Once upon a time, retail investors used to await IPOs eagerly. All one had to do was conduct a few rudimentary checks to filter out the absolute duds and fill the application forms for all the rest. The allotment ratios were not great but you could be certain that most of the shares you were actually allotted could be sold off at a reasonable profit. In fact, so foolproof was this strategy that sometime in the mid-nineties, I remember reading a research paper about it. The paper's author had proven that in practice, the best possible strategy was to apply for every single IPO and then sell all your allotments as soon as the stock listed. This scenario actually dates back to the eighties, when IPO prices were fixed by an arm of the Government of India called the Controller of Capital Issues (CCI). The CCI always severely underpriced issues, effectively turning the IPO application process into a lottery.
However, those days are long gone. Over the last few months, there has hardly been any IPO in which the retail investor has shown any interest at all. This has been specially true of the large power IPOs as well as all the PSU divestment issuances. This disappearance of the retail investor has generally been seen as a bad thing in some parts of the investing community and the media. In India, we have this notion that the IPO is a form of investing that is specially suited to the small, retail investor and that great effort should be made to induce such investors to apply for IPOs. This has resulted in all manner of special quotas and pricing to ensure that small retail investors buy shares in IPOs.
Information asymmetry
However, in my opinion the exact opposite is true. There is nothing about IPOs that makes them especially suited for the casual retail investor. If anything, compared to listed stocks, IPOs are actually less suitable for such investors. The reason is simple. IPOs are less known quantities. Here the balance of power (as in the power of information) lies with the seller. The companies have not been in the public eye at all. Invariably, the promoter has spent the preceding months carefully building up an image to ensure that the investing public has a positive image (unless the promoter is the Government of India, but more on that later). Unlike listed stocks, the financials haven't been scrutinised by analysts quarter after quarter for years. And of course, the price is the promoter's gambit, rather than one that has been arrived at through the price discovery cauldron of the market.
All in all, this is not the kind of situation in which the retail investor has any way of knowing whether a stock is worth buying or not. With the same money, he is far more likely to get a better deal in the secondary market if he buys an existing stock that is well-understood and has been in analysts' eyes for a long time.
Special deals don't work
The only way that IPOs can be made attractive to retail investors is by giving them some kind of a special deal in the form of a lower price. But these special deals do not work. They distort the market in some way. If they are made attractive enough, then they lead to non-retail investors masquerading as retail - which became a major scandal a few years back. If they are not made attractive enough, then the retail investor is not interested, as we are seeing now. In any case, if you look at this situation from the promoters and, in the case of FPOs, the existing shareholders' eyes, then why should any special deal be given? If there is a price at which professional investors are willing to buy a stock then, it doesn't make any economic sense for the promoter to sell it to anyone else at a lower price.
The whole situation is a mess created by this uniquely Indian cultural hang-up about IPOs being the preferred medium for the small investor to get into the stock markets. It is not. This idea is a mutated descendant of the CCI legacy and it should be laid to rest now. The truth is that IPOs and the small retail investor are especially unsuited for each other. Most sensible retail investors have already discovered this, and it's time that this became the generally recognised truth.
Flogging LIC
Which brings us to the Government of India's IPO and FPO adventures which promise to enthral and entertain the investment community over the next year. As has become clear by now, investors are simply not interested in these issues. It's possible that if one buys and holds these issues for years then some of them may turn out to be good investments. But in India's investment culture, those kinds of investors do not really exist in large numbers. We largely have punters who are focussed on flipping the stocks within days, and sometimes even hours, of listing.
The government needs money to fill its budget hole and so it's rushing into a series of hastily planned and poorly-executed issues. If the three issues that have happened so far are any indication, then most of them will succeed by virtue of being subscribed by public sector banks and LIC. As I've written earlier, this exercise has degenerated into a blatant transfer of policyholders' funds from LIC into the central government's coffers. Private and government put together, the coming year could well see the biggest amount of fresh stock to be sold to Indian investors. However, unless something drastically unexpected happens, retail investors should not pay any attention.
This article was originally published on April 27, 2010.
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