismatch

The treatment of the disease is to reduce, if not eliminate, mismatch in the demand and supply.

There have been some coordinated attempts on the part of the regulatory bodies, particularly SEBI, to introduce additional investments products — like REITs, Infra-REITs, retail and corporate debt, and government securities — but none of these has actually taken off. There may be a variety of reasons and the regulators must be working to address them.

Promotion of a new instrument in the capital market warrants a different approach. It may be desirable for regulators to consider introducing ‘market making’ in all the new instruments, at least until they are understood and become popular.

In India’s fully automated price-time priority-driven electronic order flowing market, ‘non-central market-making’, currently being used by Euronext and ECNS of the US among others, could be the choice of the format. Market-makers will compete with common investors in the order flow by continuous entry into the system with the ‘limit order’ of buy and sell. There will be transparency in the limit order book of all the participants, which will lower the transaction cost, particularly for uninformed investors. This system will also prevent monopolistic flow of information of order book to anyone. In this system, the duties and obligations of market-makers can be predetermined in the set of qualification rules. Since access to the market will be only through the terminals, similar to any other broker, there will be no need to deploy additional technical or human resources to monitor. It will translate into lower cost of surveillance. This system of market-making is believed to be least costly to regulate.

A recent news report that global pension and sovereign funds are looking to invest in India’s REITs suggests that there is interest amongst institutional investors. In any case, insurance companies, pension funds, and other institutions mobilising long term savings in India are looking for instruments that can deliver decent real rate of returns with lower risk and help diversification of the portfolio. REITs and Infra-REITs will be ideal instruments for them. The hitch, however, seems to be liquidity.

There is a chicken-and-egg problem in addressing the challenge of liquidity. Unless institutional investors participate, depth and liquidity cannot be built, and unless there is a possibility of easy exit, institutions hesitate to enter. Further, the absence of depth in the market for an instrument creates kinks for price manipulation. Market-making with all its inadequacies has been used to address such issues globally.

Inadequate supply of quality instruments has the potential to create opportunities for fraud, froth and manipulation of valuation and may continue to haunt investors even while regulators treat the symptoms.

The writer is a former chairman of SEBI and LIC.

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