Rise of retail investors and associated risk

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On April 4, Finance Minister Nirmala Sitharaman hailed Indian retail investors for investing large sums of money in Indian stocks, thereby shielding markets from external shocks. This was in response to a question in parliament about the flight of foreign institutional investors (FIIs) amid war in Ukraine and interest rate hikes by central banks around the world. The increase in purchases of Indian stocks by retail investors partly offsets these sales, although this comes with its own risks and vulnerabilities.

In December 2021, the latest month for which official data is available, retail investors held 9.7% of companies listed on the National Stock Exchange (NSE), a 14-year high. In December 2019, this figure was 8.4% and has been rising ever since. Among the eight categories of investors, Indian private developers and retail investors are the biggest gainers in ownership shares. FII, the second-largest, saw the largest decline in share, along with government. The December 2021 FII share of 19.7% was a nine-year low.

Direct investment by retail investors in Indian stocks, as opposed to indirect investment through mutual funds, has seen a significant increase over the past two years. This was spurred by people confined to their homes due to the covid-19 pandemic, mobile apps that facilitated stock trading and rising stock markets. The total number of active demat accounts, which one needs to trade on the stock exchange, more than doubled between March 2020 and March 2022, and currently stands at 89.7 million. It is likely that this increased further when LIC went public.

Risk factors

A storied market held the promise of quick gains and sparked interest from retail investors. Since March 2020, the Nifty has appreciated by 89%. A significant portion of Indian companies made higher profits. New companies have been listed, including internet companies like Zomato and Paytm. A number of these new retail investors have seen nothing but gains. But how will their portfolios behave, and how will these investors behave, in an environment of increasing volatility, as we are currently seeing, or even a falling market?

Retail investors are naturally at a disadvantage in terms of market understanding and information flow. This is magnified in difficult markets. In the March quarter, for example, retail investors saw their stake increase in 994 NSE-listed companies, but the average equity returns generated by this set were (-) 7%. In addition, all of the 699 companies where retail investors reduced their stake posted average stock market gains of 8.9% in the quarter.

Point and counterpoint

For now, the importance of retail investors in the domestic stock market is underscored by the volatility of FII flows to India over the past decade. FIIs are generally speculative capital flows and are extremely sensitive to interest rate differentials between countries. FII inflows in India remained consistently high between 2009-10 and 2014-15. With interest rates in developed economies very low due to a monetary stimulus following the 2008 financial crisis, investors sought higher yields elsewhere.

However, net FII flows remained low between 2015-16 and 2019-20, before reaching a record high of $36.2 billion in 2020-21, as the covid-19 pandemic necessitated monetary stimulus and a reduction in interest rates. However, the tide turned again in 2021-22 as negative global signals including rising inflation and consequent monetary tightening by major global central banks led to a record net outflow of $18 billion. of dollars. A strong base of domestic retail investors can act as a counterweight to the extreme volatility of FIIs.

Sector breakdown

After a three-year hiatus, domestic retail investors became net buyers in 2020, making net purchases of 51,200 crore on the NSE. In 2021, this has increased further to reach 1.43 trillion. A sector analysis reveals that retail investors are diversified across several sectors. Financial services (20.3%), followed by materials (15.3%) and information technology (12.5%), are the main sectors for retail investors. Unlike government and FII, which have a high exposure to the financial sector (38.5% and 34.8%, respectively), retail investors have a much more even distribution.

Over the past two years, retail investors have increased their participation in eight of the 11 sectors surveyed. This includes those that have benefited during the pandemic, such as IT and healthcare, while holdings in financials and energy have declined. The current stock market volatility will test the resolve of Indian retail investors and determine whether they are here to stay or not.

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