Should SEBI restrict retail investor's equity exposure based on net worth?If you wanted to get rich by investing in stocks, here is a dampener. The Securities Exchange Board of India (SEBI) is apparently looking to use net worth criteria to cap the domestic retail investor’s equity exposure. This proposed linking of an individual investor’s exposure to direct equity shares and derivatives to their net worth is a highly debatable topic on many counts. Over the past 3-4 years, stock markets have given bumper returns and thereby managed to either bring new investors like you or reinforced the belief that even the small fish i.e. retail investors can make money from the bazaar. But the net worth limit rule, if implemented, may seriously hit the markets, the economy and the less-affluent in different ways.

Mark to market

First, the basic news. Click here to read how Sebi wants to prevent individuals from going overboard on equity investments. The market regulator often comes up with different proposals and discusses them with the intermediaries. So, how does this affect you? If you are an indirect equity investor i.e. invest money in shares through mutual funds, NPS or unit-linked insurance plans (ULIPs), then this has no impact. This is because the Sebi proposal relates to direct equity exposure, that is directly buying shares etc.

It is no secret that Indian stock markets have given good returns. Good performance is the best advertisement. Hence, new investors arrive in thousands. We have seen this happen numerous times over different market cycles, especially when bulls dominate Dalal Street. But, the stock market is also not a place for the faint-hearted. If you do not believe, ask the small and mid-cap stock investors, who over the last 3-4 months have seen a terrible carnage. Such things happen in the market, and excesses are levelled. Small and mid-cap stocks had a great run for quite some time, and naturally, a correction was always in the offing. But a correction is as much part of Mr Market as a rally. By now, retail investors understand the ups and downs of stocks.

Belief in stocks

The Indian stock market has come a long way from the days of Harshad Mehtas and Ketan Parekhs. While stocks were always favourites of rich investors, the small investor too has profited of late. Retail investors remain an important part of overall stock market penetration. A large part of the annual savings by Indian households goes into bank FDs and property. That trend is changing, with more money coming into financial savings. Bumper listing of IPOs (new share sales by companies), online broking and the desire to consistently beat inflation have underlined the recent equity culture of the country.

India is a country of young people. Standard asset allocation frameworks (i.e. how much of your money should be in stocks or debt) usually ask youngsters to invest more in stocks. This is because longer holding periods are suited to their risk appetite. Age is on the side of youngsters and so is their ability to hold such investments for the longest period of time. If most retail investors, who do not have a net worth of Rs 10-20 lakh excluding home loan, are permitted to invest only up to their net worth, then a lot of the investors may not be able to invest more in direct equities. The rich do not need any help in making money; it is the poor that need to own financial assets like shares to build wealth. Just about 55% of the poorest population owns any financial assets. Instead of capping direct equity exposure, low and middle-income households should be incentivised to shift into financial assets to bump up their returns.

Best asset class for retail

The overall stock market will also miss a lot of inflows if retail investors’ stock play is limited in any way. Firstly, stock brokers will not get the day trading activity and volumes generated by many retail investors looking to make a quick buck. Two, increasingly retail investors happen to be turning long-term and holding shares for more than 4-5 years. Any sort of a cap on retail direct equity exposure has the potential to negatively affect this trend. While any sort of leverage should, of course, be disallowed for retail investors, caps and limits do not send the right signals. Of all the asset classes like stocks, bonds/debentures, gold, property etc., the liquidity of stocks remains very high.

 This is because there is an active stock market, which allows investors of all shapes and sizes to enter or exit quickly. We can even argue that the stock market provides the best liquidity to retail investors in most cases. Compare to that, real estate transactions often involve lakhs and entry/exit takes a lot of time. Other asset classes may provide good liquidity, but either their returns are fixed or they fail to beat inflation consistently.

On the other hand, certain tendencies of the retail investor could be controlled by implementing a few norms. Firstly, margin funding and futures & options (F&O) remain a riskier play than buying stocks based on delivery. Margin funding involves taking leverage, and that could be restricted for most retail investors. Simple retail investors also do not need to hedge their positions through F&O, and so derivatives could be kept out of bounds for them. But any restriction on delivery-based buying and selling of stocks will not really help the average retail investor. Equity as an asset class is a long-term wealth creator especially for those looking to execute goals like building a neat retirement corpus, child’s education & marriage etc. Therefore, any regulatory change should not reduce the opportunity for investors.

Staff Writer

This article is written by RupeeIQ editorial staff.