Do India’s Stock Market Investors Lack Sophistication?

Via Manish’s News Tab at Ultrabrown, a blog post by John Elliott (“Riding the Elephant”) at Fortune. Is it just me, or is there a certain contradiction in the following paragraphs?

India has unsophisticated investors. I’m talking about stock market investors of course following the stock market crash, with Mumbai’s key Sensex index plummeting 19% from an all time and over-priced high of above 21,000 on January 8 to under 17,000 by Tuesday. Such a remark, judging from past Riding the Elephant experience, will generate a furious tirade of comments, especially from readers based in the United States who are always anxious to protect India’s reputation.

But how else can you explain a market which swings from such extremes. Last week it mobilized bids totaling an astronomic $180 billion for the $2.9 billion initial public offering launched by Anil Ambani’s Reliance Power (which has yet to produce a revenue stream). On Monday and Tuesday, it crashed, seemingly ignoring the country’s strong economic fundamentals. As Palaniappan Chidambaram, India’s finance minister, pointed out when he tried to calm nerves during the slide, the fundamentals are strong. The economy, he pointed out, is growing at around 9%, and the prime minister’s economic advisory council is forecasting 8.5% for 2008-09.

It’s not just Indian retail investors, but foreign funds (many of them based in the United States) that have been rushing herd-like into Mumbai in recent months – and then rushed out on in the past days. This afternoon I spoke to a leading Mumbai banker who has close links with the United States. “If anyone thought that having strong foreign institutional involvement in the Indian market would bring stability, it is clear that that assumption was misplaced,” he said (anonymously because of his links). He complained about a “lack of conviction and analysis” by foreign funds which “on Tuesday told me they were ‘getting the hell out of India’ and today are saying ‘buy.’” (link)

Who is John Elliott referring to when he talks about “India’s Investors”? His title and first sentence suggest he means local Indian investors. But the main focus of his post, starting in the third paragraph, is actually on foreign investors, who have added to the instability of the Indian markets with panic selling. Read the rest of his post — who do you think he is really talking about?

44 thoughts on “Do India’s Stock Market Investors Lack Sophistication?

  1. I am not sure who John is speaking of, most of the money being traded in the Indian stock market is institutional investors, the frenzy is not unique to India as Nikkei, Hang seng and European indexes fell earlier this week. The retail investors don’t have deep pockets to cause this kind of mayhem. The drop was not adequately countered in my view because a lot of excess cash was sucked out in the previous weeks due to two massively oversubscribed IPOs, I can only recall Reliance Power and the second name fails me. The volatility is magnified by foreign investors and that is why Chidambram wanted to regulated foreign speculative investments in Indian Derivatives. Running for a meeting, more later.

  2. 2 · Manish Vij said

    ‘India has unsophisticated investors’ means ‘India attracts unsophisticated investors,’ I think.

    That helps :) Thanks for the clarification.

  3. I dont know what is going on in this article, but “India has unsophisticated investors” might be the nerdiest slap in the face in the history of bigotry. He might as well said “India lacks players with strong coat of armor and powerfull fairy dust in Dungeons and Dragons roleplaying game”

  4. 2 · Manish Vij said

    ‘India has unsophisticated investors’ means ‘India attracts unsophisticated investors,’ I think.

    Well, one would think if they had so much money to throw around, they’d take a finance course or something.

  5. It’s strange, because in the first paragraph he anticipates being attacked for making the claim, which would suggest that he at least thinks he’s talking about local investors. As I see it, the charge doesn’t make sense if he’s talking about foreign funds; it’s like saying that the British are “uncivilized” — it bounces off. The slight only sticks if there’s a preexisting prejudice…

    I’m actually not so worried about the characterization. I think Elliott wants to make a provocative charge (with a catchy headline), but ends up pointing to factors that don’t support it directly. The main example in the post is the massive Reliance Power IPO last week, which seems to have in some ways contributed to the scope of this week’s crash. What he doesn’t specify is how the $120 billion in “foreign and local funds” breaks down, in terms of foreign vs. local.

  6. “India has unsophisticated investors.”—John Elliott

    Me thinks Johnnyboy is pissed India has investors, period. What a gauche statement to make.

