Beware of information paucity and liquidity risk in unlisted shares

Even seasoned investors should bet only 5-10% on such securities

StocX.in, a portal on which investors can transact in unlisted stocks, has launched an index of such scrips called the StocX Private Market Index (SPMI). It will track the prices of more than 30 companies actively traded in the unlisted market. Daily prices will be collected from various dealers.

As the privately-traded market develops and more brokers start offering these securities, retail investors need to make a well-considered decision regarding whether to invest in them.

Early entry advantage

If demand for a stock is high, getting adequate allocation to it in its initial public offering (IPO) is difficult. Hence, enterprising investors buy stocks of quality companies, which are likely to go for an IPO soon, in the unlisted market.

“A category within the unlisted space that is less risky and has been gaining popularity is pre-IPO companies. These are companies that are bound for their IPO within the next 6-12 months. Many a times, their stocks are available in the market as employees who got shares via ESOPs (employee stock ownership plans) sell some of them to create liquidity,” says Jatin Khemani, managing partner and chief investment officer, Stalwart Investment Advisors LLP, a Sebi-registered independent equity research firm.

Early entry gives these investors an advantage. “If the quality of the stock is good and you purchase it at the right price, you could earn high returns at the time of listing,” says Umesh Paliwal, cofounder, Unlistedzone, a website on which investors can buy and sell unlisted shares.

Unregulated space

Investors should, however, be aware that this is an unregulated market. “The protection available from the Securities and Exchange Board of India (Sebi) if you transact on the regulated exchanges is not available here,” says Ankur Kapur, managing partner, Plutus Capital, a Sebi-registered investment advisory firm.

Price discovery doesn’t happen through a large number of transactions between buyers and sellers on an exchange. “The price discovery is not efficient. The only benchmark you have is the price at which the last transaction happened,” says Kapur. The spread between the buy and the sell price could be large.

Liquidity risk

Investors also have to contend with liquidity risk. “Most investors enter this market thinking they will exit when the IPO happens. But sometimes the IPO gets delayed. In such a scenario, someone who wants to exit may find it hard to do so at a good price, especially if the company is not performing well,” says Paliwal.

The investor also faces counterparty risk. “The buyer often has to pay an advance to the broker. He has to bear counterparty risk, as there is no clearing corporation to ensure proper settlement, as happens on a stock exchange,” says Khemani. He suggests dealing only with known or credible brokers.

There is also a paucity of information on unlisted securities. Research reports by brokerage house analysts are not available for them. “A lot of investing in unlisted stocks happens on the basis of tips. But just because a friend or a relative has recommended a stock doesn’t make it a good pick,” says Kapur.

Finally, there is valuation risk. Paying too high a price, especially in exuberant market conditions, could affect returns, if for some reason (lower liquidity, change in market sentiment, etc.) the stock doesn’t list at a premium or tanks after listing.

Not a space for novices

New investors should steer clear of unlisted stocks. “Begin your investment journey with fixed deposits, Public Provident Fund, and Employees Provident Fund. Next graduate to mutual funds. Once you have gained some experience, enter direct equities. Here, too, you should invest in large-, mid- and small-cap stocks—in that order. Only after you have experienced all these products should you invest in the unlisted market,” says Kapur.

Even experienced investors, says Kapur, should restrict their allocation to unlisted stocks to 5-10 per cent of their equity portfolio.  

If you decide to invest in unlisted companies, download their financials from the Registrar of Companies’ website and study them. Also study the prospects of the industry the company operates in and its competitive strength therein.