Irrational exuberance

The exuberant sentiment in the secondary market has now extended to the initial public offer (IPO) market , with offers made in recent times being massively oversubscribed and the stocks listing with stellar gains. While a vibrant market for IPOs is good for the economy as it opens a viable fund-raising channel for corporates, the rush towards some of the recent offers borders on frenzy and seems driven by speculative rather than investment demand. The ten IPOs made in July amounting to around ₹18,400 crore received a subscription that was 48 times the amount offered. The oversubscription is not limited to the retail portion of the offer with institutional and high networth individuals appearing equally keen. Strong listing day gains — with four of the most recent IPOs yielding 65 to 113 per cent return on the listing day — is only further stoking this demand.

A positive fallout of this craze is that it is drawing new investors into the equity market, as evidenced by the sudden surge in new demat accounts and investor registrations with exchanges. But if these investors are lured by the prospect of quick profits, they are unlikely to contribute to the long-term growth of the stock market ecosystem. The manner of allotment in the IPOs — with retail allotment in over-subscribed issues based on lucky draw — has made this investing process highly dependent on chance. With most recent issues performing spectacularly on listing, investors seem to be of the opinion that this run will continue, assuring them of super-normal profits on allotment. An ecosystem has also been formed to finance these IPO bets, comprising of market intermediaries and financing institutions allowing investors to apply for the shares with just a fraction of the application amount. The market regulator needs to increase awareness among investors regarding the risks in investing in the primary market, informing them that chances of capital loss are high if the current uptrend in stock market halts or reverses.

SEBI also needs to monitor the primary market closely to detect any illegal practices aimed at creating and maintaining buoyancy in IPO stocks in the period after listing. In 2010, SEBI had cracked down on many promoters, brokers and investment bankers who had manipulated the post-listing prices of IPO stocks. The set of rules governing IPOs, introduced then, had helped clean the primary market substantially. The regulator has prescribed a circuit limit of 5 per cent on either side from the listing price, applicable for the first day of trading, for issues under ₹250 crore and a limit of 20 per cent for issues above ₹250 crore. But there is no circuit limit in the pre-listing call auction, where the listing price is determined. SEBI needs to monitor the trades made in these special pre-listing sessions. The grey market for IPOs, which is being used as an indicator of the listing price of issues, needs to be curbed.

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