Brokers' secret: How to make money in falling markets

Over the last few years equity brokers have diversified from being pure brokers to wealth managers to doing everything that a non-banking finance company (NBFC) does.

More than the attractiveness of other businesses, it was declining profit margins in existing businesses that drove these brokers in search of new avenues.

The broking industry has gone through considerable change after inclusion of the derivative segment in the late 1990’s. From being a pure cash market, the derivative segment today accounts for 92 percent of everyday volume.Even of the remaining 8 percent volume in cash segment, delivery trades (where the client takes or gives delivery of his shares bought or sold) account for only one-third of them, while the remaining trades are squared off by the day’s end.

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Brokerage charges for delivery cash segment is nearly 10 times of that charged in an intra-day segment. Customers giving higher volumes are charged lower brokerages.For the derivative segment rates are either comparable or lower than those charged in the intra-day segment.

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Retail interest is higher in the option segment as price swings are high. While the index moved up by 11 percent in January some of the call options gained by almost 6 times during the same period. It is this potential of higher earning in a small time span, that attracts volume in the option trading.

With mounting cost of branches, and declining brokerage income, despite higher volume, broking firms were forced to move out to other segments for revenue.

Mutual funds and insurance were the natural extension as the products could be sold to its existing client base. These products could also be sold to conservative investors as the products were managed by professionals. Further, fee income from some of the insurance products were as high as 40 percent of the fund invested. Equity based Unit linked insurance plans generated such high fees which were later corrected by the Insurance regulatory body.

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As revenues started falling from insurance segment, brokers resorted to giving out loans against anything that had some value, be it equity shares, gold or real estate.

As a result of this diversification, though brokers are not making too much money in their broking business, they are profitable thanks to non-broking activity.

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India Infoline, which saw its stock rising as high as 30 percent today after the company announced its results, also has a similar story to say. While its broking business fell by 32 percent compared to December 2010 quarter and 9 percent over previous quarter, financing and investing income shot up by 26 percent while marketing and distribution income rose by 56 percent over previous quarter. This resulted in the company posting a 62 percent jump in profit over its previous quarter.

However, with other players catching up, share of newer segment will drop beyond a point as has been witnessed in the numbers of Religare Enterprises.

While international players are entering India to capture the institution side of the business, Indian broking community is happy growing internally, innovating newer products to feed its existing client base. Not a healthy business model from a community that advises anyone who is willing to listen on how to grow their wealth.