Retail investor needs more than reassurance, Mr Sinha

U K Sinha, chairman, Securities and Exchange Board of India, has outlined in Mint and The Economic Times that the ‘retail investor’ is at the heart of the regulator. It is always nice to reiterate objectives which originally drove the formation of Sebi – the idea was to have the retail investor at the heart of the regulatory framework.

So why is Sinha stating the obvious?

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The presence of widespread retail participation can have a dramatic impact on the depth of the capital market and even corporate governance. Here is what your participation could do to India’s equity markets.

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Lets look at the mutual fund industry. According to Sinha, 32 percent of the total equity amount raised from equity mutual funds still comes from Mumbai alone. As much as 75 percent is from the top 10 cities, he told The Economic Times. The total equity assets under management of equity mutual funds are worth Rs 1,70,406 crore. The total BSE 500 market cap is Rs 26,80,806 crore. This is a free-float market cap. Translation: it is the total value of these companies excluding promoter or the holding of controlling shareholder that is available to investors.

The Indian equity mutual fund industry controls just 6.3% of the available float. Foreign institutional investors own Rs 4,49,058 crore or 16.7% of the total value. Needless to say, domestic mutual funds have little influence over the direction of the market.Foreign investors have options to take the money out of India and invest elsewhere if Indian shares get volatile. Hence,Indian equity markets remain vulnerable to volatile capital flows from FIIs.

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Hence, if you invest more in Indian equities through mutual funds, you can indirectly influence the direction of the stock market.Domestic investors will have to back strong companies in a situation of market volatility as they have to only invest in Indian equities.

The other impact of strengthening domestic mutual funds is that they will be able to play an ‘active’ role inin corporate governance. In US, the shareholder activism is led by large pension and mutual funds.

For example, very often promoters or controlling shareholders in India dilute equity at will. This can diminish shareholder returns. Institutional investors can pick up the phone and tell companies to curtail this process if not needed. Their chance of influencing corporate decisions improves if the money they manage is of substance.

Shareholder activism will not take off in India unless institutional investors have more exposure to Indian companies. And this cannot happen unless retail investors give that mandate to them.

Hence, Mr Sinha has to speak of a revolution in the context of the retail investor.

The other key issue he raised was of the takeover code. There is a need to do more to protect the interest of minority shareholders.

Indian laws need to align themselves with takeover code laws across the world. For example, in UK and many other markets, the need for a public offer for all shareholders is triggered only if the ownership crosses 30 percent of the company’s equity. In India, this is done at 15 percent.

India needs money through foreign direct investment. Making an open offer to all shareholders costs money. Hence, this puts off large private equity or corporate money that could otherwise be invested in Indian companies. Presence of private equity investors and strategic investors in companies can put company managements on their toes. Besides, mutual funds, these entities can also exert pressure on listed companies on corporate governance.

Currently, with minority shareholding, small-size mutual finds are not able to do so. Perhaps, increasing the cap to 25 percent as proposed in the takeover code, could usher in another set of reforms and enhance shareholder democracy.