With Indian indices Nifty and Sensex making all-time highs almost every day, how much juice is still left in the Indian market? Do market practitioners find it difficult to get bargain hunting in current euphoria?
Well not so. On the contrary, a few believe that India is an inefficient market where price and value diverge a lot as there is a lack of institutional eyes monitoring the Indian markets.
Speaking to Fortune India from New York, Siddharth Singhai, co-founder of Ironhold Capital, says India is a big market with very few Institutional players that makes it an easier market compared to developed markets like the U.S.
“U.S. equity market is like a crowded lake with too many fishermen and it’s hard to capture the big fishes when everyone is looking for them. India on the other hand not only has bigger fish as higher GDP growth number and a large number of traded shares on bourses but fewer fishermen like less hedge and mutual funds,” he said.
To grasp the number in context, sample the market size: according to BSE, there were 3,495 actively traded companies on the Bombay Stock exchange on September 6. Association of Mutual Funds says 42 mutual funds invest in these stocks. Similarly, as per SEBI, there are 790 Alternative Investment Fund (type III funds are hedge funds) listed with SEBI.
In comparison, in 2020, just the U.S. had 7,636 registered mutual funds, 3,635 Hedge Funds were actively chasing over 4,000 stocks on U.S. bourses. India’s institutional participation is not even 10% when compared to the U.S., even though the number of companies listed on the bourses is nearly identical.
Singhai says lack of competition and non-participation from institutions in the Indian market is generating inefficiency—which means that the market is not very good at identifying intrinsic values of listed shares in the short term. Hence, even in this euphoric market where valuations are stretched globally, India still offers some opportunities for good market return especially in the oil and gas, auto, and insurance sectors, he added.
The heavy participation of institutional investors has made it difficult for money managers to generate alpha in U.S. markets. On the other hand, Indian markets are yet to see the kind of institutional investor participation as seen in U.S. markets, which means there is still scope for fund managers to generate alpha and deliver outperformance for the investors.
So, even though passively-managed funds have grown significantly (asset size up 13 times in five years) and got investor interest, active fund management still has a role to play in investors’ portfolios in Indian markets.
Kunal Bhakta, founder of First Water hedge fund—which was the best performing fund in Asia for the 12 months ended July 2021 as per Barclays Hedge Database—concurs with Singhai. “Indian markets are likely to see a lot more Institutional participation going ahead and this coupled with a disproportionate increase in domestic investor participation is likely to aid much better price discovery and increase market depth,” he said.
Currently, domestic mutual funds and hedge funds (AIF category-III) command less than 5% of the entire listed universe which stood at ₹254 lakh crore as of September 6, at market closing. As per AMFI, at the end of July 2021, pure growth equity-oriented 355 mutual fund schemes have ₹11.7 lakh crore as Net Asset Under Management while as per SEBI hedge funds invested ₹41,754 crore in listed equities. Foreign Portfolio Investors (FPIs) still have a relatively bigger say in the Indian market as they command 44.29 lakh crore (approx. 17.5%) of Indian equities. Now, compare it with the U.S. where 78% of the market value of the U.S. broad-market Russell 3000 Index is owned by institutions.
Indian equity markets are still controlled by company promoters who hold over 130,07,191 lakh crore (approx. 51% of total market cap) of Indian equities.
Though, lately, things have started changing for good. As per Bloomberg, India received $31.26 billion (₹2.34 lakh crore) in the last 12 months ending July 21. Globally, this was the largest emerging market FIIs equity flow. In fact in the same period, except Brazil, all prominent emerging markets saw outflow.
To be sure, Institutional participation is also a function of market size. As per CEIC, in August, the combined market cap of all listed entities on the Nasdaq was $26.94 trillion while National Stock Exchange-listed entities—with a $3.14 trillion market cap—were just 11.65% of Nasdaq. In Asia, Shanghai ($7.27 trillion), Tokyo ($6.6 trillion), Hong Kong ($6 trillion) and Shenzhen ($5.59 trillion) are bigger stock exchanges than NSE, India.
Bhakta believes the problem of market size would be bridged down in the coming days as Indian markets are likely to see a lot more listings in the future. Zomato—the first unicorn to be listed on the stock market—trades at a market cap of $15 billion. 60 more unicorns have raised equity at a valuation north of $170 billion based on their last funding rounds.
“Even if we assume that 30 of these get listed at an average market cap of $5 billion, we can expect incremental market cap of $150 billion (11.25 lakh crore) which is huge and will automatically increase institutional participation in the Indian market,” he viewed.
Nitin Shanbhag, Senior Group VP, head- Investment Products, Motilal Oswal Private Wealth, pointed out that the U.S. is a fairly developed and the most competitive market—where there are almost nil chances of information arbitrage. Generating Alpha—which is the excess return over index—is fairly difficult in the U.S. as the same information is available to public and fund managers at the same time.
He admits that inefficiencies in the Indian market or anywhere in the world are mainly due to information gaps and says that increased hedge fund participation would reduce inefficiencies in the Indian market. Shanbag points out that hedge fund as a concept is fairly new for India.
Explaining the reason for the information gap, Shanbag said that it has nothing to do with the gap in the availability of public information but it's all about how you analyse publicly available information. In the U.S., S&P 500 universe is well covered by Institutional research and the public while in India neither Institutions nor the public goes beyond BSE 200 universe while researching and investing.
Shanbag points out that hedge fund as a concept is fairly new for India. Avendus Fund—which is the biggest hedge fund in India—is just north of ₹4,000 crore, which is too small when we compare it with the average size of U.S.-based hedge funds. “So, we have miles to go and till then there would always be discrepancies in price and value in the Indian market that would be exploited by active fund managers,” he said.
Views expressed are personal.