Mar 06, 2013 10:38 PM IST | Source: CNBC-TV18

DIIs to blame for midcap carnage: IIFL's Nirmal Jain

Lack of retail participation and continuous selling by domestic institutional investors (DIIs) remains the key concern for Indian market, believes Nirmal Jain, chairman-IIFL.

Lack of retail participation and continuous selling by domestic institutional investors (DIIs) remains the key concern for Indian market, believes Nirmal Jain, chairman-IIFL. 

"FIIs have invested USD 8.5 billion in India this year and DIIs have sold around USD 4 billion dollars this is offsetting the impact of foreign fund inflow and increasing our dependence on FIIs," adds Jain.

Also Read: Investors seem disinterested; Nifty to slip further: Baliga

According to Jain, sharp volatility seen in midcap share price is because FIIs keep switching money from large cap stocks to sectors.

"The midcap space is becoming very shallow in terms of depth and breadth of holding and trading, therefore there is an increased volatility in these stocks," he adds.

A dramatic fall in the share prices of about a dozen mid-cap stocks was seen last week pulling down the Indian indices drastically. Last year July, a similar crash was witnessed in midcaps in a single day, leading to a Sebi probe into the sell-off.

The structural problem with most midcap stocks is that there are no buyers from mutual funds and insurance companies even for well run companies, he points out.

Below is the verbatim transcript of Nirmal Jain's interview on CNBC-TV18

Q: What do you think are we about to see next? This year has not been very good so far. Do you think we have a near-term support around 5700-5600 or are we staring at a deeper correction?

A: It will depend on how news events take place from hereon in terms of credit rating, global turbulence. In this year, if you really look at the liquidity which has been the driver of the market then foreign institutional investors (FIIs) poured in about USD 8-8.5 billion and our domestic institutional investors (DII) i.e. mutual funds and insurance companies sold about USD 4-4.5 billion. Another USD 4-4.5 billion has come from the offer for sale (OFS) from government and promoters trying to bring their stakes down to 75 percent.

One key problem with our market today is the lack of participation of local investors - retail investors, high networth individuals (HNI) or mutual funds and insurance. In mutual funds and insurance, there has been continuous outflow. Therefore, market is depending on FIIs and FIIs are chasing large caps and certain sectors. So, the midcap is becoming hollow and shallow in terms of depth and breadth of holding and trading and therefore, you see very volatile movements. In this year, what we have seen in midcaps the broader indices do not reveal the actual picture, but the midcap indices are down by 17-18 percent YTD which is dramatic in two months time.

It does not look like we are in a bull market and the problem is that when they say that there is a funding against four-five stocks and goes beyond the margin call, you sell one stock to make up for that entire thing. If one stock falls because of pledged shares, then a broker will end up selling all five stocks or partly all five stocks and that causes the panic and cascading impact.

The problem is that there are no buyers for mutual funds and insurance companies from midcap and small cap even when the stocks are good and well run companies. This is a structural problem which will have a long-term solution as well as long-term implication. It is not something that can be visualised for any solution overnight. So, we are looking at volatile midcaps, small caps even if FII money continues to flow in.


Q: Domestic traders hold more of midcaps and FIIs hold more of large caps. We have not seen instances where stocks like National Hydroelectric Power Corporation (NHPC) fall 25 percent in a day. What is different about these midcap holdings and the carnage that we are seeing right now?

A: It is a continuous outflow from mutual fund and insurance and this year we have also seen a lot of redemptions with Life Insurance Corporation (LIC) and other life insurance companies. If you look at assets under management (AUM) of insurance companies, this year, it has not gone up much. It is the last straw on the back of the problem. The problem has been building up for last five years. Our local mutual funds and insurance are not getting new money for a number of reasons.

The problem is regulators, government wants to make the products very attractive for the customer, but they forget that unless there is industry and you do not align industry’s interest also, who will sell the product to the customer, because the profit motive will drive, number of brokers and independent financial advisors (IFA) have gone out of the system. Slowly and gradually mutual funds and DIIs are becoming smaller and smaller and is now becoming visible. The process has been there for last five years, but it has come to a stage where their shareholding is so low and their trading, participation in market is so low that we are seeing these volatile movements.

