Sucheta Dalal :First signs of growing stock bubble
Sucheta Dalal

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First signs of growing stock bubble  

Feb 14, 2005


As stock prices continue to surge and Foreign Institutional Investors (FIIs) remain bullish about India, we are probably beginning to see the first signs of a growing stock bubble. The return of the retail investor, especially the large body of new investors in the capital market, is indeed good news. But it would have been even better if these investors showed a greater interest in good fundamental investment, than those who retired hurt after chasing the dreams peddled by scamsters in 1992 and 2001.


Blue chip stock prices are already overheated because of the scarcity of good investment opportunities, consequently stock operators are finding a ready following when they ramp up dubious mid cap and penny stocks. There is also a quality problem in the IPO (Initial Public Offerings) market for equities, which is why mediocre issues get an exaggerated public response. The average investor is unable to evaluate risk factors in the face of all the hype generated by market intermediaries and institutional investors, especially since the bull market ensures that these IPOs list at a premium to offer price.


Since mutual fund schemes are considered the best bet for small and relatively uninformed investors, there has been a huge rush to invest in mutual fund IPOs; but this is sending out another set of danger signals. Domestic mutual funds, who were consistent sellers in the secondary market until December 2004 (they sold over Rs 2700 crore when FIIs were relentless buyers), have finally turned net buyers. In 2005, most mutual funds are flush with funds and under pressure to deploy the record mobilisation of their new schemes in the market.


In fact, the situation is reminiscent of 1994 when people stood in long snaking queues to subscribe to a close-ended scheme of Morgan Stanley that has never ever lived up to the initial hype.


Funnily, the madness seems reserved for Initial Public Offerings (IPOs) of mutual funds. Retail investors seem to believe that by investing in a new scheme they come in at par value and into a clean new account. Fund Managers say that investors often redeem existing mutual fund investments and transfer to newer ones despite hefty exit loads. Such investors seem to ignore the fact that new schemes have to build their portfolios in an already heated market and will be under pressure to invest quickly in just a few hundred core investible scrips. But it is not quite clear whether such churning occurs due to the persuasion of investment advisors and distributors, who earn a fee on IPO investments but gain nothing if investors stay invested in old schemes.


The big mutual fund successes in the last few months include the Tata Infrastructure Fund raised which raised Rs 750 crore and HDFC Mutual Fund which picked up Rs 400 crore at the end of 2004. This year, mutual fund IPOs have picked up over Rs 1700 crore through a plethora of new schemes. Kotak’s mid cap offering raised Rs 577 crore in January this year and Sundaram Mutual Fund collected 367 crore.


ING Vysya Mutual Fund, which manages assets of around Rs 1,400 crore is seeking permission to set up a second Asset Management Company with Bajaj Capital. While Franklin Templeton Mutual Fund, Escorts Mutual Fund and Merrill Lynch Mutual Fund are others in the market with new schemes. Apart from IPOs, the Birla Mutual Fund picked up Rs 1000 crore and SBI Mutual Fund raised Rs 828 crore. This new investment has come in mainly from thousands of retail investors rather than a few large corporate investors or High Networth Individuals.


The danger is that the rush of investment creates impossible expectations and tempts Fund Managers to cut corners or abet stock operators in manipulating prices. Every scam since the 1990s has seen big involvement of mutual funds. If the Harshad Mehta scam exposed the complicity of several Canbank and other bank promoted mutual funds then Ketan Parekh’s mischief pushed the giant Unit Trust of India to the brink of closure in 2001.


The lure of the market is clearly not restricted to mutual fund investment. Investors are borrowing to invest directly in equities, to experiment with derivatives trading and also to dabble in commodity futures. Personal loans offered by private bank and foreign banks at 15 per cent interest and repayable in equated monthly instalments are dangerously popular with small investors. These banks ask no questions, but employ ruthless recovery tactics when faced with a default.


The more seasoned investors borrow against shares; although a part of the borrowing is against their core holding, anecdotal reports suggest that the borrowing is fast being leveraged into a dangerous pyramid. The increased demand is evident from bankers lobbying the Reserve Bank of India (RBI) to enhance their capital market exposure. HDFC Bank has recently been allowed to increase its market exposure from five to eight percent and others banks are seeking similar relaxation.


This time around, provident funds will provide a new element to watch out for. The government has allowed provident funds to invest 5 per cent of their incremental investment in equity and 10 per cent in Mutual Funds.


So far, most Pension Funds have expressed a reluctance to invest in the capital market, or to be lured by the trite claim that equity investment offers better returns over the long term. But it is only a matter of time before smart brokers ‘influence’ them to test the waters. Given the lack of liquidity and shortage of good stocks, provident fund trustees would be well advised to insist that investment in the capital market is initially restricted to index funds, which carry a lower risk. But the decision has been made and only tight vigilance and a regular disclosure of portfolios will ensure that Pension Fund managers do not lose sight of their fiduciary responsibility towards peoples retirement funds.


In conclusion, one has to admit that although there are danger signals there is good news in the fact that there is no bull operator playing on the scale and brazenness as a Harshad Mehta or Ketan Parekh or with a similar investor following.


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-- Sucheta Dalal