Unlike previous bear markets, domestic investors have stuck to equity in 2011
Since January 2011, the Nifty has lost over 21 per cent. The global slowdown and currency issues have affected overseas investments during the last 11 months. Foreign institutional investors (FIIs) have been net equity sellers to the tune of Rs 18,573 crore between January 1 and November 18. Domestic interest rates have also risen, affecting corporate margins as well as the ability to raise financing for new ventures. The primary market has stagnated. In the circumstances, one would have expected a flight of rupee capital out of equity and into less risky assets. That has not happened. Domestic institutional investors (DIIs) have increased their equity commitments in 2011, with net equity investments of over Rs 21,740 crore. What is more, mutual fund assets under management (AUM) have also grown through the first three quarters of 2011. Between January 1 and September 30, the average AUM for Indian funds, and funds of funds, rose by Rs 11,931 crore and Rs 1,794 crore, respectively. This is a significant development, because in previous bear markets there has usually been a collapse of DII equity investment, and a shrinking of AUM.
There are several reasons why fund investors may have kept faith with equity in this downturn. Regulatory changes may have played a role. For instance, the removal of entry loads has definitely made funds more attractive. There is also anecdotal evidence that the fund industry has benefited from the removal of fixed tenures for Systematic Investment Plans (SIPs), which may now be maintained till perpetuity, or terminated at will. Industry experts say that most SIPs are now being held for over 12 months, in contrast to previous practice when six-month SIPs were most popular. Tax policy also continues to favour equity over debt. Equity capital gains are tax-free for units held over 12 months, as opposed to debt returns, which are subject to income tax. But the tax regime has not changed much for several years, and this did not prevent flight out of equity in the 2008 bear market.
Another possibility is that investment in housing has been affected adversely by continuous rate hikes and the Reserve Bank of India’s efforts to reduce the banking system’s exposure to real estate. Equated monthly installments, or EMIs, have inflated, and loan tenures have risen. Some retail investors may have deferred housing purchase plans, and chosen to park their savings in equity until such time as the rate cycle peaks. On the face of it, therefore, the retail investor seems to have become more sophisticated. This is consistent with the established tenets of financial planning. Most financial planning models recommend that investors should hold a mix of financial assets and maintain stable weights across asset categories, ignoring short-term cyclical fluctuations. What is more, the life-cycle approach says younger people should hold higher equity exposures via SIPs, to reap optimal benefits from the excess returns equity yields in the long term. An SIP-based method lowers the average cost of acquisition during bear markets like 2011 and, thus, helps smooth out the volatility of equity returns. It remains to be seen if the apparent change in investor behaviour is permanent. If India’s young workforce is indeed committing itself to long-term equity exposures, this could be another example of the demographic dividend.