Understanding Retail Investor Psyche

Outlook ProfitUnderstanding Retail Investor Psyche

Internship Report

“Understanding Retail Investor Psyche”

Company Name: Outlook Profit

Submitted By: Viral Rajesh Shah

FLAME School of Business

Masters of Business Education Batch 2010-12

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Declaration

I, the undersigned, hereby declare that the Project Report entitled “Understanding Retail Investor Psyche” written and submitted by me to ‘Outlook Profit’, in partial fulfilment of the requirement for the award of degree of Masters of Business Administration is my original work and the conclusions drawn therein are based on the material collected by myself.

Place: Mumbai

Date: 22nd July 2011

Signature:

(Viral Rajesh Shah)

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Table of Contents

Serial No.

Contents Page no.

1) Abstract 4

2) Introduction 4

3) Research Methodology 6

4) Data Collection 7

5) Limitation of the study 7

6) Literature 8

7) Data Presentation, Analysis and Interpretation

9

8) Summary & Conclusion 19

9) References 20

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Abstract

This paper aims at identifying factors influencing the Indian investor behavior. It develops a questionnaire which included thirteen questions relating to various aspects of capital markets. Factors found to be most important on the Indian investor behavior were the promising potential of the Indian economy, expected corporate earnings, financial ratios and past performance of the stock.

Introduction

Research in Behavioral finance is relatively new. Behavioral Finance is the study of influence of psychology on behavior of financial practitioners and the subsequent effects on the markets. Behavioral Finance focuses upon how investors interpret and make investment decisions. It places emphasis upon investor behavior leading to market anomalies.

Within Behavioral finance it is assumed that information structure and the characteristics of market participants systematically influence individuals’ decision as well as market outcomes.

Behavioral Finance as defined by Meir Statman and Glenn Klimek “is a framework that augments some parts of standard finance and replaces other parts. It describes behavior of investors and managers; it describes the outcomes of interactions between investors and managers in financial and capital markets; and it prescribes more effective behavior for investors and managers”.

Understanding the behavioral process and outcomes is important for financial planners because this will help advisors devise appropriate asset allocation strategies for investors.

This study aims at exploring the Indian investor behavior who generally believes that the Indian markets follow an unpredictable pattern governed by manipulations. This belief stems from the pre-reform stock market era. However reforms have changed all this.

Today, the stock market closely follows economic trends and is aligned to global economic and financial performance. FII money is increasingly flowing into India for the promise and resilience shown by the Indian economy in the past few years.

India is a land of contradictions. On one hand, India has one of the largest populations in the world. On the other, it has one of the most heterogeneous preference groups. India’s growth in per capita income is one of the fastest in the world. It has the most price sensitive consumers. India is amongst the largest saver in the world. It has one of the lowest financial services penetration rate. Today the investor is excited by these contradictions in the land with great business opportunities.

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The Indian investor is predominantly a debt investor. His chief aim has always been to protect the old inherited wealth. However, the last few years have seen a radical shift in this mind set. More and more funds of these investors are increasingly finding their way into the Equity markets. In fact the boom in the last decade in the Equity markets can be attributed to the fund inflows provided by the HNIs and Ultra HNIs into the markets.

India’s capital market has seen steady rise of retail participation since 1992. This is because India’s market today features developed regulatory environment, modern market infrastructure, steadily increasing market capitalization & liquidity, robust mutual fund industry and increased transparency. Table 1 compares some key market statistics for Indian markets in 1992 and 2010.

Key Market Characteristics 1992 2010Market Capitalization $144.6 Billion $1.59 Trillion

Market Capitalization to GDP (%) 57 132Number of registered foreign investors 0 1711

Number of mutual funds 6 51Number of Demat accounts 0 5874000*

* Data as on August 2009

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Research Methodology

Research questions

This study intends to answer the following questions:

1. What is your main reason for investing in the stock markets?2. What is your investment horizon?3. Besides direct investing, do you use the mutual fund route also? If yes what mutual

funds do you generally invest in?4. How do you make your investment decisions? What do you rely on – broker

guidance/own analysis/Research Reports? Do you do your own analysis also after broker/ newspaper recommendation?

