Sucheta Dalal :The Disenchanted Ordinary Investor (7 July 2003)
Sucheta Dalal

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The Disenchanted Ordinary Investor (7 July 2003)  

A booming capital market, soaring equity prices and the two leading stock exchanges recording a huge run up of the major stock indices all seem to confirm a significant bull run. In fact, it is the time to talk about investors’ trading profits rather than investors’ worries.

But a soon to be released study of retail investors says that the bulk of investors are not quite hot on the equity market. And their gradual withdrawal from the capital market has weakened its structure. The study, titled “Why Ordinary Investors Remain Disenchanted” was conducted by the Society of Capital Market Research and Development (SCMRD) with Vivek Financial Focus Ltd and is authored by Dr LC Gupta, Navin Jain and Utpal Choudhury.

It comes up with four major factors that have influenced investors to exit the market. At the top of the list are fraudulent company management and a worsening of corporate governance (80 per cent had little or no confidence in company managements), the others are, price manipulation and excessive volatility, weak market regulation and active discouragement of retail shareholding through high dematerialisation charges.

The SCMRD study of 2003, although handicapped with a small random sample of 531 respondents, has a detailed analysis which estimated that about one per cent of individual shareholders are exiting from the markets each year, while the net addition to share owning population is zero or negative. In a country where less than five per cent of the population owns shares, this is a disturbing pointer to the state of the capital market. Other details illustrate the gradual confidence erosion. For instance, data on when the respondents became shareowners for the first time shows that the biggest addition to the investor population happened in the period of 1986-90 (when nearly 24 per cent of the respondents first bought shares) and 1991-92 (17 per cent). Only, 8.2 per cent of those surveyed came into the market in 1993-94 after the securities scam, despite the primary market mania. The percentage of new entrants dropped to single digits (7.1 and 6.8) in the succeeding two years of the IPO boom and only 3.8 per cent of those surveyed had started investing during the incredible bull run leading up to the Scam of 2000. Only two per cent of those surveyed said they had started investing after that.

Yet, the bulk of India’s capital market development took place in the decade of the 1990s. Trading became sophisticated and automated and turnover increased from around Rs 300 crore per day to a whopping Rs 10,000 crore plus in 2000 (and remains at that level today if one combines the derivatives and equity segments). But it didn’t attract new investors.

The study also found that 64 per cent of those surveyed prefer direct investment to the equity route, which is why the high cost of dematerialisation is keeping investors out of the market.

SCMRD says that the high annual cost of share custody has made the depository system uneconomical for retail investors and the system seems designed for large investors, frequent traders and speculators.

When the first depository was set up, the Securities and Exchange Board of India had said that “the benefits of reduced risk and lower transaction costs will extend to the vast majority of market participants and lead to improved investor protection and service” (SEBI annual report 1996-97). Empirical data however suggests that a less than a fourth of those surveyed hold all their shares in demat form. The rest—as many as 76 per cent of those surveyed—continue to hold paper shares. Around 36 per cent had only paper certificates and 40 per cent held a combination of paper and dematerialised holding.

The study says that the big blow to investors came in April 2002, when NSDL switched from a turnover based fee to a flat fee. This was a huge advantage to large investors but is much too exorbitant for small ones. For instance, where investors earlier paid a custody fee of 50 paise for shareholding of Rs 5,000 (at the rate of 0.01 per cent), they now pay Rs six for the same value—which is a twelve time increase. On the other hand, a large investor with a shareholding valued at Rs one crore has seen a 99.4 per cent reduction. Their annual custody fees drop from Rs 1,000 under the old system to Rs six under the new one. SEBI had appointed a committee in 2001 to consider a reduction in demat costs for investors. But ironically, the switch over to flat rates happened even before the committee completed its report, leading to angry protests and dissent from the two investor representatives on the board. This induced a nominal reduction in NSDL’s charges, but investor complaints about unaffordable demat charges continue to mount.

The survey also found that Depository Participants (DPs) are free to decide many of their charges and often add to costs by levying courier charges, interest and penalties or in case of banks, there is a minimum cash deposit of a few thousand rupees. The near monopoly of NSDL gives investors no choice. The charge for switching to the rival Central Depository of Securities Ltd (CDSL) is also very high.

The study concludes that since a majority of retail investors hold shares for the long term and find custodial charges far too high, the two factors together are hindering the growth of the equity market. NSDL too has usually encouraged infrequent traders to hold their shares in physical form. Unfortunately, this advice was good in the earlier days when NSDL was struggling to find its feet. But under compulsory demat; it only puts such investors at a disadvantage by shutting them out of the market.

Investors often lose money by holding dematerialised shares because while the company may not pay a dividend, there is no escape from the high custodial charge. SCMRD points out that the Depository Trust & Clearing Corporation of the US provides a pure “safe-keeping” facility for investors, and argues that the regulator needs to consider such an economical safekeeping facility, at least for small shareholders. In fact, there is no reason why the cost of such safekeeping should not be borne by companies, who are big beneficiaries of dematerialisation.

At a time when the New York Stock Exchange too is taking steps to encourage and support individual investors, it is imperative for the Indian regulator to examine the issue raised by SCMRD’s study and initiate urgent corrective action.

-- Sucheta Dalal