  7. But how else can you explain a market which swings from such extremes. Last week it mobilized bids totaling an astronomic $180 billion for the $2.9 billion initial public offering launched by Anil Ambani’s Reliance Power

    This article says it garnered bids totalling $27B. So the offer was oversubscribed. Doesn’t mean people are willing to pay that much for the shares. If 10 guys offer $10 per share for the same 100 shares, the shares are still worth $1000, not $10,000.

  8. From what I recall the reliance issue was 117 times oversubsribed, which created a cash squeeze, the excess cash will not be returned to investors for almost a month. The other IPO was Future Capital Holdings which was 132 times oversubscribed.

  9. ‘India has unsophisticated investors’ means ‘India attracts unsophisticated investors,’ I think.

    Maybe he meant sophistry like the fantastic sophistication of the US stock market has consistently produced, be it the earnings report misstatements of the late 90s, the current subprime crisis with its complex web of financial instruments, or the feared upcoming bond insurance crisis, which could be the tipping point in the fears about drying up of capital.

  10. I am of the opinion we have not even seen the tip of the subprime fallout. Citi still has $38 billion worth of subprime CDOs sitting on their Balance sheet and they have written down only $18 billion, plus the fear is of default in Student/auto and credit card loans. I am scared of the months ahead.

  11. Assuming he means India attracts unsophisticated investors as Manish pointed out, sophisticated investors itself is a rare breed. Not just India, everywhere. Plus in these times of securities backing securities backing securities, risk being disbursed across the system in corners no one entity is aware of, etc etc sophistication in investment becomes impossible anyways. The recent financial troubles show as much and that even investors in every part of the world including the US have not much of an idea.

  12. I think investors in google are unsophisticated….how many times over earnings is that valuation?!…its just as overheated as Sensex

  13. I think Mr. Elliot is trying to say something right, but he cant find right words to say it. He needs to differentiate unsophisticated investors from unsophisticated markets. There is a HUGE difference.

    Having worked in finance in both NYC/Mumbai, here is my take. Indian investors are very, very sharp. What that means is that they understand the risk-reward very well, given a particular amount of information. Now obviously, not all the retail investors are as smart as the others, but overall the indian investors are definitely not more unsophisticated than their ny counterparts. The big difference is that the market is lot more unsophisticated. There is a lack of instruments to manage risks (f&o, short selling etc).

    But, there is so much alpha still left in the market that people (retail investors, big bad boys) keep coming in. And so they should! Sure the market fluctuates. That is the nature of the beast, but in long term the only people who are burnt are the people who are impatient. So anyone who understand and respect the high risk-reward game are not unsophisticated, the ones who come to the high roller table and expect the risk-reward of a slot machine are unsophisticated.

    A good post on Indian markets:

  14. “There is a lack of instruments to manage risks (f&o, short selling etc).”

    very true
  15. There is a lack of instruments to manage risks (f&o, short selling etc).

    I was going to say that. On the other hand, it is complicated overuse of all these complicated hedging instruments and products that has brought the US financial system to its current tenuous state (and that is probably why John Elliot doesn’t explicitly say that – I assume, maybe unjustifiedlu (I am not familiar with his work), that he knows whereof he speaks?), so it cuts both ways.

  16. in addition unsophistication in the market comes from the SEBI rules not being a shade on the FASB rules. So even big public companies present shitty information to their investors that their investors can use as TP. And then it is so beautiful to see the same companies present immaculate stuff when either a PE firm asks for it or when they have to list in foreign markets. They get away with a lot and if we give PChids another half a decade, he is going to clean up things in good time. not that the increasing foreign players are not pressuring the market in that direction anyways.

    Another reason why Indian market should not get totally fuked is that on the bond side we are safe, because we have *minimal corporate debt in even the biggest of companies.

  17. Paranoid,

    Excellent points, I believe the largest commodity futures exchange in India is MCX and the financial derivatives are still highly regulated and it is only a matter of time when sophisticated F&O will be a norm. I read a great paper on derivatives markets in India, I will link to it when I find it. Also wouldn’t the counterpart of SEBI in the US be SEC?