5. What fundamentals do you look at before investing? Do religious beliefs play a part in your investment decision?

6. Does your approach vary from sector to sector? If you have bought a stock and some big broking house comes out with a sell rating do you sell the stock?

7. What kind of return expectations do you invest with? Do you sell it if you have achieved targeted returns or do you re-evaluate? How do you react if the stock falls below your buying price?

8. Would you describe yourself as a proactive or reactive investor? Can you give a few examples to support your statement?

9. Can you recollect your investment behaviour during the frenzy of 1992, 2000, 2008 or the panic of late 2008 early 2009

10. What do you think makes the market move? Do you think markets have any particular logic or a path which it follows?

11. Do you track investment masters closely, would you invest in stocks if it is reported that Radhakishan Damani, Rakesh Jhunjhunwala or Nemishbhai Shah has invested in a stock

12. Do you also invest in IPO’s? If yes why, If no why? What do you do with IPO's of start ups companies?

13. Where all do you invest besides equities? Have you invested in physical gold or silver over the last three years? If yes - Are you still holding it? Reasons behind investing

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Data Collection

Both primary and secondary data have used for the study. Primary data were collected from a sample of around 87 investors with the help of interviews to get a profile of individual investors, to analyze their attitudes and understanding their psyche.

The sample investors were selected from Ahmedabad and Mumbai with the help of stock brokers and friends. Respondents were selected in clusters. These clusters were divided into investors with experience of less than 5 years, investors with experience of less than 10 years, investors with experience of less than 15 years, investors with experience of less than 20 years, investors with experience of above 20 years, Relationship Manager with considerable market experience. The number of responses from Mumbai stood at 50 and from Ahmedabad at 37.

The secondary data were collected from seminar papers, books and websites.

Limitations of the study

The general reluctance to reveal data on investments made data gathering difficult. Reluctance of stock brokers to reveal contacts of investors made the task to find investors in both the cities very difficult. This is the major reason why number of investors interviewed was less than 100. The time limit for the project also made the task difficult.

The general reluctance to reveal data on investments made data gathering hard. Investors avoided divulging personal details like contact numbers, share brokers name and email id. This apprehension stemmed from the fact that their contact numbers might more for marketing purpose than research validation.

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Literature

This paper seeks to highlight the results of some empirical studies about retail investor behavior. It reviews evidence about how psychological biases affect investor behavior and cause market fluctuations.

Merikas et.al,(2003) adopted a questionnaire to identify factors influencing Greek Investor behavior. The results indicated that individuals base their stock purchase decisions on economic criteria combined with other diverse variables. They do not rely on a single integrated approach but rather on many categories of factors.

Hodge (2003) analyzed investors’ perceptions of earnings quality, auditor independence and usefulness of audited financial information. He concluded that lower perceptions of earnings quality are associated with greater reliance on a firm’s audited financial statement and fundamental analysis of those statements when making investment decisions.

Krishnan and Booker (2002) analyzed the factors influencing the decisions of investor analysts’ recommendations to arrive at short term decisions to hold or sell a stock. The results indicated that a strong form of analyst summary recommendation i.e., one with additional information supporting the analysts’ position further, reduces the disposition error for gains and losses.

Hussein A. Hassan Al- Tamimi (2005) adopted a questionnaire to study the factors influencing individual investor behavior in the UAE capital markets. He found that the most important factors by the order of importance were expected corporate earnings, get rich quick, stock marketability, past performance of the firm’s stock, Government holdings, the creation of organized financial markets.

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Data Presentation, Analysis and Interpretation

In this section we make an attempt to understand the Indian investor psyche. Understanding their psychology is of utmost importance because not much work has been done about understanding investor psychology and their relevance for the capital markets.

