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Recovery In Sight

Monday, November 18, 2013
By Clifton Desilva

Clifton Desilva is an investment expert and a Director at Altina Securities.

Over the last five years or so the stock markets have not generated any returns to investors. The Sensex recorded a life time high on 8th January 2008 at 21,207 and the Nifty at 6357. Today after more than 5 years the indices are almost at the same levels with the Sensex at 20399 and the Nifty at 6056
However, beyond the indices the stock markets have witnessed a sharp fall especially in the mid cap and small cap segment. Many stocks in these segments have witnessed falls of over 100%.

Volatility has been on the rise and the markets have not delivered much returns in the past five years. Mutual fund redemptions are also on the rise, and brokerages are being forced to shut down their retail divisions.

One of the reasons for the forced shut down of retail business is subdued volumes and a shift in trading activity to low margin products that has made the business unviable

On an average according to reports three brokers have called it quits each day since the financial year that started April 1. A total of 487 brokers have shut shop in 2013 so far, according to the latest data available from the Securities and Exchange Board of India (SEBI). The debate about consolidation in the broking business has resurfaced with even bigger players like HSBC announcing shutting down of their retail broking business. The bigger surprise was the news report that India Infoline which runs one of the largest retail broking operations was undergoing a major scale – down of its retail operations. This highlighted stress among players and according to brokers the business has now turned out to emerge as a high cost and low margin business
Declining volumes in the cash segment coupled with increased trading in low margin options has been one of the key reasons for broker’s woes. Since January 2011, the average monthly volumes in the cash segment have been Rs 13,000 - 13,500 crore against Rs 19,000 crore in 2010, as retail investor in the absence of visible returns have retreated from equities and moved to fixed deposits and real estate.

While overall volumes have been on the rise, derivative trades have accounted for an increasing proportion of the turnover. The options trading accounted for 76% of the overall trading market volume in 2012-13. Derivatives accounted for 93.5% share of the overall volumes so far this year.

The addressable revenue pool for brokers is on the decline, especially due to shift towards low yield options segment. Among the brokers who have exited operations so far this year, 591 have been from the cash segment; according to SEBI figures (which appear with a lag). There were 104 additions in the equity derivative segments, according to data up to August. The net number of brokers for equities is down 487.

It is not just the smaller brokers; the larger ones are also ending their operations. This clearly shows the fundamental problem is that there is scant commercial gain to be made in broking.  The lay investor has not found the market attractive for the past five years though we have a population of 1.2 billion, but investors are less than 20 million

Various analyses show the outlook appears bleak for most in the industry. Rating agency ICRA estimates a decline of Rs 400-500 crore in revenue pool for 13 prominent brokers this financial year. Its October Indian brokerage industry report pegged their total revenue at Rs 8500-9000 crore for the whole year.
Hong Kong and Shanghai (HSBC) has decided to discontinue its retail and depositary business in India as profit margins are shrinking with trades shifting to derivatives options from cash market and retail investors preferring gold, real estate and bank deposits to stocks. The bank had purchased the business from infrastructure lender ILFS in 2008 for a little over Rs 1000 crore. The exit will impact about 300 employees.

The shift in trading to low yield equity derivatives has put pressure on retail broking margins. Options trading now constitute 76% of equity derivatives. The commission pool the brokers earned had declined by 40% to around Rs 6000 crore in the fiscal year ended 2013  from Rs 15,000 crore in FY 2008, while operational costs have risen due to investments  to upgrade technology and in legal and compliance needs to adhere to regulatory changes
IIFL had a created a stir in the retail business in 2002 by offering customers accounts at 5 paisa per trade. Broking revenues of IIFL plunged 20% of total revenues in fiscal 2013 from 70% in fiscal 2008. The BSE Mid cap indices are still trading 40% lower from their peak in 2008.

The impact of regulatory cap on brokerages for domestic institutional investors -12 bps on cash trades and 5 bps on derivative trades – has also adversely impacted institutional equities segment.

The cash market volume during peak of the last bull run in 2008 was 27% of the market volumes, it in now just to 7% of market volumes. Most of the volumes as stated earlier have shifted to low brokerage bearing options segment.

In summary there is all round pessimism with retail investors deserting the markets and brokerages shutting down operations. However, for long term investors this is a healthy sign because when the pessimism is the highest and brokerages are in a mood to shut down operations it signals that we are nearing the end of a bear market and on the threshold of a sustained bull market.

There is all round pessimism with retail investors deserting the markets and brokerages shutting down operations… For long term investors this is a healthy sign because when pessimism is the highest and brokerages are in a mood to shut down operations it signals that we are nearing the end of a bear market and are on the threshold of a sustained bull market

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