  18. Which market is ‘sophisticated’. Please define ‘sophisticated’. Is it like porn – you know it when you see it. John Elliott is a …. (shall not call him names)

  19. Another reason why Indian market should not get totally fu*ked is that on the bond side we are safe, because we have *minimal* corporate debt in even the biggest of companies.

    I am not sure if bonds per se are a problem. An adequate mix of debt is required so that companies’ cost of capital is optimal and hence leads to the highest valuation. But, I am not well versed enough in Indian markets to reasonably compare the cost of equity vs cost of debt. and the effect this would have on valuations. But then again, I am not sure if all of us live in a one-factor world.

    Also, its not bonds themselves that led to US’ current subprime problems. Its an issue of risk management. Rating CDOs consisting primarily of subprime junk bonds as AAA just because it has several support tranches may obscure its stenchful soul to eyes glazed over by greed. BUT market realities (and the realities of the poor who these ARMs were unscrupulously pushed onto) proved that this exuberance was only a bubble waiting to burst. When managing my capital, if I allocated these so-called AAA bonds as hedges against my other ‘riskier’ bets (riskier, HA HA), then I would have fooled myself into thinking that I am safely hedged. Shit by any other name will still smell the same.

  20. UD, great points and thanks a bunch for the FRB link!

    You are right, the right equivalent of SEBI is SEC, but the point I was trying to make is that SEC recognizes FASB rules and gives us GAAP. The ICAI/SEBI combination does not have the balls (can i say that here) right now to impose tougher guidelines. We definitely need a GAAP equivalent to make the system cleaner.

    That, finance ministry approving more instruments and developed debt markets should make the markets lot more sophisticated, and linked to the global markets. Honestly, as much as I like financial efficiency, the inefficiency has saved us from many a heartburn (asian crisis etc), so I would rather have a more robust and gradual change than a quick move to financial transparency.

  21. “Please define ‘sophisticated’.”

    In my mind sophisticated market is one with very little arbitrage and that means less returns and frankly, i hate sophisticated markets :)

  22. As a chartered accountant;) I can say that the ICAI/SEBI comment is definitely true. Although with the adoption of IFRS (international financial reporting standards) it should become better. I feel if there were no restrictions in Indian markets, the subprime fall out in India would have been similar to what we saw in Europe.

  23. frankly, i hate sophisticated markets :)

    Paranoid- LOL. Funny but true. Thats why the overheated markets in the BRIC countries, saudi, dubai, egypt etc. Lots of mispricing. Just curious, are you a derivatives trader?

  24. 26 · Paranoid Android said

    In my mind sophisticated market is one with very little arbitrage and that means less returns and frankly, i hate sophisticated markets :)

    well india, b/c of it lack of sophisticated financial instruments, like convertible bonds or other derivatives, would therefore presumably have fewer arbitrage opportunities…since it is within these complex securities that little inefficiencies appear.

  25. It’s not just Indian stock investors who lack sophistication; all Indians lack sophistication.

  26. i think we’re confusing an overvalued market—which is a subjective call—with an inefficient market that an arbitrageur may see opportunity in. arbitrageurs, with a few exceptions, do not bet that a market is over or under valued, bit rather that 2 similar securities will converge in price, b/c they are.. well..similar.

    the least sophisticated investors, retail or institutional, are stockpickers, the vast majority or whom do not beat the market. the most sophisticated investors make money form arbitrage or active investing (private equity or venture capital) as opposed to stockpicking.

    on the other hand, a lack or arbitrage in the Indian market may make it more inefficient and therefore good for stockpickers.

  27. when did ‘sophisticated’ become a codeword for a ‘low-arbitrage’ market. Damn – been away for too long :(

  28. 32 · melbourne desi said

    when did ‘sophisticated’ become a codeword for a ‘low-arbitrage’ market. Damn – been away for too long :(

    well if gold is trading for $1000 in zurich but $998 in chacago, that doesn’t make too much sense, ie someone is being unsophisticated.