The Indian financial system has played a significant role in the development of the country. It has promoted savings and investment and helped to enlarge these resources by flowing them into the financial markets that are more productive than physical assets. Since liberalization financial markets have rewarded investors with handsome returns. Capital market returns have beaten the returns from all other asset classes. They have given returns of 1400% compared to returns of 1300% on realty and 70% in Gold since the turn of liberalization.

This has attracted long term retail investors who believe that capital markets are investment haven with the potential to create large pool of wealth for the future. Investors believe with the rise in inflation and subsequent increase in the general price level it becomes increasingly difficult to sustain with the primary source of income. Capital Appreciation and Dividends help them earn a regular source of secondary income.

Table 1

Table 1 shows that majority of the investors in both the cities believe that long term investments help in creating a large pool of wealth which will help them for their future needs. Less than 20% of investors in Mumbai invest in the stock markets with the motivation to earn secondary investment. This is in contrast to Ahmedabad where more than 35% invest into the stock markets with the motivation of secondary income. Investors are attracted towards capital markets because of the belief of the power of compounding possessed by equities. Investors also believe it is an interesting subject which can help in better growth of their investments.

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“Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years”. –Warren Buffet

This famous quote by Warren Buffet seems to have gone down well with the Indian investors who believe that investments should be given at least 5 years and if possible 10 years to grow and achieve maximum returns. 98% of the Indian Blue chip companies have given returns of 15%-16% over a 5 year period. Over a period of 10 years 100% Blue Chips have rewarded investors with 17%-18% returns.

Table 2

Investors believe equities should be given time to grow. Investors investing in equities for the very long term consider themselves to be partner in business. They feel proud to be a shareholder who supports and loves equity. Inspite of this majority of the investors hold their stocks for less than 5 years. As one investor rightly put “Investors go long thinking about short term”. This he believed hurt investors chances of gaining high returns. Investor psyche in Mumbai and Ahmedabad look very similar in terms of investment horizon. Less than 1/5 th

of the investors hold it for less than 1 year.

To diversify their portfolio and as a low risk, low return investment investors invest their money in mutual funds. They believe it is important to invest into the capital through the mutual fund route because they have the knowledge, expertise and the power to make things happen. This trend is seen more in the investors with relatively less experience in the market. Investors with greater experience and more maturity seem to prefer mutual fund less. This can be observed in Table 3

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Table 3

Investors seem to prefer One time mutual fund over SIP’s and Tax-free. They consider them to be a safe bet with the potential for good returns over a 5 year period. Investors in SIP’s argue it is impossible to time the markets. To be invested in markets at all levels it is highly important to invest in SIP’s. Young investors look to prefer aggressive midcap and focus funds over safe Index funds. The older investor seem to have more affinity towards Top 200 and Index focus defensive funds as they believe it is more important to have safe investment at their age.

Table 4

Mutual Fund

SIPsTax-FreeOne TimeOthers

Investor participation in mutual fund is relatively low. Some investors are apprehensive of the returns given by mutual funds in the past few years. Some investors also believe it is not advisable to give your money to someone who can play with them as per his wish.

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As on December 2009 4,951 companies were listed on the BSE and 1,800 companies were listed on the NSE. Keeping a track of all these companies and finding out the potential of these companies is highly difficult. To get regular updates on the markets and keep a track of their investments, investors prefer newspaper and television over other market sources like the internet and the magazine.

Table 5

But investors seem to be apprehensive about investment based on recommendations and calls given by newspapers and magazines. They look at newspapers and magazines only as a primary source of information. They believe it is highly important to do self analysis before making any investment decision. Tips given by Brokers and Friends look to be trusted more than fundamental research recommendation given by Research reports and magazines. The investor in Ahmedabad relies more on Broker tips than the investor of Mumbai who relies more on Self Analysis.

Table 6

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Majority of the investors believe that markets don’t have any logic to their movements. They believe sentiments, momentum, technicals, and events like monsoons, inflation and GDP data make the markets move in the short term. But in the long term market movements are dictated largely by fundamentals and to a great extent by promoters, punters and big market players. They believe that promoters play an important role in rigging of shares. To quote an example, an investor said he believed share of Infosys were placed with an FII at 500 and was asked to take it to 1400 levels.

