Art of extrapolation - 2

In recent times, one of the most extrapolated data by the market participants in India has been the household participation in the capital markets. Several research papers/reports have highlighted the relatively low deployment of the Indian household savings into the capital market, especially listed equity shares, to argue for a high growth potential in this area. In fact, capital market related stocks like brokerages, AMCs, depositories, exchanges and transfer agents & registrars, have been outperforming the broader markets for the past few years. Impressed by the trend, NSE has even launched an index (Nifty Capital Market index) to capture the performance of this sector.

Indubitably, the Indian capital markets are at the threshold of a major transition. Acceleration in institutionalization of household participation has been a major trend in the past five years. Access to banking and financial markets has improved materially with the advancement of technology and digitalization in the last one decade. The young demographic is looking to enhance their wealth through participation in the growth businesses. `The participation of small and medium sized entrepreneurs in the listed market is also increasing rapidly.

Nonetheless, extrapolating the current household participation data to the levels of the US and affording valuations based on 10-15yr forward earnings based on such lofty assumptions might not be appropriate in my view.

It may be pertinent to note the following in this context —

·         Household participation in capital markets in countries like UK, Australia, South Korea is about 7 to 8% of total household assets. China and Japan are higher at 11 to 12%. At present, Indian households’ allocation to shares, debentures and mutual funds is approximately 2.5% of their total assets.

The per capita income in these countries are much higher than India – the UK ($55000), Australia ($64,500), China ($13,700,), Japan ($34000), South Korea ($34600) as compared to India ($2880). As of this morning, there is nothing to suggest that India might reach $12000 (4x the current level) mean per capita income level in the next 10-12years, that might be needed to reach 7-8% allocation to capital markets (debt and equity).

​Indian households presently allocate about 29-30% of their assets to financial assets. Of this 30%, about 7-8% (2 to 2.5% of the total) is allocated to mutual funds, shares and debentures (public equity and debt). This allocation is almost the same as it was in the decade of 1990s. Not much has changed in the past three decades, since the first round of reforms and liberalization.

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·         The financial liabilities of the Indian households have been rising faster than the financial assets in the past couple of decades. The anecdotal evidence suggests that this trend is likely to sustain for the next decade also, as household savings continue to stay lower. This implies that the risk-taking ability of the Indian household would diminish further in the short to medium term. This does not augur well for a meaningful rise in the capital market participation.

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​·         Indian listed equities and mutual funds have consistently failed to generate meaningful alpha over physical assets like gold and real estate over a longer period. For example, over the past 15 years, Nifty 50 (+311%) has sharply underperformed even gold (464% in INR terms) returns. Over 50% fund managers have even failed to match the benchmark returns.

·         In the past three decades, the employment intensity of GDP has diminished materially. For 6.5% GDP growth, employment growth is less than 0.5% CAGR. This trend has pushed people towards self-employment. At present there are about 80 million self-owned enterprises, employing over 130 million people. The owner of these enterprises usually owns 100% of the equity. In many cases, the value of self-owned enterprises’ equity is more than the networth of the household. It could be a matter of debate whether households who fully own their enterprise do actually need to invest in listed equity. But no asset allocator would advise further equity exposure to a person who has 100% (or more in many cases) of his networth invested in the equity of his own business.

To conclude, I would say, the capital market in India is on a high growth path. The next couple of decades would see material jump in the level of activity; market capitalization; household ownership of listed equity and debt; and the people employed or engaged in the capital market activities. However, extrapolating it to matching earnings growth for all the participants might not be a great idea.