Vijay Kumar Gaba

Continuing from yesterday (see De-institutionalization of household savings)

It is important to note that investors moving away from passive investing to active investing is not an India specific phenomenon; rather it is a global shift. For example, there is massive outflow of funds from equity mutual funds in US, while benchmark indices have been scaling new highs. This outflow of funds has coincided with the tremendous rise in "Robinhood" investors - people buying and selling stocks directly on discount brokerage platforms.

As Sanjay Satapahty, a fund manager at Ampersand Capital, highlights "Trend of ETF was a megatrend over last decade and the reversal can have huge implications." (see here)

In past five months we have seen some glimpses of the likely implications for the market, should the shift from passive investing to active investing sustains over a longer period. Since the market bottom in March 2020, the small cap stocks (+73%) have outperformed the benchmark (+51%) and Midcap (+57%) significantly. The sharp small cap outperformance in June and July has coincided with the net outflows in equity mutual funds since middle of June 2020.

This outperformance has come on the back of massive rise in market volumes in value terms; number of daily trades; quantity of shares traded daily; and positive market breadth. It is also important to note that this has happened with no major change in implied volatility, much stricter margining norms and no significant rise in leverage.

I find that the following factors behind these trends-

(a)   Dismal performance of asset managers (mutual funds as well as PMS). Most fund managers have disappointed the investors who were given high hopes through aggressive "Mutual Fund Sahi Hai" campaign. There have been many instances of impropriety and unethical practices, especially in case of PMS. This might have led the investors to take the things in their own hand.

(b)   The socio-economic lock down due to outbreak of COVID-19 has rendered many people jobless. Besides many businesses have been working at zero or sub optimal capacity reducing the working capital requirement materially. Many of the jobless individuals and idle businessmen with cash may have started trading in equities in order to generate some income.

(c)    Many young professionals who have been told to work from home, may have found spare time, which they are utilizing in trading in stocks. (For more details see "Rise of Retail Investor")

My primary view has been that this trend of "Robinhood investing" may not sustain as it prevails presently. Nonetheless, we may see the following corrections in the markets over next one year or so:

(a)   The top heavy indices may inspire changes in the methodology of stock market index construction. Till then-

(i)    The diversified funds may take precedence over ETFs based on benchmark indices.

(ii)   Index heavyweights may either stagnate or see correction in prices and broader markets may remain more active.

(b)   The compensation and performance evaluation rules for professional asset managers may see material changes to make them more accountable

(c)    As the economic activity picks up from 2021, the part time investors and traders may return to their jobs. Also, the spare working capital of partially operative businesses may also flow back to routine business. This should mark the beginning of the decline of Robinhood investing.

Tomorrow I shall share my technical view on the Indian equity markets.

For two years 2017 and 2018, the growth in Indian stock market was mostly attributed to the institutionalization of household financial savings, as investors increasingly turned to the professional fund managers for managing their money. The asset under management of mutual funds, portfolio managers, pension managers, ULIPs etc grew at highest rate. The regulators also supported the fancy campaign "Mutual Fund Sahi Hai!"

Net inflows in domestic mutual funds quickly reached from sub Rs5000cr during summer of 2016 to Rs.20,000cr in autumn of 2017. The contribution through systematic investment plans (SIP) increased from Rs3000cr in April 2016 to over Rs8000cr by end 2018. The total asset under management of equity mutual funds had increased from ~Rs5trn in early 2017 to over Rs10trn by August 2018.

In July 2020, the net inflows in mutual funds were negative.

The Economics Times, recently conducted a survey of investors to analyze the trend. The survey discovered that 3 out 10 mutual fund investors may have moved to directly investing in stocks. This indicates a serious setback to the trend of institutionalization of household savings. It is pertinent to note that this trend is developing when the savings of the Indian household are contracting structurally.

About 79% of the investors who decided to invest directly instead of mutual funds thought that COVID-19 induced correction in stock markets offers better opportunity in the stock market and they can better utilize this opportunity than the professional fund managers. About 29% felt that mutual funds have not performed well and they need to trade themselves to make the loss. About 15% found that cost of direct trading is less than the cost of investing through mutual funds; while another 9% have used trading in stock markets to compensate for lower income or job loss due to lockdown.

It is important to assess whether this is just a small blip in the long term trend of institutionalization of financial savings or the trend has stalled and may reverse from here!

Will be glad to share my thoughts in later posts.