Table 7

With increasing FII and DII participation in the markets investors believe fundamentals will play a much larger role in the market movements. More than 90% investors believe it was important to look at fundamentals before making long term investments. They believe it was important to look at the Balance sheet and management/Group before making long term investment. “It is important to know the captain of your ship” quoted an investor to support his argument when asked why it was important to look at the management and the group.

Reading the Balance Sheet, investors believe is of utmost significance as it is the cornerstone of any company’s financial position. Looking at the Debt and Cash reserves is important before making any investment decision. Financial ratios look to be preferred by the investor in Mumbai over Share-holding pattern while it is the opposite in Ahmedabad. Other factors studied at by investors include future plans of the company, the sectoral outlook, Business model and Government policies. In the recent past investors have also emphasized on knowing the number of pledged shares as they believe that if majority of the shareholding is in the hands of promoters signifies his interest in the company.

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Table 8 shows the preference of investors in Ahmedabad and Mumbai towards different fundamental indicators.

Table 8

Investors who have been tracking the markets closely believe it is important to understand market movements to make most of the investments in the stock markets. The phenomenon which most investors believed was that the markets moved in cycles in the short run as well as long run. In the short run stocks move in cycles e.g.: SBI always moves in cycles. It touches the 52 week high in April and 52 week low during September- October. In the long run investors believe that Indian markets move in cycles of 8 years. They believe that the long term trend of the Indian markets is that it tanks every 8-9 years. An investor said he expects the next downfall by the end of 2016 or early 2017. To support his claim he said that markets had crashed in 1992, 2000 and 2008/9. This means downfall every 8 years. Another investor slightly varied from this claim and said market cycles increased after every fall. He expected the markets to bottom 2018 before scaling 40,000 levels by 2020.

Following this market pattern helped investors avoid great losses in the downfall of 1992, 2000 and 2008. Some investors said they always believed that these downfalls are a temporary phenomenon and therefore one should not panic. This, they said helps in long term. During the downturn of 2008 these investors started accumulating shares @12000 and 14000 levels. They were confident of the India growth story and therefore held the shares even during the downfall and added new at lower levels. Some of them altered their portfolio and sold older stocks to buy new stocks as they believe that with the change in market cycles sectors which pull up the markets also change.

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Few investors added new stocks to their portfolio during the downfall of 2008@ 12000 levels. Majority of the investors said they avoided entering the markets at such low levels because they expected it to tank further to sub 10,000 levels. Some investors who expected the markets to rise after touching 10,000 levels said they did not have enough surplus cash to make investments into the markets. This was because their business was going through a dry phase and cash invested in the markets is always the one which is surplus to business requirements.

Investors in the markets since 1990 said they had seen their investments become mere papers in stocks like Mazda. Few investors who always avoided punters stocks said they remained invested and sold only when they earned profits on their investments. These investors believe that the Indian retail investor has become smarter over the years and spends much more time looking at fundamentals than investing solely on tips.

Investors believe their investments should earn them returns above risk free interest rate and the inflation rate every year for the risk taken in investing in equities. More than 30% of the investors in Mumbai and 35% of investors in Ahmedabad said they had no targets in mind before making investments in equities. They continue to hold their investments for as long as possible. These investors like to sell part investment which would cover their principal investment and the associated interest after few years. Thus making most of their portfolio held for more than 5 years almost free. Investor expectation in Ahmedabad and Mumbai can be seen in Table 9.

Table 9

To earn high returns investors believe that time in the market is more important than timing the markets. They believe that sectoral outlook is more important than fundamentals of the stocks. When asked why sector was more important than stock in the medium term most investors replied by saying that if a sector is beaten up investor frenzy towards stocks in that

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sector would also be muted. Industries most favoured by investors for the long term were those which had presence in basic essentials.