  29. Just curious, are you a derivatives trader?

    Not really. a consultant by the day and an indo-market phile by the night (after the opening bell over there). So, i could be talking out of my aRs.e or a$$, depending on which market I am talking about. ;)

  30. elliots article smells like BS or Monday morning QBing at the least. first of all, no sophisticated investor complains that the market is unsophisticated, as paranoid android alludes to, but rather exploits the market at that time, which has the effect, if the investor is influential enough, of making the market fairly priced.

    Elliot labels investors in the Indian market as unsophisticated b/c they drove prices to an irrational level. so when they sold off had they suddenly become sophisticated. No. according tho Elliot the selling in the face of a sound fundamental economy was also unsophisticated.

    presumably, since its so easy to tellwhen the market’s overvalued, he sold or shorted at the top then bought back in or covered after the sell-off. but something tells me he did neither, or else he wouldn’t have to work for TWX for a living.

  31. in great contrast to elliot is warren buffet, who tells one of the best stories about unsophisticated or inefficient markets.

    the first real arb hedge fund was long term capital management, run by a bunch of geniuses, some of whom had nobel prizes. well they where holding similar govt bonds betting that the prices would converge…and in a rational world they had too. but alas, the world is not rational all the time. in 1997 there was an east asian currency crisis that rocked the world markets, causing these bond prices to inexplicitly diverge.

    Now, LTCM was heavily leveraged, meaning that the longer these securities kept diverging the less collateral they had to maintain their loans. eventually they had to sell to repay their loans and in stepped warren buffet, who had loads of cash from Berkshire Hathaway and could therefore hold onto the arb bet for a much longer time.

    but bill gates invited him to vaca in Alaska at the time so buffet couldn’t negotiate in person. the fed eventually stepped in to arrange a private bailout squashing buffets deal. eventually the prices did converge and ever since buffet says that vaca with gates was his most expensive vacation ever, costing him $3billion.

  32. John Elliot’s evaluation of the Indian investor based on the events of the past few days is what lacks sophistication.

    What we witnessed in the Indian market and other markets is the herd instinct in operation. The tendency for investors to follow the herd is not unique to any particular group of investors. What I do not know is the extent to which margin is permitted in transactions in the Indian markets because the use of margin in funding stock purchases can result in forced liquidations if the market/stock valuations fall beyond a certain point creating a margin call.

    What is also a common thread to all markets which have had a decent bullish run, is that the “unsophisticated” investor makes his/her appearance because he/she has heard stories about the amount of money that friends and associates have been making in the market and decided they would like to partake in the bonanza. These are usually the so-called “weak hands” who are neither able nor willing to withstand losses during a decline and will exit in a hurry when the market turns down.

  33. India has unsophisticated lovers– yes. Indians are unsophisticated in relationships — yes maybe. And Indians are unsophisticated investors–maybe. But as someone (#15) pointed out, not any more than someone buying Google now.

  34. Can a Societe Generale happen in India? Better unsophisticated than a Societe Generale. My investment approach is very unsophisticated and the money in my SG account is still there. Just checked.

  35. Wish John would just stick to music charts like the other Elliott & not index plotting charts. “Arey Reliance ! paisa dalo !” , “Arey gira ! becho becho !” (We are like this only)

  36. Every market has unsophisticated investors, US, developing countries and frontier markets. Elliot’s article seems to imply that significant swings in market indices, despite a sustainable economic growth rate, points to investors being uneducated/unsophisticated. I agree with a previous mutineer’s post that valuations are a subjective call and I believe that these swings in the Sensex have everything to do with more involvement by both foreign AND local investors, rather than the level of any one group’s sophistication. In my opinion, the Indian market (as well as China, Russia and select other emerging markets) have been overvalued for more than 1 year. I believe that the growth in India is sound but many investors (particularly foreign funds) have not lived through the gut-wrenching corrections in past emerging markets crises and have been drawn into markets they may not be suited to invest by the multi-year strong returns. I think we are going to see more pain in the near term and the market swings will continue. The real education for both investors and journalists will begin then.

  37. Hi – I’m the writer of Riding the Elephant and am monoths late replying to this but yes, I was referring to investors in the Indian stock market, mainly but not exclusively from outside the country. Do visit my blog again – it left during some budget cuts in the summer and is now at best wishes to all my old readers and comment writers – come and visit je