As the finance expert from the Oxford University, Tarun Ramadorai has found an ideal platform in the Indian stock market to study behavioural pattern of individual investors in emerging markets.
Having co-authored the study 'Getting Better: Learning to Invest in an Emerging Stock Market' with John Campbell and Benjamin Ranish, the Professor of Financial Economics, Said Business School, University of Oxford was on a visit to India to speak on the same at the International Finance Conference held at the IIM Ahmedabad.
In an interview with Vinay Umarji on sidelines of the conference, Ramadorai talks about how individual investors are increasingly opting for delegation of their investment instead of directly investing in stocks and advises investors to avoid trading too much as well as hold diversified portfolio for better returns in the long run. Excerpts:
What has been your observation regarding the trend of retail investors in India during index movements towards peak and bottom levels?
Participation in the Indian stock market is heavily influenced by returns in the market. We have observed that when returns are very high in the Indian stock market, there is a very large influx of new investors in the market.
Whereas we find when there is a trough or decline in terms of profit, it is not that the participation reverses but certainly new participation doesn't come at the same rate.
It is almost as if the investor base remains pretty constant during the periods when the market is crashing but then increases quite rapidly during the periods when the market is climbing. It has also been seen that doing really well in initial days of investment can be detrimental to an individual investor while doing bad can actually help him behave properly later on.
It has been seen that cash segment remains a top priority of retail investors than the derivatives or bonds. What do you think about the behaviour of retail investors in India?
We haven't looked at the single stock futures and options or the index futures and options market. There is something that is important one of the strongest determinants of negative performance is high churn or turnover in your portfolio. One of the things that we have found is that as your experience levels increase, you stop churning your portfolio.
Another piece of advise on top of our advise that one should hold a diversified portfolio is don't trade so much. If one is investing in cash segment, one lesson is to diversify and second is not to keep churning. And I suspect that turnover in the futures and options market is very high.
In the time of IPO boom in India during 2008-09, even the roadside small tea traders and housewives became investors. How do you see this as a sign of increasing participation of retail investors in the equity market?
Increasing participation is, of course, a good thing because finance theory tells you that investing at least some portion of your investment in stock is a good idea. But it is not just the participation that is important but it is also how you participate.
If you participate and if you are holding only two or three stocks; if you are churning them like crazy; if you are hanging on to your losing stocks too long and selling your winners too early; and if you are tilting your portfolio towards stocks that have historically underperformed in all the countries around the world, then you are destroying the benefits of investing in a stock market.
So another way to say this is, if you are going to invest in the stock market, which is a sensible thing to do, then you should also behave sensibly once you are in the market. We know that beating the market or timing the market is very difficult.
How much does corporate governance or the lack of it impact individual investors' behaviour?
Corporate governance issues are of first order. It is really great that Sebi is starting to get serious about it. The Sebi is working on a draft code and analysing it and it's been out there for comments for a while. This is exactly what the market needs. We are sure there will be lot of support for this in the academic community.
Once you create an environment in which the information is more transparently well-disclosed that the price also becomes more efficient. So even if an individual investor is not directly analysing the balance sheets of a company, as long as the information is out there and the price moves and if they respond to price signals, investors will be on their feet eventually and just exit the stock. So if the stock is good all around, then regardless of whether retail investors are paying attention or not, it will do well.
How much importance does formal training on equity markets have for the betterment of small and retail investors?
I think financial education is a very very important area when it comes to investment. In some sense, the research that we are doing is part of the education effort.
We are documenting facts which can be put out there in the market. It would be very useful to distribute that kind of knowledge to people. There maybe different channels through which we can do that. You don't just have to sit there and give lectures people; or try to get them to read things or take tests. There maybe other ways to deliver that information.
Do you think that delegation instead of direct investment by individual investors is growing more?
When an average household invests into the market, it tends to do so directly rather than indirectly. Indirect way is that you give your money to mutual funds who then buys stocks. I suspect that the mutual fund share has been growing over the time. We are already starting to see a penetration of intermediate investment rather than direct investment.
That is a trend that is changing and is moving towards delegation. Certainly we are seeing relatively smaller investor participation in the market than we were. By the way, this is a trend that has occurred all over the world. So the increase in institutional investor's share is something that has been documented in the US over decades.
So direct retail investor participation in the stock market is not a feature that characterises developed economies to the same extent it characterises markets like our own. Of course, there is a big question on the level of fees. Delegation is well and good only as long as people are paying appropriate fees.
You have mentioned that high quality big data intensive finance and economic research is set to grow substantially in India. Why? Can India also provide capable manpower for the same?
I think the ability that we have in this country is remarkable. There is some challenge of capacity. Having said that, if you look at the (kind of) people who are out there working on the growth of the industry of data processing and technology are all doing extremely well. And I think they are well-equipped for the future requirements.
A recent study of top companies on Nifty and other indices between 2001 and 2011 states that with promoters and institutional investors increasing their holdings, especially in domestic private sector companies, retail non-institutional shareholders saw their holdings decline in the same period.
One of the things that we do see in our data is that individual investors may or may not have latched on to stocks which have large block or promoter holding stocks. The types of investors that favour these stocks tend to be relatively younger investors in the stock market.
By younger, I don't mean the demographic age but the number of years of experience in stock market. Whereas more experienced investors in the market tend to move away from such stocks. As the individual investor grows over a period of time in his investment life cycle, he almost starts to look more like an institutional investor in terms of behaviour.
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