Investors believed companies with a presence in the basic necessities of mankind- ‘Roti, Kapda, Makaan’ will continue to grow even in times of adversities as they are the fundamental to the everyday living. Most investors include FMCG, Realty, Pharma in their portfolio to avoid major losses during downturns. Investors believe industries supporting innovation and using path breaking technology in sectors like man-made fibre, pesticides, Exports and Power will give healthy returns in the long term. To cite an example of returns given by companies investing heavily in innovation an investor said Aditya Birla Nuvo which was trading at Rs 50 in 2000 is now trading at Rs 900. This they think is because of their continuous focus on technological advancement and emphasis on generation next.

Majority of the investors in India seem to be risk averse. They believed one should never make losses in the markets even if that comes at the cost of moderate gains. Because of this most investors heavily invest in frontline blue chip stocks. Portfolio of majority of the investors incorporated atleast 60% ‘A’ group stocks. Investors with risk taking abilities invest in small caps and midcaps looking at valuations. Beaten up undervalued stocks seem to be preferred by such investors. Small caps are avoided by most investors. Most investors agreed it was not advisable to invest in stocks trading at values of less than 30. These stocks they believed have most chances to be rigged by promoters and is an easy target for punters and stock manipulators’

An Investment banker who was into rigging shares and balance sheets of companies said Initial Public Offerings (IPO’s) of most companies these days were rigged. He said he had floated IPO of two small companies where the promoter was paid only 30% of the total amount collected and the rest was retained by him. This he said was possible as promoters did not mind collecting money for merely distributing papers. He slashed the notion that markets and stocks run on fundamentals. He gave examples of many companies which were fundamentally strong, ones whose EPS had doubled and YoY profits had also increased dramatically, had seen their stock prices drop by half. He argued if markets were run by fundamentals these stocks should have seen their prices rise and not fall. He believed stocks continue to perform only till the time punter is interested in those stocks disregard of any recommendation calls of big broking houses.

It seems the retail investor seems to agree to his thoughts and is the reason why retail participation in the primary markets in the recent past has seen dramatic downfall. Most investors said they invested only in IPO’s of large companies as they are trusted more than small and mid caps. Recent disinvestment drive by the government also seems to have gone down well with the Indian investor who has heavily invested in IPO’s of PSU’s. Small Caps and mid caps are mostly avoided by investors because of their high valuations. They believe most of these are available at half their prices in the secondary markets. Those who had subscribed to the IPO’s of start-ups and small caps said they put in their money solely with

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the purpose of short term gains. Most investors subscribed in these companies looking at the black market premiums. They sold these stocks in the black markets or on listing to gain some quick returns.

To gain more insights into investor psyche they were asked questions about tracking the investments of Indian investment gurus. 50% of the investors said they regularly followed the masters and kept a track of their investments. But when asked if they invested in stocks the masters had invested in, an overwhelming majority said they did not invest just because the masters had invested. Few investors said they did their own research before investing in stocks of the masters. The reason most investors cited to avoid investing in stocks of the masters was because they were apprehensive about the authenticity of the information and rumours about these investments. They also believe that by the time information comes out in the market most of the action has already occurred and the share prices have already risen.

Those who tracked the masters regularly said they had gained good insights from following them. They said the vision of the masters helped them make some important long term investments. One investor following Mr Nemish Shah regularly said a stock generally falls by 20% after Mr Nemish Shah has invested. He said he enters these stocks at these levels and suggested everyone should follow this strategy as this had helped him make huge profits in the long run. He cited the example of Finolex Industries which Mr Nemish Shah had bought at 100 and now trades at 75.

India is a land of religions. But surprisingly religion seems to have the least influence on the behaviour of the retail investor. The only real influence of religion was seen on the Jain and the Muslim investor. Jain investors avoid stocks of hotels, fisheries and other companies dealing in non-vegetarian items and killing of animals. They say it was against their religious practices and would not want to run their house on money earned by killing animals. The Muslim investor avoids stocks of liquor and spirits companies. Some Muslim investors also avoid intraday trading as they consider it to be a form of gambling.

‘Don’t put all your eggs in one basket’. This age old adage seems to augur well with the philosophy of retail investor who believes in diversifying his investments between all asset classes.