It has happened two days before the Budget which sends the government as well as regulator into a bit of overdrive and that causes panic. There is always a fear psychosis that there cannot be any leveraging, but in last 20 years the equity markets work only on financing, leveraging and liquidity. There are intraday traders, speculators that give liquidity and that liquidity gives stability to the market. It is the problem that has been building up over time for the last 4-5 years and whatever we are seeing now is a cumulative impact now, because gradually it has come to a stage where it is visible.

Q: There was a hope that this will change post the Budget, both with what the government might do with new equity type of schemes to get the retail crowd excited and the market itself might go up and attract more participation. Do you think the opposite has happened that the midcap carnage of the last few weeks has driven people into more of a hole?

A: You must also recall that midcap stocks in November-December and earlier had risen very quickly. The midcap has become volatile and goes both up and down in a swift manner. If there is a bad news, then there are handful of players, the retail, the weaker hands are playing into the stocks, so the moment there is some problem it just collapses.

There is no backup buying from institutional investors like LIC or mutual funds and that is the key problem. When the stocks went up after Chidambaram took charge there were a bit of over expectations, the run up was also very quick and meltdown was quicker. There are some individuals who are playing in the market, the retail investor has been decimated, so the problem is the market does not have the breadth which it requires for a bit of stability.

Q: Do you expect to see any regulatory action or can this be explained as a basic margin issue and hence no punitive action can be taken against the people concerned?

A: Every time market falls, somebody has done something wrong and when the market goes up at that time, we do not get into the same investigative mode. It will cause more damage to the market sentiment, because a typical small investor or a man on the Street who is investing money in bank, real estate views market with too much of uncertainty and too much of risk. One regulatory or punitive action causes cascading impact because there is a fear psychosis which grips.

People think that we would be ultra careful, so we cannot do anything and that reduces the trading volume and confidence in the market. Then people look at real estate and gold which are safer investments, where you do not run the risk of too much of regulatory inquiries or a punitive action. We must understand that whenever market falls there would be talks about regulatory action, investigation, somebody has done something wrong, some fraud has happened, why not the same thing when market goes up very quickly. Logically, they are two sides of the same coin.


Q: NHPC is a well held stock. It is a PSU company and cracked 20-30 percent yesterday. Is everything possible in having these blowups?

A: No, participation of local mutual fund and insurance companies has reduced to a level that if the FII holding is not there, then we are vulnerable to very volatile gyrations in the stock prices. Not only that, I am also worried about the fact that FIIs are driven by some global factors. God forbid if there is selling of a couple of billion dollars by FIIs and there are no takers, the broader markets will face problems and that is what we need to address. How do we get back the confidence of mutual fund, insurance? How do you get the money back into these avenues of investment?

We are not noticing the continuous outflows in mutual funds. There are continuous redemptions and fall in the assets of insurance companies. They are not rising the way they were. On one hand the economy is growing and on the other hand there are no new assets which will invest in small caps, midcaps and certain other sectors which FIIs are not looking at. So, that is the key problem whether it is NHPC or Core or any other stock, it is a manifestation of the same problem.

Q: Over the course of the last few weeks, a lot of market experts have come and told us that this correction has seen many good quality midcaps come down to interesting levels and it is a good opportunity to buy. Do you agree with that?

A: 2008 peak has yet not come even five years later. Most of the small investors, retail investors and even HNI, whoever is taking exposure to direct equity have lost money. Even in mutual funds and maybe unit linked plans of insurance or any other investment schemes they have not made money. So, there is a bit of a frustration and on the other hand they are seeing that people who invested in real estate have made money, whether that lasts or not. The human psychology that I invested in stock markets, lost money; my friend invested in real estate, made money, so that is what is driving savings more to unproductive instruments like gold and real estate.

The entire approach of the regulatory bodies as well as government should be rather than making gold unattractive you have to make the financial savings and investments more attractive. Today, gold imports have to be brought down, discourage people from buying gold, now contrast this with what central banks are doing world over and even RBI. They are increasing their gold reserves because they want to hedge against turbulent financial world. As a household, we would still think that it is a turbulent environment whether stock markets in India or outside, so I need to put my assets little bit in gold.

We have to look at the problem from a long-term perspective which goes with the intent of the investors and also works well for them rather than saying that okay gold is creating a problem of CAD, we will ban it. We will try and discourage it. But the more constructive approach will be to make financial instruments more attractive.

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