Table 10 shows the different asset classes invested in by the retail investors. Fixed Deposit (F.D) looks to be the most favoured asset class for the safety attached to it. FD’s are followed by Gold and Silver as the preferred investment option. Most investors in Gold are bullish on the yellow metal in the long run. They believe it is the safest investment bet in the long run. Investors in silver expect silver to touch the magical mark of Rs 100000 in the next 3-5 years. This they say is because of the scarcity of this metal along with its increasing importance in industrial use.

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Table 10

Sceptics argue the frenzy surrounding gold and silver is uncalled for. They believe high prices in gold and silver are temporary phenomena. They say it has been proved in the long run gold and silver give the least returns. They say that the real value of gold and silver is much less and believe these high prices are the work of manipulators’ and vested interests. In the long run they expect money invested in gold and silver to be diverted to the stock markets.

Investment in provident fund is limited and debt market participation by retail investors looks moderate. Other investments made by investors include Post office savings, company deposits and property. Property seems to be the fancy of the big investor with tons of cash. Small retail investors cannot afford to invest in property because of the high investment cost and the attached problem of liquidation in times of dire need of money.

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Summary & Conclusion

In this paper factors influencing the investor psyche of the retail investor were identified. The paper developed a questionnaire and investors in Ahmedabad and Mumbai were interviewed accordingly. Factors attracting investors towards the stock markets were creating large pool of wealth, secondary income and high returns associated with the stock markets. More than 50% investors in Mumbai and more than 35%investors in Ahmedabad expect to earn 50% in 3 years and believe in holding stocks for as long as possible once the principal amount is recovered. To earn this return they hold the stock for 3 years.

Investors believe future stock market events will be dictated by FII’s and DII’s who rely on fundamental analysis to make investment decisions. To make investment decisions investors have increasingly started studying the fundamentals of the company before investing. The most influencing fundamentals by the order of importance: Balance Sheet, Management, Ratios, past track record and shareholding pattern. Majority of the investment decisions are taken after self analysis of the company. Investors also rely on brokers and friends for investment recommendations. Newspapers, Magazines and Research reports are the least favoured options for making investment decision.

The Indian investor is risk averse who believes in diversifying his portfolio. An overwhelming majority invested major chunk of money into frontline stocks. He believes this is necessary because markets do not have any logic to its movements. In the short run it can fluctuate vastly because of sentiments and actions of big market players. To avoid losses during this period it was important to remain invested in ‘A’ & ‘B’ group companies.

Investors believe in the long term Indian stock markets show a cyclical trend. They believe Indian markets follow 8 year cycles and this was the reason for downfall in of markets in 1992, 2000, 2008. They believe it is more important to study sectors than stocks because with every change in market cycles, there are changes in sectors driving the markets upwards.

The factor which had unexpectedly had the least influence of the Indian investor was religion. Only Jain and Muslim investors said religious influences played a part in their investment decisions.

Other asset classes most favoured by investors include Fixed Deposits, Gold and Silver, Provident Fund, Debt markets and property.

It is highly difficult to differentiate the investor of Ahmedabad from the investor of Mumbai. The investment psyche of both the investors looked very similar. Though there are minor differences in expectations and understanding of the markets investors of both the cities cannot be said to be very different.

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References

Martin Sewell (April 2010), University of Cambridge, Behavioral Finance

Meir Statman and Glen Klimek (2008) What is Behavioral Finance

Hussein A. Hassan Al- Tamimi (2005). Factors influencing investor behavior: An empirical study of UAE financial markets

Merilikas and Prasad (2003) Facotors influencing Greek investor behavior on the Athens stock exchange

Hodge F.D. (2003), Investors perceptions of earnings quality, auditor independence and the usefulness of audited financial information, Accounting Horizons

Krishnan and Booker (2002) Investors use of Analysts’ recommendation, Behavioral research in Accounting

www.en.wikipedia.org

www.bseindia.com

www.moneycontrol.com

www.nseindia.com

www.behavioralfinance.net

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Understanding Retail Investor Psyche